The Tax Cuts and Jobs Act enacted in late 2017 was more than 500 pages long, with detailed changes affecting everything from the taxation of trusts to the treatment of life insurance policy acquisition costs. But for most taxpayers, the biggest changes have to do with the new income tax rates, a higher standard deduction, and new limits on many popular deductions.
- The new tax law increased standard deductions but limited or eliminated many other popular deductions.
- The tax bracket income limits and rates were adjusted.
- Far fewer people will claim itemized deductions in the future.
Here is a quick overview of the changes and details on how they may affect your taxes.
Standard versus itemized deductions
A major change from tax reform was a sharp increase in the standard deduction. For tax years 2018 through 2025, the standard deduction will be $12,000 for single filers and $24,000 for married couples filing jointly. That’s close to double the levels in 2017. The law also slightly increases the higher standard deduction for the elderly, the blind, and persons with a disability. But it eliminates the $4,050 personal exemption (see table below).
|Married filing jointly (MFJ)||$12,700||$24,000|
|Elderly or blind (single and not a surviving spouse)||Additional $1,550||Additional $1,600|
|Elderly (both over age 65 and MFJ)||Additional $2,500||Additional $2,600|
|Exemption||Personal exemption||$4,050 per family member||Eliminated|
Changes to deductions and credits
During the debate about tax reform, lots of changes were proposed. Some didn’t make the final bill and remain unchanged—including capital gains rules for the sale of a primary residence, deductions for student loan interest, treatment of tuition waivers, adoption assistance, investment interest, teachers’ out-of-pocket expenses, and the credit for electric car purchases.
A number of important retirement savings incentives were unchanged as well, including deductions for 401(k)s, traditional IRAs, and health savings accounts (HSAs).
On the other hand, there were a wide range of other deductions and credits that were changed, added, or eliminated, including:
|Dependent credit (other than child)||N/A||$500 credit per qualifying dependent|
|Child/dependent tax credit||$1,000 credit per qualifying child < age 17 (modified adjusted gross income [MAGI] limit $110,000 MFJ/$75,000 single)||$2,000 credit per qualifying child < age 17 (MAGI limit $400,000 MFJ/$200,000 single)|
|Moving expenses||Deductible (move >50 miles for a new job)||Eliminated|
|State and local taxes||Deductible (property and sales or income tax)||Capped at $10,000 of expenses (property and sales or income tax, regardless of filing status)|
|Mortgage interest||Limited to interest on $1,000,000 of debt on primary or secondary home||Limited to interest on $750,000 of debt on primary or secondary home (no change for existing mortgages)|
|Home equity loan interest deduction||Limited to interest on $100,000 of debt||Eliminated (does not apply to home equity loans for substantial home improvements that comply with debt limit)|
|Medical expense deduction||Deductible if >7.5% of AGI||No change for 2018
>10% of AGI 2019–2025
|Casualty and theft||Deductible if >10% of AGI||Eliminated (except in the case of federally recognized natural disaster)|
|Alimony||Deductible by the payer;
taxable to the payee
|The deduction for the payer is eliminated;
the recipient is no longer taxed
|Investment interest expense||Deductible up to the amount of net investment income||Unchanged|
|Miscellaneous expenses, including:
· Tax prep fees
· Investment advisory fees
· Unreimbursed work expenses (travel, parking, meals, and entertaining)
· Depreciation on phone or computer required for work
· Investment expenses
· Job search expenses
|Deductible in excess of 2% of AGI||Eliminated|
|Charitable gifts of cash||Limited to 50% of AGI||Raised to 60% of AGI|
Other major changes
The tax reform law included a number of other major changes for individual taxpayers. For one, the new law eliminates the Pease phaseout on itemized deductions for taxpayers with high AGIs from 2018 to 2025. In addition, the law made changes to the alternative minimum tax (AMT) and was designed to reduce the number of taxpayers forced to pay using that system.
The law also created a new opportunity for education funding, allowing taxpayers to use 529 accounts to fund up to $10,000 of K–12 qualified tuition expenses per student each year, in addition to the existing uses for higher education.
|AMT exemption, single||$54,300 exemption||$70,300 exemption|
|AMT exemption, MFJ||$84,500 exemption||$109,400 exemption|
|Pease itemized deduction phaseout, single||Started at $261,500||Eliminated|
|Pease itemized deduction phaseout, MFJ||Started at $313,800||Eliminated|
|529 education savings||Qualified higher education expenses||Expanded to include up to $10,000 in K–12 tuition per beneficiary per year|
New tax rates
Tax reform also reset the tax brackets, setting new income thresholds and tax rates, while retaining the total number of 7 brackets. It’s worth remembering that the tax code is progressive, so your marginal tax rate is the top tax rate you pay—the rate you would pay on an additional dollar of income. But you will generally pay taxes at a variety of rates, depending on your taxable income. So looking at the chart below, a single filer with $85,000 in income would pay taxes at the 10% rate on the first $9,525, pay 12% on the income from $9,526 to $38,700, pay 22% on additional income up to $82,500, and have a marginal tax rate of 24%.
