In 2017, a tax bill was introduced in Congress called the “Tax Cuts and Jobs Act of 2017” but was renamed “An Act to provide for reconciliation pursuant to Titles II and V of the concurrent resolution on the budget for fiscal year 2018.” The change was required by the Parliamentarian of the United States Senate for the bill to meet certain Senate requirements. While the original title is friendly and warm (who isn’t in favor of jobs?), the final title more accurately describes the bill’s complexity and wide-ranging changes. Regardless of the final title, tax experts refer to this change in tax law as “TCJA.
For simplicity, this article is split in two parts and cover the tax changes for 2018–2025. The first section will examine some of the lesser-publicized changes to the tax code and their impact on clients. The second section will cover the mostly dry and straightforward changes to the tax code.
Section One: Taxable Income
Contrary to many people’s beliefs, the penalty provisions of the Patient Protection and Affordable Care Act are still law in 2018. Taxpayers without qualifying health insurance or an exemption will face the greater of a penalty of up to $695 per adult and $348 per child up to a max of $2,085 per return or 2.5 percent of income above the filing threshold up to a max of the cost of a bronze plan in the health insurance marketplace. Starting January 1, 2019, TCJA adjusts the penalty amounts to $0.
The tax for certain children who have unearned income, also known as the “Kiddie Tax,” has changed the tax rates used to determine the amount of tax owed. TCJA now requires a child’s unearned income over $2,100 to be taxed at tax rates normally reserved for trusts instead of adding the income to the parent’s return and taxing the income at the parent’s marginal rate. This actually simplifies the tax calculation since information from the parent’s return is not required to complete the child’s return, but the tax brackets for trust returns are very compact. The 37 percent rate for trusts starts at just $12,500 of taxable income (compared to $500,000 for single and $600,000 for married filing joint filing statuses), and while trusts also benefit from the reduced rate for long term capital gains and qualified dividends, the top preferential rate of 20 percent starts at just $12,700. Unearned income is all taxable income that isn’t earned income including taxable interest, dividends, rents, royalties, pension income, annuity income, IRA distributions (excluding Roth), and more.
Clients may encounter the Kiddie Tax when their children use assets in the child's name to pay for college. This can happen when grandparents have gifted or left assets to grandchildren to pay for their education. If the assets have large unrealized capital gains, then using the sale of the assets to pay for college may trigger the Kiddie Tax. One solution would be to encourage grandparents to establish a 529 savings account instead of passing on assets directly to the child.
529 college savings accounts are typically established with the parent or grandparent as the owner and a child or grandchild as the named beneficiary. These accounts provide for federal tax free growth and federal tax free distributions if the distribution is used to cover post secondary school-related expenses. Going forward, TCJA expanded eligible expenses for 529 accounts to include private or parochial tuition for K-12 education up to $10,000 per year per student.
Many grandparents were already using 529 accounts to move assets from their taxable estate prior to their death to avoid paying estate taxes. TCJA reduces the emphasis on estate size by increasing the estate tax basic exclusion to $11,180,000. The exclusion is also portable, so a surviving spouse could transfer assets worth $22,360,000 to their heirs without incurring estate tax. Expect more developments from the estate planning community as professionals advocate bringing assets back into the estate to benefit from the step up in cost basis while total assets are still below the estate tax exclusion.
Section Two: Definitions and Special Rules
These changes have been more widely discussed in the financial planning press and will be presented briefly here.
The standard deduction nearly doubles to $24,000 for married filing jointly, $12,000 for single, and $18,000 for head of household. Additions to the standard deduction for personswho are age 65+and/or blind is $1,300 for 2018.
Regarding itemized deductions, interest on home equity lines of credit are no longer deductible unless the loan is used to build, buy or improve the home secured by the loan. The itemized deduction for income, sales, and property taxes from state or local sources is capped at $10,000. Miscellaneous itemized deductions subject to the 2 percent AGI floor are no longer deductible. This includes unreimbursed employee business expenses (uniforms, travel reimbursed below the federal rate (54.5 cents per mile in 2018, work tools, etc.), tax preparation expenses, safe deposit box rental fees, hobby expenses, investment fees, and legal expenses. Congress did leave in place the above the line adjustment to income for unreimbursed business expenses for Reserve Component Service Members.
The child tax credit is increased from $1,000 to $2,000 of which $1,400 of the credit is refundable, allowing taxpayers without a tax liability to treat the credit just like withholding from a paycheck. The credit also has a much larger phaseout. For married filing jointly, the credit starts to phase out at $400,000 ($110,000 in 2017). For all other statuses, the phase out starts at $200,000 ($75,000 for singles in 2017). Dependents who don’t qualify for the child tax credit (mainly dependents older than 16 or dependents with individual tax identification numbers or ITINs) can get a $500 credit.
Personal and dependent exemptions are now $0.
The tax rates are lower and are wider. For example, the top rate is 37 percent (39.6% in 2017) on income over $500,000 ($418,400 in 2017) for the single filing status.
For divorce decrees issued after December 31, 2018, alimony received will no longer be included in taxable income, and alimony paid will no longer be deductible from taxable income. Divorce decrees issued before 2019 but modified after Dec 31st could choose to use the new tax treatment.
Expenses related to moving for employment are no longer deductible except for members of the armed forces making a permanent change of station (PCS). Moving expenses that are reimbursed by employers will now be included in income except for members of the armed forces making a permanent change of station (PCS).
The consumer price index (CPI) used to adjust tax deductions and credits will now be a chained CPI. The chained CPI recognizes that consumers will substitute for other goods when prices rise, thus lowering the amount of inflation actually measured. Tax rate brackets, the standard deduction, and other phaseouts will now adjust by smaller amounts. The Joint Committee of Taxation estimates that this change will bring in an additional $128 billion into the U.S. Treasury over the next 10 years.
TCJA made even more changes to the tax code that are not covered in this article; some changes, like the 20% deduction on the profits of pass through entities, are still being reviewed by the IRS and could remake the taxable entity decision. Look for more information in the latter half of 2018 as the IRS starts issuing guidance and draft forms for the 2018 tax year.
Andrew Zumwalt, MS, CFP®, is an Assistant Extension Professor, Associate State Specialist, & Co-Director of the Office for Financial Success at the University of Missouri in Columbia, MO. He can be reached at firstname.lastname@example.org.