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Major Tax Reform Enacted:
What You Need to Know

For the first time since Ronald Reagan's 1986 Tax Reform Act, major tax reform has been enacted. Republican lawmakers worked until Friday, Dec. 15 on blending the House and Senate proposals into how the law currently stands. After some minor changes due to parliamentary exceptions raised by the Democrats, the Bill cleared both the House and Senate on Dec. 20 and is expected to be signed into law by President Trump.

The overarching goal of Republican lawmakers was to simplify the tax code by lowering rates and eliminating certain deductions. To that effect, it reduced the corporate rate from 35% to 21% and reduced the top individual tax rate from 39.6% to 37%.

Effect on Individuals and Families

Marginal Tax Rates and AMT

In the end, the structure of the tax brackets most closely mirrored the Senate's proposal. Seven different brackets remain, as opposed to the House's original proposal of four. Marginal Tax Rates saw an adjustment downward, while the dollar spread for associated income brackets saw varied incremental increases.

Much like the Marginal Tax Rates, the individual Alternative Minimum Tax (AMT) ended up looking like the Senate's proposal. The individual AMT was not eliminated; instead, the exemption amounts were increased along with significant increases to corresponding phase-out levels. Currently, for an individual filer, $55,400 is exempted from AMT with a 25-cent phase-out for every dollar of income earned over $123,100. For a married couple filing jointly, $86,200 is exempted from AMT with the phase-out beginning at $164,100. Under the new tax Bill, the exemption amounts are going to $70,300 for individuals and $109,400 for married taxpayers filing jointly, with corresponding phase-outs at $500,000 and $1,000,000.



Standard Deduction, Personal Exemptions, and Child Tax Credits

Currently 70% of tax returns are filed using the standard deduction as opposed to itemizing. The Tax Policy Center, when analyzing a previous House Republican tax plan, estimated that 84% of itemized filers would be better off taking the standard deduction if it was doubled. This is what the Bill attempted to do: push more filers into simple standard deduction returns by increasing the standard deduction amount and removing or lowering other tax breaks currently in existence.

To this end, the current tax Bill nearly doubles the standard deduction, from $6,500 to $12,000 for an individual and from $13,000 to $24,000 for a married couple. Simultaneously, the Bill eliminates personal exemption amounts currently available based on the number of dependents living in a taxpayer's household. To make up for the removal of the personal exemption amounts, the Child Tax Credit amount is being raised from $1,000 to $2,000, with $1,400 of that being fully refundable, thanks to the last-minute demands of Sen. Marco Rubio.

State and Local Taxes

Originally both the House and Senate proposals were going to allow a capped amount of real estate taxes to be deducted with no deduction allowed for income taxes. After significant lobbying by states with high income tax levels, the Bill acquiesces by allowing state and local income taxes to be included in the capped amount. Filers will now be able to deduct the summation of their property and income or sales taxes, subject to the $10,000 cap. This could potentially hurt filers in high income tax, high property tax states, such as Illinois.
*Note the latest legislation specifically addresses pre-paying taxes owed in 2018 or later as not deductible in 2017.

Mortgage Interest Deduction

Homeowners with new mortgages on first or second homes will be able to deduct their mortgage interest on loan amounts up to $750,000. This is a decrease from the current amount of $1,000,000. However, the Bill allows for all homeowners with existing mortgages to grandfather in their current mortgage interest deduction amount.

Medical Expenses

The House Bill originally called for the elimination of the deductibility of medical expenses. Like several other provisions, the Senate's proposal won the day, and medical expenses continue to be deductible for amounts exceeding the threshold. As a nice benefit to filers with medical bills in 2017 and 2018, the Bill temporarily lowers the threshold amount necessary to 7.5% from 10%. Starting in 2019 the threshold returns to 10% where it will remain.

Charitable Contributions

Taxpayers can continue to donate to their local church, charity, or community organization and receive a tax deduction.

Student Loans and Graduate Tuition Waivers

Again, the House Bill called for the end of deductibility of student loan interest and no longer exempting the value of reduced graduate school tuition from tax treatment, but the Senate version won out and the tax treatment for college students remains as it was before.

401(k) and IRA

In the weeks leading up to the House presenting its proposal, rumors regarding 401(k) and IRA contribution amounts were swirling. The rumors ranged from limiting the contribution amounts to $2,000 all the way to doubling the current amounts. The current Bill leaves the contribution limitations exactly where they would have been had nothing been passed.

Determining Gain on Investment Sale

One provision that was not included from the Senate's bill was the requirement to compute taxable gain on the sale of investments by using the first-in-first-out (FIFO) method. Investors are still able to minimize their taxable gain by selecting which lots to sell in a certain transaction.

Estate Tax and Generation Skipping Tax

Initially the House proposal regarding "Death Taxes" was to immediately double the exemption amount, index it to inflationary increases, and eventually do away with it completely. The final Bill does immediately double the exemption amount from $5.6 to $11.2 million per individual, allowing a married couple to now pass $22.4 million to their heirs without a tax implication. However, although indexed for inflationary increases, the Estate and Generation Skipping Taxes are here to stay.

Obamacare Individual Mandate

Although the Bill does not get rid of the Individual Mandate that a taxpayer must buy a qualifying health insurance plan or face a tax penalty, the tax penalty has been reduced to zero, essentially negating the mandate.

Investment Fees

Currently, taxpayers are able to deduct fees paid to an investment advisor if those fees exceed 2% of their income. The new Bill does not allow for any deduction of fees paid to an investment advisor.

Divorce

In the past, alimony payments made from one ex-spouse to another were deductible by the payer and counted as income for the receiver. Starting with any divorce agreement in 2019, alimony amounts will not be deductible by the paying ex-spouse and will similarly not be counted as income for the receiving ex-spouse.

Moving Expenses

Under the current tax code, if you needed to relocate to a new job, as long as it was more than 50 miles away from your previous employment, you were able to deduct the associated moving expenses. The finalized Bill does not allow for deducting moving expenses related to a change in work in any circumstance, with a special carve-out for members of our military.

Tax Preparation

Taxpayers will no longer be able to deduct the expenses they incur for the preparation of their tax returns under the Bill. This includes accountant fees, software fees, and the fee to file your forms electronically.

Effect on Corporate Filers

Corporate Tax Rate

Far and away the largest change made by the Bill is the lowering of the Corporate Tax Rate from 35% to 21%. Originally the President had said he wanted the rate as low as 15%, and both the House and Senate initially shot for 20%, but in the end 21% was necessary to allow for some current deductions to remain available.

Pass Through Entities

The Bill allows for a 20% tax deduction applicable to the first $315,000 of joint income earned by all businesses organized as S corporations, partnerships, LLCs, and sole proprietorships.

Corporate AMT

Much to the delight of corporate tax return filers everywhere, the Bill totally eliminates the Corporate Alternative Minimum Tax.

Capital Expenditures

Businesses will be able to write off the full cost of any new equipment they purchase to improve operations or enhance the skills of their workers. This could have huge implications.

So What Does it All Mean?

The Bill probably does not simplify the Tax Code in a way that makes it truly simple. What does happen is that an even larger majority of individuals and families will be opting for the standard deduction instead of itemizing. Lower individual tax rates should hopefully lead to more money remaining in the individual's hands, which is then able to be spent on goods and services. There is a huge chance that the drastic lowering of the corporate tax rate and simultaneous unlimited increase on the ability to expense capital expenditures could lead to re-patriotization of overseas earnings by U.S. corporations. If that happens, it could be a massive kick-start to the economy. Whether this occurs and helps pay for the $1.46 trillion projected cost of the Tax Bill remains to be seen.

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