We Read The 429-Page Tax Bill So You Don't Have To

How would a "sample Above the Law family" do under the new tax proposal?

(Photo by Drew Angerer/Getty Images)

Last week, the House Ways and Means Committee released the text of the Tax Cuts and Jobs Act (fun fact: Trump wanted to call it the “Cut Cut Cut Act”…thank goodness for the adults in the room).  The summary provided by the Ways and Means Committee is 82 pages, so if you want something that touches on all of the changes, go read that. If you’re a real masochist (or a tax lawyer or accountant), you can read all 429 pages of the bill. If you just want to find out how big the check will be that you write to Uncle Sam as a result of this bill, you’ve come to the right place.

The TCJA is noteworthy for the sections of the Internal Revenue Code it was willing to axe in order to pay for significant corporate tax cuts and a very generous giveaway to high net worth taxpayers through the increased estate tax exemption (and eventual repeal) and step up in basis in assets at death. Past attempts at tax reform have avoided changes to deductions that were previously considered untouchable: the mortgage interest deduction, state and local tax (“SALT”) deductions, and education credits and deductions. The TCJA, however, is a sweeping slaughter of the previously-sacred cows of our tax code. While this has been touted by the GOP as a tax cut for the middle class, that is hardly the truth. Lower and middle-income taxpayers may or may not see a tax cut, depending on their individual circumstances. A much larger percentage of corporations and very high-income taxpayers will see large tax cuts, thanks to the lower corporate tax rate of 20% and the new 25% rate on income from pass-through entities such as partnerships and S corporations. When carried out beyond ten years, any lower- and middle-income tax cuts disappear.

There’s been a lot of talk from politicians about the need to simplify the tax code, and, wrongly, the big talking point has been our seven tiers of tax brackets. Kelly Phillips Erb provides a great graphic of the rate and bracket changes proposed under the TCJA below. As Kelly notes, taxable income is still something of a fluid definition under the TCJA, so take any analysis of your final tax bill at this state with a very large grain of salt.

Any focus on rates and brackets is misguided, however. If rates and brackets are the demogorgons of our tax code, figuring taxable income is the shadow monster. It is the primary source of the code’s complexity and the reason postcard tax returns are a pipe dream.  The TCJA attempted to reign in that complexity by eliminating a large number of very popular deductions:

  • Student loan interest
  • Qualified tuition expenses
  • State and local income tax
  • Property taxes above $10,000
  • Mortgage interest on new mortgages over $500,000
  • Medical & long-term care expenses
  • Dependent care assistance programs and other employee fringe benefits

Sponsored

The changes aren’t all bad, though. The TCJA eliminates some more unpopular revenue-raisers (paid for by the cuts above):

  • The alternative minimum tax
  • The estate tax and generation-skipping taxes
  • The Pease limitation (this limited itemized deductions for higher-income taxpayers)
  • Student loan forgiveness income

To justify the controversial deduction eliminations, the TCJA raises the standard deduction to $12,000 for single filers and $24,000 to married filing jointly. Twice is nice, but the personal exemption of $4,050 per taxpayer and dependent was axed, negatively impacting families with kids. The child tax credit is increased to $1,600 from $1,000, and there’s a new $300 tax credit for taxpayers and non-child dependents, but not everyone is going to benefit from that due to income phase-outs that were unchanged under the TCJA. The bottom line is that whether you win or lose under the TCJA is very fact-specific: it depends on where you live, what your home ownership situation is, how many kids you have, and how you earn your income.  Those in high income tax and property tax areas are unlikely to find much relief in the higher standard deduction because it may not exceed the deductions they would have taken for payment of property and income taxes under the current version of the tax code. Add in the loss of the personal exemptions, and it is even worse.

The mortgage interest deduction is another area that saw big changes under the TCJA. Previously, taxpayers could deduct mortgage interest on up to $1 million of indebtedness, which could include indebtedness on a vacation home. Under the TCJA, taxpayers can only deduct mortgage interest on mortgage debt up to $500,000, and then only debt that is incurred to purchase the taxpayer’s primary residence.  If you already have a mortgage, or you entered into a binding contract before November 2, 2017 to purchase a home, then your mortgage will be grandfathered and you will be able to deduct the interest under the current law. You will not, however, be able to deduct interest on any second homes.

