Tax Reform Special Report

On Friday, December 15, 2017, the House and Senate conferees signed off on a consolidated tax bill resolving the two versions of the “Tax Cuts and Jobs Act of 2017”. Votes on this final bill are expected in the House and Senate this week. We have outlined the differences between current law and the conference report.

TAX CUTS AND JOBS ACT OF 2017

This table compares the predominate changes made by the “Tax Cuts and Jobs Act of 2017” to the tax law as it was during 2017 for individuals and small businesses.

2017

Tax Cuts & Jobs Act (2018)

Exemptions
$4,050 Suspended through 2025 (effectively repealed)
Standard Deductions
Single: $6,350 Head of household: $9,350 Married filing joint: $12,700 Add’l Elderly & Blind Joint & Surviving Spouse: $1,250 Others: $1,550 Single: $12,000 Head of household: $18,000 Married filing joint: $ 24,000 Add’l Elderly & Blind Joint & Surviving Spouse: $1,300 Others: $1,600
Itemized Deductions
Medical – Allowed in excess of 10% of AGI Retained for 2017 and 2018 with an AGI threshold of 7.5% regardless of age. Threshold increases to 10% after 2018. 7.5% threshold also applies for AMT purposes for ’17 and ’18.
TaxesProperty taxes, and state and local income taxes are deductible. Taxpayers can elect to deduct sales tax in lieu of state income tax. The deduction for taxes is retained but capped at $10,000 for the year. Foreign real property taxes may not be included. The Act prohibits claiming a 2017 itemized deduction on a pre-payment of income tax for 2018 or other future taxable year in order to avoid the dollar limitation applicable for taxable years beginning after 2017.
Home Mortgage InterestAllows interest on $1M of acquisition debt on primary and second home and interest on $100K of home equity debt. Allows interest on $750K of acquisition debt on primary and secondary home. Grandfathers interest on up to $1M of acquisition debt for loans prior to 12/15/2017. Repeals the deduction for home equity debt.
Charitable Contributions – Allows charitable contributions generally not exceeding 50% of a taxpayer’s AGI. Continues to allow charitable contributions and increases the 50% of AGI to 60%. Bans charitable deduction for payments made in exchange for college athletic event seating rights. Also repeals certain substantiation exceptions.
Gambling Losses Allows a deduction for gambling losses not exceeding gambling income. Continues to allow a deduction for gambling losses not to exceed the gambling income. Clarifies that “gambling losses” includes any deduction otherwise allowable in carrying on any wagering transaction.
Personal Casualty & Theft Losses – Casualty and theft losses are allowed to the extent each loss exceeds $100 and the sum of all losses for the year exceeds 10% of the taxpayer’s AGI. Suspends personal casualty losses through 2025, except for casualty losses attributable to a disaster declared by the President under Sec 401 of the Robert T Stafford Disaster Relief and Emergency Assistance Act.
Tier 2 Miscellaneous – Includes deductions for employee business expenses, tax preparation fees, investment expenses and certain casualty losses. Suspends all tier 2 (those subject to the 2% of AGI threshold) itemized deductions through 2025.
Phase-out of Itemized DeductionsItemized deductions are phased out for higher income taxpayers. The phase-out is suspended through 2025.
Above-The-Line Deductions
Teachers’ Deduction – Allowed up to $250 (indexed) for classroom supplies and professional development courses. Continues to allow this deduction.
Moving Deduction & Reimbursements – Allows a deduction for moving expenses for a job related move where the commute is 50 miles further and the individual is employed for a certain length of time. Qualified moving expense reimbursements are excluded from the employee’s gross income. Deduction is suspended through 2025 except for military change of station. Employer (other than military) reimbursement would be included as taxable wages.
Alimony – Allows the payer of alimony to claim an above-the-line deduction for qualified payments; recipient reports the income. For divorce agreements entered into after December 31, 2018 or existing agreements modified after that date that specifically include this amendment in the modification, alimony would no longer be deductible by the payer and would not be income to the recipient.
Performing Artists Expenses – An employee with an AGI of $16,000 or less who receives $200 or more from each of two or more employers in the performing arts field can deduct their performing arts expenses that exceed 10% of AGI as an above-the-line deduction. Retained – The House Bill would have repealed this deduction but the conference agreement retains it in its current form.
Government Officials’ Expenses – An official who is paid on a fee basis as an employee of a state or local government and who pays or incurs expenses with respect to that employment may claim the expenses as a deduction in calculating AGI. Retained – The House Bill would have repealed this deduction but the conference agreement retains it in its current form.
Employee Fringe Benefits
Bicycle CommutingAllows reimbursement of $20 per month as tax-free compensation Suspended through 2025
Employer Provided Housing – Allows an exclusion from income for the costs of housing provided an employee for the convenience of the employer Retained – The House Bill would have limited the excludable amount, but the conference agreement retains the exclusion in its current form.
Dependent Care Assistance – Allows an exclusion from gross income of up to $5,000 per year for employer provided dependent care assistance. Retained – The House Bill would have repealed the excludable amount, but the conference agreement retains the exclusion in its current form.
Adoption Assistance – An employee can exclude a maximum of $13,570 (2017) for qualified adoption expenses paid or reimbursed by an employer. The exclusion is phased out for higher-income taxpayers. Retained – The House Bill would have repealed the exclusion, but the conference agreement retains the exclusion in its current form.
Tax Rates
There are seven tax brackets: 10, 15, 25, 28, 33, 35 and 39.6%. There will continue to be seven tax brackets but at different rates and thresholds. The rates are: 10, 12, 22, 24, 32, 35 and 37%
Identifying Shares Sold
Under current law a taxpayer who disposes of part of his shares in a corporation that were acquired at different times or for different prices is allowed to choose which shares are considered sold if they are adequately identified. The Senate version of the bill would have required using the first-in first-out (FIFO) method of selection for which shares were sold. However, the final bill does not include that requirement.
Child Tax Credit
