Well, here it is. The House and Senate Republicans released their joint version of the Tax Cuts and Jobs Act on not even 2 weeks ago. Both the House and the Senate voted on the legislation and passed bill, which sent to the White House for the President’s signature, as was signed into law on December 22, 2017.
Known as Public Law no. 115-97, this is a law passed by the United States Congress that amended the Internal Revenue Code of 1986. It is based on tax reform advocated by congressional Republicans and the Trump administration.
Below is information on many of the changes included in the bill. Most changes are effective January 1, 2018 and none will affect 2017 income tax returns filed during 2018.
Impact on your estate plan
One thing the TCJA doesn’t do is repeal the federal gift and estate tax, as originally contemplated by the House of Representative’s version of the bill. It does, however, temporarily double the combined gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption, creating new estate planning challenges and opportunities.
For the estates of persons dying, and gifts made, after December 31, 2017, and before January 1, 2026, the gift and estate tax exemption and the GST tax exemption amounts increase to an inflation-adjusted $10 million, or $20 million for married couples with proper planning (expected to be $11.2 million and $22.4 million, respectively, for 2018). Unless changed, the exemptions will revert to their 2017 levels (adjusted for inflation) beginning January 1, 2026. The marginal tax rate for all three taxes remains at 40%.
According to some estimates, the increased exemption amounts will reduce the number of U.S. estates subject to estate tax from approximately 5,000 to around 2,000. But just because the possibility of estate tax liability seems remote for most families, it doesn’t mean the end of estate planning as we know it.
For one thing, there are many non-tax issues to consider, such as asset protection, guardianship of minor children, family business succession, and planning for loved ones with special needs. Plus, it’s not clear how states will respond to the federal tax law changes. If you live in a state that imposes significant state estate taxes, many traditional tax-reduction strategies will continue to be relevant.
It’s also important to keep in mind that the exemptions are scheduled to revert to their previous levels in 2026 — and there’s no guarantee that a future administration won’t reduce the exemption amounts even further. As discussed below, however, the exemption increases planning opportunities that can help you shield your wealth against tax changes down the road.
Record-high exemption amounts, even if temporary, create a rare opportunity to take advantage of strategies for “locking in” those exemptions and permanently avoiding future transfer taxes. These include:
Lifetime gifts. By using some or all of the increased exemption amount to make additional tax-free lifetime gifts, you can shield that wealth — together with any future appreciation in value — from taxation in your estate, even if smaller exemptions have been reinstated when you die.
Keep in mind, though, that lifetime gifts, unlike assets transferred at death, aren’t entitled to a stepped-up basis. This can increase income taxes on any gain realized by the recipients should they sell a gifted asset. So, when considering lifetime gifts, it’s important to weigh the potential estate tax savings against the potential income tax costs.
Now may be an ideal time to establish a dynasty trust. These irrevocable trusts allow substantial amounts of wealth to grow and compound free of federal gift, estate and GST taxes, providing tax-free benefits for your grandchildren and future generations. The longevity of a dynasty trust varies from state to state, but it’s becoming more common for states to allow these trusts to last for hundreds of years or even in perpetuity.
Avoiding the Generation Skipping Tax ( GST) is critical. An additional 40% tax on transfers to grandchildren or others that skip a generation, the GST tax can quickly consume substantial amounts of wealth. The key to avoiding the tax is to leverage your GST tax exemption, which will be higher than ever starting in 2018.
Let’s say you haven’t yet used any of your gift and estate tax exemption. In 2018, you transfer $10 million to a properly structured dynasty trust. There’s no gift tax on the transaction because it’s within your unused exemption amount. And the funds, together with all future appreciation, are removed from your taxable estate.
Most important, by allocating your GST tax exemption to your trust contributions, you ensure that any future distributions or other transfers of trust assets to your grandchildren or subsequent generations will avoid GST taxes. This is true even if the value of the assets grows well beyond the exemption amount or the exemption is reduced in the future.
The TCJA makes several other changes that may have an impact on estate planning strategies. For example:
529 plans. The new law permanently expands the benefits of 529 college savings plans. These plans, which permit tax-free withdrawals for qualified educational expenses, also offer some unique estate planning benefits.
Contributions are removed from your estate even though you retain the right to change beneficiaries or get your money back. And you can bunch five years’ worth of annual gift tax exclusions into one year. So, for example, in 2018, when the annual exclusion is $15,000, you can contribute $75,000 to a plan ($150,000 for married couples) without triggering gift or GST taxes or using any of your exemptions.
Under the TCJA, beginning in 2018, tax-free distributions from 529 plans can be used for elementary and secondary school expenses, not just higher-education expenses, making them even more valuable.
