The new tax reform law — commonly referred to as the "Tax Cuts and Jobs Act" (TCJA) — is the most significant tax legislation in decades. Although the law was passed only a few weeks ago, the impact on the economy and business outlook cannot be overlooked as the stock market rally continues and both individuals and businesses appear the most optimistic in quite some time.
Tax Reform was originally described to us as simplification. In fact, initial thoughts were that you would be able to file your taxes on a postcard. Although some aspects of the code have been simplified, other new provisions such as the 20% Qualified Business Income Deduction are very complex.
The TCJA significantly impacts both individuals and businesses. Let's start with a basic overview of what's covered in the new law. (Except where noted, these changes are effective for tax years beginning after December 31, 2017.)
The new law makes small reductions to income tax rates for most individual tax brackets, and it significantly increases individual AMT and estate tax exemptions. But there's also some bad news for some individuals: the TCJA eliminates or limits many tax breaks. In addition, much of the tax relief for individual taxpayers will be available only temporarily.
Here are some of the key changes. Except where noted, these changes will sunset after 2025.
Individual Tax Rates
The majority of physicians will notice tax savings due to an overall reduction in tax rates. Below is a summary comparing tax rates and income brackets pre and post TCJA.
Tax Brackets for Ordinary Income Under Current Law and the Tax Cuts and Jobs Act (2018 Tax Year)
Married Filing Jointly
Current Law Tax Cuts and Jobs Act
10% $0-$19.050 10% $0-$19,050
15% $19,050-$77,400 12% $19,050-$77,400
25% $77,400-$156,150 22% $77,400-$165,000
28% $156,150-$237,950 24% $165,000-$315,000
33% $237,950-$424,950 32% $315,000-$400,000
35% $424,950-$480,050 35% $400,000-$600,000
39.6% $480,050+ 37% $600,000+
Physicians will notice that not only have the tax rates been reduced, but the upper thresholds of most income brackets have also increased, resulting in more of your income being taxed at lesser rates. For instance, under the new brackets, the 24% bracket extends all the way up to taxable income of $315,000, whereas under the old law, the 25% bracket only went up to taxable income of $156,150. For a married filing joint taxpayer with taxable income of $315,000, this results in tax savings of almost $15,000.
Itemized Deductions / Personal Exemptions / Limitations
Every taxpayer has the choice whether to itemize deductions (mortgage interest, charitable contributions, property taxes, state and local taxes, etc.) on Schedule A of their 1040 or take the allowable standard deduction. Under the new law, the standard deduction nearly doubles as follows:
$24,000 for married individuals filing a joint return
$18,000 for head-of-household
$12,000 for all other individuals
Even with the increased standard deduction, physicians with home mortgages and charitable giving will most likely continue to itemize deductions.
The phase-out on itemized deductions, known as the Pease limitation (named after Rep. Donald Pease), has been repealed. Under the Pease limitation, many physicians found their itemized deductions limited because their taxable income exceeded the amount allowed for full deductions.
Although the benefits noted above are positive, there are some “take-aways” that should be noted, such as:
- Personal exemptions of $4,050 (per taxpayer, spouse, and dependent) have been
- Elimination of the deduction for interest on home equity debt
- Mortgage interest deduction limited to interest on debt up to $750,000 for new loans (previously $1,000,000). Taxpayers can continue to deduct interest on primary residence and secondary residence/vacation home
- New $10,000 limit ($5,000 if married filing separate) on the Schedule A deduction for state and local income/property taxes
- Elimination of moving expense deduction
- Elimination of miscellaneous itemized deductions such as investment fees and unreimbursed itemized deductions
Since the law passed, I have had several phone calls and emails from individuals concerned they will no longer be allowed to deduct their charitable contributions. Please note that charitable deductions remain fully deductible under the new law. In fact, taxpayers are able to contribute more under the new law – up to 60% of their adjusted gross income as opposed to 50% previously. There is one exception, an admittedly BIG exception. Donors are no longer able to deduct 80% of the amount paid for the right to purchase tickets for athletic events (i.e. Tide Pride, Tigers Unlimited).
Although the Estate Tax was not repealed under the TCJA, its impact was significantly reduced through increased gift and estate exemption amounts. Previously, the estate and gift tax exclusion was $5,490,000 in 2017, but under the new law will double to $11,200,000 in 2018 (including inflation). Married couples will have $22,400,000 in exemptions. The increased exemption amounts are set to expire January 1, 2026. This creates significant planning opportunities for physicians to transfer wealth using the increased exemption.
Alternative Minimum Tax (AMT)
AMT is a “supplemental” tax that hits many physicians. It essentially taxes those whom the IRS believes are taking too many deductions under the standard income tax system. For instance, under AMT, no deductions are allowed for state and local taxes, real estate and personal taxes, etc.
