The Impact of the Tax Cuts & Jobs Act on High Tax Bracket Individuals - Show Me the Numbers!
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Objective: To quantify the effects of the Tax Cuts & Jobs Act for taxpayers in the highest individual tax bracket; to quantify the effects of the increase in the lifetime estate and gift tax exemption for taxpayers at all levels of wealth; and to identify the challenges and opportunities available for taxpayers as a result of these changes.
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The Impact of the Tax Cuts & Jobs Act on High Tax Bracket Individuals - Show Me the Numbers!
- 1. The Impact of the Tax Cuts & Jobs Act on High Tax Bracket Individuals Show Me The Numbers! Wednesday, May 30, 2018 Michelle Johnson, CPA Amber Gutschlag, CPA
- 2. Objectives • To quantify the effects of the Tax Cuts & Jobs Act for taxpayers in the highest individual tax bracket • To review the effects of tax reform on trusts and the estate and gift tax exemption • To identify some of the challenges and opportunities available for taxpayers as a result of these changes
- 3. Bracket Math • Old law – top rate 39.6%; starts at $470,700 of taxable income • New law – top rate 37%; starts at $600,000 of taxable income Old Law New Law AGI $1,000,000 $1,000,000 Standard Deduction $12,700 $24,000 Taxable Income $987,300 $976,000 Tax $342,952 $307,249
- 4. Itemized Deductions • State/local taxes limited to $10,000 • Home equity loan interest nondeductible • Mortgage interest deduction limited to $750,000 debt • No miscellaneous 2% itemized deductions – Investment Advisory Fees – Unreimbursed Employee Business Expenses – Tax Prep Fees
- 5. Pease Limitation • Old law - reduced itemized deductions for high income taxpayers. AGI threshold was $313,800 MFJ • New law – repeals Pease limitation
- 6. Itemized Deduction Illustration A • Example: – MFJ, $1,000,000 wages – $30,000 real estate taxes, $50,000 charitable, $50,000 investment advisory fees Old Law New Law State/Local/Property Tax $30,000 $10,000 Charitable Contribution $50,000 $50,000 Investment Advisory Fees $50,000 - Miscellaneous 2% Limitation ($20,000) - Pease Limitation ($20,586) - Net Itemized Deductions $89,414 $60,000
- 7. Itemized Deduction Illustration A - Continued Old Law New Law AGI $1,000,000 $1,000,000 Itemized Deductions $89,414 $60,000 Taxable Income $910,586 $940,000 Tax $312,573 $293,929
- 8. Itemized Deduction Illustration B • Example - at what point would this taxpayer not save under the new law? – Approximately $47,000 more misc 2% deductions Old Law New Law AGI $1,000,000 $1,000,000 Itemized Deductions $136,414 $60,000 Taxable Income $863,586 $940,000 Tax $293,961 $293,929
- 9. Charitable Deduction Strategies • Old law – standard deduction was $12,700 for MFJ; strategy was to double up on real estate taxes every other year • New law – standard deduction is $24,000 for MFJ; with taxes limited to $10,000/year, should we consider bundling charitable?
