How does the new tax bill affect me?
The Tax Cuts and Jobs Act brought the most significant changes to the U.S. tax code in over 30 years. It lowered income tax rates, increased the standard deduction, eliminated personal exemptions, and cut the corporate tax rate. You can find very comprehensive reviews and detailed explanations of the tax bill all over the internet. This, however, is not one of those posts. My purpose is to answer the question, “how does this affect me?”
The short answer is this: If you used to take the standard deduction, you’re likely saving money on your taxes. If you used to itemize your deductions or you have kids, you’re probably still saving a little bit on your taxes. If you own a business, you’re very likely saving money on your taxes.
For a longer answer, let’s start with some basics:
The way income taxes work
Every time we get paid, taxes are withheld from our paycheck. At the end of the year, we calculate how much we owe in taxes. If we withheld more than what we owe, we get a refund. However, if we withheld too little, then we owe the government more money. But how do we calculate the amount we should owe? That’s when the tax return, and a collective sigh, enter the picture. On a high level, your tax return helps you calculate how much you owe in three sections.
In section 1, you take your gross income and subtract things like contributions to retirement plans, health savings accounts, and student loan interest. The result is called your Adjusted Gross Income, or AGI.
Section 2 allows you to reduce your income even more. You do this by choosing the standard deduction or itemized deductions. The standard deduction is a fixed amount while itemized deductions require you to add up what you spent on things like medical expenses, charitable giving, interest on your mortgage, and other taxes like property taxes and state and local income taxes. You get to take the higher of the standard deduction or itemized deductions, but not both. The new reduced amount is called your taxable income. This amount is what you plug into the tax brackets to find out how much you owe.
You may get to lower your tax bill in Section 3 with the help of tax credits. Credits are generally more valuable than deductions because credits actually lower your tax bill, rather than just lowering your taxable income. You may qualify for a tax credit for spending money on higher education, childcare, buying ‘green’ cars and appliances, or having/adopting children during the tax year. The amount of the tax credit reduces your taxes owed. Then, you simply compare taxes owed with taxes already withheld from your paycheck. The difference is either the amount we owe or the amount of our refund.
How the new tax bill impacts this calculation
The new tax bill affects all sections of your return, and then some. It begins with your paycheck, well before you file. The new tax bill brought new tax brackets, generally lower than previous years. This means the amount your employer withholds from your paycheck has also been lowered. Many people believe they will receive a larger tax refund come April 2019. In reality, much of that refund has already been given to you throughout 2018, in the form of a slightly bigger paycheck.
Although the tax code is now even more complicated, most taxpayers will have simplified returns. This is because the standard deduction is much larger, meaning fewer taxpayers will benefit from itemizing their deductions. Therefore, fewer taxpayers will be required to track and report expenses to the IRS. Other changes, like removing the personal exemption and limiting state and local property tax deductions will hurt taxpayers that used to itemize, and force them to also take the standard deduction. For these taxpayers, the lower tax rates tend to balance out the negative effects of the changes.
Taxpayers with children have also been affected by the changes. Previously, families could claim a personal exemption for each dependent. By removing personal exemptions, families with children stood to see their tax bills rise. To combat this, they doubled the child tax credit to $2,000 and made it available to more families. They also included a $500 credit for taxpayers with dependents over the age of 17. This helps taxpayers who provide for their elderly parents or their college-age children.
In summary, most taxpayers will see their tax bills decline and many taxpayers will also see their tax returns simplified. Although, this is true for the majority of taxpayers, there are also some taxpayers that will end up paying more in taxes. Tax changes and their implications are unique to each taxpayer’s situation. It’s impossible to make blanket statements that apply to every single person. This post is written to give a high-level understanding and should not be considered tax advice. Please consult your tax preparer to discuss your specific circumstances. It’s also important to note that the changes to individual taxes are effective from 2018-2025. Under current law, we will revert back to the old system beginning in tax year 2026.
Tax planning opportunities
Conversations that we have been having with clients regarding tax planning have been focused in two areas. The first is for small businesses. The tax law creates the ability for businesses structured as LLCs, partnerships, and sole proprietors to take a 20% deduction on their taxable income. This benefit does phase out as income levels increase for service-based businesses. For example: dentists, doctors, insurance agents, and tax firms. If you own a business, we’d be happy to discuss tax planning related to the new law. Very closely related to tax planning, we also help business establish and manage retirement plans. These include 401(k)s, SEP IRAs, and SIMPLE IRAs.
The second area that we are doing a lot of planning in is charitable giving. Because fewer people will be itemizing deductions moving forward, fewer people will benefit from charitable donations. Specifically, if you don’t itemize then charitable gifts don’t reduce your taxable income. For retirees, the most efficient way to work around this is to send a withdrawal from your retirement account directly to the charity. This prevents the income from ever showing up on your tax return, saving you tax dollars. This is especially important for individuals over age 70.5 as they are required to take distributions each year known as RMDs. You could send an RMD or donate stock from a portfolio tax efficiently, rather than writing a check every Sunday at church or giving sporadically to causes you care about. Using a Donor Advised Fund to lump charitable contributions together into one tax year is another example of a way to maximize tax savings for those that are charitably inclined. This is very close to our hearts and we would love the opportunity to help you create the biggest possible impact for causes that you care about.