SUPPLEMENT TO TAXATION FOR DECISION MAKERS, 2018 EDITION Shirley Dennis-Escoffier and Karen A. Fortin
Changes introduced by the Tax Cuts and Jobs Act of 2017
INTRODUCTION On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (TCJA) that represents the most comprehensive changes to the tax law in over 30 years. TCJA impacts all taxpayers by eliminating or changing many long-standing rules and adding new provisions. While Congress made most corporate changes permanent, the changes to the individual rates and deductions are temporary to comply with budget rules under reconciliation. As a result, most individual changes are effective for tax years beginning after December 31, 2017 and before January 1, 2026; effectively suspending existing law with the 2017 rules reinstated in 2026. This supplement updates the text for these revisions as well as other important changes since publication. Changes made retroactively affecting 2017 tax returns are discussed first; then changes affecting future years are highlighted in the next section of this supplement. These changes are keyed to the 2018 edition by chapter and section number. RETROACTIVE CHANGES Chapter 5
Section 5.4.1 5.7.2
5&9
5.4.5 9.3.1
7
7.3.2
Brief Description of Change The minimum amount of unreimbursed medical expenses that are not deductible is reduced from 10% to 7.5% of AGI for 2017 and 2018 for all taxpayers (regardless of age) for regular income tax and for the alternative minimum tax (AMT). The 10% threshold is reinstated in 2019 for regular tax and AMT. The $100 floor for casualty losses from disasters in 2016 or 2017 is raised to $500 per casualty and the 10%-of-AGI threshold does not apply. Taxpayers who do not itemize can increase their standard deduction by the net disaster loss for these two years. Bonus Depreciation is increased from 50 percent to 100 percent for purchases after September 27, 2017. A more detailed discussion of this provision with an example follows.
Retroactive Change to Bonus Depreciation Prior to the passage of the Tax Cuts and Jobs Act, bonus depreciation only applied to new (not used) property at a 50% rate. TCJA temporarily increased bonus depreciation to 100% for assets acquired after September 27, 2017 and extended it to used property. The 100% rate will begin to phase out after 2022 and expire at the end of 2026.
Supplement to Taxation for Decision Makers, 2018 Edition
Property previously used by an unrelated taxpayer may qualify for bonus depreciation if purchased and placed in service after September 27, 2017 and the taxpayer had not used the property at any time before acquisition. Additionally, the property’s basis cannot be determined by reference to the adjusted basis of the taxpayer from whom it was acquired (carryover basis transactions). If there was a written binding contract to acquire property in effect prior to September 28, 2017, the property is deemed acquired the date the contract was entered into and is not eligible for the 100% bonus depreciation rate. Instead, the 50% bonus rate applies with only new property eligible. If the purchase of the property is completed before September 28, 2017 but it is not placed in service until 2018, the bonus depreciation rate is 40%; if placed in service in 2019, the bonus rate is only 30%. Bonus depreciation applies only to tangible personalty, software, and certain improvements. Any basis remaining after the reduction for the bonus depreciation is deducted is subject to regular MACRS depreciation. Realty and other assets with recovery periods greater than 20 years are not eligible for bonus depreciation. Bonus depreciation is not limited to small businesses, however; there is no phase-out provision (or taxable income limitation), unlike Section 179 expensing. When electing Section 179 expensing, the expensed amount is deducted first before computing bonus depreciation; thus, bonus depreciation is sandwiched between the Section 179 expensing and regular MACRS depreciation deductions. Example: On September 1, 2017, Molokai Corporation, a calendar-year corporation, purchased $1,810,000 of 5-year equipment and expensed $510,000 under Section 179. If this was used equipment, the maximum allowable first-year depreciation is $770,000: $510,000 Section 179 expensing and $260,000 *($1,810,000 − $510,000) × 20%+ regular MACRS depreciation. Its second-year depreciation is $416,000 *($1,810,000 − $510,000) × 32%+. If Molokai had purchased new equipment, its maximum allowable depreciation expense deduction for 2017 is $1,290,000, consisting of $510,000 Section 179 expense, $650,000 [($1,810,000 − $510,000) × 50%+ bonus depreciation and $130,000 *($1,810,000 − $510,000 − $650,000) × 20%] regular MACRS depreciation. Its 2018 depreciation deduction would be $208,000 *($1,810,000 − $510,000 − $650,000) × 32%+. If Molokai had instead purchased the equipment after September 27, 2017, it could deduct the entire $1,810,000 in the first year using the new 100% bonus depreciation.
