INDIVIDUAL INCOME TAX AND ESTATE TAX
TCJA makes significant revisions to the individual income tax and the estate tax. Unless otherwise noted, these provisions expire at or before the end of 2025. There are, however, several notable permanent provisions in this category, including the zeroing out of the Affordable Care Act (ACA) individual mandate penalty, the change in inflation indexing, and changes in the tax base for measuring business income (other than the pass-through deduction, see below) which apply to both corporations and pass-through entities.
Tax Rates
TCJA reduces marginal statutory tax rates at almost all levels of taxable income and shifts the thresholds for several income tax brackets (figure 1).The top marginal rate falls from 39.6 to 37 percent. The remaining rates are 10, 12, 22, 24, 32 and 35 percent.
Child Tax Credit and Who Qualifies
You can claim the Child Tax Credit for each qualifying child who has a Social Security number that is valid for employment in the United States.
To qualified for child tax credit, your dependent generally must:
- Be under age 17 at the end of the year
- Be your son, daughter, stepchild, eligible foster child, brother, sister, stepbrother, stepsister, half-brother, half-sister, or a descendant of one of these (for example, a grandchild, niece or nephew)
- Provide no more than half of their own financial support during the year
- Have lived with you for more than half the year
- Be properly claimed as your dependent on your tax return
- Not file a joint return with their spouse for the tax year or file it only to claim a refund of withheld income tax or estimated tax paid
- Have been a U.S. citizen, U.S. national or U.S. resident alien
You qualify for the full amount of the 2023 Child Tax Credit for each qualifying child if you meet all eligibility factors and your annual income is not more than $200,000 ($400,000 if filing a joint return).
Parents and guardians with higher incomes may be eligible to claim a partial credit.
TCJA expands the child credit in several ways. Under prior law, the credit was $1,000 per child under 17 years old, not indexed for inflation; an amount equal to 15 percent of earnings over $3,000 was refundable, up to the full $1,000 per child value of the credit. The child tax credit phased out starting at income of $110,000 (for married filing joint returns and $75,000 for singles).3 The credit value and the income phaseout range were not indexed for inflation. Under TCJA, the maximum credit amount doubles to $2,000 per child under 17 years old in 2018. The refundable portion was also increased to 15 percent of household earnings above $2,500, up to $1,400 per child in 2018.The credit phaseout range was increased substantially and does not begin until income reaches $400,000 for married filing jointly returns and $200,000 for singles. The $1,400 maximum refundable amount limit is indexed for inflation,but the maximum total credit amount and the income phaseout range are not. Unlike prior law, TCJA limits eligibility for the credit to children who have a Social Security number.
The TCJA creates a new nonrefundable $500 credit for any other dependents the taxpayer can claim, including children who are too old to be eligible for the child tax credit, full-time college students, or any other adult member of the household for whom the taxpayer provides significant financial support. The$500 amount
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is also not indexed for inflation. Taxpayers do not need a valid Social Security number for these dependents to be eligible for the new credit.
Standard and Itemized Deductions
The standard deduction for taxpayers who do not itemize deductions on Form 1040, Schedule A, has increased. The standard deduction amounts for 2023 are:
$27,700 – Married Filing Jointly or Qualifying Surviving Spouse (increase of $1,800)
$20,800 – Head of Household (increase of $1,400)
$13,850 – Single or Married Filing Separately (increase of $900)
Taxpayers who are 65 and Older or are Blind
For 2023, the additional standard deduction amounts for taxpayers who are 65 and older or blind are:
$1,850 for Single or Head of Household (increase of $100)
$1,500 for married taxpayers or Qualifying Surviving Spouse (increase of $100)
TCJA also changes the structure of several major itemized deductions.Under prior law, itemizers could claim deductions for all their state and local property taxes and the larger of either income or sales taxes (subject to overall limits on itemized deductions). TCJA limits the itemized deduction for all state and local taxes to $10,000 annually, for both single and joint filers, and does not index that limit for inflation.
Under prior law, taxpayers could deduct interest on mortgage payments associated with the first $1 million of principal paid on debt incurred to purchase (or substantially renovate) a primary and secondary residence plus the first $100,000 in home equity debt. For taxpayers taking new mortgages, TCJA limits the deductibility to the interest on the first $750,000 of loan principal on primary residences only for new loans after the effective date and eliminates the deductibility of interest for home equity debt.4
Previously, out-of-pocket medical expenses (including costs for health insurance) above 10 percent of adjusted gross income (AGI) were deductible. For 2017 and 2018, TCJA allows deductions for out-of-pocket medical expenses above 7.5 percent of AGI. After 2018, the prior law 10 percent threshold applies.
TCJA repeals the phase-down of the amount of allowable itemized deductions (Pease provision). This limitation took effect at incomes above$320,000 for taxpayers filing joint returns ($266,700 for single filers).