Allows a credit of $1,000 per qualified child under the age of 17. The credit is reduced by $50 for each $1,000 the taxpayer’s modified gross income exceeds $75K for single taxpayers, $110K for married taxpayers filing joint and $55K for married taxpayers filing separate. Taxpayers are eligible for a refundable credit equal to 15% of earned income in excess of $3,000. There is also a special refundable computation when there are 3 or more qualifying children. Retains the “under age 17” requirement and increases the child tax credit to $2,000, with up to $1,400 being refundable per qualified child. The credit phases out for taxpayers with AGI over $200,000 ($400,000 if married joint). Thresholds are not inflation-indexed. Child must have a valid Social Security Number that is issued before the due date of the return to qualify for this credit.
Non-child Dependent Credit
No such provision Allows a $500 non-refundable credit for non-child dependents. Same phaseout rule as for Child Tax Credit.
Alternative Minimum Tax (AMT)
Individuals – 2017 Exemption amounts are $84,500 for married taxpayers filing jointly, $42,250 for married filing separate, and $54,300 for single and head of household. The exemption phase-out thresholds are: $160,900 for married taxpayers filing jointly, $80,450 for married filing separate, and $120,700 for single and head of household. Retained, but the exemption amounts are increased to: $109,400 for married taxpayers filing jointly, $54,700 for married filing separate, and $70,300 for single and head of household. The exemption phase-out thresholds are increased to: $1 Million for married taxpayers filing jointly and $500K for others.
Corporate Repealed
Education Provisions
American Opportunity Credit (AOTC) –The AOTC provides a post-secondary education tax credit of up to $2,500 per year, per student for up to four years. 40% of the credit is refundable. The credit has a phase-out threshold of $160K for MFJ filers (no credit allowed for MFS) and $80K for others. Retained – The House Bill would have extended the credit to a fifth year, but the conference agreement retained the credit in its current form.
Lifetime Learning Credit (LLC) –LLC provides annual credit of up to $2,000 per family for post-secondary education. The credit has a phase-out threshold of $112K for MFJ filers (no credit allowed for MFS) and $56K for others. Retained – The House Bill would have repealed the LLC, but the conference agreement retains the credit in its current form.
Coverdell Education Accounts – An annual non-deductible contribution of up to $2,000 is permitted and with tax-free accumulation if distributions are used for grammar school and above education expenses. Retained – The House Bill would have barred any further contributions to Coverdells, but allowed a rollover to a Sec 529 plan. However, the conference agreement retains Coverdell accounts in their current form.
Sec 529 Plans – These accounts allow non-deductible contribution and provide for tax-free accumulation if distributions are used for post-secondary education expenses. Amended to allow tax-free distributions of up to $10K per year for grammar and high school education tuition and expenses.
Discharge of Student Loan Indebtedness– Excludes from income the discharge of debt where the discharge was contingent on the student working a specific period of time in certain professions and for certain employers. Modified to exclude income from the discharge of indebtedness due to death or permanent disability of the student.
Higher Education Interest – Allows an interest deduction of up to $2,500 for interest paid on post-secondary education loans. Retained – The House Bill would have repealed the higher education interest deduction, but the conference agreement retains the deduction in its current form.
Tuition Deduction – Allows an above-the-line deduction for tuition and related expenses in years before 2017. The amount of the deduction is limited by AGI and the maximum deduction for any year is $4,000. Retained – The House Bill would have repealed the tuition deduction, but the conference agreement retains the deduction in its current form. This means that the termination date of December 31, 2016 still applies, so this deduction would not be allowed for 2017 and later.
Employer Provided Education Assistance – An employer is permitted to provide tax-free employee fringe benefits up to $5,250 per year for an employee’s education. Retained – The House Bill would have repealed employer provided education assistance, but the conference agreement retains the assistance in its current form.
Exclusion of Qualified Tuition Reduction – Employees of educational institutions, their spouses and dependents may receive a nontaxable benefit of reduced tuition. Retained – The House Bill would have repealed the exclusion from income of tuition reductions, but the conference agreement retains the benefit in its current form.
Exclusion for Interest on U.S. Savings Bonds used for Higher Education Expenses – Interest earned on a qualified United States Series EE savings bond issued after 1989 is excludable from gross income to the extent the proceeds of the bond upon redemption are used to pay for higher education expenses. The exclusion is phased out for higher income taxpayers. Retained – The House Bill would have repealed the exclusion from income of U.S. savings bond interest used for higher education expenses, but the conference agreement retains the benefit in its current form.
Sec 529 – Able Account Rollovers Distributions after 2017 from 529 plans would be allowed to be rolled over to an ABLE account without penalty, provided that the ABLE account is owned by the designated beneficiary of that 529 account, or a member of the designated beneficiary’s family.
Home Sale Exclusion
Generally, where a taxpayer owns and uses a home as his principal residence for 2 out of the 5 years prior to its sale, the taxpayer can exclude up to $250,000 ($500,000 for a married couple) of profit from the sale. Both the Senate and House bills would have changed the qualifying period to 5 out of 8 years, and the House bill would have phased the exclusion out for higher income taxpayers. The conference agreement retains the current law.
Roth Conversion Recharacterizations
Permits, within certain time limits, a Traditional to Roth IRA conversion to be undone. Once a traditional IRA is converted to a Roth IRA, it cannot be undone. However, recharacterization is still permitted with respect to other contributions. For example, before a return’s due date a contribution for the year to a Roth IRA can be recharacterized as a contribution to a traditional IRA.
Estate & Gift Taxes
$5.49 Million (2017) is exempt from gift and/or estate tax. This is in addition to the annual gift tax exclusion, which for 2017 is $14,000 per gift recipient. The exclusion is increased to $10 Million adjusted for inflation since 2011, which is estimated to be approximately $11.2 Million. The annual gift tax exclusion is retained. The House Bill would have repealed the estate tax for decedents dying in 2025 or later, but the conference agreement did not include this provision.
Entertainment Expenses
A taxpayer who can establish that entertainment expenses or meals are directly related to (or associated with) the active conduct of its trade or business, generally may deduct 50% of the expense. No deduction is allowed for (1) an activity generally considered to be entertainment, amusement or recreation, (2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes, or (3) a facility or portion thereof used in connection with items (1) and (2). Also disallows a deduction for expenses associated with providing any qualified transportation fringe to the taxpayer’s employees. Employers may still deduct 50% of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel).
