TCJA - Many areas in need of guidance

The Tax Cuts and Jobs Act enacted December 22, 2017 includes a lot of new provisions. For example, Section 199A, is seven pages long in single space! It allows a deduction for owners of business activity (other than as a C corporation). The purpose is to also provide some rate reduction for businesses other than only a rate reduction for C corporations. The new rule is lengthy because it involves a lot of definitions and special rules. Now, while many business owners have income below the thresholds where they must deal with the complexity, just understanding the basics might be complete for many.

The AICPA Tax Section volunteers and staff have identified 39 areas in need of guidance (as an initial list). Most of these will require IRS work, such as to define terms. Some might be clarifications from Congress or the Joint Committee on Taxation as to what was intended by language that is not completely clear.

Here is the AICPA's January 29, 2018 letter listing various items. And the AICPA also noted in a letter to Congress on January 30, 2018 that IRS needs resources to provide timely guidance.

What do you think? Where do you think guidance is most needed?

Tax Cuts and Jobs Act, Complexity and Data

There is certainly some new complexity in the Tax Cuts and Jobs Act (P.L. 115-97 (12/22/17)). But it won’t affect most individual filers. Here are some data points to support that statement.

• Prior to reform, IRS data indicate that 69% of individual filers claim the standard deduction rather than itemize deductions. The increase to the standard deduction by the TCJA will increase that number significantly. Thus, fewer people deal with itemized deductions.

• 16% of filers file a Schedule C (2015 data; about 18.8 million reporting income and 5.9 million reporting loss). Those generating income will likely qualify for and need to (and want to) deal with the new Section 199A, Qualified Business Income deduction but most will be below the income limits in this rule which means the calculation will be simpler than for the minority of individuals with higher income ($157, 500 if single and $315,000 if married filing jointly).

• IRS stats indicate that 83% of individual filers have adjusted gross income (AGI) of $100,000 or less. Individual filers hit the top 10% of filers by AGI once they reached AGI of $133,445 (for 2014).

• Also, per IRS stats, only about 6% of individual returns report S corp or partnership income, so will deal with the new Section 199A deduction but some of these folks overlap with the Schedule C filers.

• Also per IRS stats, about 7% of individual filers report rent or royalty income which can also lead to calculating a Section 199A deduction. But again, there is overlap among the filers meaning that they might have a Schedule C, partnership income and/or rental income.

• Zillow Research estimates that with the lower acquisition debt cap of $750,000 for qualified residence interest (mortgage interest) (note it is up to $1 million if it existed at 12/15/17), and the cap on state and local tax deduction, only about 14% of homes are likely to lead the owner to itemize deductions. They note that the percentage varies from county to county. (! – that’s my comment living in an area where the median home price is just over $1 million! [see 1/29/18 Mercury News article])

So, yes, complexity exists along with getting used to a variety of new rules depending on the types of income you have, but compliance remains relatively simple if you only have wage income and can file a Form 1040-EZ or 1040-A. But so far as transparency, I think many individuals may be confused as to what has changed for their income tax calculation (such as personal and dependency exemptions versus a child credit and non-child dependency credit, etc.).

For CPAs, their client base tends to include the individuals in the top 20 to 30% of income levels and so they deal with the complexity, as well as dealing with business returns which can often involve complex multijurisdictional transactions and complex tax rules.

What do you think?

We have tax reform!

Today (12/22/17), President Trump signed H.R. 1, the Tax Cuts and Jobs Act (the name we all know it by, but its real name is something else*) (P.L. 115-97). This is a big deal because there are lots of changes and many will have impacts on other provisions. There is too much to cover in this post, but I'll offer a few observations for individuals to get ready.

