Tax Reform: Major Changes for Individuals and Families

Tax Cuts & Jobs Act Impact on Individual/Family Taxes

Although the tax reform was pitched as a simplification of the tax code, the nearly seven-hundred page Tax Cuts and Jobs Act do little to simplify the number of pages in the tax code. You, however, will probably see much simpler taxes in the coming years because the vast majority of taxpayers will no longer need to itemize deductions.

For an estimated 94% of taxpayers, their taxes will be simpler mainly because the standard deduction is so extremely attractive. Gone will be the days of all the paperwork and filing requirements associated with itemizing deductions. So from that measure, the Tax Cuts and Jobs Act definitely did simplify taxes for many.

Tax Planning is Still of Vital Importance

Even though most will use the standard deduction, tax planning remains an important part of a comprehensive financial plan. While it seems all anyone talks about is the itemized deductions, that is an over-sized amount of focus to be placed on one line out of the 79-line Form 1040. Those who take the standard deduction will still lots of opportunity to be helped (or hurt) by the new tax code.

To prepare, the following are many of the major changes to the tax code which will impact individuals and families. (The new tax brackets are covered in another article.) Use this information to manage your taxes or talk with your financial adviser or tax adviser about how these provisions will impact your personal taxes.  

Estate Tax & Gift Tax Exemption Doubled

The estate & gift tax exclusion double the exclusion under the tax reform, which now allows an individual to pass up to $11.2 million on to heirs estate tax free. Portability brings it up to $22.4 million for married couples.

Although many have worried about the economic impact of an increase in the estate tax, others argue the increase will actually be a net positive to government revenue. Both sides are correct in their theories.

The estate tax is the most costly tax the IRS has to enforce. The IRS must review non-standardized business valuations, property valuations, and collect an enormous amount of information about every possible asset before it can run the numbers. For massive estates, this is well worth it - but for small estates the cost of enforcement is more than the tax revenue generated. The only question is, where is that line? 

Alimony No Longer Taxable Income

Beginning January 2019, alimony will no longer be taxable income to the recipients. The payer of alimony will also no longer receive a deduction for alimony paid. This rule only applies to divorces which are finalized after December 31st 2018. Congress gave this window to allow divorce agreements time for divorce agreements which are currently to be completed.

Typically, this will favor the lower-income divorcee (usually women), although a good divorce attorney will likely factor this into the calculations and negotiations. For divorcing couples, the changes to how Alimony is treated will become extremely important in negotiating divorce agreements. 

1031 Exchanges Limited to Real Estate

Real estate investors probably had their heart skip a beat when they read there was a change to the 1031 Exchange laws. Fortunately, they don't have to worry, as real estate is the only thing which can now be exchanged under section 1031.

While real property is the most talked about 1031 exchange, investors and businesses could actually use the 1031 Exchange laws to avoid current taxation on any type of property. This includes equipment, vehicles, and even artwork. Now 1031 is only limited to real estate.

AMT Gets More Progressive

The Alternative Minimum Tax (AMT) remains in the tax code, although the reform did make it more progressive. Under the old law, many middle-income families were caught up in the AMT due to it not being indexed for inflation for 40 years

The AMT exemptions were increased to $109,400k for married filing jonitly (MFJ), $54,700 for married filing single (MFS), and $70,300 for all others except estates and trusts. Those slightly over those exemption amounts will also not lose their exemptions as the phase outs start at $1 million for MFJ and $500 for all others.

Additionally, many preferences items which used to trigger the AMT are not there anymore because the tax code eliminated the deductions (so basically no one gets them). For example, state taxes used to trigger the AMT for dual-income professional households in states like California and New York. With the new limitation on state tax deductibility, the AMT will no longer be triggered.

While the tax reform didn't solve the problem, the AMT now more closely resembles it's intention to apply to higher-income individuals.

Shared Responsibility Penalty

Republicans couldn't "repeal and replace" the Affordable Care Act, but they did make the penalty for not having insurance easier to deal with. The tax code still requires everyone to buy insurance under the Affordable Care Act, but the penalty will be set to $0 for 2019 and beyond. Notice, the penalty still applies if you do not have health insurance during 2018. If you cancel your insurance during 2018, you will still have a penalty assessed for not having health insurance.

529 Plan Now More Powerful

The 529 plan is an integral part of helping families pay for education for their children. The new tax reform added two new features to the plan which will help all families, but especially families who have children with disabilities.

Pre-College Education Expenses

First, up to $10,000 per beneficiary (not account) may be used for elementary and secondary school expenses. This is a big improvement for families who want to provide tutoring, test-prep education, supplemental help, or private education to their children. The money can also be used to pay for dual enrollment with a college, allowing a child to finish high-school classes and earn college credit at the same time.

Those who home school their kids can also use 529 money for home school expenses including curriculum, books or other instruction materials, and online education. For those with disabled children, the same $10,000 can be used for educational therapies.

Provide for Disabled Children through ABLE Rollovers

Under the new tax code, now any unused money in a 529 can be rolled over to an ABLE Account for the benefit of a dependent with a disability. ABLE Accounts are an Obama-era creation which allow disabled children to have money for their support without threatening their Medicaid or other government aid. 

Rollovers can come from the disabled child’s 529 or from any family member’s. Rollovers from family members count toward the annual funding limit for the ABLE account. Check with your tax adviser or financial planner to see if the entire amount can be rolled over from the special-needs child's 529.

Anti-Abuse Provisions

Although it's not talked about a lot, one of the goals of almost every tax reform or major update to the tax code is to limit what Congress feels are abuses of the tax code. Things which clever tax advisers and financial planners do to legally help their clients limit their tax exposure, but which Congress never intended.

The following are the elements of the tax plan which are intended to either close loopholes or stop people from legally, but in the eyes of Congress unfairly, taking advantage of tax law. 

Limitation of Excess Business Losses

Business owners of pass-through entities used to be able to take massive amounts of business losses against their personal income taxes. This type of tax shelter allowed high-income individuals to significantly reduce their incomes. Now, losses being claimed on a tax return in excess of $500,000 for MFJ or $250,000 for all others will be denied. Instead, the loss will be added to a taxpayer’s net operating loss for subsequent years.

While business owners will still be able to use the losses, they won't be able to use them to avoid current income taxes.

Kiddie Tax on Steroids

Children with income above a couple thousand dollars will now pay taxes at the trust tax rates, which reach the top tax brackets at extremely low income levels. In 2017, trusts hit the top tax bracket at $12,500.

This rule is an expansion of the Kiddie-tax rule which was enacted to stop wealthy taxpayers from avoiding taxes by passing income-producing assets to their children. In the past, wealthy individuals in the top tax bracket would shift income to their kids by transferring assets. This saved on taxes for a simple reason, a two year-old child is in the lowest tax bracket. Congress has now fully closed that tax loophole.

No More Roth Conversion Recharacterizatoins

A Roth Conversion is when a person converts a Traditional IRA to a Roth IRA, which would accelerate the tax liability to today, but would make the IRA money tax-free for the future. Under the old rules, a taxpayer could do the conversion and then wait until next year to see if converting in the new year would cost them less in taxes. If the tax cost was less (say the portfolio dropped in value also reducing the taxes due), the person could hit the reset button and do the conversion in the following year instead.

Congress saw this as a strategy intended only to avoid taxes (which in many cases it was) and decided to close the loophole. Now, if you convert a Traditional IRA to a Roth, you better be comfortable with the decision.

Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. His career includes having been a VP at a financial institution leading up to 2008, and involved with technology and internet stock research leading up to 2000. He can be reached for comment at info@purposefulfinance.org