The US Congress passed the 2017 Tax Cuts and Jobs Act on December 20, 2017 and it has since been signed into law by President Donald Trump.

Under the Act, the largest decrease in tax would potentially go to high-income married couples filing jointly. The top tax rate drops from 39.6 per cent to 37 per cent, providing a significant benefit. Under current law, the 39.6 per cent tax rate applies to taxable income over $480,050. The increase to $600,000 for the highest tax rate bracket provides an additional significant benefit to this group.

The benefit to high-income taxpayers is not as great, as the highest rate bracket threshold only moved from $426,700 to $500,000.

The rate brackets after 2018 will be adjusted for inflation. However, the methodology will change from the current use of the Consumer Price Index for All Urban Consumers (CPI-U) to the Chained Consumer Price Index for All Urban Consumers (C-CPI-U). This is expected to reduce the benefits of the changes in rate brackets (and other tax attributes) over time.

The Act does not require the Internal Revenue Service (IRS) to issue new wage withholding tables until January 2019. However, it is anticipated that new wage withholding tables would be implemented by February 2018 to take into account the changes in rates.

For a summary of what will change in tabular format, please click on the attachment on this webpage, located under the heading, “Related Media”.

State taxes

The Act generally limits the personal deduction of state and local taxes to $10,000 per taxable year. Property and income taxes can be deducted up to the limit. Taxpayers can deduct sales tax, in lieu of income taxes.

Practitioners had thought, based on early versions of the legislation, that it might have been possible to prepay 2018 income taxes in 2017. The Act specifically provides that income taxes that are prepaid will be treated as paid on the last day of the taxable year to which it relates. As a result, it would not have been possible to deduct 2018 (and later) income taxes in 2017 to avoid the $10,000 limitation.

State and local (and foreign) taxes that relate to a trade or business are still deductible, as well as taxes that relate to the production of income. That is, taxes that in past have been properly deducted on Schedules C, E, and F are still deductible.

AMT

The AMT is retained for individuals. However, the exemption amount is increased to $109,400 ($70,300 for single taxpayers). In addition, the phase-out threshold is increased to $1 million ($500,000, in the case of a single taxpayer).

Currently, most individuals are liable for AMT due to adjustments for state and local tax deductions. With the new limitation of the deduction to $10,000, it is doubtful that many individuals will be liable for AMT in the future.

Other personal deductions

The Act would also repeal the following personal tax benefits:

• Deduction for personal casualty losses (other than with respect to a federally designated disaster).

• Deduction for alimony payments (as well as inclusion in gross income by recipient) for divorces and separations executed (or modified) after December 31, 2018.

• Charitable deduction of college athletic event seating rights.

• Deduction and exclusion for moving expenses (other than for members of the armed forces).

• Exclusion for bicycle commuting reimbursements.

Business income

At present, individual rates on business income can go as high as 39.6 per cent. The Act significantly reduces the taxes owed by business owners. Individuals, estates, and trusts will be permitted to deduct an amount equal to 20 per cent of taxable domestic net profits from a partnership, ‘S’ corporation, or sole proprietorship. This provision reduces the rates on business income to a range of approximately 8 per cent to 29.6 per cent.

Employees will not benefit from the 20 per cent deduction with respect to their wages. In addition, the trade or business of performing services as an employee is not treated as trade or business that qualifies for the deduction.

Similarly, wages and guaranteed payments received by an equity-holder in a business will not be taken into account in determining the amount of the deduction.

Service income received by high-income taxpayers will not generally qualify for the 20 per cent deduction. A service trade or business will not generally be treated as a qualifying trade or business if the principal asset of the business is the reputation or skill of one or more employees or owners.

More specifically, the deduction is generally unavailable with respect to services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. (The deduction is available with respect to Engineering and architecture services.)

In addition, the deduction is generally not available with respect to a service trade or business which consists of investing and investment management, trading, or dealing in securities (and other financial assets).

Service trades or businesses described in the prior paragraph will qualify for the 20 per cent deduction if the taxpayer has taxable income of $315,000 ($157,500 for single taxpayers) or less.

The benefit of the deduction is phased out for taxpayers over the taxable income threshold. The benefit is fully phased out if the taxpayer has taxable income of $415,000 ($207,500 for single taxpayers) or more. It should be noted that taxable income, for this purpose, takes into account all of the income and deductions of the taxpayer (other than the 20 per cent deduction).

