Congress approved the Tax Cuts and Jobs Act on December 22, 2017, which provided for some of the most significant tax reform in recent memory. It affects nearly all taxpayers in every circumstance and could affect how you plan for your future as well. Over the next few posts, we will analyze a few of the changes in the tax law, but you should consult your financial professional and estate planning attorney to know how the new law affects your finances and your estate plan.
Tax Brackets and Tax Rates
Under the new tax law, most tax rates were reduced by 2-4 percent, and the brackets were generally broadened. This means that most individuals will see their taxes decrease, although some will see an increase. To illustrate that, here is a comparison between 2017 and 2018 tax rates and brackets for two common types of tax situations: single filers, and married filers filing jointly.
Table 1: Single
|10%||Up to $9,525||10%||Up to $9,525|
|15%||$9,525 - $38,700||12%||$9,525 - $38,700|
|25%||$38,700 - $93,700||22%||$38,700 - $82,500|
|28%||$93,700 - $195,450||24%||$82,500 - $157,500|
|33%||$195,450 - $424,950||32%||$157,500 - $200,000|
|35%||$424,950 - $426,700||35%||$200,000 - $500,000|
|39.6%||$426,700 or more||37%||$500,000 or more|
Table 2: Married, filing jointly
|10%||Up to $19,050||10%||Up to $19,050|
|15%||$19,050 - $77,400||12%||$19,050 - $77,400|
|25%||$77,400 - $156,150||22%||$77,400 - $165,000|
|28%||$156,150 - $237,950||24%||$165,000 - $315,000|
|33%||$237,950 - $424,950||32%||$315,000 - $400,000|
|35%||$424,950 - $480,050||35%||$400,000 - $600,000|
|39.6%||$480,050 or more||37%||$600,000 or more|
As you can see above, most Americans will see a reduction in their base tax rate, or they may even move to a lower tax bracket altogether. However, this is not true for everyone. A married couple, filing jointly in the 2017 tax year with a taxable income of $420,000 would have a base tax rate of 33%, whereas in the 2018 tax year, with the same income, their base tax rate would be 35%. Fortunately, this only affects a small group of taxpayers.
Taxes for Applicable Trusts Changed
Just like the tax rates and tax brackets for individuals were altered under the new tax law, tax rates and tax brackets for certain applicable trusts was also altered. Revocable, grantor-type trusts (like a Revocable Family Wealth Trust set up with your estate planning attorney) are not taxed; however, when certain irrevocable trusts generate income, such as interest, dividends, or rent, such trusts typically have to pay income tax at a different rate. Table 3 below compares the changes.
Table 3: Trusts and Estates
|15%||Up to $2,550||10%||Up to $2,550|
|25%||$2,550 - $6,000||24%||$2,550 - $9,150|
|28%||$6,000 - $9,150||35%||$9,150 - $12,500|
|33%||$9, 150 - $12,500||37%||$12,500 or more|
|39.6%||$12,500 or more|
The Trustee of an Irrevocable Sub-Trust, Family Wealth Preservation Trust, or another irrevocable trust, should take note of these changes when filing tax returns for the trust.
Even if a trust’s or taxpayer’s base tax rate might have gone down based on a previous year’s taxable income, however, a significant change in tax deductions in the new law could cause taxable income to increase, applying a higher tax bracket than expected.
In the next section, we will cover changes to deductions and how it might affect taxable income.
Deductions and Taxable Income
In the section above, we addressed the changes the Tax Cuts and Jobs Act of 2017 made to tax rates and brackets affecting most Americans. While the tax rate for many was lowered, the changes in deductions could actually cause some people with lower base tax rates to see an overall increase in their actual taxes.
Taxpayers are only taxed on their taxable income, which is usually their gross income, minus any deductions or exceptions. Contributions to tax-deferred retirement accounts are never part of taxable income for a tax year, but taxpayers may also deduct from their gross income other activities. These deductions may include donations to charitable organizations and medical expenses, among others.
Two changes significantly affected what taxpayers could deduct. First, the standard deduction for each type of taxpayer was doubled (for example, for a married couple filing jointly, they can take a standard deduction of $24,000 instead of $12,000). Second, many itemized deductions were eliminated including all miscellaneous deductions. This means that while taxpayers with less deductible activities will likely be benefited by the change, taxpayers who regularly itemized their deductions prior to 2018 may be affected adversely due to the reduction in activities that are deductible and an increase in the bar they must cross for those deductions to be beneficial.