Tax Credits
Electric Vehicle CreditProvides a non-refundable credit of up to $7,500 for the purchase of a qualified electric vehicle. Retained – the House Bill originally repealed this credit, but the credit is retained in the conference agreement.
Adoption Credit– Provides a credit of up to $13,570 for child under the age of 18 or a person physically or mentally incapable of self care. Retained – the House Bill originally repealed this credit, but the credit is retained in the conference agreement.
Sec 1031 Exchange
There is non-recognition of gain when taxpayers trade properties of like-kind that are used for business or investment. For exchanges completed after December 31, 2017, only real property will qualify for Sec 1031 treatment.
Real Estate Recovery Periods
Currently real property has a MACRS recovery period of 39 years for commercial property and 27.5 years for residential rental property. The Senate version would have shortened the recovery period for real property. However, the conference agreement retains the 27.5 and 39-year recovery periods.
Net Operating Loss (NOL) Deduction
Generally a NOL may be carried back 2 years and any remaining balance is then carried forward until used up or a maximum of 20 years unless the taxpayer elects to forego the carryback and carry the loss forward only. The 2-year carryback provision is generally repealed after 2017 except for certain farm losses. Beginning after December 31, 2017, the NOL deduction is limited to 80% of taxable income (determined without regard to the NOL deduction) for losses arising in taxable years beginning after December 31, 2017.
Sec 179 Expensing
A taxpayer can elect to expense up to $510,000 of tangible business property, off the shelf software and certain qualified real property (generally leasehold improvements). The annual limit is reduced by $1 for every $1 over a $2,030,000 investment limit. The Sec 179 deduction for certain sport utility vehicles is capped at $25,000. For property placed in service after 2017: The annual expensing and investment threshold limits are increased to $1,000,000 and $2,500,000, respectively, with both subject to inflation indexing. SUV cap to be inflation-adjusted. Definition of Sec 179 property expanded to include certain depreciable tangible personal property – e.g., beds and other furniture, refrigerators, ranges, and other equipment used in the living quarters of a lodging facility such as an apartment house, dormitory, or any other facility (or part of a facility) used predominantly to furnish lodging or in connection with furnishing lodging. Expands the definition of qualified real property eligible for Sec 179 expensing to include any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
Unlimited Expensing
For 2017 current law allows 50% of the cost of eligible new property to be deducted with the balance of the cost depreciable. This is commonly termed “bonus” depreciation. The bonus rate is scheduled to decline to 40% for 2018, 30% for 2019 and 0% thereafter. Allows 100% unlimited expensing of tangible business assets (except structures) acquired after September 27, 2017 and through 2022. Applies when a taxpayer first uses the asset (does not need to be new).
“Luxury Auto” Depreciation Limit
Annual limits apply to passenger autos used for business on which depreciation is claimed. For vehicles placed in service in 2017 the limits are $3,160, $5,100, $3,050 and $1,875, respectively, for years 1, 2, 3, and 4 and later. If bonus depreciation is claimed, the first-year limitation is increased by an additional $8,000. For passenger autos placed in service after 2017 the maximum amount of allowable depreciation is increased to the following amounts if bonus depreciation is not claimed: $10,000 for the placed-in-service year, $16,000 for the 2nd year, $9,600 for the 3rd year, and $5,760 for the 4th and later years. Amounts will be indexed for inflation after 2018.
Listed Property
To claim a business deduction for certain types of property, referred to as listed property, enhanced substantiation requirements must be followed and deductions are only allowed if business use of the property is more than 50%. Computers have been included in this category. Computers and peripheral equipment placed in service after 2017 have been removed from the definition of listed property.
Deduction For Pass-Through Income
No such provision. Taxpayers with pass-through income will be able to deduct 20% of domestic qualified business income from a partnership, S corporation, or sole proprietorship. However, the deduction ratably phases out for joint filer income between $315,000 and $415,000 (between $157,500 and $207,500 for others). This provision provides an alternate limitation based on wages and capital. The limitation is the greater of 50% of the wages paid or 25% of the wages paid plus 2.5% of the unadjusted basis of the business’ capital assets. The deduction applies only to compute income tax, i.e., reduces taxable income but not adjusted gross income. Does not reduce income subject to SE tax.
Excess Business Losses For Individuals
Losses, other than passive losses, were allowed, and if a net loss was the result, a NOL deduction was created and carried back 2 years and then forward 20 years until used up. A taxpayer other than a C corporation would not be allowed an “excess business loss.” Instead, the loss would be carried forward and treated as part of the taxpayer’s net operating loss (NOL) carryforward in subsequent taxable years. Excess business loss for a taxable year is defined in the Act as the excess of the taxpayer’s aggregate deductions attributable to the taxpayer’s trades or businesses for that year, over the sum of the taxpayer’s aggregate gross income or gain for the year plus a “threshold amount” of $500,000 for married individuals filing jointly, or $250,000 for other individuals. The provision will apply after taking into account the passive activity loss rules.
Domestic Production Deduction (Sec 199)
Sec 199 provides a deduction from taxable income (AGI in the case of an individual), equal to 9% of the lesser of the taxpayer’s qualified domestic production activities income or taxable income (determined without regard to the section 199 deduction) for the taxable year. The deduction is further limited to 50% of the W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts for the year. Repealed, effective 2018
ACA Individual Insurance Mandate
Anyone who does not meet one of the limited exemptions must have health insurance or pay a penalty. In the tax code this is referred to as the “shared responsibility payment.” The penalty is the greater of an inflation adjusted flat dollar amount or 2.5% of the taxpayer’s household income. For 2018 the flat dollar amount is $695 per adult and $347.50 per child but not more than $2,085 per family. Repealed, effective 2019.

