Article Dean Dorton
Below, we have created a visual representation of the 2020 federal income tax brackets for both single and married taxpayers. Although our graph stops at $700,000, the top bracket continues up indefinitely.
https://deandorton.com/wp-content/uploads/2020/11/Brackets-graph-for-web-800×822.png
This article was originally published in News & Views (Dean Dorton’s quarterly newsletter).
Article Dean Dorton
While it is possible you missed it, it’s doubtful. The first major reform of the federal tax code in 30 years was enacted into law at the end of December. Promising tax cuts for everyone, the bill is called the Tax Cuts and Jobs Act (TCJA). This article highlights some of the changes made to individual income taxation.
Individual tax rates
Under the new tax law, the individual income tax brackets are structured as follows:
| Tax Rate | Single | Married Filing Jointly |
|---|---|---|
| 10% | $0 – $9,525 | $0 – $19,050 |
| 12% | $9,526 – $38,700 | $19,051 – $77,400 |
| 22% | $38,701 – $82,500 | $77,401 – $165,000 |
| 25% | $82,501 – $157,500 | $165,001 – $315,000 |
| 32% | $157,501 – $200,000 | $315,001 – $400,000 |
| 35% | $200,001 – $500,000 | $400,001 – $600,000 |
| 37% | $500,001+ | $600,001+ |
These rates are lower than the previous rates; however, not significantly lower. The big savings for individuals is to come through the near doubling of the standard deduction.
Personal exemptions and the standard deduction
The TCJA eliminates personal exemptions but compensates by increasing the standard deduction to $12,000 single and $24,000 married filing jointly (MFJ), indexed for inflation for tax years beginning after 2018. According to the Tax Foundation, nearly 70% of all filers take the standard deduction, meaning only 30% of filers itemize deductions. Therefore, even after the elimination of the personal exemption, when the lower rates are coupled with the increase in the standard deduction, the result should be a tax decrease for many taxpayers.
So what about the 30% that itemize deductions?
Every deduction on Schedule A has been modified to some extent. Accordingly, the 30% of taxpayers that have historically itemize deductions will be impacted.
Some of the more significant changes are described below. Unless otherwise noted, these changes are in effect for tax years beginning after December 31, 2017 and before January 1, 2026.Changes to deduction for medical and dental expenses
Under pre-TCJA tax law, the deduction for qualified medical expenses was allowed for qualified medical expenses exceeding 10% of adjusted gross income (AGI). This floor was reduced to 7.5% of AGI for taxpayers 65 and older; however, that provision expired on December 31, 2016. Under the TCJA, the 7.5% floor is extended through 2018.
Changes to state and local tax deduction
Under pre-TCJA law, taxpayers were entitled to a deduction, without limitation, equal to the state and local taxes (SALT) paid during the year. The deduction primarily consisted of state, local, and/or foreign real property and income taxes paid.
Under the new tax law, SALT deductions are capped at $10,000. Since this has traditionally been one of the largest itemized deductions, it is anticipated that it will have one of the greatest impacts on taxable income.Changes to mortgage interest deduction
Under the TCJA, mortgage interest on loans used to acquire a principal residence and/or a second home remains deductible, but only on debt up to $750,000. The limitation was $1 million under prior tax law. Taxpayers with debt acquired on or before December 15, 2017 remain subject to the $1 million limitation, as the new law is not applied retroactively.
Changes to charitable contributions deductions
Under the TCJA, the limit for cash contributions has been extended from 50% to 60% of the contribution base, which is generally a taxpayer’s AGI. However, payments made to a college or university in exchange for the right to purchase tickets to an athletic event are no longer deductible.
Changes to miscellaneous itemized deductions
Under the new law, all miscellaneous itemized deductions that are subject to the 2% of AGI floor are no longer deductible. Common miscellaneous itemized deductions included unreimbursed employee expenses, investment expenses (i.e. brokerage fees), and tax preparation fees.
Is there more?
Yes, there is much more, but just three additional changes are discussed here.
Expanded use of Section 529 account funds: For distributions after December 31, 2017, “qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school, and various expenses associated with home schooling, up to a $100,000 limit per tax year.
Individual alternative minimum tax (AMT): The TCJA doesn’t repeal the AMT for individuals as was hoped for, but it does increase its exemption amounts. Before the TCJA, the individual AMT exemption for MFJ was $86,200 and that amount was reduced by 25% of the amount by which the couple’s alternative taxable income exceeded $164,100. The TCJA increases the AMT exemption amount to $109,400 MFJ and that amount is reduced by alternative taxable income above $1 million.
Child tax credit: Under pre-TCJA tax law, individuals could claim a maximum child tax credit (CTC) of $1,000 for each qualifying child under the age of 17. The CTC was phased out for taxpayers with AGI above certain threshold amounts.
The TCJA modifies the CTC by increasing the credit amount to $2,000 per qualifying child and increasing the threshold amounts for the phase-out to $400,000 MFJ and $200,000 for all other returns. Additionally, $1,400 of the CTC is refundable.
