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Tax Reform: Changes & Impacts
Guest Article
Tax Reform: Changes & Impacts
by Evan Watson, CPA, Gammon & Drueck
Evan Watson is a Tax and Business Advisor with Gammon & Drueck CPAs and a graduate of Tennessee Tech University. He is a member of the Mt. Juliet Noon Rotary Club, Mt. Juliet Young Professionals, and Chamber of Commerce Ambassador, and is currently pursuing his MBA. Comments or questions can be shared at ewatson@gdcpaspllc.com .
This time last year, the tax world was abuzz with the possibility of a system overhaul and the implications to business and individuals’ bottom line. After a reconciliation of House and Senate bills, the Tax Cuts and Jobs Act (TCJA) of 2017 was signed into law, ushering in the largest tax reform since 1986. Nearly a year later, taxpayers are still scratching their heads trying to maneuver the changes and understand the impacts. The TCJA took aim at tax rates at nearly all levels, from taxable corporate structures to individual and pass-through entities. The details of the law can be overwhelming to say the least, so the overview below should help bridge the gap between what you’ve heard, and what the law says.
Individual Tax Filings
An apparent theme of the reform was simplification in the filing of individual tax returns. Many changes were made on the individual side including a widening of tax brackets with a lowering of overall rates. The most generous of these cuts came through the middle brackets at 22%, 24%, and 32% ranging from $77,400 to $315,000 for married filing joint taxpayers and $38,700 to $157,500 for single individuals.
The standard deduction changes have also been a hot topic since the bill was signed. Previously, single and married filing jointly taxpayers received a standard deduction of $6,350 and $12,700 respectively. New provisions nearly double these amounts bringing them to $13,000 for single filers and $24,000 for joint filers. Naturally, this should lower the number of taxpayers who need to file itemized deductions in 2018, giving them a more advantageous position by using the standard amount.
Further changes to certain itemized deductions can encourage filers to shift to the standard
deduction. Deductions for state and local taxes (SALT) have been limited to a total of $10,000 each year. This would include sales tax, property tax, and income tax. While this is of little concern to Tennesseans who enjoy a low-tax state, it could impact those who own multiple personal properties or pay tax in other states.
A change that could prove costly for taxpayers this year is the elimination of most miscellaneous itemized deductions. Housed in this provision previously was the deduction for unreimbursed employee expenses that often totaled thousands for those who travel and drive personal vehicles for work. Under prior law, these taxpayers would be able to add expenses that rose above 2% of their adjusted gross income to their itemized deductions. That deduction has been removed under the TCJA. While the increased standard deduction should help lessen the blow, it may be a time for employees to approach their employers about developing a reimbursement program to avoid out-of-pocket expenses.
Personal exemptions were another provision chopped by the TCJA. Personal exemptions were previously an amount deducted from adjusted gross income to arrive at taxable income. Taxpayers were entitled to one for themselves, spouse, and dependents in the amount of $4,050 each (this would have been $4,100 for the 2018 tax year). For a family of four, this totaled a valuable exemption of $16,200. For a family in the 28% tax bracket, this meant a savings in tax of more than $4,500. The new tax law does away with these exemptions completely.
In order to soften the blow from the loss of personal exemptions, the Child Tax Credit also underwent some changes. The Child Tax Credit doubled to $2,000 per qualifying child under 17 accompanied by an increase in the amount refundable to $1,400. More taxpayers will also be eligible to claim the Child Tax Credit as the income threshold was drastically widened as well. Taxpayers filing jointly don’t experience the phase out until $400,000 in taxable income; the same limit was previously $110,000.
Business Tax Filings
The business world saw major changes as well. The corporate tax rate was slashed to a new top rate of 21%, down from a previous high of 35%. Corporations are usually taxed twice- once at the entity level (corporate) and again at the individual level (shareholder).
A large change in the new tax code that was glossed over by many relates to how certain business expenses are deducted. The ever popular ‘meals and entertainment’ expenses utilized by so many has undergone a complete renovation. Under previous law, you could snag tickets to the ballgame, grab a client, eat some hotdogs, keep the receipts, and write them off at a 50% rate come tax time. Not so fast. Under new laws, the entertainment part of the outing is no longer deductible as a business expense, even to the extent of 50% of the cost.
Business meals are still deductible at 50% given they are not lavish or extraordinary and serve a business purpose - so you are still in the clear on buying lunch before the round of golf. Not being aware of this important new change could prove costly to many when their expenses are turned away during filing season.
