Taxation: 2018 Tax Reform

Written by:

Christopher M. Barra, MS, EA 

Tax Reform

 

The tax bill has passed. Please keep alert and return here for updates as I read and re-read through the bill. Ever read a tax bill? - HORRIBLE. This article is already too long, and I left some things out to try not to bore you too much. Don't believe everything you hear - believe me. I like the law mostly, some of it I don't. It is far better than what we've had for so long - but it isn't as good as it could have been.

All I have been hearing it seems is that this is a tax cut for the rich - I was hoping they were right, but alas, no. It is a tax cut for everyone, with the lower and middle income earners getting the lions share of the benefits. As I read through this new law, I am more and more disappointed that it is not primarily a tax cut for the rich, but one more designed to help the lower and middle income levels. It does reduce some tax from the upper income earners as well, just not so dramatically on a percentage basis as it does for others.

Overall I like it, because I like all tax cuts. I would have preferred that more attention be paid for those who pay most of the income tax - but some relief is certainly better than none.

REMEMBER 

There is a good chance that you have already received benefits from this tax law - in the form of reduced withholding tax. So - your annual tax liability may not seem like it is any better than before when you file for 2018 - but it very likely will be. If you received $100 extra every week, that is $5,000 for the year - so your refund may actually be smaller than in the past - BUT - it doesn't mean you lost. There is also a good chance that your company may have gotten it wrong and over-withheld as sometimes happens when tax rates change. - If that is the case, it could seem worse - but try to remember that money received in reduced withholding in March is the same as it is if received in a refund the following year.

We tend to forget that we may have already benefitted from this reduction in taxation because after a few weeks, we get accostomed to having more money every week. - on to the details...

HIGHLIGHTS

NEW TAX BRACKETS:

The top marginal tax bracket drops from 39.6% to 37%. We will still have 7 slightly different brackets, and at each level the tax rate will be a little lower overall. This reduction in the highest rate takes some of the sting out of the fact that this bill is not very good for upper income individuals, but at least the top rate will be lower, so better lower than higher.

Former tax brackets were (in percentage):

10, - 15, - 25, - 28, - 33, - 35, - 39.6

New Brackets are:

10, - 12, - 22, - 24, - 32, - 35, - 37

This of course isn’t the whole story, in almost every case, given identical taxable income, the rate applied will be lower. The exception is in the range of about $400K where the 35% rate is imposed when it was only 33%. Not everyone will be happy, could be your tax is still lower - sometimes it won't be.

STANDARD DEDUCTION INCREASE

The standard deduction is the amount we can earn before we must pay any tax.

Most have heard that the standard deduction will be increasing to $24,000 for married people and to $12,000 for single – which is about almost double the current deduction. This means simply that income tax will not start until after reaching these income levels.

There is more to it -

Along with the increase in standard deduction comes the elimination of the personal exemptions. Currently at $4,050, taxpayers are allowed to deduct that amount for each dependent member of the household. So, a married couple with zero children, would receive the current SD of about $13,000 PLUS another $8,000 for $21,000. Under the new proposal that would rise to $24,000 – so, better, but not all that much better.

Under today’s code, a married couple with three kids would have these automatic deductions: Standard deduction $13,000 (I use round numbers for simplicity) plus 5 times $4,000 personal exemptions. That comes to $33,000 before any tax would kick in.

Under the new law, that $33,000 income reduction for standard deduction plus exempltions would drop to $24,000 because personal exemptions are eliminated - but the child tax credit has doubled to make up for this difference...

EXAMPLE:

If the children are under 17, there would be an additional tax credit of $2,000 each, (up from $1,000) so that is something there, but if they are all over 17 and in college, no such luck. Of that $2,000 new child tax credit, $1,400 is refundable, meaning that even if the family pays no tax, they will still receive $1,400 for each eligible child – from someone else. This will be in addition to any earned income tax credit they may receive – I have seen no changes to that.

The child tax credit extends much farther up the income ladder than it did in the past as it begins to phase out at $400,000 – more than double the previous phase-out level. So, here again, upper income will get no benefit, but upper-middle will be receiving some of this credit which they did not before.

A lower-middle income example:

Young married couple with 2 kids earning $60,000.

Subtract 24K for standard deduction = $36,000 taxable

Tax is about $4,000 on this amount.

$2,000 child tax credit deduction for the kids = ($4,000)

Tax liability = $0

Great for some, not so good for others, but overall better than before for most.

MORE DETAIL:

MEDICAL DEDUCTIONS

Under current law, individuals who itemize their deductions and spend over 10% of their income on medical expenses are allowed to deduct those costs over the threshold from their taxable income; for those over 65 the threshold is 7.5%.

The original bill eliminated medical deductions, a big mistake; the revised bill made them even better than before by reducing the recently enacted 10% threshold back to 7.5%, but that threshold will be back up to 10% again in 2020 - or so they say...

