The Tax Cuts and Jobs Act of 2017 was the most sweeping set of changes to the Internal Revenue Code since 1986. It passed the house 227 to 203, with no Democrats voting for it, and squeaked out of the Senate in an even closer 51-48 vote. The last significant federal tax legislation, The Internal Revenue Code of 1986 was an orderly rethinking of the entire tax code, with major structural changes, and involved over a year of thoughtful study and compromise by both houses and both political parties in Congress.
The 2017 Tax Act was certainly not Congress’ finest hour. Small concessions to win over one or two senators at a time were written in the margin of the draft legislation in long-hand, and instead of a comprehensive cure to some major inequities and overcomplexities already existing, it was more of a big band-aid. Clearly, part of Congress was under pressure from the President to have something to show for having been on the job for a whole year and not accomplished anything.
A few months afterward, Speaker of the House Paul Ryan called on the House Chaplain, a Jesuit, Reverend Patrick Conroy to resign. Conroy, trained as both a lawyer and a priest, had delivered a prayer during the tax cut debate that included a request “May their efforts these days guarantee that there are not winners and losers under new tax laws but benefits balanced and shared by all.”
On the individual tax law changes, we went from the former structure of seven tax brackets, topping out at a marginal rate of 39.6 % to one with seven tax brackets, topping out at a marginal rate of 37%. The top rate under the new legislation was reached at taxable income levels that were higher than under the previous law, producing some clear winners among those with higher incomes.
NEW STANDARD DEDUCTION
The new standard deduction, which you can use instead of adding up your medical expenses, mortgage interest, income and property taxes, and charitable contributions, is in all cases about twice the size of the old standard deduction. Going the other way, Congress also eliminated an old standby, the personal exemption, worth roughly $4,000 per taxpayer.
CHARITABLE DONATIONS
The new larger standard deduction produced some real heartburn among the religious and nonprofit sector, which relies heavily on contributions. The concern is that some people will enjoy little or no tax benefit from donations, and that might weaken their plans to do so.
For individuals over the age of 70 ½ who must take distributions from their traditional taxable IRA accounts, the tax benefit of contributions is still around, but has changed a bit. For those folks, they can take a “qualified charitable distribution” from an IRA, then have the IRA custodian send a check directly to their intended charity so as to avoid having to include the distribution in gross income. The amount can be any amount, not to exceed $100,000 per senior taxpayer, in a given year. By not having to include the distribution in gross income, the person has effectively gotten at least as much benefit as including it in income, then taking a full deduction for the amount of the gift, but now doesn’t have to itemize deductions to make this withdrawal a tax neutral donation. This way, the gift is left out of gross income, and you get to use the newly doubled standard deduction, and in many circumstances, come out with lower taxable income, except for having lost the personal exemption of $4,000 a head.
The only real downside to this approach is that under current law, North Carolina is not along for the ride. On your state tax return, you have to add the qualified charitable distribution amount back into income and are then instructed that you MUST take the standard deduction (with no contribution deduction) if you used the standard deduction on your federal tax return. In 2017, this wasn’t so bad, because the state standard deduction was 35% larger than the federal standard deduction, but in 2018, the state’s standard deduction will be about 25% smaller than the federal standard deduction. The extent of the loss here will be at North Carolina’s tax rate of about 5 ½ percent. In order to decide which is the better way to go, it’s like the answer to all tax questions—it depends. Run the numbers!
Let’s backtrack for a minute and remember some of the federal provisions that do benefit significant givers. The big one is the rule that giving appreciated property to a charity yields a deduction equal to the fair market value of the property, and that you generally don’t have to recognize the growth in value since you first got it as taxable income. Apple stock that cost $1,000 twenty years ago is worth about $300,000 now. You can give some of that to your church, get an itemized deduction for the value, and do nothing about the windfall increase in value. The only limitation is that on gifts of appreciated property like that, you can only deduct up to 30% of the gross income for the year of the gift. Any amount above that is carried forward to the next year, subjected to the 30% test in that year, and so on, until the carryforward amount expires after the fifth carryforward year. Just remember that the gift is of the property. Do not sell it, and then give them money, unless you give all of it. Otherwise, it will be bad news in April.
Staying with the focus on doing good works with your money, some people are concerned with the prospect of outliving their money, and are uncomfortable with parting with too much while they are alive, but don’t mind giving some away after they’re gone. A great solution to this, again, is with retirement accounts. Charities and churches, being generally exempt from income tax, can be designated as your beneficiary, either complete or partial, on your IRA or other company retirement plan, like a 401K plan. When you die, the money goes to the charity, and no income tax happens.
There are some other more exotic approaches to charitable giving with remainder trusts, charitable gift annuities and such, where you transfer property or cash to a charity or a charitable trust, with a requirement to pay money back to you, either for a sum of years, or for the rest of your life. Just remember that if you’re getting money back, the value of the gift will be reduced so that it represents what is likely to go to the charity after your interest has terminated. That is accomplished by using designated interest rates and life expectancy tables, provided by the IRS.
OTHER MAJOR CHANGES
There were a few just random things that Congress took aim on and limited or did away with. They limited the amount of mortgage interest on your principal residence and one other, so that if you are itemizing, there is a cap on how much indebtedness you can deduct the interest. For mortgages in place before 2018, the debt cap was $1 million, but for new ones the cap is $750,000. The deduction for state sales and income taxes and property taxes was capped at $10,000.
One real shocker was that unreimbursed employee business expenses, investment management fees, theft and casualty losses, and tax preparation fees were just reformed right out of existence. That was not the kind of tax simplification that most people were hoping for. Also gone is the deduction for gambling losses to offset to the extent of gambling income. I’ve seen clients who won $10,000 playing blackjack, but stayed till they gambled all of it away. Through last year, I could offset winnings with losses. Now it doesn’t make any difference. With respect to these types of deductions that were eliminated, Congress was actually following in the footsteps of North Carolina, which did away with the same kinds of deductions five years ago.
For those of you who are in business for yourself, there were some items in the new tax act for you. Depreciation write-offs are generally larger and quicker, and for self-employed sole proprietors, participants in partnerships, LLCs and Subchapter S corporations, there is a deduction for 20% of the lesser of business income or taxable income, that may work well for you. Congress painted their customary bullseye on the back of people in medicine, law, accounting, financial services, and such, and limited the amount of benefits those folks can get. Oddly, there were not similar restrictions on engineers and architects, so you can tell who has the better lobbyists in Washington.
Because major tax reform like this happens so seldom, it may be worthwhile for you to schedule tax-planning consultation earlier in the year to ensure you reap the most tax savings possible for the 2018 tax year.
Contact us today to see how we can help!
