Tax Law Updates

A Newsletter for Clients and Friends of Naman, Howell, Smith & Lee, PLLC

The Tax Cuts and Jobs Act (the “Act”) recently passed by Congress and signed by President Trump has been described as the most significant amendment to the federal tax laws since 1986. It is generating substantial interest among taxpayers who wish to understand how the Act will affect them.

There are parts of the Act that will affect most taxpayers, such as rate reductions, increased standard deductions, elimination of personal exemptions and limitations on deductions related to mortgage interest and state and local taxes. Favorable changes have also been made in the federal estate and gift tax so that these taxes will now affect only a very small number of taxpayers. While the changes in the Act are voluminous and there are many unknowns at this time, we have addressed in this newsletter issues that we believe will be important to you.

Tax Rates

The Act lowers income tax rates for many individual brackets as well as for trusts and estates. We have included tables below for single filers and married filing jointly which reflect the prior rates and the new rates under the Act:

The “kiddie tax” (which is applicable to children’s earned and unearned income) no longer taxes certain children’s income at a child’s parent’s tax rate. Rather, a child’s earned income is now taxed at the rates for single filers and unearned income is taxed at rates applied to trusts and estates.

Estate and trust tax rates have also changed, but both estates and trusts are still taxed at the highest rate (now 37%) upon reaching $12,500 of income.

Quite notably, for taxable corporations (“C Corporations”), there is now a 21% flat corporate tax rate, down from the highest rate of 35% prior to 2018. Additionally, the Corporate Alternative Minimum Tax has been repealed.

Deductions

The Act significantly altered deductions and exemptions for all taxpayers. As has been widely discussed, the standard deduction has doubled and the personal exemptions have been eliminated. The standard deduction has been increased to $24,000 for a married couple filing jointly, $18,000 for taxpayers filing as head of household, and $12,000 for all other taxpayers, including single filers.

The following changes have been made with regard to itemized deductions for individuals:

· The Act suspends the phase out limitations on itemized deductions for higher income filers (these limitations were often referred to as the “Pease” limitations).

· Deductions for state and local taxes, including property taxes, which are not paid or accrued in carrying on a trade or business, are limited to $10,000. Deductions for interest paid on home equity loans have been repealed.

· Mortgage interest deductions on a qualified residence are now limited to interest on $750,000 of indebtedness, down from $1,000,000. However, the Act grandfathers the treatment of debt which was incurred on or before December 15, 2017, or which was contractually bound to be incurred on or before December 15, 2017, and which closes prior to April 1, 2018.

With regard to charitable deductions, the Act increases the limitation on deductions for charitable contributions of cash from 50% of adjusted gross income to 60% of adjusted gross income. However, the Act completely eliminates any charitable deductions for contributions paid in exchange for college athletic event seating rights.

· Under prior laws, deductions were generally permitted for certain medical expenses to the extent the expenses exceeded 10% of the taxpayer’s adjusted gross income or 7.5% if the taxpayer or the taxpayer’s spouse had attained the age of 65. The Act lowers the 10% threshold to 7.5% for all taxpayers regardless of age.

· Effective for divorce decrees entered into after December 31, 2018, alimony is no longer deductible and the recipient of such alimony is no longer required to include such income on his or her return.

· Moving expenses incurred in connection with starting a new job are no longer deductible unless the taxpayer is a member of the armed forces.

· All miscellaneous itemized deductions that were subject to the 2% floor (such as expenses incurred for the production or collection of income, unreimbursed expenses attributable to a trade or business, excess deductions allowed to a beneficiary on the termination of an estate or trust, indirect miscellaneous deductions from pass-through entities, safe deposit box rental fees, business liability insurance premiums, tax preparation expenses, etc.) are suspended and not allowed for tax years 2018 through 2025.

Additionally, the Child Tax Credit is increased to $2,000 per qualifying child. Also, the credit begins to phase out at $200,000 for a single filer and $400,000 for a married couple filing jointly.

The laws regarding 529 plans and Coverdell education savings accounts have remained largely unchanged except that the definition of qualified education expenses has been increased to allow for payments of tuition in connection with enrollment or attendance at an elementary school or secondary public, private, or religious school. The Act limits the amount you may withdraw for elementary and secondary school expenses to $10,000 per year.

There are also important changes to many business deductions, including, but not limited to, changes to deductions for business interest expenses, net operating losses, as well as entertainment expenses, meals, transportation and other fringe benefits often provided by an employer to an employee.

Many of these changes will sunset on December 31, 2025, meaning, without any change, the deduction and exemptions would return to 2017 levels.

Estate, Gift and Generation Skipping Transfer Taxes

The Act doubled the estate and gift tax exclusion amounts as well as the Generation Skipping Transfer (GST) exemption amount to $10 million (as adjusted for inflation in year 2012). Thus, in 2018, the estate/gift tax exclusion and GST exemption is estimated to be $11.2 million per person due to inflation indexing prior to 2018. As with the income tax deductions discussed above, the increased exemption amounts will also sunset December 31, 2025, and without any additional congressional action, the exemption amounts would return to $5 million per person, indexed for inflation, on January 1, 2026. Estate and trust tax rates have also changed, but both estates and trusts are still taxed at the highest rate (now 37%) upon reaching $12,500 of income.

For taxpayers with estates that exceed the exemption amounts in 2017 (which was $5.49 million per person), this increase in exemption amounts provides an opportunity to make large gifts that would not incur gift taxes or generation skipping transfer taxes and which would remove assets from the taxpayer’s estate even if the exemption amounts were to go back to 2017 rates (plus inflation indexing) in 2026.

For taxpayers with estates that do not exceed the exemption amounts in 2017, this increase in exemption amounts may provide an opportunity to revise wills to focus on basis adjustment planning.

Other than the increased exemption amounts, most of the laws relating to estate, gift and generation skipping transfer taxes have remain unchanged.

Pass-Through Entity Deduction

One change that is of great interest to taxpayers is the pass-through entity deduction. The new 20% pass-through entity deduction allows non-corporate taxpayers to deduct 20% of the qualified business income (“QBI”) received from a partnership, S corporation, sole proprietorship, and from most limited liability companies, subject to various special rules, limitations and phase outs. The deduction amount is determined by a complex series of formulas and definitions. In general, this deduction applies only to income from a trade or business (probably not income from property leased to others unless it rises to the level of an active business), it never applies to portfolio income such as interest or dividends from public companies (even if coming through an active business) and there are complicated limitations on this deduction for higher income individuals.

Please note that additional guidance is still needed to fully understand this deduction. We understand that the IRS is diligently working to implement these changes and issue additional guidance to taxpayers. We are monitoring these developments and will follow up with you once additional details are known.

Conclusion

As mentioned before, it is important to note that many of the changes discussed in this letter and created under the Act will expire at the end of 2025, unless there is additional Congressional action.

As you can see, the changes made by the Act are numerous. Please contact us should you wish to discuss these new laws and how they may affect you, your business, or your family.

Waco Attorneys

Naman, Howell, Smith & Lee, PLLC is a unique Texas law firm with four offices located throughout Texas. Founded in Waco in 1917, the firm has provided the finest legal services available to businesses and individuals in Central Texas and other areas of the state for over 100 years. Nothing contained herein should be construed or relied upon as legal advice, and readers who have legal questions should consult an attorney to discuss their specific situation