The Tax Cuts and Jobs Act (TCJA) – Part 1
Lately I’ve received a lot of calls, as well as impromptu questions when I am moving around town, from people wanting to know what the heck is the ‘new tax law’ all about and how these changes will affect them.
So, I thought the best and most efficient way to get preliminary information out to everyone is through this blog with a “brief” (Lol) overview.
And, off to the races we go……
Soooo, there have been many claims on both sides of the political aisle about the Tax Cuts and Jobs Act which is also referred to as the TCJA (and as a side note the TCJA is over 500 pages). Will your taxes go down? By how much? For middle class taxpayers it will ultimately depend on your particular situation. There’s no doubt that some taxpayers in states with high income and/or real estate taxes could see their taxes go up. And it can also depend on what other deductions you’re losing. But higher-income taxpayers won’t feel the pinch as much. That’s because their deductions under the old law may be phased out or lost because of the Alternative Minimum Tax (AMT). Most taxpayers will see a decline in their taxes, a few will see an increase. The higher your income the bigger the benefit, both in absolute and percentage amounts. The increase in the exemption for the Alternative Minimum Tax will mean far fewer taxpayers will be caught in the trap. In fact the estimate is that only about 200,000 taxpayers will pay the tax, down from 4.4 million. For many taxpayers that can be a big saving.
Home ownership will not be as attractive as it was, particularly in high tax states. And that could depress home prices. On the other hand, new benefits for landlords will make owning a rental more profitable. That could be enhanced because more people may be renting.
Business owners should fare well under the new rules. While owners of business in certain services (medicine, accounting, legal, etc.) may not do as well as others, everyone will get a benefit. For C corporations (otherwise known as a regular corporation) tax rates will be materially lower; for owners of S corporations and other pass-through entities, the benefits are less clear, but should be significant. But there are some changes that could reduce the benefits. For example, an employee who is asked to move to another location may want more of an incentive since his moving expenses are no longer deductible.
One issue that I haven’t heard mentioned more than once is the effect on state income taxes. Most states tie their computation of taxable income to the federal rules. Some do it automatically (when the fed makes a change, the state automatically does), some have to pass a legislation to follow the change. Most states have modifications to federal taxable (or adjusted gross) income. For example, New York State excludes state and federal pensions and allows an exclusion for up to $20,000 in other pension income. It also exempts all of Social Security income. But it doesn’t follow some of the federal depreciation rules.
Some deductions were eliminated in total. For example, moving expenses are no longer deductible (with an exception for the armed forces). But unless a provision of existing law was mentioned, it’s still in effect. The 0.9% medicare tax on wages of higher income individuals as well as the 3.8% tax on net investment income. The special benefits for capital gains and dividends were largely untouched.
Most amounts in the new law are adjusted for inflation using the ‘chained consumer price index’ (C-CPI-U) approach (for your reference, a quick read primer about the ‘chained consumer price index’ (C-CPI-U) is here. This is a method, that will be used going forward, that results in smaller annual increases in tax brackets, thresholds, etc.
Finally, keep in mind that most of the provisions take effect January 1, 2018. (Technically, they apply to tax years beginning after December 31, 2017; I’ll point out any that don’t). Most of the provisions that apply to individuals expire on December 31, 2025.
Beginning with this article you and I will take a look at all the important changes in the law and how it will affect taxpayers.
Individual Tax Rates
Tax Rates Based on Filing Status
There’s no question that income tax rates are lower across the board (with the exception of estates and trusts). But how much varies with your situation. Of course, you could still pay higher taxes if your taxable income is higher because you can’t deduct some of your state and local taxes, can’t claim a credit, etc. That’s why it’s important to work through your numbers. Unless you take the standard deduction and never have any unusual circumstances, trying to make them arrive at generic examples is very difficult =>(Solid Tax Solutions can work the numbers for you).
