This morning, President Trump signed the Tax Cuts and Jobs Act into law. Some of the coming changes are fairly simple to understand, such as the change in tax rates, while other aspects, such as the pass-through income deduction, will take longer to completely decipher.

This is a more in-depth look at the tax reform bill recently passed by the House and Senate. This is not an all-encompassing review of tax reform but covers the key items that could impact you or your business. In general, many of the items related to businesses are permanent changes to tax law where the individual changes often only apply from 2018 to 2025.

Overall, the highest tax bracket has been reduced from 39.6 percent to 37 percent. Historically, the married filing separately status would be subject to higher tax brackets than the single filing status but under the new law, the marriage penalty only remains for those in the top tax brackets. The long-term capital gain and qualified dividend tax brackets are set to remain at the same bracket levels, but the brackets are to be set based on income levels that differ from the income tax brackets.

Federal Individual Income Tax Bracket Chart
(Tax years after December 31, 2017 through December 31, 2025)

Long-Term Capital Gains and Qualified Dividend Tax Brackets
(Tax years after December 31, 2017 through December 31, 2025)

For individuals, the alternative minimum tax (AMT) remains. Instead of the anticipated removal, the exemption levels and phase out thresholds have been temporarily increased. The exemption has been increased to $109,400 for married taxpayers filing joint (half that amount for taxpayers filing under married filing separately), and $70,300 for other individual taxpayers. The phase-out thresholds have been increased to $1,000,000 for married filing joint taxpayers and to $500,000 for other individual taxpayers. These amounts are intended to be indexed for inflation. This applies to tax years 2018 through 2025.

This is an additional 3.8 percent tax that applies to investment income if certain thresholds have been reached. The current bill has not altered or adjusted this tax and it still remains.

The deduction for alimony payments is repealed alongside the treatment of alimony as part of gross income for divorce or separation instruments executed after December 31, 2018. In addition, it is indicated that this treatment applies to any modification to current instruments after the December 31, 2018, date. This is a permanent feature of the bill, so there is no expiration date for this treatment. This is meant to add parity between the treatment of spousal and child support and to simplify the tax code.

There were discussions to modify the current law; however, no changes were made under the final bill.

For tax years beginning after December 31, 2017, and ending prior to January 1, 2026, moving expenses are only deductible to members of the armed forces. Under the prior law, certain moving expenses were deductible for individuals.

For tax years following December 31, 2017, amounts that have been converted from a traditional IRA to a Roth IRA cannot be recharacterized to remove the Roth conversion. The conversions of funds within a traditional IRA to a Roth IRA is a taxable transaction. Under the prior law, amounts that were converted during a taxable year could be recharacterized by the due date of the tax return including extensions. This would allow a taxpayer whose Roth account lost money or if the tax from the conversion was higher than anticipated, to effectively change their mind before paying the tax due on the conversion.

These modifications are temporary. Unless noted otherwise, these provisions apply to tax years 2018 through 2025.

This was a highly anticipated change to simplify filings for most taxpayers. It’s estimated that about 120 million tax returns will be impacted. By almost doubling the standard deduction, itemizing will not be beneficial to many taxpayers. This is a temporary change that increases the standard deduction to $24,000 for married filing jointly, $18,000 for the head of household, and $12,000 for other individual filers. This provision is set to sunset for taxable years beginning after 2025.

For tax years starting after December 31, 2017, and before January 1, 2026, the personal exemption deduction has been suspended. Under current law, the maximum exemption deduction for each qualifying individual is $4,050.

The child tax credit will be temporarily increased from $1,000 to $2,000 per qualifying child. The maximum refundable credit for a qualifying child is $1,400. In addition, a new temporary $500 nonrefundable credit for qualifying dependents other than qualifying children will be granted. The importance of a credit’s refundability is that a nonrefundable credit can only offset taxes due. A refundable credit allows individuals who do not owe tax (or not much tax) to receive a benefit. The income phaseouts have been increased substantially for these credits to $400,000 for a joint return and $200,000 for all others. These provisions are set to apply to tax years beginning after December 31, 2017, and are set to expire for tax years beginning after December 31, 2025.

The healthcare mandate, the penalty for the lack of essential healthcare coverage, is being repealed for healthcare coverage status beginning after December 31, 2018. The premium tax credits or subsidies for taxpayers purchasing their healthcare coverage on the market were not discussed within the tax bill.

Federal Estate and Trust Income Tax Bracket Chart
(Tax years after December 31, 2017 through December 31, 2025)

For partnership interests transferred to a taxpayer in connection with the performance of services, the sale of such interests can be treated as a capital gain under both the new and prior law. This carried interest income remains a capital gain but will be subject to a longer holding period of three years in order to qualify for the long-term capital gain rate.

Under the prior law, if 50 percent or more of the total interest in the partnership’s capital or profits was sold or exchanged, a technical termination of the partnership would occur. The tax reform repealed the technical termination rules for tax years starting after December 31, 2017.

For sales and exchanges of a partnership interest on or after November 27, 2017, the gain or loss from the sale or exchange of a partnership interest is effectively connected with a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange. The bill requires that any gain or loss from the hypothetical asset sale by the partnership be allocated to interests in the partnership in the same manner as non-separately stated income and loss. Further, the bill requires the transferee of a partnership interest to withhold 10 percent of the amount realized on the sale or exchange of a partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation.