Year-End Tax Planning To Take Advantage Of Possible Tax Reform

With the prospect of major tax reform on the horizon, some strategies can be employed before the end of the year that can substantially reduce your 2017 tax bill.

Itemized deductions under current law include 5 major categories: medical, taxes, interest, charitable gifts and miscellaneous deductions. Under the proposed tax reform, these deductions would be limited or eliminated. If that is the case, then taxpayers who itemize in 2017 should take the following actions before the year’s end to maximize their 2017 deductions:

  1. Medical – The House version of tax reform does away with medical deductions beginning in 2018 while the Senate version retains them. So to be on the safe side you may want to consider paying all outstanding medical bills, but keep in mind that the total amount of unreimbursed medical expenses is only deductible to the extent that it exceeds 10% of your adjusted gross income (AGI). Some anticipated medical expenses can be prepaid. An example would be a dental bill, if you have a child receiving orthodontic treatment for braces and you are on an installment payment plan. You can pay off the bill and increase your medical deductions for 2017, and the dentist might even give you a discount for paying early. But if you can’t reach the 10% of AGI threshold, don’t make a special effort to pay any outstanding medical bills.
  2. Property Tax – The Senate version of tax reform eliminates all property tax itemized deductions beginning in 2018, while the House versions retains a limited deduction. If the property taxes on your home, second home or vacant property are being paid in installments with an installment due in 2018, it may be appropriate pay that balance in 2017 to increase your tax deductions for this year.
  3. State Income Tax – Both the House and the Senate versions of tax reform eliminate the deduction for state and locale income taxes beginning in 2018. If you reside in a state that has a state income tax, estimate your 2017 state tax liability and make sure your full liability is paid before the year’s end. You can ask your employer to boost the amount of your state withholding by a reasonable amount, or if you are self-employed, pay your 4th-quarter estimate due in January in December and increase your deduction.
    A word of caution: taxes are not deductible for alternative minimum tax (AMT) purposes. The tax-maximizing strategy could trigger the alternative minimum tax (AMT).
  4. Miscellaneous Deductions – This deduction category includes unreimbursed employee business expenses, investment expenses, certain legal fees, casualty losses, gambling losses and others. Generally, few of these expenses would support payments other than when they occur, and this category is only deductible to the extent that the deductions exceed 2% of your AGI.