Tax Rates: Single Taxpayers–>2018
Taxable income: Tax: Over But not over Tax +% On amount over $ 0 $ 9,525 $ 0.00 10 $ 0 9,525 38,700 952.50 12 9,525 38,700 82,500 4,453.50 22 38,700 82,500 157,500 14,089.50 24 82,500 157,500 200,000 32,089.50 32 157,500 200,000 500,000 45,689.50 35 200,000 500,000 ....... 150,689.50 37 500,000
Tax Rates: Married Individuals Filing Joint and Surviving Spouses–>2018
Taxable income: Tax: Over But not over Tax +% On amount over $ 0 $ 19,050 $ 0.00 10 $ 0 19,050 77,400 1,905.00 12 19,050 77,400 165,000 8,907.00 22 77,400 165,000 315,000 28,179.00 24 165,000 315,000 400,000 64,179.00 32 315,000 400,000 600,000 91,379.00 35 400,000 600,000 ....... 161,379.00 37 600,000
Tax Rates–Head of Household–>2018
Taxable income: Tax: Over But not over Tax +% On amount over $ 0 $ 13,600 $ 0.00 10 $ 0 13,600 51,800 1,360.00 12 13,600 51,800 82,500 5,944.00 22 51,800 82,500 157,500 12,698.00 24 82,500 157,500 200,000 30,698.00 32 200,000 200,000 500,000 44,298.00 35 200,000 500,000 ....... 149,298.00 37 500,000
Tax Rates: Married Filing Separate–>2018
Taxable income: Tax: Over But not over Tax +% On amount over $ 0 $ 9,525 $ 0.00 10 $ 0 9,525 38,700 952.50 12 9,525 38,700 82,500 4,453.50 22 38,700 82,500 157,500 14,089.50 24 82,500 157,500 200,000 32,089.50 32 157.500 200,000 300,000 45,689.50 35 200,000 300,000 ....... 80,689.50 37 300,000
Tax Rates: Estates and Trusts–>2018
Taxable income: Tax: Over But not over Tax +% On amount over $ 0 $ 2,550 $ 0.00 10 $ 0 2,550 9,150 255.00 24 2,550 9,150 12,500 1,839.00 35 9,150 12,500 ....... 3,011.50 37 12,500
So what are the savings? I computed the tax using several levels of taxable income. I didn’t take into account different situations such as the loss of tax deductions or the higher standard deductions or the Alternative Minimum Tax. I used 2017 rates for the “old” rates because many taxpayers want to compare last year to the new rates. If the law hadn’t been enacted, 2018 rates would be slightly lower after accounting for the annual cost-of-living adjustment.
Here’s how a married couple would fare under four different taxable income assumptions.
Taxable Income of $40,000– Jack and Jill have taxable income of $40,000. Under the new law they’ll pay tax of $4,419 versus $5,068 under the old law. That’s a savings of $649.
Taxable Income of $100,000– Assume taxable income of $100,000. They’ll pay $13,879 under the new law versus $16,478 under the old. A savings of $2,599.
Taxable Income of $375,000– With taxable income of $375,000 they’ll pay $83,379 versus $98,967 for a $15,588 savings.
Taxable Income of $600,000– Taxable income of $600,000 will result in $161,379 under the new law, down from $182,831 under the old law. A savings of $21,452.
I also computed the saving at taxable income of $75,000. That was $1,699, in between the $40,000 and $100,000 savings amounts.
For single individuals, I computed the differences at taxable income of $100,000 and $500,000. At $100,000 there’s a savings of $2,692; at $500,000 the savings rise to $3,129.
There’s no question that the tax rates are lower, and higher-income taxpayers will see the biggest savings, both in absolute and percentage amounts. But all taxpayers should benefit. The question is how will this be offset by the loss of deductions? That depends on your particular situation. Both the rates and brackets generally combine to lower taxes. For example, in 2017 the 25% rate for a married couple filing joint started at $75,901; under the new law, the rate is 22% and the bracket starts at $77,401. But there are some anomalies, such as the 35% bracket for married, filing joint starts at $416,701 under the old law and $400,001 under the new.
Capital Gain Rates and Related Taxes
The tax rate on long-term capital gains follows the old rules updated for the new rates. For example, under the old rules, you’d pay no tax on qualified dividends or long-term capital gains if you’re in the 10% or 15% bracket. There is no 15% bracket under the new law. The 12% bracket is substituted. Thus, if you’re in the 10% or 12% bracket, you pay no tax on qualified dividends or long-term capital gains. Above that, qualified dividends and long-term capital gains are taxed at 15% until you reach the top bracket. If you’re in the top bracket, they’re taxed at 20%.
The maximum tax rate on unrecaptured Section 1250 gains remains at 25%; the maximum tax on collectibles is 28%, as under prior law.
The Net Investment Income Tax (NIIT) of 3.8% remains in effect. This tax generally applies to dividends, capital gains, and passive income. The additional medicare tax of 0.9% continues to apply to Medicare wages in excess of the threshold amounts.
Alternative Minimum Tax
Congress did not eliminate the alternative minimum tax for individuals, but by making two strategic changes it slashed its impact.
