As many of you know, there have been a lot of changes to the tax code under the Tax Cuts & Jobs Act that will affect everyone to some extent. Most of these changes are taking effect this tax year (2018) and will last until 2025, at least, so I thought it would be helpful to highlight a number of the changes here just in case you wanted to get started on your tax planning early this year (and you should)!
Keep in mind, this is not meant to be a comprehensive list of changes, but rather a high-level summary of changes that will most commonly affect my clients. As always, consult with your accountant, or feel free to reach out to us, to determine exactly how the new tax laws impact your specific situation.
- Married couples filing jointly
- Individuals filing single
- Changes that affect everyone regardless of filing status
- Anyone with children or dependents
- Anyone who itemizes deductions
- People with businesses or “side hustles”
- Anyone worried about their estate taxes
How to find your tax bracket
- Get out your tax return from last year.
- On page 1, look at boxes 1-5 under the “Filing Status” heading. You will have checked one of those boxes. Click the button below that corresponds to what you checked on your return.
- Now, go to page 2 of the return and look at line 43.
- Take that number and plug it into the chart below based on your filing status.
|Your 2017 marginal tax bracket is…|
|And your 2018 marginal tax bracket would be…|
(*Only an estimate. Assuming standard deduction, among other things.)
This is your current marginal tax bracket, which I will allude to in some of the sections below.
Changes Affecting Married Couples Filing Jointly
At almost every income bracket, married taxpayers filing jointly will see a reduction in their income tax rate. Unfortunately, there is a small sliver of taxpayers who were at the very top of the 33% tax bracket that will now be paying a little bit more under the new tax code (unless they can do some planning to drop back into a lower bracket), and those who were in the 10% or 35% bracket will continue to pay their same marginal rates. Congrats to all other brackets, though. You win!
Also, for all but the top bracket, you can now say goodbye to the marriage penalty! What’s this so-called, “marriage penalty,” you ask? Well, in the old tax code, mid-to-upper brackets for joint filers would start at income levels that were less than double those of single filers. Effectively, this penalized couples who have roughly equal incomes. They had to pay at higher tax rates than they would if they were single. You can read more about the marriage penalty on Wikipedia.
Now, though, tax brackets for married filers start at levels that are double those of single filers. Except for the top bracket. That top brackets starts are $500k for single filers and only $600k for married taxpayers. (If the marriage penalty were truly eliminated, the joint bracket would start at $1 million.) Sorry all of you rockstar, high-earning couples. On the bright side, you’ll still be paying less in taxes at the 37% rate than you were when it was a 39.6% bracket!
The standard deduction is going up to $24k for married filers. Many more people will be taking advantage of this higher standard deduction rather than going through the hassle of itemizing deductions. However, if you itemize now, you will still want to review what itemized deductions will look like under the new tax code. If you have more than $24k in itemized deductions, even with the changes, it will still be more advantageous to itemize.
The new standard deduction isn’t quite as good of a deal as it sounds, though, because personal exemptions are being thrown out the window. This was the $4k deduction you would get for each dependent. Instead, there is now a smaller tax credit (which is better than a deduction), for dependents. You can read more about this in the dependents section below.
In summary, tax rates will be going down from the old 2017 levels for almost everyone that files jointly. However, that does not mean the amount of tax you pay will go down for everyone. With some of the other changes to the tax code, including the removal or limitations of certain itemized deductions, it is possible for you to be bumped into higher brackets. Also, there are a few income levels where rates will either stay the same or increase slightly, and it is these brackets that doing some tax planning could really help. It’s always best to check with your accountant about your specific situation.
Changes Affecting Individual Taxpayers
For individual taxpayers, the new tax code isn’t all sunshine and rainbows. It will help some taxpayers and hurt others. Most notably, for anyone whose taxable income (after deductions) falls between roughly $157k-425k, your tax rates will be going up. Where you were paying 28-33%, you will now be paying 32-35% to the IRS on every additional dollar you earn. If you fall in this range, it becomes even more important that you do some tax planning to minimize what you pay the government and maximize what you keep for yourself.
The standard deduction will be increasing to $12k for single filers, but you will be losing out on the $4k personal exemption you used to get. In effect, you will get you an additional $1,600 in deductions under the new rules, assuming you’d previously been taking the standard deduction. If you were itemizing in the past, that may very well still be better for you. However, to what extent depends on what exactly your deductions were. You should check out the changes to itemized deductions below to estimate what your situation could look like going forward.
Changes That Affect Everyone Regardless of Filing Status
Expanded Standard Deduction:
As noted previously, the IRS has increased the standard deduction for everyone. It is now going to be $12k for single filers and $24k for joint filers. This means that more and more of you are going to be taking the standard deduction rather than itemizing. However, However, you should always track deductible expenses and compare whether itemizing or the standard deduction will be better for you. If you were itemizing in the past, there’s a good chance you will still be itemizing in 2018.
