The Tax Cut and Jobs Act (TCJA) is now officially law. Both the House and Senate passed the new tax reform bill in December with straight party-line votes and no support from Democrats. President Trump signed it into law right before Christmas. It is the first overhaul of the tax code in more than 30 years.
In this issue of The Elder Counselor, we will mostly look at how this tax law is likely to impact seniors and persons with disabilities.
It’s Good News for Most Americans
Retirees, most of whom are on relatively fixed incomes, are probably the most concerned about what the new tax law will mean for them. But, generally, they will be less affected than others because the changes do not affect how Social Security and investment income are taxed. In fact, many will benefit from the doubling of the standard deduction and, with the new individual tax brackets and rates, will be paying less in taxes when they file their tax returns in April, 2019. (Most of the changes will apply to 2018 income, not 2017 income.)
Key Individual Provisions to Know
Here are main provisions in the tax law that could particularly affect retirees and persons with disabilities. These individual provisions are set to expire at the end of 2025 so Congress will need to act before then if they are to continue.
(Mostly) Lower Individual Income Tax Rates and Brackets
There are still seven individual tax brackets and rates, but most are lower. Current rates are 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. Here are the new rates and how much income will apply to each:
Rate Individuals Married, filing jointly
10% Up to $9,525 Up to $19,050
12% $9,526 to $38,700 $19,051 to $77,400
22% $38,701 to $82,500 $77,401 to $165,000
24% $82,501 to $157,500 $165,001 to $315,000
32% $157,501 to $200,000 $315,001 to $400,000
35% $200,001 to $500,000 $400,001 to $600,000
37% $500,001 and over $600,001 and over
Standard Deduction is Almost Doubled
For single filers, the standard deduction is increased from $6,350 to $12,000. For married couples filing jointly, it increases from $12,700 to $24,000. Under the new law, fewer filers would choose to itemize, as the only reason to continue to itemize is if deductions exceed the standard deduction.
Personal and Elderly Exemptions
Currently, you can claim a $4,050 personal exemption for yourself, your spouse and each dependent, which lowers your taxable income and resulting taxes. The new law eliminates these personal exemptions, replacing them with the increased standard deduction.
The blind and elderly deduction has been retained in the new law. People age 65 and over (or blind) can claim an additional $1,550 deduction if they file as single or head-of-household. Married couples filing jointly can claim $1,250 if one meets the requirement and $2,500 if both do.
Medical Expenses Deduction
Currently, people with high medical expenses can deduct the portion of those expenses that exceeds 10% of their income. For example, a couple with $50,000 in income and $10,000 in medical expenses can deduct $5,000 of those medical expenses.
The new law increases this to medical expenses that exceed 7.5% of income. In the example above, the couple would be able to deduct $6,250 of their expenses. Note that this part of the new law applies to medical expenses for 2017 and 2018.
State and Local Tax (SALT) Deduction
The amount you pay in state and local property taxes, income and sales taxes can be deducted from your Federal income taxes—and the amount you can currently deduct is unlimited. The new law limits the deduction for these local and state taxes to $10,000.
Residents in the vast majority of counties in the U.S. claim an average SALT deduction below $10,000. Most low- and middle-income families who currently itemize because of their SALT deduction will likely take the much higher standard deduction unless their total itemized deductions (including SALT) are more than $12,000 if single and $24,000 if married filing jointly.
Originally lawmakers in the House and Senate wanted to repeal SALT entirely, to help pay for the tax cuts, but lawmakers in high-tax states (specifically CA, IL, NY and NJ) fought to keep it in. Those in higher income households in high-tax states will benefit from the SALT deduction.
Lower Cap on Mortgage Interest Deduction
Currently, if you take out a new mortgage on a first or second home, you can deduct the interest on up to $1 million of debt. The new law puts the cap at $750,000 of debt. (If you already have a mortgage, you would not be affected.) The new law also eliminates the deduction for interest on home equity loans, which is currently allowed on loans up to $100,000.
Temporary Credit for Non-Child Dependents
Under the new law, parents will be able to take a $500 credit for each non-child dependent they are supporting. This would include a child age 17 or older, an ailing elderly parent or an adult child with a disability. It is temporary because it is set to expire at the end of 2025 along with the other individual provisions.
Higher Exemptions for Alternative Minimum Tax (AMT)
The AMT was created almost 50 years ago to prevent the very rich from taking so many deductions that they paid no income taxes. It requires high-income earners to run their numbers twice (under regular tax rules and under the stricter AMT rules) and pay the higher amount in taxes. But because the AMT wasn’t tied to inflation, it has gradually been affecting a growing number of middle-class earners. The new tax law reduces the number of filers who would be affected by the AMT by increasing the current income exemption levels for individuals from $54,300 to $70,300 and for married couples from $84,500 to $109,400.
