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Whose Taxes Will Go Up Next Year?
By Anthony J. Viola, CPA
In December 2017, Congress passed legislation signed by President Trump that provided changes to the IRS tax code under the “Tax Cuts and Jobs Act” (“TCJA”) effective for the 2018 tax year.
Under the 2017 tax laws, common deductions such as real estate taxes, state income taxes, and “2% deductions” (unreimbursed employee business expenses, tax preparation fees, financial investment fees, etc.) were generally allowable. With the passage of the TCJA, the aforementioned deductions have either been limited or eliminated altogether. Taxpayers in “high-taxed states” (high real estate and state income taxes) such as California, Connecticut, New Jersey, and New York reacted immediately with concern over the possibility that their federal tax liabilities would increase from tax years 2017 to 2018, due to the restriction/elimination of significant deductions relating to their respective tax filings. The “marketing” that was publicized throughout the media, from the tax reform bill supporters, was that the loss of such key deductions would be offset by lower income tax rates passed within the TCJA. So the question became: Who will get an increase in their tax bills in the 2018 tax year?
This has become a popular and extremely difficult question to answer, but one would have to have historical context and information to make such a prediction. For example, while the loss of significant deductions appears to be a tremendous blow to taxpayers in “high-taxed states,” the fact of the matter is that a good portion of those deductions were limited anyway for the tax years prior to 2018. The infamous “Alternative Minimum Tax,” or “AMT,” a form of “flat tax” for high middle-income taxpayers, eliminates the deductions discussed here, while utilizing specific tax rates (generally 26% and 28%) to compute a taxpayer’s minimum tax liability (all taxpayers cannot pay less than the tax calculated under the AMT). In addition, high middle-income taxpayers who realized large qualified dividend income and/or net long-term capital gains, and who enjoyed a lower tax rate on these long-term capital gains for “regular tax purposes,” were also penalized under the AMT calculation, resulting in paying more taxes on such categories of income than what was originally intended under the “regular tax” calculation. In general, and in reality, the AMT was a net tax increase to high middle-income taxpayers who had large investment income subject to the “special capital gain” tax rates and/or taxpayers with large deductions who basically lost the discussed deductions under the AMT calculation.
So now that we understand where we came from under the “old” tax laws, now we can discuss the potential impact of the “new” tax law. In my opinion, high middle-income taxpayers who live in high-taxed states will not see much change in their 2018 federal tax liabilities, in comparison to their 2017 federal tax liabilities. My firm utilizes tax software that projects a client’s 2018 tax liability for federal tax purposes based on the client’s 2017 tax information (income and deductions), resulting in an “apples to apples” comparison. As a result, in general, my opinion has proven to be correct. Readers must keep in mind that many of the new tax laws are still in the “temporary seven year” phase and they are not considered “permanent” as of yet, but we, as professional advisors, have no choice but to make assumptions as to our clients’ projected 2018 tax liabilities for federal purposes, to implement our clients’ tax planning process.
In going through the process of comparing projected 2018 tax liabilities to actual 2017 tax liabilities, it has become generally apparent that taxpayers with incomes that exceed one million dollars will see a higher tax liability in 2018 than they did for 2017. However, this is not a definitive statement as charitable deductions, allowable under both the “old” and “new” tax laws, will influence a taxpayer’s resulting tax liability. For example, a taxpayer that has charitable contributions that approach approximately 10% of total income levels, for taxpayers in the one million dollars to two million dollars level of income, may not see an increase in their tax liabilities for 2018. In addition, taxpayers who own businesses that qualify for the “20% flow through net income exclusion” under Internal Revenue Service Code Section 199A may get relief from the loss of key itemized deductions that may result in a lower tax liability in 2018 than in 2017.
There are a lot of moving parts to the TCJA that still have to be defined and that have to be explained by the Internal Revenue Service, as to the intention and resulting implementation of the 2018 tax laws. The term “technical corrections” has been a mainstay since the major tax reform bill of the 1986 tax laws under President Reagan. In general, technical corrections are a further explanation of new tax laws recently implemented. Sometimes, these corrections are implemented years after the original tax law changes were made.
In summary, I think that it is safe to say that taxpayers with income that exceeds one million dollars per year will likely see an increase in their 2018 federal tax liabilities in comparison to their 2017 federal tax liabilities. How much that increase will be in actual dollars or how much of a percentage increase will be based on a taxpayer-by-taxpayer case, as it all depends on the specific circumstances and factors surrounding each taxpayer’s sources of income and the category of allowable deductions.
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