On November 20, 2017 President Donald J. Trump promised to give Americans “a huge tax cut for Christmas.” One month later, he declared a political victory after a sweeping tax overhaul passed along a straight party line in both champers of Congress. On December 22, 2017, the President signed the massive tax-cut bill into law. While some believe the new code amounts to nothing more than a vast social engineering project that assumes society is better off with owners instead of renters, others believe the new bill will lead to major job growth and a revitalized economy. Whichever side you tend to agree with, its important that all taxpayers become aware of the ways the new bill may affect their income tax return. Here are just a few changes and the ways you may be affected:
1. Standard Deduction and Personal Exemptions – Under the new plan, there are no more personal exemptions, however, the standard deductions have increased substantially (from $6,350 to $12,000 for single/married filing single (MFS) taxpayers, and from $12,700 to $24,000 for married couples filing jointly). This lowers the taxable income from $89,600 to $88,000 for the individual/(MFS), and from $79,200 to $76,000 by the couple. This change is therefore positive for taxpayers receiving a fixed income as their steady taxable income will now be subject to a lower rate. Taxpayers expecting their income to increase exponentially may find themselves in a higher bracket, albeit at the same rate.
2. Itemized Deductions – The higher standard deduction may not make itemizing worthwhile for millions of Americans. For example, a single father of one who pays $8,000 in mortgage interest, $2,000 in real-estate taxes, $3,500 in state and local taxes and makes a $4,000 in charitable contributions, has paid $17,500 in itemized deductions. It made sense under the old plan to itemize his deductions. Under the new plan, because his standard deduction has risen to $18,000 he would need to donate more than $4,000 to see any significant tax deduction from his charitable giving which could discourage him from giving in the future.
3. New Tax Brackets – The seven brackets (i.e., a chart of rates) preserved under the new plan timidly lowers rates across the board including the top marginal rate which decreases from 39.6% to 37%. Most taxpayers will receive a modest tax cut starting next year. BE WARNED! Although the corporate tax cuts are permanent under the new bill, the individual cuts expire after 2025 and many analysts expect them to rise substantially – unless Congress intervenes.
4. 529 Plans – 529 Plans (education savings plan operated by the state and designed to help families set aside funds for future college students) currently grow free of any capital gains tax so long as the money is only withdrawn to pay higher education expenses. Under the new plan families can begin to withdraw up to $10,000 each year, per child, to pay for private or religious school tuition (kindergarten through 12th grade). Much to the chagrin of families participating in homeschooling, who would have been able to deduct $10,000 in expenses but for a last-minute provision, families participating in homeschooling will not be able to deduct any money from 529 Plans for education expenses. The new plan will certainly benefit the 10 percent of families who currently send their children to private school.
5. Individual Mandate (Obama Care) – The Individual Mandate is repealed under the new plan. Beginning in 2019, the penalty for not purchasing health insurance will no longer be assessed. Although the individual mandate was a major component of the Affordable Care Act, it’s repeal does nothing to other marquee components of Obamacare including protections that shield people with pre-existing medical conditions, income-based subsidies, the expansion of Medicaid for low-income adults, and the mandate that larger employers provide coverage to their workers or face fines.
6. Alternative Minimum Tax (AMT) – The AMT effectively insures that high-income taxpayers pay their statutory rate, despite how many deductions they claim, by requiring them to calculate their taxes twice – once under the standard tax system and once under the AMT – and pay whichever is higher. Because the AMT didn’t account for inflation, AMT calculations have begun to apply to more and more people, including the middle class. So, while married taxpayers earning more than $84,500 (the current AMT exemption amount) can breathe more easily, so can everyone earning less than $1 million under the new plan.
7. Pass-through Businesses – The new bill allows people with pass-through income – profits from a partnership, S-corporation, sole proprietorship, etc., – to write off 20% of their pass-through income. Stated more plainly, a small business owner earning $100,000 in profit will be permitted a $20,000 tax deduction before the standard (or itemized) deduction applies. The phaseout income limits that apply to “professional services” business owners such as lawyers, doctors, dentists, consultants, and accountants start at $157,500 for single filers and $315,000 for pass-through business owners who file a joint return.
8. Alimony - The deduction giving the tax break to the spouse paying alimony disappears along with the tax assessed on the alimony received. The change moves away from the current setup which tends to preserve more money that can be allocated between the parting parties. For example, a higher-earning spouse subject to tax at 33 percent and paying $30,000 a year in alimony saves $9,900 by shifting the income to the lower earning spouse taxed at 15%, or $4,500. Because the incentive to save $5,400 ($9,900 - $4,500) is now gone, higher-earning spouses may become more reluctant to pay as much to their exes creating more contentious divorces.
9. Education Expenses – Luckily for many taxpayers, the lifetime learning credit as well as the student loan interest deduction are still in place. Many teachers will remain eligible to take a $250 deduction for money they spend on certain job-related and classroom expenses. Although the House wanted to slash the tax break for educators, the Senate proposed to double it temporarily. Neither proposal made the final bill, and the tax rule will remain the same, for now.
10. Corporate Tax Rates – The most debated changes to the tax law are found in the corporate provisions of the bill. The new plan lowers the corporate tax rate to a flat 21% on all profits. This major tax cut brings the U.S. rate under the 25% global average – which many hope will lead to the repatriation of foreign cash and assets. To bring back the cash, the new bill sets a one-time repatriation rate of 15.5% on cash and 8% on illiquid assets which is big news for large companies such as Apple (with over $200 billion in foreign assets), Pfizer ($80 billion), Microsoft, and General Electric ($100 billion, each)