Tax Reform—The Biggest Changes

With the close of tax filing season for 2017, now is a good time to consider the 2018 tax year. The most sweeping tax reform package in decades took effect on January 1, 2018. You should notice the impact of the changes in your 2018 paychecks soon.

Although a number of changes for retirement savings programs were considered, in its final form the legislation preserved key retirement savings incentives. As a result, the changes don’t materially affect your UC retirement savings plans.

But the rules have changed for income taxes, deductions, college savings, and more. Here’s an overview of the biggest changes to be aware of.

KEY RETIREMENT SAVINGS PLAN FEATURES UNCHANGED

The new law makes no changes to the amount you can contribute to your UC 403(b), 457(b), or DC Plan accounts, and it leaves the favorable tax treatment for these plans intact. Likewise, hardship withdrawal provisions and tax rates on early withdrawals remain unchanged. The law also left the rules for health savings accounts intact.

ADJUSTED INDIVIDUAL TAX BRACKETS AND LOWER RATES

The new tax code reduced several of the marginal income tax rates (see chart). Those new tax brackets and the other changes to the individual tax code are all temporary—Congress will need to act or the rules will revert to 2017 law after December 31, 2025.

NEW HIGHER STANDARD DEDUCTION

Tax reform combines the personal exemption and standard deduction into a single higher standard deduction, which is indexed to inflation. The child tax credit increased and there is a new dependent tax credit. The higher standard deduction for people age 65 and older still exists. The new provisions expire for taxable years after December 31, 2025, and the rules return to 2017 tax law.

The new law changes the balance between itemized and standard deductions. Higher standard deductions mean it will make sense for fewer people to itemize deductions—so charitable gifts, medical expenses, home mortgage interest, and other itemized deductions all face a higher threshold before they become useful.

In addition, the new law directly changes or limits a large number of deductions and credits. Here is a look at how a few of the most popular deductions changed:

TEMPORARY INCREASE IN FEDERAL ESTATE TAX EXEMPTION

The law roughly doubles the federal estate tax exemption to $11 million per person ($22 million per couple). This change will help some families avoid this tax at the federal level. That limit is indexed to inflation, but will expire and revert back to 2017 law after 2025.

CHANGES TO THE ALTERNATIVE MINIMUM TAX (AMT)

The AMT was designed to prevent high-income individuals from avoiding income tax by piling up deductions. It is essentially a parallel method for calculating your income tax liability.

The tax reform law makes changes designed to limit the impact of the tax. The law raises the minimum income level at which the AMT applies, from $50,600 to $70,300 for individuals and from $78,750 to $109,400 for couples married filing jointly.

NEW CORPORATE TAX RATE AND PASS-THROUGH TAX RATE

Corporate tax rates dropped to 21% beginning in 2018. That tax cut is not scheduled to expire.

Pass-through businesses, businesses structured as sole proprietorships, partnerships, and S-corporations are taxed at individual tax rates, but are able to deduct 20% of income. To prevent high-income individuals from taking advantage of this deduction, it is only available to couples filing jointly with incomes below $315,000. For income above that level, the rules are complex, but it appears that certain kinds of businesses might still be eligible for a partial deduction.

The plan lets businesses fully expense new equipment right away, but the provision will eventually expire.

529 PLANS BECOME MORE FLEXIBLE

The tax legislation allows up to $10,000 per year in 529 savings plan assets to be used for education expenses for grades K–12, in addition to college and post-graduate study. It also temporarily increases the contribution limits to ABLE accounts under certain circumstances.

THE BOTTOM LINE

In light of the new legislation, here are a few things you may want to consider and consult with a tax professional about.

  • Rethink your mortgages and deductions: If you have traditionally made charitable gifts or benefited from the mortgage interest or state and local tax deduction, look at how the new standard deduction will affect you. The imposition of a cap on state and local tax deductions may also impact where some people choose to live in retirement.
  • Look at your education expenses: 529 plans have long offered tax benefits for families saving for college. So if you have kids or grandkids, consider how these accounts factor into your savings plans. With the new rules, families that pay for private elementary or high schools also may want to consider the benefits of these accounts. Some offer state income tax deductions and preferential treatment for investment gains, which can help to manage the cost of education.
  • Estate tax: Even in the absence of tax reform, it makes sense to periodically review your estate plan. If the estate tax limit changes are relevant to your plan, it may make even more sense to revisit your strategy. You may want to meet with your estate planning attorney.
  • Small-business income: If you own a small business, you may want to reconsider how you structure your income and the form of your enterprise. Depending on the size and particulars of your business, you may want to consider the benefits of incorporation or the restructuring of pass-through organizations. Consult with an expert in small-business taxation.
  • Timing corporate expenses: With new rules in place temporarily for expensing capital equipment purchases, business owners may want to review their capital expenditure plans.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

Investing involves risk, including the risk of loss.

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