On November 2nd, the U.S. House of Representatives proposed a comprehensive tax reform bill known as The Tax Cuts and Jobs Act (“Bill”) which it hopes will pass the House by Thanksgiving. However, the Senate is planning to release its own tax reform bill later this week. Some of the highlights of the House bill are detailed below. Most of the proposed changes would take effect for the 2018 tax year.
Proposed Changes for Individual Taxpayer
Changes to Rates and Brackets – There are significant proposed changes to the individual income tax rates and brackets, including the elimination of the Alternative Minimum Tax, which has affected an increasing number of the taxpayers in recent years. The Bill would reduce the current seven tax brackets to four. The proposed brackets are below:
- Increased Standard Deduction – The standard deduction would increase from $6,350 to $12,000 for single taxpayers and from $12,700 to $24,000 for married taxpayers filing jointly, but in doing so, the personal exemption of $4,050 each for the taxpayer and spouse would be eliminated.
- Elimination of Limitation on Itemized Deductions – The Bill would repeal the limitation on itemized deductions based on a taxpayer’s adjusted gross income.
- Increased Child Tax Credit – The child tax credit would increase to $1,600 from $1,000 for each qualifying child. The Bill would also increase the income levels at which the credit phases out from $75,000 for single taxpayers to $115,000 and from $110,000 to $230,000 for married taxpayers filing jointly. (As a trade-off for the increased child tax credit, the $4,050 per child exemption would be eliminated.)
- New Non-Child Dependent Credit – A new $300 credit for each non-child dependent and parent would be in place for the next five years beginning with the 2018 tax year.
- New Family Flexibility Credit – Another new credit known as the “family flexibility credit” would be allowed with respect to the taxpayer (each spouse in the case of a joint return) who is neither a child nor a non-child dependent. This credit would only be in place for the next five years beginning with the 2018 tax year. More details are to come on this credit.
- Changes to Education Credits – The Bill would provide for an “enhanced” American Opportunity Tax Credit (AOTC) but would eliminate the Lifetime Learning Credit. The revised AOTC would provide for the same annual credit limit as the current law but would apply for five years of post-secondary education with the credit for the fifth year available at half the rate as the first four years.
- Deduction for Property Taxes – Although they would no longer be able to deduct state and local income taxes or sales taxes, individual taxpayers could still deduct up to $10,000 of real property taxes if they itemize.
- Changes for Home Mortgage Interest – Taxpayers are currently able to deduct home mortgage interest up to the first $1 million of the home loan. This Bill would decrease that eligible loan amount to $500,000 for mortgages obtained after November 2, 2017. The Bill would also limit taxpayers to one qualified residence.
- Gain from Sale of Primary Residence – The Bill would require that, in order to exclude gain from the sale of a principal residence (up to $500,000 for joint filers, $250,000 for others), a taxpayer would have to own and use a home as their primary residence for 5 out of the previous 8 years (as opposed to 2 out of 5 years under current law). In addition, the exclusion could only be used once every 5 years, and it would be phased out at higher income levels.
The following would be eliminated in this Bill for individual income tax returns:
1. State and Local Income Tax, including sales taxes
2. Personal Exemptions
3. Medical Expense Deductions
4. Property and Casualty Losses Deduction
5. Student Loan Interest Deduction
6. Moving Expenses Deduction
7. Tuition and Fees Deduction
8. Alimony Payment Deduction (possible exception applies)
9. Deduction for Unreimbursed Employee Business Expenses
10. Tax Preparation Deduction
- Net Operating Losses – The Bill would allow net operating losses to be carried forward indefinitely, but would generally eliminate the ability to carry back losses to prior years to offset previous income and receive refunds of taxes previously paid. The Bill would also mandate that no more than 90% of a taxpayer’s income for a given year could be offset by a net operating loss that has been carried forward.
- Estate Tax – The current estate tax is effective for estates worth $5.49 million or more, but this Bill would increase that to apply only to estates worth $10 million or more. The estate tax would be phased out over the next six years, but the step-up in basis rules would be retained.
- Gift Tax – The Bill would retain a basic exclusion amount of $10 million and an annual exclusion of $15,000 (for 2018), as indexed for inflation. It would also lower the top rate to 35% for gifts made after December 31, 2023.
Proposed Changes for Businesses and Business Owner
- 25% “Business Income” Rate – The Bill would limit the tax rate applicable to business profits from pass-through entities to 25% for businesses other than professional service entities. However, for active business owners, a default 70-30 wages-to-profits ratio that would tax 70% of the business income at individual rates and 30% at the 25% pass-through rate would apply unless a specified formula is elected and used for five years.
- Expensing Rules for Equipment Purchases – The Bill would increase bonus depreciation from the current 50% deduction to a full 100% write-off. Property would be eligible for this immediate expensing if it is the taxpayer’s first use, repealing the current requirement that the original use of the property begin with the taxpayer. The Bill would also increase the Section 179 expensing from the current $500,000 annual expensing limit to $5,000,000 and the $2,000,000 annual limit for property placed in service (the dollar amount of purchases at which expensing limits are reduced) to $20,000,000 of property in service.
- C-Corporation Rate Changes – The top corporate tax rate for C-corporations is currently 35%. The proposed top corporate tax rates would be 25% for personal service corporations (i.e. medical, legal, or accounting professions) and 20% for all other corporations.
- Repeal of the Domestic Production Activities Deduction (DPAD) – This Bill would repeal the deduction allowed on income that is attributed to domestic production activities which has been used for years by those in industries such as manufacturing, construction, and professional services which serve the construction industry.
This Bill is currently in the proposal process and has not been finalized or signed into law at this time. We at MNMW want to keep our clients and business partners aware of potential changes, and will make sure to share any updates as they occur. Once the final Tax Bill has been signed into law we will share additional details at that time.