Removed Personal Exemption:
You used to get a personal exemption for each filer and dependent. Unfortunately, those exemptions will be going away, starting in 2018. With the expanded standard deductions, this seemingly hurts those of you who have dependents. However, the new rules have expanded some tax credits to help with this, so you may actually be better off.
Individual Health Care Mandate Repealed:
Starting in 2019, you will no longer be penalized if you do not have health insurance. You still need to have insurance in 2018 to avoid the penalty. Also important to note is that regardless of whether there’s a penalty or not, it’s still worth it to have coverage. Even if you only get a high deductible health plan to save on costs, it’s worth it (especially if you can get one of those high deductible health plans that allow you to also get an HSA).
Alternative Minimum Tax (AMT) Exemptions & Phaseouts Increased:
With the newly increased AMT exemption and phaseout threshold in place, and with the more limited itemized deductions (many of which are added back to your income in calculating AMT), there aren’t too many people who will even be subject to the minimum tax anymore. Furthermore, if you were paying AMT and won’t be paying it in the future, you may be eligible to receive a Minimum Tax Credit for taxes you did pay. Score!
Examples of exceptions where you would want to be proactive about planning are those of you with Incentive Stock Options (ISOs) or very large amounts of capital gains.
More Flexibility Around 401k Loan Rollovers upon Termination:
If you leave a job or are terminated from service while you still have a loan out on your 401k, you now have a little bit longer to pay the money back. It used to be that you only had 60 days to repay the loan before it was considered a distribution (subject to tax plus a potential 10% penalty – ouch). Now, you have until the due date (plus extensions) of that year’s tax return. This is a welcome relief for anyone who has a current loan out on their 401k and may be looking at switching jobs. However, whether you even want to take a loan from your 401k is a different story altogether.
Roth Recharacterization of Conversions Disallowed:
If you make a Roth conversion, it is now a permanent decision. You can no longer “un-convert” it if you don’t like what your investments within the account have done. So, you better be sure ahead of time that converting from a traditional account to a Roth account is the right thing for you and your plan before actually executing the conversion. (This is for Roth conversions only. Roth IRA contributions are not affected by this law change.)
Anyone Who Itemizes Deductions
The IRS has made some pretty major overhauls to itemized deductions, potentially affecting anyone who would normally file a Schedule A. For the most part, they have removed or set a cap on deductions people would commonly write off. As a result, many people will be reverting back to taking the newly increased standard deduction instead of itemizing, depending on which deductions they were taking advantage of. You will always want to compare whether taking the standard deduction or itemizing is better for you. Here are the major things that have changed:
State and Local Tax (SALT) Deduction Has Been Capped at $10k:
State and local taxes are things like: state income tax, sales tax, or property taxes on your home or car. It used to be that you would get a full deduction on your 1040 for your income tax or sales tax paid (whichever was higher) plus property taxes. Starting in 2018, if that number adds up to more than $10k, you will only get a $10k deduction.
People who live in states with high income tax rates, like CA and NY, will be most affected by this change. Because of that, many of those high income tax states are looking at ways to help alleviate some of these lost deductions for their taxpayers. I suspect more news will come out about this throughout the course of the year.
Changes to Mortgage and Home Equity Loan Interest Deductions:
The ability to deduct interest on “home acquisition indebtedness” has now been reduced to $750k, down from what was $1 million. Also, interest on up to $100k of “home equity indebtedness” is no longer deductible. The difference between acquisition indebtedness and equity indebtedness is what the proceeds are used for, not what type of loan you use.
Acquisition = money that is used to acquire, build, or substantially improve your house, and interest IS deductible on the first $750k of loan regardless of whether it is a primary mortgage, refinance, or home equity line of credit (HELOC).
Equity = money that is used for anything else, and interest IS NOT deductible at all.
Removal of the Miscellaneous Deductions Above 2% of AGI:
These miscellaneous deductions are becoming a thing of the past. This includes things like unreimbursed employee business expenses (such as travel for work, union dues, job education, etc.), tax preparation fees, investment expenses, safe deposit box fees, etc. If your employer will pay for any of these, now is the time to make sure you submit your reimbursement requests!
Moving Expense Deductions/Exclusions Also Removed:
Regardless of how far you move, you will no longer be able to deduct any moving expenses on your personal tax return. And if you think you can get around this one by asking your employer to pay for the moving expenses, think again. Under the new rules, whatever your employer pays in moving expenses becomes taxable income to you. (There are some exceptions to this for certain expenses for active duty military, who will have the ability to deduct those specific expenses.)
