The Tax Cuts and Jobs Act (The Act) has been characterized as the first major reform of the Internal Revenue Code in 31 years. The legislation slashes the top corporate tax rate to 21%, lowers the top marginal rate for individual taxpayers to 37%, eliminates or scales back several popular deductions, reduces taxes on business income earned by pass-through businesses, doubles the estate tax exemption, and substantially enhances immediate expensing of capital investments. (See our March 1 newsletter for information on pass through income tax.)
KEY INDIVIDUAL PROVISIONS
- Tax rates The new law imposes a new tax rate structure with seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The top rate was reduced from 39.6% to 37% and applies to taxable income above $500,000 for single taxpayers, and $600,000 for married couples filing jointly. The rates applicable to net capital gains and qualified dividends were not changed.
- Standard deduction The new law increases the standard deduction to $24,000 for joint filers, $18,000 for heads of household, and $12,000 for singles and married taxpayers filing separately. Given these increases, many taxpayers will no longer be itemizing deductions. These figures will be indexed for inflation after 2018.
- Exemptions The new law suspends the deduction for personal exemptions. Thus, starting in 2018, taxpayers can no longer claim personal or dependency exemptions. The rules for withholding income tax on wages will be adjusted to reflect this change, but IRS was given the discretion to leave the withholding unchanged for 2018.
- Alimony For divorces and legal separations that are executed (i.e., that come into legal existence due to a court order) after 2018, the alimony-paying spouse won’t be able to deduct the payments, and the alimony-receiving spouse doesn’t include them in gross income or pay federal income tax on them. Under a special rule, if taxpayers have an existing (pre-2019) divorce or separation decree, and they have that agreement legally modified, then the new rules don’t apply to that modified decree, unless the modification expressly provides that the new rules are to apply.
- Miscellaneous itemized deductions There is no longer a deduction for miscellaneous itemized deductions which were formerly deductible to the extent they exceeded 2% of adjusted gross income. This category included items such as tax preparation costs, investment expenses, union dues, and unreimbursed employee expenses.
- Overall limitation on itemized deductions The new law suspends the overall limitation on itemized deductions that formerly applied to taxpayers whose adjusted gross income exceeded specified thresholds. The itemized deductions of such taxpayers were reduced by 3% of the amount by which AGI exceeded the applicable threshold, but the reduction could not exceed 80% of the total itemized deductions, and certain items were exempt from the limitation.
- Medical expenses Under the new law, for 2017 and 2018, medical expenses are deductible to the extent they exceed 7.5% of adjusted gross income for all taxpayers. Previously, the AGI “floor” was 10% for most taxpayers.
- State and local taxes The itemized deduction for state and local income and property taxes is limited to a total of $10,000 starting in 2018.
- Mortgage interest Under the new law, mortgage interest on loans used to acquire a principal residence and a second home is only deductible on debt up to $750,000 (down from $1 million), starting with homes purchased in 2018. And there is no longer any deduction for interest on home equity loans, regardless of when the debt was incurred.
- Charitable contribution base increase Under prior law, the deduction for most types of charitable contributions was (generally) limited to 50% of an individual’s adjusted gross income. The new law increases the contribution-base percentage limit for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, for deductions of cash contributions by individuals to “50% charities” from 50% to 60%.