First Thoughts on the "Tax Cuts and Jobs Act"

As we write this post (on December 20, 2017), the United States Senate has passed the Republican "Tax Cuts and Jobs Act" and the House of Representatives is set to re-vote on that legislation this afternoon (the House must re-vote because the version of the legislation it rushed to vote on December 19 contained provisions which violate Senate procedural rules). Following that vote the legislation will quickly receive the President’s signature and become law. That is when this process really gets interesting.

Republicans pushing this legislation have claimed, it is the “largest tax cut ever” (it is not) and a boon to the middle class (we will reserve judgement for now) and all manner of other grandiose claims. Whether some, all, or any of the promises made while promoting this legislation will ever come to pass remains to be seen, however there are certain things that will result from the legislation becoming law.

With respect to estate planning, those individuals with the largest estates will see a huge windfall, with the Estate Tax Exemption doubling from $5.5 million to $11 million per person. Under prior law only .02% of estates were subject to estate taxation. The new legislation further assures that large estates receive a significant benefit because the number of estates which will incur liability under these new provisions will amount to less than .01% of taxpayers. Despite this significant increase, in the exemption there has been no change in the laws with respect to basis, so heirs and beneficiaries will continue to receive a stepped-up basis for property transferred at death.

From an income tax perspective, the legislation maintains the number of tax brackets (there are seven) but changes the tax rate and income range for each of the brackets. These changes reduce the top tax rate and increase the threshold before a taxpayer will pay that rate and have varying effects on the other brackets to the benefit of some and detriment of others. The average middle-class taxpayer (making 19,050-$77,400) will now fall into a 12% bracket, down from 15%. However a number of individual deductions have been reduced, including the mortgage interest deduction and the deduction for state and local income/sales taxes, which may result in those same taxpayers owing more than in years past. On a positive note for many, the final legislation does not contain provisions in the original House bill which eliminated deductions related to tuition waivers for graduate students, student loan payments, and medical expenses.

Corporate tax rates will see a dramatic reduction with the tax rate dropping to 21% from 35% with few existing deductions seeing any substantial change. Although the legislation itself has not been dissected by experts because it was kept under wraps during the legislative process, it is believed that “Pass-Through” companies such as LLC's, partnerships, sole proprietorships and S-corporations may also see a significant benefit. Owners of Pass-Through companies will be able to deduct 20% of the income from those entities, subject to certain caps, effectively lowering the top tax rate they will pay. While some effort was made to limit individuals with "service industry" income (such as lawyers) from taking advantage of these provisions, a significant number of tax experts have recently detailed ways they believe these provisions can be manipulated to the taxpayers advantage.

Unanticipated loopholes in the provisions regarding Pass-Through entities are unlikely to be the only errors which Congress will need to correct in the legislation. Multiple lawmakers are already acknowledging that they will need to pass additional legislation to correct certain provisions of the tax bill to correct unintended consequences which are mostly a result of the speed with which the legislation was passed. Additionally much of the legislation leaves rule-making up to the Internal Revenue Service (IRS), which will now be busy attempting to prepare for significant changes which take effect in under two weeks (note the IRS has 18 months to write Rules which will be retroactive to January 1, 2018).

In addition to its implications for the tax code, the current legislation also contains language that will significantly impact other areas of public policy. It contains provisions which open sections of the Arctic National Wildlife Refuge to drilling and eliminates the individual mandate to purchase health insurance contained in the Affordable Care Act. Further, estimates of the fiscal impact of the legislation from groups across the political spectrum indicate that it is likely to balloon the deficit by many billions of dollars, with the Joint Committee on Taxation indicating that the bill will increase the deficit by $1.45 trillion over the next 10 years.

Overall this legislation is a benefit to corporations, pass-through entities, the wealthy heirs, and anyone with income in the six figures. It appears less beneficial to individuals with smaller incomes because the reduced tax rates are offset by limitations on deductions these taxpayers previously benefited from and decreases to the individual rates expire in 2025. Individuals in states and municipalities with higher local taxes will also see increased federal taxes because they will no longer be able to deduct their complete local tax bill. The repeal of the Affordable Care Act’s individual mandate to purchase health insurance is also likely to result in an increase in health insurance premiums for those people who continue to purchase health insurance.

It is important to regularly review the state of the tax code and to make changes to policy to reflect the changing times and while promoting this legislation Republicans suggested that was their goal. Tax experts will be busy trying to make sense of and take advantage of the new provisions, and the IRS will be busy writing regulations designed to close unintended loopholes. With the changes, tax law will be in flux for quite some time. As the 500+ pages of the new tax law become public we and others will be providing explanations of how the law impacts you. Be careful to consult your tax expert before changing any of your tax planning.

Matt and Al