Final Tax Reform Bill Released

The final version of the Republican “Tax Cuts and Jobs Act” legislation was released a few hours ago. It is 1,097 pages. I am going through it page by page.

It is not my intention to repeat the “big picture” changes that have been reported in the media over the last few weeks and months. It is is easy to find that information elsewhere.

My primary intention is to point out changes or items that I found interesting, including some significant items that were not widely reported or that would be interesting primarily to other tax professionals (e.g. things that most journalists get wrong).

  • The 20% pass-through deduction applies to business income plus qualified REIT dividends and PTP (publicly traded partnerhip) income.
  • For high-income taxpayers, the 20% pass-through deduction is limited to either 50% of W-2 wages or a combination of W-2 wages and unadjusted basis of deployed assets. The rationale is to minimize the amount of “labor income” that gets conveniently accounted for as “business income” and therefore subject to the deduction. For example, if a closely held S corporation pays low wages, it will qualify for a small pass-through deduction. But paying higher wages incurs additional employment tax. It will be interesting to see if the new deduction causes some S corporations¬† on the margin to pay higher wages.
      • It is a simple algebra problem for an S corporation to determine the ratio of wage to pass-through income that results in the maximum pass-through deduction. It will be interesting to see if this ratio becomes a new “target” for S corporation wage-to-income. I haven’t done the algebra but I believe the result is lower than current rules of thumb.
      • Page 29-30 lay out what items are included in W-2 wages. I didn’t follow the bread crumbs but I’m assuming it is largely box 1 with perhaps a few adjustments. For S corporation 2% shareholders, I’m hoping health insurance premiums are included (they are included in box 1).
      • The 20% pass-through deduction does not apply to investment income (this isn’t a surprise). Page 33.
      • Certain services businesses do not receive the 20% pass-through deduction if taxable income is greater than $315,000 for MFJ. Interesting that it is based on taxable income rather than AGI. There are far more ways to reduce taxable income than AGI. For business owners in the phaseout, things like 401(k) deductions, health insurance premiums, HSA’s, mortgage interest, and charitable donations just became more valuable.
  • The new pass-through deduction does not reduce AGI.
  • The new pass-through deduction is not an itemized deduction. It is available to non-itemizers. I suspect it will show up on the back side of Form 1040 between “Itemized deductions” and “Taxable income.” Perhaps it will take over the line for “Exemptions” which are no longer relevant.
  • The standard deduction is roughly doubled (widely reported) while personal exemptions are gone (less widely reported).
  • Child tax credit doubled (very widely reported due to the drama over Rubio’s and Lee’s vote). The credit will apply to FAR more people as the phaseout is bumped up from $110,000 to $400,000.
  • Many people have expressed interesting in prepaying 2018 state tax before the end of 2017 in an attempt to take advantage of the final days of the unlimited state income tax deduction. This strategy is almost certainly not allowed under general tax principles. And just to put an exclamation point on it, the bill specifically disallows that strategy. See pages 89-90.
  • Deduction for home equity interest is gone (this was somewhat widely reported). See page 90.
  • Acquisition/construction interest is deductible up to $750,000 rather than the current $1 million. Debt incurred before today (Dec 15, 2017) is grandfathered in to the $1 million rule.
  • All miscellaneous itemized deductions are gone. Some tax returns just got a lot simpler.
  • Alimony will not be deductible for divorce agreements after 2018. This provides a 1 year window to make your divorce more tax efficient. I wonder if we will see an uptick in divorces in 2018. Existing divorces as well as 2018 divorces are grandfathered in to the old rules but are allowed to opt out. Page 102.
  • Individual mandate repealed. Are insurance companies allowed to offer plans that don’t include the minimum essential benefits? If so I suspect and hope we will see new, less expensive insurance plans offered. My own premiums have gone from $300/month in 2016 to $950/month in 2017 to $1100 in 2018. It’s rising as fast as Bitcoin.
  • Increased exemption for AMT. With the $10,000 SALT limit it already limits the number of taxpayers that will find themselves subject to AMT. The increased exemption limits it further.
  • The 21% corporate rate is great for big corporations, but bad for small corporations that were previously taxed at 15%. I haven’t seen this point made in the media.
  • I had seen reports that the depreciation period for residential rental property was going down from 27.5 years to something shorter. Instead it has increased in the final bill to 30 years. Page 154-55.
  • Nonresidential increased to 40 years.
  • No more like-kind exchanges for personal property. Page 192. Cryptocurrency traders no longer have even a colorable argument that their trading qualifies for 1031.
  • Business entertainment expenses are no longer deductible. Page 194.
  • Meals provided at convenience of employer are no longer deductible starting in 2026. Eight years from now. Page 199.
  • I don’t believe I saw a change to the Section 121 exclusion (excluding capital gains on sale of primary residence). Did that not make it into the final bill?
    • UPDATE: Section 121 remains unchanged. You can still live in your house for 2 years and exclude the gain.

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