The following breakdown was prepared by the tax practice at our affiliate, Wipfli LLP. With more than 1,900 associates, 48 offices across the United States and two offices in India, Wipfli ranks among the top accounting and business consulting firms in the nation.
On the morning of December 20, both the Senate and House voted to pass their final tax reform bill, which is expected to make its way to President Trump’s desk within the coming days.
The bill includes sweeping changes for businesses, trusts and individuals. Here is our detailed summary of some of those key changes; unless otherwise noted, the changes would be effective for tax years beginning after 2017.
Individual Income Tax Reform
— Retains the current structure of seven tax brackets, but temporarily modifies the rates to: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Rate structure is not applicable after December 31, 2025.
— Retains lower rates on capital gain income and qualified dividends.
— Temporarily increases the standard deduction to $12,000 and $24,000 for individuals and married-filed-jointly taxpayers, respectively.1
— Temporarily increases the child tax credit to $2,000 (partially refundable) per qualifying child, and a $500 nonrefundable credit for qualifying dependents other than qualifying children. The phase-out at certain adjusted gross income (AGI) levels applies.2
— Preserves pretax contribution amounts to 401(k) plans and deductions to health savings accounts (HSAs).
— Temporarily increases both the exemption amount and the phase-out thresholds for the individual alternative minimum tax (AMT).3
— Suspends the deductions for personal exemptions until tax years beginning after December 31, 2025.
— Temporarily limits the aggregate deduction for nonbusiness state and local income tax, sales tax and property tax deductions to $10,000 ($5,000 for married taxpayers filing separately).4 Specifically states an individual may not claim an itemized deduction in 2017 on a prepayment of income tax for a future taxable year.
— Retains the deduction for mortgage interest expense, but in the case of taxable years beginning after December 31, 2017, and beginning before January 1, 2026, a taxpayer may treat no more than $750,000 as acquisition indebtedness ($375,000 in the case of married taxpayers filing separately). In the case of acquisition indebtedness incurred before December 15, 2017, this limitation is $1 million ($500,000 in the case of married taxpayers filing separately). 5
— Temporarily suspends the deduction for interest on home equity indebtedness.6
— Retains the charitable contribution deduction and increases the AGI limitation for cash donations to public charities to 60%.
— Retains the Lifetime Learning Credit, Hope Scholarship Credit and American Opportunity Tax Credit.
— Provides more liberalized rules for Section 529 plans, allowing distributions of up to $10,000 of elementary and secondary school tuition until the end of 2025.
— Temporarily reduces the threshold for deducting medical expenses to 7.5% for all taxpayers for tax years beginning after December 31, 2016, and before January 1, 2019.
— Temporarily suspends the deduction for miscellaneous itemized deductions.7
— Temporarily suspends most above-the-line employee moving expense deductions, and repeals the exclusion from gross income and wages for qualified moving expense reimbursements.8
— Temporarily repeals the 3% AGI limitation on itemized deductions, also known as the “Pease limitation.”9
— Repeals the special rule allowing the recharacterization rule to be utilized to unwind a Roth IRA conversion, but retains the ability to contribute to an IRA and convert to a Roth.
— Limits the current deductibility of business losses to $250,000 ($500,000 for married filing jointly). Excess business losses over the limit are carried forward to future years as a net operating loss.
— Eliminates the individual insurance mandate effective January 1, 2019.
— Eliminates the deduction for alimony payments under divorce or separation agreements entered into or modified after December 31, 2018. Payments will not be treated as income for the recipient spouse.
— No requirement to determine the basis of shares sold on a first-in, first-out basis.
Business Tax Reform
— Creates a flat corporate income tax rate of 21%. No special rate for personal service corporations.
— Repeals the AMT.