Affordable Care Act (ACA) Penalty Tax
Starting in 2019, TCJA sets the Affordable Care Act’s individual mandate penalty tax to zero.5 Previously, households without qualifying health insurance were required to pay a penalty equal to the lesser of 2.5 percent of household income or $695 per adult and $347.50 per child, up to $2,085. Under the new law, individuals who do not enroll in adequate health coverage plans will not face a penalty starting in 2019. This will reduce the federal budget deficit because fewer people will obtain free or subsidized coverage, and the reduced costs of the ACA premium tax credit and other subsidies and Medicaid benefits will far exceed the lost revenue from setting the penalty tax rate to zero. This provision does not sunset.
Capital Gains and Alternative Minimum Tax
TCJA retains the 0, 15, and 20 percent preferential tax rates on long-term capital gains and qualified dividends and the 3.8 percent net investment income tax (NIIT). The 15 percent rate now applies to those with taxable incomes between $77,200 and $479,000, and the 20 percent rate applies to those with taxable income over $479,000. Under prior law, capital gains for those in the 25 through 35 percent tax brackets were taxed at a 15 percent rate, and capital gains for those in the 39.6 percent bracket were taxed at a 20 percent rate. The TCJA separates the tax rate thresholds for capital gains and dividend income from the tax brackets for ordinary income for taxpayers with higher incomes. The NIIT applies to interest, dividends, short- and long-term capital gains, rents and royalties, and passive business income.
TCJA retains the individual alternative minimum tax (AMT) but raises the exemption levels to $109,400 for taxpayers filing joint returns ($70,300 for singles) and raises the phaseout threshold to $1,000,000 for joint filers($500,000 for singles). Under prior law, the exemption was $86,200 for taxpayers filing joint returns ($55,400 for singles), and it began to phase out at income above $164,100 for joint filers ($123,100 for singles). The exemption amounts and phaseout thresholds are indexed for inflation.
Inflation Indexing
TCJA changes the measure used for inflation indexing, from the CPI-U to the chained CPI-U. The chained CPI-U more accurately measures changes in consumer welfare resulting from price changes because it accounts for the fact that people substitute for goods whose prices increase faster than others. It thus generally increases at a slower rate than the traditional CPI-U, implying that individuals will end up in higher tax brackets and that indexed tax credits (like the EITC) will increase at slower rates than they would have under the old indexing system. The change in indexing is permanent.
Pass-Through Deduction
TCJA introduces a new complex deduction for income from pass-through business entities (sole proprietorship, partnerships, limited liability companies, and S corporations). The deductible percentages vary based on taxpayers’ income, business type, and the wages paid and property owned by the business. Joint filers with taxable income below $315,000 ($157,500 for singles) are eligible to receive a 20 percent deduction of their qualified business income (QBI), regardless of business type.
At higher income levels, business type, wages paid, and investment property affect the deductions. If taxable income is between $315,000 and$415,000 (Married Filing Jointly), the unlimited deduction for QBI phases out,with the deduction formulas depending on business type.6 If taxable income is above $415,000 (joint filers), there is no deduction for income from a “specified service trade or business.”7 For other businesses, the deduction cannot exceed the applicable share of the greater of (a) 50 percent of W-2 wages paid by the business or (b) 25 percent of wages plus 2.5 percent of qualified property for the business.
Changes in Tax Base for Pass-Through Businesses
In general, pass-through businesses, like corporate income taxpayers,will be subject to TCJA’s changes to business income and deduction items(changes in the tax base). The new law extends 100 percent bonus depreciation(more commonly known as expensing) for all business taxpayers until 2022 and then phases it out in 20 percentage-point increments through 2027. TCJA also includes simplified accounting rules for smaller
firms and increases the annual Section 179 expensing limit up to $1 million for qualified property (sometimes called “small business expensing”).But the law limits the amount of net interest (interest paid less interest received) that large pass-through businesses can deduct to 30 percent of adjusted taxable income, similar to that for corporations (firms with less than $25 million in gross receipts are exempt).8 Under prior law, interest was generally deductible without limits.
TCJA also changes the law regarding net operating losses for businesses.First, TCJA limits the size of the net operating loss deduction to 80 percent of the business’s net income in a given year. Losses can be carried forward indefinitely, but not backward (except for farm businesses, in certain cases).Under prior law, losses could be carried back for up to two years and carried forward for up to 20 years. Second, TCJA eliminates the ability for a taxpayer to use a net operating loss in one business to offset income from other sources. All pass-through investment rules (in contrast to the deduction described in the previous section) are permanent except for expensing of equipment investment.
Estate Tax
TCJA doubles the estate tax exemption to $11.2 million for single filer sand $22.4 million for couples and continues to index the exemption levels for inflation. The top estate tax rate remains at 40 percent.
Sunsets
A notable feature of the individual tax and the estate tax provisions is that all of them expire after 2025 except the reduction of the ACA penalty tax,the change in inflation indexing, and the changes in the business tax base that apply to both pass-through businesses and C corporations. Some provisions expire sooner (for example the increased deductibility of medical expenses applies only to tax years 2017 and 2018). In contrast, many of the corporate tax provisions discussed below do not sunset, although some of the rates for corporate tax components will change. These choices were made to limit the revenue cost of the TCJA to a level consistent with the overall constraint on the 10-year revenue loss in the Congressional Budget Resolution and to complywith Senate budget rules that require no increase in the federal budget deficitafter the 10th year.