Many were hopeful AMT would be repealed in its entirety, but that did not happen. Instead, the exemption amount was raised significantly, thereby subjecting fewer individuals to AMT. It’s very likely that if you were subject to AMT tax in the past, you may not be going forward in 2018.
Affordable Care Act
During the final days of the bill’s negotiation process between the House and the Senate, a provision was added for the permanent repeal of the individual mandate called for under the healthcare reform bill. Many took this to mean that the Patient Protection and Affordable Care Act (PPACA) was gone; however, that is not the case. The tax reform bill merely removed the penalty associated with the mandate for individuals to obtain health insurance. PPACA is still very much in play.
There was no change to the 3.8% net investment income nor the additional .9% payroll tax on high wage earners, which were taxes created under PPACA. In addition, large employers (generally those with 50 or more FTE’s) are still required to provide affordable minimum essential healthcare coverage to full-time employees. Those employers are also still required to complete Form’s 1094 and 1095 annually to report the details of healthcare coverage provided to employees.
Under the TCJA, individuals will no longer be allowed to deduct payments for alimony or separate maintenance payments. Likewise, the recipient of those payments will no longer include payments in their income. This is generally effective for divorce or separation agreements executed after December 31, 2018. Current rules of allowing a deduction for alimony will continue to apply to existing divorces and separations, as well as divorces and separations that are executed before 2019.
In addition to the individual provisions noted above, the TCJA also has many provisions which will impact business both large and small. In general, the law significantly reduces the income tax rate for corporations and eliminates the corporate alternative minimum tax (AMT). It also provides a large new tax deduction for owners of pass-through entities and makes major changes related to the taxation of foreign income. But it also reduces or eliminates many business tax breaks.
Following are some of the key business-related changes:
Corporate Tax Rate Reduction
Under the old law, corporations were subject to graduated tax rates that topped out at 35%. Personal service corporations, which include physician practices, were taxed at a flat 35%. The TCJA reduced the corporate tax rate to a flat 21% rate. Although the tax rate reduction is a positive, most physician practices organized as C Corporations “bonus” or “zero out” income at year-end to avoid paying corporate tax at all, making this somewhat irrelevant.
20% Qualified Business Income Pass-Through Deduction
For those organized as a pass-through entity (S corporation, Partnership, Limited Liability Company or Sole Proprietorship) there is a NEW pass-through deduction available. This new deduction is commonly referred to as the “pass-through deduction,” as income from these entities pass through to owners and is included on the individual 1040 income tax return. However, this new deduction is only available through 2025.
The deduction is 20% of the entity’s qualified business income and is taken as a deduction against taxable income on Form 1040. Qualified business income (QBI) is essentially the net income of the practice. It excludes any investment-related items, such as interest, dividends, or capital gains or losses from the sale of property.
What appears rather straightforward at first, quickly becomes complex and illogical with a strict or literal reading of the law. In some cases, the amount calculated for the 20% deduction varies among entity types with all else being equal, which may or may not be the outcome Congress intended. These ambiguities will most likely be addressed in later regulations or technical corrections which will provide further details on interpretation and application of the law. This will be a key area to monitor for developments the remainder of 2018.
The 20% deduction is subject to a tangled web of limitations and phase-outs. Service related entities (i.e. physician practices) are also subject to even more limitations that, depending on income level, could quickly eliminate the 20% deduction all together.
Let’s first examine the limits applicable to both service and non-service businesses alike. The 20% deduction is limited if an individual’s taxable income as shown on their 1040 exceeds $157,500 if filing single or $315,000 if filing jointly. In these cases, the 20% qualified business income deduction is limited to the greater of:
For physician practices, several favorable changes were made to the existing rules regarding depreciation. Most notably, equipment purchased after September 27, 2017 and before January 1, 2023 (in most cases) can by fully expensed or deducted in the year of purchase rather than depreciating over the equipment’s useful life. Previously, this “bonus” depreciation was limited to 50% of the asset’s cost, but has now been increased to 100%. In addition, the equipment no longer has to be original use or new property - used property also qualifies for the deduction.
In addition to bonus depreciation, the provisions of Code Section 179 were also modified to allow for more property types to qualify for immediate write-off, including subsequent improvements to commercial property such as roofs, heating and A/C systems, fire protection, alarm and security systems.
Other Business Impacts
In addition to the major overhauls noted above, there were several other impacts to businesses as well, including but not limited to:
The TCJA will have a significant impact on both business and individuals. The above items highlight the major provisions of the law that are most impactful to physicians. The new tax law is certainly broad-reaching and complicated.
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