So how does this affect you, average Above the Law reader? Various tax policy groups have engaged in the “Battle of the Sample Families” to figure out who wins and loses under this bill, so let’s get in on that fun and make up Professional Sample Family 1: They are dual income W-2 wage earners in the professional services business (lawyer, accountant, consultant, etc.) with 2 kids and combined salaries of $350,000. They have property taxes of $20,000, state income taxes of $12,000, and have saved up to buy a home with a $625,000 mortgage, which they will purchase sometime in the first quarter of next year. They give $2500 annually in charitable contributions. Running this family through tax software, we find that they actually get a slight tax break under the bill. Under current law, they would pay about $73,000 in federal income tax, and under the new bill they pay around $72,000.

Sponsored

Professional Sample Family 2 has the same set of circumstances, but only earns $260,000. This family pays around $41,000 in income tax under current law, but about $44,000 under the new law—a more than 7% increase in their tax bill. The difference between these two families primarily illustrates the benefits that higher-income taxpayers see from the repeal of the Alternative Minimum Tax, which is a tax imposed on higher earners in order to make sure taxpayers don’t wipe out their tax obligations with deductions. The AMT repeal offsets the loss of the deductions for Professional Sample Family 1, but not for Professional Sample Family 2. This analysis shows that lower-earning Professional Sample Family 2 is truly hurt by the elimination of the SALT deductions, the loss of the personal exemptions, and the reduction of the mortgage interest deduction. It’s important to note that while both of these families earn too much to take the student loan interest deduction (it is phased out at higher income levels), many recent law grads and lawyers in lower income brackets will be hurt by the loss of this deduction as well.

If we were to compare our Professional Sample Families to, say, a Real Estate Sample Family, we would see that under the TCJA, how much you earn doesn’t matter as much as how you earn it. While these professional services families each earn a decent amount, they are not in the category of taxpayers who will benefit from some of the big giveaways in the TCJA, primarily because they earn their money from providing services, which remains taxed at graduated ordinary income tax rates up to 39.6%, even if earned through a partnership or S corporation. Owners of partnerships or S corporations get the 25% reduced pass-through rate on their passive income, but personal services pass-through income is excluded from that benefit. This is actually consistent with current law and the treatment of services income. Interestingly, the TCJA did introduce a facts and circumstances test around capital-intensive service activities that might allow some non-passive partners to apply the 25% pass-through rate to a portion of their income. Facts and circumstances tests are what makes the tax lawyer’s world go ‘round, so this was certainly not a step in the direction of simplification.

There are a few other traps that apply to some specific circumstances. For example, under existing law, a married couple could exclude capital gain on their primary residence as long as they lived there 2 of the last 5 years. That is now increased to 5 out of the last 8 years, which could catch some families who move out of areas with hot real estate markets within 5 years of purchasing their home. There is also a new income-based phaseout of this tax break that starts at $500,000 of adjusted gross income.

While 401ks remained untouched under this bill, non-qualified deferred compensation takes an enormous hit, causing much NQDC to be taxable in the year it no longer becomes subject to risk of substantial forfeiture (a definition that has expanded under this bill) rather than the year distributed to the employee. This creates a situation where the employee ends up with a tax bill on cash he or she does not yet have access to. Worse, it accelerates tax on existing NQDC plan balances in the year 2025. In other words, if an employee has $500,000 in NQDC that was earned prior to January 1, 2018 and no longer subject to potential forfeiture, she will have to pay tax in 2025 on that $500,000.  This is a big win for corporations, and a big loss for their employees who benefitted under these plans. If you’re in-house, this probably applies to you.

The TCJA claims to simplify the tax code by eliminating many of the deductions that are responsible for the complex calculations required to determine taxable income. It does make some progress in that regard, but the changes seem to primarily fund other tax breaks rather than introduce real simplicity to the tax system. The House is attempting to pass this bill without significant committee hearings or input from outside groups. There have already been questions raised as to whether they have the votes to pass it, given that many representatives from states that rely heavily on the state and local income tax deductions have unhappy constituents.

The Senate is scheduled to release its bill in the next week or so, and it remains to be seen if it will do a better job at real tax simplification instead of just creating ways to pay for other tax cuts.


Cindy Grossman is a tax partner with the private client services law firm Giordani, Swanger, Ripp & Jetel LLP. Cindy practices in Austin, Texas and New Jersey, helping businesses and individuals navigate complex tax situations. She can be reached at cgrossman@gsrjlaw.com and on Twitter at @CLGesq.