President Trump intends to sign into law H.R. 1 (the act), [1] the most comprehensive change to the Internal Revenue Code since 1986. The text of the act numbers nearly 500 pages. What follows is a brief summary of some of the key provisions that affect individuals and closely held business owners.
Doubling of the Estate and Gift Tax Basic Exclusion Amount and GST Tax Exemption Amount
The act temporarily doubles the basic exclusion amount for purposes of the estate and gift taxes and the generation-skipping transfer (GST) exemption amount for purposes of the GST tax. Under current law, the basic exclusion amount was scheduled to increase to $5.6 million on January 1, 2018. For individuals dying and gifts made after December 31, 2017, and before January 1, 2026 (the covered years), the basic exclusion amount now equals $10 million, adjusted for inflation annually for each taxable year after 2011. Because the GST exemption amount equals the basic exclusion amount, a corresponding increase in the GST exemption amount will also apply to generation-skipping transfers made during the covered years. On January 1, 2018, the basic exclusion amount and GST exemption amount will both increase to approximately $11.2 million per individual (or $22.4 million for married couples).
*Approximate, subject to the computation and announcement of the actual inflation-adjusted exclusion and exemption amounts by the Internal Revenue Service.
The temporary increase in the basic exclusion amount expires on December 31, 2025. Congress has authorized the Treasury Department to issue guidance addressing the treatment of gifts made during the covered years by individuals dying after 2025.
Although the increase in the basic exclusion amount and GST exemption amount will not expire until the end of 2025, individuals with significant wealth should consider making use of the increased amounts in 2018. The increased amounts provide clients the opportunity to leverage gifts for future generations. Individuals should consider estate-planning techniques that benefit most from the increases, including:
- making gifts to existing or new irrevocable trusts, including generation-skipping trusts where appropriate;
- leveraging gifts to support the funding of life insurance or existing sales to trusts; and
- pairing gifts with philanthropy.
Changes to Income Tax Brackets and Rates for Individuals, Estates and Trusts
The act changes the federal income tax brackets and corresponding tax rates for individuals, trusts and estates for the covered years. The following chart summarizes the differences between the 2018 tax rates and brackets that were scheduled to go into effect before passage of the act and the 2018 tax rates and brackets under the act.
The tax brackets for individuals, estates and trusts increase each year after 2018 based on the Chained Consumer Price Index for All Urban Consumers (C-CPI-U). A “chained” CPI takes into account anticipated consumer shifts from products whose prices increase to products whose prices do not increase or increase at a lower rate. The result would generally be smaller inflation adjustments and higher tax levels over the long term.
The brackets and rates introduced under the act sunset on December 31, 2025, in accordance with Senate budget rules. For taxable years beginning after 2025, the brackets and rates revert to the brackets and rates in effect under current law (as adjusted for inflation). The act does not modify the tax rates for long-term capital gains and qualified dividends. The 3.8 percent net investment income tax remains in place under the act.
Modification and Elimination of Deductions and Credits Available to Individuals, Estates and Trusts
The act modifies or eliminates many tax deductions and credits previously available to individuals, estates and trusts. Here are some of the most notable changes to deductions under the act.
- During the covered years, individuals may deduct state, local and foreign taxes only when incurred in connection with a trade or business. However, an exception permits individuals to deduct up to $10,000 for the aggregate of state and local (but not foreign) property and income taxes whether or not incurred in connection with a trade or business.
- The act increases permanently the limit on deductions by individuals for certain charitable contributions of cash from 50 percent to 60 percent of adjusted gross income.
- Individuals may no longer claim a charitable deduction for contributions to colleges or universities in exchange for the right to purchase tickets or seats at athletic events.
- During the covered years, the deduction for home mortgage interest is available only for interest paid on the first $750,000 of acquisition indebtedness. However, a grandfathering provision permits taxpayers who entered into mortgages effective before December 15, 2017, to continue deducting interest paid on the first $1 million of acquisition indebtedness for such existing mortgages.
- The act suspends the deduction for interest paid on home equity indebtedness during the covered years (including for existing mortgages), unless the indebtedness is incurred to acquire, construct, or substantially improve the taxpayer’s residence.
- The act repeals the overall limitation on itemized deductions during the covered years.
Modifications to the Alternative Minimum Tax Exemption Amount
The act increases substantially the alternative minimum tax (AMT) exemption amounts for individuals and repeals the corporate AMT, but does not modify generally the AMT applicable to estates and trusts.
The AMT is an alternative tax regime that applies to all taxpayers but primarily affects corporations and high-income individuals. AMT is based on the amount the taxpayer’s alternative minimum taxable income exceeds the AMT exemption amount. The changes to the AMT exemption amounts under the act are illustrated below.
The act also increases the thresholds at which the AMT exemption begins to phase-out, from $160,900 to $1 million for married individuals filing joint returns and from $120,700 to $500,000 for unmarried individuals. The increase in the AMT exemption amounts and phase-out thresholds, combined with the modification to the federal income tax brackets and rates, should change considerably the individuals who are subject to the AMT.
Deduction for Qualified Business Income of Pass-Through Entities
In a sweeping modification to the code, the act creates a new deduction available to individuals, trusts and estates for qualified business income from pass-through and disregarded entities.
During the covered years, individuals, estates and trusts may deduct from taxable income 20 percent of qualified business income from a partnership, S corporation or sole proprietorship, including a disregarded entity treated as a sole proprietorship, subject to certain limitations.
Generally, a taxpayer’s qualified business income is income derived from an active trade or business. It excludes any amounts paid by an S corporation treated as reasonable compensation, guaranteed payments to a partner in a partnership, and amounts paid to a partner acting in a capacity other than as a partner. The act excludes income generated from certain specified service businesses (such as law, health and accounting) from qualified business income status if the taxpayer’s taxable income exceeds certain thresholds.
The pass-through deduction is limited to the lesser of 50 percent of the W-2 wages paid by the qualified business or to 50 percent of the W-2 wages plus 2.5 percent of the depreciable property in service in the qualified business. This new deduction could mean significant income tax savings for many closely held business owners.
More Information
The act will create enormous planning opportunities for high-net-worth individuals, closely held business owners, and fiduciaries of estates and trusts in 2018 and beyond. Please note that the information contained in this alert is general in nature and should not be relied upon in specific situations. Taxpayers should seek the advice of a professional tax adviser regarding their specific situations.
Contact any lawyer in McGuireWoods’ Tax & Employee Benefits, and Private Wealth Services Groups for more information. Our lawyers are studying the act and will provide greater analysis and advice over the coming weeks and months. A series of webinars of individual, corporate, charitable and employee benefits topics will be announced in early 2018.
1. The complete title of the act is “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.”