Peak Alert: GOP Tax Bill
Dear Valued Clients,
After months of politicking, lobbying, hyperbole, press conferences, and general chaos in Washington, it appears that the GOP tax bill has been finalized. Unless there is some last minute intrigue, the bill should be signed into law by President Trump before Christmas. We are compelled to highlight several key components of the proposed legislation with the caveat that the ink on the 429 pages is not yet dry.
Lower Tax Rates
First, while there are still seven tax brackets (what happened to that postcard?), on the whole, the rates will be lower. Today, the seven brackets are as follows: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. In 2018, the rates will shape up this way: 10%, 12%, 22%, 24%, 32%, 35%, 37%. All things being equal, the new brackets will tend to bend the tax burden down in the near term (although the new complicated calculation used to determine the value of deductions and credits will be disadvantageous). Also, the standard deduction is being increased substantially from $6,350 for individuals to $12,000 and from $12,700 to $24,000 for married couples filing jointly and the child tax credit is being doubled to $2,000. The child tax credit is available to parents for children under 17 and the income threshold to claim the credit is being increased substantially from $75,000 to $200,000 for individuals and $110,000 to $400,000 for married couples. The Alternative Minimum Tax, a shadow tax computation that results in higher taxes for certain individuals and families, is also being softened. When you add it all up, one concept seems pretty certain: if you are a lower or middle class individual or married couple with young children, your federal taxes should go down, in some instances substantially.
529 Plan Expansion
The tax reform bill expands allowable expenses for 529 plans. Previously, 529 plans could only be used to cover qualified college education costs, but the new law dictates that 529 plans will be able to pay for private and public elementary and secondary school expenses up to $10,000 per student each year. Additionally, the new reform also covers homeschooling expenses, again up to $10,000 per student.
Temporary Increase in Deductible Medical Expenses
Many of our clients have benefitted from deducting medical expenses in excess of 10% of their adjusted gross income. The final tax bill reduces the threshold down to 7.5% for 2018 and retroactively for 2017. Unfortunately, this provision sunsets after the 2018 tax year and will revert to 10% beginning in 2019.
Doubling of Federal Estate and Gift Tax Exemption
Regarding estate and gift taxes, this new legislation does not eliminate them as was called for in earlier iterations of the bill; however, it does double the federal estate and gift tax exemption amounts to $11.2 million for individuals and $22.4 million for couples. While this change essentially removes any estate taxes for all but the ultra-wealthy, please remember that state level estate taxes remain in place. For example, in Massachusetts, estates over $1 million are subject to a state estate tax. As such, there may be a migration to states such as Florida, Texas, New Hampshire, and Alaska (o.k., maybe not Alaska) which do not impose an estate tax.
Kiddie Tax Changes
Many of you have established custodial accounts for your children under a Uniform Transfer to Minors Act (UTMA) or a Uniform Gift to Minors Act (UGMA). Of course, the new bill makes significant changes to the taxability of these accounts (also known as the “Kiddie Tax”). Currently, $2,100 of investment income from these accounts is not taxed for children and any portfolio income above this amount is added to their parents’ return to be taxed at their marginal bracket. The new bill scraps this existing system entirely and replaces it with more punitive tax brackets that are generally applied to trusts. In some cases, this new system may be more favorable for smaller UTMAs that do not generate high unearned income.
Possible Robust Growth of the U.S. Economy
Other provisions of the tax bill are predicted to increase hiring and economic activity which could spur economic growth. Business taxes are going to be reduced. From the largest companies in the world to the sole proprietor, the tax burden will be lessened, leaving greater capital available for investments in workers, building, equipment, and infrastructure. Also, a provision that will make it more attractive for U.S. multi-national companies to repatriate profits could also result in an increase in domestic corporate spending. Some economists have predicted that the business tax provisions could increase gross domestic product back to the heady levels 4-5%, which will result in higher tax collections and a reduction in the national debt and deficit. Others believe this notion is greatly exaggerated, especially in light of the total increase to the deficit over the next ten years, which is expected to top $1.5 trillion. Economics 101 says that higher tax collections can result in deficit reduction if overall government spending is reduced but one strains to remember the last time that happened.
