The New Tax Law: What Does It Mean For Your Tax Bill?
By: Beverly Bird - January 24, 2019
The Tax Cuts and Jobs Act (TCJA) became a done deal when President Donald Trump signed it into law on December 22, 2017. The House first proposed its version of the bill in early November 2017, and it was tweaked and changed several times before it went into effect in January 2018.
Technically, we've had almost a year to grapple with all its changes and implications, and to determine what it means to each of our personal financial situations.
Of course, we haven't yet rolled up our shirtsleeves to begin preparing our 2018 tax returns yet. That will be the true test of what the final tax bill means to each of us and our families. In the meantime, we’ve broken down the final terms to help you sort through it all.
About Those Tax Brackets and the Standard Deductions
The standard deduction has increased significantly as originally promised, from $6,500 to $12,000 for single filers; from $9,550 to $18,000 for head of household filers; and from $13,000 to $24,000 for married taxpayers who file joint returns. You can pretty much double the amount of your income that gets taken off the board and is not subject to taxation in 2018.
An early version of the bill sought to eliminate the advantageous head of household filing status, but that provision didn’t make it into the final approved bill. The head of household status lives on.
You might recall that Republicans initially wanted to pare down the existing seven tax brackets to just four, but that didn’t end up happening. There are still seven brackets, but the tax rate percentages have changed and each bracket now accommodates slightly more earnings.
If you earned $35,000 under the 2017 tax system, you would have fallen into a 15-percent tax bracket. That drops to 12 percent with the new legislation. If you earned $75,000, you would have paid 25 percent. That's now down to 22 percent. At $100,000, you would have paid 28 percent in taxes, and that’s now reduced to 24 percent.
The tax bracket for the very highest earners, those with incomes of more than $426,700, was 39.6 percent in 2017. It drops to 37 percent under the new law, and it doesn't kick in until individuals reach incomes of $500,000 or more, or $600,000 if you're married and filing jointly.
So Who Benefits From the New Tax Bill?
Who among us will benefit most from all this? The Tax Policy Center has indicated that the Tax Cuts and Jobs Act will reduce taxes “on average” for all income groups, and the Tax Foundation has said the same thing.
The key word here is “average.” Some taxpayers might fare a little worse while some will fare better. It's important to keep in mind that tax brackets and rates are percentages.
A taxpayer who earns $100,000 and sees a 4-percent reduction in his effective tax rate would realize a far greater dollars-and-cents increase in after-tax income than a low-income taxpayer earning only $10,000 a year and seeing the same 4-percent reduction. Indeed, the Tax Policy Center says that low income households won't see much of a difference at all when the overall provisions of the tax bill are taken into account.
Here, then, is a quick overview of how much taxpayers in each income group will save under the bill.
If You’re a Low-Income Earner
The Tax Policy Center indicates that if you earn less than $25,000 a year, you’ll see about a 4 percent increase in your after-tax income, somewhere in the neighborhood of $60 annually for most people. Don’t spend it all at once.
If Yours Is a Middle-Income Household
You’ll see an additional $930 a year or so in after-tax income if you earn between $49,000 and $86,000, according to the Tax Policy Center—an increase of about 2.9 percent. The Tax Foundation’s estimate is a little more conservative. They indicate that the “bottom” 80 percent of American earners, including low income and middle income households, will see an increase in after-tax income of anywhere from 0.8 to 1.7 percent.
If You're a High Earner
If you earn between $149,400 and $308,000 a year, the Tax Policy Center says you should see an additional $7,640 in after-tax income on average, a difference of about 1.6 percent. That’s nothing to sneeze at, and this jumps to about 4.1 percent if you earn more than $308,000—somewhere in the neighborhood of $13,480 in increased after-tax income annually. But again, the Tax Foundation is more conservative and puts the number at only 1.6 percent.
You Might Not Want to Itemize Your Deductions Any Longer
The new tax bill makes changes to several itemized deductions as well, and this is expected to affect taxpayers who have historically itemized rather than claimed the standard deduction for their filing statuses. The itemized deductions that remain might not amount to more than the standard deduction you’re entitled to, so you’d be better off taking the standard deduction now that it's increased so significantly.
On the flip-side, though, are those taxpayers whose total itemized deductions typically exceed the new standard deduction amount for their filing status. If that's you, then you’d be among the taxpayers who are actually hurt by this new legislation.
To see if the new tax law could result in you paying more in taxes, ask yourself these questions:
How Much Is Your Home Mortgage?
The mortgage interest itemized deduction is now capped at mortgage values of $750,000 instead of $1 million. Unless you have a very expensive home, this shouldn’t affect you. The average mortgage debt was $200,935 as of the last quarter of 2017, according to TransUnion. There’s still a whole lot of room between that and the new cap.
This is obviously one of those changes that will affect high earners most, but there’s a catch with this tweaked deduction that can affect middle-income families as well...
Are You Deducting the Interest on a Refinance Loan?
The home interest mortgage deduction used to cover both acquisition debt—mortgages taken out to purchase or build a home—and equity debt, such as when you refinance and take some cash out of your home’s value to spend on other things, such as your child’s college education. The new tax bill eliminates this deduction for equity debt, so you’ll no longer be able to claim the interest on refinance loans as a tax deduction unless you use it to "buy, build, or substantially improve" a home.
Have You Been Deducting State and Local Taxes?
Then there’s the matter of state and local taxes. Changes to this itemized deduction caused quite an uproar among citizens and legislators alike in the weeks leading up to the final bill’s passage.