- 10. Bundling Charity Illustration A 2018 Unbundled 2019 Unbundled 2018 Bundled 2019 Bundled AGI $1,000,000 $1,000,000 $1,000,000 $1,000,000 Standard/ Itemized Deduction $30,000 $30,000 $24,000 $50,000 Taxable Income $970,000 $970,000 $976,000 $950,000 Tax $305,029 $303,213 $307,249 $295,813 Total Tax 2018/2019 Unbundled: $608,242 Total Tax 2018/2019 Bundled: $603,062
- 11. Bundling Charity IllustrationB $20,000/Yr for 5 Years $100,000 in Yr 1 Tax Year 1 $305,029 $275,429 Tax Year 2 $303,213 $305,174 Tax Year 3 $301,344 $303,046 Tax Year 4 $299,409 $300,815 Tax Year 5 $297,425 $298,535 Total $1,506,420 $1,482,999
- 12. Education Savings • Old law – distributions for qualified higher education expenses were tax-free • New law – allows distribution of $10,000/year per student for elementary & secondary school
- 13. Education Savings Illustration Child 1 Child 2 Initial Contribution $50,000 $50,000 Plan Earnings $25,000 $25,000 Plan Balance $75,000 $75,000 Transfer ($75,000) $75,000 New Balance $0 $150,000 Private School Tuition 4 Yrs - ($40,000) Remaining Balance - $110,000
- 14. Kiddie Tax • Old law – over $2,100 unearned income was taxed at parent’s top rate • New law – over $2,100 unearned income is taxed based on trust brackets/rates Income Child High Child Low Parent High Win Win Parent Low Lose Win
- 15. Kiddie Tax Illustrations Old Law New Law Child’s Portfolio Income (AGI) $15,000 $15,000 Standard/Itemized Deduction $1,050 $1,050 Taxable Income $13,950 $13,950 Tax $5,214 $3,266 Old Law New Law Child’s Portfolio Income (AGI) $25,000 $25,000 Standard/Itemized Deduction $1,050 $1,050 Taxable Income $23,950 $23,950 Tax $6,425 $6,966
- 16. Alternative Minimum Tax • Old law – In 2017 the AMT exemption was $84,500 and the exemption began to phaseout at $160,900 for MFJ taxpayers. • New law – Individual AMT is retained, but the AMT exemption amount is increased to $109,400 and the exemption phaseout is increased to $1,000,000 for MFJ taxpayers. • Many deductions that were previously preference items have been repealed.
- 17. Child Tax Credits • Old law – phased out if MFJ MAGI was over $110,000 • New law – phased out if MFJ MAGI is over $400,000 • Credit increased from $1,000 to $2,000 • New $500 credit for other dependents
- 18. The Happy Family Total Tax 2017 Wages $400,000 Taxes ($30,000) Mortgage Interest ($15,000) Misc Itemized Ded ($50,000) 2% of AGI $8,000 Phaseout $2,586 Exemptions $7,290 Taxable Income $308,296 Tax (Regular) $76,955 Tax (AMT) $19,116 Total Tax $96,071 AMT Calculation 2017 AGI less itemized deductions $315,586 Taxes $30,000 Misc Itemized Ded $42,000 Phaseout ($2,586) AMTI $385,000 Exemption ($28,475) Tentative Min Tax $96,071 Regular Tax $76,955 AMT $19,116
- 19. The Happy Family - Continued Old Law New Law AGI $400,000 $400,000 Itemized Deductions $84,414 $25,000 Taxable Income $308,296 $375,000 Regular Tax $76,955 $83,379 AMT $19,116 - Total Tax $96,071 $83,379 Child Tax Credits - ($8,000) Net Tax Liability $96,071 $75,379
- 20. Net Investment Income Tax (NIIT) • Old law - investment fees and the amount of state income tax attributable to investment income reduced investment income subject to NIIT • New law - no change to NIIT itself, but some deductions are no longer allowed • Taxpayers should be aware that if they are subject to this tax, the amount will likely increase
- 21. NIIT Illustration • Taxpayer had $100,000 of investment expenses, reduced to $81,500 of deductible expenses after 2% AGI limitation • The loss of that deduction under the new law will increase the taxpayer’s NIIT by $3,097 ($81,500 x .038 = $3,097)
- 22. What’s New for Trusts? • Rates changed, but brackets remain the same (except the 28% bracket eliminated) 2017 Bracket 2017 Rate 2018 Bracket 2018 Rate $0 - $2,550 15% $0 - $2,550 10% $2,551 - $5,950 25% $2,551 - $9,050 24% $5,951 - $9,050 28% $9,051 - $12,400 33% $9,051 - $12,400 35% $12,401+ 39.6% $12,401+ 37%
- 23. What’s New for Trusts? • No miscellaneous itemized deductions (investment advisory and tax preparation fees among others) • $10,000 cap on all state and local income and property taxes (unless trade/business activity) • Business losses limited to $250,000 to offset portfolio income • 20% deduction for business income of certain pass-through entities
- 24. What Did Not Change for Trusts? • Law retains the preferential rates for qualified dividends and long-term capital gain income, but adjusts the thresholds. • The law does not appear to change the deductibility of trustee fees, but clarification is needed. • Trust and estate personal exemptions are unchanged. • The law did not amend the AMT for trusts and estates.
