2017 Tax Cuts and Jobs Act: Top 6 Changes to Individuals and Businesses

There were arguments on both sides of the aisle regarding many topics and the media was eating it all up.

In the end, the new Tax Bill did pass and it impacts some items on your 2017 Tax Return, although most of the changes will begin in 2018 and into 2019.

Those who are in favor of the Bill argued that it was designed to cut taxes and create jobs.

Those who are not in favor argue that the little guys and individuals will be hurt more and the wealthiest and big businesses will have the most to gain.

 

A Quick Rundown of Basic Economics

Since our economy is cyclical in nature in order for the individual to feel any effects of a tax cut, businesses must see the biggest tax cuts.

For example, a homeowner wants to buy a kitchen table:

1. Business “A” knows there is a demand for the kitchen table;

2. Business “A” purchases raw materials from a local Supplier “B” to manufacture the table;

3. Business “A” sells the table to Store “C” so that the homeowner can easily and affordably purchase the table they are in need of.

The individual, the business, and the supplier are not separate, but rather there is a cause and effect relationship that indirectly impacts them all. 

This one table has created jobs that Business “A”, Supplier “B” and Store “C” employ.

If you dig deep enough, you will further see that homeowner works for a Business, Supplier, Store, or other types of business (even if they are self-employed).

Businesses are at the center (see below), and directly stimulate both the micro and macro economies.

When small and big businesses receive tax cuts, they create new local jobs, employ the individual and push the economy forward.

 

As a CPA, small business owner, and someone who did not grow up with a silver spoon, I see both sides of the argument.

Ultimately, I do think that this Bill will produce positive results.

I am a big believer in making the Federal Government smaller so that individuals, businesses, and local governments can facilitate economic growth, regulations, and so on.

I am also a believer that those in the Federal Government making legislative and fiscal changes cannot govern on a micro (or individual) level, but rather they govern on a macro (global) level.

In other words, even though my opinion is this Tax Bill should produce more positive results than negative, there will still be some individuals and businesses in positions where they will be hurt by it.

Through education and effort, the majority of individuals and businesses should be able to get out of the way of any negative impact of these changes.

 

A Quick Lesson on Sources of Income and the much hated “Income Tax”

The “Income Tax” is the reason why people have strong feelings towards the IRS and cringe at April 15th.

Income Tax Law allows the Local, State, and Federal governments to apply a tax on the earnings, interest income, and other increases (gains) from Individuals and Corporations in order to fund government activities.

Not 100% of your income and earnings are taxed. The Internal Revenue Code (IRC) allows taxpayers to reduce total income through certain deductions, adjustments, and credits.

However, there are types of income that are excludable from being taxed.

The basic rule is that unless specifically excluded, all Income is taxable.

Taxable Income is categorized as one of the following sources:

 

1. Ordinary (Earned) Income: up to 37% Rates + subject to Social Security & Medicare

1. Wages and Salaries

   1. State/Local Tax Refunds

   2. Pension Amounts

   3. Self-Employment Income

   4. Unemployment

   5. All other income not classified as Portfolio, Passive or Capital

 

1. Portfolio Income: Taxed at Ordinary or Capital rates, varies

   1. Larger amounts required reporting on Schedule B

   2. Interest

   3. Dividends

 

1. Passive Income: Taxed at Ordinary Rates

   1. Income earned from activity that taxpayer did not actively participate in.

   2. Only passive losses may offset passive income.

   3. Net passive losses cannot offset Ordinary or Portfolio income but are carried forward

 

1. Capital Gains Income: Up to 20%

   1. Sales of capital assets, generally any property

   2. Gains taxed at 0%, 15% and 20%

   3. Losses, of up to $3,000/year can offset other sources of income.

Now that you have a better understanding of basic economies, the types of income, and how they are taxed, the changes from the Tax Cuts and Jobs Act should make more sense.

Below are two sections that break down how the new bill will impact Individuals and Corporations.

Keep in mind that Corporations, C-Corps, are the only business entity that pays tax. Partnerships, Limited Liability Companies (LLC), and S-Corporations are considered “pass through” entitles and literally pass the taxable income to the Individual Owners, Members, Partners, or Shareholders.

A Sole Proprietorship is not a separate business entity and automatically includes business income on the Individual’s tax return.

So, some impacts cross over between individuals and Businesses.

  

Part I: 
What does it mean for YOU as an Individual?

 

Big Change #1:

Standard and Itemized Deductions Changes

The Standard (or Itemized) Deductions is one of those deductions from total income that reduces how much tax you pay. A taxpayer gets a choice between:

Standard Deduction – A flat amount freely given by the IRS

-OR-

Itemized Deduction – A group of allowable deductions that combine and is reported on Schedule A.

 

Standard Deduction Changes:  

Note:
The largest percentage of tax filers are MFJ/MFS/Single that uses the Standard Deduction

Bottom line: The Negative Impacts will hit the Smallest Percentage of Tax Payers.

 

Itemized Deductions Changes:

Note:
The largest percentage of tax filers are MFJ/MFS/Single that uses the Standard Deduction

Bottom line: The Negative Impacts will hit the Smallest Percentage of Tax Payers.

As you can see from the charts, those taxpayers who are accustomed to using high itemized deductions will be negatively impacted, however, only 30% of taxpayers itemize.

 

Big Change #2:

Personal Exemptions – Now Zero per person

Another form of the deduction is through Personal Exemptions, a flat amount given to the taxpayer and each dependent claimed on the tax return.

This amount for 2017 is $4,050/person. For example, a family of (4) received a total deduction of $16,200.

Personal exemptions are now $0/person, beginning in 2018. Part of the reason for nearly doubling the Standard Deduction amount is to provide relief for those who are missing out on the Personal Exemption allowances.

