With the passage of the Tax Cuts and Jobs Act, we’ve entered a new regime of personal income taxation that for most will see a reduction in their federal income taxes. According to the Tax Policy Center, 80% of taxpayers will receive a tax cut – averaging about $2,100 – and about 5% would face an increase. With all the news being reported, we thought it would be good to touch on a few of the most impactful changes our clients will likely experience.
Marginal Tax Brackets Are Generally Reduced
As the following charts demonstrates, the majority of clients will see a slight reduction to their marginal tax bracket ranging between one and four percent. These marginal brackets are in effect through 2025.
Keep in mind these brackets are based on your taxable income, not your gross income. Generally, taxable income is your gross income adjusted for personal exemptions and deductions.
Personal Exemptions and Standard Deductions Combined
To simplify the tax filing process, the Act eliminates personal exemptions and doubles the standard deduction. Single taxpayers would see their standard deduction go from $6,000 to $12,000, while married couples filing jointly would see theirs go from $12,000 to $24,000. Although personal exemptions were eliminated, the increased standard deduction will translate into a lower taxable income for most taxpayers, and hence a lower tax bill.
For those of you with children, you may be wondering what the elimination of the personal exemption means for you. The Act provides for a child tax credit of $2,000 per qualifying child. This actually works out better than the old scheme since a tax credit directly offsets your tax due rather than reducing your taxable income. The bill also creates a new $500 credit for qualifying dependents who are not qualifying children, i.e. taking care of parents. These tax credits begin to phase out for married taxpayers filing jointly at $400,0000 and at $200,000 for everyone else.
Itemized Deductions See Changes Too
- The Act imposes several changes to itemized deductions. Here are a few that are note worthy:
- The Act repeals the overall limitation on itemized deductions through 2025.
- Mortgage interest: The home mortgage interest deduction is modified to reduce the limit on acquisition debt to $750,000 from $1 million.
- Home equity loans: Home equity loan interest deduction is repealed through 2025.
- State and local taxes: The Act limits the amount of the deduction to $10,000. In Florida, we’re able to deduct the sales taxes we pay on the goods we purchase throughout the year. This, coupled with your property tax will be limited to the $10,000 deduction ($5,000 for married filing separate).
- Miscellaneous itemized deductions: All miscellaneous itemized deductions subject to the 2% floor are repealed through 2025. This includes investment advisory fees, tax preparation fees, etc.
- Medical expenses: The Act reduces the threshold for deduction of medical expenses to 7.5% of adjusted gross income for 2017 and 2018. If you have medical expenses this year, get your records together and see if they exceed the threshold.
- Charitable contributions: The Act increases the limit for charitable contributions to public charities to 60% of adjusted gross income.
Capital Gains and Qualified Dividends Remain As Is
Under the Act, the thresholds for the 0%, 15% and 20% long-term capital gains and qualified dividends tax rates remain unchanged and will be applied according to the old marginal tax brackets, not the new ones. This means preferential rates for capital gains and qualified dividends will no longer clearly align with the ordinary income tax brackets. The 3.8% Medicare surtax on net investment income still applies for individuals with and AGI of $200,000 and $250,000 for married couples.
Business Income From Pass-thru Entities Taxed More Favorably
Individuals whose income includes income from the ownership of a business (LLC, S Corp or sole proprietor) will be allowed to deduct 20% of the “qualified business income”. What this effectively means is the marginal tax rate assessed against this business income will be reduced by 20%. If you are a married taxpayer filing jointly and are in the 24% marginal bracket, the business income portion of your taxes will be taxed at 19.2% instead of 24%.
There are quite a few nuances to this part of the Act, but generally speaking, pass-through business income will be taxed at a lower marginal rate than wage income.
There are many more provisions in the Act that may influence your personal circumstances. We’ve already begun to dive in and explore the bill. As we meet with you throughout the coming year, we’ll be focusing on how the new tax regime applies to your situation and offering advice on how to make smart decisions and avoid mistakes. Until then, if you have any questions, please let us know.