Tax Reform: Individual Income Tax Rate Cuts

The Tax Cuts and Jobs Act passed Congress on December 20, 2017 and was signed into law by the President on December 22, 2017 (the enactment date).  The legislation is massive, running 1,097 pages with committee reports.  Congress authorized the Treasury Department to write “legislative” regulations, so the law won’t be settled for years to come.  Further, a technical corrections bill is expected.  Every individual and business will be impacted and whether you win or lose depends on your circumstances:  where you live, how you earn income, and the form of your business entity.  The business tax cuts are generally “permanent” but the individual tax cuts are temporary, sunsetting after 2025.  The massive number of changes, the temporary nature of many of the significant changes, and the risk of change in future political power bring a real sense of disruption and uncertainty.  Long-standing tax laws, to which people have organized their businesses and personal lives, have changed and will likely change again in the next eight years.  Generalizations will be dangerous.  Professional advisors will need to “unlearn” the old ways of planning and embrace the challenge of learning how to plan in the new landscape of “tax reform.”

Because so many tax laws have changed, I will be posting a series of articles reviewing some of the more important changes.  This first post deals with individual income tax rate cuts.

Married Filing Joint, Ordinary Income Tax Rates—2018

Prior Law		New Law
$19,050	10%	$19,050	10%
$77,400	15%	$77,400	12%
$156,150	25%	$165,000	22%
$237,950	28%	$315,000	24%
$424,950	33%	$400,000	32%
$480,050	35%	$600,000	35%
$480,051+	39.6%	$600,001+	37%

Single, Ordinary Income Tax Rates—2018

Prior Law		New Law
$9,525	10%	$9,525	10%
$38,700	15%	$38,700	12%
$93,700	25%	$82,500	22%
$195,450	28%	$157,500	24%
$424,950	33%	$200,000	32%
$426,700	35%	$500,000	35%
$426,701+	39.6%	$500,001+	37%

Trust/Estate, Ordinary Income Tax Rates—2018

Current Law		New Law
$2,600	15%	$2,550	10%
$6,100	25%
$9,300	28%	$9,150	24%
$12,700	33%	$12,500	35%
$12,701+	39.6%	$12,501+	37%

Long-Term Capital Gain and Qualified Dividend Tax Rates—2018

Rate	MFJ	Single	Trust/Estate
0%	$77,200	$38,600	$2,600
15%	$479,000	$425,800	$12,700
20%	$479,001+	$425,801+	$12,701+

Observations Regarding the New Tax Rates

·      The lowered tax rates are effective only for tax years beginning in 2018 through 2025 after which the prior law rates return.

·      The reduced top rate is still higher than the 2012 tax rate of 35%.

·      There is a sweet spot between $165,000 and $315,000 of MFJ taxable income where the tax rate is significantly reduced.

·      There is no “marriage penalty” for the first 5 rate brackets.  Previously this was true only for the first 2 brackets.

·      Although not shown, the head of household brackets vs. single brackets are better only for the first three instead of all seven brackets as was the case previously.

·      The brackets are indexed by the slower link-chained inflation method (C-CPI-U vs CPI-U) where the consumer is assumed to be able to substitute cheaper products in response to increased prices.  The new method does not sunset.

·      With rates scheduled to increase after 2025, Roth retirement account contributions should be considered before then.

·      Tax savings should be invested for retirement as increasing deficits will likely affect Social Security and Medicare benefits for the upper middle class.

·      Although estates and electing trusts can use a fiscal year to defer income tax, most should think about a calendar year for the lower tax rates.

·      The preferential long-term capital gain and qualified dividend tax rates are no longer linked to the ordinary tax rate brackets.

·      The 3.8% net investment income tax under the Affordable Care Act remains and applies when modified adjusted gross income exceeds:  $250,000 MFJ; $200,000 single; and $12,500 trusts and estates

“Kiddie Tax” Simplified

The current nightmare of preparing income tax returns of children under age 19 (24 if a full-time student) is simplified.  Instead of using the parents’ tax rates, and lumping siblings together, a child’s unearned income is taxed using the trust and estate tax rate brackets for both ordinary and capital gain rates for unearned income.  The child’s earned income is taxed under the rates for single individuals.  However, simplification comes at a cost for families not in the highest income tax bracket because the top trust ordinary and capital gain tax rates are reached at only $12,500 of taxable income.

Individual Alternative Minimum Tax Retained

Surprisingly, the AMT was retained at the last minute as part of the horse trading to secure votes from key senators.  Repealing the AMT would have been a great simplification to the law and it is disappointing to see that it remains.  The exemption from AMT was increased slightly but the exemption phase-out threshold was dramatically increased.  For MFJ, the exemption is increased from $86,200 to $109,400 with phaseout starting at $1,000,000 up from $164,100.  For a single, the exemption is increased from $55,400 to $70,300 with phaseout starting at $500,000 up from $123,100.  The $24,600 exemption for an estate or trust is not changed and the phase-out continues to start at $82,050.

Observations Regarding the AMT

Those paying 2017 AMT may find their marginal tax rates increasing in 2018 when AMT is less likely to apply.  For example, at $500,000 of taxable income the rate would increase from the 28% AMT rate to the 35% regular tax rate.  With the dramatic changes to itemized deductions, AMT will be less likely to apply, although it will continue to apply in a couple of circumstances.  First, those exercising and holding incentive stock option stock will continue to risk incurring the AMT.  Second, because regular tax rates were cut but AMT tax rates were not cut, it is possible upper middle-class taxpayers will continue to be subject to the AMT, but at a higher income level.  As generalizations are dangerous, it is important to run tax projection calculations to determine how the AMT may apply to taxpayers in the future.