Tax reform: Individual tax implications of the recently enacted Tax Act

This post is part three of a three-part series outlining the critical changes impacting small and medium-sized businesses as a result of new tax legislation. Part one of this series focused on the generalities, concepts, and key new provisions from a macro perspective. Part two focused on business implications. Part three examines the impacts to individuals, their families, and their estates.

Congress and the President have altered the individual tax landscape in dramatic fashion and all taxpayers will be impacted.

Most will pay a little less tax, some will pay a lot less tax, and a few will see their federal taxes increase.

These changes are generally effective in 2018 and most new provisions expire in 2025.  While the Act was focused on businesses and their taxation, there are plenty of changes impacting each of us at the individual level.  I believe that while many of the provisions are temporary (note, technically all tax laws are temporary as the next Congress and Administration may repeal and change these laws at any time) the framework of these changes is set to move the USA to a flatter style tax structure where personal itemized deductions will no longer exist.  This change isn’t imminent, but it has been discussed in tax circles since I was in school. Accordingly, the prudent individual taxpayer will want to consider what their tax situation could look like without any itemized deductions including mortgage interest (already limited), state taxes (already limited), medical deductions (already limited), miscellaneous deductions (already removed), and charitable deductions (still in place).

For individuals, the most important items to consider are the impacts to their 2018 and forward tax filings.  While some aspects of the Act apply to 2017 (depreciation on post-September purchases, for example), the majority begin in 2018.

The major items include:

• Loss of exemptions – under the prior laws, taxpayers received deductions for qualified dependents.  Large families received more, and small families received less under a theory that there were some baseline costs per person.
• Increased qualified child tax credits and a new non-child tax credit – under the new laws, there is a $2,000 tax credit for each qualified children with $1,400 of this amount eligible to be refunded should your net tax liability fall below the cumulative level of the credits.  Additionally, for qualified dependents that don’t meet the qualifying child requirements (e.g. older children, parents, etc.) there is now a $500 tax credit.  This $500 tax credit is not refundable.
• Limitations on itemized deductions –
  • Mortgage Interest – mortgage interest has been limited for many years.  Prior amounts were $1M of qualified acquisition debt (think purchase price plus improvements) along with $100k of pure “equity” debt (think you borrowed for personal use and used your house as collateral).  Under the new rules, equity debt is disallowed on new debt after the Acts enactment, and the overall limitation on new mortgages is $750k.
  • State and Local Taxes –beginning in 2018 there is an overall limitation of $10k of allowable deductible taxes. Of course, this limitation doesn’t apply to businesses and separate entities (like rental properties).   This limitation applies to all such taxes regardless of their character (e.g. property, sales, and income)
  • Miscellaneous Itemized Deductions – are all disallowed.  These include investment expenses, legal costs to produce income, job hunting expenses, union dues, and similar types of expenses.
  • Casualty losses are now only allowed in Presidentially declared disaster areas.
  • Medical expenses remain at their current levels (that is above 7.5% of adjusted gross income) for 2018 and 2019. Beginning in 2020, the threshold amount rises to 10% of adjusted gross income.
• Increased Standard Deduction – in exchange for the above-itemized deduction limitations, the Act increases the standard deduction (the amount that is allowable without having to actually spend it).  The new values for jointly filed returns is $24,000, head of household is $18,000, and single is $12,000.  For renters and people who own homes without mortgages, these increased standard deduction amounts are quite positive.  For those with mortgages and living in high state tax jurisdictions, the immediate benefit of purchasing a home will be muted and the limitation of state tax deductions will be felt through higher federal taxes.
• Overall the number of tax rate groups remains unchanged at seven and except for a small range in the above $400k in taxable income, the marginal tax rates are all lowered.
• As mentioned in part two of this series, there is a new section known as 199a that provides a 20% reduction from taxable income certainly qualifying business profits. Of course, there are phase-outs, limitations, and complexities, however, many family-style businesses should benefit greatly from this reduction

There are several other major provisions including how alimony will be taxed for agreements settled after 2018.  Under our previous laws, alimony paid to a former spouse was deductible to the payer and taxable to the recipient.  Beginning in 2019, alimony will no longer be deductible, nor will it be taxable.  Accordingly, should you be facing divorce, the timing of your final decree and how you allocate post-marital assets will be quite impactful.

For parents and families that have saved for college expenses under the Section 529 type plans, there is an expansion of how those funds may be used that now includes grammar and secondary schools.  Additionally, excess funds are now transferable to other family members.

Finally, no discussion of the new Act would be complete without a conversation about estate and wealth transfer changes.  The federal “tax-free” estate value has doubled to $11.2 million per person.  For multi-generational family businesses including extensive farms and farmers, now is an excellent time to consider what these changes mean.  While the law covers these values through 2025, there is nothing holding Congress and the President from changing their minds and moving the exemptions back to pre-Act values or even lower to $1M or less. There are active strategies available that protect your wealth, provide lifetime access to your funds, and prevent a clawback should changes occur.  While these strategies are beyond the scope of this article, your tax advisor should be able to assist.  And if not, feel free to contact me and I’ll be happy to assist with some local referrals that can help you.  As a simple reminder, some states have a much lower estate tax exemption threshold and you should confirm how these changes impact your personal situation.

While taxes are the cost of a civilized society, no one should pay more than required.  Protecting your own best interests by remaining diligent as to the impacts of these changes, along with recognizing that states have different rules, and many will conform while others may or may not conform will also complicate your future filings.  The best tax advisor you can have is likely yourself.  You know your facts and future options better, faster, and in more detail than any professional.  Professionals provide excellent value as they help you clarify your objectives, confirm that you are complete as to all of the options available, and they reduce risks of common mistakes that non-experts make.  Ultimately, we live in a changing landscape and as any good Gardner knows, it is always best to keep pests out before they invade and to do that well, takes active participation and engagement.

For more information on these tax changes, tune into my recent interview on the Sage Advice Podcast with Ed Kless.