Tax cuts are on the way, Hooray! Whether that Hooray! was sarcastic or not depends on your incorporation status. Corporations got a fist pumping Hooray! Pass-throughs/small business owners, I have to call my accountant first, but Hooray! Normal everyday W-2 employees, I have to run the numbers, but maybe a Hooray? I’ve done 3 different CE courses on the Tax Cuts & Jobs Act (TCJA) and the running joke in every course was “It’s clear as mud”. Hopefully I will able to give you some insight into the changes to see what your Hooray looks like.
Individual Tax Cuts
I’ll start on the individual side. The current 7 rate structure does not change. But rates do go down at the top six levels, with the bottom rate staying at 10%. The way it was structured, on a percentage basis the top 4 brackets received the most bang for their buck. The big changes are the items that are eliminated or reduced. Although, teachers did get keep their break for helping their students and 529 plans can now be used K-12 education expenses.
Personal exemptions are gone.
That was $4,050 each person on your return, now the standard deduction is now $12,000 if single or $24,000 if married.
Reduces mortgage interest deductions.
The max principal loan amount is now $750,000 down from $1 mil. No deduction for home equity interest.
Eliminates miscellaneous itemized deductions.
Tax prep fees, gone. Investment management fees, gone (this one affects my clients). No more employee business expenses. Work from home or put in miles for your company, no more deductions. Any professional & union dues, gone.
This was a big one. Combined state, local & property taxes max deduction is now limited to $10,000.
Except for military. This is one is strange to me. Don't you want to promote mobility in an economy?
Casualty loss deductions.
Another one bites the dust. Only for presidentially declared disasters. This one just seems mean.
Even with these deductions going away, most Americans under the old tax code didn’t itemize deductions. With the standard deduction going up to $24k for married couples, that will probably make people just take the standard deduction more often. And the child tax credit goes from $1,000 to $2,000, with up to $1,400 refundable. The phase out phase goes up to $110K from $75K, allowing more people take advantage. I think the child tax credit is a good one for families. There are still things within the alternative minimum tax (AMT) that need further clarification from the IRS, but overall it seems that there will be fewer people paying AMT. Because of the changes to SALT, more tax payers will pay more taxes and therefore no longer will fall into AMT. A tough way to avoid the AMT.
Business Tax Cuts
On the business side, it’s party time. Corporate rates go from 35% down to 21%. The AMT is also eliminated for corporations. There are numerous changes to deductions with a good portion of them being for the benefit of corporations. But not all the changes were on the plus side. There are a couple of changes that will be tax increases for businesses. Research & development costs must be amortized over 5 years, specifically includes software development and of course excludes oil & gas. Another one is elimination of entertainment expenses. I wonder how the super bowl seating would have looked if the corporate sponsors didn’t own most of the tickets, we may soon find out. Will companies still buy all the suites if there’s not a tax deduction? But at this point, there is also lots that the IRS will have to clarify, because this law wasn’t passed with the most care to the details (that’s being kind).
The pass-through entities tax deductions are a lot more complicated, but generally favorable for most small business owners. The biggest one being 20% deduction if the income is less than $157,500 for singles and $315,000 for marrieds. Based on the Small Business Administration 2015 numbers the average income of the owner is $49,804. That would be almost $10k for the average business owner would keep in their pocket. Nothing to sneeze at. The numbers are too complicated to get into all the details here if you are over the 20% deduction limit, but again generally favorable. The question I’ve been getting the most from business people is, “Should I switch my business to a c-corp?” The short answer is probably not. If it made the most sense to be a pass-through entity before, that’s probably still the case. But as always check with your CPA, your specific business might have an advantage.
So, what does all this mean for the economy? It’s still a matter of what happens to the windfall that corporations received. There have been announcements of one-time bonuses and at the same time layoffs. A few big retailers are bringing up the minimum wage, although some of those would still qualify for federal aid. Cough, Cough, Wal-Mart. Although the numbers say that the hourly wage is rising, if you dig a little deeper, last week’s report also says that the average weekly take home pay went down. Corporations are very good at managing expenses. I think that buybacks and dividends will still encompass most of the cuts. And corporations have said as much.
One of the more immediate effects has been what the CBO now forecast for inflows into the government. Since the tax law went into effect, there will be $10-15 billion less coming in every month. We have already been under extraordinary measures since December 8th of last year. Which basically means we were already shifting money around to pay the bills. But now we can’t even do that. The treasury would run out of money in early March. Bringing the how do we pay bills debate a few months earlier than the treasury thought just in December. This is while economists have started warning us about a slowdown paradoxically based on the economy overheating from tax cuts and possible interest rate hikes. The CBO also now estimates deficits of $700b and $975b for 2018 and 2019. Almost double the numbers based on Trump’s budget proposal of last year where they showed deficits of $392b and $465b over the same time period. This doesn’t look good for deficit hawks on the hill, if there’s such a thing.
So, what did we learn today? Businesses won the tax changes. Almost everyone will see tax decreases, but not everyone. There are still lots of areas where clarification from the IRS is going to take a while. While this tax cut was sold on growth being the key, for the time being it’s going to be really, really expensive. It's clear as mud.
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