The Tax Cuts and Jobs Act (TCJA) of 2017 was one of the most sweeping tax code overhauls in decades. The majority of its provisions kicked in January 1, 2018, and most of the changes will expire at the end of 2025 unless Congress extends them. Even though they are likely temporary, the changes could have a potentially big impact on your taxes. Let’s take a look at some of the more important provisions:
1. Tax rates and brackets were changed.
The TCJA kept seven tax brackets but makes significant changes to the tax rates. The tax rates and brackets work in unison and are intended to lower tax bills for the majority of taxpayers.
For example, in 2018 the top tax bracket for married couples filing jointly was formerly 39.6% and applied to incomes over $480,050. Under the revised tax code for 2018, the top rate became 37% and applied to incomes over $600,000 for married/joint filers.
The graphic below shows how the TCJA and pre-TCJA tax rates and brackets compare to each other. The tax law decreased five out of the seven tax rates. In addition, the tax brackets (the amount of money taxed at each rate) shifted, resulting in more income being taxed at lower rates.
Former tax rates and brackets compared to the TCLA tax law, for 2018
Source: Schwab Center for Financial Research.
2. The standard deduction increased.
The revised tax law nearly doubled the standard deduction, to $12,000 from $6,350 for single filers, and to $24,000 from $12,700 for married filers (amounts for 2018). About 70% of taxpayers claim the standard deduction, which includes most low- and middle-income households. The increased standard deduction combined with the increased child tax credit (read more below) is intended to lower the tax bills for the majority of these households.
3. Some itemized deductions were reduced or eliminated.
The revised law reduced or eliminated many itemized deductions in favor of a higher standard deduction. These changes include the following:
- The deduction for state and local income taxes, property taxes, and real estate taxes is capped at $10,000.
- The mortgage interest deduction is limited to $750,000 of indebtedness. However, those who had $1,000,000 of home mortgage debt prior to December 12, 2017, may still deduct the interest on that loan.
- All miscellaneous itemized deductions are eliminated. This includes deductions for tax preparation fees, investment advisor fees and unreimbursed job expenses.
Here are the itemized deductions that remained relatively unchanged and even slightly improved with the TCJA:
Medical expenses: The revised 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 through 2020. Beginning in 2021, only medical expenses that exceed 10% of adjusted gross income are deductible.
- Charitable donations: The revised law preserves all the major charitable donation deductions and increases the cash donation limit to 60% from 50% of adjusted gross income (AGI).
Note: For 2020 only, you’re allowed to deduct up to 100% of AGI for donations of cash to certain charities, under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
All else being equal, if you’re in a high-income household in a high-tax state, with a large mortgage and high property taxes, these changes could increase your tax liability. However, some of the negative impact will may be offset by the changes to the tax rates and brackets.
If you didn’t normally itemize your deductions prior to the TCJA—or your itemized deductions are traditionally less than the new standard deduction implemented with the TCJA—these changes shouldn’t be an issue, and the increased standard deduction will likely benefit you.
4. The child tax credit has increased.
The tax law increased the child tax credit to $2,000 from $1,000, and the income level of households eligible for the credit also increased. Prior to the TCJA, only households with incomes below $75,000 for single filers or $110,000 for joint filers qualified for this credit. Now, households with incomes below $200,000 as a single filer or $400,000 as a joint filer can claim this tax credit.
Generally, tax credits are better than tax deductions, because credits reduce your taxes dollar for dollar, while deductions only lower your taxable income. This change was intended to benefit many low- and middle-income households with children.
5. The personal exemption and dependent deduction were eliminated.
The revised law eliminated the personal exemption and dependent deduction. However, when combined with the increased standard deduction and increased child tax credit, lower- and middle-income households should have seen a net benefit despite the elimination of these deductions.
However, higher-income taxpayers might see an increased tax bill from this change if they have large families and don’t qualify for the child tax credit.
6. The alternative minimum tax (AMT) was changed but not eliminated.
The revised law increased both the exemption and the exemption phase-out amount for the individual AMT. Beginning in 2018 and ending in 2025, the AMT exemption amount increases to $113,400 for married taxpayers filing a joint return and $72,900 for all other taxpayers. The phase-out thresholds increase to $1,036,800 for married taxpayers filing a joint return and $518,400 for all other taxpayers (amounts for 2020).
These changes should have benefited 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 this tax law.
8. The taxation of income from pass-through entities has changed.
This is a complex area of tax law, and the TCJA law included numerous changes to the taxation of income from pass-through entities such as S corporations, limited-liability corporations and partnerships. In general, the 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 should be beneficial to many business owners, but a lot of service businesses may not get to enjoy all the benefits of these changes.
9. The corporate tax rate has declined.
The revised tax law reduced the corporate tax rate to a flat 21% from the highest 35% rate in the prior system. Lowering the corporate tax rate was intended to increase the profits of many companies, thus providing additional capital for business expansion, increasing dividends to shareholders, and making 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 revised 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 taxes, including earned income, credits, deductions and other factors, work together like interacting cogs. So, each of these tax changes should not be assessed solely in isolation.
Because of the large number of tax law changes in the TCJA, it’s more important than ever to meet with a tax or financial planning professional to go over your specific situation and ensure that you’re maximizing your tax benefits under these tax laws.