New tax plan: what you and your clients should know

The new tax plan is now law. Schwab’s Washington insider, Michael Townsend, offers his synopsis of the key changes.

The new tax plan is now law. Understand key changes so you can anticipate top-of-mind concerns from your clients.

Key Points

  • Congress just passed the most sweeping tax overhaul effort in decades, and investors have many questions: How will this affect me? What should I do now? While there is still much uncertainty around implementation, it is important to start thinking about how the new tax code may impact your clients and your business.

Mike Townsend

Michael Townsend,
V.P., Legislative & Regulatory Affairs, CS&Co.

President Donald Trump signed Congress’ sweeping tax bill on December 22, 2017, and most of the new law’s provisions took effect on January 1, 2018. The changes won’t affect most 2017 filings, but could still pose a significant challenge to the IRS, and corporations and individuals, who have to get up to speed on the changes and make the necessary systems updates to handle them. It is expected that some delays could occur in implementation.

What's in the new law?

Here are the highlights of the tax code changes:

  • New individual tax rates: The new law sets seven individual brackets at 10%, 12%, 22%, 24%, 32%, 35% and 37%. The new 37% top rate applies to taxable income in excess of $500,000 for single filers and $600,000 for joint filers.
  • No changes to capital gains and dividends: Capital gains and qualified dividends will continue to be taxed at the current 0%, 15% and 20% rates, depending on income. Wealthier filers will continue to pay an additional 3.8% tax on investment income, known as the Net Investment Income Tax.
  • Increased standard deduction: The standard deduction will nearly double, to $12,000 for single filers and $24,000 for joint filers.
  • Increased child tax credit: The per-child tax credit will double from $1,000 to $2,000.
  • Increased exemption for Alternative Minimum Tax (AMT): The AMT will be retained for individuals, but the exemption and phase-out amounts have sharply increased.
  • Mortgage interest deduction: Individuals will be allowed to deduct interest paid on new mortgages (issued after Jan. 1, 2018) of up to $750,000. That’s down from the previous cap of $1 million. The deduction will also apply to second homes, but not for home equity lines of credit.
  • State and local tax deduction: Taxpayers will be allowed to deduct up to $10,000 in a combination of property tax and income tax (or sales tax).
  • Estate tax exemption doubled: Estates of up to $11 million (or $22 million for couples) will be exempt from taxation.
  • Numerous other deductions and tax credits repealed: The law repeals deductions for investment expenses (such as advisor fees, but not investment interest expenses), safe deposit fees, tax preparation, moving expenses and alimony payments, among others.
  • Expiration of most individual tax provisions: Virtually all of the provisions that apply to individuals are set to expire at the end of 2025. A future Congress would have to vote to extend them, otherwise they would revert to 2017 levels.
  • Repeal of the individual mandate: Starting in 2019, the law repeals the requirement set by the Affordable Care Act that individuals purchase health insurance or pay a penalty.
  • Preserves deduction for medical expenses: Medical expenses above 7.5% of adjusted gross income will be deductible in 2017 and 2018. Beginning in 2019, the threshold will rise to 10%.
  • Reduction in the corporate tax rate: Corporations will be taxed at 21% beginning in 2018, down from today’s top corporate rate of 35%.
  • Reduction in taxes for “pass-through” businesses: Most so-called “pass-through” businesses, such as S corporations, limited liability corporations, partnerships and sole proprietorships, including those owned by trusts, will be allowed to deduct 20% of their income. There are special rules for certain types of services businesses. This provision is extremely complicated. Advisors may want to consult a tax specialist for details.
  • Repeal of IRA “recharacterizations”: The law repeals the ability of taxpayers to recharacterize, or undo, a Roth conversion, effective for conversions made after December 31, 2017. One open question, however, is whether the new law applies to conversions made earlier in 2017. There are differing interpretations of that question. As a result, the industry is calling on the IRS to issue guidance or clarification as soon as possible. Unfortunately, it is unclear when (or even if) such guidance will come.

Other issues of particular interest to investors:

  • No changes to cost-basis rules: The Senate version of the legislation would have required investors to use the “first in, first out” (FIFO) method when calculating their cost-basis for stock sales. That provision was dropped from the final agreement. Investors will continue to have the ability to choose which lots of stock they are selling.
  • Expansion of 529 college savings accounts: Up to $10,000 per year of money in a 529 college savings plan can be used to pay for K-12 school tuition.
  • No major changes to retirement savings accounts: Contribution limits to IRAs, Roth IRAs, 401(k)s and other retirement plans were not changed.
  • Gift tax exclusion increases: While this was not part of the new tax law, the IRS previously announced that the gift tax exclusion amount would increase from $14,000 to $15,000 for 2018.

So what happens next?

Given the high degree of uncertainty over implementation of the new tax code, and all the provisions and specifics that need to be put in place, it may be premature to consider making changes to financial plans. Clients may find this time stressful and feel compelled to take action before they fully understand how their financial households are affected. For now, ignore the political noise, check in with concerned client, learn more and wait until conditions are clear before considering any changes.

This report is current as of January 16, 2018 . Advisor Services™ is committed to keeping you abreast of the latest happenings in Washington. Look for a future RIA Washington Watch from Schwab’s D.C. insider, Michael Townsend.