Hard to believe they were planning on eliminating this very important deduction to some people, I am glad they saw the light. Medical expense deductions have not only been retained, they have been improved.

STATE AND LOCAL TAX DEDUCTIONS (S A L T)

Most people who itemize their deductions benefit from deducting their state income tax paid and their property taxes from their total income through schedule A. This reduces income for federal tax calculations. The new law limits these deductions to $10,000.

This “penalty” targets two major groups. The first is high income earners in high tax states who pay high property taxes and income tax – they will be limited. Many of my clients pay well over $10,000 in state taxes, but they will be limited to only the first $10,000. The lower tax rates will take some of the sting out of this, but not all in every case.

In addition, many were also affected by the Alternative Minimum Tax, which won’t impact as many. The computation of the AMT does not allow for state and local tax deductions, so it is hard to tell exactly what the difference may be here. Suffice it to say, it will hurt some.

The other intended target of this law is the out-of-control states and localities who tax their citizenry too much. The idea is to encourage a ground swell of support for the reduction of local tax rates in the higher states. Maybe it will work – I don’t have a lot of hope for that. They are more likely to complain about how unfair it is to expect them to run their governments as frugally as others do.

Deductions of property and state income tax up to $10,000 would still be permitted, but only applicable after the $24,000 (joint filing) standard deduction has been surpassed.

Standard deduction increase will absorb some of the pain.

 

IF YOU OWE ANY ESTIMATED TAX TO YOUR STATE, DO NOT WAIT UNTIL JANUARY, PAY IT IN 2017 IF POSSIBLE

- YOU MAY LOSE THIS DEDUCTION ENTIRELY

 

MORTGAGE INTEREST DEDUCTIONS

Currently, the mortgage interest deduction allows taxpayers to deduct interest on home mortgages up to a principal balance of $1 million dollars. This means that if you have a loan of $2 million dollars, than half of your interest deduction would be allowed today.

The new law will limit interest deductions to the interest paid on $750,000 home loan. The older loans will be grandfathered, and still deductible. This will not impact those already in a larger mortgage, but would have the effect of forcing new buyers of pricier homes into more stringent financial calculations. This will likely reduce the home values in the upper ranges simply because it will cost the buyer more after tax dollars to buy them, so they will naturally want to pay less.

This reduction in mortgage interest allowance clearly again targets upper middle income earners. A $750,000 loan is generally on a home of value of about $1 million or so, - lower income and middle class do not buy these homes.

This will hurt upper-middle income taxpayers looking to step up in housing, and will likely depress, or slow the growth of that real estate market at least a little in those price ranges. Should have left this alone.

I do not like this change. 

CHARITABLE CONTRIBUTIONS

Slight change to charitable contributions. They will be retained in full as before, - maximum deductible amount increased from 50% of AGI to 60%. So, if you want to give away more than half of your income for the year, now you can. 

MISCELLANEOUS DEDUCTIONS ELIMINATED

Miscellaneous deductions are primarily those expenses employees have in order to perform their jobs, or to help with personal financial management. The biggest loser here will be the outside salesmen, who deduct lots of miles saving quite a bit of tax. Others deduct investment management fees, tools and travel for work, really anything that is business related.

Most don’t use this deduction because it had to surpass 2% of AGI threshold before it was allowable – but for those who do, it will be a big loss.

The fix here is that most of these people work for corporations who’s tax rates were lowered. A new agreement will likely be hammered out between the smart employees and their management to cover these costs at the company level where they can be deducted. An accountable plan in which the employee is reimbursed with non-taxable payments from the company should be able to handle this well.

The company will be able to deduct the cost and no one gets hurt too badly, maybe even both win if it is done right. Call me.

ALIMONY DEDUCTION ELIMINATED

Where this idea came from is a mystery, - probably from someone who receives a lot of taxable alimony. On the one hand, we have one spouse who earns taxable income, and is forced by the court to turn some of it over to a former spouse. The payer receives the deduction for money he can’t use, the receiver must declare the income for money he can use. That seemed pretty fair to me.

Generally the spouse with the higher earnings, and so in the higher tax bracket gets more of a tax break than the tax paid by the recipient. This seems to me to be a tax grab to generate a little more tax from the split couple.

This change unfairly forces alimony paying x-spouse to pay tax on money he can’t ever actually use while allowing the recipient to receive non-taxable income.

I believe this is a terrible change – To allow someone to receive money tax free from someone else who can’t possibly use it by court order, and the payer not the recipient must pay the tax on it? This is disgraceful.

If you are getting divorced soon and expect to have to pay alimony, do it now. If you are the breadwinner and start to have a problem with your spouse after 2018, you really need to try to work it out. This law kicks in in 2019.