- 25. Trust Illustration A Will trusts pay more tax? Income/Expense 2017 2018 Interest Income $50,000 $50,000 Tax Prep Fees ($2,500) - Investment Advisory Fees ($28,000) - 2% Limitation $948 - Exemption ($100) ($100) Taxable Income $20,348 $49,900 Income Tax * $6,340 $16,862 • Note – This trust is also subject to net investment income tax (NIIT) but NIIT was not calculated for this example. NIIT will also increase due to the loss of deductions for expenses.
- 26. Trust Illustration B (Trapped Income) Income/Expense 2017 2018 Accounting Income Interest $70,000 $70,000 $70,000 Tax Prep Fees ($2,500) - ($1,250) Investment Advisory Fees ($28,000) - ($14,000) 2% Limitation $543 - n/a Adjusted Total Income $40,043 $70,000 $54,750 Income Distribution Deduction ($40,043) ($54,750) Taxable Income $0 $15,250 In 2017, AI > DNI, so IDD = DNI In 2018, AI < DNI, so IDD = AI
- 27. Estate & Gift Tax Reform • Old law – lifetime exemption was $5,000,000 indexed for inflation ($5.49MM in 2017) • New law – lifetime exemption is $10,000,000 indexed for inflation ($11.18MM in 2018) • Portability is still available – GST exemption does not port to surviving spouse
- 28. Estate & Gift Tax Reform • Why worry about this anymore? – What will happen to your assets? – Privacy – Probate – State estate taxes – Top rate is still 40% – Law reverts to $5MM after 2025
- 29. Estate & Gift Tax Reform • Basis is the name of the game Estate Assets Basis FMV Cash $500,000 $500,000 Brokerage Accounts $1,000,000 $2,500,000 House $2,000,000 $7,000,000 Total $3,500,000 $10,000,000 Beneficiary’s Tax Scenario Calculation Proceeds (FMV) $10,000,000 Basis ($10,000,000) Net Capital Gain $0 Capital Gains Tax $0
- 30. Estate/Gifting Illustration Estate Assets Basis FMV Cash $500,000 $500,000 Brokerage Accounts $1,000,000 $2,500,000 House (previously gifted) n/a n/a Total $1,500,000 $3,000,000 Beneficiary’s Tax Scenario Calculation Proceeds (FMV) $10,000,000 Basis (Inherited Assets) ($3,000,000) Basis (Gifted Asset) ($2,000,000) Net Capital Gain $5,000,000 Capital Gains Tax $1,190,000
- 31. Other Reform Topics • Alimony • Moving Expenses • Medical Deduction Floor • Personal Exemptions • Capital Gains Rates
- 33. CONTACT INFORMATION Michelle Johnson mjohnson@gppcpa.com (214) 635-2601 Amber Gutschlag agutschlag@gppcpa.com (214) 635-2603
- 34. Appendix - Net Operating Losses • Old law –NOL could be carried back 2 years or carried forward 20 yrs and offset 100% of income in the taxable year. • New law - in general, no carrybacks, but may carry forward an NOL indefinitely. – NOLs created in 2018 and future years may only offset 80% of taxable income in the year carried forward. – NOLs generated before 2018 can offset 100% of taxable income in the year carried forward.
- 35. Appendix - Excess Business Losses • Old law – excess business losses could offset an unlimited amount of ordinary and portfolio income • New law – excess business losses can only offset $250,000 ($500,000 MFJ) of ordinary and portfolio income
- 36. Appendix - 20% Pass-through Deduction • Below the line deduction for 20% of qualified business income – Qualified trade/business income – Not a specified service trade/business – Does not include investment income – Limited to greater of 50% of W-2 wages or sum of 25% of wages plus 2.5% of unadjusted basis of qualified property
Notas do Editor
- Tax brackets: The number of tax brackets did not change. For all income ranges (except noted) the new tax rate is the same or lower with the new law. Note that for MFJ, taxable income between $400k and $424,950, the old rate was 33% and the new rate is 35%. Assumptions: Taxpayer is married, with no dependents Savings in above example: $35,703
- State and local tax (including income tax or sales tax, real estate tax, and property tax) is now limited to $10k (5k if MFS). Home equity debt is not grandfathered, and the interest is no longer deductible. The home mortgage interest deduction was modified to reduce the limit on acquisition indebtedness to $750k (from the prior $1M limit). A taxpayer who entered into a binding contract before 12/15/17 and closes on the property before 4/1/18 is considered to have incurred the debt prior to 12/15 and is therefore subject to the $1M limit. Also note that for refinancing, if amount is equal or less than grandfathered debt, the $1M limit is still in place. There was no change to investment interest expense.
