By Nick Spoltore
On November 2, 2017, the House released The Tax Cuts and Jobs Act. It is the most comprehensive tax legislation since 1986. Its intended tax reform may very well affect each American taxpayer. The Senate just announced it will release its own tax reform legislation by the end of this week, so soon we’ll be looking at differences in the two bills with an outlook to eventual reconciliation and possible enacted legislation. Now is a great time to discuss some key topics that practitioners will soon be fielding from clients seeking the latest tax and financial advice. To that end, here are some Tax Cuts and Jobs Act talking points to help you address the top five questions you’ll get from your clients:
1. Let’s start with tax rates. The Act retains the current highest individual rate of 39.6% on individual return income over $500,000 and joint return income over $1M. However, the benefit of the graduated 12% rate phases out for a single filer earning $1M and a married couple making $1.2M, with the benefit phased out by $6 on every $100 of income until the 12% rate relief has been clawed back. A married couple would thus face a 46.5% marginal rate on earnings between $1.2M and approximately $1.6M, with the rate then returning to 39.6%. I point this out not to highlight the approaching one-half rate on income of high earners. After all, many 1040 accountants will never prepare a return with that level of scratch. But the rate is noteworthy because it was not widely publicized. Some commentators are going so far as to referring to the rate as secretive or even hidden within the Act. There are a number of other points in this Act which are similarly not being given much breath or ink – which leads me to #2.
2. Tucked away in the Act, there is a provision treating up to $10,000 a year for elementary and high school expenses as qualified under the §529 plan rules. Currently, §529 dough can only be used for post-secondary education – think college and graduate schools. But now, the Act proposes that the same money can be used for private school tuition at the grade school and high school levels. This is very much a point you should be making to your parent and grandparent clients. Many would jump at the chance to fund or offset Junior’s tuition and fees for private grade school and/or high school. Hammer this point home and perhaps you can cultivate a professional referral source relationship with a trusted financial advisor from all the new money flowing into §529s. Oh, and for all of us non-DIY types constantly complaining there are not enough plumbers and HVAC professionals, the Act would also expand qualified expenses to include costs associated with apprenticeship programs. Do yourself a financial favor and apprise your clients of these educational reforms.
3. The mortgage interest deduction ($1M mortgage cap) is retained for mortgages already existing on November 2, 2017. It also will remain the same for taxpayers who entered into a binding written contract before that date. For new mortgages, the deduction is limited to $500,000 ($250,000 for a married individual filing separately). The interest on home equity debt incurred after November 2, 2017 would presumably not be deductible. The bill also limits new debt and the attendant lower $500,000 deduction limit to one qualified residence.
The National Association of Home Builders and other organizations have come out against this reduction in mortgage interest. Without any consideration given to mortgage insurance, and with a 20% down payment of $125,000, a purchaser of a home worth approximately $625,000 would be able to fully deduct the mortgage interest on a $500,000 note. More expensive homes, in say, New York City or Hawaii, would not afford their mortgagors the full deduction. Prognostications of a housing recession have been made, and this provision will be targeted for mark-up and potentially altered by the forthcoming Senate bill. STAY TUNED.
4. The Act eliminates the deduction for state and local income or sales taxes. Much has been written about this provision, and I would simply note that it’s high time to cue the politicos in high income tax states such as New York and New Jersey to fight passage of this take-away. However, its effect would be seen in high sales tax Republican states such as Tennessee.
5. For the §121 exclusion of gain on a principal residence, the Act dictates Taxpayer must own and use the home as the Taxpayer’s principal residence for 5 out of the previous 8 years to qualify for the exclusion. Taxpayer may use the exclusion only once every 5 years. The exclusion is phased out by one dollar for every dollar by which a Taxpayer’s AGI exceeds $500,000 ($250,000 for single filers). No longer would the two out of five years criteria apply, effectively restoring the pre-1978 rule.
The Act eviscerates the estate tax insofar as the base exclusion amount exempt from estate and gift tax will be doubled from the 2011 $5M (as indexed for inflation to $5.6M in 2018) to $10M (also indexed for inflation and $11.2M in 2018). As such, with portability a couple will be able to effectively shield $22.4M from estate taxes beginning in 2018. Estate and GST taxes would not apply to estates of decedents dying after December 31, 2023, and the provisions for stepped-up basis will remain intact.
A couple of long past years are referenced in this article – Restoring pre-1978 rules…Most comprehensive tax legislation since 1986. It is worth pointing out, for nothing more than historical and perhaps archaic context, that the popular TV series Diff’rent Strokes ran on NBC from 1978 to 1986. Against this timeframe, we can better understand the far-reaching and pivotal changes potentially brought about by this Act as truly once in a generation.
Go much deeper on these five talking points, as well as many other aspects of the Act with all of Surgent’s tax reform CPE courses.
Nick Spoltore is Senior Director of Tax & Advisory Content for Surgent CPE. Mr. Spoltore is a graduate of the University of Notre Dame and of Delaware Law School. Before joining Surgent, he practiced tax and business law at the firm of Heaney, Kilcoyne in Pennsylvania and also in Delaware.