Last week congress passed the most comprehensive overhaul to the US tax code in decades. While the largest parts of that bill target large corporations (the drop in the corporate tax rate could save the six largest media conglomerates a combined $6 billion annually by one estimate), many of them will affect you directly.
Below we tried to succinctly highlight what we think impacts our clients the most, but we are still dealing with all the planning challenges and opportunities on a case-by-case basis and encourage you to reach out to us with specific questions. The interplay of many of these changes with the elusive and complex Alternative Minimum Tax (which was already phasing out some of these deductions for many of our clients) makes any hard and fast rules challenging, if not misleading.
What We Still Don’t Know:
We started with this topic to stress that it’s still quite a lot, and that may be the case for some time. Those of us preparing taxes in 1986 remember the years it took to work through all the “fixes” required to clarify applications and eliminate unintended loopholes in Reagan’s Tax Reform Act, and that piece of legislation had a much longer drafting and vetting process (14 months of public hearings including 80 expert witnesses vs. virtually no public debate now).
Arguably, the biggest area of uncertainty affects our clients with closely held business or loan-out companies that “flow-thru” income to the individual owners’ return (including s-corporations, partnerships, LLCs and sole proprietorships). The new law rolls out sizable tax breaks for flow-thru income, but has excluded personal service businesses whose owners have more than $415K in joint net income on their tax returns. Personal service businesses includes those providing traditional medical, law and accounting services, as well as entertainment services rendered “in front of the camera.”
“Behind the camera” income (writers, directors, producers, composers) is not considered to be generated via personal service and stands to benefit from the lack of income cap above. However, there may still be issues in qualifying for the flow-thru benefit if that revenue comes from predominantly one source (like an overall deal) or if there are no non-owner employees in the business.
Bottom Line: We are waiting for further clarification, but it seems likely there will be some planning opportunities in changing structures for existing loan-out companies or creating new flow-thru structures. The tax incentives may also mean lower income earners should consider incorporation sooner than in the past, especially if they are able to take fewer deductions on their personal tax returns.
What’s Really Changing?
- Tax Brackets: The new law lowers the tax rates overall and increases the income threshold for the upper brackets. Bottom Line: You can make more and stay in lower tax brackets.
- State & Local Tax Deductions: Itemized deductions will be capped at just $10,000 for the aggregate of state and local property taxes paid during the year. Deductions for prepaid taxes will be disallowed, taking away one of the planning tools we used frequently to shift income between calendar years. Bottom Line: Upper-income taxpayers or homeowners who purchased high-value residences in states like CA and NY may pay more in taxes because of the new limits, despite the lower overall tax rates.
- Mortgage Interest Deduction: After 2017, taxpayers cannot deduct interest associated with debt in excess of $750,000. For debt incurred before December 15, 2017, the cap will be $1 million, down from $1.1MM currently. Bottom Line: Existing mortgage holders with mortgage balances between $1MM and $1.1MM may lose some marginal deductions, but this change will mostly impact future purchases. It may also affect real estate prices, probably most dramatically for homes in the $1MM-$2MM range.
- Entertainment/Meal Deductions: The deduction for entertainment expenses is going away, but the new law preserves the deduction for certain meals (but subjects all meals, even those provided to staff on-premises, to the 50% limit). After 2025, deductions for meals will no longer be permitted. Bottom Line: It will become more important to distinguish certain entertainment expenses that may qualify under other provisions of the code (like research) for entertainment professionals.
- Unreimbursed Employee Business Expenses/Tax Preparation/Investment Advisory Fee Deductions: The new tax law repeals employee business expense as well as tax and advisory service deductions starting in 2018. Bottom Line: Talent who are paid as W-2 wage earners by studios/networks may want to consider incorporation sooner due to loss of deductions for agent/manager/attorney commissions on an individual taxpayer’s Schedule A. Conversely, expenses incurred via corporate entities (commissions/fees/tax prep) or retirement accounts (advisory fees) will not be affected.
- Film & TV Production Expenses: Beginning late next year, productions will be able to fully expense (without a cap) production costs if 75% of the project is made in the U.S. A similar law that expired in 2016 capped the deduction at $15MM per production. Bottom Line: The latest attempt to try to curb runaway productions.
What’s Sort-of Changing?
- Charitable Contribution Deductions: Charitable contributions are still deductible, but you can now deduct contributions up to 60% of taxable income (AGI), increasing the cap from 50% under current law. Bottom Line: This is pretty straight-forward, and it doesn’t apply to gifting of appreciated property or gifting to privately held foundations. Corporate charitable capabilities are set to expand under other sections of the law, however, which could help clients who want to donate profit participation revenue streams upon their demise.
- Alternative Minimum Tax: AMT is staying put, but the thresholds are increasing so that fewer taxpayers will fall under it. Bottom Line: AMT should have less impact on our CA and NY residents anyways, given the bill’s limits on deductions for state and local taxes.
- Estate Taxes: The estate tax is also staying put, but the exemption on gifting is doubling. Under current law estate taxes could be triggered for couples with more than $11.2MM in assets. Now it will only be a concern for those above $22.4MM. Bottom Line: Fewer families will expect to pay estate taxes for now. The increase is only in effect until 2025, so estate planning will continue to be laden with challenges and potential opportunities.
- 529/College Savings Plans: The basic provisions for college planning are remaining intact, but the program will now expand to allow up to $10K per year to be taken from a 529 plan for elementary or secondary school tuition. Bottom Line: Parents and grandparents with young children may want to take advantage of the ability to accumulate tax-free gains for private schooling at elementary and high school levels. Penalties will likely still apply if monies are taken out for non-education expenses, though, so caution is still warranted around the potential for over-funded plans.
- Roth IRA Conversions: The removal of income caps for converting existing IRA assets to Roth IRAs is staying. However, the ability to re-characterize Roth conversion up until your filing deadline is going away starting in 2018. Bottom Line: You can no longer overshoot on your Roth conversions and then bank on the ability to “fix” it if you have more income than expected when you go to file your return the next year.
- Alimony Payments: For settlements reached after 2018, alimony payments will not be tax-deductible, and alimony received will no longer be taxable income to the recipient. Bottom Line: This only affects future divorce settlements, and makes the treatment of alimony similar to the current treatment of child support. Alimony amounts awarded will probably adjust to compensate for the tax changes, keeping this one pretty neutral.
What’s Not Changing?
- Investment Taxes: Capital gains tax rates and your ability to choose which cost lots you want to sell/donate are staying the same. There may be some benefits for certain real estate partnerships that pass through sizable rental income via the new flow-thru rules, too.
- Capital Gains when Selling a Home: The exemption for a personal residence is staying at $250K for individuals and $500K for couples in most cases.
- 401K Contribution Limits: Despite some early talk of limiting the ability to put away money tax-free, these are staying in affect and will increase marginally for 2018, as planned.
- Electric Car Credit: Buyers of qualifying plug-in electric vehicles can still claim this, so no need to cancel your Tesla reservation.
This material was created for educational and informational purposes only and is not intended as tax, legal or investment advice. If you are seeking advice specific to your needs, such advice must be obtained separate from this educational material.