Perhaps the most important feature of the TCJA is the shiny new Section 199A Business Income Deduction.This deduction will allow taxpayers and “flow-through” entities to deduct up to 20% of qualified business income (QBI) from a trade or
business. Sole proprietors, partnerships, and SCorps will all qualify for the deduction. The deduction is calculated on net income determined at the partner or shareholder level if applicable and would result in a direct lowering of taxable income for federal income tax purposes. Seems straight forward, right? The code section is riddled with its fair share of complications as the calculation has detailed limitations.
For starters, the income is capped by the greater of two scenarios: 1) 50% of the W-2 wages from the qualified trade or business and 2) the sum of 25% of the W-2 wages in addition to 2.5% of the unadjusted basis of all qualified property. Furthermore, the deduction may also not be more than 20% of taxable income. Although there are other particular limitations, this is enough to give us an overview.
The second limitation applies to the nature of the trade or business. An important distinction must be made to determine whether the trade or business is “qualified” for the purposes of the code section. This would include all forms of a trade or business except those deemed to be “specified service” trades or businesses which include those rendering services in the fields of law, accounting, financial services, and any field where the principal asset can be determined as the reputation or skill of one or more owners and employees.
Businesses which fall into the category of “specified service trade or business” can still qualify for the deduction given their taxable income stays below that of $157,500 for single filers and $315,000 for taxpayers filing jointly (phaseout range is $207,500 for single filers and $415,000 for married-filing-joint). Along the same vein, qualified trade or businesses whose income falls under the same threshold are exempt from the W-2 limitations.
The examples below can further clarify:
Example 1
An individual is a single filer and has $100,000 of qualified business income from his single-member LLC. His income is under the limitation of $157,500 so his Section 199A deduction would be the full 20% or $20,000 ($100,000 x 20%).
Example 2
An individual is a single filer and has $125,000 of business income from a specified service trade or business. Although the income is derived from a specified service trade or business, it is under the threshold and therefore eligible for the full 20% deduction of $25,000 ($125,000 x 20%).
Now let’s take a look again considering some of the limitations:
Example 3
An individual is a single filer and has $200,000 of qualified business income from his single-member LLC. During the year, he paid out $60,000 in W-2 wages to employees. 20% of the qualified business income would mean the deduction would be $40,000 ($200,000 x 20%). However, the taxpayer has exceeded the phaseout limitation and his deduction is now limited to 50% of W-2 wages, resulting in a deduction of $30,000 ($60,000 in W2 wages x 50%).
Example 4
An individual is a single filer and has $200,000 of business income from a specified service trade or business. During the year, he paid out $60,000 in W-2 wages to employees. This taxpayer is not eligible for the 20% deduction because it is from a specified service and over the phase out threshold. The W-2 wage limitation is also disregarded because of the service trade. The deduction would be reduced based by the percentage the taxpayer is over the phase out threshold.
It’s important to remember that the deduction is calculated from net income and only applies to federal income tax – not self-employment tax. There are many considerations when determining the amount of the Section 199A deduction and its application to a tax return. A tax return is the result of specific planning and strategy and the
addition of Section 199A makes it even more so. From income strategy to wage planning, each amount could contribute to a maximum deduction allowed or cause a taxpayer to miss out on the new opportunities offered by the tax reform.
Conclusion
If simplification was the goal, they missed it by a mile in my humble opinion. For those tax payers who previously itemized, it may indeed take out the hassle of tracking certain deductions. Sole proprietors and participants of pass-through entities have a whole new list of items to consider now revolving around the aforementioned code section. It is important to remember that many of these provisions are set to expire in 2025 without further Congressional action. The impact of the law as a whole has been interpreted differently by experts in the industry and will undoubtedly continue to be debated. The U.S. Treasury has reported an estimated $1.8 trillion in additional revenue due to the changes. Only time will tell if this bill will be shouldered by individuals or corporations.
Gammon & Drueck CPAs - Located in Mt. Juliet, Tennessee, Gammon & Drueck CPAs specializes in Tax and Business Advisory Services, Tax Compliance, Accounting, and Third- Party Administration of Retirement Plans.
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Editor’s Note – For additional information on recent changes to the federal tax code, please consult the following links:
Tax Reform, What’s New for Your Business, IRS Publication 5318, available at https://www.irs.gov/pub/irs-pdf/p5318.pdf
IRS Tax Reform News, available at https://www.irs.gov/newsroom/tax-reform-news
