Many questions for which you must be looking for answers. Don’t worry – You are not alone. I am sure millions of professionals like you are thinking the same.
The most important point now – how will this impact your mid-year Tax Planning? While my best recommendation for you is to seek professional advice, here are nine ways the new law could impact your tax situation. Let’s discuss.
The GOODs
1. You are less likely to be hit with Alternative Minimum Tax (a.k.a. AMT)
Let us admit it – Alternative Minimum Tax (a.k.a. AMT) has been the tax enemy for many working professional couples for a long time now – especially for those with kids and with hefty property taxes.
The Tax Reform Bill, while not repealing AMT entirely, is likely to make this much better for middle-income families. It does so by increasing the AMT thresholds and by reducing deductions significantly. The net effect is unless your income is high like more than $500K or unless you have AMT elements such as hefty ISO (Incentive Stock Option) bargain elements, your AMT exposure is going to be limited.
2. If you have a pass-through business, you get a tax deduction on your Business income
Traditionally business income, such as the income that flows through from an S-Corp, partnership, an LLC or a Sole Prop business is taxed 100% and taxed at the rate of the individual income taxes of the person or the couple that file the return. While the character of the taxation remains the same, under the new law, the amount of business income that gets taxed in such situations gets a break – only 80% of the business income is taxed.
As you probably guessed, of course, this rule comes with few exceptions. Notable among them are: the 20% deduction is up to a limit of 50% of payroll in case of an S-Corp, the Phase-outs on the amounts of deductions for “specified service” businesses such as health, law, accounting, financial services, etc.,
3. 529 plan distributions can now be used tax-free for private elementary and secondary school expenses
A friend of mine once asked me if he could use the funds in his 529 accounts towards the costs for educating his 5th-grade daughter in a private institution. I told him, unfortunately, 529 distributions are not allowed tax-free for funding K-12 education. We then looked to see if my friend could save in a Coverdell account. However, his income was too high for the limits set to save in a Coverdell.
The Tax Reform Bill changes this.
Parents can now save in a 529 Plan and use the distributions tax-free to fund the private elementary or secondary school education of their children.
The BADs
1. Losing personal exemptions is costly for empty-nesters and couples with no children
Yes, that is correct! You cannot take personal exemptions in the new Bill. Assuming 2017 numbers, that means a family of 5 will lose $20,250 worth of exemptions, while a couple with no children will lose $8,100.
That said, families with children are compensated for this loss by an alternative provision – Increased child tax credit (doubled to $2,000 per child age 17 or under ) and increased income phase-out limits (Phase out begins at AGI $400,000 – up from current $110,000) to become eligible for the credit. Accordingly, the groups most affected by losing personal exemptions are empty-nesters like me or couples with no children.
2. Deductions for State Taxes and Property Taxes are limited in the Tax Reform Bill
The new Bill stipulates a deduction cap of $10,000 combined for Property taxes and State and Local Taxes (a.k.a. SALT). This is a significant change, especially if you live in a state where property and state taxes are high. In fact, when coupled with the increased standard deduction limits, this change will most likely cut down your ability to benefit from itemizing your deductions.
For example, a hypothetical couple with $20,000 property taxes, $10,000 Mortgage interest, and $12,000 state taxes can itemize and deduct from their income a total of $42,000 currently. Thanks to the new Bill, the same couple will have to settle for the $24,000 standard deduction as opposed to limited itemized deductions ($10,000, Mortgage interest + $10,000 capped Property and state taxes).
3. Moving Expenses deduction repealed, Employer reimbursed moving expenses will be taxable income to employees
Under current law, taxpayers are allowed to claim an above-the-line deduction for job-related moving expenses as long as requirements are met per IRS publication 521. The new tax law repeals this deduction beginning in 2018. So, you are out of luck to save money on taxes if you have an upcoming job-related move!
Secondly, if your employer pays for your move, some or all of such moving expenses used to be tax-free for you. Not anymore. Next year and beyond, reimbursed moving expenses will be fully taxable income to employees.
The UGLYs
1. You do not know whether the Tax Reform changes last beyond 2025
The new Tax Bill includes a “sunset” provision. What this means is that all the individual tax law changes are only available until the year 2025. Whether these changes will be made permanent by the, then Congress, is anybody’s guess.
For a significant change such as this, perhaps this is as fuzzy as it can get.
2. It is difficult to know whether your contribution to charity will be tax-free
For the last few years, whenever I contributed to charity, I knew I could get some tax reprieve. That is because charitable contributions are part of itemized deductions and my itemized deductions have always been more than my standard deduction. This is going to change now with the new Bill.
In order for me to know if my charitable contribution is going be tax-free, I need to see if I have enough itemized deductions that are more than my allowed standard deduction. If I do, I am likely to get a tax break for the contribution. If not, I am out of luck. The point is you do not know if your charitable contribution could get you a tax break until you do some tax calculations.
3. Now you wonder – Which is more beneficial? Staying as an Employee? Or becoming a contractor and get the 20% pass-through business deduction?
I have a good friend who always asked me what if any, is the financial benefit of becoming a contractor and doing the same job he has been doing as an employee. I could not offer him any valuable advice.
As a consequence of the Tax Reform, I now can suggest an option for my friend: Perhaps, he could set up a pass-through entity and let his pass-through firm contract his services to his previous employer. Assuming he becomes eligible after all the fine print in the pass-through provision, he could effectively save taxes on 20% of his income!
So, what do you think? Are you looking to understand how the Tax Reform Bill will impact your bottom line finances? If so, hope this article provided you some useful information. For a customized advice, please consult with your tax adviser. Good luck!
