Speaker at Tax Update Session Highlights Changes in New Tax Overhaul

By:
Chris Gaetano
Published Date:
Dec 20, 2017

Congress

The House of Representatives and the Senate have passed the Republicans' new tax reform bill, the largest and most dramatic shift in the country's tax system in decades. While the changes are voluminous and their implications still being analyzed, John J. Connors, president of the Tax Educators Network and a speaker at the Foundation for Accounting Education's 2017 Federal Individual Income Tax Update, highlighted some of the changes in the vote's immediate aftermath, as they apply to individuals. 

Connors said he empathized with those struggling to figure out every relevant implications of the new tax law. 

"This is crazy. This is not your mother's federal tax update you went to every fall, is it? I feel your pain, I feel my pain," he said, noting that practitioners will probably want to take a few weeks to read about the changes and think of how they might apply to their clients. 
 
While the House plan to collapse the number of tax brackets to four did not pass into the final version, the size of the brackets and who is in them did change. The final bracket structure is now 10, 12, 22, 24, 32, 35 and 37 percent. Connors noted that these rates will be tied to inflation, though he said this calculation would be based on the "chained consumer price index," which measures inflation by assuming that when the price for one item goes up, people sometimes settle for a cheaper substitute.

He also noted that both personal and dependency deductions are now gone. While some tax preparers might think this spares them from the "rigmarole" of having to determine who is and is not a qualified dependent, he said this is not the case due to other provisions of the tax code that have remained the same. 

"You still need the code section because how do you get head of household? You need a qualified child, you still need one, so even if you don't have a dependency exemption, for head of household you'll still need all the rigmarole," he said. 

He added that it's similar with the child care expense credit on Form 2441, which has been retained. For someone to qualify for the credit, they will still need someone who meets the legal definition of a child. The same goes for the child tax credit, which increased from $1,000 to $2,000 per child, refundable up to $1,400. 

He also said that what's colloquially known as the "kiddie tax" (the tax on a child's investments and other unearned income) has been simplified under the new bill. The treatment of earned income has remained the same, where it's taxed according to an unmarried taxpayers’ brackets and rates. The new bill, however, will use the trust and estate tax tables, meaning a child's tax situation is unaffected by the child's parents' tax situation. 

"It doesn't matter where their parents are. ... They'll look to the trust and estate tax rates," he said, but added that the 3.8 percent Medicare surtax will now apply at $12,500 of taxable income, whereas before the parents needed in excess of $250,000 of adjusted gross income (AGI). 

Connors also spent time talking about provisions affecting K-1 income and net profit from partnerships, such as CPA firms. The final bill allows a deduction of 20 percent against qualified business income, which he said first applied only to K-1 Box 1 trade or business income. However, he noted that a last-minute insertion allows this deduction to also apply to net rental income in Box 2 of the K-1. The deduction works differently, depending on whether or not the income came from a service-based business like an accounting firm. If it is a service-based business, then the K-1 recipient can enjoy the deduction so long as the taxable income is less than $157,000 for single taxpayers and $315,000 for married joint filers. 

He talked about an example of two partners in an accounting practice making $175,000 each, with no employees. Assuming they were both married, the two partners, he said, would get the deduction so long as their taxable income, not the K-1 income, is below the threshold. 

"Because I don't care about $175,000 from K-1 Box 1. I care about what you've got on Line 37. Will you be below $315,000? If you are, regardless of whether we get $175,000 from their accounting practice, you'd get 20 percent [deduction] of $175,000," he said. 

Companies that are not considered service-based businesses can go over this threshold, but in order to do so, the deduction amount would be calculated only after any wages are paid to an S corp owner/employee, or after any guaranteed payments are made to the taxpayer. The overall deduction is limited to 50 percent of either of these two amounts. 

What exactly is a service-based business? He said it's a very broad definition that encompasses not just CPAs but doctors, lawyers, consultants and other professionals (though he noted that the bill specifically excluded engineers and architects from this definition, with the logic being that they're part of the construction industry). In sum, it's "anything where [clients] say, 'I want you advising me' whatever my field is." 

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