Federal Estate Tax Exemptions Doubled
The new law does not repeal the Federal estate tax, but it eliminates it for almost everyone by doubling the estate tax exemption to $11.2 million for individuals and $22.4 million for married couples. Amounts over these exemptions will be taxed at 40%. The new rates are effective starting January 1, 2018 through December 31, 2025.
Eliminates Individual Mandate to Buy Health Insurance
With the elimination of the individual mandate to purchase health insurance, there will no longer be a penalty for not buying insurance. This is expected to help offset the cost of the tax bill and save money by reducing the amount the federal government spends on insurance subsidies and Medicaid.
The Congressional Budget Office expects that fewer consumers who qualify for subsidies are expected to enroll on Obama Care exchanges and fewer people who are eligible for Medicaid will seek coverage and learn they can sign up for the program. (Estimates of those who are expected to have no health insurance by 2027 are all over the place, ranging from 3-5 million to 13 million.)
Critics, including AARP, claim that eliminating the individual mandate will drive up health care premiums, result in more uninsured Americans and add $1.46 trillion to the deficit over the next ten years, which could trigger automatic spending cuts to Medicare, Medicaid, and other entitlement programs unless Congress votes to stop them.
Some claim the individual mandate helps to encourage younger and healthier Americans to sign up for coverage. Without it, the individual market might lean more toward sicker and older consumers, which might lead some insurers to drop out of the market. 29% of current enrollees on the federal exchange already have only one option in 2018. Others maintain that the mandate is not a key driver for obtaining insurance. About 4 million taxpayers paid the penalty in 2016.
Inflation Adjustments Slowed
The new tax law uses “chained CPI” to measure inflation, which is a slower measure than that currently used. This means that deductions, credits and exemptions will be worth less over time because the inflation-adjusted dollars that determine eligibility and maximum value would grow more slowly. It would also subject more of your income to higher rates in the future.
529 Plans Expanded
529 plans have been a tax-advantaged way to save for college costs. The new tax law expands the use of tax-free distributions from these plans, including paying for elementary and secondary school expenses for private, public and religious school, as well as some home schooling expenses. Educational therapies for children with disabilities are also included. There is a $10,000 annual limit per student.
ABLE Accounts Adjusted
ABLE accounts, established under Section 529A of the Internal Revenue Code, allow some individuals with disabilities to retain higher amounts of savings without losing their Social Security and Medicaid benefits. The new tax law allows money in a 529 education plan to be rolled over to a 529A ABLE account, but rollovers may count toward the annual contribution limit for ABLE accounts ($15,000 in 2018). The new law also changes the rules on contributions to ABLE accounts by designated beneficiaries who have earned income from employment.
What to Watch
Expect some clarifications and strategies as the experts weigh in. There will also undoubtedly be some adjustments as the new tax bill goes into effect. Please don’t hesitate to reach out if you have questions about these new provisions and how they may impact you or those you work with.
Written by, CRAIG W. SMALLEY, MST, EA
For most practioners the estate tax hasn’t come into play for many years. Instead of eliminating the estate tax, the estate tax exemption has been raised to $11 million for an individual, and $22 million for a married couple that elects portability. For a majority of people the estate tax doesn’t come into play. However, let’s take a moment to explain how the estate tax exemptions and gift tax works.
The estate tax exemption and the gift tax work together in a sense that you have a unified lifetime credit for gifts, which match the estate tax exemption. The unified credit increases each year, along with the estate tax exemption. Each year there is an amount that you can gift, in a sense that you are removing assets from your taxable estate. For instance, in 2018 the amount that you can gift is $15,000. If you are married and elect to split your gifts, you can give someone $30,000. These amounts can be given without having to file a gift tax return. If you give a person an amount over the exemption, then you must file a gift tax return, and the amount over what you could give is deducted from your unified lifetime credit. If you go over this unified lifetime credit then you have to pay a gift tax of 40%.
There are a ton of steps that you can take to eliminate the estate tax, if you are subject to it. I used to help clients with their taxable estates, back in the days when the estate tax exemption was $600,000. However today, estate planning serves a couple of purposes.
First of all, if you make no plans at all, you die intestate, which is a legal term that means you had no will or estate plan. Your estate goes through a probate process and your assets pass according to the laws of the state, and no one wants that. Another reason to do estate planning would be to avoid as much of the probate process as possible.
