As of Dec. 1, 2017, major U.S. tax reform appears to be a certainty and President Donald Trump expects to sign the bill into law by the end of 2017. The bill will likely not take effect until Jan. 1, 2018, which means this reform should not impact the filing of your 2017 federal income tax return. Below is an update regarding important elements of filing your 2017 tax return as they are presently known. Should tax reform occur and some provisions are backdated, turn to your personal CPA or the PICPA for those specific changes that will impact your filing season.
Filing Your 1040 – The Basics
There are no changes to the 2017 filing status categories. Taxpayers can file as single, married filing jointly, married filing separately, head of household, or qualifying widow(er) if the circumstances legally support the status chosen. If you are married and filing jointly, you can take advantage of certain tax deductions, tax credits, and benefits not available to couples filing separately. Generally, a status of married filing separate (MFS) is the least helpful. Unmarried taxpayers may file as single or, if they qualify, head of household.
The top 2017 income tax rate is presently 39.6 percent for single taxpayers making more than $418,400, head of households making more than $444,550, and married filing jointly taxpayers and surviving spouses making more than $470,700 (or $235,350 if married filing separately). Below that, the ordinary income tax rates are presently 10, 15, 25, 28, 33, and 35 percent, with different brackets for each type of filer’s income threshold.
Most proposed tax legislation includes tax bracket reduction as a goal. Elimination of four of the seven individual bracket rates, with the highest rate to be set at 35 percent, was in the reform proposal released in September 2017, and likely remains a priority. Many factors will affect the likelihood of this proposal being adopted.
The Affordable Care Act (ACA) still exists. As of this writing, the ACA is the law of the land, which means it continues to include additional Medicare taxes on earned and unearned income. The Medicare contribution tax rate on earned income – such as wages, compensation, or self-employment income – continues to be an additional 0.9 percent, if that income exceeds certain filing thresholds such as for married filing joint filers with income of $250,000 ($125,000 if married filing separately) and $200,000 for all other taxpayer filing statuses. For unearned income, see the “Net Investment Income Tax” section in this brochure.
For 2017, the exemption amount has remained constant at $4,050 for yourself, your spouse, and each of your dependents who are qualifying children or relatives. Proposed regulations update the definition of a dependent eligible for exemption to include a child who has been lawfully placed with a taxpayer for adoption. Exemption amounts are subject to phase-outs beginning at $261,500 (single), $287,650 (head of household), $156,900 (married filing separately), and $313,800 (married filing jointly); with a complete phase-out at $384,000 (single) and $436,300 (married filing jointly).
The standard deduction amounts for 2017 have been indexed slightly higher and are as follows: $6,350 if single or married filing separately, and $12,700 for married filing jointly or qualifying widow(er), and $9,350 for head of household.
Taxpayers who are 65 and older or are blind receive an additional standard deduction of $1,250 if married and filing jointly or separately, or $1,550 for those filing as single or head of household.
For individuals claimed as a dependent on another tax return, the 2017 standard deduction is the greater of $1,050 or $350 plus earned income, not to exceed the standard deduction amount for those who are not dependents.
The American Tax Relief Act (ATRA) of 2012 reduced itemized deductions by 3 percent of any excess adjusted gross income (AGI) over $261,500 (single), $287,650 (head of household), $156,900 (married filing separately), and $313,800 (married filing jointly). ATRA also increased the AGI limitation floor from which you can claim unreimbursed medical expense deductions from 7.5 percent of AGI to 10 percent of AGI before such deductions can be claimed. Previously, only those over 65 could use the 7.5 percent floor; however, this has been removed for all taxpayers. The 2 percent floor for unreimbursed business expenses, the 10 percent floor for casualty losses in excess of insurance reimbursements, and the standard charitable contribution limitations still apply.
Mileage and vehicle costs can be significant considerations in computing itemized deductions. The 2017 business mileage rate is $0.535 per mile. The medical and moving mileage rate is $0.17, and the charity mileage rate is $0.14 per mile.
Retirement Savings Tax Breaks
You may contribute up to $5,500 to a 2017 traditional or Roth IRA. Those 50 or older at year-end can make an additional “catch-up” contribution of $1,000. Contributions to traditional IRAs may be deductible depending on several factors, including filing status. The deductible amounts are phased out at higher levels of AGI. Nondeductible contributions are allowed up to applicable limits. Distributions are fully taxable as ordinary income, unless there were historical nondeductible contributions.