At one point, the deduction for state and local income taxes was on the chopping block, but that’s no longer the case. It escaped repeal...sort of. The total amount you can deduct for all state and local taxes, including sales, income, and property taxes, is now limited to $10,000.
This will almost certainly negatively affect itemizing taxpayers who live in states with high property and income taxes, such as New Jersey and New York. If you've been paying and deducting more than $10,000 a year in state and local taxes, you may end up on the wrong end of the tax bill.
Do You Have a Lot of Medical Bills?
The itemized deduction for medical expenses actually improves under the new legislation. This deduction includes out-of-pocket uncovered medical costs, deductibles, co-pays, and insurance premiums that are not reimbursed by your employer.
As of 2017, you were limited to claiming a deduction for only the portion of these expenses that exceeded 10 percent of your adjusted gross income (AGI)—a pretty high hurdle. That’s now been dropped to 7.5 percent, so you may be able to shave a little more off your taxable income there. Unfortunately, it's set to go back up to 10 percent in 2019.
One senator, Susan Collins of Maine, fought particularly hard for this adjustment. She’s quoted as saying that approximately 8.8 million Americans claim this deduction, and most of them earn less than $50,000 a year. The original House version of the bill wanted to do away with the medical expense deduction entirely, but Collins prevailed in her fight to keep it and actually managed to increase it, at least temporarily.
Do You Pay Alimony?
This change seems particularly unfair because affected taxpayers haven't had to itemize to claim this deduction. It was an "above the line" adjustment to income on page 1 of Form 1040. You could subtract alimony payments you made from your taxable income, then claim either the standard deduction or itemize your deductions as well. Meanwhile, your ex had to claim that alimony as income and pay taxes on it.
Not anymore. Now you not only have to pay your ex, but you have to pay taxes on that portion of your income, too, under the terms of the new tax bill. As for your ex, she gets to collect that income tax-free.
If there's any good news here at all, it's that this change will apply only to divorces and divorce agreements finalized after December 31, 2018.
The Effect of Those Lost Personal Exemptions on Families
Personal exemptions did end up being eliminated in the final version of the tax bill, just as was proposed in initial versions of the bill, and this could hit large families hard. Personal exemptions are dollar amounts that taxpayers could deduct from their taxable incomes for themselves and for each of their dependents—$4,050 per person as of the 2017 tax year.
It’s projected that single taxpayers with no children will probably still come out a little ahead even after this change. After all, they’re losing just the single $4,050 exemption they were able to claim for themselves, which is more than offset by that increased standard deduction.
But what if you’re married and have three kids? That’s a total of five exemptions that you could have claimed on a joint tax return under the 2017 tax law—a walloping $20,250 more in income that you’ll have to pay taxes on under the new legislation.
That's a good deal more than the increased standard deductions. Those deductions are only increasing by $8,450 for head of household filers and by $11,000 for married parents filing jointly. Losing the exemptions for two dependents would put head of household filers in the hole, and losing three exemptions would tank married parents.
Of course, this will be balanced somewhat by the altered tax brackets, but it's still unlikely that large families will end up coming out ahead.
The Expanded Child Tax Credit
The Center on Budget and Policy Priorities protested the changes to the Child Tax Credit from the beginning. On the surface, the changes appear generous. Not so, says the CBPP, at least not for the lowest income families.
This tax credit has always been tricky to calculate. Technically, it’s non refundable so all it could do was eliminate any tax bill you might have owed. But there was a tack-on—the Additional Child Tax Credit. This would allow a portion of the credit to become refundable, meaning that after it erased your tax bill, you could expect to receive a check from the IRS for part of the balance.
The nonrefundable part of the old tax credit was $1,000 per child. The new tax bill amps this up to $2,000 and makes up to $1,400 of that amount refundable while eliminating the "extra" Additional Child Tax Credit. Senator Mark Rubio of Florida is credited with forcing the $1,400 provision, but the CBPP says that it still fails to offer any real relief for the poorest American families.
Why? Because the refundable portion of the credit is 15 percent of a taxpayer’s or family’s earnings over $3,000 up to the $1,400 limit. You see where this is going. We’re back to percentages again. A single mom earning $10,000 has less income over $3,000 than does a middle-income family earning $50,000. In fact, she doesn't have enough income to qualify for the full $1,400 refundable part of the credit.
Meanwhile, high income families used to be unable to claim this tax credit because they earned too much, but the new bill expands the income limits so now many high earners will be able to take advantage of it.
It’s Not Forever
These are just a few of the many tax rules that change under the new legislation. And there’s one more significant change between the first version of the bill and the final version that was ultimately agreed upon by both the House and the Senate: The Tax Cuts and Jobs Act is not permanent.
Many if not most of the provisions are scheduled to expire or “sunset” on December 31, 2025 unless Congress rolls up their shirtsleeves once again and renews them or otherwise haggles out a whole new tax bill at that time. The Tax Policy Center warns that more than 10 percent of Americans can expect their tax bills to jump again after 2025 even if they receive tax relief between now and then, assuming that the provisions are indeed allowed to sunset.
The Tax Cuts and Jobs Act is expected to cost the government some $1.5 trillion in revenues, and that’s obviously not sustainable over the long haul. So, stand by and get ready to revisit this issue again in seven years.
** Disclaimer Required by IRS Circular 230** Unless otherwise expressly approved in advance by the undersigned, any discussion of federal tax matters herein is not intended and cannot be used 1) to avoid penalties under the Federal tax laws, or 2) to promote, market or recommend to another party any transaction or tax-related matter addressed.