The Tax Cuts and Jobs Act (TCJA) was the most comprehensive revision of income taxes in the last three decades. As taxpayers and their advisors start to prepare their 2018 income tax returns, it is helpful to consider the personal impact of the top five TCJA changes.
The top five changes for most taxpayers will be the increased standard deduction, home mortgage interest rules, state and local tax deductions, the increased child tax credit and the repeal of miscellaneous deductions.
- Standard Deduction – The TCJA replaced the personal and dependent exemption deductions with a much larger standard deduction. The standard deduction for married couples filing joint returns nearly doubled from $12,700 in 2017 to $24,000 in 2018. The standard deduction for single filers increased from $6,350 to $12,000. The near-doubling of the standard deduction will simplify tax filing for many Americans. An estimated 90% of taxpayers will use the standard deduction for 2018 returns. The number of itemizers is likely to decline from 30% in 2017 to 10% in 2018.
- Home Mortgage Interest – If you itemize, your home mortgage interest is generally deductible. The loan limits for mortgages after December 15, 2017 changed from the previous $1 million to $750,000. There are exceptions for homes under contract by December 15, 2017 with closings by March 31, 2018 and for refinancing where the new loan balance is equal to or less than the previous amount. Most home equity loan's interest are no longer deductible.
- State and Local Taxes (SALT) – The 2017 unlimited deduction for SALT is capped to a maximum amount of $10,000 in 2018. You may combine property taxes on a U.S. residence with state and local income taxes for a total deduction of $10,000. You also could elect to deduct your state sales tax rather than your state and local income tax. Many upper-income individuals from high-tax states will pay larger federal tax for 2018 due to the $10,000 SALT limit.
- Child Tax Credit – Families will benefit from a $2,000 tax credit per dependent child. With several child credits and the increased standard deductions for married couples of $24,000, some families will pay no federal income tax. Some families may qualify for up to a $1,400 refund on each child's tax credit.
- Miscellaneous Deductions – In 2017, your miscellaneous deductions for investment expenses, unreimbursed employee business expenses, tax preparation fees and other fees could be deducted if they were over 2% of your adjusted gross income. The miscellaneous deductions were repealed by the TCJA.
Many of the 90% of taxpayers who take the standard deduction are over age 70½. Most of these taxpayers have a traditional IRA or other qualified retirement plan and must take a taxable required minimum distribution (RMD). Those seniors who support charitable organizations should make their gifts through an IRA rollover. The IRS calls this IRA rollover a qualified charitable distribution (QCD). It is a transfer directly from the IRA custodian to a public charity and fulfills part or all of the IRA owner's RMD.
Individuals or couples over 70½ who make charitable gifts through a QCD will reduce their taxable income because part or all of the RMD was transferred to charity and is not taxable to the doner. If taxpayers reduce income through a QCD and take the larger standard deduction, many may pay little or no federal income tax.
Bipartisan Conservation Easement Bill
In January, Senate Finance Committee Members Steve Daines (R-MT) and Debbie Stabenow (D-MI) introduced the Charitable Conservation Easement Program Integrity Act (CCEPIA). The bill limits the tax deduction for charitable conservation easements to two and one-half times the property owner's cost basis if the property is held by a partnership.
Sen. Daines stated, "The conservation easement tax incentive is meant to help conserve land and protect family farms. This bill makes several important changes to the tax incentive that will help curb abuses and make sure that the program remains an important conservation tool."
CCEPIA is supported by the Land Trust Alliance (LTA), The Nature Conservancy and Ducks Unlimited. LTA President Andrew Bowman stated, "This legislation is timely and essential. Sen. Daines and Sen. Stabenow are working together – with the support of 1,000 nonprofit land trusts across our nation – in the best tradition of sensible bipartisan cooperation to get this done. Their leadership on this issue sends a clear message that conservation easements are not to be used as tax shelters."
Many conservation organizations support CCEPIA because of abuses reported in an IRS study. Partnerships would acquire property and then make conservation gifts to obtain charitable tax deductions. The study for years 2010 through 2016 showed that these partnerships claimed average deductions equal to nine times the partners' cost basis. The total claimed deductions during that period were $20 billion.
The IRS further reported that during 2016, there were 248 transactions that were potentially questionable. These transactions involved a reported $6 billion in inflated charitable deductions.
Opposition to CCEPIA comes from the Partnership for Conservation (P4C). P4C Executive Director Robert Ramsey noted, "Conservation partnerships have helped protect hundreds of thousands of acres in perpetuity. Taking this critically important tool out of our conservation toolbox, as this legislation aims to do, will lead to less land being conserved – an environmental challenge neither political party can afford to ignore."
Many conservation organizations are concerned that abuse of the charitable deduction by some partnerships will lead to less support for conservation by Members of Congress.
Final Regulations on Sec. 199A
On January 18, 2019, the IRS published final regulations, a revenue procedure and a notice on Sec. 199A.
In the Tax Cuts and Jobs Act, the top income tax rate was lowered to 37% and a new 20% deduction for pass-through business income was created. The effective top rate for qualified business income (QBI) was reduced to 29.6%.
The QBI deduction is available for sole proprietorships, partnerships, subchapter S corporations and some trusts and estates. It may not be taken for wage income or earnings from a C corporation.
A QBI deduction is permitted if the individual's taxable income is below the single person or married couple threshold. It is limited over the threshold by "(i) the type of trade or business engaged in by the taxpayer, (ii) the amount of W-2 wages paid with respect to the trade or business (W-2 wages), and/or (iii) the [unadjusted basis immediately after aquisition (UBIA)] of qualified property held for use in the trade or business (UBIA of qualified property)."
The QBI deduction is available to some trusts and estates with qualified real estate investment trust (REIT) dividends or pass-through income. QBI deductions are further limited to the lesser of "(1) the sum of the combined amounts described in the prior two paragraphs or (2) an amount equal to 20% of the excess (if any) of taxable income of the taxpayer for the taxable year over the net capital gain of the taxpayer for the taxable year."
- Final Regulations – This guidance clarifies the definition of net capital gain and UBIA. It covers the trust anti-abuse rules and various Sec. 199A provisions.
- Calculation of W-2 Wages – Revenue Procedure 2019-11 explains three methods for calculating business W-2 wages. Section 199A(b)(2) limits the QBI deduction based upon W-2 wages.
- Rental Real Estate – Notice 2019-7 creates a safe harbor test for rental real estate. It generally requires separate books for each property, 250 hours of rental services provided and contemporaneous records.
The Sec. 199A deduction is quite complex if taxpayers are over the thresholds ($157,500 for single filers and $315,000 for married couples filing jointly in 2018). The guidance is helpful, but CPAs will still need to exercise a substantial level of judgment when completing tax forms due to a number of areas of uncertainty.
Applicable Federal Rate of 3.4% for January -- Rev. Rul. 2019-3; 2019-2 IRB 1 (19 December 2018)
The IRS has announced the Applicable Federal Rate (AFR) for January of 2019. The AFR under Section 7520 for the month of January is 3.4%. The rates for December of 3.6% or November of 3.6% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2019, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return.