HIGHLIGHTS OF CHANGES AFFECTING 2018 TAX YEARS AND LATER The following changes are effective beginning with 2018 tax years (affecting tax returns filed in 2019) or later. The details on these changes will be incorporated in the new 2019 edition of Taxation for Decision Makers available in July 2018. Highlights are provided here for instructors who want to address these changes in their current classes. Chapter 1&4 1 & 12
1 & 12
Section 1.1.4 4.1.1 1.1.6 12.1.3 1.1.6 12.1.3
Brief Description of Change The wage base for social security is increased to $128,400 for 2018. The estate and gift tax exemption is doubled and after its 2018 inflation adjustment is expected to be $11,200,000 million ($22,400,000 for a married couple). The 2018 gift tax exclusion, as adjusted for inflation, increases from $14,000 to $15,000.
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Supplement to Taxation for Decision Makers, 2018 Edition
Chapter 1&5
Section 1.2.1 1.4.1 5.7
1 & 10
1.2.1 10.2.6 1.4 5.1
1, 5 & 11
Brief Description of Change Seven marginal tax rates for individuals are retained but these rates are reduced for 2018-2025 and the tax brackets are wider. 2017 rates: 10%, 15%, 25%, 28%, 33%, 35%, 39.6% 2018 rates: 10%, 12%, 22%, 24%, 32%, 35%, 37.0% The tax rates for dividends and capital gains remain at 0%, 15% and 20%. For tax years beginning after December 31, 2017, the graduated rates for all C corporations are eliminated and replaced by a single flat rate of 21%. A new deduction was added for 2018-2025 to address the difference between the tax rates for C corporations and flow-through businesses. The deduction is generally 20% of the individual’s qualified business income (QBI) from a partnership, S corporation, or sole proprietorship. QBI is the individual’s share of the income less deductions from the business. It does not include investment-related items (capital gains, capital losses, dividends, and nonbusiness interest income), compensation paid to the individual, or guaranteed payments from a partnership. This deduction reduces the individual’s taxable income (but is not a deduction for AGI) and can be claimed by taxpayers who take the standard deduction or itemize. The new law is complex and designed to favor businesses that manufacture or produce products rather than service businesses by stating that the deduction is not available to businesses that primarily involve the performance of services (unless the exception for a small service business is met) to prevent a service business from recharacterizing wage income into more favorably taxed business income. There are also limitations based on the W-2 wages and the adjusted basis of qualified property acquired by the business. The overall limit on the deduction is 20% of QBI but the deduction cannot exceed the greater of (1) 50% of the taxpayer’s share of the W-2 wages paid by the business or (2) the sum of 25% of such W-2 wages plus 2.5% of the unadjusted basis of tangible depreciable business property acquired. These W-2 limitations do not apply if the owner’s taxable income (from all sources) is less than a threshold ($315,000 if married filing a joint return and $157,000 for all other individuals). If taxable income exceeds the $157,000 threshold by $50,000 (or $315,000 threshold by $100,000), the full W-2 limitations apply. Taxpayers in a service business including accounting, law, health, consulting, financial services, performing arts, actuarial science, athletics, brokerage services, investing, trading in securities, or any business where the principal asset is the reputation or skill of its employees (except for engineering and architecture which are specifically excluded) can deduct 20% of their QBI if their income is below the threshold. The deduction is gradually phased out for taxpayers in these service businesses when income is between $157,000 and $207,500 ($315,000 and $415,000 if married filing jointly). If a taxpayer is in one of the affected service business and taxable income exceeds $207,500 ($415,000 if married filing a joint return), the deduction is zero for that business.