The talk has just begunMuch is yet to be determined about the changes enacted by the TCJA. There will be many more articles and discussions as issues and unintended consequences appear and regulations are issues. Be sure and stay tuned.
As originally published in Kentucky CPA Journal
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After vigorous debate on the floors of both the Kentucky Senate and House of Representatives, on Monday, April 2, the General Assembly passed the Free Conference Committee Substitute for HB 366. The bill, which might be called “Tax Reform Lite,” makes significant changes to Kentucky’s tax code, but many argue there is much reform left to be done.
The bill raises Kentucky’s cigarette tax by 50 cents to $1.10 per pack and includes changes to Kentucky’s individual and corporation income taxes, sales and use tax, and one small, but important change, to the state’s property taxes. Additionally, the bill limits and suspends some existing tax credits and incentives. Here is a brief look at a few of the more significant provisions of the bill.
Individual income tax
Corporation income tax
Property taxKentucky is one of only a handful of states that imposes a property tax on business inventory. The bill attempts to “phase-out” this tax by allowing a non-refundable income tax credit of 25% for taxes paid in 2018 and increasing the credit by 25% each year until there is a 100% credit for taxes paid on business inventory for years beginning on or after January 1, 2021. Stated otherwise, the property tax will remain, because of its importance to local governments, but taxpayers will receive a non-refundable credit against their state income tax for the inventory tax they pay.Sales and use tax
Effective for transactions occurring on or after July 1, 2018, the bill imposes sales and use tax for the first time on the following:
The bill repeals the sales tax exemption for pollution control facilities for transactions occurring on or after July 1, 2018.
Credits and incentivesThe Kentucky Industrial Revitalization Tax Credit, Kentucky Investment Fund Tax Credit, and Kentucky Angel Investor Tax Credit are suspended for four years to provide time for the General Assembly to study the impact of the credits. Also, the film tax credit, which has been subject to negative press, is retained but limited by the bill.Revenue estimatesThe tax bill is estimated to provide additional revenue of $234.1M in fiscal year 2019 and $244.1M in fiscal year 2020. Much debate took place in the House as to the accuracy of these estimates.ConclusionThe Tax Foundation, a leading independent tax policy research organization, has stated the changes instituted by HB 366 will move Kentucky from 33rd to 18th on the State Business Tax Climate Index published by the Foundation.
In that case, a constitutional majority (51 votes in the House and 20 votes in the Senate) could override the Governor’s veto.
If you have any questions, please contact your Dean Dorton advisor or Erica Horn at ehorn@deandorton.com.
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In Part 1 of this Tax Cuts and Jobs Act QBI deduction series, we discussed the computation of the deduction and the limitations on the deduction based on wages, property, and taxable income. In Part 2, we will discuss the businesses that qualify for the deduction and the types of income that qualify. (Please note that the discussion below is based on the statute and committee explanations and is subject to change with additional guidance.)
The legislation describes which trades or businesses are eligible for the deduction by defining those that are not eligible for the deduction. These ineligible businesses are defined as “specified service” trades or businesses. The statute provides that the specified service trades or businesses below do not qualify for the deduction:
Additionally, performing services as an employee does not qualify. Even though these businesses do not qualify for the deduction, there is an exception to this disallowance, if the taxable income of the taxpayer is below a certain amount, which will be discussed in Part 3 of this series.
The listing of the various disqualified businesses above raises several questions since the businesses are very broad. For example, performing arts and athletics are not eligible, but is operating a theatre or athletic facility, or leasing the facility to the operator, also ineligible? Do consulting services include management services? Additionally, the application to businesses where the principal asset of the business is the reputation or skill of the employees or owners is uncertain. Does this apply only to pure service businesses, or does it apply to such businesses as restaurants, home improvement, and so forth?
Additionally, no guidance has been issued with respect to multiple businesses owned by the same taxpayer. For example, a taxpayer may own three businesses—a manufacturing business, a sales business, and a management company that manages both businesses. The deduction may be significantly different depending on whether these businesses are grouped as one or treated as separate for the calculation of the deduction. However, at this time, there is no guidance on how to treat these related businesses.
The deduction applies to qualified business income from a business that is conducted in the United States. Accordingly, businesses operated outside the United States do not qualify. Guidance is needed for businesses with operations within and outside the United States.
Qualified business income is the sum of all income, gain, deduction, and loss from the business that is reportable or allowable in determining taxable income. This does not include nonbusiness and investment income in the form of short-term and long-term capital gains, dividends, interest, commodity, and foreign currency gains and losses, and other investment income, and the deductions related to nonbusiness and investment income. Additionally, it does not include wages paid to an S corporation shareholder or certain guaranteed and other payments to partners for services.
One item of business income where the application is unclear is capital gains and losses from a business. For example, the gain on the sale of a building used in a business or rented to a tenant may already be taxed at 20%. The additional deduction could lower the effective rate of tax on this gain to 16%.
