Well, folks – it’s finally here. Congressional Republicans spent most of the fall crafting, arguing over, and adding and deleting provisions from a sweeping tax reform bill, and President Trump just signed it into law (and held up his huge signature to the cameras). It’s the first significant legislative achievement of The Donald’s presidency and the first major overhaul of the tax code since 1986. Also, just like Obamacare in 2010, the new tax law passed without a single vote from the minority party. In contrast, the 1986 tax law passed with a simple “voice vote” in the House, and by a 97-3 majority in the Senate – results that can only be attributed to a long-forgotten and apparently outdated concept called “bipartisanship.” I had to Google it – 21st Century lawmakers may want to think about doing the same.
Immediately after signing it, the President had the new law shipped to the North Pole to be loaded onto Santa’s sleigh and delivered to all Americans (both naughty and nice) just in time for Christmas. He had to send it FedEx because the U.S. Postal Service couldn’t guarantee on-time delivery (#Sad). Anyway, whether waking up to find the revised tax code in your stocking on Christmas morning made you feel like you got a brand new iPhone X or just a gigantic lump of government-issued coal will depend on several factors. My job is to go through how those factors will affect individual taxpayers, so you can decide whether to drink a little more egg nog to celebrate your tax windfall, or to spend New Year’s Day plotting how to tell President Trump and Congressional Republicans: “You’re fired!!!” as soon as possible.
First, tax rates go down for all taxpayers.
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So, what are the big picture takeaways here?
1) Generally speaking, the rates themselves are lower pretty much across the board. The progression is 10%-12%-22%-24%-32%-35%-37%, instead of 10%-15%-25%-28%-33%-35%-39.6%.
2) The dollar amounts subject to lower rates are generally higher. Let’s take taxpayers who are married filing jointly – they get an additional $400 of income taxed at the lowest 10% rate, then the next bracket up caps at $77,400 instead of $75,900, the next one up caps at $165,000 instead of $153,100, then at $315,000 instead of $233,350, and so forth. At the top, only income above $600,000 is taxed at the highest rate, instead of everything above $470,700. The results are similar for single taxpayers.
While the tax brackets and rates are certainly important, anyone who’s done their own taxes knows that before those numbers apply, you have to determine how much of your income is actually subject to taxation. This is where the ever-popular “tax deduction” comes in. Tax deductions come in two primary flavors: 1) “Above the line” deductions; and 2) “Below the line” deductions.
Above the Line Deductions
Above the line deductions are those you enter on the first page of your tax return. They are technically “adjustments to income” because they are subtracted from your gross income to determine your Adjusted Gross Income (“AGI”). Generally speaking, above the line deductions are more valuable than their below the line brethren. This is for two main reasons: 1) You can take above the line deductions even if you don’t itemize your below the line deductions – they are taken in addition to (not instead of) the standard deduction (if you go that route) below the line; and 2) As alluded to above, they reduce your AGI – and the lower your AGI, the more below the line deductions and tax credits you may qualify for. Let’s go through some of the most common above the line deductions to see what, if anything, has changed under the new law
1) Traditional IRA Contributions – No change. Still an above the line deduction, and contribution limits remain $5,500 for people under 50, and $6,500 for folks 50 or older.
2) Contributions to Other Qualified Retirement Plans – Here, we’re talking about 401(k)’s, 403(b)’s, and other types of retirement plans. Contributions to these remain above the line deductions as well. In fact, if your employer withholds your contributions from your paycheck, these contributions are already deducted for you and are not even reported as income on your W-2. The new law doesn’t make any significant changes here.
3) Health Savings Account Contributions – There had been talk that the GOP would “supercharge” this deduction by greatly increasing the annual HSA contribution limits. No such luck. HSA contributions for 2018 are capped at $3,450 for individuals and $6,900 for families (which represents a small inflation-related increase over 2017, which had already been announced). These contributions remain an above the line deduction.
4) Student Loan Interest Payments – This is a big one for those of us who went to graduate school and have what one of my former law school classmates likes to call a “soul-crushing” student loan debt burden. The current law provides some minor relief from that soul-crushing burden by allowing an above the line deduction for up to $2,500 of student loan interest paid during the year, as long as your income doesn’t exceed certain AGI limits. The House bill eliminated this deduction completely, and prompted thousands of sad-face emojis from grad school alumni across the country. Luckily, the Senate swooped in, and in the final law, the student loan interest deduction survived without change.
Below the Line Deductions
When it comes to below the line deductions, we all have two choices, take the Standard Deduction offered by the government, or, if they add up to being more than the Standard Deduction, list and report the various types of expenses the government has decided that you may deduct from your taxable income (i.e. “itemize” your deductions). Let’s see what happened to some of the most popular below the line deductions:
1) The Standard Deduction – Before we get into the individual itemized deductions, we have to talk about the Standard Deduction because the changes here will likely lead to a lot less people itemizing. The amount of the Standard Deduction has increased from $6,350 to $12,000 for individuals, and from $12,700 to $24,000 for folks who are married and filing jointly. So, cue the confetti and champagne, right? Not so fast.