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Supplement to Taxation for Decision Makers, 2018 Edition
Chapter 1, 5 & 11
Section 1.4.1 5.1 11.3.6
1&5
1.4.1 5.3.1
1&4
1.4.1 5.5
1 & 12
1.4.2 12.6.3
1 & 10
1.5.3 10.2.5
3&6
3.2.2 6.6.2
3
3.2.2
3&5
3.4.3 3.4.5
Brief Description of Change For 2018-2025, a new limitation applies to the deductible amount of net business losses of a sole proprietorship, partnership, or S corporation that can be deducted on an owner’s return. It is generally limited to $250,000 ($500,000 if married filing jointly); the disallowed excess loss is treated as a net operating loss (NOL) and carried forward. Example: In 2018, Justin is single and has $670,000 of gross income and $980,000 of deductions from his sole proprietorship resulting in a $310,000 loss for the year. His excess business loss is $60,000 ($980,000 – ($670,000 + $250,000). Justin can deduct $250,000 of the loss in 2018 and carry the $60,000 excess business loss to 2019 as an NOL. The standard deduction is temporarily increased substantially, reducing the number of taxpayers who will itemize deductions. It will be indexed for inflation through 2025 and then will revert back to the 2017 amounts in 2026. 2018 2017 Married filing a joint return $24,000 $12,700 Head of household 18,000 9,350 Single and married filing separately 12,000 6,350 The additional standard deduction for the elderly and blind are $1,600 if single or head of household and $1,300 if married for 2018. The standard deduction for a dependent remains at the greater of: (1) $1,050 or (2) earned income plus $350, not to exceed the new $12,000 standard deduction for 2018. The deduction for personal and dependency exemptions is eliminated for 2018–2025; but will be reinstated in 2026. The rules for identifying dependents are retained in the interim to be used for other purposes (e.g., head of household filing status and the child tax credit). The income tax rates for estates and trusts are reduced from five tax brackets in 2017 (15%, 25%, 28%, 33% and 39.6%) to four tax brackets (10%, 24%, 35% and 37%) for 2018 through 2025. After 2025, they will revert to the 2017 rates. Net operating losses (NOLs) incurred after 2017 can be carried forward only (not back) and are deductible only to the extent of 80% of the taxpayer's taxable income. NOLs can be carried forward indefinitely. More corporations are now eligible to use the cash method of accounting because the gross receipts limit is increased from $5 million to $25 million average annual gross receipts over the three prior years. Businesses with inventories that meet the same no-more-than $25 million average gross receipts test can use the cash method and account for their inventories as non-incidental supplies and are also exempt from the UNICAP rules. Income can be recognized no later than the year in which the income is taken into account on an applicable financial statement. For divorce agreements executed after 2018, alimony is no longer deductible and is not taxable to the recipient. Existing divorce agreements are not affected.