MOVING DEDUCTION ELIMINATED

Under current law, if a taxpayer changes jobs from one employer and moves to another more than 50 miles away, moving costs can be deducted. Not sure why this was ever in the law because this is really more of a personal decision, not a business one. Maybe U-Haul lobbied for it? Certainly it has benefited some, but in my opinion, the tax code should ignore personal decisions that can be controlled.

This is a law that we didn’t need. Sure it benefited some over the years, but it is more of a personal decision. I am OK with this change

ALTERNATIVE MINIMUM TAX

The individual AMT is an alternative method of taxation which every taxpayer must calculate to determine if it affects him or not. It was established in the late 60’s to snare those very wealthy who through huge deductions somehow got away with paying nothing. It was a good idea at the time, but now it hits ordinary middle and upper income taxpayers more than it was originally intended to do.

Basically it is the same system with a higher “standard deduction” and without as many allowable personal deductions. Some of those disallowed deductions were state and local taxes and business deductions, as well as personal dependency exemptions. So much of this is already incorporated into this new law.

Congress has discussed eliminating this ever since I have been preparing taxes and has never done so. The reason is simple; it generates a lot more tax from a lot of people.

This has not been eliminated as discussed, but has been tweaked to impact fewer taxpayers by slightly raising the threshold before it kicks in.

BUSINESS

IMMEDIATE EXPENSING OF EQUIPMENT

When a company decides to make a major purchase in business, they calculate the time it takes to recover that cost. When they can deduct the cost immediately, obviously the time to recovering the cost is shorter.

There currently exists what we in the business call “Section 179 deductions” - this is the amount the taxpayer is allowed to deduct on equipment in any given year without extending that period throughout it’s depreciation time frame, usually of five or more years. It is currently limited to $510,000 and further limited as expenses increase.

The proposal is to double this and allow companies to immediately deduct $1 million of the cost of new equipment used for business equipment previously allowed.

This will have the effect of stimulating the economy as small and large companies expand. They will circulate more money, increase the productivity of their own businesses, likely hire more employees and increase the business of every company from whom they buy.

LANDLORDS

Expensing of furniture and appliances have not been allowed in the past. The new law allows this, a big break for landlords. No more depreciation of appliances or furniture if you don't want to - just deduct it as a Secton 179 expense. So rather than deducting these expenses over 5 or 7 years, you can write them off in the year you placed them in service. Of course if the property is disposed of before the end of the normal depreciable useful life, there will be recapture of the excess depreciation as is the case with any other business.

 

PASS THROUGH BUSINESS TAX RATE REDUCTION

A “Pass through” business is most notably an S-Corporation or a Partnership, but also includes less formal arrangements like personal Limited Liability Companies and Sole-proprietorship with no formal designation.

Currently, the rate of tax of income received from pass-through businesses was the same as any other income tax. The proposal is for business profits, meaning people who own their own business would pay at a new “pass-through rate”. There will be some restrictions on what kinds of businesses can claim this fulll deduction rate, to avoid individuals abusing the lower tax when they are not really businesses.

The plan will give a 20% deduction from income of pass through businesses. This has the effect of reducing the amount of taxable income by that amount. So, if your pass through business nets $100,000, you pay tax at whatever rate you land on but only on $80,000, not the full $100,000. ($100,000 - $20,000 = $80,000) . There are other limitations, but this is the gist of it.

Unfortunately, this does not apply to everyone, we have winners and losers here. I am a loser (been called that many times) as tax and accounting is considered a “Specified Service Business” - as are Doctors, lawyers, financial service providers, - well here it is from the law

A "Specified Service Activity" means any trade or business activity involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees, or investing, trading, or dealing in securities, partnership interests, or commodities.”

For some reason professional people have been singled out to be excluded from this benefit allowed other pass through businesses, but the deduction will be allowed for incomes lower than $315,000 if filing joint and $157,500 filing single- so it could be worse.

A little complicated, but paying tax on less is always better than paying tax on all of it, even if we have to sharpen a pencil or two.

Real estate landlords will also benefit from this new deduction as we are also considered pass through entities.

CORPORATE TAX CUT FROM 35% TO 21%

Corporate tax maximum rate will be cut to 21% from the current 35%. It is designed to be permanent.

Our corporate taxes are some of the very highest in the world and we can’t compete globally as we once did. We had to lower our rates to have any chance of survival. We had to make it worthwhile for business to headquarter here and for those who’ve already left for lower tax rates, to return.

Lower rates mean more jobs, more opportunities, healthier competition. This appears to be a tax cut for the giant corporations, but it is really a jobs law which should allow companies to hire more, and pay even better.

Corporations are double taxed. They are taxed first at the corporate level, and then the shareholders are taxed on their dividends. So if a corporation is at the current 35% rate, they lose that plus up to another 15% when it trickles down to the shareholder.