Roth IRA contributions are not deductible, but earnings accumulate tax-deferred and may be withdrawn tax-free and penalty-free if you meet certain requirements. Allowable contributions, however, are phased out at higher levels of AGI, depending on filing status.
Pretax contributions to traditional 401(k) plans reduce federal, but not necessarily state or local, taxable wages. Matching contributions and income earned within your plan are tax-deferred until distributed. The employee contribution limit for 2017 is $18,000. Employees age 50 or older may make an additional catch-up contribution of $6,000. Distributions are fully taxable as ordinary income.
Roth 401(k) contributions are made with after-tax dollars. Earnings accumulate tax-deferred, and may be withdrawn tax-free and penalty-free if you meet certain requirements. Taxpayers are generally allowed to roll over certain pretax qualified retirement accounts such as traditional IRAs and 401(k)s to designated Roth IRA accounts. Such rollovers are generally taxable on the amount of traditional pretax contributions.
Due to the complexity of the rules related to retirement plans, you should consult your CPA if you are receiving, or are about to receive, retirement account distributions.
To encourage taxpayers to contribute to qualified retirement plans, Congress provides a “saver’s credit.” For individual elective contributions up to $2,000, there is a credit up to 50 percent, for a maximum credit of $1,000. The credit is phased out for higher-income taxpayers.
Tax Breaks and Other Considerations for Homeowners
Interest, Points, and Certain Taxes
Home mortgage interest on up to $1 million of home acquisition loans secured by your principal residence or second home is fully deductible. You also may deduct interest on up to a $100,000 home equity loan or line of credit. Points paid to secure a loan for the purchase or improvement of a principal residence usually are fully deductible in the year paid. However, points paid to refinance an existing mortgage must generally be amortized and deducted over the life of the loan. Real estate taxes and state and local property taxes on tangible property are also deductible, as are your state and local income taxes.
There has been speculation about the elimination of the home mortgage interest and real estate tax deductions. But as of this writing, President Donald Trump has publicly stated he is in favor of keeping these deductions.
Exclusion of Certain Capital Gains upon Sale
You can still exclude up to $250,000 in gains ($500,000 if married and filing jointly) on the sale of your home. To qualify, you generally must have owned and used your home as a principal residence for at least two years during the five-year period ending on the date of sale. Limitations may apply if you had any “nonqualified use.”
First-Time Homebuyer Tax Credit Pay Back
This tax issue from several years ago is still around, and it can be easily missed when switching tax preparers. Taxpayers who claimed a first-time homebuyer credit on a home acquired in 2008, 2009, or 2010 may have to repay the credit under certain circumstances, including a subsequent sale to a related party, an abandonment or destruction of the home, or conversion of the home to a business or rental property.
Energy Tax Credit Incentives
There is a 30 percent tax credit on the cost of alternative energy equipment, available in 2017 through 2019. Qualified equipment includes solar hot water heaters, solar electric equipment, and wind turbines. There is also a personal (non-business) energy property credit of 10 percent of the cost of qualified energy-efficient improvements up to a maximum lifetime limit of $500.
Child and Education-Related Tax Breaks
Child Tax Credit
The Child Tax Credit is $1,000 for each qualifying dependent child who is under age 17 (this includes permanently disabled children). The credit may be partially refundable. The credit phases out, however, when modified AGI exceeds certain levels.
Child and Dependent Care Credit
Parents who, in order to work, pay for the care of a dependent under age 13 (whether the care is provided outside or inside the home) may be eligible for a nonrefundable tax credit of between 20 percent to 35 percent of qualifying expenses, depending on income level. For 2017, the maximum amount of qualifying expenses on which the credit can be claimed is the lesser of the amount of qualifying expenditures ($3,000 for the care of one dependent or $6,000 for at least two qualifying children) or the taxpayer’s earned income.
Earned Income Tax Credit
If a taxpayer earned income within certain thresholds, there may be a refundable earned income tax credit (EITC). While subject to a variety of qualifications, EITC may be available to those with qualifying dependents and those considered “childless.” Some of the qualifications include filing status, number of qualifying children, amount of earned income, AGI amount, and earned income of the “childless.”
Higher Education Tax Benefits
American Opportunity Tax Credit
Up to $2,500 per qualifying student for qualifying expenditures is available for each of the first four years of college, and up to 40 percent of the credit is refundable if total tax is cut to zero.
Additionally, a Lifetime Learning Credit of 20 percent of up to $10,000 of eligible expenses per year is available for undergraduate, graduate, and professional degree courses. Both credits phase out for higher-income individuals, and you cannot claim both credits for the same student in the same tax year.
