INVESTOR’S BUSINESS DAILY
By Paul Katzeff
Wondering what’s in the new U.S. tax bill for you? After early Wednesday’s Senate approval, the bill heads back to the House for re-approval. Meanwhile, here are six highlights with big impacts for individual taxpayers, barring last-minute legislative tweaks.
President Trump is expected to sign the massive tax rewrite before Christmas. But if the hurricane of competing headlines - some praising the bill, others pillorying it - have left you wondering whether you gain or lose from the bill, here’s an explanation of me key rules changes that impact individuals.
The crux of the changes: Congress has trimmed or eliminated many deductions. For your own tax planning, it is essential to know what deductions will be gone outright starting Jan. 1 for 2018 tax returns. It is also crucial to know which deductions have been changed. Here’s a rundown of changes with widespread impact.
- Standard deduction: the standard deduction will be nearly doubled. That’s to soften the blow of the elimination of personal exemptions.
The personal exemption is a $4,050 deduction that each taxpayer can take for him- or herself plus for each of their dependents. That will be totally gone starting next year. In its place, the standard deduction - which taxpayers can take instead of itemizing - rises to $24,000 from this year’s $13,000 for marrieds filing jointly and it climbs to $12,000 for singles.
- Mortgage interest deduction: going forward, the deduction will be limited to interest on the first $750,000 you borrow. That’s down from the current rule, which lets you deduct interest on the first $1 million of debt.
Existing loan debt would be grandfathered in. The new, lower deduction will apply to loans taken after Dec. 15, 2017.
Interest on loans for a second home will still be allowed. But you’ll only be able to deduct the first $750,000 of interest on the combined value of loans on your first and second homes.
- Tax rates and brackets: the bill retains the current seven brackets. But rates and income levels to which they apply will change.
Notably, the top rate drops to 37% from the current 39.6%. And the 37% won’t kick in until your taxable income hits $600,000, up from the current $480,050 for marrieds filing jointly. For singles, the threshold rises to $500,000, up from $426,700.
The new 35% bracket will have lower starting points: $400,000 vs. the current $424,950 for marrieds filing jointly, and for singles $200,000 vs. today’s $424,950.
- Pass-through business income: taxes on partnerships, S corporations and sole proprietorships will be calculated by exempting 20% of all net business taxable income that the business earns, with limits.
One of those limits caps the 20% exemption at the greater of 50% of the wages paid to employees and reported on a W-2, or 25% of those wages plus 2.5% of the cost of depreciable property owned by the business, according to Tim Steffen of Baird Private Wealth Management.
That’s the basic new rule. But a slew of limits apply. And the new rules expire after 2025. After that, today’s rules concerning taxation based on standard individual tax rates and brackets would reapply.
As a result of this change (and the new lower tax rate on C corporations), the decision on how to structure a business becomes much more complicated, Baird’s Steffen said in a report to clients. “Prior to this proposal, pass-through entities were generally viewed as the most tax-efficient structure,” he said. “They would now have a top effective tax rate of 29.6% - still less than C corporations. However, the limitations put on qualifying for the 20% exemption may have some pass-through businesses reconsider becoming a C corporation.”
- Recharacterization of a Roth IRA conversion: The bill kills the ability to do a recharacterization for tax years after Dec. 31.
Under current law, you can recharacterize a Roth IRA conversion from a traditional IRA for any given tax year if you do it by the following Oct. 15. People typically recharacterize, or undo their conversion, if a stock market dip after the conversion means you’d be paying a capital gains tax based on a much higher value for the assets than they’re worth after the market decline.
Investors often recharacterize with an eye to converting again later on, so their cap-gains tax will be lower, based on the post-decline valuation.
- State and local taxes: an individual’s itemized deduction for state income taxes and local property taxes will be capped at a total of $10,000.
However, property and sales taxes paid by a business such as a sole proprietorship or on rental property will remain fully deductible.
While Congress has wiped out the use of recharacterizations of Roth IRA conversions - a step that many investors took to lower their cap-gains taxes - Congress so far has declined to limit or kill the deductibility of contributions to traditional 401(k) accounts or traditional IRAs.
Certain congressmen had talked about killing that deduction on 401(k)s as a way to raise taxes to offset lost revenue caused by many other tax reductions. Eliminating that deduction would have turned all or part of traditional 401(k) accounts into Roth 401(k) accounts, which give account owners no upfront tax deduction on contributions, but allow their earnings to grow tax-free and make eligible withdrawals tax-free.
“There is no proposal so far for Rothification of retirement accounts,” said David Musto, president of Ascensus, a retirement and college savings services provider. “So this is a case of no news is good news for retirement savers in general.”
Baird’s Steffen bottom lines the changes this way: “The general rules of thumb still applies, especially this year - defer income and accelerate deductions. There are always exceptions to that advice, but this year it will make more sense than ever. In terms of capital gains, since there’s no substantive changes to the capital gain tax rules, maybe push those sales off to 2018 in order to delay the tax bill a while longer. Of course there’s an investment risk to doing that, but if you’re OK with the risk then delaying the tax makes some sense.”
2017 state income and local property taxes are the sorts of expenses you should consider paying this year even if they are not due until 2018. That way you can deduct them being limited to the $10,000 cap, Steffen says.
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