As noted in Part 1 of this series, income from partnerships and S corporations qualify for the deduction at the partner or shareholder level. This pass-through entity will be required to provide the required information related to business income, wages, and property to its partners or shareholders to permit them to calculate their deduction for each separate business. The pass-through entities may need to provide this information for multiple businesses if the entity has more than one business. Guidance is needed to determine the number of qualified businesses in these circumstances and the allocation of income, gains, deductions, and losses to each separate business.
Additionally, trusts and estates may both claim the deduction at the trust or estate level and distribute business income, wages, and property amounts to beneficiaries based on distributable net income so that they can claim a deduction. The rules related to trusts, estates and beneficiaries are complex and beyond the scope of this article.
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In our fourth installment, we will discuss the new expansion of the limitation on the deduction of interest expense. For tax periods beginning after December 31, 2017, the limitation has been expanded to include individuals (and businesses owned by individuals). One major consideration, however, is that taxpayers who have gross receipts under $25 million are exempt from this limitation. Real estate businesses that otherwise would have to apply this limitation can elect out by using the alternative depreciation system (ADS), rather than MACRS. ADS lives are longer than MACRS lives (although the residential real estate life has been reduced to 30 years), and assets using ADS lives are not qualified for the 100% bonus depreciation or Section 179 expensing. As such, if the business interest limitation applies to a taxpayer, they need to consider the financing terms and interest expense relative to net income, as well as the implications of cost recovery/expensing of assets, and the QBI deduction.
If the taxpayer is not exempt and does not elect out of the limitation, business interest expense will be limited to the sum of:
Adjusted taxable income is taxable income adjusted for income and expenses not related to a trade or business, net business interest, NOLs, QBI deduction, and depreciation. The depreciation addback only applies until January 1, 2022.
This limitation is calculated at the partner level as well as the partnership level, so the partner’s share of income from a partnership will be excluded at the partner level (since the limitation would already have been calculated at the partnership level). Currently, there is little guidance on the potential that a partner might elect out and the partnership might not (or vice versa), and the interplay with the calculation at the partner level.
There is a concept that any “excess taxable income” generated by the partnership can be used to calculate the partner’s individual limitation. Conversely, if the partnership passes through excess business interest expense in a tax year which could not be deducted, the interest will be retained at the partner level and deducted if there is excess taxable income from the partnership in a future tax year.
Due to the fact that this will be considered at the entity as well as owner level, there will be more reporting requirements for the partnership to ensure all the information that is needed to calculate the applicability of this limitation is passed through to owners.
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As we continue our analysis of the Tax Cuts and Jobs Act (TCJA), we will address a provision that has not been widely reported, but could have an immediate impact in 2018 to certain taxpayers.
Effective for tax years beginning after December 31, 2017, an excess business loss of a non-corporate taxpayer will be disallowed in the current tax year and converted into a net operating loss to be carried over to the following tax year. An excess business loss is the excess of the taxpayer’s aggregated net active business losses over $250,000 ($500,000 MFJ). To illustrate:
H and W are married taxpayers filing a joint return. In 2018, H generates a net tax loss from his business of $600,000 and W generates a net tax loss from her business of $200,000. Both H and W actively participate in their businesses. Their aggregated net tax losses from trades or business is $800,000. Their excess business loss for 2018 is $300,000 ($800,000 – $500,000).
How does this limitation impact the taxable income of H and W?
Let’s assume that, in addition to the losses generated from their businesses, H and W have other investment income totaling $1,000,000. The following table illustrates how taxable income is calculated before and after the TCJA:
| Before TCJA | After TCJA | |
|---|---|---|
| Investment income | $1,000,000 | $1,000,000 |
| H’s active business loss | (600,000) | (600,000) |
| W’s active business loss | (200,000) | (200,000) |
| Excess business loss (see above) | 0 | 300,000 |
| Net taxable income | $200,000 | $500,000 |
While H and W cannot reduce their 2018 taxable income by the $300,000 excess business loss, this loss is converted to a net operating loss and carried over to the following year. H and W can use the net operating loss in 2019 to offset up to 80% of their taxable income. To illustrate, let’s assume that H and W have the exact same facts as above for 2019. Their 2019 taxable income would be calculated as follows:
| 2019 | |
|---|---|
| Investment income | $1,000,000 |
| H’s active business loss | (600,000) |
| W’s active business loss | (200,000) |
| Excess business loss (see above) | 300,000 |
| Net taxable income before net operating loss carryover | $500,000 |
| Net operating loss carryover from 2018 (lesser of NOL of $300,000 or 80% of taxable income before NOL ($400,000)) | (300,000) |
| Net taxable income after net operating loss | $200,000 |
This illustrates that the excess business loss limitation is merely a timing issue. Affected taxpayers, however, may be in for a surprise in this first effective tax year if not aware of this provision.