The last time we had a major tax overhaul was in 1986 with the Tax Reform Act signed by President Reagan.  Although it simplified the income tax code for some folks, it also created complexity for others, not to mention a great deal of work for accountants and tax lawyers who were tasked with interpreting and planning around the new law.  Tax professionals (and the IRS) now again have their hands full in interpreting and implementing the newly enacted Tax Cuts and Jobs Act, which took effect on January 1, 2018.  To ring in the New Year, we thought it helpful to provide clients with a summary of the new law with a specific emphasis on how it affects your businesses and estate planning.  Keep in mind that although the new law is effective now, individuals won’t see any change to their tax returns until spring 2019 (when 2018 returns are filed).

Although a comprehensive review of the new tax bill is not realistic in this memorandum, here are some highlights that we think most affect our clients.

Estate Taxes

The new tax legislation increases the federal estate tax exemption from $5M to $10M (indexed for inflation), so that an individual who dies in 2018 may shelter $11.2M from federal estate taxes.  The new exemption sunsets in 2026 when the amount reverts to $5M indexed.  The “portability” provision remains in the new law, so married couples who do proper estate planning may shelter up to $22.4M from federal taxes in 2018.  The annual exclusion amount remains the same, too: $15,000 in 2018, indexed for inflation.  And your heirs will continue to receive a step up in basis upon death for assets which are includible in the decedent’s taxable estate.

The State of Maine is one of fourteen states plus the District of Columbia which levy a state estate tax.  Maine’s estate tax exemption for 2018 is $5.6M. Going forward this amount will be adjusted each year for inflation.

Pass-Through Entities

The new tax law includes significant tax relief for pass-through businesses, which include partnerships, disregarded LLCs, sole proprietorships, and S Corporations.  Under the old law, income for such entities was not taxed on the corporate level and instead passed through to and declared on the owners’ personal tax return, and taxed at ordinary income tax rates.  These pass-through attributes remain in the new law, however owners of pass-through businesses may now take a 20 percent deduction for “qualified business income” received from the business.  Generally speaking, “qualified business income” is net nonwage income; it does not include an S Corp owner’s “reasonable salary”.  The deduction is capped at 50% of W-2 wages paid, or 25% of W-2 wages paid plus 2.5% of capital assets, whichever is greater.  There is also a phase-out for some professional services businesses – specifically for individual owners whose taxable income exceeds $157,500, and for married couples filing jointly whose taxable income exceeds $315,000.  Certain owners of commercial real estate may be eligible for the deduction beyond those limits.

Corporations

Entities taxed as corporations (C Corps) also receive significant tax relief under the new law:  the corporate tax rate has been cut from a floating rate (with a maximum rate of 35%) to a flat rate of 21%.  Due to this change, you may see tax benefits if you convert from a pass-through entity to a C Corp, although additional payroll and/or dividend taxes from C Corp taxation (i.e. double taxation) may diminish those benefits.

Some Miscellaneous Items

  • Increase in Standard Deduction; Various Itemized Deductions Changed or Eliminated: The standard deduction will increase from $6,350 to $12,000 for single filers ($12,700 to $24,000 for married filing jointly).  The law eliminates moving expenses (except for members of the military) and alimony payments as itemized deductions.  The deduction on mortgage interest can now only be claimed on the first $750,000 of debt (previously $1,000,000).  The deduction for interest on home equity lines of credit has been eliminated.  The deduction for state and local taxes including municipal real estate taxes (previously unlimited) is now limited to $10,000.  This last item could significantly many of our clients who have both high real estate taxes (i.e. waterfront properties) and state income taxes.
  • Personal Exemptions Eliminated: The $4,050 personal exemption for yourself and each claimed dependent has been eliminated.  That means that families with children may end up paying higher taxes even though the standard deduction has been dramatically increased.
  • Individual Mandate under Affordable Care Act Eliminated: The fee imposed on those who can afford healthcare but choose not to buy it has been eliminated.  In other words the penalty for not having health insurance has been repealed.
  • Individual Alternative Minimum Tax (AMT): Although the corporate AMT was eliminated in the new tax bill, the AMT for individuals has been retained – albeit a softened version.  The new AMT rules raise the exemption (i.e. the amount a taxpayer may subtract from his or her AMT liability) the phase-out level (i.e. income level at which those exemptions are reduced).
  • Net Operating Losses – Changes to “Carry Back” and “Carry Forward” Rules: Under the previous rule, businesses could apply net operating losses (NOLs) to the previous two tax years to receive refunds for taxes paid in those years.  Under the new rule, the carry back rule is eliminated.  The new law also changes the rules regarding carry forward NOLs by eliminating the prior 20-year limit.  In other words, businesses may carry forward NOLs indefinitely and use to offset taxable income in any subsequent tax year.  However, the new law limits the offset to 80% of taxable income in the carryforward year.