Tax Reform Basics – The Tax Cuts and Jobs Act
Tax Cuts and Jobs Act
If you have turned on the radio or the TV in the past 12 months, you have probably heard about Tax Reform and President Trump’s “Tax Cuts and Jobs Act.” Regardless of your political perspective, the Tax Cuts and Jobs Act is the biggest tax reform in more than thirty years. It creates unprecedented estate planning opportunities for both individuals and businesses. The following is a summary of the tax reform basics:
Temporary Changes to Individual Rates Through 2025
The Tax Cuts and Jobs Act keeps the current seven-bracket structure, but changes the income level and rates. From January 1, 2018, to December 31, 2025, the individual income tax brackets are set at 10, 12, 22, 24, 32, 35, and 37 percent.
The Tax Cuts and Jobs Act increases the standard deduction from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for married couples. The standard deduction is indexed for inflation. The Tax Cuts and Jobs Act does not change the additional standard deduction for elderly or blind taxpayers under current law. The increase of the basic standard deduction expires after December 31, 2025. The Tax Cuts and Jobs Act also repeals all personal exemptions through December 31, 2025, with the withholding rules to be changed to reflect the elimination of personal exemptions.
The widening of brackets, rate reductions, and increase in the standard deduction are all intended to offset the repeal of personal exemptions and ultimately lower individual income taxes. Given the loss of personal exemptions, the increased standard deduction will not provide taxpayers with significant net benefit. But the increased standard deduction will change the way that many taxpayers file their taxes. Given the increased amount and the limitations imposed on many itemized deductions, many taxpayers will find that their standard deduction exceeds their itemized deduction. This will lead to fewer taxpayers taking itemized deductions.
The Tax Cuts and Jobs Act limits the deduction for state and local taxes to $10,000 ($5,000 in the case of a married individual filing a separate return). The limitation applies to all state and local taxes in the aggregate. The Tax Cuts and Jobs Act provides that any amount paid in a taxable year beginning before January 1, 2018, for state and local taxes imposed for a taxable year beginning after December 31, 2017, are treated as having been paid on the last day of the taxable year for which the tax is imposed. Clearly, this hurts taxpayers in states with high income and property tax, such as California.
The Tax Cuts and Jobs Act modifies the home mortgage interest deduction to reduce the limit on acquisition indebtedness from $1 million under current law to $750,000. A transition rule retains the current $1 million limit for taxpayers who signed binding purchase agreements by December 15, 2017, to close on the sale before January 1, 2018, and who actually purchase the residence before April 1, 2018. The $1 million dollar limit is also retained for mortgages already in effect. The reduced limit expires on December 31, 2025, at which time interest on mortgage indebtedness up to $1 million would be deductible, regardless of when incurred.
If you are paying more than $10,000 in state and local income taxes, the new $10,000 cap on the SALT deduction could significantly curb this offset and increase the aggregate state and federal income taxes you owe. To get relief from this increase, you should consider incomplete non-grantor trusts (INGs). An ING is a trust designed to be an incomplete gift for federal transfer tax purposes while avoiding grantor trust status. INGs are established in states with strong domestic asset protection laws and a tax system that does not tax trust income. Because the transfer to the trust is not a completed gift for transfer tax purposes, there are no estate or gift tax consequences to establishing the trust. But the non-grantor-trust status allows the trust to be treated as a separate taxpayer for federal and state income tax purposes. The trust will pay federal income taxes on its income, but should escape state income taxation in the grantor’s state of residency if properly drafted and administered.
INGs provide opportunities for those with significant state-level income taxes on assets and who already pay federal income taxes at the highest rate. They should also be considered if you have assets you plan to sell or otherwise dispose of in a taxable transfer.
Temporary Increase to Estate Tax Exemption Through 2025
The Tax Cuts and Jobs Act doubles the estate, gift, and GST tax exemptions from $5 million to $10 million (adjusted for inflation after 2011) for estates of decedents dying, generation-skipping transfers, and gifts made after December 31, 2017 and before January 1, 2026. The increased exemptions remain in place until December 31, 2025, at which time they revert to the current $5 million level (indexed for inflation). The doubling of the estate, gift, and GST tax exemptions means that, beginning in 2018, taxpayers can transfer up to $11.2 million of assets without transfer tax consequences. This creates significant gifting opportunities between January 1, 2018, and the sunset of the increased exemptions on December 31, 2025. If the increased exemptions are temporary, you will have until December 31, 2025, to remove assets from their estates and exempt future appreciation from taxation.
Estate, gift, and generation-skipping transfers remain subject to a maximum tax rate of 40 percent. The current basis step-up under Code § 1014 for property inherited from a decedent remains in place. The rules (including the additional time for relief under Revenue Procedure 2017-34) regarding portability of estate and gift tax exemption also remain in place. Note that there is no portability of the GST tax exemption.
If your Trust previously contemplated an estate that may be more than $10 million, but less than $20 million, you may want to consider making changes to the Q-TIP trust or “C” Trust.+
Now may be the best time in a client’s life to contribute to self-settled domestic asset protection trusts (DAPTs). There are various ways that DAPTs can be designed with built-in flexibility, such as by naming a trust protector or non-fiduciary with authority to add the grantor back as a trustee at a later time (hybrid DAPT). Establishing and funding a DAPT not only removes assets (including future appreciation) from the estate, but also provides ongoing asset protection for the term of the trust.
Temporary Deduction for Pass-Through Businesses (Sole Proprietorships, Partnerships, LLCs S-Corps)
For tax years beginning in 2018 and ending in 2025, the Tax Cuts and Jobs Act creates a new deduction of 20 percent to apply against income of pass-through businesses. The deduction applies at the owner level and also applies to 20 percent of qualified real estate investment trust (REIT) dividends, qualified cooperative dividends, and qualified publicly traded partnership income. The deduction is available for trusts and estates that own pass-through businesses. There are many exceptions or limitations depending on the type of income, type of business and amount of taxable income. In short, the deduction is great for real estate investment businesses, and not so great for service businesses. This deduction is only valid until December 31, 2025.
Permanent Reduced Tax Rate for C Corporations
Taxable income of a C corporation was previously taxed under a four-step graduated rate structure at rates of 15, 25, 34, and 35 percent. Effective January 1, 2018, The Tax Cuts and Jobs Act eliminates this graduated rate structure, taxes all corporate income at 21 percent, and repeals the corporate alternative minimum tax (AMT). Unlike the deduction for pass-through businesses, there is no sunset provision for the reduced corporate income tax rate or corporate AMT repeal.
Orange County Estate Planning Attorney
Please contact John Wong, Orange County Estate Planning Attorney at Modern Wealth Law to discuss how these tax changes affect your situation.
John Wong advises on all aspects of estate planning, probate, asset protection and trust administration. He believes that estate planning is about planning for life; while having protections in place should the unexpected occur.
