Tax Reform: 10 Crucial Things to Know for New Yorkers

Taxation

Late last year, I published a client newsletter speculating about how final tax reform legislation would look and some of the steps you should take in anticipation of the President signing a bill into law.  Now that the Tax Cuts and Jobs Act of 2017 has officially passed, the time has come to break down what the new laws actually say and how they might affect you as a New York taxpayer.  While we’re still waiting on the IRS to write regulations and issue other necessary guidance to tell us how the agency will interpret the new laws, those developments won’t change how the law works at a fundamental level.  In our estimation, here are the ten aspects of the new tax law you most need to know:

  1. Everybody’s Rate Has Been Cut. Marginal income tax rates for individuals went down across the board.  While most brackets saw a 2-4% rate cut, a married couple filing jointly will see a whopping 9% cut for all income between $237,950 and $315,000 – a nearly $7,000 windfall.
  2. Changes to Deductions. The federal government doubled the standard deduction from about $6,000 per person to $12,000 per person ($18,000 head of household).  With a $24,000 standard deduction for a married couple, most taxpayers will not itemize anymore, moving America closer to the GOP’s stated goal of “filing on a form the size of a postcard.”  Those taxpayers itemizing will see the loss of almost every traditional deduction except medical expenses, and student loan interest up to $2,500.  This includes the repeal of the deduction for union dues and tax preparation fees.
  3. SALT in the Wound. The major drawback for New York taxpayers is the limitation on the deduction for state and local income, property, and sales taxes to $10,000 per filer.  This means both a married couple and a single filer may only deduct up to $10,000 annually for those expenses.  For most affected taxpayers, the limitation on this deduction will eat into most or all of the benefit from reduced marginal rates.  Without question, it’s a tough pill to swallow for New Yorkers and their brethren in high-tax jurisdictions.
    Governor Cuomo signed two potential workarounds into law.  First, New York will allow individuals to make a “charitable” contribution to a state fund in lieu of paying taxes.  The problem with this idea is its dependence on IRS guidance that can (and likely will) be easily reversed.  Second, employers may increase payroll taxes (deductible to the employer) to decrease individuals’ state-level income taxes (not deductible to the individual).  This approach may be sound depending on employers’ willingness to go through the trouble of adopting it, but it’s no help for business owners or others who do not receive W-2 wages.
  4. Real Estate Changes Hurt, Too. The mortgage interest deduction is now limited to the first $750,000 of principal, reduced from $1,000,000 previously.  Whereas interest on a home equity loan was deductible up to the first $100,000 of principal, home equity loan interest is not deductible at all under the new law.  The IRS has stated they will take the position any loan taken out to repair, improve, or expand an existing home will still get an interest deduction – but the $750,000 total principal limit will still apply.  So if you borrowed $800,000 to buy your home and borrowed another $250,000 to improve the home, only the interest on the first $750,000 of principal will be deductible.
    For New York homeowners, this outcome is awful.  Anyone trying to sell a home with a purchase price of about $1 million or more will see a decrease in the number of buyers willing to shoulder a mortgage in excess of $750,000.  For homeowners with existing mortgage balances of $750,000 or higher, any further loans to improve the home will not have deductible interest.  In a place like Long Island, owning a home may actually be less financially fruitful than renting – a real shocker when you consider the region’s history.
  5. Businesses Get a Big Tax Cut. Big business won out most on this one; C-Corps now pay a 21% flat rate, down from a 35% top rate under the old regime.  For all sole proprietorships and pass-through entities (i.e., all business that are not C-Corps), a 20% deduction applies for all income derived from business activities, but complicated rules apply.  The most impactful rule: “service businesses,” defined rather vaguely in the statute, are not eligible when taxpayers breach a certain income tax bracket.  Watch out for regulations and other IRS guidance to clarify this in the coming months.
  6. But Businesses Lose a Treasured Deduction. Congress repealed the 50% deduction for entertainment, long used to pay for golf outings, tickets to the ballgame, and a host of other activities.  A debate among practitioners rages on about how this change impacts business meals, but by our reading, business meals appear to remain deductible.
  7. Bonus Depreciation Gets a Big Boost. The new law provides that certain business property will be eligible for 100% bonus depreciation (i.e., an immediate write-off) until 2023.  This property includes most business equipment, computers and other IT hardware and software, furniture, certain vehicles, and real estate fixtures.  Consult your accountant to figure out how you might take the most advantage of this change.
  8. 1031 Exchanges Survive. Though Congress narrowed Section 1031 to apply only to real estate, that was by far the most popular use anyhow.  Section 1031 exchanges for vehicles, intellectual property, artwork, and other non-real estate property no longer exist.
  9. The Estate, Gift, and GST Exemptions Have Doubled. Whereas the exemptions were previously about $5.5 million per person, they’ve now doubled to about $11 million per person.  However, keep in mind New York State assesses its own estate tax, and the exemptions remain $5.5 million per person.  Note as well that New York’s exemption is not “portable” between spouses, so planning will be necessary if your net worth exceeds about $5 million.
  10. It’s the “Fiscal Cliff” All Over Again. To meet the requirements of the so-called “Byrd Rule,” Congress stipulated that all individual tax changes (basically, everything except the C-Corp rate cut) will “sunset” on December 31, 2025 and revert back to the old law.  Congress’s decision to extend these changes will probably wait until the last minute again.  But you didn’t think this version of the tax law would be “permanent,” did you?

The foregoing is not meant as tax or legal advice.  Kindly consult us and/or your accountant for individualized advice.  Subsequent actions by Congress and/or the IRS may change the nature or accuracy of this information.  Contact us at any time if you have any questions or you’d like to discuss any of this material further.

Posted by Matthew Rappaport