Small Business Taxes & ManagementTM--Copyright 2017, A/N Group, Inc.
In our Daily Update we provided a list of the changes in the House proposal. Here's a more detailed analysis of some of the changes of most interest to individuals and small business owners. Keep in mind that this is just the House proposal. The Senate Finance Committee will be writing its own version and there's a chance there could be floor amendments before voting. And passage by both the House and Senate is far from assured. There are many provisions that are controversial. Nonetheless, much of the provisions may be in any final bill in substantially the same format. There is no reason to go into the fine details since changes are likely, particularly in the finer points. The important consideration is general tax planning.
This is the first of several parts
The proposal creates four tax rates:
Similar adjustments would be made for head-of-household and married filing separate. The 12% bracket would be phased out for taxpayers with incomes above $1,000,000 for single filers and $1,200,000 for joint.Married Filing Joint Taxable Income Tax Rate $0-$90,000 12% $90,000-$260,000 25% $260,000-$1,000,000 35% over $1,000,000 39.6% Single and Married Separate Taxable Income Tax Rate $0-$45,000 12% $45,000-$200,000 25% $200,000-$500,000 35% over $500,000 39.6%
Clearly, the rates are lower than the current ones. There are less brackets, but that is not where tax simplification comes from in this proposal. For a comparison with the 2017 rates, go to our Tax Facts page. A married couple with taxable income of $450,000 would pay $119,800 under the proposal and $124,383 under prior law. That's a saving of $4,583. The largest savings arise when taxable income is between $500,000 and $1,000,000 for a married couple filing jointly.
In the example above we compared the tax on the same amount of taxable income. But that's not a great comparison. The repeal of the AMT could make the savings greater (by around $4,000 depending on state taxes and other adjustments); while the repeal of itemized deductions could reduce the savings, again depending on circumstances, but probably by a similar amount to the AMT savings. And how your income is generated could also make a difference. Income from qualified dividends and capital gains will continue to be taxed at a lower rate.
The alternative minimum tax (AMT) would be repealed. This tax affected some 4.5 million taxpayer households in 2017. With the repeal of many of the itemized deductions less taxpayers would be affected even if the tax remained. Nonetheless, for many taxpayers, the repeal could provide substantial savings in addition to simplifying filing. Taxpayers with carryforward credits for the AMT would be able to utilize them in the future.
Capital gains and qualifying dividends would continue to receive preferential treatment with changes to conform to the new tax rates and brackets. Thus, 0 percent capital gains rate applies to income up to $77,200 in the case of married couple filing jointly; the 15 percent rate applies to income up to $479,000; the 20% rate applies on income above that amount.
What's the bottom line? It will depend significantly on your deductions, both the size and type, and how you earn your income. In the next part we'll discuss the taxation of income from pass-through entities such as S corporations and LLCs. To get a true feel of how the proposal would affect you, you'll have to actually run the numbers. At this time, the easiest approach is to take your 2016 return and apply the proposed law and rates. That should give you a good idea unless 2016 is substantially different than what you'd expect in the future. The inflation adjustments for 2017 and 2018 should not distort your results.
Exemptions and Deductions
The proposal would eliminate the personal exemption. Currently, $4,050 (2017 amount) for every individual in the family that qualifies. For example, Fred and Sue have two daughters, one 12, the other 15. They're entitled to $16,200 in personal exemptions. Those would be eliminated. The child credit would be increased to $1,600 (from $1,000). For Fred and Sue that would be a savings of $1,200 in taxes. A credit instead of a deduction is more valuable to a taxpayer in a lower bracket. If Fred and Sue are in the 25% bracket, the extra $1,200 in credits is equivalent to a deduction of $4,800 of lost deductions. The additional $300 credit for non-child dependents (such as parents) isn't enough to consider in an analysis. The child tax credit and the non-child dependent credit would be phased out at $230,000 for those filing married, joint and $115,000 for single filers. That's considerably higher than under current law.
The standard deduction would be increased from $12,700 (married, joint) to $24,400 and from $6,350 (single) to $12,200. Single filers with at least one qualifying child would have a standard deduction of $18,300. If you already normally take the standard deduction or your itemized deductions are only slightly more than these amounts, you'll come out ahead under the plan. This is probably one of the easiest areas to "tweak" in a final version of the law, allowing more benefits to lower income taxpayers.
But itemized deductions would be severely limited. You would only be able to deduct up to $10,000 of real property taxes and mortgage interest on a principal residence where the debt does not exceed $500,000. (Interest on preexisting debt would be grandfathered.) Thus, after November 2, 2017, interest on a home equity loan, a vacation home, or a motor home or boat with living facilities would no longer be deductible. Casualty losses would be deductible only if incurred in a federally declared disaster area. That would mean the loss of uninsured property would produce no tax savings. A theft of a antiques in your home would not be deductible. On the other hand, a theft at your business would still be deductible. Being fully insured will be more important than before.
Charitable contributions would still be allowed, but the special rule that provides a charitable deduction of 80 percent of the amount paid for the right to purchase tickets for athletic events would be repealed.
You would no longer be able to deduct non-real property taxes, medical expenses, or most miscellaneous itemized deductions. That means unreimbursed employee business expenses would also not be deductible. The effect of this change will depend on your specific situation. Medical expenses now must meet a 10% threshold to be deductible. Many taxpayers don't meet that threshold. But as medical expenses rise and more employers require employees to pick up more of the bill and more procedures are not covered by insurance, taxpayers would be more likely to claim that deduction.
Income and sales taxes related to a trade or business or for the production of income would still be deductible.
The outcome for any taxpayer will depend on his or her particular situation. Currently, only about 30% of taxpayers itemize. If your itemized deductions don't exceed the standard deduction, you take the standard. Thus, currently, a married couple who have only $4,000 in state income taxes, $5,000 in real estate taxes and $1,000 of mortgage interest will take the standard deduction. If that mortgage was $8,000 it would pay for them to itemize.
There was no mention in the proposal about investment interest and expenses. But even if they continue to be deductible, the amount, when combined with mortgage interest and real property taxes would have to exceed the larger standard deduction to make them deductible.
Taxpayers with high medical expenses, high income and real property taxes, and high mortgage interest could be substantial losers, even with lower rates.
The proposal would repeal the deduction for alimony payments. The receipt of alimony would no longer be includible in income. Taxpayers have been able to "game" the system to come out ahead with the right mix of alimony and property settlement.
The deduction for moving expenses would be repealed for tax years beginning after 2017. In addition, reimbursements by an employer for moving expenses would be includible in the income of the recipient.
No deduction would be allowed for contributions to an Archer MSA (Medical Savings Account). Health Savings Accounts (HSAs) would continue unaffected. Since they provide the same benefits, this change is neutral.
Under the proposal, no deduction would be allowed for expenses related to the trade or business of performing services as an employee. While the IRS often challenges taxpayers on this issue and there have been abuses, this could be an important issue for some small business employees who are not reimbursed for expenses. Some small business owners may have to change their policies. Certain professionals who must take continuing education courses, purchase uniforms or tools, etc. for which they are not reimbursed, may also feel the loss of this deduction.
Under the proposal, a number of credits would be eliminated. That includes the disability credit for individuals over 65 who retired on disability, the adoption credit, the credit for mortgage credit certificates and the credit for plug-in electric drive motor vehicles.
Copyright 2017 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 11/06/17