While it expands the Standard Deduction, the new law also repeals the “Personal Exemption” which was $4,050 per family member in 2017, subject to being phased out at certain AGI levels. So, in 2017, a married couple with three children under the age of 18 taking the Standard Deduction could deduct a total of $32,950 below the line: $20,250 ($4,050 x 5 family members) worth of Personal Exemptions, and an additional $12,700 for the Standard Deduction. In 2018, by taking the Standard Deduction again, that same family of five will only be able to deduct $24,000 below the line because there are no Personal Exemptions available.
2) Mortgage Interest Deduction – The current law allows you to deduct interest paid on up to $1 million of qualified home acquisition indebtedness with respect to your principal residence and one other residence, as well as interest paid on up to $100,000 of qualifying home equity indebtedness.
The new law does not change anything when it comes to deducting interest on loans used to purchase such residences prior to December 15, 2017. However, it does place a new cap of $750,000 of acquisition indebtedness used to acquire, build, or substantially improve such residences after December 15, 2017. It also eliminates any deduction for home equity indebtedness, effective January 1, 2018, without any grandfathering for existing home equity indebtedness. This means that once you kiss your significant other at midnight on New Year’s Eve, you can also kiss goodbye any deduction for home equity indebtedness.
3) State and Local Tax (“SALT”) Deduction – Currently, you can take a deduction for the amount you pay in state and local property and real estate taxes, plus either the amount you pay in state and local income taxes or state and local sales taxes. After nearly being eliminated completely, the final law preserves the SALT deduction, but caps it at $10,000 (in the aggregate between property taxes and either income or sales taxes) per year. In addition, to prevent folks from attempting to maximize their state and local tax deductions in 2017 (before the cap takes effect in 2018), the new rules explicitly state that any 2018 state income taxes paid before the end of 2017 are not deductible in 2017 (and instead will be treated as having been paid at the end of 2018). However, this restriction applies only to the prepayment of income taxes (not property taxes), and applies only to actual 2018 tax liabilities.
4) Charitable Deduction – No major changes here. However, while the limit for this deduction is currently 50% of AGI, it will be increasing to 60% of AGI starting in 2018.
5) Medical Expense Deduction – The current law permits a deduction for medical expenses in excess of 10% of AGI (7.5% of AGI for people 65 and older). The House bill eliminated this deduction entirely. However, the Senate stepped in again, and the new law not only retains the deduction, but allows the deduction to begin at 7.5% of AGI for all taxpayers in 2017 (yes, retroactively) and 2018. After that, the deduction is only available to the extent that expenses exceed 10% of AGI for all taxpayers (so, there’s no 7.5% AGI carve out for those 65 and older).
Tax credits are awesome because, unlike both above and below the line deductions, they are subtracted from your actual tax liability, instead of from your taxable income. So, while a $100 tax deduction might save you as much as $37 in taxes in 2018 (if you are in the highest 37% tax bracket), a $100 tax credit will save you $100 in taxes. Put another way, tax credits reduce the amount of tax you owe dollar for dollar.
There are tax credits out there that apply to premiums for health insurance purchased on the Health Insurance marketplace, certain education expenditures, folks living abroad, and other situations, but I am going to focus on two credits that apply to families and parents:
1) The Child Tax Credit – Currently, parents get a $1,000 tax credit for each qualifying child under the age of 17, but that credit phases out starting at $75,000 of AGI for individuals, and $110,000 of AGI for those of us who are married filing jointly. Under the new law, the credit is increased to $2,000 per qualifying child, and the phase out wouldn’t kick in until $200,000 of AGI for individuals and $400,000 of AGI for married couples filing jointly. In many cases, this will help to offset the loss of the personal exemptions described above. Of the $2,000 credit per child, $1,400 is “refundable.” This means that if the application of the credit brings your total federal income tax liability below $0, up to $1,400 of the credit, per child, will still be added to the refund check the government will send you.
2) The Child and Dependent Care Credit – This provision allows you to claim a tax credit equal to somewhere between 20% and 35% (depending on your AGI) of actual child and dependent care expenses up to $3,000 for one person, and up to $6,000 for two or more people. This credit was not changed (or seriously threatened to be changed) during the tax overhaul process.
One more thing, Republicans also used the opportunity of crafting a new tax law to strike a serious blow to the crowning legislative achievement of President Trump’s predecessor – namely, Obamacare. Starting in 2019, the penalty for failing to purchase qualifying healthcare will be reduced to $0. This is what they mean when they say the new tax law repeals the ‘individual mandate.”
At the end of the day, at least in the short term (the law expires in 2025, unless it is subsequently renewed), most Americans will see at least a small increase in their paychecks because of the new law. So, who are some of the biggest winners and losers under the new system?
Winners: People with Multiple Children under Age 17. Most Americans will qualify for the full $2,000 credit, per child. So, if you’ve got five kids under 17, that’s a $10,000 tax credit and $7,000 of it is refundable.
Losers: High Income Taxpayers in High Tax States. For some people in places like New York, New Jersey and California, the $10,000 limitation on the SALT deduction will increase their taxable income by $50,000 or more. Yikes – I guess Republicans figure they weren’t winning these states anyway!
Winners: People with High Medical Expenses. The Medical Expense Deduction survived and was even expanded for 2017 and 2018.
Losers: Empty Nesters and People without Children. The Child Tax Credit serves to at least partially offset the loss of the Personal Exemption (and in some cases the math even comes out better for parents). No such luck if you don’t have any kids under 17.
Winners: Charitable Donors. Republicans retained this deduction, and increased the percentage of donations that can be deducted.