This year has brought us the “Tax Cuts and Jobs Act,” which will impact PR agency owners personally as well as their agencies. This column will review the key provision changes that we will be facing in 2018 and beyond.
New income tax rates and brackets
To determine your regular tax liability, there are now new tax rate schedules. There will be four tax rate schedules based on filing status. Under the pre-Act law, individuals were subject to six tax rates: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent and 39.6 percent. The new tax law introduces seven brackets for individuals: 10 percent, 22 percent, 32 percent, 35 percent and 37 percent. For example, a married couple with taxable income over $165,000 but not over $315,000 will incur a tax of $28,179 plus 24 percent on the excess over $165,000 up to $315,000.
There are basically three ways to measure tax rates: marginal tax rate, average tax rate and effective tax rate. The marginal rate is the tax rate that applies to the next additional increment of the taxpayer’s taxable income. The average tax rate is the average rate of taxation on each dollar of tax income. The effective tax rate is the rate of taxation on each dollar of total income (both taxable and nontaxable). In my view, most taxpayer’s focus on the effective rate.
The standard deduction
We all know that the tax act eliminates the deduction for state and local taxes that are more than $10,000 and reduces the amount that can be deducted for home mortgage interest (see below). The new standard deduction is $24,000 for married filing a joint return, $18,000 for head-of-household filers and $12,000 for all other taxpayers. Note, no changes are made to the current law additional standard deduction for the elderly and the blind. The deduction for personal exemptions is effectively suspended by reducing the exemption amount to zero.
Mortgage and home equity indebtedness interest deduction limited
Under the pre-Act law, the mortgage interest and home equity loan deduction was limited to acquisition indebtedness of up to $1 million ($500,000 in the case of married filing separate), plus home equity indebtedness of up to $100,000.
The new tax law provision suspends home equity indebtedness and the deduction for mortgage interest is limited to underlying indebtedness of up to $750,000 ($375,000 for married filing separately). For tax years after December 31, 2025, the prior $1 million/$500,000 and home equity indebtedness is restored. Note, the treatment of indebtedness incurred on or before December 15, 2017 is not subject to this new provision. Also, if you entered into a binding contract written before December 15, 2017 to close on the purchase of a principal residence before January 1, 2018 and purchase such residence before April 1, 2018, the new tax law limitation will not apply.
An open question: Assume you own a home and have no mortgage but need to make substantial improvements to your home; a new kitchen and baths as an example. You borrow under a new “home equity” loan to make these improvements (banks generally do not lend under a “mortgage”). Will the underlying debt be considered “home acquisition indebtedness” allowing the interest to be deducted? In my view this should work! However, guidance is needed by the IRS to put this to rest. Some tax professionals say “yes” and others “no.”
Miscellaneous itemized deductions suspended
Under the pre-Act law, taxpayers could deduct certain miscellaneous itemized deductions to the extent they exceeded, in the aggregate, two percent of adjusted gross income. For tax years beginning after December 31, 2017 and before January 1, 2026, this deduction is suspended.
This means any “business expenses” incurred by an employee of a PR agency will not be deductible! This is a good time to learn how an employer can bypass this rule by setting up an “accountable plan.”
Internal Revenue Code Section 83 governs the amount and timing of income inclusion for property, including employer stock, transferred to an employee regarding the performance of services. Under the code, an employee must generally recognize income for the tax year in which the employee’s right to the stock is transferable or is not subject to a sub substantial risk of forfeiture. The amount of income to be recognized is the excess of the stock’s fair market value at the time of substantial vesting over the amount, if any, paid for the stock by the employee.
The new law allows a qualified employee to elect to defer for income tax purposes the amount of income attributable to qualified stock transferred to the employee by the employer. The deferral period is made by election no later than 30 days after the first time the employee’s right to the stock is substantially vested or is transferable, whichever occurs earlier. (Note: the balance of the rules are complex and professional advice is needed!!)
Obviously, I can’t review every provision in this column. However, one important provision to understand is the new deduction for pass through income. Generally, the new law allows a non-corporate taxpayer, including a trust or estate, who has qualified business income from a partnership, S corporation or sole proprietorship to deduct what is known as the 20 percent deduction. Have you been told this will now work for PR agencies? We’ll discuss this next month.
Richard Goldstein is a partner at Buchbinder Tunick & Company LLP, New York, Certified Public Accountants.