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Friday, December 22, 2017

We have tax reform!

Today (12/22/17), President Trump signed H.R. 1, the Tax Cuts and Jobs Act (the name we all know it by, but its real name is something else*) (P.L. 115-97). This is a big deal because there are lots of changes and many will have impacts on other provisions. There is too much to cover in this post, but I'll offer a few observations for individuals to get ready.
  • To know if your taxes are going up or down, you need to run your own numbers. Just because a friend will have a tax decrease or increase doesn't mean you will. Variables include your income level, age of your children, how many itemized deductions you are losing (see next), whether you have a business, and more.
  • No personal or dependency exemption starting in 2018. Instead, you get a $2,000 credit per child under age 17; $500 credit for other dependents. The phase-out threshold is raised ($200,000 if single and $400,000 if married filing jointly).
  • The standard deduction is increased.
  • Key changes to itemized deductions are that interest on home equity debt is no longer deductible starting in 2017, for 2017 and 2018 the medical deduction AGI threshold will be 7.5% for both regular tax and AMT, no casualty or theft loss unless from a federally-declared disaster, no miscellaneous itemized deductions subject to the 2% of AGI threshold, and state tax deduction can't exceed $10,000.  Charitable deductions mostly remains the same except the income threshold for cash donations increases from 50% to 60% and there is no deduction for seating rights at the university athletic stadium. The limitation on itemized deductions for high income taxpayers is repealed starting 2018. Note: No deduction allowed in 2017 for prepayment of 2018 state and local income or property taxes.
  • Tax rates change. The top rate will be 37% rather than today's 39.6%.
  • The capital gain rate structure mostly stays the same.
  • The individual AMT remains but with higher exemption amounts.
  • No alimony deduction or income for agreements entered into after 2018.
Tax reform will warrant some new thinking. For example, many individuals who have itemized in the past might find their standard deduction amount is higher. Fewer people will be subject to AMT. The reason is that common adjustments that caused many individuals to owe AMT are gone or diminished. Home equity debt interest expense and miscellaneous itemized deductions subject to the 2% of AGI threshold are no longer deductible for regular tax. So they won't cause you to owe AMT. Also, your state tax adjustment can't be any larger than $10,000 because that is all you're allowed to deduct for regular tax purposes.

There is a lot to get used to!

Most items go into effect for 2018.  Most individual changes expire after 2025 and we go back to the law as it is today.  One exception to that is that the penalty for an individual not having insurance coverage goes away permanently, starting in 2019 (not 2018). Also, the use of a less favorable inflation index is a permanent change.

Many people will see a tax cut for 2018 and perhaps beyond (at least through 2025).  Here is one example with an explanation of how the tax savings comes about.

EXAMPLE - Married couple, no children, rents an apartment, salary $150,000

2018 Pre-Tax Reform
H.R. 1
W-2 earnings
Standard deduction
Personal exemptions
Taxable income

Tax reduction under H.R. 1

Marginal tax rate

Explanation for tax savings under HR 1:

  • Deductions are $2,700 more resulting in savings under HR 1 
  • Under both current law and HR 1, the first $19,050 is taxed at 10%
  • The next $58,350 is taxed at 15% under current law and at 12% under HR 1 for savings of $1,751
  • The balance of $51,300 under current law is taxed at 25% ($12,825) while the balance under HR 1 of $48,600 is taxed at 22% ($10,692) for a savings of $2,133
  Total savings = $1,751 + $2,133 = $3,884

Will this couple have any costs associated with tax reform? Arguably, yes. Repeal of the insurance mandate for individuals starting in 2019 will mean fewer people purchase health insurance resulting in higher insurance costs for others. (See CBO 's 11/8/17 report on repeal.) Also, this couple's share of the $1.5 trillion debt embedded in H.R. 1 is $1,008/year as spread among all individual filers (see 11/24 post). And perhaps the couple's employers will offer fewer fringe benefits due to law changes. It is also possible that if the employer has tax savings under H.R. 1, it might increase employee wages.

What do you think?

*Final title of H.R. 1 - An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.

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