Yesterday, Congress passed a comprehensive tax bill that will have a significant effect on your taxes in the years to come. Most changes are effective for the 2018 tax year (not for the current year 2017). From changes in personal income taxes to business taxes and estate taxes, the changes are broad and deserve a few minutes of attention. What follows is a comprehensive summary of the new rules and their effective dates.
To make this article more useful to you, I have divided the impacts of the new law to low, middle and high-income taxpayers. This should help you determine how the new law will directly affect you.
Low-Income Taxpayers: Annual Income of less than $75,000
To help low-income tax payers, the new law has expanded the amount of income that is not subject to any taxation. To accomplish this goal, the standard deduction (this is the deduction that is allowed without regard to expenses such as mortgage interest or property taxes etc.) was increased to $12,000 for single taxpayers and $24,000 for married taxpayers. This means that income earned under these thresholds is not subject to any income tax. This expansion was meant to simplify filing for lower income households and replaces the current system of a standard deduction plus personal exemptions (In 2017 this non-taxable amount is the combination of a $6,350 standard deduction and a $4,050 personal exemption or $10,400 for single filers which is doubled for married filing jointly). The actual impact of this change is an increase of roughly 15% in the amount of income that can be earned completely tax free.
Additionally, to aid families, the Child Tax Credit has been expanded from $1,000 for each child dependent (up to and including age 16) to $2,000 per child dependent, with up to $1,400 of that amount being refundable. The result of this is that even if a taxpayer does not have any tax liability, they are eligible for a refund of up to $1,400 per child dependent. There is an additional $500 family tax credit for non-child dependents. This helps families with older children or parents living at home. The Earned Income Tax Credit was left unchanged by the new tax law.
Middle-Income Taxpayers: Annual Income between $75,000 and $300,000
The most obvious impact of this bill to middle-income taxpayers is the changes to the tax rates. The new law reduces each tax bracket. The chart below explains the reduction in each bracket.
|Income Tax Rate||Income Levels for Those Filing As:|
|Current (2017)||Tax Bill (2018)||Single||Married-Joint|
Some negative effects of the new tax rules are that all state and local tax deductions are limited to $10,000 per year. This includes income taxes paid to the state as well as property taxes. Additionally, the deduction for mortgage interest is limited to acquisition indebtedness up to $750,000 (decreased from our current law of $1 million. The home equity loan interest deduction will be completely eliminated as well. For individuals living in high tax states (California and New York are the big ones here), there could be a significant tax increase resulting from this change.
One favorable change made by the bill is the reduction of the threshold for deduction of medical expenses for tax years 2017 and 2018 to 7.5% (currently 10%) of adjusted gross income (AGI). Until now, medical expenses had to be more than 10% of your AGI to count at all, now this hurdle is reduced. This is a favorable change for individuals with large medical expenses.
Of significant interest to large families is the change to the phase out threshold for the Child Tax Credit. This has been increased dramatically, from $110,000 to $400,000 for married filers. This means that a family earning $200,000 will now be able to take advantage of child tax credits which were formerly unavailable to them.
Although the new tax law retains the Alternative Minimum Tax (AMT), this will apply to far fewer taxpayers. The AMT has always served to put a cap on certain deductions and exemptions. Consequently, the elimination of personal exemptions, and most state tax deductions, prevents most taxpayers from having any exposure to this tax in the first place. For those who still are subject to it, the exemption amount will increase to $109,400 for married taxpayers filing a joint return (half this amount for married taxpayers filing a separate return) and $70,300 for all other taxpayers. Additionally, the phase-out thresholds for this exemption would be increased to $1 million for married taxpayers filing a joint return and $500,000 for all other taxpayers. This may not seem like a big deal, but the AMT exemption phase-out is actually a sneaky tax that affects numerous middle income taxpayers. With an increased exemption phase-out, all middle income taxpayers will be allowed to take the full AMT exemption which could result in substantial tax savings.
High-Income Taxpayers: Annual Income above $300,000
The changes to the tax rates detailed above will provide a sizeable tax break to high income taxpayers. Additionally, the increased phase out threshold for the AMT will yield substantial savings to certain high income taxpayers. I will discuss the changes for pass-through income later in this email.
Additionally, the upper limit for the charity deduction has been increased from 50% to 60% of the taxpayer’s AGI.
Estate & Gift Tax
The threshold for estate tax has doubled to roughly $11 million per spouse. This allows married couples to transfer almost $22 million without any estate tax implications.
Additionally, the gift tax annual exclusion increases next year to $15,000 per donee (the current amount is $14,000).
Other Significant Changes
The new bill lowers the corporate tax rate from 35 to 21 percent. This affects businesses organized as C Corporations.
Effective January 1, 2019, the penalty imposed on taxpayers who do not have health insurance that provides at least minimum essential coverage will be reduced to zero. It is important to note that this is not effective for another year. For 2018 you will still need health insurance.
While changes to the $500,000 Home Sale Exclusion (Section 121) were discussed, it will remain as in current law. The same applies to the Qualified Tuition Reduction which was left unchanged by the new law.
Income from pass-through businesses (sole proprietorships, limited liability companies, and S Corporations) that are considered a service type business (think accountant, consultants, attorneys, etc.) is allowed a 20% deduction. This deduction is eliminated if the taxpayer’s income (single) exceeds $157,500 or $315,000 for married filing jointly. The 20% deduction for non-service type businesses from a pass-through entity is first subjected to the $157,500/$315,000 income limitation. If the income exceeds this limitation the 20% deductible amount is capped at the greater of (A) 50% of the wages paid by the business and (B) 25% of the wages plus 2.5% of the business’s investment in qualified property.
Practically speaking, the pass-through deduction will have the most obvious value for low income taxpayers who are below the $315,000 threshold, or high income taxpayers with substantial payrolls or significant capital in a non-service type business (think expensive real estate).
While there are other provisions and details in the new law that may affect a small number of Taxpayers, I have attempted to summarize the most pertinent and visible changes. Based on a simple reading of these rules, at least 90% of taxpayers should experience at some tax benefit from these new laws, with larger families in the middle-income range and high-income taxpayers experiencing the most benefits.
Joe Willig, CPA, CFP®