President Trump has made good on his pledge to massively overhaul the tax code for the first time in nearly 30 years. That’s a HUGE win for the President and the GOP. But what does it mean for you?
Bottom Line: About 90% of you will get a tax cut in 2018. Others will see little change. And for a small and enraged portion of the population – the lower end of the upper one percent – taxes will actually go up. The new tax law is also a gigantic boon for the US economy.
The legislation will reduce taxes by $120 billion for Individuals (and small businesses) and $85 billion for corporations.
Exactly how much of that will you see in your wallet? More on that later.
You can’t underestimate the potential impact of this legislation. It’s the largest tax overhaul bill in the history of America.
- Bigger than the 1963 Kennedy tax cuts
- Bigger than 2003 Bush Tax Cuts
- Second only to the 1981 tax cuts (over the first two years) but arguably bigger overall when all said and done.
I’ve heard this package described as the “shock and awe” tax reform and can find few reasons to disagree. The package equates to an immediate $205 billion stimulus to the US economy in 2018, equating to just over 1% of US GDP. This package dwarfs the Bush cuts in 2003.
Given the similar scope, I think looking at GDP before and after the 2003 cuts is a useful exercise. In 2002 and 2003, real GDP growth averaged 1.5%. Following the cuts, real GDP rose to 4.0% in 2004 and stayed above 3.0% in 2005 and 2006. We think a similar impact could be felt in the coming years, particularly as real GDP has averaged around 2.0% in 2016 and 2017.
So, enough of the macro stuff. How will the Tax Cuts and Jobs Act for 2018 (TCJA) impact your finances? There are 10 factors to consider:
1. The Federal Tax brackets are expanding from 6 to 7. This is a big part of the change. The new brackets are slightly more precise than before, with the lowest rate remaining at 10%, and the highest rate capped at 37%, down from 39.6%. Note that these brackets are set to revert to the pre-2018 levels after the year 2025.
2. Standard Deduction DOUBLES to $12,000 and $24,000 – This part of the new code carries significant weight in helping middle-class families reduce their overall federal taxes. If you spent time and money on tax prep in the past, itemizing a total of $14,000, that may no longer be necessary, as the standard deduction for a married couple is a whopping $24,000.
3. Mortgage Deduction changes – Pretty simple. The maximum mortgage level you can use for mortgage interest deductions will come down from $1.0M to $750k. This is a big deal that this provision was retained…as most Americans have mortgage balances below $750k.
4. SALT – The State and Local Tax Deduction is now capped at $10k. This is arguably the biggest single change in the new tax plan. It takes away dramatic deductions for high wage earners, particularly in high-income tax states like New York, New Jersey, and California. However, from most of our calculations, high earners will still receive a small tax cut (in percentage terms) as the top income bracket has now been reduced from 39.6% to 37%. This bracket reduction (for some taxpayers) will make up for the loss of the SALT deduction.
5. Child Tax Credit Massively Increased – This is being raised from $1000 to $2000 per child, and the number of people who will be able to use this will go up dramatically up to $200,000 if you are single, and $400,000 for married folks. Amazingly, $1400 of this is refundable! Meaning that if you don’t owe taxes, you can get a check back from the government for this refundable credit.
6. Obamacare Individual Mandate Penalty Removed (but not Obama-era increase in Medicare taxes) – No longer are you required to buy health insurance, and no longer will you have to pay a penalty if you DON’T buy coverage. This is a 2019 provision! The average penalty for not carrying insurance had been $470 a year.
7. AMT retained, but with higher exemption amounts – This essentially means that fewer Americans will get hit with the hated Alternative Minimum Tax. For example, under the old law a couple married filing jointly had an $86,200 exemption to protect against AMT, now that income level exemption jumps to $109,400.
8. Charitable Deduction Limit Upped from 50% of AGI to 60% – This is pretty straightforward. And if you give MORE than 60%, the additional amount can be carried forward for up to 5 years.
9. New Inflation Measure – moving from CPI-U to chained CPI-U. Chained link CPI-U grows at a slower rate than standard CPI-U. Moving to chained link CPI will slow the rate at which the tax bracket starting points will rise, resulting in more people jumping to higher tax brackets in the future, that would have been the case under the old way (plain CPI-U). It’s essentially a covert way for the government to increase tax revenue over time.
10. Capital Gains Tax Remains Largely the Same – 0%, 15%, 20%. The Act generally retains present-law maximum rates on net capital gains and qualified dividends. It retains the breakpoints that exist under pre-Act law but indexes them for inflation using C-CPI-U in tax years after Dec. 31, 2017.
- The 2018 15% breakpoint is $77,200 for joint returns and surviving spouses (half this amount for married taxpayers filing separately), $51,700 for heads of household, $2,600 for trusts and estates, and $38,600 for other unmarried individuals.
- The 2018 20% breakpoint is $479,000 for joint returns and surviving spouses (half this amount for married taxpayers filing separately), $452,400 for heads of household, $12,700 for estates and trusts, and $425,800 for other unmarried individuals. (Code Sec. 1(h)(1), as amended by Act Sec. 11001(a)(5))
So, now let’s apply all that to some relatable examples. For this exercise, let’s assume the following:
1. Home Value was 1.5X to 3X your annual income, and mortgage balance was 80% of that value. Due to the tax bill, mortgage interest deductions capped at $750k.
2. Property taxes were 1.8% of the home’s value – this helps the calculator determine if you would/would not lose some of your property tax deduction.
3. SALT – The tax calculator we are using automatically calculates your State Income Tax Deduction. You add in your property taxes, and the calculator automatically caps your total SALT at $10k. We did not assume any other itemized deductions on top of this.
Under the new tax bill:
– Jim, single, no kids, makes $50,000. Taxes go down by about $200 (a 5% reduction in federal taxes).
– Beth is a single mother making $50,000 with 2 kids. Her taxes go down by 73%. From $1366 in taxes to $370.
– Marc and Tracy are married with two kids making a combined income of $150,000. Their taxes will go down by about 8%. Or $1200 bucks.
– Marshal and Lindsay are married with no kids making an income of $150,000. Their taxes actually go up about 800 bucks.
– If Marshal and Lindsay were NOT itemizing, let’s say not homeowners and renting, their taxes would actually be going down relative to what they paid last year by about $3800 because their standard deduction is going up. But rental Marshal and Lindsay, still actually pay more than homeowner Marshall and Lindsay.
– The single $500k guy with no kids gets hammered. Taxes actually going way up. By about $17,000.
– That same guy gets married and has 2 kids and his taxes actually go down. The tax changes seem to reward those filing jointly and who have children under the age of 17.
– Big Big Earners. $2.0 million a year. It really depends on how much you are deducting. But, for the most part, this group should stay flat to go down in what you pay.
For a better assessment of how your taxes might change under the new law, check out this calculator.
Contrary to what you may be hearing from the media, this is a very good tax bill. For you. For companies. For Small Business Owners. When it comes to the economy – ALL of us will benefit. Better for jobs, better for wages, more small business optimism, and entrepreneurship. What’s more, the overhaul may “more than pay for itself”. A GDP uptick from the projected 1.8% to 2.5% “pays for” the $1.5 Trillion in cuts. A 3.5% GDP growth rate pays for the cuts and reduces the debt by $1.5T. Reduces the debt. The jury is still out on this, but this tax bill gives the economy a fighting chance.