Congress has just passed the most sweeping tax code overhaul in decades. The majority of its provisions kicked in on January 1 and many of the changes will expire after 2025. The tax law changes should have almost no effect on your 2017 tax return.
Let’s take a look at some of the more important provisions within the new law, and the likely effect on your taxes:
1. Tax brackets have changed.
The new law keeps seven tax brackets but changes the tax rates, which shifts income into lower tax brackets. The long-term capital gains tax rates remain essentially unchanged, and short-term capital gains will be taxed at the new ordinary income tax rates.
Most (although not all) taxpayers will owe less under the new rules, according to analyses by various independent think tanks, including the Tax Foundation and the Tax Policy Center. The impact of the changes will vary based on each taxpayer’s income level, amount of itemized deductions and other factors.
Former ordinary income tax brackets compared with brackets in the new law for tax year 2018.
Source: Schwab Center for Financial Research.
2. The standard deduction has increased.
The new law nearly doubles the standard deduction, to $12,000 from $6,350 for single filers, and to $24,000 from $12,700 for married filers. About 70% of taxpayers claim the standard deduction, so most taxpayers claiming this deduction likely will benefit from this change.
If you’re a low- or middle-income household, an increased standard deduction combined with an increased child tax credit should lower your tax bill.
3. Some itemized deductions have been reduced or eliminated.
The new law reduces or eliminates many itemized deductions in favor of a higher standard deduction. These include:
Limiting the deduction for state and local income taxes, property taxes, and real estate taxes to $10,000.
Limiting the mortgage interest deduction to $750,000 of indebtedness.
Eliminating all miscellaneous itemized deductions.
Here are the itemized deductions that remain relatively unchanged:
Medical expenses: The new law preserves the deduction for medical expenses and temporarily reduces the limitation from 10% to 7.5% of adjusted gross income for tax years 2017 and 2018. Beginning in 2019, only medical expenses that exceed 10% of adjusted gross income are deductible.
Charitable donations: The new law preserves all the major charitable donation deductions, with the exception of few specific deductions (such as the deduction for payments made in exchange for college athletic event seats).
All else being equal, if you’re in a high-income household in a high-tax state, with a mortgage and high property taxes, these changes could end up increasing your tax liability. However, if you don’t normally itemize your deductions these changes won’t be an issue, and the increased standard deduction should end up benefiting you.
4. The child tax credit has increased.
The new law increased the child tax credit to $2,000 from $1,000, and the income level of households eligible for the credit. The tax credit is fully refundable up to $1,400, and begins to phase out for married/joint filers at income of $400,000 and for single filers at $200,000.
Tax credits are generally better than tax deductions, because credits reduce your taxes dollar-for-dollar, while deductions only lower your taxable income. This change should benefit low- and middle-income households with children.
5. The personal exemption and dependent deduction have been eliminated.
The new law eliminates the $4,050 personal exemption and dependent deduction. When combined with the increased standard deduction and increased child tax credit, lower- and middle-income households should see a net benefit despite the elimination of these deductions.
However, higher-income taxpayers could see an increased tax bill from this proposal if they have large families and don’t qualify for the child tax credit, because of the income phase-outs within the tax bill.
6. The alternative minimum tax (AMT) was changed but not eliminated.
The new law increases both the exemption and the exemption phase-out amount for the individual AMT. Beginning in 2018 and ending in 2025, the AMT exemption amount is increased to $109,400 for married taxpayers filing a joint return and $70,300 for all other taxpayers. The phase-out thresholds are increased to $1 million for married taxpayers filing a joint return, and $500,000 for all other taxpayers.
These changes should benefit many middle- and high-income households that were previously affected by this tax.
7. Treatment and calculation of cost basis on investment sales remains unchanged.
The Senate tax bill had a provision that would have required investors to use the “first-in, first-out” (FIFO) method to calculate cost basis for investment sales. Investors can breathe a sigh of relief, as this provision was not included in the new tax law.
8. Changes to the taxation of income from pass-through entities.
This is a complex area of tax law, and the new law includes numerous changes to the taxation of income from pass-through entities such as S corporations, limited-liability corporations and partnerships. In general, the new law allows businesses to exclude 20% of their net income from taxation, subject to certain limitations. The deduction could also be limited or disallowed for specified service trades—such as lawyers, doctors and accountants—based on an income threshold.
Overall the changes to the taxation of pass-through entities will be beneficial to many business owners, but a lot of service businesses won’t get to enjoy all the benefits of these changes.
9. The corporate tax rate has declined.
The new tax law reduces the corporate tax rate to flat 21% from the highest 35% rate in the prior system. Lowering the corporate tax rate will increase the profits of many companies, which could provide additional capital for business expansion, increase dividends to shareholders and make the U.S. a more attractive place for foreign businesses to open operations.
10. There were no changes to tax-deferred retirement accounts.
Early on in the tax debate, it was rumored that there could be changes to the deductions taxpayers receive for contributing to tax-deferred retirement accounts, such as IRAs or 401(k) retirement plans. The new tax law did not include changes to tax deferred accounts.
It’s important to remember that the impact of any of these changes on your personal tax liability will depend on your specific circumstances. In addition, the individual components of your tax bill, including earned income, credits, deductions and other factors work together, like interacting cogs. Therefore, each factor should not be assessed solely in isolation.