Included in deductions that are no longer available are employee business expenses, tax preparation fees, and personal casualty and theft losses. Moreover, deductions for state income tax and state real estate tax are limited to $10,000.
Penalty for Failure to Obtain Health Insurance Removed
The so-called “individual mandate” or tax penalty for those who did not maintain health insurance that qualified under the Affordable Care Act during a tax year has been removed. There is no longer any penalty for failing to purchase health insurance.
Additional Deduction for Small Business Owners
Taxpayers who are self-employed or own a qualifying small business like an S Corporation can now deduct up to 20% of their income from that business. This can be especially beneficial for small business owners who may have seen other itemized deductions removed or limited.
In the next section, we discuss some of the bigger changes to the taxation of businesses and how it could affect business owners and shareholders.
Corporate Tax Changes
In the section above, we discussed the changes in deductions and how its effect on taxable income could affect your actual taxes owed. Many of these individual changes, however, are set to expire without renewal by Congress. Many of the corporate tax changes, however, do not come with an expiration date. The corporate tax rate has been reduced permanently to a flat 21%. This is a significant reduction from the previous graduated tax rates, taxing income over $10,000,000 at 35%. Moreover, because this change is permanent and not set to expire, it is unlikely to be changed anytime soon.
Other Changes in Corporate Taxation
- Short-lived capital investments can be immediately expensed for five years, increasing the cap from $500,000 to $1,000,000.
- Net operating loss carrybacks have been eliminated, and carryforwards have been reduced to 80 percent of taxable income.
- The corporate alternative minimum tax was also eliminated, which could lead to a significant change for those who were used to using it.
Different Corporate Fiscal Calendars Could Lead to Blended Tax Rates
The tax changes enacted in the Tax Cuts and Jobs Act of 2017 went into effect on January 1, 2018, including the reduction of the Corporate tax rate to 21%. Many corporations, however, begin and end their fiscal years at different points during the year. This means that part of the year would be taxed at the old rate, and part would be taxed under the new law. Needless to say, meticulous recordkeeping could result in significant savings.
In our next section, we discuss changes to Gift and Estate Taxes, and how certain Estate Planning tools can help you maximize the benefit offered in the law.
Estate and Gift Tax Changes
In the section above, we discussed changed to the taxation of businesses, now in our final section, we talk about the estate and gift tax changes. The exclusion amount for estate and gift tax has been increasing under federal law for quite some time, and the Tax Cuts and Jobs Act of 2017 was no exception. The exclusion amount for estate and gift tax as calculated upon a person’s passing has been doubled under the new law, adjusted for inflation. This means that a person can pass up to $11,180,000 to their heirs or beneficiaries without any tax consequences upon their death. This is a substantial increase from the 2017 tax year’s exemption of $5,450,000.
During their lifetime, a person can also pass up to $15,000 per year, per person without any tax consequences. Gifts over $15,000 require a Gift Tax Return to be filed, and counts against the personal exemption. For example, if a single parent gave their daughter a piece of property worth $515,000 during their lifetime, as a gift, then upon the parent’s death, the estate could only pass $10,680,000 to their heirs or beneficiaries without tax. This is an increase from 2017 in which only $14,000 was allowed to be gifted per person, per year, without tax consequences.
State Estate Taxes Still Apply
If the state in which you are domiciled at your death has its own estate tax, it remains unaffected by this federal law. In Minnesota, for instance, an estate must pay estate tax if it exceeds $2,400,000 (increasing by $300,000 per year until 2020).
Certain Trusts Can Provide Tax Benefits
If an estate is worth more than $11,180,000, or worth more than the state’s separate estate tax exclusion amount, there are still estate planning techniques that can reduce or eliminate tax liability. For instance, a married couple living in Minnesota with a Revocable Family Wealth Trust can double both the federal and state estate tax exclusion with flexibility and ease; allowing up to $22,360,000 to pass without any federal estate tax and up to $4,800,000 to pass without any tax due to Minnesota (as of 2018).
The IRS advises all taxpayers to check whether their withholding is still appropriate given the new law. They have designed an online questionnaire to guide taxpayers through this check, called the Withholding Calculator: https://apps.irs.gov/app/withholdingcalculator/
The IRS has also released a number of articles, comments, videos, and other resources on the new law, which can be found here: https://www.irs.gov/newsroom/tax-reform