— Introduces a new 20% deduction relating to “qualified business income” of individuals (sole proprietor or owner of a pass-through entity). The deduction is subject to limitations based on wages for taxpayers whose taxable income exceeds $157,500 ($315,000 for married filing jointly). The deduction relating to “specified service trade or business” income will phase out to zero for any taxpayer with taxable income in excess of $207,500 ($415,000 for married filing jointly). “Specified service trade or business” means any business engaged in performing services in the fields of: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or any trade or business in which the principal asset of the business is the reputation or skill of one or more of its employees or owners, or a business which involves the performance of services that consist of investing and investment management, trading or dealing in securities, partnership interests, or commodities. Special rules apply to specified agricultural or horticultural cooperatives.
— Permits full expensing. One hundred-percent expensing is allowed for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. The “new property” requirement is removed and replaced with a taxpayer’s first-use rule.
— Increases Section 179 expensing to $1 million. The phase-out amount would be increased to $2.5 million and indexed for inflation for tax years beginning after 2018.
— Limits interest expense. The deduction for net interest expense incurred by a business is limited to 30% of the sum of the business’s adjusted taxable income, business interest income and the floor plan financing interest. Adjusted taxable income is taxable income computed before net interest expense or income, and net operating losses.10 Any disallowed interest expense can be carried forward indefinitely.
Small business interest expense exception: businesses with average gross receipts of $25 million or less would be exempt from the interest limitation rules.
— Modifies net operating loss (NOL) deduction limitations. An NOL carryover or carryback will be limited to 80% of the taxpayer’s taxable income for losses arising in taxable years beginning after December 31, 2017. In addition, all carrybacks will be repealed, except for a special two-year carryback in the case of certain losses incurred in the trade or business of farming, beginning after 2017. Losses arising in taxable years beginning after December 31, 2017, shall carryover indefinitely.
— Eliminates the Section 199 (DPAD) manufacturing deduction.
— Retains (with modifications) the rehabilitation credit.
— Retains the Research and Development Tax Credit, Work Opportunity Tax Credit, Low Income Housing Tax Credit and the New Market Tax Credit.
— Limits the use of like-kind exchanges. Section 1031 deferral of gain on like-kind exchanges will be available only for real property.
— Disallows the entertainment deduction. No deduction (50% is currently allowed) would be allowed for entertainment, amusement or recreation activities, or facilities or membership dues relating to such activities. The 50% deduction for meal expenses associated with operating the trade or business is retained.
— With regard to the cash method of accounting: the bill increases the $5 million average gross receipts threshold for corporations and partnerships with corporate partners to $25 million (indexed for inflation), and extends it to farm corporations and farm partnerships with a corporate partner, as well as family farm corporations. The requirement of meeting the test for all prior years is repealed.
— Permits businesses with average gross receipts of $25 million or less to use the cash method of accounting, even if the business has inventories, as long as it treats inventory as non-incidental materials and supplies, or the method of accounting conforms to the taxpayer’s applicable financial statements.
— Depreciation recovery periods of 39 years and 27.5 years remain unchanged, and a singular Qualified Improvement Property category has been created with a 15-year recovery period to consolidate several previously separate categories.
International Income Tax Reform
— Creates exemption for foreign-sourced dividends (does not apply to hybrid dividends). One hundred percent of the foreign-sourced portion of dividends paid by a foreign corporation to a U.S. corporate shareholder who owns 10% or more of the foreign corporation would be exempt from U.S. taxation. This applies to distributions made after 2017. Neither the foreign tax credit nor the deduction is allowed. A holding period applies.
— Modifies taxation of deferred foreign profits. Accumulated foreign earnings held in cash — or cash equivalents — and in illiquid assets are deemed repatriated and taxed at 15.5% and 8%, respectively. Taxpayers may elect to pay the resulting liability over an eight-year period in equal annual installments of 12.5% of the total tax liability due.
Estate Tax Reform
— Temporarily doubles the estate and gift tax exclusion amounts.11 The basic exclusion amount is doubled from $5 million (as of 2011) to $10 million per person, indexed for inflation. Note that the exclusion amount was scheduled to be $5.6 million per person in 2018, and the annual exclusion was scheduled to be $15,000 in 2018.
Additional complexity is expected, as many states do not automatically adopt federal changes, but continue under a prior version of the Internal Revenue Code.