Taxes

Tax Planning For Writers Under The Tax Cuts And Jobs Act Of 2017


Over Christmas, Santa gave Congress a new tax bill named The Tax Cuts And Jobs Act Of 2017 (TCJA). It passed on December 20, 2017 and the President signed into law two days later. After a tad bit of research on the tax reform and tweaks, here is my digest on how TCJA impacts authors for their 2018 earnings.

In general, business expense deductions still exist for expenses attributed to a bona fide business. For authors who were itemizing deductions before TCJA, that tax strategy will probably continue for most authors in 2018. For authors who were not itemizing deductions, the standard deduction increase and reduced tax rates in the new law may provide a tax break for some authors. But other authors who live in states with high property and income taxes may see an increase. For authors with a pass-through entity, whether a self-proprietorship, LLC, or S-Corporation, read further to understand what changes may affect these entities. The tax reform for pass-through entities are some what complex and will probably take tax experts time to unravel all the implications for authors with pass-through entities.

Corporate Tax Cuts

The largest tax reform in the new legislation goes to corporations (a tax rate reduction from 35% to 21%). Alternative Minimum Tax (AMT) was repealed and the tax brackets collapsed to a single 21% tax rate. The corporate tax cut is permanent (unlike the individual tax cuts which lapse in 2025).

Individual Tax Cuts

While the corporate tax rates were slashed, individual tax rates were only tweaked. Individuals will still have to contend with the seven tax brackets, but the rates have been reduced by a few percentage points (between 1% and 4%). Only the 10% and 35% brackets were not reduced.

Rate Income/Individuals Income/Married Filing Jointly
10% Up to $9,525 Up to $19,050
12% $9,526 to $38,700 $19,051 to $77,400
 22% 38,701 to $82,500 $77,401 to $165,000
24% $82,501 to $157,500 $165,001 to $315,000
32% $157,501 to $200,000 $315,001 to $400,000
35% $200,001 to $500,000 $400,001 to $600,000
37% over $500,000 over $600,000

These brackets are on top of the AMT, which still remains for individuals (but the exemption has widened). Most individuals will still be able to claim itemized deductions but those have been limited (see below). These limits along with the increase in the Standard Deduction (see below) may mean fewer individuals will claim itemized deductions in 2018.

Here are some of the bigger changes from the TCJA.

