On Dec 22, 2017, President Trump signed a reform bill called the Tax Cuts and Job Act (TCJA).This sweeping tax reform bill went into effect on January 1, 2018 and has made changes throughout and beyond the tax code. These changes affect:
- Tax brackets
- Deductions: new, eliminated, adjusted
- Personal, estate and gift tax exemptions
- Divorce and separation tax
- Alternative minimum tax (AMT)
- Roth IRA recharacterization
- Child tax credits
- Medical expenses
- Deferred income
- 529 savings plan
- Charitable donations
- Individual mandate penalty
- Statutory withholding rates
Here is a closer look at these changes and how they may affect your taxes in 2018.
Marginal Tax Rates
Marginal tax rates are now lower for every taxpayer across the board starting with 2018 taxes and going forward, as shown in the table below.
The standard deduction is almost doubled for both married joint filers (from $12,700 to $24,000) and single filers ($6,370 to $12,000). (For related reading, see: How do I know whether to itemize deductions or take the standard deduction?)
State and Local Taxes (SALT)
Deductions for state income taxes, local taxes and any property taxes are now capped at $10,000. This change in the tax code was heavily debated in Congress as its impact would be felt by high-earning taxpayers who would pay more in states such as New Jersey, New York, California and others.
The Pease limitation capping the number of itemized deductions has been removed for federal taxes. States have their own rules regarding the number of itemized deductions allowed.
Mortgage interest rates have been capped at $750,000 for the remaining mortgage loan principal for any loans taken out December 15, 2017 or later. The deduction for home equity loans has been removed as compared to $100,000 being deductible under the prior tax rules. Homeowners with a home equity line can still borrow against their home to buy rental properties and claim an itemized deduction for investment interest.
Estate and Gift Tax Exemption
Prior to the TCJA, heirs paid estate tax on 40% of any inheritance valued over $5.49 million. The new tax act increases the amount to $11.2 million in inheritance tax exemption for individuals, while a married couple can combine this for $22.4 million. This significantly lowers the collective number of families and individuals paying this tax going forward. You may want to revisit your estate plans and the terms of any agreements, such as trusts, to ensure your funds will be properly divided and both your kids and surviving spouse receive estate benefits. (For more from this author, see: 5 Benefits of Creating a Trust to Manage Wealth.)
Divorce and Legal Separation Tax Changes
Alimony payments are no longer deductible by the payor for divorce or separations that occur after Dec 31, 2018. The payee also does not claim alimony payments as income.
Alternative Minimum Tax (AMT) Exemption
With the new tax reform bill, the alternative minimum tax exemption has been raised, thereby reducing the number of taxpayers who have to pay it. The income levels increased from $120,700 to $500,000 for single taxpayers and from $160,900 to $1 million for married couples with a joint filing. The deductions have also gone up simultaneously to $70,300 for single taxpayers and $109,400 for married couples with a joint filing.
Recharacterization of Roth IRA
After 2017, Roth IRA conversions cannot be recharacterized back to a traditional IRA. This was a strategy employed to benefit account owners by avoiding paying tax if the value of their securities went down during the conversion. (For related reading, see: 6 Reasons Not to Recharacterize Your Roth IRA.)
Income via Internal Revenue Code Section 83(i) Can Be Deferred
Employees can now defer income from qualified stock (employer stock options) or restricted stock unit (RSU) legal settlements from private companies until the stock is liquid through an IPO.
Personal Tax Exemption Removed
Given the significant increase in the standard deduction, the personal tax exemption has been removed. Americans will be able to keep more of their money as the increase in the standard deduction will make up for the removal for the personal tax exemption.
Child Tax Credit Thresholds Increased
The child tax credit thresholds for both single and married (filing jointly) status have increased for 2018 significantly.
529 Savings Plans Can Be Used for Other Education Costs
The new TCJA reforms the existing 529 college savings plan, allowing you to invest money for your child’s education at any level tax-free, similar to a Roth IRA. Previously, the 529 account applied only to college. But be aware, if you use up the funds in this account early on, you will not benefit from the compound interest that occurs when the funds are left alone over a longer period of time. You can also superfund this account with up to $75,000 per donor or parent in 2018. (For more from this author, see: How to Save for Your Kids' College Education.)
Charitable Donations Increase
TCJA increases the deductions you can take for qualified charitable donations to 60% (a 10% increase over 2017) of your income.
Medical Expenses Deduction Increased
Before TCJA, taxpayers were only able to deduct medical expenses not reimbursed at 10% above their adjusted gross income (AGI). AGI is your income after taking out all your deductions. TCJA allows you to deduct expenses at 7.5% of your AGI and up.
Individual Mandate Penalty Removed
While the Affordable Care Act remains, TCJA eliminates the individual mandate penalty, so people who do not purchase health insurance no longer pay a tax penalty. This change will be enacted in 2019.
Additional Deduction Changes
Additional deductions eliminated by TCJA include moving expenses, tax preparation expenses, casualty and theft losses beyond federal disasters, alimony payments, employer-subsidized parking and reimbursement for transportation, and employee expenses that were not reimbursed.
Statutory Withholding Rates Lowered
Withholding rates prior to TCJA on supplemental income were 25% until income reached $1 million, then the rate increased to 39.6%. TCJA changes statutory withholding rates to 22% for income up to $1 million, then 37% above $1 million, matching the new tax rate brackets.
TCJA Will Affect Everyone Differently
TCJA makes tremendous changes in taxes, but its impacts vary by individuals and per family. Hence it is important to plan your taxes carefully and pay attention to any changes in your state as well.
(For more from this author, see: 20 Financial Facts You Should Know by Age 35.)