On Dec. 22, 2017, President Trump signed tax reform legislation, Public Law 115-97, generally referred to as the Tax Cuts and Jobs Act into law. The act is the most sweeping tax legislation to be enacted in decades. It is broad in scope, complicated, and will impact almost every aspect of tax, legal, estate, retirement, business and other planning. While there has been substantial media coverage of selected aspects of the new law, that coverage has barely touched the myriad provisions that might be relevant to you, or your business. Your individual income tax, estate, and business tax planning may all be affected.
How the Act May Affect Your Individual Income Tax
Marginal income tax rates have been lowered. The Alternative Minimum Tax (AMT) is not being repealed but the thresholds for when it applies, phase outs, and which items may trigger it have all changed. This might affect the way you invest, estimate tax payments, and more.
The standard deduction is doubled, which changes planning for charitable contributions, medical expenses and other items significantly. For example, it might prove advantageous to plan deductions over a timespan of several years to maximize the amounts deductible.
State and local taxes (property and income) will only be deductible up to $10,000. This will affect many aspects of home ownership, investing and tax planning. For some it might be the final “straw” in a decision as to where to live.
Alimony payments on divorces after 2018, or prior divorces that opt to accept the new rules, will no longer be deductible. Changes in tax rates, property values, exemptions and more suggest that, if you are divorced, or in the process of divorcing, you should review the implications of the new law.
529 accounts can now be used for elementary and secondary schools, so you may wish to consider gifting more to such accounts.
How the Act May Affect Your Estate Planning
The estate tax exemption has been doubled to about $11.2 million per person or $22.4 million per couple. These higher amounts are temporary and will disappear in 2025 or earlier if the political climate in Washington changes. From an estate planning perspective, changes to existing plans need to be viewed by wealth level.
Smaller Estates: If you have a small estate, you can and should take advantage of opportunities to maximize income tax bases and avoid future capital gains.
Moderate Wealth Estates: If you have a moderate wealth estate, you should evaluate whether you should use some of the new exemptions before they either sunset or are changed by a future administration in Washington.
Ultra-High Net Worth Estates: If you have an ultra-high net worth estate, you should aggressively pursue planning to minimize future estate taxes as the estate tax is not being repealed and a future administration could make the planning environment much less friendly.
All wealth levels: Everyone should review existing estate planning documents because the new law may make how assets are allocated, tax planning clauses and more, obsolete. Or, in some instances destructive to planning goals.
How the Act May Affect Your Business
There are many changes made by the act for businesses. Some, but not all of them, are discussed below.
The maximum corporate tax rate has been reduced to 21 percent and the corporate Alternative Minimum Tax (AMT) has been repealed. These changes will have profound planning implications and change many long-held perspectives on planning because the corporate tax rate is now lower than the individual tax rate. For some business owners, it may prove advantageous to change the form of business operation.
Pass-through business entities (proprietorships, LLCs, partnerships and S corporations) may qualify for a 20 percent deduction, but the rules are complex. Advanced planning may be important. Some service businesses will not now benefit from the lower rates or pass-through entity deduction but there may be valuable planning opportunities to restructure business operations to obtain some of these benefits.
Enhanced tax benefits on investments in new assets have been enacted. New favorable bonus depreciation rules apply and the amount that can be expensed in the year property is purchased has been increased to $1 million and that amount does not phase out until qualifying new property purchases exceed $2.5 million.
New restrictions on interest expense deductions and new operating losses have been enacted.
Actions Steps for Business Owners
- Evaluate the form of the business entity.
- Review the relationship between various entities and whether steps can be taken to change contractual and transfer pricing between entities to enhance tax results.
- Buy-sell agreements should be reviewed.
- The classification of employees as employees or independent contracts might warrant review.
There are also changes made by the act for executive compensation and employee benefits. For example, under the Internal Revenue Code, prior to the new tax act, publicly traded companies were not allowed federal income tax deductions for compensations in excess of $1 million paid to the company’s CEO and three other highly compensated officers (other than the CFO), except for compensations in the form of commissions and performance-based compensations. This is sometimes referred to as the Code Section 162(m) disallowance.
The new act removes the performance-based exemption to the disallowance of deductions in excess of $1 million. The new act also adds the company’s CFO to the list of those considered highly compensated officers. Note that compensation agreements in place as of November 2017 are grandfathered in and therefore not subject to these new provisions.
Deferred compensation arrangements subject to Code Section 409A remain subject to the 409A provisions. For tax-exempt and governmental organizations, the act imposes an excise tax of 21 percent on the employer for compensation in excess of $1 million each to the top five highly paid employees. Using Code section 280G’s determinations of base compensation, the act also imposes this excise tax on employers who pay severance to a highly compensated employee in amounts in excess of three times the employee’s base compensation.
Subtle nuances exist under the act with regard to the length of time that these excise taxes and deduction limitations will continue to apply in each situation. Under the act, employees of “qualified private companies” may defer recognition of income from the exercise of certain types of private company stocks received as options. These deferrals may be for up to five years following vesting. There are limitations and requirements that must be met. This deferral provision is covered under a new Code Section 83(i) and notably this deferral will not trigger Code Sections 409A issues.
Action steps to consider regarding employee compensation and benefits may include reviewing and possibly restructuring stock option grants or other incentive awards that may be implicated by these new disallowances and excise taxes.
Other Employment Changes
What we describe as the McKayla Maroney provision which denies deductions to employers for settlement payments or attorneys’ fees paid for sexual harassment or abuse claims that are subject to nondisclosure agreements.
Credits available through 2019 to employers for certain amounts paid to employees who are out on FMLA leave, subject to certain limitations on the percentage of employees’ normal wages.
The Obamacare individual mandate penalty is reduced to zero. Note that the employer mandate for those with 50 or more employees remains in place. Action steps to consider may include: Reviewing current or proposed settlement agreements in sexual harassment/abuse cases to remove any references to maintaining confidentiality of the agreements. Employers may still seek release from future claims provided no gag orders or nondisclosure provisions regarding the sexual harassment/abuse is inserted in the agreement.
For employee benefits, note that certain employee fringe benefit deductions are now a thing of the past. Entertainment deduction, a mainstay for employers is eliminated. Moving expenses covered by the employer will now become taxable to the employee and the employer will not be able to take deductions for them, subject to certain exceptions for service members.
This article is merely an overview of some of the changes in this massive tax legislation. Now is an excellent time to seek guidance from employment, business and tax professionals for your individual income tax, estate planning and business tax needs.