The Tax Cuts and Jobs Act, released on Nov. 2 and approved, as amended, by the Ways and Means Committee on Nov. 9, would make major changes to individual income taxation.
These include, among many others, a reduction in the number of tax brackets, an increase in the standard deduction, repeal of personal exemptions, a reduced maximum rate on business income, an increase in the child tax credit and a new family tax credit, a new limit on mortgage interest, and a dollar limit on property tax deductions.
Changes to Tax Rates and Brackets
New brackets & break points. The Act would reduce the number of tax brackets (ranging from 10% to 39.6%) from seven to four: 12%, 25%, 35%, and 39.6%. (Act Sec. 1001(a))
The 25% bracket would begin at: $90,000 for joint returns/surviving spouses, $67,500 for heads of household, half of the joint amount for any other individuals (i.e., $45,000), and $2,550 for an estate or trust. (Income under this amount would be subject to the 12% rate.) (Act. Sec. 1001(b)(1))
The 35% bracket would begin at: $260,000 for joint returns/surviving spouses, half of the joint amount for a married individual filing separately (i.e., $130,000), $200,000 for any other individuals, and $9,150 for an estate or trust. (Act Sec. 1001(b)(2))
The 39.6% bracket would begin at: $1 million for joint returns/surviving spouses, half of the joint amount for any other individual (i.e., $500,000), and $12,500 for an estate or trust. (Act Sec. 1001(b)(3))
In addition, the Act would provide for a “phaseout” of the 12% rate under which, as described in the Section-by-Section summary, the benefit of the 12% rate is phased out for taxpayers with AGI over $1 million ($1.2 million for joint filers). (Act Sec. 1001(e))
Kiddie tax. Under the Act, for unearned income of children: the 25% bracket threshold amount is the taxable income of such child for the tax year reduced by the net unearned income of the child; the 35% threshold is taxable income reduced by net unearned income plus the 35% bracket threshold for trusts and estates under Act Sec. 1001(b)(2)(D) (i.e., $9,150); and the 39.6% threshold is taxable income reduced by net unearned income plus the 39.6% threshold for trusts and estates under Act Sec. 1001(b)(3)(C) (i.e., $12,500) (Act Sec. 1001(d)) (b)(2)(D))
Illustration : As illustrated by the Joint Committee on Taxation: a child subject to these rules has $60,000 taxable income of which $50,000 is net unearned income which would otherwise be treated as ordinary income. The 25% bracket threshold amount for the tax year is $45,000 for an unmarried taxpayer, and the 35% and 39.6% brackets thresholds for a trust are $9,150 and $12,500. The 25% bracket threshold for the child would be $10,000 [i.e., $60,000 less $50,000], the 35% threshold would be $19,150, and the 39.6% threshold would be $22,500. So, the first $10,000 would be subject to a 10% tax, the following $9,150 to 25%, the following $3,350 to 35%, and the remaining $37,500 to 39.6%.
Capital gains. The Act generally retains the present-law maximum rates on net capital gain and qualified dividends, retaining the existing breakpoints between the 0%, 15%, and 20% breakpoints (except that the breakpoints would be indexed using chained CPI, as explained below). (Act Sec. 1001(b))
Inflation adjustment. The dollar amounts above, as well as other annually adjusted IRS figures, would be indexed for inflation based on chained CPI (Consumer Price Index), as opposed to CPI-U (CPI for all urban customers) under current law. (Act Sec. 1001(c)) This change was originally to go into effect beginning in 2023, but the Chairman's Mark accelerated the date to 2018.
Effective date. Except as otherwise provided, the above changes would be effective for tax years beginning after Dec. 31, 2017.
Increased Standard Deduction and Elimination of Personal Exemptions
Standard deduction increased. The Act would increase the standard deduction to $24,400 for joint returns and surviving spouses, three-quarters of the joint amount for unmarried individuals with at least one qualifying child (i.e., $18,300), and half of the joint amount in any other case (i.e., $12,200). (Act Sec. 1002(a).
According to the section-by-section summary, this increase would significantly reduce the number of taxpayers who choose to itemize their deductions.
For individuals who are claimed as dependents, the Act would limit the standard deduction to the greater of $500 or the sum of $250 and the individual's earned income. (Act Sec. 1002(a))
Personal exemptions repealed. The Act would repeal the deduction for personal exemptions (which under current law is scheduled to be $4,150 for 2018, subject to a phase out for higher earners), as well as the personal exemption phase out. (Act Sec. 1003)
Effective date. The new standard deductions and repeal of personal exemptions would go into effect for tax years beginning after Dec. 31, 2017.
New Maximum Rate on Business Income of Individuals
25% “business income” rate. The Act would provide a new maximum rate of 25% on the “business income” of individuals. (Act Sec. 1004(a)) The Act sets out a formula under which it reduces the tax that would otherwise apply to “qualified business income” in order to achieve this maximum rate.