Removal of the Itemized Deduction Limitation:
Due to many of the other changes made to itemized deductions, most notably in areas where the IRS has set a cap on how much you can deduct, there is no longer an income range where your itemized deductions begin to phaseout. Really, this only affects you if you are an upper-income individual/family who was itemizing deductions and losing out on some of those deductions because your income was too high.
Maximum Deduction for Charitable Donations Going Up to 60% of Income:
This rule change applies for cash donations to public charities. Unfortunately, you are still limited to 30% of income if you are donating appreciated stock or mutual funds. For those of you who have unused charitable carryforward, though, this could be a good opportunity for you to use more of it sooner.
If you plan on doing some charitable giving, it would be smart to look at strategies utilizing a donor advised fund, where you can bunch donations together to get big tax breaks in certain years and then take the standard deduction the other years.
Anyone with children or dependents
Dependents can be a lot of work and a large expense. As such, the IRS tries to ease your burden in the form of deductions, exemptions, and credits. With this tax code update, you will unfortunately be losing out on personal exemptions for each of your dependents. However, the IRS has taken that into account and offered alternatives that may be even better for you from a tax savings perspective.
Expanding the Child Tax CREDIT and Qualifying Dependent Credit:
The new rules have raised both the amount of the child tax credit as well as the income level where you start to lose the credit, meaning more taxpayers will have access to it. Starting in 2018, you get a $2,000 credit for each qualifying child, which is any child that is under age 17. That credit is refundable, which means it can reduce your income tax liability below $0. (The government might have to pay you!) It phases out at an AGI of $200k for individual taxpayers and $400k for joint filers. In addition, non-qualifying children or other qualifying dependents receive a credit of $500, which is not refundable.
Changes to the “Kiddie Tax”:
Prior to 2018, unearned income to children above a $2,100 threshold was taxed at the parent’s tax rate. Now, income over that amount will be taxed at trust income tax rates instead of parent’s tax rates. Ultimately, that means unearned income to children reaches top tax brackets much sooner, around $12,500. This only applies to unearned income. If the child has earned income, it would still get taxed at the child’s regular income tax rates.
Changes to 529 Plans:
529 education savings plans can now be used for qualified expenses at the elementary and secondary education levels, rather than only for higher education expenses as the rules previously stated. However, there is a cap of $10k per student for elementary and high school expenses. No cap is in place for qualified higher education expenses.
While Coverdell Education Savings Accounts will still be available, the ability to contribute a higher annual amount (Coverdell contributions are capped at $2k per student per year) and the added flexibility of the 529 Plans will likely make the 529 a more attractive alternative to save for early education costs.
People with businesses or “side hustles”
There are a ton of choices that you must make on a daily basis when running a business, and the new tax code has made some very significant changes which will add even more considerations for business owners. These changes could fundamentally shift the way you structure your business, but there are too many of them to cover in the scope of this post. Instead, I will touch on one change that could have a major tax savings for owners of pass-through entities (i.e., S-corporations, LLCs, and partnerships) or anyone filing a Schedule C.
Qualified Business Income (QBI) Deduction for Pass-Through Entities
There is a new deduction of up to 20% of business income for owners of qualified businesses or entities, which is really any business that isn’t a C-corporation, including partnerships and sole-proprietorships.
As with everything IRS related, there are quite a few exceptions and rules that could limit or eliminate how much you can deduct, as well as which businesses qualify and which ones don’t. For the most part, though, if you make less than $157,500 for individuals and $315,000 for joint filers, you won’t have to worry about those limits and you should be able to deduct the 20% QBI on your personal tax return. Essentially, this means you will only need to pay taxes on 80% of your business income, which could result in quite a savings compared to what you are paying now. If you make more than those income threshholds, you can read more about whether you and your business can take advantage of the new qualified business income deduction and how much you might look to benefit from these tax changes.
Anyone worried about their estate taxes
If you were previously in a taxable estate, it’s possible that you no longer will be under the new IRS rules. The new estate tax exemption is $11.2 million for individuals and $22.4 million for couples, which is double what it used to be.
The estate tax rate, however, has remained the same. You will still pay 40% for any amounts that are over your unused exemption. Likewise, assets will continue to receive a step up in basis at the death of the owner, which will help to reduce future capital gains for your heirs.
What Has NOT Changed?
Most notably, capital gains rules have not changed at all. The maximum capital gains tax rate remains at 23.8%, including the Medicare surtax. Likewise, capital gains rates are still tied to the old tax bracket amounts, which can make it more difficult to tell which capital gains rates you will pay simply by looking at your 2018 regular income tax brackets.