Don’t forget, corporations are innate entities, they don’t really pay that 35% tax now. It is the shareholders of these companies and the employees who are paid less who lose when the corporate taxes are high, because it never gets to them. Shareholders run the gamut from multi millionaires holding millions of dollars worth of shares to smaller investors, pension plans, mutual funds retaining them in for individual accounts, 401(k)’s and IRA’s. Employees of course are of every stripe.

It is very possible that this can open the door to providing more and better jobs, and higher wages or bonuses as lower tax rates always free up money. If we get disappointed in the amount of jobs created, the little guy still wins along with the big one as net after tax earnings should increase, dividends should increase, and stock share values should rise, and employees have a better shot at making more money too.

Lower corporate rates is a tax change that helps everyone. 

ESTATE TAX

The current threshold for tax applies only to estates with greater than $5.6 million in assets during 2018, would about double to $11.2 million. This means that estates valued at less than $11.2 million dollars will pay no federal estate tax. Of course you still have to worry about your greedy state tax collectors.

I know a lot of people bristle when I suggest that there should be no estate tax at all. Those who earned it, should keep it in the family. A heavy estate tax is a favorite of many whose goal is to redistribute wealth, and by the way, is a primary plank of the communist party manifesto as written by Karl Marx; that government should inherit all assets at death. This discourages many from wanting to even build a large estate – what would be the point of great success?

Please see my argument for the complete elimination of the estate tax. There is a lot more to it than just wanting the people who earned it to keep it in the family - it isn't just their family we are protecting.

ESTATE TAX

Increasing the threshold before which estates will be taxed is always a good idea – for everyone.

OBAMACARE INDIVIDUAL MANDATE REPEALED

The mandate requiring individuals and companies to buy awful health insurance or pay stiff penalties is going away – but not until 2019. Why the delay? Don’t know – but at least it is going away. This will force insurance companies to offer what people really want rather than force them to buy whatever expensive crap they decide to offer because the government insurance police will make them do it.

A step back in the right direction, I don’t like the delay, I see no reason to wait on this. It makes me wonder if they really intend to eliminate it or are planning to "extend" the termination date.

TAX LAW SUMMARY 

Overall I would give this new tax law proposal a grade of B. I have a lot of issues with it, but it is a much better plan than what we have now. Since better by definition is always better than worse, I would have voted for it. I am a little disappointed, but I live in the real world, I know tax law will never be perfect.

I don’t like the fact that it concentrates so heavily on benefiting the lower to middle income classes. From the increased standard deduction, and doubling the child tax credits as well as lower rates.

If you hear that the rich got the lions share of the benefits, well, that is a lie. At least it is a lie in terms of precentage savings. The wealthy pay the most, and their paultry reduction in rate from 39.6 to 37 will save some tax. Many lower and middle class earners will see a 50% or more drop. But 50% of $5,000 is only $2,500, while 7% of 1$ million is $70,000. Who got the better deal? So, lets compare apples to apples. There can not be a legitimate tax cut without cutting the tax at least some for those who pay the most. 

This law also benefits upper middle and upper income earners, just not so much, Upper middle and upper income earners will not like some of this – not because it doesn’t help, it does help overall, and they will very likely save some, but this could have been so much better. Still it is an improvement over what we had before. The rates are lower. This new law taketh away and it giveth some back.

FEDERAL REFUNDS LIKELY TO BE LOWER

Your tax is likely to be less in 2018 than it was in 2017 given similar circumstances. Those circumstances INCLUDE WITHHOLDING TAX. If your employer withholds less based on the new withholding rates, you may receive a lower refund simply because you received it in smaller chunks throughout the year.  Simple math explains this. If you earn $100 dollars, government withholds $30 in income tax, then gives you back $10 when you file your taxes - your tax liability was $20 ($30-$10).

If you earn $100, government withholds $22, then gives you back $7 as a refund, your tax liability was lower by 25%, - only $15 ($22-$7) - BUT your refund was lower, $7 is less than $10. Think about that - if you want the same  or larger refund, make sure your employer knows and withholds appropriately.

GOOD FOR MOST

Almost everyone will pay at lower rates, but we lose deductions, some more than others. Some will be disappointed, and will even pay slightly more because one of the rates (35%) starts a little sooner than it did last year. For those in that bracket window, you may actually see a slight increase in tax depending on your particular financial situation - sorry.

This is a law that benefits most taxpayers. Those who will see the greatest percentage benefits, already pay the least tax. This is why I only give it a grade of "B", but most tax laws I give an "F" - so this is pretty good. They should have lowered the highest tax bracket more, and made sure no one who has the same taxable income could wind up in a higher bracket. 

 

Christopher M Barra, MS EA

Barra Tax Service