The tax bills that have made it through the House and the Senate are now in the process of reconciliation and a final version of the bill is expected to be signed before the end of the year. There are a LOT of changes in the current tax law that will be affecting us next year and so the really big question is whether you are ready for this.
As an aside, do not be fooled by headlines and statements calling this tax reform. Just as with health care, it is not really true reform but rather change. We know that change is often difficult. Depending on your personal situation, the new tax law will be a blessing or a pain or perhaps both. Also, do not believe everything you see or hear about the proposed tax law changes: there are still changes being made as of this writing and far too many opinion writers commenting on the legislation are trying to politicize this legislation for their own purposes whether on the right or the left.
Let’s look at a few different areas to see how you may be affected. We will focus on those items which apply to individual taxpayers and changes to corporate taxes will not be addressed.
First, with regard to saving for retirement, little has changed. Your contributions to tax deferred and tax advantaged accounts are not impacted. Non-qualified deferred compensation will now be considered taxable once any substantial risk of forfeiture has ended and not necessarily when actually paid. Note that more care with Roth conversions will be necessary since the ability to recharacterize such conversions (so as to undo them) will no longer be permitted.
It appears that most of the seven tax brackets will be adjusted for marginal rates a couple of percentage points lower than they are at present which for most taxpayers will mean a lower tax liability. However, at the top of the income pyramid, for single filers with more than $500,000 in income and married filers with over $600,000 in income, the top rate will drop to 37% from its current 39.6%. This seems to be a significant tax cut at the top level, both raising the income level subject that highest bracket while lowering the rate.
Much discussion and attention has been given to the proposed changes with respect to deductions from income. First, in a move that should simplify filing for many taxpayers, the standard deduction is to be nearly doubled – to $12,000 for single filers and $24,000 for married filers. This should eliminate the need to itemize deductions for many taxpayers, which may be a positive thing, particularly given the limitation and elimination of many common deductions in the new tax law. The additional portion of the deduction available for the blind or those taxpayers over age 65 will remain in place at $1,250.
However, other types of common deductions are changing. Deductible mortgage interest will be limited to a maximum mortgage value of $750,000 instead of the current $1,000,000. Deductible state and local taxes – income or sales, property – will be limited to a maximum of $10,000 unlike current law which allows full deductibility for all but the highest earners. The deduction for qualified medical expenses, currently limited to those expenses which exceed ten percent of adjusted gross income, will be increased to allow deduction of expenses above seven and one-half percent of adjusted gross income, an improvement for the taxpayer with such expenses. Finally, the deduction for miscellaneous expenses – such as investment advisory fees – goes away entirely as will the deduction for alimony paid and the deduction for moving expenses. These changes may have substantial impact for some taxpayers.
Unlike the deductions, children have been subject to a variety of income adjustments. First, the personal exemption of $4,050 available to all taxpayers, and including their dependent children, is eliminated under the new law. This means the loss of a substantial amount of protection for taxpayers with children. Instead of the four thousand plus dollars for each person in the household protected from taxation, there will be no benefit. However, some benefit may be derived by taxpayers from the doubling of the child tax credit from $1,000 to $2,000 under the new law. That tax credit can shelter a significant amount of income and is an improvement on prior law. It may be interesting to note that the Kiddie Tax will no longer be charged at the parent’s marginal tax rate but at the trust tax rate, which may be higher for larger accounts.
If you have been subject to the AMT, you may be glad to know that the exemption amounts have increased somewhat under the new law, with almost a $20,000 increase for single filers and over $30,000 increase for married filers. In addition, the phase-out threshold will be increased.
Another big change in the tax law, one which should benefit many small business owners, is the creation of a deduction for 20% of pass-through income of some small businesses. This will benefit joint filers with business income below $315,000 and single filers with business income below $157,500. Note that this does not apply to many service businesses and will not be attractive to larger, higher income businesses.
As you can see, the new tax law will change how we approach doing our taxes and setting our withholding amounts. It will take time before all of the changes are fully understood and planning catches up to the law. We can’t forget that many of these provisions will terminate – sunset – in 2025 so we also know that these changes are not permanent. And the fact that some proposed changes did not make it into the final bill suggests that more changes are possible in the future.
George Chamberlin & Mentor RIA Consulting © 2017