The president signed into law H.R. 1 (originally known as the “Tax Cuts and Jobs Act”), making sweeping changes to existing tax law. It will impact virtually every taxpayer in some way. Here’s what to watch for.
Final bill, final votes
The House and Senate previously passed different versions of the TCJA, and a conference committee worked to reconcile them in a final bill. On December 15, the final bill emerged from the committee and was directed back to the House and Senate for final passage. That bill passed along partisan lines by votes of 224-201 in the House and 51-48 in the Senate. The sole Republicans to cast dissenting votes were 12 House members from California, New Jersey, and New York. Their districts are expected to be significantly impacted by the new limitations on state and local tax deductions. In the Senate, Sen. John McCain (R-AZ) missed the final vote due to illness.
What to watch for
For a more complete analysis of the provisions in the final bill, please consult our recent Federal Tax Alert. In general, the new tax law will take effect in 2018, but a number of provisions will take effect in 2017, and many provisions related to individual tax will also expire after 2025.
The TCJA will impact individual taxpayers in several ways. The tax brackets have been widened and the highest incremental rate has been reduced to 37 percent (down from 39.6 percent). The changes to tax brackets will largely mitigate the existing marriage penalty, except for taxpayers in the two highest brackets. The standard deduction has been almost doubled (to $12,000 for single taxpayers and $24,000 for joint returns), so many taxpayers will no longer itemize deductions. Personal exemptions have been eliminated, and many other deductions and credits have been limited or eliminated. In particular, the deduction for state and local taxes will now be limited to a maximum of $10,000. The child tax credit has been increased, and may offset the loss of personal exemptions and itemized deductions for certain taxpayers. Finally, the alternative minimum tax (AMT) will be maintained albeit with much larger exemptions and a substantially higher phase-out range than under prior law.
The TCJA will significantly reduce tax on most businesses, regardless of whether they are taxed as a C corporation or as a pass-through entity. For C corporations, this is accomplished by lowering the corporate rate to 21 percent beginning in 2018 and eliminating the AMT. For pass-through businesses, a 20 percent deduction against certain pass-through income has been created for individuals and trusts. However, the benefits of the pass-through rules do not apply to all taxpayers and businesses equally. Rather, a number of factors will determine the benefits available, including the taxpayer’s total taxable income, the amount of W-2 wages paid, the industry in which the business operates, and the acquisition costs of depreciable property used in the business.
The new law also modifies certain deductions for businesses. Some deductions, such as depreciation, will be significantly enhanced while other deductions, like interest expense, will be significantly limited. Some credits have also been repealed or altered.
The TCJA reshapes the entire system of U.S. taxation of foreign activity through the adoption of a “territorial” tax system. To implement this change, earnings that have been deferred in foreign subsidiaries will be deemed repatriated and subjected to a repatriation tax. This will result in a reduced ability to take the foreign tax credit, and limitations on the ability to defer income. Foreign-owned companies will face significant curbs on their deductions, but potential tax incentives may exist for income earned from intellectual property.
Next steps: Year-end planning and future actions
This is the most significant tax legislation to be enacted in several decades and is expected to impact almost every taxpayer in at least some respect. In the very short term, taxpayers have until Dec. 31, 2017 to implement year-end planning techniques to maximize tax benefits under existing law or the new law. We previously identified a number of year-end planning ideas that may be considered.
Going forward, the TCJA will create both challenges and opportunities for taxpayers over the next several years. For businesses, this will require reconsideration of many decisions, such as entity choice (C corporation v. pass-through), capitalization (debt v. equity), and accounting methods. For individuals, the widening of tax brackets and reduction in the maximum rate will generally result in lower tax liabilities. However, the changes to deductions and a number of other programs will require consideration of available planning opportunities.
Given the speed with which this bill was crafted, the full extent of some of its provisions are still being unpacked. Please watch this space for additional analyses in the coming weeks and months.