The TCJA also makes an important change to the “kiddie” tax. One popular estate planning technique is to transfer investments or other income-producing assets to your children to take advantage of their lower tax brackets. The kiddie tax makes this difficult to do. Under pre-TCJA law, it taxes all but a small portion of a child’s unearned income at the parents’ marginal rate (if higher), defeating the purpose of income shifting. The kiddie tax generally applies to children age 18 or younger, as well as to full-time students age 19 to 23 (with some exceptions).
The TCJA makes the kiddie tax even harsher by taxing a child’s unearned income according to the tax brackets used for trusts and estates, which are taxed at the highest marginal rate (37% for 2018) once 2018 taxable income reaches $12,500. In contrast with all other filers, for a married couple filing jointly, the highest rate doesn’t kick in until their 2018 taxable income tops $600,000. In other words, in many cases, children’s unearned income will be taxed at higher rates than their parents’ income.
The TCJA raises the adjusted gross income limitation for deductions of cash donations to public charities from 50% to 60% from 2018 through 2025. On the other hand, because fewer people will be subject to federal gift and estate taxes, charitable strategies designed to reduce those taxes will be less valuable from a tax-saving perspective.
Other changes include the following, which does not necessary affect your estate planning, but affect us in other ways.
Individual Income Tax Rates:￼ To see the actual rates, go to Beyer, Pongratz & Rosen's Webpage and go to blogs. This Webpage is unable to accept the rate schedule. I am sorry about that.
Non the less, the number of income tax brackets remains the same, but the rates and applicable income thresholds are adjusted, and the top rate is lowered from 39.6% to 37%. The individual income tax rates are effective beginning January 1, 2018 and are set to expire after 2025.
The Alternative Minimum Tax is still in place for individuals, but with an increased exemption for tax years 2018-2025. The exemption is increased to $109,400 for married taxpayers filing jointly and $70,300 for all other taxpayers. The exemption phases out beginning at $1,000,000 and $500,000, respectively. The exemption and phase out amounts are indexed for inflation.
Capital gain tax rates are unchanged at 0%, 15% and 20%. The brackets for capital gain income are unchanged as well, which means they will not follow the cut offs of brackets listed above. Instead, the rates apply to where previous brackets would have fallen. For 2018 the 0% rate will apply up to $77,200 for joint returns, $38,600 for single filers, 15% will apply up to $479,000 for joint returns, $425,800 for single filers, and 20% on income in excess of those amounts. These amounts are indexed for inflation.
The net investment income tax remains unchanged at 3.8% for modified adjusted gross income over $250,000 for taxpayers filing jointly, $200,000 for taxpayers filing as single, and $12,500 for trusts & estates.
Individual Taxpayer Deductions:
* The standard deduction is increased to $24,000 for taxpayers filing jointly and $12,000 for taxpayers filing single. The deductions were $12,700 and $6,350, respectively. The increased deduction is effective for 2018 through 2025.
* Personal exemptions are eliminated, effective 2018 through 2025.
* State and local income taxes, sales tax, real estate and personal property taxes are grouped together and deductible up to $10,000 per year in total. Previously there was no limit to the deductions. The limitation expires after 2025.
* For mortgage debt on personal residences originating after December 15, 2017, interest is deductible on principal up to $750,000 for tax years 2018-2025. Mortgages in place prior to that date retain deductions for interest on up to $1,000,000 of principal. Mortgages on up to two personal residences can still be deducted, under the total principal limits. Beginning in 2026 the law reverts to a limitation on interest for principal up to $1,000,000 for mortgages originated at any time. Additionally, deduction for any home equity debt interest is suspended for tax years 2018-2025.
* Medical expenses are deductible as an itemized deduction for any portion that exceed 7.5% of adjusted gross income, regardless of the taxpayer’s age. The reduction of this limitation is in place for 2017 and 2018 only.
* Cash charitable donations are limited to 60% of adjusted gross income, increased from 50%.
* No deduction is allowed for donations to higher education institutions when, in exchange, the payor receives the right to purchase tickets or seating at an athletic event.
* Qualified Charitable Distributions, which are distributions from a qualified retirement accounts directly to a charity by taxpayers over 70.5, remains unchanged and available up to $100,000. This method of charitable donations will be increasingly valuable as fewer taxpayer itemize their deductions and are therefore unable to benefit from cash or property donations.
* Miscellaneous itemized deductions are suspended for tax years 2018-2025. These include tax preparation fees, un-reimbursed employee business expenses, investment expenses, professional and union dues.
* Deductions for casualty losses are limited to those attributable to federally declared disaster areas for tax years 2018 -2025.
* Expenses for a work related move are not deductible for tax years 2018-2025. During that same period qualified moving expenses paid by an employer are not excluded from the employee’s gross income.
* Overall limitations to itemized deductions are repealed for tax years 2018-2025.
* Payment of alimony pursuant to a divorce decree are not deductible by the payor for divorce or separation agreements executed after December 31, 2018. Income and deductions related to agreements exiting prior to that date will not be affected.
