In Dec. 2017, Congress passed the largest piece of tax legislation in three decades. This massive overhaul is the first complete restructure of the tax code since Regan’s presidential year. The new legislation went into effect Jan. 1, 2018, but did not affect most taxpayers’ 2017 returns. A number of updates have been discussed over the past year and both taxpayers and tax-preparers have continued to educate themselves on the changes.

As we move into 2019 and begin to prepare 2018 tax returns, the common questions still remain, “What changed with the 2018 Tax Reform and what do I need to know?” In our world, these questions are commonly heard from candidates and practicing physicians alike. Teaming up with trusted partner Benjamin Yin, Owner at Generational Financial Partners, and Andres Callender, ApolloMD VP of Finance and Operational Controls,  we recapped some of the key changes you need to know from the 2018 Tax Reform.

Key Changes

The 2018 Tax Reform introduced a number of new changes. Here is a high-level overview of some of the changes:

1. Marginal Tax Rates and Income Brackets

New legislation introduced a decrease in marginal tax rates. Marginal tax rates are the percentages of income an individual pay in taxes. Depending on how much an individual makes, income is taxed at several different rates.

For example, if an individual makes $300,000 the flat tax rate is not 35%. Instead, a portion of the individual’s income is taxed at 35%, another portion at 32%, another portion at 24%, another at 22%, another at 12% and a portion at 10%.

In the previous ruling, the highest marginal tax rate was 39.6% which has now decreased to 37%.

The seven tax brackets still remain with modifications to decrease most individual income tax rates. Tax brackets are known to change from time to time but marginal tax rates only change when new tax legislation is passed. For taxpayers, the decrease in marginal tax rates is a positive change. Taxpayers pocket more of their income because of this change.

2. Alternative Minimum Tax

Alternative Minimum Tax (AMT) is confusing for most taxpayers. It was designed to keep the wealthy taxpayers from using loopholes to avoid high tax rates, however, it eventually started to impact the middle-class taxpayers because it was not updated to keep up with inflation.

What does it do?

AMT expands the amount of income taxed by adding items normally considered tax-free and not allowing deductions on the regular tax system. Most commonly, this rule affects high-income families with children in high-tax states. Households and individual taxpayers calculate the amount of taxes due under the regular income tax rules and AMT rules. These households and individuals have to pay the higher tax rate.

New tax legislation almost eliminated the AMT thresholds which resulted in a positive change for taxpayers. Previously, the exemption amount was $84,500 for married joint-filing couples, $54,300 for single filers and $42,250 for married couples filing separately. Anyone making more than $400,000 had excessive Schedule A deductions in the past.

Even though the AMT is here to stay, fewer households and individuals will be subject to its thresholds. New exemption amounts are $70,300 for single taxpayers, $109,400 for married joint-filing couples, $54,700 for married couples filing separately and $70,300 for heads of households.

3. Personal Exemption

In the past, taxpayers were able to reduce adjusted gross income by claiming personal exemptions. Personal exemptions are claimed for an individual, a spouse and any children. Now, this ruling has been completely eliminated. Some taxpayers may view this as a bad thing, however, there is a trade-off with the new standard deduction and child tax credits.

4. Standard Deduction

We mentioned a trade-off with the elimination of personal exemptions above – the increased standard deduction is this trade-off.

What is a standard deduction?

The standard deduction is a set amount of money taxpayers are allowed to deduct from overall tax bills. This is another option for those who choose not to compile all of their expenses, keep proof of those expenses and then itemize them. Those who choose to take the standard deduction get a flat amount set by the government. In the past, the hassle of itemizing deductions was worth it for taxpayers whose expenses exceeded the standard deduction amount.

The 2018 rulings nearly doubled the standard deduction for all. Previously, those who did not itemize could claim the following: $6,350 for single individuals, $6,350 for married couples filing separately, $12,700 for married couples filing jointly and $9,350 for heads of household. Now, the standard deduction is $12,000 for single individuals, $12,000 for married couples filing separately, $24,000 for married couples filing jointly and $18,000 for heads of household.

For most taxpayers there are several positive outcomes of this new change:

  • A simplified tax income preparation process – no hassle of keeping up with itemized deductions and all of the proper proof needed for each line item.
  • More money pocketed from each pay check – increased standard deduction amounts make up for the elimination of personal exemptions in most cases.

5. Child Tax Credit

Families with eligible children are benefiting from new changes to the child tax credit. In the previous ruling, a $1,000 credit was given per child for parents who made less than $75,000 individually and heads of household, $55,000 married filing separately and $110,000 jointly. This credit was reduced by $50 for every $1,000 a parent earned more than the threshold.

Now, the credit is doubled meaning a lot more parents will be able to receive tax credits for their children. Parents will receive $2,000 per qualifying child and up to $1,400 of the child tax credit can be received as a refundable credit. Also included is a $500 nonrefundable credit per dependent other than a qualifying child. Phaseout thresholds are now $200,000 for individuals and $400,000 for married couples filing jointly.

