The Tax Cuts and Jobs Act was signed into law on December 22, 2017 and represents the most significant reform of the U.S. tax code in over 30 years. Before we get into the details, you should be aware that almost everything listed below expires after 2025, and the tax structure reverts to its current form in 2026 unless Congress acts between now and then. However, the corporate tax rate cut from 35 percent to 21 percent does not expire.
Key Features of the Act:
- Corporate Tax Rate. The maximum corporate tax rate is reduced from 35% to 21% with no sunset provision.
- Deduction for Pass-through Businesses. Owners of pass-through businesses (i.e. sole proprietorships, partnerships, S corporations, and limited liability companies) pay tax at their individual tax rates. The Act reduces the effective rate of income tax on certain pass-through businesses by providing owners with a 20% deduction. However, some pass-through businesses will not qualify for this deduction.
- Individual Tax Rates. The seven marginal tax rates for individuals are slightly reduced and the brackets adjusted, with the top bracket dropping from 39.6 percent to 37 percent.
- Standard Deduction and Personal Exemption. The standard deduction increases to $12,000 for individuals, $18,000 for heads of household, and $24,000 for joint filers, all adjusted for inflation. Personal exemptions largely disappear.
- State and Local Tax Deduction. Referred to as “SALT,” this deduction is now subject to a cap of $10,000.
- Home Mortgage Interest Deduction. The limit on deducting interest on up to $1 million of mortgage interest stays in effect for existing mortgages. New mortgages taken on or after December 15, 2017, are subject to a $750,000 limit. The deduction for interest on home equity loans disappears.
- Medical Expense Deduction. After much outcry in response to the House version of the tax bill, which would have eliminated the medical expense deduction, the medical expense deduction survived and was actually enhanced by permitting medical expenses in excess of 7.5 (rather than 10) percent of adjusted gross income to be deducted in 2017 and 2018.
- 529 Plans. These accounts permitting tax-free accumulation of capital gains and dividends to pay college expenses can now be used for private school tuition of up to $10,000 a year.
- Estate Taxes. If you weren’t worried about federal estate taxes before, you really don’t need to worry now. With the federal exemption already scheduled to increase in 2018 to $5.6 million for individuals and $11.2 million for couples, the Act doubles this to $11.2 million and $22.4 million, respectively, indexed for inflation. The tax rate for those few estates subject to taxation remains at 40 percent.
Depending on your income and the amount of state and local taxes you have been paying, you will likely benefit from a tax reduction in 2018.