Tackling TCJA changes this tax season
Updated: Jan 24, 2019
By Paul Bonner
Tax practitioners have known and discussed the tax law changes for 2018 returns for more than a year since the Dec. 22, 2017, passage of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97. But even forearmed with that knowledge, CPAs now face a daunting task putting those new and revised provisions into practice. While past years' changes have often been piecemeal and incremental, those now facing taxpayers and preparers are nothing short of seismic.
Here is a discussion of some of the most important new provisions for individuals and businesses across a broad cross section of income tax returns. Many dollar amounts of brackets, thresholds, and other benchmarks for the 2018 tax year are given in this handy Filing Season Quick Guide PDF.
The changes are extensive, the IRS is still issuing guidance, and final regulations interpreting and implementing many provisions are not likely to be issued until after 2018. While the Service has issued proposed regulations upon which taxpayers may rely in many areas, such as the new Sec. 199A qualified business income (QBI) deduction described later, those proposed regulations and many others still leave unanswered questions.
Perhaps the most obvious change on individual returns is the nearly doubled standard deduction, along with the suspension of personal and dependent exemptions and the limitation of some itemized deductions. As has been often observed, the upshot is that fewer taxpayers will claim itemized deductions and will take the standard deduction instead. The Heritage Foundation estimates that 90% of taxpayers will take the new standard deduction amount (Heritage Foundation, "Analysis of the 2017 Tax Cuts and Jobs Act"), up from less than 69% for tax year 2016 (IRS, Individual Income Tax Returns, 2016). Preparers asking clients if their itemized deductions would total less than the standard deduction ($12,000 (single filers) or $24,000 (joint filers)) are more likely to get an unequivocal answer, and get it quicker, than previously, e.g., for the 2017 amounts, $6,350 or $12,700, respectively. But they might mention to clients that the tax benefit of the higher standard deduction may be offset by the loss of the personal/dependency exemption deduction. For example, for a family of three who each would have been eligible for a personal/dependency exemption deduction under prior law, the loss of those deductions (which under the prior law would have totaled $12,450 in 2018) is greater than the increase in the standard deduction under the TCJA (an $11,300 increase for joint filers). For larger households, the difference becomes even greater.
For those taxpayers who do itemize this year, there are several changes. Most importantly, all miscellaneous itemized deductions subject to the 2% floor under current law are repealed through 2025. The deduction for state and local income or property taxes is capped at $10,000 ($5,000 for married taxpayers filing separately). The threshold for deducting medical expenses has been lowered to 7.5% of adjusted gross income (for 2017 and 2018 only). Moving expenses are not deductible, except for members of the armed forces on active duty who move pursuant to a military order and incident to a permanent change of station. Personal casualty losses are deductible only if the loss is attributable to a federally declared disaster. However, the overall limitation on itemized deductions has been suspended through 2025.
Child tax credit increase
If one or more household members is a qualifying child under 17, the loss of personal exemptions could be made up for by a higher child tax credit amount (see "Tax Practice Corner: Child Tax Credit Now Higher, More Widely Available," JofA, June 2018). The TCJA doubles the basic credit amount from $1,000 to $2,000 per qualifying child and increases its refundable portion. The TCJA also nearly quadruples the credit's phaseout threshold for joint filers and raises it significantly for others.
In addition, the TCJA introduces a $500 partial credit for dependents who are not qualifying children under Sec. 24(c). These include dependent children over age 16 and qualifying relatives under Sec. 152(d). Qualifying relatives, among other criteria, must meet a gross income test that is still tied to the personal exemption amount, which for 2018 is deemed to be $4,150 for this and other purposes.
The 'kiddie' tax
The special rules for treatment of net unearned income of children, or the "kiddie tax," were changed by the TCJA, and practitioners should pay attention to how the changes affect taxpayers. Previously, a child's net unearned income was taxed at a parent's top marginal rate, or, if greater, at the child's rate on all the child's income without regard to the kiddie tax rules. Under the TCJA, for 2018 through 2025, the child's net unearned income is instead taxed, effectively, at the rates applicable to trusts and estates. For more, see "Understanding the New Kiddie Tax," JofA, Nov. 2018.
New Form 1040
Form 1040, U.S. Individual Income Tax Return, has been reformatted into a "postcard" size (by removing much of what has appeared on Form 1040 in the past to six new accompanying numbered schedules). The new form will also replace Form 1040A and Form 1040-EZ, Income Tax Return for Single and Joint Filers With No Dependents.
Not all the tax law changes this year are due to the TCJA; some temporary provisions expired at the end of 2017 and as of this writing had not been renewed for 2018, including several common ones affecting individual taxpayers. These are the itemized deduction for treatment of mortgage insurance premiums as qualified residence interest (Sec. 163(h)(3)(E), but see the discussion of itemized deductions above); the exclusion from gross income of discharge of qualified principal residence indebtedness (Sec. 108(a)(1)(E)); and the option to deduct higher education tuition and fees above the line rather than claiming them toward an education credit (Sec. 222). Action could be taken on these provisions after the midterm elections, legislators have said (see "Tax Extenders Among Brady's Lame-Duck Priorities," Tax Notes, Oct. 8, 2018, p. 257).