There is also a deduction for AGI, available even if you do not itemize, of up to $2,500 for qualifying student loan interest, although it also phases out for higher income taxpayers. Instead of using education credits, an alternative tuition deduction of up to $4,000 is available for 2017, subject to certain income limitations.
An adjustment to K-12 teachers’ gross income of a maximum of $250 is also available.
Tax Considerations for Investors
Capital Gain and Loss Planning
Planning when to realize capital gains or losses can be extremely beneficial. Such planning should consider the continued risk (or benefit) of holding an investment longer, current and future cash needs, the “wash sale” rules that disallow certain losses, and current vs. future tax rates.
For 2017, net capital losses (including any net capital loss carryovers) are still fully deductible against current year capital gains. If capital losses exceed capital gains, you can deduct up to $3,000 in net capital losses against ordinary income ($1,500 if married filing separately). Any remaining capital losses can still be carried over indefinitely to successive tax years to offset future capital gains.
Rates on Capital Gains and Dividends
The preferential tax rate is 0 percent to the extent the income would have been taxed in the 10 percent or 15 percent tax rate bracket if it were ordinary income; 20 percent to the extent the income would have been taxed in the 39.6 percent tax rate bracket if it were ordinary income; and 15 percent for all other taxpayers. (Note, there are different rates on gains from certain assets such as collectibles, depreciable real property, and qualified small-business stock.) Interest income and short-term capital gains (held 12 months or less) continue to be taxed at ordinary rates, currently as high as 39.6 percent.
Net Investment Income Tax
The health care law brought with it an additional 3.8 percent tax on certain net investment income if a taxpayer’s modified AGI exceeds certain threshold levels. For 2017, these levels are $250,000 for married filing jointly (or $125,000 if married filing separately) and $200,000 for all other filing statuses. In general, net investment income includes, but is not limited to, interest, dividends, capital gains (after offset of capital losses), rental and royalty income, certain annuities, and income from businesses that are passive activities to the taxpayer, including gains on their sale.
The net investment income tax will not apply to any amount of gain that is excluded from gross income for regular income tax purposes, such as the exclusion of the first $250,000 ($500,000 in the case of a married couple) of gain recognized on the sale of a principal residence. To calculate your net investment income, your investment income is reduced by certain expenses properly allocable to the income, such as investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in net investment income.
Children’s unearned income may be subject to tax at the parents’ highest applicable marginal rates for their unearned income. This is known as the “Kiddie Tax.” Any net unearned income over $2,100 will be taxed at the applicable parental rates if the child is in one of these three categories as of year-end: Under age 19, age 19 and does not have earned income exceeding 50 percent of his or her support, and age 19 through 23 and is a full-time student who does not have earned income exceeding 50 percent of his or her support. The amount exempt from tax and the amount taxed at the child’s rate is $1,050.
Other Tax Considerations
Alternative Minimum Tax (AMT)
Talk of repealing the AMT has occurred continuously since it was enacted in 1976. AMT generates $38 billion, or 2.5 percent, of all individual tax revenue. This tax isn’t going anywhere soon! AMT exemptions for 2017 are $54,300 for single and head of household filers; $84,500 for married people filing jointly and qualifying widows or widowers; and $42,250 for married people filing separately. The exemption amounts are phased out at 25 cents for each dollar of AMT income over the thresholds.
Section 179 Expense
Section 179 expense election for acquiring new or used tangible personal property in a business is $500,000. The limitation is reduced dollar-for-dollar if acquisitions exceed $2.02 million, and is eliminated above $2.5 million, but limited to the business’s taxable income.
As of this writing, progress on tax law changes has been slowed by congressional differences of opinion regarding, among other things, expanding and extending Section 179 expensing of capital improvements versus those who think this small-business benefit is expensive and not sufficiently “stimulative.”
Bonus depreciation is available through 2019 for up to 50 percent of qualified business property placed in service during the period of 2015 through 2017. Bonus depreciation is reduced in 2018 to 40 percent, and reduced again in 2019 to 30 percent.
Note: Most of the content above was prepared in September 2017. Additional legislation may be passed before year-end. The PICPA worked carefully to prepare this guide, but it cannot be used as official tax advice that would protect taxpayers from penalty due to the complexity of tax law, individual taxpayer facts and circumstances, and changes enacted after this writing. We encourage taxpayers to seek advice from our member CPAs about the items contained in this resource, as well as other tax issues and planning opportunities.
For more tax tips from Pennsylvania CPAs, visit www.picpa.org/taxhelp