Even though the strategy of prepaying tax-deductible expenses this year may yield tax savings, be thoughtful about borrowing money to execute this strategy. Interest on borrowed money can dampen the tax benefits.

Three Other Strategies
If you are an investor, a popular year-end strategy is to review your stock portfolio and sell off losers to offset your gains. Also remember: you are allowed to deduct a loss of up to $3,000 ($1,500 for married filing separate taxpayers) from the sale of investments. However, your investment strategies should take precedent over selling stocks to develop a loss.

Make the most of post-secondary education tax credits. Both the Lifetime Learning Credit and the American Opportunity Credit allow qualified taxpayers to prepay tuition bills in 2017 for an academic period that begins by the end of March 2018. This means that if you are eligible to take the credit and you have not yet reached the 2017 maximum for qualified tuition and related expenses paid, you can bump up your credit by paying the tuition for early 2018 before the end of 2017. This strategy may not apply to you if you’ve been paying tuition expenses for the entire 2017 tax year, but if your student just started college this fall, it will probably provide you with some additional help.

If you own a business and are considering purchasing equipment before the end of the year, take note that most equipment purchased by a small business can be expensed and will provide a substantial tax deduction. Keep in mind that just purchasing the equipment will not give you a tax deduction. You also must place the equipment in service before the end of the year, so you need to plan ahead and not wait until the last minute.

If you would like to make an appointment to develop a year-end tax strategy, please give us a call.

Year-end moves to make in light of tax reform legislation

Dear Client:

Congress appears poised to enact a major tax reform law that could potentially make fundamental changes in the way you and your family calculate your federal income tax bill, and the amount of federal tax you will pay. This letter is designed to help you cope with the changes Congress is hammering into shape right now-to take advantage of tax breaks that may be heading your way, and to soften the impact of any crackdowns. Keep in mind, however, that while most experts expect a major tax law to be enacted this year, it’s by no means a sure bet. So keep a close eye on the news and don’t swing into action until the ink is dry on the President’s signature of the tax reform bill.

Lower tax rates coming. Both the tax bill passed the House of Representatives and the one before the Senate would reduce tax rates for many taxpayers, effective for the 2018 tax year. Additionally, businesses may see their tax bills cut, although the final form of the relief isn’t clear right now.

The general plan of action to take advantage of lower tax rates next year would be to defer income into next year. Some possibilities follow:

  • If you are an employee who believes a bonus is coming your way before year end, consider asking your employer to delay payment of the bonus until next year.
  • If you are thinking of converting a regular IRA to a Roth IRA, postpone your move until next year. That way you’ll defer income from the conversion until next year and hopefully have it taxed at lower rates.
  • If you run a business that renders services and operates on the cash basis, the income you earn isn’t taxed until your clients or patients pay. So if you hold off on billings until next year-or until so late in the year that no payment can be received this year-you will succeed in deferring income until next year.
  • If your business is on the accrual basis, deferral of income till next year is difficult but not impossible. For example, you might, with due regard to business considerations, be able to postpone completion of a job until 2018, or defer deliveries of merchandise until next year. Taking one or more of these steps would postpone your right to payment, and the income from the job or the merchandise, until next year. Keep in mind that the rules in this area are complex and may require a tax professional’s input.
  • The reduction or cancellation of debt generally results in taxable income to the debtor. So if you are planning to make a deal with creditors involving debt reduction, consider postponing action until January to defer any debt cancellation income into 2018.

Disappearing deductions, larger standard deduction. Beginning next year, both the House-passed tax reform bill and the version before the Senate would repeal or reduce many popular tax deductions in exchange for a larger standard deduction. Here’s what you can do about this right now:

  • The House-passed tax reform bill would eliminate the deduction for nonbusiness state and local income or sales tax, but would allow an up-to-$10,000 deduction for real estate taxes on your home. The bill before the Senate would ban all nonbusiness deductions for state and local income, sales tax, and real estate tax. If you are an employee who expects to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding on those taxes. That way, additional amounts of state and local taxes withheld before the end of the year will be deductible in 2017. Similarly, pay the last installment of estimated state and local taxes for 2017 by Dec. 31 rather than on the 2018 due date, or prepay real estate taxes on your home.
  • Neither the House-passed bill nor the bill before the Senate would repeal the itemized deduction for charitable contributions. But because most other itemized deductions would be eliminated in exchange for a larger standard deduction (e.g., in both bills, $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for many. If you think you will fall in this category, consider accelerating some charitable giving into 2017.
  • The House-passed bill, but not the one before the Senate, would eliminate the itemized deduction for medical expenses. If this deduction is indeed chopped in the final tax bill, and you are able to claim medical expenses as an itemized deduction this year, consider accelerating “discretionary” medical expenses into this year. For example, order and pay for new glasses, arrange to take care of needed dental work, or install a stair lift for a disabled person before the end of the year.