  1. State and Local Tax Deductions (SALT) — There is a $10,000 cap for deducting state and local income taxes, and property taxes. The cap is for the combined total of taxes paid for state, local, and property taxes, not each one. The SALT limitation is more problematic for people living in states like New York, California, New Jersey, and Maryland who pay high state income and property taxes. The $10,000 cap applies to individuals and married couples filing jointly. For married couples filing separately, the cap is reduced to $5,000 to prevent people from getting an extra bump in deductions.
  2. Mortgage Interest Deductions are limited to the interest on debt up to $750,000 for primary and one secondary home. This limit applies to loans after Dec 15, 2017. Homeowners with loans prior to that date will not be affected by the change. They still receive the benefit of the original $1,000,000 limit of debt principal.
  3. Charitable Deductions are increased from 50% to 60% of adjusted gross income. Any gifts over $250 require contemporaneous written documentation.
  4. Medical Expense Deductions were expanded but only temporarily. Previously, out-of-pocket medical expenses that exceeded 10% of adjusted gross income could be deducted. TCJA reduces that threshold to 7.5% of adjusted gross income. But don’t get comfy with the change. After 2018 the percentage reverts back to the 10% threshold. The Affordable Care Act penalty for individuals without an insurance plan has been eliminated by reducing the penalty to zero in 2019.
  5. Causality Losses are now limited to federal disasters only. Any losses that exceed 10% of a person’s adjusted gross income and were not compensated for by insurance can be deducted but only if the disaster is declared a national disaster, like the recent California wildfires or Hurricane Harvey.
  6. Miscellaneous Itemized Deductions for individuals that fell in the 2% of adjusted gross income are no longer deductible. This included things like tax preparation expense, unreimbursed employee business expenses (like the home office deduction), annuity losses, and a few other expenses for the production of income like investment advisory fees.
  7. Business Expenses on the other hand, whether for an LLC, S-Corp, or sole proprietorship entity, are still deductible, including investment advisory fees, tax preparation fees, the home office deduction, agent commissions, and other business expenses. However, if you are an author who works as an employee for a writing project and you receive a W-2 (instead of an independent contractor and a 1099), the business deductions are no longer possible.
  8. The Pease Limitation was repealed. Originally, if an individual’s adjusted gross income was more than $261,000 ($313,800 as married couples), the Pease Limitation eliminated 3% of the taxpayer’s itemized deductions. Now, with the Pease Limitation repealed, upper-income individuals effectively receive a tax rate reduction by being able to use those itemized deductions.
  9. The Marriage Penalty still exists for high-income couples. The so-called marriage penalty occurred when two high-income individuals paid more taxes filing as married than as individuals. The original Senate version of the tax changes eliminated the marriage penalty by doubling the individual tax bracket thresholds for married couples. Some of this made it into the final version to eliminate the marriage penalty in the lower tax brackets but not for high-income couples who hit the 37% tax bracket. The threshold for the 37% tax bracket is over $500,000 of income, but for married couples it is only $600,000.
  10. The Personal Exemption and Standard Deduction have merged. Or you could say the Personal Exemption has been eliminated and the Standard Deduction doubled. Either way, the new Standard Deduction is $12,000 for individuals and $24,000 for married couples (up from $6,350 and $12,700 respectively). This change is problematic for those who had multiple personal exemptions. For example, if you filed under the old law as a married couple with two children, normally the standard deduction with personal exemptions for two children would have been around $28,000. Now, under the new law without the personal exemptions allowed for two children, the new Standard Deduction of $24,000 equals a decrease.
  11. The Individual Tax Laws Lapse in 2025. This time limitation was added to comply with the Byrd Rule that allows the Senate to block legislation that might increase the federal deficit past a ten-year term. Senate legislation could be passed with a simple majority if the tax cuts did not go beyond ten years, hence the 2025 expiration date. Otherwise, the Senate would have needed 60 votes to pass the tax cuts.
  12. The Estate and Gift Tax brackets have been condensed to four brackets — 10%, 24%, 35%, and 37%. Most people will be taxed at the upper rate, because it only takes $12,500 in estate income to reach the 37% tax bracket (which was reduced from 39.6% to 37%).  But the Estate Tax Exemption has been doubled – from $5.6 million to $11.2 million for individuals ($22.4 million for couples). With such high exemptions, estate planning will be irrelevant for all but the uber-wealthy.
  13. The Child Tax Credit has been expanded from $1000 to $2000 per child under the age of 17. Parents can collect a refund of up to $1400 (up from the current $1000 refund) if the child tax credit is larger than their federal income tax liability.
  14. The Kiddie Tax rules have been revamped. What is the Kiddie Tax? It is the tax that applies to income earned by children under 19 or full-time students under age 24.  Under the new law, earned income (like wages or self-employment) for children under 19 or full-time students under age 24 will be taxed at their own individual tax bracket (see chart above). But any unearned income will not be added to a parents’ income for reporting purposes. Instead, any unearned income (i.e. portfolio income) is now subject to the estate tax rates (see number 12 above). A child would have to have a sizeable portfolio of around $400,000 (assuming an average yield of 3%), to generate enough unearned income to meet the $12,500 threshold for the 37% estate tax bracket.
  15. Long Term Capital Gains continue to use the old 0%, 15%, and 20% rates.
  16. Deduction for Pass-Through Businesses — The changes for pass-through businesses (like a partnership, LLC, S-Corp, or sole proprietorship) are some of the most complex in the new law. It will take some time for tax experts to unravel all the implications for those individuals with pass-through entities. Here are a few points to know about deductions for pass-through entities:
    1. Originally, pass-through income (income made by the business and passed through to the business owner’s individual tax return) was taxed at the same rate as any other income. Now, TCJA allows individuals to deduct 20% of their business income from a pass-through entity. In other words, pass-through businesses are taxed on 80% of the pass-through income. The 20% deduction is claimed on the individual’s personal tax return. This change allows business owners to keep more earnings tax-free. There are limitations and restrictions, like how income and wages are classified, and which service businesses are excluded from using the pass-through deduction. Consult an expert for tax planning advice if you have a pass-through business. Michael Kitces does a great job explaining the new rules for pass-through businesses in his article Individual Tax Planning Under The Tax Cuts And Jobs Act.
    2. One important limit, the 20% pass-through deduction only applies to individuals with taxable income below $157,000 ($315,000 for married couples). Income over that encounters a phase out of the pass-through deduction. The deduction is lost when individuals hit $207,500 ($415,000 for married couples).
    3. For the self-employed person working as an LLC, S-Corp, or sole-proprietorship, their tax rate could be lower than one as an employee doing the same work because of the 20% deduction. People may want to shift to freelancer/independent contractor status as an LLC, S-Corp, or sole proprietorship if the individual is under the income threshold of $157,000 in order to capitalize on the 20% deduction. Because of the $157,000 threshold, large businesses that make income over that threshold lose the 20% deduction and are taxed at the higher rate of 37%. These larger businesses may want to transfer to a C-corporation and take advantage of the reduced corporate tax rate of 21%.

 

In view of the complexity of the new tax environment, tax strategies will continue to emerge with a fuller understanding of the tax laws. Consult an expert for tax planning advice.

Need further information?  Check out these excellent articles about TCJA:

 

 


Photo Credit: Alan Cleaver | Visualhunt.com | CC BY

 

Legal Disclaimer: The information in this article is provided for educational purposes only. Consult a qualified lawyer or tax expert in your jurisdiction for all legal and tax opinions for your specific situation.

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