- The Pease limitation (reducing most itemized deductions by 3% of the amount by which AGI exceeds a threshold amount [$313,800 in 2017 for married couples] but with a maximum reduction of 80%) is eliminated for 2018-2025.
- Assumptions: Married filing joint taxpayers, no dependents, $1,000,000 wages $30,000 tax deduction, $50,000 charitable deductions and $50,000 advisory fees
- Assumptions: Married filing joint taxpayers, no dependents, $1,000,000 wages $30,000 tax deduction, $50,000 charitable deductions and $50,000 advisory fees For both scenarios, additional Medicare tax equals $6,750 = .9% x (1,000,000-250,000) Savings in above example: $18,644
- Assumptions: All same as prior slide, with an additional $47,000 miscellaneous itemized deductions (could be investment expenses, unreimbursed business expenses, passthrough expenses, etc.)
- Law change allows charitable deductions to offset up to 60% of a taxpayer’s AGI, versus 50% in prior law. Provision expires after 2025. No charitable deduction is allowed for a payment to a higher education institution in exchange for which the payor receives the right to purchase tickets or seating at an athletic event. This provision is permanent. Another change is that the exception to contemporaneous written acknowledgement requirement was repealed, meaning that the written acknowledgement must be obtained now for any contribution of $250 or more). This is effective for 2017.
- Assumptions: Married filing joint taxpayers, no dependents, $1,000,000 wages Unbundled scenarios - $10,000 tax deduction, $20,000 charitable deductions made annually Bundled scenarios - $10,000 tax deduction each year, no charitable in the first year, $40,000 charitable in second year For both scenarios, additional Medicare tax equals $6,750 = .9% x (1,000,000-250,000) Tax liabilities assume an increase in brackets and standard deductions due to inflation adjustments Total tax for two year period unbundled = $608,242 Total tax for two year period bundled = $603,062 Savings in above example = $5,180
- Assumptions: Married filing joint taxpayers, no dependents, $1,000,000 wages Unbundled scenarios - $10,000 tax deduction, $20,000 charitable deductions made annually Bundled scenarios - $10,000 tax deduction each year, $100,000 charitable in the first year, no charitable in years 2-5 (taking standard deduction) For both scenarios, additional Medicare tax equals $6,750 = .9% x (1,000,000-250,000) Tax liabilities assume an increase in brackets and standard deductions due to inflation adjustments Savings in above example = $23,421 Savings are nearly the 2 year bundled savings x4 years Illustration does not consider time value of money or the discipline of the taxpayer Other strategies: Make a qualified charitable distribution (QCD) from an IRA directly to charity. Satisfies required minimum distribution, which will reduce adjusted gross income. Available to taxpayers 70 ½ or older. Transfers from IRAs only – not available from 401(k) plans. Gifting of appreciated stock to a public charity. Avoids long term capital gain tax and NIIT.
- Distributions from qualified tuition programs are excluded from gross income of the donor or beneficiary if used for qualified higher education expenses (QHEEs). QHEEs include tuition, fees, books, supplies and equipment required for enrollment. Room and board are included if the beneficiary is enrolled at least half time in a degree or certificate seeking program. Under the new law, the $10,000 distributions allowed for elementary or secondary school tuition expenses. Schools may be public, private or religious. Only the earnings have potential taxable consequences, and are calculated based on a ratio of qualified expenses to distributions. A 10% tax applies if distributions are not used for QHEEs and a limited exclusion does not apply. 35 states offer a deduction or credit for education plan contributions. There may be an opportunity to fund a plan, let it sit for a while, and then make a withdrawal for private school tuition to take advantage of the state tax deduction. Wisconsin and Montana are two states that assess penalties for this strategy, and we’ll have to watch how the state laws may change as a result of the federal law change. Plans can be rolled over tax-free to another tuition plan or ABLE account of a family member which include: a child, including foster and adopted children, or descendent of; brother, sister, stepbrother, or stepsister; father or mother or ancestor of either; stepfather or stepmother; niece or nephew of the beneficiary; aunt or uncle of the beneficiary; and son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. In order for a rollover or a change in the beneficiary of a QTP to escape gift and generation-skipping transfer (GST) taxes—the new beneficiary must be of the same or higher generation as the old beneficiary, and a member of the same family (IRC § 529(c)(5)(B) ). Student loan forgiveness will not be taxable income to student upon death/total disability.