The top corporate tax rate is lowered from 35% to 21% beginning January 1, 2018. This applies to companies taxed as C-Corporations. The Alternative Minimum Tax is repealed for corporations and no change is made to the 35% rate applicable to personal service corporations.
Qualified business income that is taxable on individual income tax returns, including partnerships, LLC’s, sole-proprietors and S-Corporation income, will receive a deduction of 20% of business income, subject to limitations. Qualified business income does not include wages or guaranteed payments paid from the business to the owners.
The 20% deduction is phased out beginning when taxpayer’s total income is $315,000 for couples, $157,500 for taxpayer’s filing single, completely phasing out when income is $415,000 and $207,500, respectively.
Once you are past the phase out amounts your total deduction begins to be limited to the lessor of qualified business income or, the greater of 50% of W-2 wages paid by the business, or the sum of 25% of the W-2 wages paid plus 2.5% of the unadjusted basis of all qualified property. Qualified property is defined as depreciable tangible property placed in service before the end of the taxable year, whose depreciable life is at least ten years and the depreciable life of the property has not ended prior to the close of the taxable year.
Specified service businesses, which are any businesses which involves the performance of services, are eligible for the deduction only up to the phase out levels noted above. These include the fields of health, law, consulting, athletics, financial services, or any business where the reputation or skill of the employees and owners is a principal asset.
The deduction is made from taxable income, it does not affect adjusted gross income. Net pass-through income after the 20% deduction is subject to taxpayer’s marginal income tax rates, listed above. If the taxpayer has a net qualified business loss, that loss will carry over to the next year and can be used to offset qualified business income in that year.
Business interest expense is now subject to a limitation for some taxpayers, while previously all business interest was deductible. Beginning in tax year 2018 business interest is limited to the sum of business interest income plus 30% of adjusted taxable income. Taxpayers with average annual gross receipts less than $25 million are exempt from the limitation.
Any interest expense that is not deductible will be carried forward indefinitely. For pass-through entities the limitation is applied at the entity level rather than the individual level. Business interest does not include investment interest.
Additional first year depreciation, or bonus depreciation, is expanded to be 100% of the cost of qualified assets placed in service September 27, 2017 through December 31, 2022. Beginning in 2023 the allowable bonus depreciation is reduced by 20% per year, making 80% bonus depreciation apply in 2023 and 0% bonus apply in 2027. Also, all property will now be eligible even if the original use does not commence with the taxpayer, previously only new assets qualified for bonus depreciation.
Section 179 expensing is increased to $1,000,000 and the phase out is increased to begin at $2,500,000 of total assets placed in service. Expensing of sport utility vehicles is still limited to $25,000. All numbers are now indexed for inflation beginning in 2019.
Passenger automobiles are subject to limited depreciation. The limits are increased to $10,000 the first year, up from $3,160 currently, $16,000 in the second year, $9,600 in the third year and $5,760 for fourth and later years for vehicles placed in service after 2017.
Section 199 deduction for domestic production activities is repealed.
Deductions for activities which are considered entertainment or recreation are no longer deductible. Previously 50% of these costs were deductible.
Corporations with net operating loss deductions are now limited to 80% of taxable income for any losses arising after December 31, 2017.
The Child Tax Credit will increase from $1,000 to $2,000 per child under age 17, with up to $1,400 being refundable. The credit begins phasing out when income is at $400,000 for joint tax returns, $200,000 for single taxpayers, and is completely phased out when income is $440,000 and $240,000. This change expires after 2025.
Conversions of one type of IRA to another type, often traditional IRA’s to Roth IRA’s, can no longer be recharacterized back to their original account type beginning with conversions occurring January 1, 2018.
The penalties for not having health insurance, which were a part of the Affordable Care Act, are eliminated beginning in 2019.
Items That Are Not Changing:
No changes are made to student loan interest deductions, retirement accounts, educator expenses or higher education expenses and credits. No changes are made to exclusions available on gains from the sale of personal residences. The credit available for adoption expenses remains in place.
Original drafts of the bill included a provision to require securities to be sold a first-in-first-out basis, rather than specifically identifying the shares sold. This change is not included in the final bill.
This is the largest tax law change the country has seen in decades. In addition to the items summarized here there are many additional provisions, most of which only apply to a very small group of taxpayers. Many of the changes follow what we anticipated would be included in the final bill and have discussed in previous newsletters. There is still time to plan and make any necessary changes before the end of the year.
Review your plan.
These and other changes made by the TCJA may have a significant impact on your estate planning strategies. We’d be pleased to review your estate plan in light of the new tax law to ensure that you’re taking full advantage of the opportunities the TCJA creates, and minimizing any downsides that may affect your family. For a free review with Mr. Beyer , contact his office at 916 645-9529.