*Chart does not account for the Medicare surtax on high earners. Source: House of Representatives, Tax Cuts and Jobs Act, December 22, 2017.
How these changes play out
Taken together, these changes will dramatically change the tax-filing experience for many Americans. For some, it will simplify the process. Because the higher standard deduction will exceed the value of itemized deductions for many taxpayers, the Tax Policy Center estimates that more than 25 million families will stop itemizing in 2018—that’s more than half the number of people who have itemized in recent years.
How do you know whether it will still make sense to itemize? A general rule of thumb is to start with your tax returns for 2016 or 2017. If your situation is similar in 2018, and your itemized deductions fall below the new standard deduction ($12,000 individual/$24,000 MFJ), you will likely not itemize. If your total deductions exceeded the new standard deduction, you need to consider the new rules for deductions.
However, the total impact of the changes to rates and deductions will vary dramatically from one taxpayer to another. Here are a few simplified case studies that show how some of these changes could play out. These are hypothetical, and to get an accurate sense of what the tax law means for you, consult a tax professional.
Case 1: A higher standard deduction
Let’s look at Julie and Frank, retirees who live in a state with no income tax, have paid off their home, and have limited deductions. They pay taxes as married filing jointly and have been taking the standard deduction for a few years. Let’s say that in both 2017 and 2018 they have income of $90,000 from pensions, a 401(k), and the taxable portion of Social Security. Their local property tax is $4,800, and state sales taxes were $3,200. They made charitable gifts worth $2,000.
In 2017, their total itemized deductions would have been $10,000. So they would have opted for the standard deduction of $12,700. They would also have been entitled to personal exemptions of $8,100, leaving them with taxable income of $69,200. Their 2017 federal tax bill: about $9,400.
In 2018, they would again opt for the standard deduction, because $24,000 would be greater than the $10,000 of itemized deductions. But in 2018, there would be no personal exemptions. Still, they would be better off, with taxable income of just $66,000. Their federal 2018 tax bill: about $7,500.
Case 2: No longer itemizing
Let’s look at Pete and Susan, another couple living in a state without income tax. We will assume that their financial situation is the same in 2017 and 2018: They are married and file jointly, have $150,000 in income from their jobs, and paid $9,000 in mortgage interest on a $350,000 loan, $4,500 in local taxes, and about $9,000 in state sales tax.
In 2017, their total itemized deductions exceeded the value of the standard deduction—$22,500 versus $12,700—so they itemized. They deducted the $22,500 from their income, along with the $8,100 personal exemption, leaving them with $119,400 in taxable income. Their 2017 tax bill: about $21,300.
In 2018, their state and local tax deduction would be limited to $10,000, so their total itemized deductions would consist of the $9,000 in mortgage interest and the maximum of $10,000 in state and local taxes, a total of $19,000. At the same time, the standard deduction rose to $24,000. So in 2018, Pete and Susan choose to take the standard deduction, reducing their taxable income to $126,000. Their 2018 tax bill: about $19,600.
Case 3: Still itemizing
Let’s take another hypothetical couple, Lily and Joe. In this case, we will again assume identical financial situations for 2017 and 2018 and no state income taxes. The couple is married filing jointly, with income of $200,000 from jobs and investment interest, $10,000 a year in mortgage interest payments for their $500,000 home mortgage, $7,000 in property taxes, and another $5,000 in local income taxes. The couple also gives significantly to their local church, $8,000 per year, and a local hospital, $2,000 per year.
In 2017, the couple’s $32,000 in itemized deductions was greater than the standard deduction. After itemizing, they had taxable income of $168,000 and a tax bill of about $34,000.
The couple’s itemized deductions will still exceed the standard deduction in 2018, even after the limit on state and local taxes reduces their total itemized deductions to $30,000 ($10,000 mortgage interest + $10,000 state and local taxes + $10,000 charitable gift deduction). After deducting $30,000, the couple has taxable income of $170,000, higher than 2017, but new tax rates still lower their tax bill to about $29,379.
The bottom line—run the numbers
One of the goals of tax reform was simplicity through standard deductions and higher exclusions for the AMT. For some, it will still make sense to itemize, but many deductions have changed. So if you’ve considered the tax implications of a charitable giving program, property taxes, mortgage debt, or home equity debt, you’ll need to carefully examine how things will change starting in 2018.
If you have questions, it makes sense to work with a professional to see how the law may affect you, and whether there are strategies you should consider to help manage your tax situation going forward.