But, it only takes a family of five to surpass the added benefit from the extra Standard Deduction amount.

For taxpayers with (4) or more dependents, the personal exemption allowance provides a substantial reduction in taxable income. 

This is the most painful aspect of the new tax bill, in my opinion.

 As seen below, of the total exemptions claimed in 2015, 82% were attributed to dependent children.

 

Big Change #3:

Child Tax Credit & Other Dependent Credit

Although repealing the Personal Exemptions allowances is a tough pill to swallow, there is some relief for families with children through the increase of the Child Tax Credit.

The Child Tax Credit is split up between nonrefundable and refundable amounts. A nonrefundable credit will reduce your tax liability to zero, but will not cause you to get a refund.

A refundable credit can both reduce your tax liability to zero and will also provide you a refund, essentially causing your tax liability to be negative.

 

In order to receive the Child Tax Credit:

You must have a qualifying dependent. Under the old rules, a Qualifying Child is one that meets all of the following:

1. A close relative (son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, legally fostered or adopted)

2. Under 17 years old

3. Live with the taxpayer for more than half the year

4. The taxpayer must claim the child for exemption purposes

5. Must be a citizen, national, or resident of the United States (ITIN = ok)

Below summarize the changes in the Child Tax Credit, including the brand-new addition of the Other Dependents Credit.

 

Note: New Rule: Qualifying children must be a US citizen with a Social Security Number (SSN), Individual Taxpayer Identification Numbers (ITINs) are no longer allowed.

Since personal exemptions are gone, families with children will be hurt by this. However, these families will see an additional $1,000/child credit as well as a lower threshold for earned income to qualify.

Further, they will also see a $400 increase in the refundable amount, meaning they could see a larger refund.

Dependent children who are US Citizens but do not have a SSN, qualify for the new $500 “other dependent” credit.

Higher wealth families will notice they no longer qualify for this credit as the Phase-Out amounts have increased by over 67% for all tax filers.

Bottom Line:
The child tax credit will offset many of the negative impacts of the loss of personal exemptions, especially for lower-income families.

 

Big Change #4:

Different Tax Rates & Updated Brackets

The new law comes with a decrease in the highest tax bracket down 2%.

Noticed that most taxpayers will get a break except for those who have taxable income of $400-416,000 – They will pay a slightly higher percentage.

 

Big Change #5:

Alternative Minimum Tax (AMT) Changes

For high-wealth individuals, AMT has been a thorn in their side for a while now. AMT is the IRS’s way of ensuring that high-wealth taxpayers do not avoid paying tax but enforce a “minimum” tax floor.

AMT is calculated by adding back to a taxpayer’s Taxable Income specific items, such as personal exemptions, equity debt interest, and miscellaneous deductions.

Since many of these benefits are no longer allowable or drastically reduced, very few taxpayers will have to pay AMT now.

 

Big Change #6:

Kiddie Tax Rate Changes

Children with unearned income over $2,100 are subject to a “Kiddie Tax”, which means that they would pay tax on that amount at the parent’s ordinary income rate, under the old rules.

The new rule provides that the amounts of $2,100 are taxed at Estate & Trust Rates, a much lower possible rate.

 

Part II: 
What does it mean for YOU as in Business Owner? 

The majority of all businesses in the United States are not big corporations, but small businesses set up as either a Sole Proprietor, Partnership, LLC, or S-Corporation.

There were many changes to business tax rules, including the following:

 

Big Change #1:

Flat Corporate Tax Rate:  21%

 

Big Change #2:

Employee Fringe Benefits Changes 

The following are costs or benefits that employers often would provide to employees as part of their employment contracts.

They are No Longer Allowed:

1. Entertainment – Meals are still allowable if they are qualified business meals and are still subject to the 50% rules.

2. Parking & Mass Transit passes

3. Transportation/Commuting

4. Cycling Transportation

5. Moving Expenses

6. Lower Limits on Excessive employee compensation

7. Lobbying Expenses

 

UPDATE: The COVID-19 Relief Bill, signed by the President on December 27, 2020, made changes to deductions for business meals in tax years 2021 and 2022. Businesses will be permitted to fully deduct business meals that would normally be 50% deductible. Although this change will not affect your 2020 tax return, the savings will offer a 100% deduction in 2021 and 2022 for food and beverages provided by a restaurant. The objective of the temporary deduction is to stimulate the restaurant industry. In the list of examples below, we’ve indicated those deductions which will change between 2020 and 2021. 

 

Big Change #3:

Depreciation Changes

The depreciation changes revolve around Section 179 and Bonus Depreciation limits. Both of these have had positive changes to them.

One major change is that Bonus Depreciation now allows for both used and new property (so long as the property is new to the taxpayer).

This is too complicated a subject for this article, if you have tangible personal property, please consult your CPA to discuss how these new changes impact your business.

 

Big Change #4:

20% §199A Business Deduction

This was the most talked about aspect of the entire bill. The 20% deduction that no one really knew the details on.

Basically, this new deduction will dramatically help small businesses (including the Sole Proprietor) by directly reducing the taxable income by up to 20%.

There are some excluded industries, including professional businesses.

• Taxpayers that have less than $315,000 (MFJ) or $157,500 (MFS) do not count towards all the exclusion rules.

There is a complicated formula, and you should consult with your CPA to determine the true impacts.

 

Big Change #5:

Repeal of Partnership Technical Termination

Under the old rules, if a 50% Partnership changed hands at any point during the year, causing a break in the 50/50 partnership, they would need to create a brand-new partnership.

Now, the partnership under certain circumstances can continue under new partners.

 

Big Change #6:

Estate & Gift Tax Exemption Amount Changes – now doubled

(all stats summarized from IRS Stats, 2015 Tax Year, filed 2016)