- Assumptions: Parents funded a 529 plan for each of their two children Child 1 received a full scholarship to college and will not pursue graduate school Child 2 is a freshman at a private high school Alternatives: Parents could roll Child 1’s plan balance to another family member Parents could have to distribute the plan balance to themselves (the $25,000 would be subject to their tax rate plus 10% penalty). Assuming they are in the top tax bracket, that would be $11,750 of tax on $25,000 (37% top tax rate, plus 10% penalty). Grandparents or others can make gifts to educational institutions directly without impacting their annual gift exclusion ($15,000 for 2018).
- Kiddie tax rules first went into effect as part of the Tax Reform Act of 1986, and generally apply to the following children: Under the age of 19, or 24 if the child is a full-time student and either of the child’s parents are alive; And the child’s unearned income exceeds $2,100; And the child does not file a joint return Children’s tax returns can be prepared without waiting or coordinating with the parent’s return. Provisions under the new law expire after 2025.
- Assumptions: Dependent child has $15,000 of portfolio income, no earned income Bracket rate is 39.6% for the top example ($1,500,000 taxable income of parents, plus $15,000 for child); savings $1,948 Bracket rate is 28% for the bottom example ($150,000 taxable income of parents, plus $25,000 for child); loss $541 Why less tax at even the highest level? Even though compressed trust brackets are used, we are getting the benefit of brackets. Old law used top rate on all income over $2,100.
- The AMT exemption amounts are temporarily increased for individuals after 2017 and before 2026. The temporary dollar amounts are indexed for inflation after 2018. Many deductions that were previously preference items for alternative minimum tax, are either greatly limited or no longer deductible. The effect of that, along with the increase in the exemption amount and phaseout threshold, should result in significantly less taxpayers being subject to AMT.
- The child tax credit was increased to $2,000 (refundable up to $1,400) and there is also a new $500 credit for dependents that do not meet the child credit requirements, but are able to meet the dependency requirements. The credit is phased out when modified AGI exceeds $400k (MJF) or $200k (all others). The portion of the child tax credit that exceeds regular tax liability may be refundable (same calculation as prior law, except that the refundable portion cannot exceed $1,400 per qualifying child). The $500 credit is nonrefundable.
- Assumptions: Married filing jointly taxpayer with 4 dependent children Wages of $400,000 $30,000 tax deduction, $15,000 mortgage interest deduction and $50,000 of miscellaneous itemized deductions They would have additional Medicare tax in both scenarios of $1,350 ($400,000 - $250,000) x .9%. This amount is not reflected above.
- Assumptions: Married filing jointly taxpayer with 4 dependent children Wages of $400,000 $30,000 tax deduction, $15,000 mortgage interest deduction and $50,000 miscellaneous itemized deductions Additional Medicare tax, not included above, in both scenarios is $1,350 ($400,000 - $250,000) x .9%
- NIIT went into effect on 1/1/2013. It is a 3.8% tax on investment income in excess of certain threshold amounts. Income thresholds are $200,000 for single and head of household taxpayers and $250,000 for married filing jointly taxpayers. If income is over those thresholds, the taxpayer is subject to a 3.8% tax on the lesser of net investment income or the excess of modified adjusted gross income over the threshold.
- The changes to the income taxation of trusts and estates are effective for tax years 2018 through 2025 (unless otherwise noted). Brackets are subject to change for inflation adjustments.
- If taxes are incurred in a trade or business activity described in IRC Section 212, they are an exception and the $10,000 limitation will not apply.
