Tax Cuts and Jobs Act

The 2017 Tax Cuts and Jobs Act (TCJA) impacts investors, traders, and individuals positively and negatively, beginning in the tax year 2018. In this chapter, I explore TCJA’s impact on these groups.

INVESTORS

TCJA suspends “certain miscellaneous itemized deductions that are subject to the 2% floor under present law.” These include investment fees and certain investment expenses, unreimbursed employee business expenses (job expenses), and tax compliance fees for non-business taxpayers.

Investment interest expenses retained. TCJA did not suspend or modify investment interest expense on Schedule A. Investment interest expense remains deductible up to the extent of investment income. The excess is carried over to the subsequent tax year.

Business interest expense modified. Business interest expense is limited to 30% of adjusted taxable income, business interest income, and floor plan financing interest. The excess amount carries over indefinitely to subsequent tax years. (Traders are not affected unless they make over 26 million in trading gains, as explained in our guide.)

Carried interest modified. TCJA modified the carried interest tax break for investment managers in investment partnerships, lengthening their holding period on profit allocation of long-term capital gains (LTCG) to three years from one year. If the manager also invests capital in the investment partnership, she has LTCG on that interest after one year.

C-CORPS

When taking into account TCJA, traders shouldn’t focus solely on the federal 21% flat tax rate on the C-Corp level. There are plenty of other taxes, including capital gains taxes on qualified dividends, corporate taxes in 44 states, and accumulated earnings tax assessed on excess retained earnings.

When a C-Corp pays qualified dividends to the owner, double taxation occurs with capital gains taxes on the individual level. If an owner avoids paying sufficient qualified dividends, the IRS is entitled to assess a 20% accumulated earnings tax (AET). It’s a fallacy that owners can’t retain all earnings inside the C-Corp. Traders face difficulties in creating a war chest plan for justifying accumulated earnings and profits to the IRS. (See How To Decide If A C-Corp Is Right For Your Trading Business.)

INDIVIDUALS

The individual tax cuts are temporary through 2025, which applies to most provisions, including the suspension of certain investment expenses.

TCJA brings forth a mix of changes for individuals. The highlights for 2018 limits include:

• Lower tax rates in all seven brackets to 10%, 12%, 22%, 24%, 32%, 35%, and 37%; four tax brackets for estates and trusts: 10%, 24%, 35%, and 37%;
• Standard deduction raised to $24,000 married, $18,000 head-of-household, and $12,000 for all other taxpayers, adjusted for inflation;
• An expanded AMT exemption to $109,400 married and $70,300 single;
• Many itemized deductions and AGI deductions suspended or trimmed (more on this later);
• Mortgage debt lowered on new loans;
• Personal exemptions suspended;
• Child tax credit increased;
• New 20% deduction for pass-through income with many limitations;
• Pease itemized deduction limitation suspended;
• ACA shared responsibility payment lowered to zero for non-compliance with the individual mandate starting in 2019;
• Children’s income is no longer taxed at the parent’s rate; kids must file tax returns to report earned income, and unearned income is subject to tax using the tax brackets for trusts and estates.

SALT capped at $10,000 per year. The most contentious deduction modification is to state and local taxes (SALT). After intense deliberations, conferees capped the SALT itemized deduction at $10,000 per year ($5,000 for married filing separately). TCJA allows any combination of state and local income, sales, real estate taxes, or domestic property tax. SALT may not include foreign real property taxes.

Medical expenses modified. TCJA retained the medical-expense itemized deduction, which is allowed if it’s more than the AGI threshold. In 2017, the AGI threshold was 10% for taxpayers under age 65, and 7.5% for age 65 or older. TCJA uses a 7.5% AGI threshold for all taxpayers for taxable years ending after 2018 and beginning before 2021.

Mortgage debt lowered on new loans. As of Dec. 15, 2017, new acquisition indebtedness is limited to $750,000 ($375,000 in the case of married taxpayers filing separately), down from $1 million, on a primary residence and second home. Mortgage debt incurred before Dec. 15, 2017, is subject to the grandfathered $1 million limit ($500,000 in the case of married taxpayers filing separately). If a taxpayer has a binding written contract to purchase a home before Dec. 15, 2017, and to close by Jan. 1, 2018, she is grandfathered under the previous limit. Refinancing debt from before Dec. 15, 2017, keeps the grandfathered limit providing the mortgage is not increased.

