Written by: Michele Hermann, CPA
On December 22, President Trump signed into law the Tax Cuts and Jobs Act (the “Act”). This article describes some of the Act's changes that would affect C Corporations beginning in 2018 and individuals for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026.
Drop in Tax Rates
Beginning with the 2018 tax year, the Act makes the corporate tax rate a flat 21%. It also eliminates the corporate alternative minimum tax. C corporations were previously subject to graduated tax rates ranging from 15% to 35%.
Individuals are subject to income tax on “ordinary income,” such as compensation, and most retirement and interest income, at increasing rates that apply to different ranges of income depending on their filing status.
The Act still has seven tax brackets for individuals, but their percentage rates will change to: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. These rates were previously 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
While these changes will lower rates at many income levels, determining the overall impact on any particular individual or family will depend on a variety of other changes made by the Act, including increases in the standard deduction, loss of personal and dependency exemptions, and changes to the child tax credit, to name a few.
Standard Deduction Increased
Taxpayers are allowed to reduce their adjusted gross income (“AGI”) by the standard deduction or the sum of itemized deductions to determine their taxable income. The Act has increased the standard deduction to $24,000 (up from $13,000) for married individuals filing a joint return, $18,000 (up from $9,550) for head-of-household filers, and $12,000 (up from $6,500) for all other taxpayers, adjusted for inflation in tax years beginning after 2018. No changes are made to the current-law additional standard deduction for the elderly and blind.
Personal Exemption Suspended
Under pre-Act law, taxpayers determined their taxable income by subtracting from their adjusted gross income any personal exemption deductions. Personal exemptions generally were allowed for the taxpayer, the taxpayer's spouse, and any dependents. The amount deductible for each personal exemption was scheduled to be $4,150 for 2018, subject to a phase out for higher earners, but the Act has suspended the deduction for personal exemptions by reducing the exemption amount to zero.
Child Tax Credit Increase
The Act increases the child tax credit to $2,000, and other changes are made to phase-outs and refund ability. The income levels at which the credit phases out are increased to $400,000 for married taxpayers filing jointly ($200,000 for all other taxpayers) (not indexed for inflation). In addition, a $500 nonrefundable credit is provided for certain non-child dependents. The amount of the credit that is refundable is increased to $1,400 per qualifying child, and this amount is indexed for inflation, up to the base $2,000 base credit amount. The earned income threshold for the refundable portion of the credit is decreased from $3,000 to $2,500. No credit will be allowed to a taxpayer with respect to any qualifying child unless the taxpayer provides the child's SSN.
New Treatment of Alimony
These changes take effect for divorce agreements and legal separation agreements executed after 2018. It's important to emphasize that the current rules continue to apply to already-existing divorces and separations, as well as divorces and separations that are executed before 2019.
Under the current rules, an individual who pays alimony may deduct an amount equal to the alimony payments paid during the year as an “above-the-line” deduction. (An “above-the-line” deduction, i.e., a deduction that a taxpayer need not itemize deductions to claim, is more valuable for the taxpayer than an itemized deduction.) The alimony payments are taxable to the recipient spouse.
Under the Act rules, there is no deduction for alimony for the payer. Furthermore, alimony is not gross income to the recipient.
Under a special rule, if taxpayers have an existing (pre-2019) divorce or separation decree, and they have that agreement legally modified, then the new rules don't apply to that modified decree, unless the modification expressly provides that the Act rules are to apply.
Moving Expense Deduction Suspended
Under the Act, the deduction for moving expenses is suspended, except for members of the Armed Forces on active duty who move pursuant to a military order and incident to a permanent change of station.
Expanded Use of 529 Account Funds
The Act provides that “qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school up to a $10,000 limit per beneficiary per tax year.