On December 20, 2017, Congress passed the “Tax Cut and Jobs Act,” which was signed into law by President Trump on December 22, 2017. With some exceptions, the law’s provisions generally are effective for tax years beginning on or after January 1, 2018, and most of the provisions directly affecting non-corporate taxpayers will expire on December 31, 2025. The Tax Cuts and Jobs Act contains several provisions that may have a significant impact on the operations of family offices, including their investment vehicles.
Many family offices, including their investment vehicles, consist of entities that are classified as partnerships for U.S. federal income tax purposes. Partnerships are not subject to entity-level U.S. federal income taxes and, instead, income and gain and other items flow through to family members, trusts or other vehicles that own interests in the family office.
The following provisions of the Tax Cuts and Jobs Act may be relevant to your family office:
The new law reduces the maximum U.S. federal income tax rates for non-corporate taxpayers from 39.6 percent to 37 percent. Long-term capital gains and qualified dividends remain eligible for the maximum 20 percent rate. In addition, the Medicare tax on net investment income (3.8 percent rate) remains unchanged.
The individual AMT is retained but with several adjustments. The AMT exemption amount is increased to $109,400 for married taxpayers filing jointly ($73,000 for unmarried taxpayers) and the phase-out thresholds are increased to $1 million for married taxpayers filing jointly ($500,000 for other taxpayers).
The new law provides for reduced taxation on qualified business income (QBI) derived from certain businesses not held through a taxable corporation such as businesses held through partnerships and S corporations. Subject to certain limitations, a deduction equal to 20 percent is available with respect to any QBI reported by an individual, trust or estate, which results in a maximum effective U.S. federal income tax rate of 29.6 percent for such QBI (based on the new maximum non-corporate U.S. federal income tax rate of 37%). Except in the case of individuals that have total taxable income below certain thresholds, income from “specified service businesses” (which include skilled professions and any business that involves investing and investment management, trading, or dealing in securities, partnership interests, or commodities) is not considered QBI and thus is ineligible for the deduction. The deduction for each qualified business is limited to the owner’s allocable share of the greater of (i) 50 percent of the “W-2 wages” paid with respect to the qualified business, or (ii) the sum of 25 percent of the W-2 wages plus 2.5 percent of the unadjusted basis of all qualified property (tangible depreciable property) used in the qualified business determined immediately after its acquisition. REIT ordinary dividends and qualified publicly traded partnership income (e.g., oil and gas master limited partnerships) are also eligible for the 20 percent deduction, and such deduction is not subject to the wage limitation described above. QBI, however, does not include certain investment-related income, gains, loss and deductions.
The new law contains a new limitation on the deductibility of losses from trades and businesses for taxpayers other than corporations. Under the new law, “excess business losses” of an individual, estate, or trust are not currently deductible. Excess business losses for a taxable year are defined as the excess of (1) all of the taxpayer’s deductions attributable to trades or businesses of the taxpayer, over (2) the sum of (A) the total gross income or gain of the taxpayer attributable to trades or businesses and (B) a threshold amount ($500,000 for married individuals filing jointly and $250,000 for other individuals). In the case of a partnership or S corporation, the excess business loss rules apply at the partner or shareholder level. Excess business losses are carried forward as part of the taxpayer’s net operating loss carryforward. Thus, business losses of a non-corporate taxpayer for a taxable year can offset no more than $500,000 (for married individuals filing jointly), or $250,000 (for other individuals), of non-business income of the taxpayer for that year. Excess business losses include losses that are not from passive business activities under the passive activity rules of section 469.
Deductions for state and local taxes are significantly curtailed by the new law. Individuals may continue to deduct without limitation state and local sales and property taxes that are paid or accrued in a trade or business. For state and local income taxes (regardless of whether business-related) and other sales and property taxes, individuals may only deduct up to $10,000 per year of a combination of (i) either income or sales taxes and (ii) property taxes.
Through the end of 2025, all miscellaneous itemized deductions, which were deductible under prior law to the extent they exceeded 2% of adjusted gross income, are no longer deductible by non-corporate taxpayers.
Through December 31, 2025, the basic exclusion amount for estate, gift and generation-skipping transfer taxes has been doubled to $10 million, indexed for inflation (in 2018, this translates to a basic exclusion amount of $11.2 million for an individual and $22.4 million for a married couple). Beginning on January 1, 2026, the basic exclusion amount for estate, gift and generation-skipping transfer taxes will revert to the current amount (i.e., $5,000,000, indexed for inflation). The maximum estate and gift tax rate remains 40 percent. If an individual dies after 2025, the estate may owe additional estate tax on gifts that the individual made tax-free during the period when the basic exclusion amount was higher than on the date of the individual’s death. The annual exclusion for gifts in 2018 will be $15,000, and will be indexed for inflation in future years. The estates of nonresident noncitizen decedents will continue to be limited to the much lower $60,000 exemption on U.S. situs assets. Nonresident noncitizens also continue to be subject to gift tax on lifetime transfers of U.S. situs real and tangible personal property.
Rules regarding so-called “carried interest” allocations of capital gain by partnerships have been adjusted. Under the new law, gains taken into account by an individual that arose from the disposition of (i) an asset held by an investment partnership, or (ii) an interest in an investment partnership, are short-term capital gains if the individual acquired or holds his or her partnership interest in connection with specified personal services provided to the partnership, unless the holding period for the asset or interest that was disposed of is more than three years (as opposed to the normal one-year rule).
The limits on deductions for home mortgage interest have been tightened. Although qualified residence indebtedness incurred on or before December 15, 2017 is grandfathered (including certain subsequent refinancings), for new mortgages interest is deductible on no more than $750,000 of indebtedness. The $750,000 cap also applies to mortgages on second homes. Additionally, under the new law taxpayers cannot deduct interest on home equity indebtedness (and there is no grandfathering for existing home equity indebtedness).
For additional information relating to the impact of the new law in your particular circumstances or any other tax or estate planning question or concern, please contact any of us mentioned below.