The Bad and the Ugly News (For Some)…
As constructed, the legislation would seem to be detrimental tax wise to high earning homeowners in states and localities that levy income and/or property taxes on their residents. This means that many affluent folks, in states like Massachusetts, New York, Connecticut, New Jersey, and California which collect state income taxes, generally will see an increase in federal income taxes. The primary reason for the increased tax burden is a significant alteration in the permitted federal deduction for state and local income taxes and property taxes. The combined deduction for these items is now capped at $10,000 for both individuals and married couples. In addition, personal exemptions (in 2017 this amounts to $4,050 each for you, your spouse, and dependents), which generally serve to reduce income subject to tax, is being eliminated. Finally, to add insult to injury, the new tax reform bill repeals most miscellaneous deductions. Unfortunately for many itemizers, that means that all deductible expenses that were subject to the 2% adjusted gross income floor, such as tax preparation expenses, unreimbursed employee business expenses (including the home office deduction), safety deposit box fees, and investment advisory fees are completely eliminated.
In addition to the cap on property tax deductions, the advantages to homeownership may also be further diminished. Under the former rules, mortgage interest on loans of up to $1,000,000 was tax deductible. The new plan caps the loan amount at $750,000 for loans acquired after 2017 (so far, it appears vacation home mortgage interest will remain deductible again subject to the $750,000 cap). In addition, interest on home equity loans today is deductible up to a $100,000 loan amount. In the new scheme, there will no longer be a deduction on home equity loans secured after 2017.
There may be a silver lining for home shoppers in the high tax states. It has been speculated that because the tax advantages of owning a home will be diminished, values (and hence asking prices) for homes could be reduced anywhere from 1-10% to account for the loss of after tax home buying power. Also, some believe that home prices and general economic activity in high tax states could contract as companies look to move to lower tax states as a way to increase their own profits and lessen the tax burden for future employees. Indeed, the same can be said for individuals essentially burdened by a higher cost of living. Put another way, there could be an influx of tax refugees into states such as Texas, Florida, and New Hampshire, among others, that do not impose an income tax.
- Tax deductions for casualty losses are now limited to federal disaster areas
- Refinements to 529A ABLE accounts designed for disabled beneficiaries
- The tax credit for plug in electric vehicles is retained
- The $250 schoolteacher deduction is maintained
- The “Obamacare” individual mandate for health insurance is repealed (but not until 2019)
- Moving expense deductions and exclusions are eliminated
- Higher depreciation for business vehicles
- 1031 exchanges will be limited to real estate
- New limitation on deduction of business entertainment expenses
Potential Year End Steps You Can Take
Because of the black box nature of some of the provisions, it is hard to make specific suggestions on year-end tax moves that might benefit you, but we will make an attempt. First, if you are charitable (thank you by the way) and you itemize your taxes, you might consider pulling next year’s donations into this year. Next year, the charitable deduction could have less of an impact. Also, if you pay estimated state income taxes, you might also pull your normal January 15 payment (for 4th quarter 2017) into this year. If you are thinking that you might just pay a large estimated state tax payment for all of 2018, be advised that this is not allowed: only the traditional fourth quarter payment is allowed. However, this is not the case for property taxes. The current reading of the bill does not prohibit prepayments of 2018 real estate taxes so, for many itemizers, it might make sense to make a large real estate tax payment before New Year’s day. Finally, because overall tax rates are going to be lower, you might want to push income such as bonuses into next year if you can (but of course other aspects of the tax bill may make this a detrimental action).
Look to the Future and Take Action Where Prudent
As you prepare your 2017 taxes next year, try to anticipate how your taxes in 2018 (and beyond) will be impacted. If you believe you are going to be subject to higher taxes, change your federal withholding as needed and prepare mentally for a potentially larger outlay in 2019 for your 2018 taxes. If you own a business, you may want to consider changing its legal structure to take advantage of new deductions for certain business entities. If you are looking to buy a home, think about how lower deductions for real estate related expense such as mortgage interest and property taxes may impact the actual cost of homeownership. Depending on your specific situation, it may be advisable to have investment advisory fees attributable to your individual retirement accounts deducted from those very same accounts beginning in 2018, as this is considered a tax free distribution (which is advantageous). In all cases, as we meet and speak with you next year, we can discuss which strategies may be right for you.
A Final Word
Frankly, we at Peak are disappointed that the tax bill mosh pit of the last several months has not allowed tax paying citizens to make prudent financial decisions in a timely manner based on the new paradigm. Also, the bill is illustrative of the nature of federal legislators to kick the can down the road, as many important aspects of the new law are schedule to sunset in 2025. It is clear that our leaders do not represent us well when they make complex legislative and economic decisions in a haphazard manner. Who doesn’t want economic growth and great opportunity for the people? We just don’t know if the new tax legislation is that mechanism, but by nature we are optimists. In time, we will have our answer, and as always, we hope for the best.
As the specific language of the tax bill is studied by experts over the coming weeks and months, new tax planning strategies will emerge. We will stay apprised of these developments and follow up as needed to assist you with your financial planning. As always, if you have any questions or need more information, we are at your service. Enjoy the holiday season!