The Tax Cuts and Jobs Act (the Act), signed into law on December 22, 2017, makes major changes to federal income and estate tax law. There are numerous changes in the Act that affect businesses, individuals, tax-exempt organizations, the taxation of compensation arrangements, and fundamental aspects of U.S. international taxation.
As one in a series of Alerts on the Act, this piece will provide insight into significant changes to the federal income tax law affecting individual taxpayers. Except as otherwise indicated, the provisions summarized below are effective for tax years beginning after December 31, 2017, and before January 1, 2026. Earlier Alerts discussed key tax changes made under the Act affecting businesses and tax-exempt organizations.
Changes in Individual Income Tax Rates
The Act retains seven income tax brackets for individuals, but widens each bracket and changes the rate for six of the seven brackets. Under the Act, individual income tax rates will now be 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent.
The Act also changes the inflation estimate used to index each bracket to inflation from the Consumer Price Index for all Urban Consumers (CPI-U) to the Chained Consumer Price Index for all Urban Consumers (C-CPI-U). This is noteworthy because C-CPI-U produces a lower estimate of inflation than CPI-U, meaning that the annual increases in bracket thresholds to account for inflation will be smaller than before and, consequently, taxpayers are more likely to find themselves in higher tax brackets in the event of rising wages. The provision of the Act replacing CPI-U with C-CPI-U does not sunset after 2025, like the other provisions affecting individual rates.
The Act retains the capital gains rates of 0 percent, 15 percent, and 20 percent on net capital gains and qualified dividends.
Doubling of Standard Deduction
To promote simplicity, Congress is incentivizing taxpayers to take the standard deduction instead of itemizing their deductions by increasing the standard deduction for all types of filers. The Act nearly doubles the standard deduction to $24,000 for joint filers ($12,000 for unmarried individuals and $18,000 for heads of households). Consequently, many individual taxpayers are expected to claim the standard deduction. Therefore, many commonly taken deductions (e.g., the charitable contribution deduction and mortgage interest deduction) may now provide limited to no value to many taxpayers.
Limitations on Mortgage Interest Deduction
The Act imposes two significant limitations on the deduction allowed for interest on certain mortgage indebtedness. First, joint filers may now only deduct interest on mortgage indebtedness of $750,000 or less ($375,000 for married individuals filing separate returns). Prior to the Act, joint filers were allowed a deduction for interest on mortgage indebtedness of $1 million or less ($500,000 for married individuals filing separate returns). Second, taxpayers may no longer deduct interest on home equity indebtedness. Under the Act, taxpayers may only deduct interest on mortgage indebtedness incurred to acquire, construct, substantially improve, or secure a qualified residence (acquisition indebtedness).
However, the $750,000 limitation does not apply to acquisition indebtedness incurred on or before December 15, 2017. Additionally, for taxable years beginning after December 31, 2025, joint filers may deduct interest on $1 million or less of acquisition indebtedness regardless of when the indebtedness was incurred.
The Act also contains a binding contract exception, which retains the $1 million limitation in the case of a taxpayer who entered into a binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and purchases such home before April 1, 2018.
Finally, the Act treats mortgage indebtedness refinanced after December 15, 2017, as incurred on or before December 15, 2017: (i) to the extent that the refinanced indebtedness does not exceed the original indebtedness; and (ii) provided the taxpayer incurred the original indebtedness on or before December 15, 2017.
Limitation on Deduction for State or Local Taxes
The Act limits the deduction allowed for amounts paid or accrued by individual taxpayers for state or local income or property taxes, which do not arise from carrying on a trade or business or the production of income, to a combined $10,000 for all state or local income or property taxes paid or accrued. Amounts paid for state or local income taxes in 2017 for income taxes imposed for taxable years beginning after 2017 will be treated as if they were paid in the year in which imposed. This provision prevents taxpayers from pre-paying their state or local income taxes in 2017 to avoid the $10,000 limitation in future years. Additionally, the IRS issued an advisory notice, IR 2017-2010, in which it announced its position that taxpayers may only deduct payments for state or local property taxes in 2017 if such taxes had been assessed prior to 2018.
Increased Deduction for Certain Charitable Contributions of Cash
The Act allows taxpayers to claim a deduction of up to 60 percent of their adjusted gross income (AGI) for aggregate cash contributions to public charities. Prior to the Act, taxpayers could claim deductions of up to 50 percent of their AGI for aggregate contributions (of cash or ordinary income property) made to public charities. The Act preserves the 50 percent of AGI limitation for ordinary income property.
Taxpayers are allowed a five-year carry forward for cash contributions that exceed the 60 percent of AGI limitation.
Changes to Alternative Minimum Tax
While the Act repeals the alternative minimum tax (AMT) for corporations, it retains the AMT for individual taxpayers. The Act also increases the amount of income exempt from AMT to $109,400 for joint filers ($70,300 for all other filers) and increases the threshold at which the exempt amount phases out to $1 million for joint filers ($500,000 for all other filers).
Suspension of Deduction for Personal Exemptions
The Act suspends the allowed deduction for personal exemptions.
Suspension of Miscellaneous Itemized Deductions
Prior to the Act, individual taxpayers could claim miscellaneous itemized deductions to the extent such deductions, in aggregate, exceeded 2 percent of such taxpayer’s AGI. The Act suspends the allowance of such deductions, including tax preparation fees, unreimbursed employee expenses, and expenses for the production of income (e.g., investment fees and expenses). The suspension of miscellaneous itemized deductions does not apply to investment interest.
Suspension of Limitation on Itemized Deductions
Prior to the Act, individual taxpayers with AGI over a certain threshold (in 2017, $313,800 for joint filers and $261,500 for individuals) had to reduce the amount of their overall itemized deductions by the lesser of: (i) 3 percent of the excess of AGI over such threshold; or (ii) 80 percent of itemized deductions otherwise allowed. The Act suspends this limitation, commonly known as the Pease limitation.
Suspension of Deduction for Personal Casualty Losses
The Act suspends the allowed deduction for personal casualty losses, except for losses arising from federally declared disasters.
Repeal of Individual Mandate
The Act repeals the monthly tax payment required of individuals that failed to maintain minimum essential insurance coverage under the Affordable Care Act (the so-called “individual mandate”). The repeal of the individual mandate is effective for months beginning after December 31, 2018, and does not sunset.
The Act makes various other changes that will impact individual taxpayers, including, among others, repealing deductions for moving expenses (except for certain moving expenses incurred by active members of the armed forces), increasing the amount of the child tax credit, repealing the deduction for alimony payments (for divorce instruments executed after December 31, 2018), modifying the AGI thresholds for deducting medical expenses, and making various changes to rules regarding savings and retirement accounts.
As noted in previous Alerts, given the breadth of the Act, the above highlights only the major changes impacting individual taxpayers.