Other year-end strategies. Here are some other “last minute” moves that could wind up saving tax dollars in the event tax reform is passed:

  • The exercise of an incentive stock option (ISO) can result in AMT complications. But both the Senate and House versions of the tax reform bill call for the AMT to be repealed next year. So if you hold any ISOs, it may be wise to hold off exercising them until next year.
  • If you’ve got your eye on a plug-in electric vehicle, buying one before year-end could yield you an up-to-$7,500 discount in the form of a tax credit. The House-passed bill, but not the one before the Senate, would eliminate this credit after 2017.
  • If you’re in the process of selling your principal residence and you wrap up the sale before year end, up to $250,000 of your profit ($500,000 for certain joint filers) will be tax-free if you owned and used the property as your main home for at least two of the five years before the sale. However, under the House-passed bill and the bill before the Senate, the $250,000/$500,000 tax free amounts would apply to post-2017 sales only if you own and use the property as your main home for five out of the previous eight years.
  • Under current rules, alimony payments generally are an above-the line deduction for the payor and included in the income of the payee. Under the House-passed tax bill but not the version before the Senate, alimony payments would not be deductible by the payor or includible in the income of the payee, generally effective for any divorce decree or separation agreement executed after 2017. So if you’re in the middle of a divorce or separation agreement, and you’ll wind up on the paying end, it would be worth your while to wrap things up before year end if the House-passed bill carries the day. On the other hand, if you’ll wind up on the receiving end, it would be worth your while to wrap things up next year.
  • Both the House-passed bill and the version before the Senate would repeal the deduction for moving expenses after 2017 (except for certain members of the Armed Forces), so if you’re about to embark on a job-related move, try to incur your deductible moving expenses before year-end.

Please keep in mind that we’ve described only some of the year-end moves that should be considered in light of the tax reform package currently before Congress—which, it bears emphasizing, may or may not actually become law. If you would like more details about any aspect of how the proposed legislation may affect you, please call us.

Very truly yours,

Tarlow & Co., CPA, PC

 

Converted Your Traditional IRA to a Roth IRA? Worried You May Have Done It Too Soon if Tax Reform Passes?

When you convert a traditional IRA to a Roth IRA, you have to pay the tax on the conversion. However, individuals frequently do this so they can take advantage of future tax-free accumulations. Distributions from Roth IRAs are generally tax free, including any earnings (accumulations) while the account is a Roth account.

Are you considering converting your traditional IRA to a Roth IRA in 2017? Are you hesitant to do so because of uncertainty about the timing and specifics of the Administration’s and Congress’ proposal to cut tax rates for individuals? Have no fear, because you can convert your traditional IRA to a Roth IRA this year, and if tax reform passes with lower tax rates effective next year, you can undo the conversion for 2017 and then re-convert for 2018.

Tax law allows individuals who convert in one year to undo that conversion by a procedure referred to as recharacterization. The procedure has been used for years, primarily by individuals whose IRA funds are invested in stocks and who converted from their traditional IRA funds to a Roth IRA only to see the value of their Roth IRA decline after the conversion due to stock market fluctuations. Recharacterizations are also used by individuals who converted their traditional IRA to a Roth IRA and then found they could not or did not want to pay the conversion tax.

This same process can be used by anyone for any purpose. So, for example, if you converted your regular IRA to a Roth IRA in 2017 and tax reform is enacted effective in 2018, you can recharacterize (undo) your 2017 conversion back to a traditional IRA. However, the recharacterization must be accomplished by the extended due date of your 2017 tax return, which is October 15, 2018. If you choose to, you then can then reconvert the traditional IRA to a Roth IRA in 2018 and take advantage of the new lower tax rates.

Generally, you must wait at least 30 days to make the reconversion. However, if you make the recharacterization of the Roth IRA back to your a traditional IRA in 2017, you may not reconvert that amount from the traditional IRA to a Roth IRA before the beginning of 2018 or, if it is later, the end of the 30-day period beginning on the day on which you transferred the amount from the Roth IRA back to a traditional IRA by means of a recharacterization.

