The Tax Cuts and Jobs Act (TCJA) of 2017 was one of the most sweeping tax code overhauls in decades. The majority of its provisions kicked in January 1, 2018, and most of the changes will expire at the end of 2025 unless Congress extends them. Even though they are likely temporary, the changes could have a potentially big impact on your taxes for the coming filing season. Let’s take a look at some of the more important provisions:
1. Tax rates and brackets have changed.
The new law keeps seven tax brackets but makes significant changes to the tax rates. The new tax rates and brackets work in unison and should result in lower tax bills for the majority of taxpayers.
For example, the top tax bracket for married couples filing jointly was formerly 39.6% and applied to incomes over $480,050. Under the new tax code, the top rate is 37% and applies to incomes over $600,000 for married/joint filers.
The graphic below shows how the new and old tax rates and brackets compare to each other. The new tax law decreases five out of the seven tax rates. In addition, the tax brackets (the amount of money taxed at each rate) have shifted, resulting in more income being taxed at lower rates.
Former (2017) tax rates and brackets compared to the new tax law (2018)
Source: Schwab Center for Financial Research.
2. The standard deduction has increased.
The new tax law nearly doubles the standard deduction, to $12,000 from $6,350 for single filers, and to $24,000 from $12,700 for married filers. About 70% of taxpayers claim the standard deduction, which includes most low- and middle-income households. The increased standard deduction combined with the new increased child tax credit (read more below) should lower the tax bills of the majority of these households.
3. Some itemized deductions have been reduced or eliminated.
The new law reduces or eliminates many itemized deductions in favor of a higher standard deduction. These changes include the following:
The deduction for state and local income taxes, property taxes, and real estate taxes is capped at $10,000.
The mortgage interest deduction is limited to $750,000 of indebtedness. However, those who had $1,000,000 of home mortgage debt prior to December 12, 2017, will still be able to deduct the interest on that loan.
All miscellaneous itemized deductions are eliminated. This includes deductions for tax preparation fees, investment advisor fees and unreimbursed job expenses.
Here are the itemized deductions that remain relatively unchanged and even slightly improved:
Medical expenses: The new law preserves the deduction for medical expenses and temporarily reduces the limitation from 10% to 7.5% of adjusted gross income for tax years 2017 and 2018. Beginning in 2019, only medical expenses that exceed 10% of adjusted gross income will be deductible.
Charitable donations: The new law preserves all the major charitable donation deductions and increases the cash donation limit to 60% from 50% of adjusted gross income.
All else being equal, if you’re in a high-income household in a high-tax state, with a large mortgage and high property taxes, these changes could end up increasing your tax liability. However, some of the negative impact will be offset by the changes to the tax rates and brackets.
If you don’t normally itemize your deductions—or your itemized deductions have traditionally been less than the new standard deduction—these changes shouldn’t be an issue, and the increased standard deduction should end up benefiting you.
4. The child tax credit has increased.
The new tax law increases the child tax credit to $2,000 from $1,000, and the income level of households eligible for the credit has also increased. In the past, only households with incomes below $75,000 for single filers or $110,000 for joint filers qualified for this credit. Now, households with incomes below $200,000 as a single filer or $400,000 as a joint filer can claim this tax credit.
Generally, tax credits are better than tax deductions, because credits reduce your taxes dollar for dollar, while deductions only lower your taxable income. This change should benefit many low- and middle-income households with children.
5. The personal exemption and dependent deduction have been eliminated.
The new law eliminates the personal exemption and dependent deduction. However, when combined with the increased standard deduction and increased child tax credit, lower- and middle-income households should see a net benefit despite the elimination of these deductions.
However, higher-income taxpayers could see an increased tax bill from this change if they have large families and don’t qualify for the child tax credit.
6. The alternative minimum tax (AMT) was changed but not eliminated.
The new law increases both the exemption and the exemption phase-out amount for the individual AMT. Beginning in 2018 and ending in 2025, the AMT exemption amount increases to $109,400 for married taxpayers filing a joint return and $70,300 for all other taxpayers. The phase-out thresholds increase to $1 million for married taxpayers filing a joint return and $500,000 for all other taxpayers.
These changes should benefit many middle- and high-income households that were previously affected by this tax.
7. Treatment and calculation of cost basis on investment sales remains unchanged.
The Senate tax bill had a provision that would have required investors to use the “first-in, first-out” (FIFO) method to calculate cost basis for investment sales. Investors can breathe a sigh of relief, as this provision was not included in the new tax law.
8. The taxation of income from pass-through entities has changed.
This is a complex area of tax law, and the new law includes numerous changes to the taxation of income from pass-through entities such as S corporations, limited-liability corporations and partnerships. In general, the new law allows businesses to exclude 20% of their net income from taxation, subject to certain limitations. The deduction could also be limited or disallowed for specified service trades—such as lawyers, doctors and accountants—based on an income threshold.
Overall, the changes to the taxation of pass-through entities will be beneficial to many business owners, but a lot of service businesses won’t get to enjoy all the benefits of these changes.
9. The corporate tax rate has declined.
The new tax law reduces the corporate tax rate to a flat 21% from the highest 35% rate in the prior system. Lowering the corporate tax rate will increase the profits of many companies, which could provide additional capital for business expansion, increase dividends to shareholders and make the U.S. a more attractive place for foreign businesses to open operations.
10. There were no changes to tax-deferred retirement accounts.
Early on in the tax debate, it was rumored that there could be changes to the deductions taxpayers receive for contributing to tax-deferred retirement accounts, such as IRAs or 401(k) retirement plans. The new tax law did not include changes to tax deferred accounts.
It’s important to remember that the impact of any of these changes on your personal tax liability will depend on your specific circumstances. In addition, the individual components of your taxes, including earned income, credits, deductions and other factors, work together like interacting cogs. So, each of these tax changes should not be assessed solely in isolation.
Because of the large number of tax law changes, it’s more important than ever to meet with a tax or financial planning professional to go over your specific situation and ensure that you’re maximizing your tax benefits under these new tax laws.
Please Feel Free to Contact Adam Ausloos MBA CRPC to discuss any financial or tax concerns. He specializes in tax deferral structures for the sale of appreciated assets and estate tax avoidance structures to eliminate federal estate tax. 414-269-2600 Adam@defernow.com