In mid-December of last year, the federal “Tax Cuts and Jobs Act” passed by a simple majority vote. In order to make the deficit numbers pass the “Byrd Rule” test, most of the individual and estate tax provisions “sunset” after 2025. Generally, business tax changes are permanent (to the degree any policy is permanent).
The most dramatic estate tax change was a provision to double the basic federal exclusion amount to an estimated $11.18 million per individual (well over $22 million per couple.) This dramatically reduces the number of individuals exposed to a federal estate tax. This increase, however, will sunset after 2025. This change and the potential planning considerations stemming from the sunset will only impact a small percentage of the population. The prior federal exclusion amount was $5 million (indexed) per individual (and twice that for a married couple). The Maryland estate tax (with a threshold of $4 million for 2018) was slated to join the federal exclusion amount in 2019. The Maryland General Assembly froze the state estate tax at a $5 million threshold (not indexed) instead of permitting it to flow to the over $11 million next year. Importantly, the new Maryland threshold is subject to “portability”. Because of this legislative “fix”, the Maryland “gap” amount (i.e., the difference between the federal and state exclusion amounts) remains an important consideration for Maryland couples.
The increased federal exclusion amount will result in lower demand for “high-end” estate tax planning. This is exciting because clients will be able to focus more on family considerations and/or asset protection concerns when engaged in estate planning. To a large degree, most clients usually consider their family and asset protection concerns to be more important than the tax considerations. Instead of letting tax considerations drive the planning, most clients have generally relied on their lawyer to structure documents to maximize tax savings within the constricts of their desired plan. The sunsetting of the new provisions, the potential for claw-back of gifts made under the 2018-2025 temporary increased amounts, the utility of preserving the first-to-die spouse’s unified credit for the surviving spouse with a “portability” election, and the necessity for basis step-up planning will make planning challenging for those exposed, or potentially exposed, to the tax. For estate planning, the higher exclusion will allow clients to use trusts for other purposes, and the tax focus will change from estate tax planning to income tax planning.
The major business tax reform was reducing the C-corporation tax rate to 21% beginning in January 2018. This change, as well as other business tax changes, does not sunset. The new law creates a complex provision that treats the income of owners in various pass-through entities (partnerships, LLCs, and S corporations) preferentially. The new code section (§ 199A) provides a deduction equal to 20% of pass-through income for certain taxpayers. If one qualifies, and the qualified business income is $100,000, the new §199A deduction would yield a $20,000 tax deduction.
There are several catches to this new § 199A benefit, however. The full 20% deduction is only available if total taxable income from all sources is no more than $157,500 (for a single taxpayer) or $315,000 (married filing jointly). If the taxable income is over this amount, there are additional limits for some taxpayers based on the amount of W-2 income going to the employees and/or the amount of capital investment in the business. For those engaged in “specified service businesses”, there is a more draconian limit: there is no deduction if the taxpayer has over $207,500 (individual) or $415,000 (joint) of total taxable income with a phaseout in the brackets between the first threshold and the second threshold. The service businesses caught in this net include the fields of law, health, accounting, consulting, athletics, entertainment and other fields in which the individual’s reputation is a material element of the service. Some, but not all, self-employed lawyers may enjoy a tax break. Those with higher income levels, however, will see no change. The way these limitations and phaseouts work is highly complicated and certain to generate fees for our colleagues in the accounting field (ironically pushing them up into income levels where they may not be in a position to enjoy the §199A deduction).
The taxation of alimony will change dramatically beginning in 2019. This will be of particular interest to family lawyers. After the delayed effective date, the payor of alimony will receive no deduction for those payments and the payee will record no income – exactly the reverse of the present law. These new rules are effective for any divorce or separation agreement/decree that occurs after December 31, 2018. Modifications of an earlier agreement will only trigger treatment under the new rules if the amendment specifically states that the 2017 Act should apply. Negotiations for alimony after December 31, 2018, will take into consideration the adverse tax impact of the 2017 Act on the person paying the alimony.
Other individual income tax changes include an increase in the standard deduction and the cap on the SALT deduction. After factoring in the loss of various individual deductions, however, the increased standard deduction generally may not result in any large tax savings (although it will yield happy results for some taxpayers). The advertised reason for the 2017 Tax Act was to drop the corporate tax rates and spark economic growth. Many of the other provisions of the new act represent trade-offs to secure the Senate and House votes needed for the C corporation rate decrease.