SUSPENDED DEDUCTIONS

Unreimbursed employee business expenses. TCJA suspends unreimbursed employee business expenses (job expenses) that were normally deducted on Form 2106 — there is no Form 2106 for 2018 through 2025. Speak with your employer about implementing an accountable reimbursement plan and “use it or lose it” before year-end.

Tax prep and planning fees. TCJA suspended tax compliance (planning and preparation) fees as itemized deductions. Ask your accountant to break down their invoices into individual vs. business costs because the business portion is allowed as a business expense.

Miscellaneous itemized deductions. TCJA suspended “certain miscellaneous itemized deductions subject to the two-percent floor” in the Joint Explanatory Statement (p. 95-98).

Personal casualty and theft losses suspended. TCJA suspended the personal casualty and theft loss itemized deduction, except for losses incurred in a federally declared disaster. If a taxpayer has a personal casualty gain, she may apply the loss against the gain. If deducting home office expenses, enter “excess casualty losses” on Form 8829, line 29.

Gambling loss limitation modified. TCJA added professional gambling expenses to gambling losses in applying the limit against winnings. Professional gamblers may no longer deduct expenses more than net winnings.

Alimony deduction. TCJA suspended alimony deductions for divorce or separation agreements executed in 2019 and subsequent years, and the recipient does not have taxable income.

Moving expenses. Starting in 2018, TCJA suspended the AGI deduction for moving expenses, and employees may no longer exclude moving expense reimbursements, either. One exception: Active duty military members “who move pursuant to a military order and incident to a permanent change of station.”

MORE TCJA CHANGES

20% QBI deduction. TCJA introduced a new tax deduction for pass-through businesses, including sole proprietors, partnerships, and S-Corps. Subject to haircuts and limitations, a pass-through business could be eligible for a 20% deduction on qualified business income (QBI).

Traders eligible for TTS are a “specified service activity,” which means if their taxable income is above an income cap, they won’t receive a QBI deduction. The taxable income (TI) cap is $426,600/$213,300 (married/other taxpayers) for 2020, and $429,800/$214,900 (married/other taxpayers) for 2021. The phase-out range below the cap is $100,000/$50,000 (married/other taxpayers), in which the QBI deduction phases out for specified service activities. The W-2 wage and property basis limitations also apply within the phase-out range. Investment managers are specified service activities, too.

QBI for traders includes Section 475 ordinary income and loss and trading business expenses. QBI excludes capital gains and losses, Section 988 forex ordinary income or loss, dividends, and interest income.

TCJA favors non-service businesses, which are not subject to an income cap. The W-2 wage and property basis limitations apply above the TI threshold of $326,600/$163,300 (married/other taxpayers) for 2020 and $329,800/$164,900 (married/other taxpayers) for 2021. The IRS adjusts the annual TI threshold for inflation each year.

Sole proprietor TTS traders cannot pay themselves wages, so they likely cannot use the phase-out range.

Ordinary tax rates reduced. TCJA lowered tax rates on ordinary income for individuals for almost all tax brackets and filing status. It decreased the top rate to 37%, starting in 2018, from 39.6% in 2017. Short-term capital gains are taxed at ordinary rates, so investors receive this benefit.

Filing status equalization. TCJA fixed several inequities in filing status, including the tax brackets by making single, married filing jointly (MFJ), and married filing separately (MFS) brackets equivalent, except for divergence at the top rate of 37% for single filers, retaining some of the marriage penalty. See the 2020 tax brackets: MFS brackets are exactly half the MFJ brackets throughout all the rates, so MFS filers are not penalized on rates. Filing separately could unlock a QBI deduction.

Repeal of recharacterization for Roth IRA conversions. If a 2017 converted Roth account dropped significantly in value in 2018, a taxpayer could have reversed the Roth conversion with a “recharacterization” by the tax return’s due date, including extensions (Oct. 15, 2018). That option is no more; TCJA repealed it starting with 2018 Roth IRA conversions.

Charitable contribution deduction limitation increased. TCJA raised the 50% limitation of AGI for cash contributions to public charities and certain private foundations to 60%. Excess contributions can be carried forward for five years.

Per TCJA, retirees who must take required minimum distributions by age 70½ (raised to 72 under the SECURE Act) should consider “qualified charitable distributions” (QCD). This move satisfies the RMD rule with the equivalent of an offsetting charitable deduction, allowing you to take the standard deduction rather than itemize.

Expanded use of 529 account funds. TCJA significantly expanded the permitted use of Section 529 education savings account funds. “Qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school. (Check with your state.)

Excerpt from Green’s Trader Tax Guide Chapter 17 Tax Cuts and Jobs Act.