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Supplement to Taxation for Decision Makers, 2018 Edition
Chapter 3
3
4, 5 & 6
Section Brief Description of Change 3.4.5 The provision for exclusion from gross income for student loan forgiveness is expanded to exclude student loans that are discharged on account of death or disability of the obligor. 3.6.2 Prior to 2018, corporations were taxed using a worldwide system that provided incentives for U.S. corporations to keep foreign earnings offshore because these earnings were not taxed until repatriated to the U.S. For this reason, many U.S. corporations have accumulated significant untaxed and undistributed foreign earnings. Beginning in 2018, the U.S. is moving to a territorial system that taxes businesses only on income earned with the country’s borders. The new law essentially exempts income earned by foreign subsidiaries from U.S. tax by allowing corporations a new 100% dividends received deduction (DRD) for the foreign-source portion of dividends received from 10%-or-greater owned foreign corporations. To avoid a potential windfall for these U.S. corporations, a transition tax will be imposed on accumulated earnings of a foreign corporation without requiring an actual distribution. For the last tax year beginning before January 1, 2018, there is a mandatory one-time transition tax on a U.S. shareholder’s pro rata share of foreign corporation’s post-1986 tax-deferred earnings at an effective rate of 15.5% (for earnings held in cash or cash equivalents) or 8% (for noncash assets such as equipment). This can be paid over a period of up to 8 years. Corporations can use existing foreign tax credits to settle this tax. Anti-base erosion rules on intangible income effectively repeal deferral for multinational corporations with low tax offshore structures by introducing a new category of Subpart F income that impose a tax on the shareholder’s net controlled foreign corporation (CFC) income that is “global intangible low-taxed income” (GILTI). This is essentially defined as a CFC’s net income less a deemed 10% return on the CFC’s basis in depreciable tangible property. A deduction is allowed equal to the sum of 50% of GILTI included in income plus 37.5% of “foreign-derived intangible income” (FDII) for the year. FDII is the amount of a corporation’s deemed intangible income that is attributable to sales of property to foreign persons for use outside the U.S. or the performance of services for foreign persons. When combined with the 21% corporate tax rate, these deductions result in effective tax rates of 10.5% on GILTI and 13.125% on FDII. For tax years beginning after 2025, the deduction rates are reduced to 37.5% for GILTI and 21.865% for FDII. 4.1.2 Deductions for miscellaneous itemized deductions including 5.4.6 unreimbursed employee business expenses, investment expenses, tax 6.1.1 preparation expenses, and hobby expenses are eliminated for 2018-2025. 6.5.3 Miscellaneous deductions that are not subject to the 2%-of-AGI floor (such as gambling losses and impairment-related work expenses) are still deductible.
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Supplement to Taxation for Decision Makers, 2018 Edition
Chapter 4
4
4
4&5
4
4 5 5
Section Brief Description of Change 4.1.4 The limitation on deductibility of certain employee compensation in excess of $1 million is modified by eliminating the exceptions for commissions and performance-based compensation. The definition of a covered employee includes the principal executive officer, principal financial officer and the three other highest paid employees and these individuals will be treated as covered employees for all future years. 4.2.9 Meals provided to employees during working hours or through an onpremises cafeteria are still tax free to the employees, but the employer can deduct only 50% of the cost until 2026 (after 2025, these cafeteria costs become nondeductible). No deduction is allowed for employer-provided athletic facilities unless the benefits are treated as taxable compensation to the employee. 4.2.10 While the exclusion from income for qualified transportation fringe benefits such as parking and mass transit passes continues, employers may no longer deduct any expense incurred for providing transportation or any payment or reimbursement to an employee for commuting except as necessary for ensuring the safety of the employee. The exclusion for bicycle commuting reimbursement has been suspended for 2018-2025. 4.2.11 The deduction for moving expenses is eliminated for 2018-2025 (except 5.2.6 for a member of the armed forces on active duty). Reimbursements for an employee’s moving expenses will be considered taxable income (except for armed forces). 4.3 Employees of private companies can elect to defer the income for stock options and restricted stock plans beginning in 2018. The private company must offer this equity-based compensation to at least 80% of full-time employees. If the award qualifies, an employee can make an election within 30 days of vesting to defer recognition of income. If the election is made, income recognition is generally deferred until the earliest of: the date the stock is transferable, the employer has an initial public offering, or five years after the stock vests. This election is not available if the employee has the right immediately upon vesting to sell the stock to the employer or settle the award in cash. An employee who has been CEO, one of the four highest compensated officers, or a 1% owner is not eligible. 4.4.5 The Treasury decided to eliminate myRAs with deposits no longer accepted as of December 4, 2017. 5.2.2 The deduction for qualified tuition and fees expired at the end of 2016 and was not extended. 5.4.2 Itemized deductions for real and personal property taxes as well as state 5.7.2 and local income taxes (or sales taxes in lieu of income taxes) are now combined and limited to a maximum of $10,000 ($5,000 if married filing separately) for 2018-2025. Foreign real property taxes cannot be deducted if they are not related to a business. Up to $10,000 in taxes will be added back for alternative minimum tax purposes.