Each state is different and probate works differently in each one. Generally, every estate is probabated in some form. In probate, the hearing is made public, so that creditors or anyone that feels that they have a right to the assets of the decedent can make a claim against your estate. For example, if you have a will, and that is your estate plan, the will must be probated before the assets can be disbursed. If you specifically exclude someone that has a legal right to the assets of the estate, they can contest the will, and tie up the distribution of your assets until the probate court determines what will happen to them.
Famous probate cases would be Anna Nicole Smith, who married a wealthy man, who changed his will to leave all of his assets to his new wife. Her husband’s adult children, who were excluded in the will contested the will, and the case was tied up until Anna Nicole Smith’s death.
There are two ways that assets can pass. One is through probate, and the other is through an act of law. For instance, if you formed a revocable living trust, and titled your biggest assets to that trust, there can be no claim made against the trust, because a trust is a legal document, and the assets passed to the intended beneficiaries by an act of law.
A revocable living trust is a legal document that has three parties. Then grantor, or trustmaker is the person(s) making the trust. The trustee is the person or entity that controls the assets, and the beneficiaries are the ones that are inheriting the assets.
Revocable means that the document can be changed during the grantor’s lifetime, living is because you are alive, and trust is a legal document. Typically, during your lifetime, you are the trustee of the trust. At death, a contingent trustee will become the trustee. The trust becomes irrevocable, meaning that it can’t be changed, and the assets are protected from creditors or anyone else that is not named as a beneficiary. Then it becomes a taxable entity. During your lifetime, the grantor is responsible for any taxes due on the income earned while in the trust. At death, if the assets aren’t distributed, then the beneficiaries are responsible for any taxes due.
For the smaller assets, like personal effects, you would have a pour-over will, that would be probated, but the probate process doesn’t matter too much, because you have removed the biggest assets already through the trust.
The other reason for estate planning for an estate that isn’t subject to the estate tax, is for the person that is self-employed, and wants to pas their business to someone else, in the most tax advantageous way possible. For instance, if you own a business and you want to pass the business to your children, it would be a taxable event unless you have made some arrangements.
One of the most popular ways to pass a business on to someone is through a grantor retained annuity trust or a GRAT. Basically, the owner of the business, the grantor in this case, would form an irrevocable trust, and transfer their shares of stock if a corporation, or membership units if an LLC to the trust. The trust would have a trustee, other than the grantor to protect the assets from creditors and to remove the assets from the taxable estate, if it exists.
The trust would have a term of ten to twenty years. The ownership vehicle would be placed in the trust at a value determined by the grantor. The trust would then pay the grantor an amount each year, as an annuity, until the end of the trust term. When the trust ends, the ownership of the business would pass to the beneficiaries.
The problem a GRAT creates is that the annuity amount that is paid to the grantor is taxable to the grantor, and if the grantor dies while the GRAT is in effect, the assets are removed from the trust and added back to the estate, and could be taxable if the grantor is subject to the estate tax, and will pass through probate.
There are other ways to pass the business to the beneficiaries, that is a little more complicated, but protect the assets, and the owner retains control of the business, and the profit of the business is used to pay the grantor for the assets, and the tax to the grantor is better than that of a GRAT.
Most businesses are set up as S-Corporations, now that can change with the new tax law, but the theory behind this’d way of passing along the business would remain intact. The grantors forms an intentionally defective grantor trust (IDGT). What make the trust defective is that it is irrevocable, unlike most grantor trusts that are revocable. In the case of an S-Corporation, you can only have one class of stock, and its common stock. You would split the stock, into voting and non-voting shares. This split does not create a separate class of stock, it just has to do with voting rights. You would take 99% of the shares and make them non-voting shares. You would transfer those shares to the trust, and the beneficiaries would be the ones inheriting the stock. The left over 1% of stock, would be the voting shares, and remain with the grantor.
The point of this is to pass the majority of the business to the beneficiaries, and the owner of the business to retain control of the business.
The 99% of the stock that was transferred would be transferred at whatever amount the grantor determines. The grantor would become a passive owner, not required to pay themselves reasonable compensation, however the owner would take distributions from the S-Corp, until such a time as owner is paid for the business, and then relinquishes their stock, the shares in the trust are distributed to the beneficiaries, and the business is removed, and passed to the intended beneficiaries.
Just because most of your clients are not subject to the estate tax, doesn’t mean that estate planning is a dying skill. Estate planning is a hard sell to a client, partially because the estate tax isn’t a big deal to most people, and with estate planning a client has to come face to face with their own mortality. However, knowing the ins and outs is still important.