On top of the regular holiday season’s festivities, this year we’re watching the proposed “Tax Cuts and Jobs Act” likely making its way to the President’s desk for signature. The “joint conference committee” announced yesterday that they have a “final deal” and Congress is scheduled to vote on this next week. Before we review what we specifically know about the bill (not all details have been released as of this morning) and provide some recommendations concerning it, let’s step back and review it from a longer-term perspective.
Since last year’s election, stock markets have been on a tear- up over 20%, mostly driven by increased corporate profits, both here and abroad. U.S. GDP is growing and unemployment is close to 4%. Most economists believe that now is not the time for a tax cut, which could heat up an already expanding economy to produce some additional short-term growth and inflation. The Fed reported yesterday that the tax package should provide only modest upside, concentrated mostly in 2018 and have little impact on long-term growth, currently estimated at 1.8%. So, tax cuts now will not only likely increase the federal deficit by $1.5-$2 trillion over the next decade, but will take away the possibility of using tax cuts in the future, needed to spur the economy when the next recession hits. Certainly, we would all like lower taxes and even higher returns on our investments, but we’d prefer to see longer-term healthy economic growth with its benefits widely shared by all Americans and steady investment returns, rather than a boom-bust scenario and huge tax cuts primarily for the wealthy that may not increase long-term economic growth.
As of this morning, December 14th, here are the current major provisions:
- Income Tax Rates. The top tax rate will be cut from 39.6% to 37%.
- Standard deduction and exemptions. Double the standard deduction (to $24,000 for a married couple) and eliminate all exemptions ($4,050 each).
- State and Local Income, Sales and Real Estate Taxes. Limit the total deduction for these to $10,000 per year.
- Mortgage Interest. The bill would limit the deduction to acquisition indebtedness up to $750,000.
- Limitations on itemized deductions for those couples earning greater than $313,800. Repeals this “Pease” limitation.
- Roth recharacterizations. No longer allowed.
- Sale of principal residence exclusion. Qualification changed from living there 2 of 5 years to five out of eight years.
- Major items basically unchanged. Capital gains/dividends tax rate, medical expense deductions, student loan interest deductions, charitable deductions, investment income tax of 3.8%, retirement savings incentives, Alternative Minimum Tax, carried interest deduction (though 3 yr. holding period required.)
- Estate Taxes. Double the estate tax exemption from $5.5 million per person to $11 million.
- Top C-Corporation Tax Rate. Reduce to 21% from 35%.
- Alternative Minimum Tax. Eliminated.
- Business Investments. Immediate expensing for qualified property for next five years.
- Interest Expense. Limit on expense to 30% of business interest income plus 30% of adjusted EBITDA. Full deduction for small businesses (defined as $25 million sales by House, $15 million by Senate).
Another key issue, the top rate on pass through organizations (such as partnerships and S Corps), is yet to be determined. However, it appears that a reduction of 20% to 23% will be available to pass-through income, subject to W-2 minimums and adjusted gross income maximums. This would produce an effective top rate of 29.6% on pass through income.
If all of that seems confusing, you’re not alone. Lots of moving parts and lots of details still to be clarified. Even so, if the bill passes, you will have been smart to consider the following:
1) Because the bill would limit deductions for local income, sales and real estate taxes, you should make sure that you have paid all state income tax payments before December 31, 2017. If you are not sure, pay a little extra.
2) Also, make sure you pay your 2017 real estate taxes in full before 12/31/17. Because Illinois real estate taxes are paid in “arrears” it will be necessary to obtain an estimated 2017 real estate tax bill (generally due in 2018) by going to your county link and then paying this before 12/31/17. Let us know if you need help on this. In the Low country, while our CPA friends indicate that paying 2018 real estate taxes in 2017 should be deductible, as a practical matter, there appears to be no way to get an estimated tax bill for 2018 and prepay your 2018 real estate taxes in 2017.
3) Meet with us and/or your CPA in early 2018 to review the impact of the Act, assuming it becomes law, on your 2018 income tax planning. It will be important to review the various strategies that may be available to make sure you are paying the least amount of taxes.
Yes, tax reform may be here before Christmas. Not sure what it will be: a wonderful gift for this year’s holiday or perhaps a lump of coal in our stockings for Christmases to come. Stay tuned.