Tax Reform 2017 Major Changes

The New 2017 Tax Reform Bill

Perspectives from Kim Woo of Luna Capital Management.

Early in the morning of December 20, 2017, the Senate passed the "Tax Cuts and Jobs Act" by a party-line vote of 51 to 48; (Republican Senator McCain was absent for medical reasons). Irrespective of your political affiliation most would agree that this legislative achievement is the most sweeping overhaul of the US tax system in more than 30 years.

Naturally, the question we are all asking is “how does this impact me and my family?”

Well, that’s a challenging one to answer because everyone is different, but let’s examine the changes from 30,000 feet. Please remember, however, that this summary is by no means meant to be considered tax advice – you should consult your advisor to determine how it might impact you personally.

Implications for the Investor?

The good news for investors is that the tax treatment of qualified dividends and capital gains remain unchanged. A qualified dividend is a type of dividend to which capital gains tax rates are applied. These tax rates are usually lower than regular income tax rates. Ordinary dividends that do not qualify for this tax preference are taxed at an individual's normal income tax rate. Luna Capital Management emphasizes investing in companies that pay qualified dividends to investors. 

Implications for the US Economy?

By almost all accounts, the Tax Cuts and Jobs Act is predicted to raise the federal deficit by billions of dollars – and perhaps as much as $2 trillion over the next 10 years.

The big question is how much economic growth the new bill will create, thereby offsetting the increase to the federal deficit. The short answer is that no one knows with any certainty. Here are three perspectives:

• The Congressional Budget Office's analysis suggests that the cuts would add $1.4 trillion to the deficit by 2027. That estimate does not include the amount that would be offset by economic growth spurred by tax cuts.
• Treasury Secretary Steven Mnuchin predicts a “net reduction” to the national debt as a result of the new bill.
• Speaker Paul Ryan told NBC’s Savannah Guthrie that “nobody knows” if the tax bill will create enough economic growth to negate its cost.

The answer is probably somewhere in the middle.

Highlights of the Bill:

The bill is complicated and long – at least 400 pages at last count. In addition, many of the changes, especially the personal tax breaks, are considered temporary – meaning they go into effect in 2018 but expire after 2025. The reason for this expiration date is because it allows the Senate to comply with what we might consider odd "reconciliation" rules that block a Democratic filibuster, which the Republicans would not have enough votes to overturn. The good news is that the Republicans have vowed to make the changes permanent – but let’s wait and see what happens – 2025 is a long way away…

Here is a quick summary of other provisions of the tax bill:

The bill would create a single corporate tax rate of 21%, beginning in 2018, and repeal the corporate alternative minimum tax. Unlike tax breaks for individuals, these provisions would not expire.

The bill would retain the current structure of seven individual income tax brackets, but in most cases, it would lower the rates:

• the top rate would fall from 39.6% to 37%;
• the 33% bracket would fall to 32%;
• the 28% bracket to 24%;
• the 25% bracket to 22%;
• the 15% bracket to 12%; 
• the lowest bracket would remain at 10% and the 35% bracket would remain unchanged.

The bill would raise the standard deduction to $24,000 for married couples filing in 2018 (from $13,000 under current law), to $12,000 for single filers (from $6,500), and to $18,000 for heads of household (from $9,550). These changes would expire after 2025.

The bill would end the individual mandate, a provision of "Obamacare" that provides tax penalties for individuals who do not obtain health insurance coverage, in 2019. While the mandate would technically remain in place, the penalty would fall to $0.

The bill would temporarily raise the child tax credit to $2,000, with the first $1,400 refundable, and create a non-refundable $500 credit for non-child dependents.

The bill would limit the application of the mortgage interest for married couples filing jointly to $750,000, down from $1,000,000.

The bill would cap the deduction for state and local taxes at $10,000 through 2025.

The bill would temporarily raise the exemption amount and exemption phase-out threshold for the Alternative Minimum tax – for married couples filing jointly, the exemption would rise to $109,400 and phase-out would increase to $1,000,000.

The bill would temporarily raise the estate tax exemption for single filers to $11.2 million from $5.6 million in 2018, indexed for inflation. This change would be reversed after 2025. 

Final Thoughts:

Communication with your investment advisor and tax counsel during the year leads to effective financial planning which may add to your bottom line investment returns.

Many investors receive unexpected capital gain distributions from their mutual fund companies. At Luna Capital, we emphasize tax management and planning with our clients.

Consider taking advantage of the tax incentives provided to investors receiving qualified dividends.