Example: For years, Jack has been making deductible traditional IRA contributions. Then, during the summer of 2017, Jack decided to convert $25,000 of those traditional IRA funds into a Roth IRA. After the conversion is completed, late in 2017, Congress passes and the president signs a tax reform bill that reduces Jack’s marginal tax rate in 2018. To take advantage of the lower tax rate, Jack recharacterizes (undoes) the conversion back to a traditional IRA for 2017 and then reconverts it back to a Roth IRA in 2018. To do that, Jack first transfers the $25,000 (plus earnings or minus losses since the original conversion) back to a traditional IRA by way of a trustee-to-trustee transfer (it’s OK for the transfer to be with the same financial institution). He could make the recharacterization as late as October 15, 2018, but chooses to do so on January 15, 2018. Then, after making the transfer back to the traditional IRA, Jack reconverts the amount back to a Roth IRA on Feb. 20, 2018.

For more information on recharacterizations and conversions, and how they might fit into your tax planning, please give us a call.

Following Congress on its Path to Tax Reform

As Congress begins debating tax reform, you might be interested in an overview of the GOP’s proposed changes so you’ll have an understanding of what the proposals actually entail as you follow the debate and won’t have to rely on politically motivated analysis by the various media sources. It is important to understand that the GOP’s tax reform proposal is actually only an overall framework of the tax legislation that will be formulated later by congressional committees. So it only provides the “big picture,” with details to be added later. However, the devil is always in the details, and you frequently have to read between the lines and listen to and read comments by Washington insiders to glean additional detail. Based upon that, the following are the provisions of the proposed tax reform that will apply to individual taxpayers and small businesses.

Filing Status
Current Law: The current law includes five filing statuses: single (unmarried), married taxpayers filing jointly (MFJ), head of household, married filing separately (MFS) and surviving spouse. The head of household (HH) status is for single individuals and some married but separated individuals who are maintaining a home for a dependent. MFS is a filing status that applies to a married individual who is not filing a joint return with their spouse (it keeps married individuals from filing as single and abusing the intent of the tax laws). Surviving spouse is a status that allows a widow or widower with a dependent child to continue to use the joint tax rates for 2 years after the year of death of their spouse.

Proposed Law: It appears that the proposal would retain only the single and married taxpayers filing jointly statuses in an effort to simplify the tax law. If this is the actual intent, it would greatly streamline the tax code, which is littered with special treatment for HH and MFS taxpayers. Potential losers under this proposal are HH filers, who currently enjoy a standard deduction that is higher than that of a single filer as well as lower tax rates.

Personal Exemptions
Current Law: A deduction from adjusted gross income (AGI), called an exemption allowance, is permitted for the filer of the return, his or her spouse if filing jointly, and each dependent claimed on the return. For 2017, each exemption allowance is $4,050. So, for example, a married couple filing jointly with two dependent children would be entitled to an exemption allowance of $16,200. However, the exemption deduction phases out for higher-income taxpayers.

Proposed Law: Personal exemptions would be eliminated, but child and other dependent credits might take their place, as described later in this article.

Standard Deduction
Current Law: The standard deduction is for taxpayers without enough deductions to file a Schedule A and itemize their deductions. Currently a standard deduction is set for each filing status and is adjusted for inflation each year. For 2017, the standard deduction is $6,350 for single and married separate, $9,350 for head of household, and $12,700 for married joint and surviving spouse. There are also add-on amounts for each filer and spouse who is age 65 or over, plus an additional amount for blindness.

Proposed Law: The GOP’s framework would replace both the current standard deduction and the personal exemptions with new higher standard deductions. In addition, the proposal would do away with the additional standard deductions for the seniors and people with visual impairments.

When the proposed higher standard deductions were first announced some months ago, those using the standard deduction were excited to think their standard deductions would be roughly doubled. But now that we have a few more details, we find that personal exemptions would no longer be allowed, which changes the outcome significantly. The table below compares the current standard deduction and exemptions for different filing statuses and number of exemptions to the proposed standard deduction replacement.

As you can see, the proposed change favors the smaller family size, but this is supposed to be compensated for with a larger and partially refundable child tax credit that is discussed below.

Itemized Deductions
Current Law: Medical deductions are allowed to the extent that they exceed 10% of the taxpayer’s AGI, tax deductions for state and local (city) income taxes or sales tax, plus real and personal property taxes. Also included is interest paid on qualified first and second home mortgage acquisition and equity debt, provided the acquisition debt doesn’t exceed $1 million and the equity debt isn’t over $100,000. The debt amounts of the first and second homes are combined for this limitation. Other categories of itemized deduction are charitable contributions and miscellaneous itemized deductions.

Proposed Changes: The tax reform would eliminate all deductions except for charitable contributions and those that encourage home ownership, such as home mortgage interest.

There is already pushback from members of Congress whose constituents reside in states that impose an income tax on their residents. Taking away the ability to deduct state and local income tax, referred to as the SALT deduction, would most significantly impact taxpayers living in states that have income taxes, and thus they would be double-taxed on the same income. All but seven states have income tax, with California, New York and New Jersey imposing the highest rates.

Eliminating medical deductions will significantly impact senior citizens who require expensive elder care and taxpayers who incur extraordinary medical expenses.

