On December 20, 2017 one of the most overhauling tax reforms passed. The Tax Cut and Jobs Act impacts investors in many ways.
Let’s explore some of the tax reform changes that will affect investors the most.
Investment Expenses repealed
Individual investors will be losing the investment expenses they used to claim on their schedule A itemized deduction as the act suspends “all miscellaneous itemized deductions that are subject to the two-percent floor under present law.” Investment expenses include items such as investment advisory fees (your brokerage firm), newsletter fees, subscriptions, accounting and legal fees and even data fees.
The repeal of this section could mean the loss of thousands of dollars in tax savings that investors were accustomed to getting on a yearly basis.
Investment Interest Expense retained
The present law remains in effect for itemizing investment interest expense. Investment interest expense is deductible up to the extent of investment income. The excess is carried over to the subsequent tax year.
Short Sellers Deduction repealed
Brokerage firms charge short sellers what’s known as stock borrow fees. Many brokers list this expense as interest charges, but it does not change the fact that these costs should be categorized as investment expenses. To support any interest deduction, there must be a valid interest-bearing obligation under state or federal law. The IRS has ruled that short sales do not give rise to an interest-bearing indebtedness (Revenue Ruling 95-8, 1995-1 CB 107). The bottom line is, under the new tax act, short sellers that are considered traders in securities will not be able to deduct this cost.
Long Term Capital Gains (LTCG) retained
Investors holding positions more than a year will still be able to benefit from prior LTCG at 0%, 15% and 20% based on their Annual Gross Income (AGI). The Act did not change the small $3,000 capital loss limitation against other income, or capital loss carryovers to subsequent tax years. The Act also retains LTCG rates on qualified dividends.
Section 1256 Contracts retained
The 60/40 capital gain rates on 1256 contracts remain in place. Also, no changes were mentioned in relation to the section 1256 loss carryback election, which allows investors to carry back losses up to 3 years and offset any Section 1256 gains they may have had in those years.
Obamacare Net Investment Tax retained
The Act retained the Obamacare net investment tax (NIIT) of 3.8% on net investment income (NII) over the modified AGI of $200,000 single and $250,000 married. Investment expenses may still be deductible from NII.
Ordinary Tax Rates reduced
The Act lowered tax rates on ordinary income for individuals for almost all tax brackets and filing status. It decreased the top rate to 37% in 2018, from 39.6% in 2017. Short-term capital gains are taxed at ordinary rates, so investors receive this benefit. This clearly will save more money for those who are at the higher tax bracket, but at the same time they lost many other deductions they were entitled to in past years.
Corporate Tax Rate and Pass-through Tax Rate adjusted
Corporate tax rates will be cut to 21% beginning in 2018. That tax cut is not scheduled to expire.
Pass-through businesses, businesses structured as sole proprietorships, partnerships and S-corporations, will be taxed at individual tax rates, but will be able to deduct 20% of income. To prevent high-income individuals from taking advantage of this deduction, it would only be available to couples filing jointly with incomes below $315,000. For income above that level, the deduction would be limited to half of the W-2 wages or the individual’s portion of the pass-through entity’s income.
This may be good news for those who qualify as traders in securities. They may strongly consider forming a business for their trading activity. We recommend consulting with a tax professional. We’d be happy to assist.