By Alistair M. Nevius, J.D.
November 3, 2017
The Tax Cuts and Jobs Act, H.R. 1, released by the House Ways and Means Committee on Thursday, contains a large number of provisions. Many of these would affect individual taxpayers if the bill is enacted.
These provisions include new tax rates and a larger standard deduction and the repeal of many deductions, credits, and exclusions that are available under current law. The bill would also repeal the estate and generation-skipping transfer (GST) taxes and the alternative minimum tax (AMT).
Here is an in-depth look at the bill’s provisions that would affect individuals. The bill is expected to be marked up in the House Ways and Means Committee on Monday.
Under the bill, individuals would be subject to four tax rates, instead of the current seven: 12%, 25%, 35%, and 39.6%, effective for tax years after 2017. The rates under the bill would be as follows:
Married taxpayers filing jointly and surviving spouses
Married taxpayer filing separately
Heads of household
Estates and trusts
The starting points for each bracket would be adjusted for inflation for years after 2018. The 12% rate would be phased out for taxpayers with high incomes (over $1.2 million for joint filers and surviving spouses, over $1 million for other individuals).
Taxpayers would not have a return-filing obligation in any year that their gross income does not exceed the new standard deduction amount.
Special brackets would apply for certain children with unearned income.
Capital gains below $77,200 for married taxpayers filing jointly, $38,600 for married taxpayers filing separately and single taxpayers, $51,700 for heads of household, and $2,600 for trusts and estates will be taxed at 0%.
Capital gains below $479,000 for married taxpayers filing jointly, $239,500 for married taxpayers filing separately, $425,800 for single taxpayers, $452,400 for heads of household, and $12,700 for trusts and estates will be taxed at 15%. These amounts will be adjusted for inflation after 2018.
The standard deduction would increase from $6,350 to $12,200 for single taxpayers and from $12,700 to $24,400 for married couples filing jointly, effective for tax years after 2017. Single filers with at least one qualifying child would get an $18,300 standard deduction. These amounts will be adjusted for inflation after 2019.
The deduction for personal exemptions, currently at $4,050 per person, would be repealed after 2017.
Under a new Sec. 4, a portion of business income distributed by a passthrough entity, such as a partnership, S corporation, or limited liability company, would be taxed at a maximum rate of 25%, instead of at ordinary individual income tax rates, effective for tax years after 2017. The rest of the business’s passthrough income would be treated as compensation and would be subject to ordinary individual tax rates.
Income from passive activities would be taxed entirely at the 25% rate.
Business owners receiving income from active business activities (including wages) would determine the amount of their business income eligible for the 25% rate by reference to the “capital percentage” of their net income from the activity. As a safe harbor, owners would be able to elect to apply a capital percentage of 30% to their business income—meaning 30% would be eligible for the 25% rate, and the other 70% would be taxed at ordinary income rates.
However, owners will also be allowed to make a facts-and-circumstances determination of their capital percentage if that will result in a capital percentage greater than 30%. The formula would be based on the federal short-term rate plus 7 percentage points multiplied by the owner’s capital investment in the business. An owner who chooses to use this formula would be required to use it for a five-year period.
Income subject to preferential rates, such as net capital gains and qualified dividend income, would be excluded from the determination of the owner’s capital percentage and would not be recharacterized as business income. Certain other investment income subject to ordinary income tax rates, such as short-term capital gains, would also be ineligible for recharacterization as business income.
To prevent owners from recharacterizing wages as business income, the capital percentage would be limited if actual wages or guaranteed payments exceed the owner’s otherwise applicable capital percentage.
For specified service activities, the applicable percentage of business income that would be eligible for the 25% rate would be zero. These activities are those defined in Sec. 1202(e)(3)(A) (any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees), including investing, trading, or dealing in securities, partnership interests, or commodities.
The overall limitation of itemized deductions under Sec. 68 would be repealed, effective for tax years beginning after 2017.
However, many deductions would be repealed, effective for tax years beginning after 2017, including:
- The Sec. 213 medical expense deduction
- The Sec. 215 alimony deduction;
- The Sec. 165(c)(3) casualty and theft loss deduction (except for casualty losses associated with special disaster relief legislation);
- The Sec. 212(3) deduction for tax preparation fees;
- The Sec. 217 deduction for moving expenses;
- The Sec. 220 deduction for contributions to Archer medical savings accounts (and employer contributions would no longer be excludable from income). Existing Archer MSAs could be rolled over tax-free into a health savings account.
The repeal of the alimony deduction would be accompanied by a corresponding repeal of the provision in Sec. 61(a)(8) requiring alimony payments received to be included in income. This repeal would apply to divorce or separation agreements executed after Dec. 31, 2017.
Employee expenses: Under a new Sec. 262A, employees would no longer be allowed to take an itemized deduction for their expenses that are attributable to the trade or business of performing services as an employee. The above-the-line deductions for certain expenses of performing artists, officials, and elementary and secondary schoolteachers (Secs. 62(a)(2)(B), (C), and (D)) would be repealed. These provisions would be effective for tax years beginning after 2017.
Mortgage interest: The mortgage interest deduction on existing mortgages would remain the same; for newly purchased residences (that is, for debt incurred after Nov. 2, 2017), the limit on the aggregate amount of acquisition indebtedness would be reduced to $500,000 ($250,000 for married taxpayers filing separate returns), from the current $1.1 million. Also, taxpayers would be limited to one qualified residence for purposes of the mortgage deduction.
