On December 22, 2017, the President signed into the law the Tax Cuts and Jobs Act. This massive tax reform Bill was certainly well publicized and dominated news headlines for weeks before its final passage. Now that we are well into 2018, the dust has settled on the new tax rules, and we are all getting a bit more comfortable with its expansive contents. However, tax advisors are finding that misconceptions about the Bill do still exist.
Four general comments about the new tax law that are not entirely true. The following points out a few corrections to these statements.
“Since this is a massive, $1 trillion plus tax cut, my taxes are certainly going down.”
If only dissecting a massive tax Bill was this easy. Within its more than 500 pages, the new tax law makes changes to nearly every area of taxation.
It is true that overall income tax rates for individuals were lowered, and there is potential for everyone to pay tax at a lower rate. At the same time, many deductions were also eliminated which could raise the amount of income subject to tax for many people.
Miscellaneous itemized deductions– which included fees to investment advisors and tax preparers, unreimbursed job expenses for employees, and even deductions passed along through partnership investments- are no longer eligible for deduction.
State and local taxes, formerly a big deduction item for those with hefty state income taxes or local property taxes, are now limited to just $10,000 per year.
Alternatively, there are a number of new potential tax saving opportunities to go with these decreased deductions such as an expanded child tax credit and a new deduction on qualified business income through pass-through entities among many others.
Each individual taxpayer will have to consider their specific composition of income and deductions in order to determine whether this reform puts them in position to save big or owe more.
“I have always been a victim of the Alternative Minimum Tax (AMT) and I heard its impact was being cut dramatically. If I don’t have to pay AMT, then my taxes are going down.”
For decades now, the Alternative Minimum Tax, or AMT, has added an additional liability onto many taxpayers’ bills. The additional tax is calculated at a lower tax rate (maximum of 28%) but adds back many of the deductions allowed under regular tax rules- most commonly state and local taxes and miscellaneous itemized deductions.
There are two main reasons that AMT kicked in for many taxpayers.
- They had a large amount of those deductions that get added back, meaning a low regular tax was offset by the AMT.
- The exemption from AMT income was phased out at relatively low levels of taxable income.
The new tax reform Bill increases the AMT exemption, but more importantly, the exemption is not phased out unless your income is more than $1 million. Given that more people will be able to take advantage of the full, and increased, exemption, and the deductions that are required to be added back are no longer deductible for regular tax (and therefore not required to be added back for AMT purposes), the AMT should impact far fewer people than in the past.
So, if you are not hit with the AMT anymore, then your taxes should come down, right?
That may not be the case. For some taxpayers, those deductions that pushed them into paying AMT were deductions at the highest regular income tax rate of 39.6%. Then they became taxable income again under the AMT but at a rate of just 28%.
If it were just the AMT that went away, and those deductions were still in place, then taxes would certainly be going down for those taxpayers. But since the deduction no longer counts for regular tax purposes, some may see an increase in tax given these changes.
Their new AMT tax could be zero, but the increase in regular tax as a result of the elimination of some deductions could more than offset the benefit of the AMT savings.
Again, individuals will have to consider their own set of facts to determine the impact of these law changes.
“Tax reform simplified my tax return.”
One of the stated objectives of lawmakers as the new tax rules were being drafted was to simplify the tax code and make it easier to file an income tax return each year. But, by their own admission, lawmakers missed on the goal this time. After the passage of the Bill, many lawmakers noted that simplification was instead traded for lower rates.
To be fair, an increased standard deduction does mean that far fewer people will have to itemize deductions each year. That means they will not have to worry about collecting charity receipts, finding their mortgage interest statements, and so on. But there are few cases of simplicity found elsewhere in the Bill.
If anything, there are numerous brand-new wrinkles that will have to be considered this year. There is a new potential 20% deduction for owners of flow-thru business that will require complex calculations that have never existed in the past. And the same complex rules regarding tax basis, passive or non-passive income classifications, at-risk limitations, and a long list of other nuances that previously made the filing of tax returns challenging still exist.
Blending new rules into the existing complexities will likely lead to more work on tax matters than has been required in past years.
“Now that the Bill is signed, tax reform is complete.”
The tax law is now set, and it’s not likely that news headlines will focus on taxes now that the Bill is signed. But there is still much work to be done before all the new laws are fully in place.
There are more than 100 places in the new reform law that mention the need for further guidance, or for additional forms to be drafted to implement the law. The Treasury Department will have to write regulations on many of the topics covered in the law to explain how it should be interpreted.
The IRS will be required to draft new tax forms and change many existing forms to incorporate the changes in the Bill. And the courts will be busy with taxpayers challenging rulings that come about as a result of the new law.
The Bill is in place, but we still have much to learn about how it will be interpreted, and the best planning techniques to take advantage of opportunities.
Tax laws have always been, and continue to be, complex. No two taxpayers are exactly the same, and each will be impacted differently by the new rules. But with change comes opportunities. Speaking with an advisor helps ensure that you are taking advantage of opportunities associated with the new tax law.