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Supplement to Taxation for Decision Makers, 2018 Edition
Chapter 5
Section 5.4.3 5.7.2
5
5.4.3
5
5.4.4
5&9
5.4.5. 9.3.1
5 5
5.4.7 5.6.2
5
5.7
5
5.7.2
5
5.8.3
Brief Description of Change For 2018-2025, the mortgage interest deduction continues for both a principal and second residence but is limited to the interest on mortgage loans of not more than $750,000 ($375,000 if married filing separately). However, the $1,000,000 ($500,000 if married filing separately) limit continues to apply to home mortgages obtained before December 15, 2017. The debt limit does not decrease as a result of refinancing. After 2025, the $1,000,000 debt limits applies regardless of when the debt is incurred. The deduction for interest on home equity loans is eliminated. Interest on existing home equity loans was not grandfathered and is nondeductible. The charitable contribution deduction limitation for cash contributions is increased from 50% to 60% of adjusted gross income for 2018-2025. Amounts paid to colleges and universities for athletic seating rights no longer qualify as charitable contribution deductions. For 2018-2025, individuals can no longer deduct personal casualty and theft losses unless they occur in a federally declared disaster area. A limited exception applies when a taxpayer has personal casualty gains for the year (e.g., insurance proceeds exceeded the property’s cost); a taxpayer may deduct the portion of the personal casualty loss not attributable to a disaster to the extent the loss does not exceed the personal casualty gain. The phase-out for itemized deductions is eliminated. The child tax credit is doubled from $1,000 to $2,000 and up to $1,400 is refundable for 2018-2025. The threshold amount for phaseout is increased to $400,000 for a joint return ($200,000 for other taxpayers). A $500 nonrefundable credit will be allowed for a qualifying dependent other than a qualifying child (such as a grandparent who lives with the taxpayer) if a U.S. citizen, national or resident. The child’s social security number must be included to claim a credit for a qualifying child (but not for the $500 dependent credit). Under the revised kiddie tax rules, the child’s tax on unearned income (including dividends and long-term capital gains) is computed using the tax rates for estates and trusts rather than those of his or her parents. The threshold on unearned income remains at $2,100. The alternative minimum tax exemptions are increased for 2018-2025 to $109,400 for married couples filing jointly, $70,300 for single and head of household, and $54,700 for married filing separately. The exemption phaseout threshold is also increased to $1 million for married couples filing jointly and $500,000 for all others. The adjusted gross income threshold for deductible medical expenses is 7.5% for 2017 and 2018 (reverting to 10% for 2019) Although the standard deduction is disallowed in computing the AMT, the adjustment to the standard deduction for a net disaster loss before 2018 is not an AMT adjustment. Filing requirements are based on the standard deduction; thus, a single individual under age 65 will not be required to file a return for 2018 unless his or her income exceeds $12,000 ($24,000 for a married couple filing jointly).