Charitable contributions: Some rules for charitable contributions would change for tax years beginning after 2017. Among those changes, the current 50% limitation for cash contributions would be increased to 60%.
Contributions that secure college athletic event seating rights would not be deductible under the bill.
The rate at which taxpayers can deduct charitable mileage would be adjusted for inflation. It is currently set by statute at 14 cents per mile, and, unlike the other mileage rates, is not adjusted for inflation.
The Sec. 170(f)(8) substantiation exception for contributions reported by the donee on the donee’s Form 990, Return of Organization Exempt From Income Tax, (an exception that has never been implemented by regulations) would be repealed.
State and local taxes: The deduction for state and local income or sales tax would be eliminated, except that income or sales tax paid in carrying out a trade or business or producing income would still be deductible. State and local property taxes would continue to be deductible, but only up to $10,000. These provisions would be effective for tax years beginning after Dec. 31, 2017.
The bill would repeal various credits, including the adoption tax credit, the Sec. 22 credit for individuals over age 65 and the permanently and totally disabled, the credit associated with mortgage credit certificates, and the credit for plug-in electric vehicles.
Child tax credit: The allowable amount of the child tax credit would be increased from $1,000 to $1,600. The first $1,000 of the credit would be refundable (this amount would be indexed for inflation but would be eventually capped at $1,600). Taxpayers would be required to provide a Social Security number to claim the refundable portion of the child tax credit.
A new nonrefundable “family” credit of $300 would be allowed to each taxpayer (and spouse in the case of a joint return) and each dependent who is not a qualifying child. The $300 credit for nonchild dependents would expire after 2022.
The phaseout for these credits would be increased to $230,000 of modified adjusted gross income (MAGI) for married taxpayers filing jointly and to $115,000 for single taxpayers.
Education: The American opportunity tax credit, the Hope scholarship credit, and the lifetime learning credit would be combined into one credit, providing a 100% tax credit on the first $2,000 of eligible higher education expenses and a 25% credit on the next $2,000, effective for tax years after 2017. Taxpayers would be required to provide a Social Security number to claim the refundable portion of the American opportunity tax credit.
Contributions to Coverdell education savings accounts would be prohibited after 2017 (except for rollovers), but taxpayers would be allowed to roll over money in their Coverdell ESAs into a Sec. 529 plan. Sec. 529 would be amended to allow limited distributions (up to $10,000) for elementary and secondary tuition.
The bill would also repeal the Sec. 221 deduction for interest on education loans and the Sec. 222 deduction for qualified tuition and related expenses, as well as the Sec. 135 exclusion for interest on U.S. savings bonds used to pay qualified higher education expenses, the Sec. 127 exclusion for qualified tuition programs, and the Sec. 117 exclusion for employer-provided education assistance programs.
The Sec. 121 exclusion of gain from the sale of a principal residence would be amended to require that the residence have been the taxpayer’s principal residence in five of the eight years preceding the sale. Taxpayers could use the exclusion only once every five years. The exclusion will phase out for taxpayers with MAGI over $250,000 ($500,000 for married taxpayers filing a joint return). These changes would be effective for sales and exchanges after 2017.
Various other income exclusions would be repealed after 2017:
- The Sec. 74 exclusion for employee achievement awards;
- The Sec. 129 exclusion for dependent care assistance programs;
- The Sec. 132 exclusion for qualified moving expense reimbursements;
- The Sec. 137 exclusion for adoption assistance programs.
The Sec. 119 exclusion for housing provided for the convenience of the employer and for employees of educational institutions would be limited to $50,000 ($25,000 for a married taxpayer filing separately).
The special rule under Sec. 408A(d) permitting recharacterization of Roth IRA contributions as traditional IRA contributions would be repealed, effective for tax years after Dec. 31, 2017.
The minimum age for allowable in-service distributions by defined benefit plans and state and local government defined contribution plans would be lowered from 62 to 59½.
The IRS would be required within one year of the date of enactment to amend Regs. Sec. 1.401(k)-1(d)(3)(iv)(E) to allow employees taking hardship distributions from a qualified plan to continue making contributions to the plan. Employers would also be able to choose to allow hardship distributions that include account earnings and employer contributions, and not just amounts contributed by the employee as under current law.
Employees whose plan terminates or who separate from employment while they have plan loans outstanding would have until the due date for filing their tax return for that year to contribute the loan balance to an IRA. This would allow them to avoid having the loan taxed as a distribution.
AMT: The bill would repeal the AMT in its entirety, effective for tax years beginning after 2017.
Taxpayers with AMT credit carryforwards would be allowed to claim a refund of 50% of the remaining credits (to the extent the credits exceed regular tax for the year) in tax years beginning in 2019, 2020, and 2021. Then in 2022, taxpayers would be able to claim a refund of any remaining credits.
Estate, gift, and generation-skipping transfer taxes: The estate tax and the GST tax would be repealed after 2023. However, inherited property would still receive a stepped-up basis.
The estate tax exclusion amount would double from its current statutory $5 million to $10 million, indexed for inflation, for tax years after 2017.
The top gift tax rate would be lowered to 35% for gifts made after 2023. The gift tax exclusion amount would be $10 million, and the annual exclusion amount would be $14,000, indexed for inflation.
—Alistair M. Nevius (Alistair.Nevius@aicpa-cima.com) is the JofA’s editor-in-chief, tax.