Change is part of life. The Tax Cuts and Jobs Act (TCJA) has brought sweeping changes to the federal income tax rules for individuals. But how will you and your family be affected? That depends on your specific circumstances. Major life changes — from marriage and birth to divorce and death — can provide opportunities and pitfalls under the tax law. Here’s an overview of some TCJA provisions that may be relevant during different life events.
Starting a New Business under the New Tax Law
Starting up a new business is an exciting but stressful time. Unfortunately, what you might have learned in business school about choosing a business structure, deducting net operating losses (NOLs) and depreciating assets may no longer be accurate under the Tax Cuts and Jobs Act. It’s important to seek guidance from your tax and legal advisors to make tax-savvy choices for your startup.
Under the new law, C corporations are taxed at a flat 21%, and the corporate alternative minimum tax (AMT) has been eliminated. These permanent changes make old-fashioned C corporations more attractive than under prior law.
But the new qualified business income (QBI) deduction of up to 20% for 2018 through 2025 helps level the playing field for “pass-through” entities, such as sole proprietorships, partnerships, limited liability companies and S corporations. The QBI deduction is subject to various rules and limitations.
Within those limitations, there are some planning strategies to consider. For example, you can adjust your business’s W-2 wages, convert independent contractors to employees, or invest in short-lived depreciable assets to maximize your QBI deduction.
Start-ups tend to generate net operating losses (NOLs) as they ramp up operations. NOLs happen when deductible expenses exceed income for the tax year. Under the TCJA, for NOLs that arise in tax years beginning after December 31, 2017, the maximum amount of taxable income for a year that can be offset with NOL deductions is generally reduced from 100% to 80%. In addition, NOLs that arise in tax years ending after 2017 can no longer be carried back to an earlier tax year (except for certain farming losses). Affected NOLs can be carried forward indefinitely.
Important note: Congress is expected to issue additional guidance on the NOL provisions of the new law. Contact your tax advisor for the latest developments.
In addition, a new limitation applies to deductions for “excess business losses” incurred by noncorporate taxpayers. Losses that are disallowed under this rule are carried forward to later tax years, and then they can be deducted under the rules that apply to NOL carryovers. This new limitation applies after applying the passive activity loss rules. However, it applies to an individual taxpayer only if the excess business loss exceeds the applicable threshold.
Starting a business also may require you to purchase fixed assets, such as office furniture, operating equipment, vehicles and computers. In general, you’ll be able to deduct more for capital expenditures in the first year they’re placed in service, and, in some cases, depreciate any remaining amounts over shorter time periods. Two key tax breaks allow for accelerated expensing:
1. Expanded Section 179 deductions. Under the TCJA, for qualifying property placed in service in tax years beginning after December 31, 2017, the maximum Sec. 179 deduction increases to $1 million (up from $510,000 for tax years beginning in 2017) and the Sec. 179 deduction phaseout threshold increases to $2.5 million (up from $2.03 million for tax years beginning in 2017). The TCJA also expands the definition of property that’s eligible for Sec. 179.
2. More generous first-year bonus depreciation. Under the TCJA, for qualified property placed in service between September 28, 2017, and December 31, 2022 (or by December 31, 2023, for certain property with longer production periods), the first-year bonus depreciation percentage is increased to 100% (up from 50% in 2017). The 100% deduction is allowed for both new and used qualifying property. In later years, the first-year bonus depreciation deduction is scheduled to be gradually reduced and then eliminated.
Your marital status for the 2018 tax year will depend on whether you’re married on December 31, 2018. Some marriage penalties and bonuses remain under the TCJA. If you plan to tie the knot in 2018, it’s important to determine your marginal tax rate as a married couple. If both spouses work, for example, it may be necessary to adjust your current withholding.
You’ll also need to consider health care implications associated with tying the knot, such as potential exposure to the individual mandate penalty. That penalty is still in effect for 2018, although it goes off the books in 2019 under the TCJA.
If a new child joins your household in 2018 — through birth, adoption or marriage — you’ll be disappointed to learn that the dependency deduction has been eliminated for 2018 through 2025. But the expanded child tax credit could help make up the difference.
The child tax credit increased from $1,000 to $2,000 per qualifying child for tax years starting in 2018. In addition, increased phaseout thresholds of $400,000 for married individuals who file jointly and $200,000 for all other taxpayers (not indexed for inflation) will allow many more people to claim the credit.
Unfortunately, dependents who are age 17 and older won’t be eligible for the $2,000 credit. But they may be eligible for the new $500 credit for dependents who aren’t qualifying children. There have also been changes to rules regarding Section 529 qualified tuition plans and the kiddie tax rules that may provide tax savings opportunities for parents.
If you’re currently divorced or in the process of getting divorced, there’s an important change to the tax rules for alimony payments to be aware of. For payments required under post-2018 divorce agreements, alimony payments aren’t deductible, and they aren’t considered income to the recipient.
However, pre-TCJA rules continue to apply to payments required by divorce agreements that are executed in 2018 or earlier.
For individuals who will be making alimony payments, this change creates a big tax incentive to finalize divorces before year end. For individuals who will be receiving payments, the change creates a big incentive to delay settlements until 2019.
Want to modify an existing agreement? The TCJA allows taxpayers to modify existing divorce decrees to expressly adopt the TCJA rules. This may be appropriate, for example, if the expected income levels and tax rates of the alimony payer or recipient have changed.
The alimony provision of the TCJA also affects prenuptial agreements that stipulate alimony payments. Existing agreements that stipulate alimony payments based on pre-TCJA rules may overcompensate alimony recipients. So it’s worth considering updating any existing agreements based on the new law. Likewise, if you’re planning to sign a prenuptial agreement before getting married in 2018 or beyond, it’s important to factor in the tax treatment of alimony payments under the TCJA.
Interest deductions for new home acquisition debt is subject to the new $750,000 debt limit ($375,000 if married filing separately). For home equity loans, deductibility may depend on what you used the proceeds for. Interest paid on home equity loans and lines of credit may be deductible if the funds are used to buy, build or substantially improve the home that secures the loan, as long as the total home acquisition debt (including home equity loans treated as acquisition debt) is within the allowable limit.
If you moved at least 50 miles for work in 2018, you might expect a tax deduction or a tax-free moving expense reimbursement from your employer (because they were available in the past). Unfortunately, the TCJA suspends those tax breaks for most taxpayers from 2018 through 2025.
That is, the above-the-line deduction on Form 1040 isn’t available for tax years starting in 2018. And moving expenses reimbursed or paid by an employer during the suspension period must be included in your taxable income. However, there’s an exception for members of the Armed Forces on active duty (and their spouses and dependents) who move because of a permanent change of station.
Exposure to the federal estate tax is lower for people who die in 2018 through 2025 than under prior law. Under the TCJA, the base estate and gift tax exemption amount has been increased to $10 million. The $10 million amount is indexed for inflation occurring after 2011 and is $11.18 million for 2018 ($22.36 million per married couple). However, state death taxes, if applicable, may still apply, typically at lower exemption amounts.
The increased estate and gift tax exemption will also provide estate planning opportunities for high net worth individuals. And it may eliminate the need for complicated estate plans for individuals or married couples with net worth less than the exemption limits.
Start Planning Now
Tax-savvy individuals meet with their tax advisors at least annually to strategize on ways to save taxes. Midyear tax planning meetings are especially important in 2018, given the sweeping changes and potential opportunities to lower your taxes under the new tax law. The IRS is expected to issue additional guidance this fall to clarify many of the changes. Contact a tax professional to understand how the new law affects you.