The partnership substantial built-in loss rules will be modified for transfers of interests after December 31, 2017, to include that a substantial built-in loss also exists if the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical disposition. If there is a substantial built-in loss, there is a mandatory step-down of the basis of the assets in the partnership.

For partnership tax years beginning after December 31, 2017, in determining the amount of a partner’s loss, the partner’s distributive shares under Code Sec. 702(a) of partnership charitable contributions and taxes paid or accrued to foreign countries or U.S. possessions will be taken into account.

Beginning January 1, 2018, the corporate tax rate will be changed to a flat 21 percent rate, replacing the current graduated rate structure. It removes the special tax rate for Personal Service Corporations (PSC) and corporate alternative minimum tax (AMT) is also repealed.

For tax years beginning after December 31, 2017, the Domestic Production Activities Deduction (DPAD) is repealed.

For tax years beginning after December 31, 2021, specified research or experimentation costs must be capitalized and amortized ratably over a five-year period.

For amounts paid or incurred after December 31, 2017, deductions for entertainment expenses will be disallowed. For amounts incurred and paid after December 31, 2017 and until December 31, 2025, the current 50 percent limit on meals will be expanded to include meals provided through an eating facility or cafeteria or for the convenience of the employer. After December 31, 2025, such amounts also become nondeductible.

The exclusion from including in an employee wages expenses associated with providing any qualified transportation fringe benefit related to the commuting between the employee’s residence and place of employment has been removed.

For amounts paid or incurred after December 31, 2017 for employee achievement awards, a definition of “tangible personal property” is now provided for what may be considered an excludible employee achievement award. Tangible personal property shall not include cash, cash equivalents, gift cards, gift coupons or gift certificates, vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items.

The bill adds changes to deductibility of certain fines and penalties, allowing the deductibility of payments made in either restitution (including remediation of property) or amounts required to come into compliance with any law that was violated or involved in the investigation or inquiry, that are identified in the court order or settlement agreement as restitution, remediation, or required to come into compliance. Further, amounts paid or incurred for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse which are subject to a nondisclosure agreement are no longer deductible.

For tax years beginning after December 31, 2017, executive compensation is limited to a $1 million deduction with no exceptions for commissions and performance-based compensation. Under a transition rule, the changes do not apply to any compensation under a written binding contract which was in effect on Nov. 2, 2017 and which was not modified in any material respect after that date.

For amounts paid or incurred on or after the enactment date, the deduction for state and local lobbying expenses is repealed.

For wages paid in tax years beginning after December 31, 2017 and before Jan. 1, 2020, the bill allows a general business credit of 12.5 percent of the wages paid to qualifying employees during any period in which the employees are on family and medical leave (FMLA) if the rate of payment is at least 50 percent of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25 percent) for each percentage point by which the rate of payment exceeds 50 percent. The maximum amount of family and medical leave that may be taken into account with respect to any employee for any taxable year is 12 weeks.

For tax years beginning after December 31, 2017, the 80 percent dividends received deduction for corporations that own more than 20 percent of the stock of another corporation is reduced to 65 percent, and the 70 percent dividends received deduction for corporations that own less than 20 percent of the stock of another corporation is reduced to 50 percent.

For net operating losses (NOLs) arising in tax years ending after December 31, 2017, the two-year carryback is repealed. Further, for tax years beginning after December 31, 2017, the NOL deduction is limited to 80 percent of taxable income. However, NOLs for farming business can still be carried back.

For tax years beginning after December 31, 2017, the bill will move the United States from a worldwide tax system to a participation exemption (territorial) system in which corporations will receive a 100 percent dividends received deduction (DRD) for dividends distributed from specified 10 percent owned foreign corporations (generally, any foreign corporation other than a passive foreign investment company that is not also a controlled foreign corporation (CFC)). Note that no foreign tax credit or deduction will be allowed for any taxes paid or accrued with respect to a dividend that qualifies. The DRD will be available only to C corporations that are not regulated investment companies (RICs) or real estate investment trusts (REITs).

In the case of the sale or exchange after Dec. 31, 2017, by a domestic corporation of stock in a foreign corporation held for one year or more, any amount received by the domestic corporation which is treated as a dividend for purposes of Code Sec. 1248, is treated as a dividend for purposes of applying the DRD provision described above.

For dividends received in tax years that begin after Dec. 31 2017, a domestic corporate shareholder’s adjusted basis in the stock of a “specified 10-percent owned foreign corporation” is reduced by the portion of any dividend received with respect to such stock from such foreign corporation that was not taxed by reason of a dividends received deduction in any tax year of such domestic corporation, but only for the purpose of determining losses on sales and exchanges of the foreign corporation’s stock.

To transition to the new system, the bill will impose a one-time deemed repatriation tax on unremitted earnings and profits to be paid over eight years. Illiquid assets will be taxed at eight percent, while cash and cash equivalents will be taxed at 15.5 percent.

With respect to base erosion payments paid or accrued in tax years that begin after Dec. 31, 2017, certain corporations with average annual gross receipts of at least $500 million are required to pay a tax. The bill establishes the Senate’s Base Erosion Anti-Abuse Tax (BEAT), with a tax rate of five percent in 2018 and 10 percent thereafter.

We will keep you updated on the Tax Cuts and Jobs Act as new information develops. Please feel free to contact your advisor with questions regarding your specific circumstances.