• To know if your taxes are going up or down, you need to run your own numbers. Just because a friend will have a tax decrease or increase doesn't mean you will. Variables include your income level, age of your children, how many itemized deductions you are losing (see next), whether you have a business, and more.
• No personal or dependency exemption starting in 2018. Instead, you get a $2,000 credit per child under age 17; $500 credit for other dependents. The phase-out threshold is raised ($200,000 if single and $400,000 if married filing jointly).
• The standard deduction is increased.
• Key changes to itemized deductions are that interest on home equity debt is no longer deductible starting in 2017, for 2017 and 2018 the medical deduction AGI threshold will be 7.5% for both regular tax and AMT, no casualty or theft loss unless from a federally-declared disaster, no miscellaneous itemized deductions subject to the 2% of AGI threshold, and state tax deduction can't exceed $10,000.  Charitable deductions mostly remains the same except the income threshold for cash donations increases from 50% to 60% and there is no deduction for seating rights at the university athletic stadium. The limitation on itemized deductions for high income taxpayers is repealed starting 2018. Note: No deduction allowed in 2017 for prepayment of 2018 state and local income or property taxes.
• Tax rates change. The top rate will be 37% rather than today's 39.6%.
• The capital gain rate structure mostly stays the same.
• The individual AMT remains but with higher exemption amounts.
• No alimony deduction or income for agreements entered into after 2018.

Tax reform will warrant some new thinking. For example, many individuals who have itemized in the past might find their standard deduction amount is higher. Fewer people will be subject to AMT. The reason is that common adjustments that caused many individuals to owe AMT are gone or diminished. Home equity debt interest expense and miscellaneous itemized deductions subject to the 2% of AGI threshold are no longer deductible for regular tax. So they won't cause you to owe AMT. Also, your state tax adjustment can't be any larger than $10,000 because that is all you're allowed to deduct for regular tax purposes.

There is a lot to get used to!

Most items go into effect for 2018.  Most individual changes expire after 2025 and we go back to the law as it is today.  One exception to that is that the penalty for an individual not having insurance coverage goes away permanently, starting in 2019 (not 2018). Also, the use of a less favorable inflation index is a permanent change.

Many people will see a tax cut for 2018 and perhaps beyond (at least through 2025).  Here is one example with an explanation of how the tax savings comes about.

EXAMPLE - Married couple, no children, rents an apartment, salary $150,000

	2018 Pre-Tax Reform	H.R. 1
W-2 earnings	$150,000	$150,000
Standard deduction	-13,000	-24,000
Personal exemptions	-8,300	--
Taxable income	$128,700	$126,000
Tax	$23,483	$19,599
Tax reduction under H.R. 1		$3,884
Marginal tax rate	25%	22%

Explanation for tax savings under HR 1:

• Deductions are $2,700 more resulting in savings under HR 1 
• Under both current law and HR 1, the first $19,050 is taxed at 10%
• The next $58,350 is taxed at 15% under current law and at 12% under HR 1 for savings of $1,751
• The balance of $51,300 under current law is taxed at 25% ($12,825) while the balance under HR 1 of $48,600 is taxed at 22% ($10,692) for a savings of $2,133

  Total savings = $1,751 + $2,133 = $3,884

Will this couple have any costs associated with tax reform? Arguably, yes. Repeal of the insurance mandate for individuals starting in 2019 will mean fewer people purchase health insurance resulting in higher insurance costs for others. (See CBO 's 11/8/17 report on repeal.) Also, this couple's share of the $1.5 trillion debt embedded in H.R. 1 is $1,008/year as spread among all individual filers (see 11/24 post). And perhaps the couple's employers will offer fewer fringe benefits due to law changes. It is also possible that if the employer has tax savings under H.R. 1, it might increase employee wages.

What do you think?

*Final title of H.R. 1 - An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.

Tax reform and alimony

KPIX 5 December 20,2017 story by Mark Sayre

H.R. 1, Tax Cuts and Jobs Act, or per its new catchy title at 12/20/17 - ‘‘An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year
2018," changes the tax treatment of alimony effective for divorce and separation agreements entered into after 2018. So, going forward for new instruments entered into after 2018, the payor of alimony gets no deduction and the conference report states that the recipient does not pick up income. Also, H.R. 1 removes "alimony and separate maintenance payments" from IRC 61(a) where it is currently listed as an example of gross income.

This has been proposed before, such as in H.R. 1 (113rd Congress), the Tax Reform Act of 2014 by former House Ways and Means Chairman Dave Camp.

This won't affect many taxpayers. Per IRS stats, less than 1% of individual returns report alimony received.

I was interviewed 12/20/17 for a news clip for KPIX-TV (CBS) by Mark Sayre, about this. You might enjoy it, don't miss my first statement.

