When the tax reform act became law late last year, it represented the most sweeping revision to the tax code in over thirty years. What do these changes mean for you? Read on to learn how the new tax law could affect your bottom line.
Goals of the New Tax Law
The Tax Cut and Jobs Act (TCJA) is the fulfillment of two of President Donald Trump’s major tax reform goals: to provide a tax cut for the middle class and to lower the corporate tax rate on businesses to a more competitive rate worldwide. The hope is that these cuts will spur economic growth by allowing businesses to spend more on capital improvements, higher wages and job creation.
Here are eleven ways the TCJA could affect your annual tax bill.
- 1. Individual Tax Rates
While the bill maintains the existing seven tax brackets, most of the rates have decreased, with the top marginal rate now 37% instead of 39.6%:
|
Income Tax Rate |
Income Levels for those filing as: |
||
|
2017 |
2018-2025 |
Single |
Married-Joint |
|
10% |
10% |
$0-$9,525 |
$0-$19,050 |
|
15% |
12% |
$9,525-$38,700 |
$19,050-$77,400 |
|
25% |
22% |
$38,700-$82,500 |
$77,400-$165,000 |
|
28% |
24% |
$82,500-$157,500 |
$165,000-$315,000 |
|
33% |
32% |
$157,500-$200,000 |
$315,000-$400,000 |
|
33%-35% |
35% |
$200,000-$500,000 |
$400,000-$600,000 |
|
39.6% |
37% |
$500,000+ |
$600,000+ |
Source: Tax Policy Center
- 2. Deductions and Itemizations
One of the biggest impacts to most middle class earners will be the increase in the standard deduction, to $12,000 from $6,500 (single), $18,000 from $9,550 (head of household) and $24,000 from $13,000 (married-joint). It’s estimated that as many as 27 million more tax payers will take the standard deduction instead of itemizing when filing their 2018 taxes.
If you still choose to itemize, you will find substantial changes to some traditional deductions. State and local income taxes, property taxes and sales taxes (known collectively as SALT) will now be capped at $10,000. This will primarily affect people in states that have high income or property taxes. You will still be able to itemize cash gifts to charities, and for 2018 and 2019 you can claim medical expenses if they exceed 7.5% of your adjusted gross income (AGI) instead of the current 10%.
- 3. Personal Exemptions and the Child Tax Credit
The 2017 personal and dependent exemption of $4,050 will be eliminated in 2018. However, the Child Tax Credit has increased up to $2,000 from its current value of $1,000 for each child age 17 and under. A tax credit is different than a deduction: While a deduction simply reduces your taxable income, a credit is a dollar-for-dollar credit off your tax bill. The income phaseout thresholds for the Child Tax Credit have dramatically increased, from the current thresholds of $75,000 for individuals and $110,000 for married couples, up to $200,000 for individuals and $400,000 for married couples. These thresholds are not indexed for inflation.
- 4. Home Ownership
One of the most talked about changes in the tax code for 2018 involves the mortgage interest deduction. While Congress didn’t eliminate it entirely as some lawmakers proposed, they did lower the limit on interest paid on qualified acquisition debt from $1,000,000 to $750,000. This means that interest on loan balances up to $750,000 to buy, build or improve your primary residence or a second home is deductible. However, interest on home equity loans or lines of credit can no longer be deducted unless the funds are used for a home purchase or improvement.
- 5. Capital Gains and Dividends
The capital gains and dividends tax structure is basically unchanged. Long-term capital gains are defined as gains on assets held for over a year, while short-term capital gains are from assets held for a year or less. Long-term gains and qualified dividends are taxed at rates of 0%, 15%, or 20%, depending on your tax bracket, while short-term gains and ordinary dividends are taxed as ordinary income. Thus, because of the lower tax rates on ordinary income, you could see a reduction in taxes on short-term gains.
- 6. IRAs
The biggest change regarding IRAs is that taxpayers need to carefully consider whether or not to convert their regular IRAs into Roth IRAs since they will no longer be able to convert back to a regular IRA. Once you’ve moved into a Roth IRA, there’s no going back.
- 7. 529 Plans
529 plans were created as a way for families to save money for their children’s college and post-secondary educations. For 2018, 529 accounts have been expanded to cover private school tuition for grades K through 12, with a distribution cap of $10,000 a year. Although 529 Plans are funded with after-tax dollars, the investment growth inside the plan and the permissible distributions from the plan are both tax free, which make them similar to Roth IRAs.
- 8. Estate and Gift Tax
The TCJA nearly doubles the applicable exemption amount from $5.6M to $11,180,000 for individuals and $22,360,000 for married couples but leaves the tax rate the same, 40%. Just as in the prior law, the exemptions are indexed for inflation. Additionally, estate and gift taxes are unified, meaning that you can gift money while you’re alive, leave money to beneficiaries upon your death, or skip a generation (such as a grandparent leaving an inheritance to a grandchild) and there is no transfer tax as long as the gifts are within the exemption limits. For instance, under the new law, a married couple should be able to transfer $22,360,000 to their children or grandchildren without incurring any federal estate or gift tax.
- 9. Business Tax Rate
The tax rate for C corporations will be slashed from 35% to 21% for 2018, and the corporate Alternative Minimum Tax (AMT) has been eliminated. Plus, there is a new deduction for 20% of qualified business income for most pass-through entities such as S corporations, LLCs, partnerships, and sole proprietorships. What are businesses going to do with all that extra money? Stay tuned.
- 10. Alternative Minimum Tax (AMT)
As stated in #9 above, the corporate AMT has been eliminated. For individuals, the exemption has been increased, which means fewer tax filers will be exposed to this tax. For 2018, the AMT exemption amounts will increase to $70,300 for single filers and $109,400 for joint filers and will phase out for those taxpayers at $500,000 and $1,000,000, respectively.
- 11. Affordable Care Act (ACA)
A big change involves the Affordable Care Act: for 2018, the penalty that non-insured individuals had to pay has been eliminated. However, the 3.8% net investment interest tax for high-income taxpayers was retained.
More things to consider
While wage earners could notice a difference in the amount of taxes withheld from their paychecks starting this month, most of these tax code revisions won’t come into play until you file your 2018 taxes next year, which gives you time to review your personal financial situation and consider any adjustments that may be necessary. Another aspect of the TCJA that you should remember is that most of the individual tax cuts expire in 2025; the business tax cuts are permanent. Please consult your tax professional for more information about how tax reform will affect your personal or business finances.
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This information is educational and informational in nature, and not intended to be used as tax, legal or accounting advice. We advise you to consult your tax, legal and accounting advisors regarding your tax needs.
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