Casualty, theft and disaster losses are currently included in itemized deductions, and the proposal is silent as to what will become of these all-important deductions. Also unaccounted for is the deduction for gambling losses, the elimination of which will force recreational gamblers to pay tax on all winnings even if they have a net loss.

Individual Tax Rates:
Current Law: There are seven tax rates (10%, 15%, 25%, 28%, 33%, 35% and 39.6%), with the tax progressively increasing as the taxpayer’s taxable income increases. Each tax rate is applied to ever-increasing ranges of taxable income, referred to as tax brackets, with the 2017 top brackets kicking in at $418,400 for single taxpayers and $470,700 for married taxpayers filing jointly.

Proposed Changes: The tax reform would reduce the number of tax rates to three: 12%, 25% and 35%, with possibly a fourth rate for the “highest-income” taxpayers. The proposal is silent as to the ranges of taxable income these rates will apply to, making it impossible to make comparisons between the current law and the proposed changes. However, should the three rates be made into law, the wealthiest taxpayers would enjoy a significant tax cut.

Child Tax Credit (CTC)
Current Law:  Allows a tax credit of $1,000 for each qualifying child dependent under the age of 17. The credit is generally nonrefundable (meaning it can only offset your tax liability and any excess is lost). However, when a taxpayer’s income is low or there are three or more qualifying children, a portion of the credit is refundable. The credit is also phased out for higher-income taxpayers.

Proposed Changes: The reform would increase the amount of the credit by an unspecified amount and make the first $1,000 of the CTC refundable. It would also add a nonrefundable credit of $500 for other dependents of the taxpayer that do not meet the child criteria. This presumably eliminates the current complicated calculation for the refundable portion of the child tax credit. The proposal intends that the income phaseout ranges be adjusted so more taxpayers will be eligible for the credit, but the higher phaseout levels are not specified. These adjustments to the CTC are touted to make up for the loss of personal exemptions, but without knowing the amount of the credit increase and the high-income phaseout ranges, it is impossible to make comparisons between the current and proposed regimes.

Alternative Minimum Tax (AMT)
Current Law: The AMT was originally initiated to keep higher-income taxpayers from benefiting from certain tax provisions. Over the years, inflation has caused the AMT to significantly impact more taxpayers than originally intended. Determining whether the AMT applies and computing the tax adds a layer of complexity to preparing the return.

Proposed Changes: The reform would eliminate the AMT.

Estate Tax
Current Law: The current code imposes a 40% tax on the estate of a decedent whose estate’s value exceeds $5.49 million. The $5.49 million is adjusted down for certain gifts made during the decedent’s lifetime. Beneficiaries of estates receive inheritances at the fair market value of the property inherited as of the decedent’s date of death. Thus beneficiaries who inherit property and then sell it are subject to tax only on the appreciation from the time they inherited the property.

Proposed Changes: The reform would eliminate the estate tax. Unanswered in the proposal is whether a beneficiary will continue to receive inherited property at fair market value or whether the heir will inherit the decedent’s basis in the property. If the latter, then when the beneficiary sells the property the beneficiary will be stuck with paying income tax on the entire appreciation in value from the time the property was acquired by the decedent. Also unanswered is whether the gift tax will continue to apply.

Top Tax Rate for Small Businesses
Current Law: At present, business income from a Schedule C, LLC, Partnership and S-Corporation is passed through to the owner of the business and included on his or her 1040 individual return and taxed at rates ranging rom 10% to 39.6%.

Proposed Changes: As mentioned previously, the proposed changes would reduce the current seven tax rates to three. For pass-through businesses, the proposed changes limit the tax on pass-through small business income to 25%, the middle rate of the three new proposed rates. Unfortunately, the term “small business” is not defined in the proposal. This proposed change would favor successful businesses that would otherwise be subject to the highest proposed tax rates.

Expensing Business Purchases
Current Law: Generally, capital purchases by a business, such as machinery, vehicles, or computer systems, must be depreciated (written off) over their useful lives—usually 3, 5 or 7 years for most purchases by small businesses. A special allowance, usually referred to as bonus depreciation, is available in the first year for certain types of property. There is also a provision that allows expensing up to $510,000 worth of purchases in lieu of depreciating the cost of the property.

Proposed Changes: The reform would allow 100% first-year expensing of capital purchases (other than structures) after September 27, 2017. The full expensing provision would not be permanent, but would be in the tax code for a minimum of five years. A future Congress could decide to extend the provision or make it permanent.

Other issues: Other issues generally not impacting small businesses or individuals include reducing the corporate tax rate to 20% – which is below the 22.5% average of the industrialized world – with the intent to make U.S. businesses more competitive with their foreign rivals. The corporate alternative minimum tax would also be eliminated. The proposed changes would also repeal the domestic production activities deduction and most business tax credits, except the low-income housing and the research and development credits.

The current consensus is that the changes, other than the business expensing, would not be effective until 2018. We hope this provides you with insight into the GOP’s proposed tax reform. But keep in mind that these proposals could, and probably will, change as the proposal works its way through Congress.