What do you think about this change?

Tax Reform Links and Examples

UPDATED 12/22/17: Tax reform went from legislative text from the House Ways and Means on 11/2/17 to a signed bill on 12/22/17.  The House Ways and Means Committee introduced its bill - H.R. 1, on November 2 and the House passed it on November 16. The Senate Finance Committee released its proposal on November 9 and passed it on November 16. Late on 12/1/17, the Senate passed a bill that made numerous amendments to the bill passed by the Senate (see the list of amendments in this JCT document). The House and Senate held a conference committee on 12/13/17 and did some behind the scene discussion to be sure they have the votes to pass. Late on Friday 12/15/17, the conference bill/report was released (1087 pages). On 12/20/17, House and Senate approved the bill and it was renamed to ‘‘an Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.’’ President Trump signed the bill on 12/22 and it became Public Law 115-97 (12/22/17).

Following are links to the key documents on the bills and Joint Committee on Taxation analysis. I also show examples of how two different families fare under the House and Senate Finance Committee bills (final bill is a bit more favorable).  Please note that there are many variations possible of how H.R. 1 affects individuals depending on how many children a family has and their ages, the types of itemized deductions they have, and their income level and its nature.

Links in chronological order:

• H.R. 1 passed by the House on 11/16/17 (227-205) + House Report 115-409 (this started with H.R. 1 as introduced in House Ways & Means Committee on 11/2/17)
• JCT, Description of H.R. 1 before amendment (JCX-50-17; 11/3/17)
• JCT, Estimated Revenue Effects for H.R. 1 (JCX-54-17; 11/11/17)
• JCT, Distribution Effects of H.R. 1 (JCX-53-17; 11/11/17)
• Bill passed by Senate Finance Committee on 11/16/17
• Section-by-Section analysis of SFC bill
• SFC bill summaries from JCT: 253-page description of original proposal  (JCX-51-17; 11/9/17) + 103-page Chair mark (JCX-56-17; 11/14/17)
• JCT, Estimated Revenue Effects of the SFC bill (JCX-59-17; 11/17/17)
• JCT, Distribution Effects of SFC bill (JCX-60-17; 11/24/17)
• CBO, Distribution Analysis of SFC bill (11/27/17) + 11/17/17 letter to Senator Wyden
• Bill passed by the Senate on 12/1/17 (468 pages)
• JCT, Estimated Revenue Effects of the Senate bill (JCX-62-17; 12/1/17)
• Tax reform links of the House Ways and Means Committee + Senate Finance Committee
• Link to H.R. 1 and all of its versions, actions, and related items
• JCT, Comparison of H.R. 1 as passed by Senate and House (JCX-64-17; 12/7/17)
• Conference Committee language and report (12/15/17) + conference report only
• Legislation as passed by House and Senate (12/20/17)
• Legislation SIGNED by President Trump (P.L. 115-97, 12/22/17) + edited conference report noting final changes with links (from Gary McBride)
• I also have a few Code sections with track changes to show the changes - here.  and a brief summary for individuals - here.

Note: Due to the "Byrd rule" which requires budget reconciliation legislation to only deal with revenue, an amendment was made in the Senate late on 12/19 (SA 1863) to make three changes to what was agreed to by the conference committee (and voted on by the House on 12/19 requiring them to re-vote on 12/20). These changes:

  1) A name change from Tax Cuts and Jobs Act to a longer one (see first paragraph of this post).

  2) Removing homeschooling expenses from the expanded use for 529 accounts.

  3) Changing the language of new IRC Section 4968 (HR 1, Sec. 13701) to remove "tuition-paying" in defining students for purposes of this excise tax on investment income of private colleges and universities.

H.R. 1 - Two examples of individuals (based on HR 1 as passed by House and bill passed by Senate Finance Committee): [See a newer example based on final bill here.]

