Last updated: 31 July 2018
Most of the changes seen from the Tax Cuts & Jobs Act 2017 will be effective 1 January 2018, although please note that there are some transitional rules that you may want to consider. We examine how the changes could affect you.
Modification of the tax rates
For taxable years 2018 – 2025, tax rates for individuals have changed, with a new top rate of 37%. There has also been a modification to the lower tier tax rates introducing a 10%, 12%, 22%, 24%, 32% and 35% rate and replacing the current rates of 10%, 15%, 25%, 28%, 33%, 35%. The top rate of 37% applies to individuals with Adjusted Gross Income (AGI) in excess of:
Married Filing Jointly (MFJ)
Head of Household (HOH)
Married Filing Separately (MFS)
There are no changes to the long-term capital gains tax rates or the qualified dividend tax rates, which remain at 0%, 15% or 20%.
For many US individuals resident in the UK who face a top rate of tax (45%), this now represents a difference of 8% between the top US and UK tax rates. Although the lower rates in the US would generally mean that the US tax liability would reduce, for those resident in the UK this would generally mean that their excess foreign tax credits would increase. Excess foreign tax credits can be carried forward up to 10 years and can be useful for US/UK tax planning purposes. Although you would think the effective rate of tax would reduce in the US, there will be occasions when this does not happen, especially with changes to the itemised deductions and personal exemptions which will be explained later.
Increase in standard deduction
For those who do not benefit from claiming itemised deductions to lower their taxable income, the increase in the standard deduction will be welcome news. Single and Married Filing Separate taxpayers will benefit from a $12,000 deduction (up from $6,350), Married Filing Joint taxpayers benefit from a $24,000 deduction (up from $12,700) and Head of Household benefit from a $18,000 deduction (up from $9,350).
For many clients, the standard deduction is more beneficial than the itemised deduction. From 2018, the changes to itemised deductions could mean more taxpayers claim the standard deduction. This could be welcome news for some taxpayers as there would be less record keeping required for clients, which could simplify their affairs.
Suspension of deduction for personal exemptions
For taxable years 2018 - 2025, the personal exemption amount will be zero. Currently there is a $4,050 personal exemption per person in each household, potentially including spouse and dependents, although these are phased out for higher income taxpayers.
The scrapping of this exemption could mean that taxable income increases for some taxpayers with spouse and dependents where the exemptions are not phased out. You may want to consult with your advisor if you think you could be worse off, and potentially you may benefit from other provisions such as the increase in child tax credits.
Limitation on deduction for state and local, etc. taxes
For taxable year 2018 onwards, the deduction for state and local taxes will be capped at $10,000 for Married Filing Joint or $5,000 for Married Filing Separate / Single filers. This includes state and local income taxes, property taxes and sales taxes.
For those that have large state income tax liabilities this is not welcome news. We would recommend that any state tax due in relation to years prior to 2018 should be paid before the 31 December 2017 to ensure the deduction is included in your 2017 US tax return. Unfortunately, paying 2018 estimated tax before 31 December 2017 will not increase your 2017 deduction as the legislation will deem the payment to have been made in 2018.
Limitation on deduction for qualified residence interest
The mortgage interest deduction is reduced to $750k (or $375k) from the current cap of $1m (or $500k), on the amount of mortgage on which interest deduction can be claimed. The limit applies to new purchases. There are transitional rules if there has been a purchase where there is a binding contract before 15 December 2017, but completion happens early in 2018. Debt incurred before 15 December would not be affected by the reduction, as would debt incurred before 15 December where there was a refinance up to the same amount of debt.
For most of our clients, there will be grandfathered debt of up to $1m, which continues to attract mortgage interest relief. However, with the increase in the standard deduction some people may find that the mortgage interest relief may not be as beneficial going forward.
Suspension of miscellaneous itemised deductions
There will be no deduction from 2018 for miscellaneous itemised deductions subject to the 2% floor. This means expenses such as investment fees, tax preparation fees, unreimbursed employee expenses and safe deposit box fees will no longer be deductible from 2018.
Accelerating the payment of such expenses before 31 December 2017 will mean the deduction can be given for the final time in the 2017 US tax year. Please note that these expenses will not be deductible, unless in aggregate they exceed 2% of a taxpayers Adjusted Gross Income (AGI).
Suspension of exclusion for qualified moving reimbursements and deduction for moving expenses
Except for certain members of the Armed Forces in the US, the deduction for moving expenses for employment or self-employment reasons will no longer apply for 2018. In addition, the reimbursed moving expenses from an employer will now be taxable.
This may be a concern to some of our employer clients as it adds an extra cost to relocating employees and could mean revisiting budgets going forward.
Repeal of deduction for alimony payments
Certain US taxpayers who pay or receive alimony will no longer receive an alimony deduction or income inclusion. It applies to any divorce or separation instrument enacted after 31 December 2018, or modified after such date where the modification expressly provides that this rule applies.
Americans in the UK that are going through a divorce should seek US and UK tax advice as well as legal advice from a family lawyer before finalising the divorce agreement.
Increase in the Estate and Gift tax exemption
The basic exclusion amount has been doubled from 2018 to $11.2m per individual. The Estate and Gift Tax rate remains at 40%.
US individuals resident in the UK, but who are not domiciled in the UK and have a large amount of wealth outside the UK, may want to take advantage of the rules to protect their overseas estate from future UK Inheritance Tax (IHT) exposure. With a UK IHT exemption amount of £325k, there could be future exposures to IHT on worldwide assets once an individual has been UK resident for 15 years, or becomes UK domiciled under general law. Setting up an offshore trust could be attractive tax planning protecting the estate from UK Inheritance Tax while non-domiciled. Up to $22.4m per couple could be gifted into trust and protected from future IHT exposure (saving around $8.96m).
Repeal of Alternative Minimum Tax (AMT)
Unfortunately, the repeal of AMT applies to corporations only from 2018. Individuals will continue to be subject to AMT although there are increased exemptions.
Re-characterisation of certain carried interest gains
Private equity and hedge fund managers who received carried interest on their share of the partnership profits are currently taxable at the long-term capital gains tax rate of 20%. This bill introduces a three-year holding period in order to receive a long-term capital gains tax rate. This rule will apply notwithstanding section 83 or any election in effect under section 83(b).
Corporate Tax Rate
There are a great deal of tax changes from the corporate and business perspective, which will not be covered in this article. However, it is worth mentioning the significant reduction in the US Corporate Tax rate, which was one of the highest Corporate Tax rates in the world among the major economies. The magnitude of this reduction shows that from a corporate and business perspective, this Tax Bill is one of the biggest pieces of legislation, in terms of impact, that has been seen in years.
The US Corporate Tax rate has been reduced to a maximum of 21% on taxable income from 2018. Currently C corporations pay tax at graduated rates with a maximum rate of 35% on taxable income.
Modification of exclusion of gain on the sale of a principal residence.
Previous versions of the bill included changes to the $500k (or $250k) exclusion of gain from the sale of a principal residence. The final bill removed these modifications, and the current 2 out of 5-year test for ownership and occupation prevails.
We would expect the new Tax Cuts & Jobs Act 2017 to be signed by President Trump soon. Until it has been signed, there may be changes to the details above, although significant changes are deemed unlikely.
If you would like our team to discuss with you the changes seen in the Tax Cuts & Jobs Act 2017 and how we can help, please do not hesitate to get in touch and we’d be glad to assist you.