Before claiming this credit, tax payers must use these seven factors to determine if a child qualifies:

  1. Age
  2. Relationship
  3. Support
  4. Dependent
  5. Joint Return
  6. Citizenship
  7. Residence

The IRS provides a tax assistant tool to help taxpayers determine if a child or dependent qualifies for the credit.

6. Entertainment and Meals

The new tax legislation introduced significant changes to entertainment and meal deductions. Previously, 50% of meals with clients and 50% of entertainment for clients were considered a deductible expense. Now, the entertainment portion has been eliminated and is no longer deductible. Meals are still 50% deductible but if the meal is accompanied by entertainment it must be purchased separately or stated on a separate receipt. If a meal is not paid for separately from the entertainment, the meal is a nondeductible expense.

7. Qualified Business Income

One of the newest and most unfamiliar additions to the 2018 tax laws is the introduction of Qualified Business Income (QBI). Most professionals are still trying to understand the concept in its entirety. Some common questions surrounding this new ruling include:

  • What is QBI?
  • How does QBI apply?
  • How can QBI be used in my practice?

QBI is believed to be a way to structure and reduce income for some of the specialized exempt professions (i.e. independent contractor physicians, certified public accountants, financial advisors, etc.) with sole proprietorships and pass-through entities. The new deduction allows for up to 20% of QBI from partnerships, LLCs, S. Corps, trusts, estates and sole proprietorships.

According to the IRS, QBI is the amount of qualified income, gains, deductions and losses from any qualified business or trade. Only the items included in taxable income are counted.

To receive the full QBI deduction benefit, the taxpayer’s taxable income must be less than $315,000 for married couples filing jointly and less than $157,500 for all other taxpayers. If taxable income amounts are within this threshold, the deduction will be the lesser of:

  1. 20% of net business income
  2. 20% of taxable income

Married couples filing jointly with a taxable income between $315,000 and $415,000 and individuals with taxable income between $157,500 to $207,500 can still receive a limited QBI deduction.

Use the following scenario to better understand the QBI deduction benefit and how it is calculated.

A married couple makes $435,000 a year, which is more than the QBI deduction phaseout threshold. In order to receive the full QBI deduction, the couple’s taxable income must be less than $315,000.

The couple is able to subtract deductible business expenses, which in this case, is $15,000 from the business income. Now, the couple’s net business income is $420,000. Net business income is key when calculating QBI.

With a net income of $420,000 the couple can subtract 50% of Social Security and Medicare tax ($12,000), health insurance and/or health savings account (HSA) contributions ($15,000), the full collective amount of 401K or SEP IRA contributions ($56,000) and finally the standard deduction ($24,000)

This equals a taxable income of $313,000, which is below the QBI deduction threshold and qualifies the couple for the full deduction benefit. To determine the deduction, the couple must take the lesser of the following:

  1. 20% of net business income ($420,000 X 20% = $84,000)
  2. 20% of taxable income ($313,000 X 20% = $62,600)

In this case, the couple’s QBI deduction will equal $62,600, or 20% of their taxable income. The couple’s net taxable income is now $250,400 which places them in the 24% tax rate and saves approximately $15,000 utilizing the QBI deduction.

(Note: The dollar amounts used in the above example may be more or less for your personal deductions and expenses. It is not uncommon for independent contractor physicians to have more or less deductible business expenses, health insurance costs, 401k or SEP IRA contributions.)

Planning with a financial advisor and CPA is the best way to utilize the full benefit of the QBI deduction. Download the 5 Ways to Reduce Taxable Income Checklist for ideas on how to lower taxable income and meet these thresholds.

The 2018 tax reform brought many new changes and additions to the previous tax legislation. Many of these additions and changes resulted in positive consequences for tax payers. Mentioned in this article are only some of the key changes to the legislation. We highly recommend completing your own research and speaking with both a CPA and financial advisor to determine how the new tax laws impact your personal returns.

[Disclaimer] Described in this article is a brief overview of a few changes and additions to the 2018 new tax laws. This article does not serve as a complete overview of the new legislation. The scenarios provided in this article regarding tax savings strategies are neither recommendations nor suggestions, but are merely examples. We recommend before employing any of the tax savings discussed that each provider obtains the guidance and advice of an experienced financial planner and a knowledgeable accountant to make sure each specific strategy most effectively meets the provider’s individual needs.

Andres Callender joined ApolloMD in August 2017 as Director of Operations Finance and has been an invaluable member of the team. In March 2018, Mr. Callender was promoted to Vice President of Finance and Operational Controls. In this role, he oversees the organization’s payroll, taxes, 401(k), Paycom, operational controls and other corporate finance functions. Mr. Callender brings more than 13 years of experience in Healthcare Administration and more than 10 years of corporate finance experience to our team.

Prior to joining ApolloMD, Mr. Callender’s background was in big four consulting where he led various teams and successful engagements with clients ranging from Fortune 100 to Fortune 500. In his consulting role he also significantly enhanced controllable margins and focused heavily on strategy and value for finance functions within the financial service industry. Andres received his undergraduate degree in Economics and Biology and his graduate degree in Global Economics and Management and Finance, both from The University of Memphis. He has also completed multiple technical and professional certifications in corporate finance.