The first change is the exemptions. Under prior law the exemption was $84,500 for a married couple filing joint. That’s increased to $109,400. For single individuals or head of household, the exemption increases from $54,300 to $70,300; for married filing separate it goes from $42,500 to $54,700. Under both prior and new law the exemption is phased out 25 cents for each $1 that the Alternative Minimum Taxable Income (AMTI) exceeds the thresholds. That was a big trap for many taxpayers. Under prior law the phaseouts began AMTI of $160,900 (married, joint), $120,700 (single, head of household), and $90,450 for a married couple filing separately. Under the new law, phaseout of the exemption begins at $1 million for a married couple filing joint and $500,000 for all other filers. That, coupled with the fact that only the first $10,000 of state and local taxes are deductible for regular tax purposes (state and local taxes are not deductible for AMT purposes) significantly reduces a major add-back.
The rates for the AMT are unchanged from prior law (after adjustment for inflation). The 26% rate applies to AMTI up to $191,500 ($95,750 if married, filing separate) for 2018; the 28% rate applies to income above those amounts.
For many taxpayers who either paid or had to consider the AMT in the past, they should discuss the tax with their advisor. There’s a good chance a few rules of thumb may provide them with relief from having to consider the tax.
Standard Deduction, Personal Exemption and Child Tax Credit
This is where things start to get more complicated. Under prior law, the standard deduction for a single taxpayer was $6,500 and $13,000 for a married couple filing jointly. Each individual was entitled to a personal exemption of $4,150. These were the amounts released by the IRS in November that would have taken effect for 2018. Thus, a single taxpayer, taking the standard deduction would have been entitled to deduct $10,650 from their adjusted gross income to arrive at taxable income. A married couple with no children could deduct $21,300 ($13,000 standard deduction plus two $4,150 exemptions). They could deduct another $4,150 for each dependent child. In addition, a single individual or married couple with children could take a tax credit of $1,000 for each child under the age of 17. The personal exemption and child credit were phased out for higher-income individuals.
Under the new law the standard deduction is increased to $12,000 for a single individual; $24,000 for a married couple filing jointly and $18,000 for head of households. The amounts are adjusted annually for inflation. That seems generous, but the new law also eliminates the personal exemption. That would be $4,150 per person. Thus, the standard deduction isn’t going from $13,000 to $24,000 for a married couple with no children, in effect it’s going from $21,300 to $24,000. For a single individual the deduction is going from $10,650 to $12,000. It’s an increase, but a more modest one than appears on the surface.
A bigger issue is the exemptions for dependent children. These are also eliminated. In their place is a higher child tax credit.
Under prior law taxpayers could claim a tax credit of $1,000 for each child under the age of 17 at the end of the year. The credit is phased out ($50 for every $1000) for taxpayers with Modified Adjusted Gross Income (MAGI) above $110,000 (married, joint) $75,000 (single). Part of the credit may be refundable. There are other restrictions.
Under the new law the credit is increased to $2,000 per qualifying child. Phaseout begins at $400,000 (married, joint); $200,000 for any other filing status. The phaseout is the same as under the old law. In addition, a $500 credit can be claimed for each dependent who doesn’t qualify for the child credit. The maximum refundable portion is $1,400 per qualifying child. The refundable portion is equal to 15% of a taxpayer’s earned income in excess of $2,500 to the amount the tax credit exceeds the taxpayer’s tax liability. In addition, there are new requirements for a proper taxpayer identification number. A social security number will be valid only for a person who is a U.S citizen or is authorized to work in the U.S. Without this, the refundable credit is limited to $500.
So, are you better or worse off under the new law? Here it depends on your tax rate. A credit is a direct reduction in taxes. The tax savings doesn’t depend on your tax rate. With a deduction, the value depends on your tax rate. For example, Bob and Susan can get a $1,000 tax credit or a $4,150 deduction (the amount of the personal exemption for a child). They’re in the 10% bracket. The tax credit will save them $1,000 in taxes, but a $4,150 deduction will only reduce their taxes by $415 (10% of $4,150). Jack and Jill can also choose between a $1,000 credit or a $4,150 deduction, but they’re in the 35% bracket. The $4,150 deduction will reduce their taxes by $1,452.50. They’re better off with a deduction.
Under the old law a qualifying child would give you a $1,000 credit and a $4,150 deduction. Continuing the example above, under the new law Bob and Susan now have $2,000, much better than the $1,000 credit and a personal exemption which would save $415 in taxes. Jack and Jill get a $1,000 credit (which they would not have gotten under prior law because of the phaseout of the credit). But they also get another $1,000 credit instead of a $4,150 deduction which would have been worth $1,452.
There’s another important difference here. Under prior law a qualifying child for the dependency exemption had to be either under age 19 or, if a full-time student, under age 24 at the end of the calendar year. For the $2,000 credit the child must be under the age of 17. For a dependent older than that you’re only entitled to a $500 credit. Offsetting this is the phaseout of the child credit under the new law which occurs at a much higher income level.
Stay tuned ladies and gentlemen there is more TCJA fun to follow, you can find Part 2 of this article here.
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