The deductible amount with respect to each trade or business is computed separately and equals 20 per cent of the net income of the trade or business. The deductible amount is reduced by 20 per cent of the net loss for each trade or business (including net losses that were carried forward from prior taxable years).

The total deduction is limited to 20 per cent of the ordinary taxable income of the taxpayer (i.e., taxable income reduced by net capital gains and dividend income that qualifies for preferred rates).

If the taxpayer has a net aggregate loss for all of the qualifying trades or businesses in a taxable year, no deduction is available in that taxable year. The net aggregate loss is than carried forward indefinitely and reduces the 20 per cent deduction in subsequent taxable years.

The deductible amount with respect to each trade or business is generally limited to 50 per cent of the W-2 wages (including elective deferrals and deferred compensation) paid during the calendar year that ends during the taxable year. Only wages that are allocable to qualifying business income are taken into account. In addition, wages that are not reported on Form W-2 on a timely basis (or within 60 days of the extended due date) will not be treated as W-2 wages for this purpose.

Capital-intensive businesses (such as real estate) can use a different formula to determine the W-2 wage limitation (if greater). In such case, the formula is 25 per cent of W-2 wages, plus 2.5 per cent of the basis of tangible depreciable property (without adjustment for depreciation, amortisation, or depletion).

The basis of tangible property will not be taken into account after the end of the depreciable useful life of the property (or ten years, if later). For example, if an individual acquires a rental property for $100 million, the limitation on the deduction would be at least $2.5 million each year (even if the business has no employees).

The W-2 wage limit will not apply to a taxpayer with taxable income of $315,000 or less ($157,500 in the case of a single individual). The limit is phased in for taxpayers over the taxable income threshold. The benefit is fully phased-in if the taxpayer has taxable income of $415,000 ($207,500 for single taxpayers) or more. It should be noted that taxable income, for this purpose, takes into account all of the income and deductions of the taxpayer (other than the 20 per cent deduction).

In determining the net income or loss of a qualified trade or business, all items of income, gain, deduction, or loss (“taxable income items”) attributable to the qualified trade or business are generally taken into account to the extent included or allowed in determining taxable income for the taxable year.

Taxable income items with respect to a qualified trade or business are only taken into account if they are effectively connected with a US trade or business. In addition, investment items (e.g., capital gain or loss, dividends, interest) and related expenses are not taken into account in determining net income or loss.

In addition to the above, certain other items are eligible for the 20 per cent deduction. These items are:

• Dividends received from a real estate investment trust (REIT) that does not qualify for the preferred tax rate for capital gains and dividends.

• Patronage dividends received from a co-operative.

• The net amount of domestic taxable income items allocable from a publicly-traded partnership that is not treated as a corporation that is attributable to a qualified trade or business (including gain from the sale of the partnership).

The 20 per cent deduction is not taken into account in determining the amount (or usage) of a net operating loss (NOL) and is treated as an itemised deduction. However, individuals that do not itemise are also entitled to the 20 per cent deduction. In addition, the 20 per cent deduction is not available for purposes of the self-employment tax or the net investment income tax.

Other provisions

The Act changes the tax treatment of certain self-created intangible assets. As a result, the creator of a patent, invention, model or design (whether or not patented), or secret formula (or process) will not be able to treat these assets as a capital asset. As a result, gain or loss from the sale or exchange of such property will be treated as ordinary income or loss. This change is effective for dispositions after December 31, 2017.

The Act will possibly be the first of several pieces of tax legislation that will be signed into law in 2018. Other significant tax Bills that are expected to receive serious consideration include:

• Repeal of Obamacare taxes that have not yet become effective (e.g., the medical device and “Cadillac” healthcare plan excise taxes).

• Technical corrections to the new partnership audit rules (and other recently-enacted tax laws), as well as the Act itself.

• Extension of tax provisions that recently expired (or are due to expire in the near future).

• Enactment of tax reform provisions that were dropped from the Act.

Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

• James Paul Sabo, CPA, is the president of ETS Ltd, PO Box 1574, Hamilton HM GX, Bermuda. Questions should be sent to jsabo@expatriatetaxservices.com