	Family of 4, wages $100K, state taxes $8K, mtg int $10.5K, charitable $500		Family of 4, wages $250K, mtg int $40K, State tax $35K, charitable $5K, misc $3K
	2018 current law	H.R. 1	2018 current law	H.R. 1
Taxable income	$64,400	$75,600	$150,400	$205,000
Tax	$8,708	$9,072	$28,908	$39,550
Child credit	$2,000	$3,200	$0	$3,200
Non-child dependent credit	--	$600	--	$600
AMT	$0	--	$3,372	--
Net tax	$6,708	$5,272	$32,280	$35,750

Note: The family above with $40,000 of mortgage interest has a debt greater than the new $500,000 limit allowed by H.R. 1, but falls under the transition rule. If this taxpayer instead had a new mortgage, the tax would be higher because H.R. 1 limits mortgage interest to a debt of $500,000..

SFC (note the Senate version which increased the child credit to $2,000) - Same examples as above:

	Family of 4, wages $100K, state taxes $8K, mtg int (AI) $10.5K, charitable $500		Family of 4, wages $250K, mtg int (AI) , $40K, State tax $35K, charitable $5K, misc $3K
	2018 current law	SFC	2018 current law	SFC
Taxable income	$64,400	$75,600	$150,400	$205,000
Tax	$8,708	$8,739	$28,908	$39,742
Child credit	$2,000	$3,300	$0	$3,300
Non-child dependent credit	--		--	--
AMT	$0	--	$3,372	--
Net tax	$6,708	$5,439	$32,280	$36,442
Tax HR 1		$5,272		$35,750

There are numerous changes for individuals, businesses, estates, and exempt entities in the proposals. The above examples aim to illustrate that not everyone gets a tax cut; it depends on the mix of their income and current deductions.

What do you think?

Tax Reform - What's Up?

What an exciting month so far for tax reform!  We have an amended bill passed by the House Ways and Means Committee (on 11/9 by vote of 24-16). That's the bill, H.R. 1, Tax Cuts and Jobs Act, introduced just one week earlier.  On 11/9, the Senate Finance Committee released a 253-page summary by the Joint Committee on Taxation (most of the pages describe current law).

A few observations:

• The House calls for individual rates of 12%, 25%, 35%, 39.6% and a surtax on the top rate because the benefit of the 12% bracket will phase-out for those in the top bracket (over $1 million of income).
• The Senate rates are 10%, 12%, 22.5%, 25%, 32.5%, 35% and 38.5%.
• Both change the corporate rate to a flat 20% (rather than today's top rate of 35%). The Senate delays this rate until 2019.
• Both bills reduce the maximum rate on business income of passthrough entities, other than professional service firms, but in different ways, and both with some complexity!
• The standard deduction in increased with most itemized deductions other than mortgage interest and charitable contributions remaining. The Senate retains the medical expense deduction.
• Personal and dependency exemptions are repealed. Both bills have a higher child credit amount and a credit for non-child dependents ($300 in House and $500 in Senate).
• Increased expensing amounts for limited time periods.
• Section 199 is repealed.
• Section 1031 would only apply to real property (other than dealer property).
• The estate tax exemption is doubled. The House repeals the estate and GST after 2023; the Senate does not.
• The corporate system is moved to a territorial system with provisions to prevent base erosion.

And there is more.  The House bill is scored to cost $1.5 trillion over ten years as allowed by the recent budget bill.

Next steps is for the House to vote and the Senate Finance Committee to amend its bill and vote and then have it go to the full Senate. Then a conference committee is needed to work out differences to get one bill to go to House and Senate for vote. 

Waiting for ...

• What all will be temporary due to reality that this will be enacted via budget reconciliation so only 51 votes needed in Senate rather than 60. But bill cannot increase deficit after ten years.
• Anything new to be added to help reduce cost, if necessary.
• Whether simplification is possible. While many individuals will move from itemizing to taking the standard deduction, there are still a variety of complex provisions for individuals and busiensses.

We'll see.  I'll have more later

There will be some discussion of tax reform at the CalCPA Federal, State, Local and International Tax Conference on November 15 - 17 at Universal City (and webcast). I'm providing a federal tax update at the start of the program. I'm focusing on cases and rulings and regs, but will note where tax reform might change something.  Other speakers will likely do the same.  AND, for a good discussion of tax reform and the process, Mel Schwarz of Grant Thornton will be talking about tax reform on Wednesday afternoon.  Don't miss that.  Mel knows what's going on in tax reform.

What do you think?