“Qualified business income” is generally defined as the excess (if any) of (i) the sum of 100% of any net business income derived from any passive business activity plus the capital percentage of any net business income derived from any active business activity, over (ii) the sum of 100% of any net business loss derived from any passive business activity, 30% of any net business loss derived from any active business activity, plus any carryover business loss for the preceding tax year.
As explained in the section-by-section summary, owners or shareholders could elect to apply a “capital percentage” (defined as 30%) to the net business income derived from active business activities to determine their business income eligible for the 25% rate (with the remaining 70% subject to ordinary individual income tax rates), or they may elect to apply a formula based on the facts and circumstances of their business to determine an amount greater than the 30% capital percentage. The percentage may be increased for certain “capital-intensive business activities.” However, the percentage is zero for certain personal services business—e.g., law, accounting—and taxpayers actively participating in those business wouldn't be eligible for the 25% business income rate.
The section-by-section explained that special anti-abuse rule would apply to prevent the recharacterization of actual wages paid as business income.
New 25% rate for certain dividends of REITs and cooperatives. The Act would also provide that certain dividends of real estate investment trusts (REITs) and patronage dividends from cooperatives are subject to a 25% rate. (Act Sec. 1004(b) Dividends that meet certain requirements would increase net capital gain and unrecaptured section 1250 gain under Code Sec. 1(h)(11) and Code Sec. 1(h)(6), respectively (both of which set out a 25% rate).
Effective date. The above provisions would go into effect for tax years beginning after Dec. 31, 2017 (Act Sec. 1004(d), subject to a transition rule.
Enhanced Child Tax Credit and New Family Tax Credit
Increased child tax credit. The Act would increase the amount of the child tax credit under Code Sec. 24 from $1,000 to $1,600. (Act Sec. 1101(a) It would also replace the term “qualifying child” with “dependent” and eliminate the phrase “for which a the taxpayer is allowed a deduction under section 151.”
The Act would also provide a $300 credit for non-child dependents, as well as a $300 “family flexibility credit” for the taxpayer (or both spouses, for a joint return). (Act. Sec. 1101(a)) The non-child dependent credit and the family flexibility credit would be effective for tax years ending before Jan. 1, 2023.
Phase-out. The Act would also increase the income levels at which these credits phase out. Under current law, the credit is phased out beginning at income levels of $75,000 for single filers and $110,000 for joint filers. The Act would raise these amounts to $115,000 and $230,000, respectively. (Act Sec. 1103(b))
Refundable portion. Under current law, the child tax credit is partially refundable. The Act would limit the amount that is refundable to $1,000, and index this amount to inflation based on chained CPI (up to a maximum amount of the $1,600 base credit). (Act Sec. 1103(c)) A taxpayer would be required to provide a Social Security number (SSN) to claim the refundable portion of the credit. (Act Sec. 1103)
Effective date. These amendments would apply to tax years beginning after Dec. 31, 2017. (Act Sec. 1101(d))
Repeal of Certain Nonrefundable Credits
Repealed credits. The Act would repeal:
• the credit for individuals over age 65 or who have retired on disability under Code Sec. 22;
• the adoption credit under Code Sec. 23;
• the tax credit associated with mortgage credit certificates under Code Sec. 25; and
• the credit for plug-in electric drive motor vehicles under Code Sec. 30D.
Effective date. The provision repealing qualified plug-in electric drive motor vehicles would be effective for vehicles placed in service for tax years beginning after Dec. 31, 2017. The other provisions would be effective for tax years beginning after Dec. 31, 2017.
Changes to Education Incentives
Enhanced AOTC. The Act would reduce the three higher education credits under current law—the American Opportunity Tax Credit (AOTC), the Hope Scholarship Credit (HSC), and the Lifetime Learning Credit (LLC)—to one “enhanced” AOTC. The enhanced AOTC would, like the version under current law, provide a 100% tax credit for the first $2,000 of qualifying higher education expenses and a 25% credit for the next $2,000 of such expenses (for a $2,500 maximum). The HSC and LLC would be repealed.
The Act would limit the AOTC to five years of post-secondary education, with the credit for the fifth year available at half the rate as the first four years, with up to $500 being refundable.
