Tax Reform – 20 Sound Bites To Fill the Air Over the Holidays

Like a good tax nerd I spent a beautiful Saturday reviewing the US House Tax Cuts and Jobs Act H.R. 1 Section-by-Section Summary.  For your impending confrontation with Drunk Uncle (or Aunt) over the holiday season, the following is what I've been able to distill down to sound bites.

  1. The 'Simple Post Card' income tax form that our beloved leader kissed on television is a prop, the number of schedules supporting that 'Simple Post Card' is going to inevitably be YUGE.
  2. The reduction in the number of tax brackets from 7 to 4 is good.
  3. The increase in the standard deduction can be good.
  4. The repeal of personal exemptions is not so good and should be reversed.
  5. The reduced maximum rate on business income is good for corporations.
  6. The increase in the child tax credit and a new family tax credit is good for families.
  7. The repeal of the credits for the elderly is proof positive that our beloved leaders do not care about old people.
  8. The repeal of the credits for adoption expenses is proof positive that our Republicans in the House do not care about children in need and prospectively adoptive parents.
  9. The changes to education incentives is proof positive our beloved leaders want to keep the masses illiterate.
  10. New limit on mortgage interest will only slow urban sprawl that blights mother nature with Mc-Mansions.
  11. Personal casualty loss repeal is further proof that our beloved leaders are out of touch.
  12. State income and sales tax repeal is overtly targeting the higher tax more liberal states on the coasts.
  13. Medical expense repeal is still more well deserved fodder for hating Republicans in the House.
  14. Moving expense repeal specifically targets those that move regularly including military personel
  15. Tax preparation expense repeal will have little impact as it was already subject to the 2% AGI limitation
  16. Repealing employee business expense deductions for entertainment will be fun to watch unfold.
  17. A dollar limit on property tax deductions is the RINO's in the house pandering to their base.
  18. The home sale exclusion tightened and phased out at higher income levels will sting when it hits.
  19. The AMT would be repealed, and I think we will all appreciate that.
  20. The basic estate tax exclusion would be doubled and the tax repealed after 2023, with beneficiaries still getting a stepped-up basis in estate property is again the RINO's in the House pandering.

The Act also contains extensive changes to corporate and business taxes, foreign income and persons, and exempt organizations that I will blog about next. For those of you wishing to be armed with data when being confronted by Drunk Uncle, please read on...

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%.

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.)

The 35% bracket would begin at:

  • $260,000 for joint returns/surviving spouses, half of the joint amount for a married individual filing separately.
  • $200,000 for any other individuals, and $9,150 for an estate or trust.

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)
  • $12,500 for an estate or trust.

Capital gains

A 0% capital gains bracket would apply to capital gains “below the 15% rate threshold”

  • $77,200 for a joint return or surviving spouse
  • $51,700 for a head of household, half of the joint amount for other individuals
  • $2,600 for estates and trusts

A 15% bracket would apply to gains below the 20% rate threshold

  • $479,000 for joint return or surviving spouse, half the joint amount for a married individual filing separately
  • $425,800 for any other individual
  • $12,700 for an estate or trust

These thresholds would be adjusted for inflation after 2018. Presumably, the 20% bracket remains in effect for capital gains in excess of these thresholds. The above changes would be effective for tax years beginning after Dec. 31, 2017.

Increased Standard Deduction & Elimination of Personal Exemptions

  • Standard deduction increased 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).
  • 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.
  • Under current law, for 2018, $4,150 is the personal exemption claim, subject to a phase out for higher earners. The Act eliminates the personal exemption altogether.

25% “business income” rate

The Act would provide a new maximum rate of 25% on “qualified business income” generally defined as the excess (if any) of:

  • 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
  • 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.

Basically this means that:

  • Owners or shareholders could elect to apply a “capital percentage” (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, owners 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.

Child Tax Credit & New Family Tax Credit

  • The Act would increase the amount of the child tax credit from $1,000 to $1,600.
  • 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.”
  • Alternatively, the act would provide a $300 credit for non-child dependents.
  • In addition, the Act would provide for a “family flexibility credit” that would be allowed with respect to the taxpayer (each spouse in the case of a joint return) who is neither a child nor a non-child dependent.
  • Both the family flexibility credit and the non-child dependent credit would be effective for tax years ending before 2023.
  • The Act would also increase the income levels at which the credit phases 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.
  • Under current law, the child tax credit is partially refundable. The Act would limit the amount that is refundable to $1,000 indexed to inflation.
  • A taxpayer would be required to provide a Social Security number to claim the refundable portion of the credit.

Repeal of Certain Nonrefundable 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
  • the credit for plug-in electric drive motor vehicles under Code Sec. 30

Education

The Act would:

  • repeal the Hope Scholarship Credit (HSC), and the Lifetime Learning Credit (LLC) and fold them under current law into the American Opportunity Tax Credit (AOTC).
  • continue to 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).
  • 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.
  • prohibit new contributions to Coverdell education savings accounts after 2017.
  • treat up to $10,000 per year for elementary and high school expenses as “qualified expenses” from Section 529 plans.
  • add to the term “qualified education expenses” certain books and supplies required for registered apprenticeship programs.

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)
  • Employer-provided education assistance under Code Sec. 127

Housing

Mortgage interest deduction as well as state and local property tax deduction retained, but with new limits.

  • The Act would retain the home mortgage interest deduction 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).
  • The Act would also limit taxpayers to one qualified residence.
  • The Act would eliminate the deduction for State and local income or sales tax.
  • but would retain the deduction for real property taxes, subject to a $10,000 maximum.

Repealed deductions

  • Taxes not paid or accrued in a trade or business under Code Sec. 164(b)(5)
  • State and local income taxes and sales tax limitations under Code Sec. 165
  • Tax preparation expenses under Code Sec. 212
  • Alimony payments under Code Sec. 215
  • Moving expenses under Code Sec. 217
  • 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)
  • The exclusion for employer-provided contributions to MSAs under Code Sec. 106 would also be repealed.
  • Medical expenses under Code Sec. 213
  • Expenses attributable to the trade or business of being an employee under Code Sec. 262

Modified Deductions

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.

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 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.

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.

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)
  • In addition, the exclusion could only be used once every five years, and it would be phased out at higher income levels.

Repealed exclusions

The Act would repeal current-law exclusions for:

  • Employee achievement awards under Code Sec. 74
  • Dependent care assistance programs under Code Sec. 129
  • Qualified moving expense reimbursements under Code Sec. 132
  • Adoption assistance programs under Code Sec. 137
  • Roth IRA recharacterization rule repealed 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.

Estate & Generation-Skipping Transfer Taxes

  • The Act would double the base exclusion amount under Code Sec. 2010 of $5 million (as indexed for inflation; $5.6 million for 2018 per taxpayer) to $10 million, effective for tax years beginning in 2018.
  • 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, while still maintaining a beneficiary's stepped-up basis in estate property.
  • The Act would lower the gift tax to a top rate of 35% for gifts made after Dec. 31, 2023, and would retain a basic exclusion amount of $10 million and an annual exclusion amount of $15,000 (for 2018), indexed for inflation.

John R. Dundon, EA [720-234-1177, John@JohnRDundon.com] Enrolled with the United States Department of Treasury to Practice before the IRS (Enrolled Agent # 85353). Under contract with the IRS as a Certified Individual Taxpayer Identification Number (ITIN) Acceptance Agent. A Federally Authorized Tax Practitioner (USC 31 Section 330 + IRC 7525a.3.A) regulated under US Treasury Cir. 230.

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