- Capital gains and qualified dividends rates for 2018 Tax rate Thresholds 0% $0 - $2,600 15% $2,601 - $12,700 20% Over $12.700 Although personal exemptions were suspended for individuals, trusts and estates are still entitled to their personal exemptions. The amounts have not changed. The law did not amend the AMT for trusts and estates. The exemption of $24,600 and phaseout threshold of $82,050 for trusts and estates (for 2018) were not changed
- The income distribution deduction (IDD) is the lesser of distributable net income (DNI) or fiduciary accounting income. In this example, DNI = Adjusted Total Income. Disbursements from fiduciary accounting income per the Uniform Principal & Income Act: Sec. 116.201. DISBURSEMENTS FROM INCOME. A trustee shall make the following disbursements from income to the extent that they are not disbursements to which Section 116.051(2)(B) or (C) applies: (1) one-half of the regular compensation of the trustee and of any person providing investment advisory or custodial services to the trustee unless, consistent with the trustee's fiduciary duties, the trustee determines that a different portion, none, or all of the compensation should be allocated to income; (2) one-half of all expenses for accountings, judicial proceedings, or other matters that involve both the income and remainder interests; (3) all of the other ordinary expenses incurred in connection with the administration, management, or preservation of trust property and the distribution of income, including interest, ordinary repairs, regularly recurring taxes assessed against principal, and expenses of a proceeding or other matter that concerns primarily the income interest; and (4) recurring premiums on insurance covering the loss of a principal asset or the loss of income from or use of the asset.
- GST exemption is also increased to $10 million (adjusted for inflation) for transfers made after 2017 and before 2026. Portability – if the first spouse dies before 2026 and ports their unused exclusion to a surviving spouse, that DSUE will be available in full to the surviving spouse, even if the basic exclusion reverts to a lesser amount when the Act’s provisions sunset.
- We are not sure if there would be a “clawback” after 2025. (a prior gift covered by exclusion in effect when the gift was made, that could result in estate tax if the exclusion has decreased when the donor dies). The apparent intent of the Act is that regulations would clarify that clawback would not apply if the estate exclusion amount is smaller than an exclusion amount that applied to prior gifts.
- Assumptions: All other personal assets are immaterial to the asset total Estate is for a single (unmarried) taxpayer No prior gifts have been made Taxpayer dies in 2018 when exemption is $11,180,000, so no estate tax liability Heir sells inherited assets just after date of death, when FMV is equal to stepped up basis
- Assumptions: All other personal assets are immaterial to the asset total Estate is for a single (unmarried) taxpayer Prior to death, the taxpayer gifted their home to the heir, with a basis of $2,000,000. Taxpayer dies in 2018 when exemption is $11,180,000, so no estate tax liability Heir sells inherited assets just after date of death, when FMV is equal to stepped up basis. The home has a FMV of $7,000,000 at date of death. Net gain to heir is ($10,000,000 - $3,000,000 inherited basis - $2,000,000 basis of home = $5,000,000. Tax calculation assumes that the heir would pay highest capital gains tax rate 20% plus 3.8% net investment income tax on the sale of all assets.
- Alimony is no longer deductible by payor nor includible by the recipient (for divorces executed after 12/31/18). Moving expense deduction and exclusion is repealed except for active members of the Armed Forces (provision expires after 2025) Medical deduction threshold is 7.5% for 2017 and 2018 (reverts to 10% starting in 2019) Personal exemptions were repealed Capital gains rates are not exactly tied to brackets any longer, but are close, and both tied to inflation.
- The excess business loss provision applies to all noncorporate taxpayers. Step 1: Apply business interest expense limitation to each trade/business as applicable Step 2: Apply passive and at-risk limitations to the trade/business Step 3: Aggregate trade/business income and losses. If losses exceed the threshold, apply the limitation Carryover of excess business losses are treated as an NOL carryforward subject to the 80% limitation. They do not have to be applied to the trade/business activity that generated the loss.
- This new provision provides a 20% deduction on qualified business income. This deduction is taken on the individuals’ tax return from taxable income (not an above the line deduction, therefore does not decrease SE tax) and can result from the flow through of income from a sole proprietor, SMLLC, partnership, or S Corporation. The calculation is very complex and can be limited based on taxable income as well as the type of trade/business income that is applicable. A limitation based on W-2 wages and capital is phased in when the taxpayer’s taxable income exceeds a $157,500 ($315,000 MFJ) threshold amount. A disallowance of the deduction with respect to specified service trades or businesses is also phased in when taxable income exceeds the threshold amount. These limitations are phased-in if taxable income exceeds the threshold amount but is below $207,500 ($415,000 MFJ) (the phase-in range). There are a great deal of questions on how this deduction will be applied and more guidance is needed.