No new Coverdell account contributions. The Act would generally prohibit new contributions to Coverdell education savings accounts after 2017. (Act Sec. 1202(a))
Section 529 Account distributions. The Act would treat up to $10,000 per year for elementary and high school expenses as “qualified expenses” under the Section 529 plan rules. (Act Sec. 1202(b))
Qualified Tuition Program (QTP) distributions for apprenticeships. The Act would add to the term “qualified education expenses” certain books and supplies required for registered apprenticeship programs. (Act Sec. 1202(d))
Treatment of discharged student loan indebtedness. Under the Act, any income resulting from the discharge of student debt on account of death or total disability of the student would be excluded from taxable income. The Act would also exclude from income repayment of a taxpayer's loans pursuant to the Indian Health Service Loan Repayment Program. (Act Sec. 1203)
Other education provisions repealed. The Act would repeal:
• The above-the line deduction for interest payments on qualified education loans for qualified higher education expenses under Code Sec. 221;
• The pre-2017 above-the-line deduction for qualified tuition and related expenses under Code Sec. 222;
• The exclusion from income of interest on U.S. savings bonds used to pay qualified higher education expenses under Code Sec. 135;
• The exclusion from gross income of qualified tuition reductions provided by educational institutions under Code Sec. 117(d); and
• Employer-provided education assistance under Code Sec. 127. (Act. Sec. 1204)
Effective date. The above provisions would generally be effective after Dec. 31, 2017.
Changes to Deductions
“Pease” limitation repealed. The Act would repeal the so-called “Pease” limitation on itemized deductions. (Act Sec. 1301)
Mortgage interest deduction retained, but with new limits. The Act would retain the home mortgage interest deduction in its current form—i.e., subject to a $1 million cap—for mortgages that already exist on Nov. 2, 2017, as well as for taxpayers who have entered into a binding written contract before that date to purchase a home. However, for newly purchased homes, the deduction will be limited to $500,000 ($250,000 for a married individual filing separately). (Act Sec. 1302)
The Act would also limit taxpayers to one qualified residence. (Act Sec. 1302(b))
State and local property tax deduction retained, but with new limits. The Act would eliminate the deduction for State and local income or sales tax (see below), but would retain the deduction for real property taxes, subject to a $10,000 maximum. (Act Sec. 1303)
Repealed deductions. The Act would repeal deductions for:
• Taxes not paid or accrued in a trade or business under Code Sec. 164(b)(5); (Act Sec. 1303)
• Personal casualty losses under Code Sec. 165 (subject to an exception for disaster losses under the recent Disaster Tax Relief and Airport and Airway Extension Act of 2017); (Act Sec. 1304)
• State and local income taxes and sales taxes; (Act. Sec. 1303)
• Tax preparation expenses under Code Sec. 212; (Act Sec. 1307)
• Alimony payments under Code Sec. 215
• Moving expenses under Code Sec. 217; (Act Sec. 1310)
• Contributions to Medical Savings Accounts (MSAs) under Code Sec. 220; existing balances could be rolled over on a tax-free basis into a Health Savings Account (HSA); (Act Sec. 1311)
• Medical expenses under Code Sec. 213; and
• Expenses attributable to the trade or business of being an employee under Code Sec. 262. (Act Sec. 1312)
The Act would also modify the limitation on wagering losses under Code Sec. 165(d) to provide that all deductions for expenses incurred in carrying out wagering transactions, and not just gambling losses, would be limited to the extent of gambling winnings. (Act Sec. 1305)
Modified rules for charitable contributions. The Act would:
• increase the 50% limitation under Code Sec. 170(b) for cash contributions to public charities and certain private foundations to 60%;
• repeal the special rule in Code Sec. 170(l) that provides a charitable deduction of 80% of the amount paid to a college or university for the right to purchase tickets for athletic events;
• adjust the charitable mileage rate under Code Sec. 170(i) for inflation; and
• repeal the exception under Code Sec. 170(f)(8) under which a taxpayer that failed to provide a contemporaneous written acknowledgement by the donee organization for contributions of $250 or more is relieved from doing so when the donee organization files a return with the required information. (Act Sec. 1306)
Effective date. Except as otherwise noted, the above provisions would be effective for tax years beginning after Dec. 31, 2017.