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Supplement to Taxation for Decision Makers, 2018 Edition
Chapter 6
Section 6.4.1
6
6.4.6
7
7.3.1
7
7.3.2
7
7.4.1
7
7.4.2
7
7.6.1
8
8.1.6
8
8.5.2
9
9.2
10
10.2.1
10
10.2.4
Brief Description of Change The deduction for the costs of entertainment directly related to or associated with business is eliminated. Food and beverage expenses associated with a business, such as meals consumed by employees while traveling on business, are still deductible subject to the 50% limit. A business expense deduction is not allowed for any settlement, payment or legal fees related to sexual harassment or sexual abuse if subject to a nondisclosure agreement for amounts paid or incurred after December 22, 2017. The amount of depreciable tangible personalty that can be expensed in the year of acquisition under §179 is increased to $1,000,000 for 2018 and begins its dollar for dollar phaseout at $2,500,000. The use of §179 is also extended to certain building improvements. Bonus depreciation increased from 50% to 100% for purchases of qualified new or used property placed in service after September 27, 2017. 100% bonus depreciation will be gradually phased out for property acquired after 2022 at the following rate: 80% deductible for 2023, 60% for 2024, 40% for 2025, and 20% for 2026. Bonus depreciation will expire at the end of 2026. Computers and peripheral equipment placed in service after 2017 will not be treated as listed property. The declassification of computers as listed property means that beginning in 2018 bonus depreciation may be claimed even if the business use is 50 percent or less (although it can only be claimed for the actual business use portion of the asset). Listed property recapture rules will continue to apply to computes placed in service before 2018. Additionally, the failure to meet the more-than-50%-business use test will continue to disqualify a computer from §179 expensing. The annual depreciation limits for passenger vehicles are increased in 2018 to $18,000 (including $8,000 bonus depreciation) for the first year, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years. The $25,000 limit for §179 expensing for heavy SUVs will be adjusted for inflation after 2018 but this limit does not apply to bonus depreciation. Beginning in 2022, research and experimentation expenditures can no longer be deducted in the year incurred and must be amortized over 5 years. Prior to 2018, most intangible assets (such as a copyright) were not capital assets in the hands of their creator. As of 2018, patents have been added to the list of self-created intangible assets that are not capital assets. The election to defer recognition of gain on the sale of qualified small business stock if the taxpayer reinvests the sale proceeds in qualified stock is repealed for sales after 2017. Like-kind exchange rules will only apply to exchanges of realty (not held primarily for sale) for exchanges after 2017. The dividend received deduction is reduced in 2018. The 70% DRD is reduced to 50% and the 80% DRD is reduced to 65%. This means dividends subject to the new 50% DRD will be taxed at a maximum rate of 10.5% (50% x 21% tax rate) and dividends subject to the new 65% DRD will be taxed at a maximum of 7.35%. The U.S. production activity deduction is repealed after 2017.
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Supplement to Taxation for Decision Makers, 2018 Edition
Chapter 10
10
10
12
12
Section 10.2.8
Brief Description of Change For 2018-2019 employers are allowed a new general business tax credit equal to 12.5% of wages paid for paid family and medical leave (if the rate of payment is 50% of wages normally paid to an employee). The credit increases by 0.25% (but not above 25%) for each percent the payment rate exceeds 50% of normal wages. To qualify for the credit, all qualifying full-time employees must be given at least 2 weeks of annual paid family and medical leave (and all part-time qualifying employees given a commensurate amount on a pro rata basis). Beginning in 2018, the orphan drug credit is reduced from 50% to 25%. Also the rehabilitation credit is modified by repealing the 10% credit for buildings placed in service before 1936 and reducing the value of the 20% credit for certified historic structures by spreading the credit over 5 years. 10.2.9 The alternative minimum tax is eliminated for C corporations after 2017. Any unused minimum tax credit may be used to offset the regular tax liability. In addition, a portion of the unused minimum tax credit is refundable in 20182021. Appendix Exempt organizations must calculate unrelated business taxable income separately for each business so that a deduction from one business may not be used to offset income from a different unrelated business for the same tax year. A new 21% excise tax is imposed on compensation in excess of $1 million paid by an exempt organization to a covered employee. A new 1.4% excise tax applies to the net investment income of private colleges and universities with at least 500 students and assets of at least $500,000 per student. 12.2.4 Funds in a §529 college savings account can now be used for elementary and high school expenses in addition to post-secondary education. Funds from a §529 plan can be rolled over tax free into an ABLE account to assist disabled individuals. 12.7.3 Trusts lose their exemption deduction of $300 for a simple trust and $100 for a complex trust.
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