Of all the many changes affecting businesses, the one that perhaps has drawn the most attention is the QBI deduction under new Sec. 199A. The deduction of up to 20% of taxable income was intended by Congress to provide a tax reduction for most noncorporate business income comparable to the rate reduction in corporate income taxes the TCJA provided, the latter from a top rate of 35% previously to a flat rate of 21% for 2018 and subsequently. The IRS issued proposed regulations and other guidance for Sec. 199A in August (REG-107892-18 and Notice 2018-64; see also "Tax Matters: Qualified Business Income Deduction Regs. Proposed," JofA, Oct. 2018). Many questions and concerns remain, however, such as those highlighted in the AICPA's comments on the proposed regulations, available at aicpa.org.
Generally, noncorporate entities and individuals can receive a deduction of the lesser of (1) combined QBI, or (2) 20% of taxable income over net capital gain. Combined QBI is the sum of the deductible amount for each qualified trade or business of a taxpayer, plus 20% of the aggregate amount of the qualified real estate investment trust dividends and qualified publicly traded partnership income of the taxpayer. The deductible amount for a qualified trade or business is (1) 20% of the trade or business's QBI, or (2) the greater of (a) 50% of the trade or business's W-2 wages, or (b) the sum of 25% of the trade or business's W-2 wages plus 2.5% of the unadjusted basis of all the trade or business's qualified property immediately after its acquisition.
QBI is the net amount of qualified items of income, gain, deduction, and loss for any of a taxpayer's qualified trades or businesses. A qualified trade or business is a trade or business other than performing services as an employee or a specified service trade or business (SSTB). An SSTB is a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services; a trade or business the principal asset of which is the reputation or skill of one or more of its owners or employees; or a trade or business that involves performing services in investing and investment management, trading, or dealing in securities, partnership interests, or commodities.
The W-2 wage limitations and the exclusion from QBI for qualified amounts from SSTBs do not apply to taxpayers with taxable income under a threshold amount of $157,500 for a single filer or $315,000 for joint returns. The limitations are phased in as income rises above the threshold to $415,000 (married filing jointly) or $207,500 (all other taxpayers). These threshold amounts are adjusted for inflation for years after 2018. For more on the QBI deduction generally, see "Mechanics of the New Sec. 199A Deduction for Qualified Business Income," JofA, May 2018, and "Understanding the New Sec. 199A Business Income Deduction," The Tax Adviser, April 2018.
One of the biggest unknowns with respect to the QBI deduction has been what trades or businesses are SSTBs; the guidance released to date has clarified this area considerably. Notably, a trade or business that is considered an SSTB solely because its principal asset is the reputation or skill of its owners or employees encompasses only businesses in which a person receives fees, compensation, or other income from (1) endorsing products and services or (2) appearing at events or on radio, television, or other media, or that (3) license and receive fees, compensation, or other income for using an individual's image, likeness, name, signature, voice, trademark, or other such symbol (Prop. Regs. Sec. 1.199A-5(b)(2)(xiv)). In certain circumstances, taxpayers can aggregate separate trades or businesses when applying the Sec. 199A provisions. A de minimis rule is also provided, based on the percentage of gross receipts attributable to SSTB activities (Prop. Regs. Sec. 1.199A-5(c)(1); see also "Tax Practice Corner: The New QBI Deduction Is Finally Clearer," JofA, Nov. 2018).
100% bonus depreciation and more
The TCJA allows 100% first-year special allowance ("bonus") depreciation for property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (stepping down to 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026 — those stepdown dates are a year later for certain aircraft and longer-production-period property). In addition, the TCJA permanently increased the dollar limitation for Sec. 179 expensing for 2018 to $1 million in aggregate cost taken into account per tax year (from $510,000 for 2017) and increased the threshold at which that limitation is reduced to $2.5 million in Sec. 179—eligible property placed in service during the tax year (from $2,030,000 for 2017). These figures are adjusted for inflation in years after 2018. In addition, bonus depreciation is now generally allowed for qualifying used as well as new property.
Sec. 179 expensing is limited by taxable income from all the taxpayer's active trades or businesses, with any excess carried forward (Sec. 179(b)(3)), while bonus depreciation can create or contribute to a net operating loss (NOL) (but see the next section of this article, under the heading "NOLs Limited"). However, deferring a deduction is sometimes preferable, notably where it would cause or increase an NOL that would prevent another deduction.
Beginning with NOLs arising in tax year 2018, most NOLs may no longer be carried back, and carryovers may equal no more than 80% of taxable income for the carryover year (Sec. 172(a)). An NOL is calculated without regard to the new Sec. 199A QBI deduction (Sec. 172(d)(8)) (see "Tax Practice Corner: Carry Your Losses (Further) Forward," JofA, May 2018).
A TRANSFORMED TAX SEASON
Practitioners face several new concerns and considerations in preparing 2018 returns, due to the TCJA's reshaping of scores of provisions in the Code. Beyond what is discussed here, many provisions have been written about in the JofAand The Tax Adviser. Readers can consult the archives for past articles at journalofaccountancy.com and thetaxadviser.com by typing in search terms.
CPAs who have been diligent in studying the transformations may well encounter implementation issues of many kinds. They may welcome a chance to compare notes and perhaps do a little mutual problem-solving. Membership in the AICPA Tax Section includes a subscription to The Tax Adviser and access to other resources (see the resources box, below). Another good place to do so is on the AICPA's Tax Community webpage, which includes a LinkedIn group for tax practitioners. This tax season all but promises to be a memorable one.