Changes to Exclusions and Taxable Compensation
Employer-provided housing. The Act would limit the exclusion for housing provided for the convenience of the employer and for employees of educational institutions under Code Sec. 119 to $50,000 ($25,000 for a married individual filing a joint return). The exclusion would also phase out for higher-income individuals. (Act Sec. 1401)
Additional holding period required for carried interest. The Act, as amended, would impose a 3-year holding period requirement for certain partnership interests received in connection with the performance of services to be taxed as long term capital gain rather than ordinary income. An anti-abuse rule would tax as ordinary income transfers of applicable partnership interests to certain related persons within the 3-year holding period. (Act Sec. 3314)
Gain from sale of principal residence. The Act would require that, in order to exclude gain from the sale of a principal residence under Code Sec. 121 (up to $500,000 for joint filers; $250,000 for others), a taxpayer would have to own and use as a home the residence for five out of the previous eight years (as opposed to two out of five years under current law), effective for sales and exchanges after Dec. 31, 2017. In addition, the exclusion could only be used once every five years, and it would be phased out at higher income levels. (Act Sec. 1402)
Five-year deferral of private company compensatory option and restricted stock gain. The Act, as amended, would give certain employees of nonpublic companies who receive stock options or restricted stock under widely applicable, written equity compensation plans, and later exercise those options or units, an election to defer income recognition for up to five years. The deferral election would not be available to 1% owners (within the meaning of Code Sec. 416(i)(1)(B)(ii)), CEOs, or CFOs (and their relatives), or to certain highly-compensated officers). Employers would have new withholding and reporting rules related to the deferral stock. Coordinating rules would apply to incentive stock options, employee stock purchase plans, and nonqualified deferred compensation. The deferral election would be available for stock from options exercised, or restricted stock units settled. Until regulations are issued on certain aspects of the deferral election, employers would be expected to operate under a reasonable good-faith standard. (Act Sec. 3804)
Repealed exclusions. The Act would repeal current-law exclusions for:
• Employee achievement awards under Code Sec. 74; (Act Sec. 1403)
• Dependent care assistance programs under Code Sec. 129, beginning in 2023; (Act Sec. 1404)
• Qualified moving expense reimbursements under Code Sec. 132; (Act Sec. 1405) and
• Adoption assistance programs under Code Sec. 137. (Act Sec. 1406)
Effective date. Except as otherwise noted, the above provisions would be effective for tax years beginning after Dec. 31, 2017.
Changes to Savings, Pensions and Retirement
Roth IRA recharacterization rule repealed. The Act would repeal the current-law provisions, in Code Sec. 408A, under which an individual may re-characterize a contribution to a traditional IRA as a contribution to a Roth IRA (and vice versa) and may also recharacterize a conversion of a traditional IRA to a Roth IRA. (Act Sec. 1501)
Reduction in minimum age for allowable in-service distributions. The Act would permit all defined benefit plans (Code Sec. 401(a)(36), as well as State and local government defined contribution plans (Code Sec. 457(d)(1)), to make in-service distributions beginning at age 59-1/2. (Act Sec. 1502)
Modified rules on hardship distributions. The Act would require IRS to, within one year from the date of enactment, change its regs under Code Sec. 401(k) to allow employees taking hardship distributions to continue making contributions to the plan. (Act Sec. 1503)
The Act would also let employers choose to allow hardship distributions to include account earnings and employer contributions. (Act Sec. 1504)
Extended rollover period for the rollover of plan loan offset amounts in certain cases. The Act would modify Code Sec. 402(c) to provide that employees whose plan terminates or who separate from employment while they have plan loans outstanding would have until the due date for filing their tax return for that year to contribute the loan balance to an IRA in order to avoid the loan being taxed as a distribution. (Act Sec. 1505)
Modification of nondiscrimination rules. The Act would amend Code Sec. 401 to allow expanded cross-testing between an employer's defined benefit and defined contributions for purposes of the nondiscrimination rules, effective as of the date of enactment. (Act Sec. 1506)
Effective date. Except as otherwise provided, the above provisions would be effective for tax years beginning after Dec. 31, 2017.
Estate and Generation-Skipping Transfer Taxes
Basic exclusion doubled. The Act would double the base exclusion amount—i.e., the amount of transferred property that is exempt from estate and gift tax—of $5 million (as indexed for inflation; $5.6 million for 2018) to $10 million (which will also be indexed for inflation), effective for tax years beginning after Dec. 31, 2017. (Act Sec. 1601)
Estate and GST taxes repealed after 2023. The Act would repeal the estate and GST taxes such that they do not apply to the estates of decedents dying after Dec. 31, 2023. The rule under which a beneficiary receives a stepped-up basis in inherited property would not be repealed., while still maintaining a beneficiary's stepped-up basis in estate property. (Act Sec. 1601)
Gift tax provisions. The Act would lower the gift tax to a top rate of 35% for gifts made after Dec. 31, 2023, and would provide for a basic exclusion amount of $10 million and an annual exclusion amount of $15,000 (for 2018), as indexed for inflation. (Act Sec. 1602)
Alternative Minimum Tax Repeal
AMT repeal. The Act would repeal the AMT—specifically, Code Sec. 55 through Code Sec. 59—generally effective for tax years beginning after Dec. 31, 2017. (Act Sec. 2001(a))
Treatment of carryforwards. If a taxpayer has AMT credit carryforwards, the Act would allow the taxpayer to claim a refund of 50% of the remaining credits (to the extent the credits exceed regular tax for the year) in tax years beginning in 2019, 2020, and/or 2021, with the remainder (up to 100%) claimed in the tax year beginning in 2022. (Act Sec. 2001(b))