In the third and final section of our three-part Tax Cuts and Jobs Act article series, we are going to discuss changes to marginal tax brackets, the standard deduction and personal exemptions, and make note of some suspended or modified deductions beginning in 2018.
Changes to Marginal Tax Rates
To start, marginal tax rates based on your taxable income have changed in 2018. The new rates are based on how you plan to file: individual, married filing jointly, married filing separately, head of household, or estates and trusts.
For taxpayers currently in the 28% or lower marginal tax brackets, the new rates will create a positive taxable impact. Additionally, the amount of income taxed in these brackets has increased. These taxpayers will need to pay less taxes on a higher amount of income. Score!
Those in tax brackets above 28% may experience an increase or decrease depending on their level of income.
In order to envision the marginal tax bracket process, imagine each bracket to be like a bucket to fill; each bucket can only hold a certain amount of money and is taxed at a higher percent as income rises.
For example, let’s say your taxable income is $42,000 and you’re filing as a single individual. The changes in your marginal tax brackets between 2017 and 2018 would look like this:
The first bucket (which you must pay a 10% tax rate on) fills up to $9,525 of your income. The second bucket can hold up to $38,700 of your income, and since you have already paid taxes on $9,525 at 10%, the remaining amount for the second bucket becomes $29,175. This second amount is taxed at 12%. The third bucket can hold up to $82,500, but since your taxable income is only $42,000 in this example, this bucket will not be full. The remaining amount of your income that has yet to be taxed is $3,300, which will be taxed at 22% in the third bucket. In total, you will pay a sum of each bucket’s taxed value.
Here is a break-down of the math:
Taxable Income = $42,000
- $9,525 x 10% = $952.50
- $29,175 x 12% = $3,501
- $3,300 x 22% = $726
Total amount paid (marginal tax sum) = $5,179.50
If your income is higher, you will fill more buckets and pay a higher percent of taxes as that number increases (and vice versa with lower income). The bracket percentages have also changed for those married filing jointly, married filing separately, head of households, and estates and trusts.
Changes to Standard Deduction
In 2018, taxpayers will only be able to deduct from their Adjusted Gross Income (AGI) the greater of the standard deduction or sum of itemized deductions. This will determine taxable income. (Previously, you would deduct any personal exemptions from this total as well. See the section below on changes to the personal exemption rule).
In 2017, the standard deduction for single individuals and married couples filing separately was $6,350, and for married couples filing jointly was $12,700. In 2018, the standard deduction has increased to $12,000 for individuals and married couples filing separately and is now $24,000 for married couples filing jointly.
At first glance this seems like a win for taxpayers because you are able to subtract a much higher amount from your AGI and significantly lower your taxable income, especially if you did not itemize or your itemized deductions were below $24,000. However, each taxpayer’s situation will be different due to changes in allowed personal exemptions, which we discuss below.
Changes to Personal Exemptions
Prior to the Tax Cuts and Jobs Act, taxpayers were allowed to subtract personal exemptions from their AGI, which was a set amount for each individual on the tax return (i.e., taxpayer, spouse, and any dependents). In 2017, the personal exemption was $4,050 each. If you had a five-family household, for example, you’d be allowed to deduct $20,250.
Post-TCJA, personal exemptions have been eliminated, meaning the new exemption amount is zero. No personal exemptions can be deducted for anyone on the tax return. For some taxpayers this may significantly impact them negatively.
For example, a married couple filing jointly in 2017 with no dependents would have received a $12,600 standard deduction as well as a personal exemption of $8,100 ($4,050 per person). This gives them $20,700 in total deductions. In 2018, this same couple can now receive a standard deduction of $24,000, but cannot deduct any personal exemptions. In this instance, the couple benefits from the new law and receives $3,300 more in total deductions.
On the contrary, a family with four children in 2017 would have been able to receive a $12,600 standard deduction (married filing jointly) and would also have been able to deduct $24,300 ($4,050 per person) in personal exemptions, which is a grand total of $36,900. Now, in 2018, they are allowed a $24,000 standard deduction, but are no longer allowed any personal exemptions and thus lose out on $12,900 worth of deductions.
Essentially, the more dependents you have, the more negatively this new law will impact your possible deductions. However, if this applies to you, there are also modifications to the child tax credit that can help (see below*).
Important Suspended or Modified Deductions Beginning 2018
Child Tax Credit
2017: Taxpayers could claim a child tax credit of up to $1,000 per child under 17 years of age. The credit was available up to an income level of $75,000 for single filers, $110,000 for married filers, and $55,000 for married individuals filing separately. For every $1,000 over that income level, the taxpayer loses $50 worth of credit per child until fully eliminated.
2018: Taxpayers can now claim up to $2,000 worth of child tax credit per child under 17 years of age. This credit is available up to a $400,000 income level for married couples filing jointly, and up to $200,000 for all other taxpayers. As in the old law, for every $1,000 over that income level, the taxpayer loses $50 worth of credit per child.
* This child tax credit modification can help families with many dependents who have seen significant losses in their deductions due to changes in personal exemptions.
Personal Casualty & Theft Losses
2017: Taxpayers could claim an itemized deduction for uncompensated personal casualty losses, such as that of a fire, storm, shipwreck or other casualty as well as theft.
2018: Personal casualty and theft losses have been suspended except for those declared in a Federally-declared disaster area.
State and Local Tax Deduction
2017: There was no monetary limitation on the amount of property, sales, and/or income taxes that could be deducted.
2018: All property, sales, and/or income taxes combined are limited to a $10,000 deduction if you itemize. This will impact high wealth taxpayers and those in states with high property, sales, and income taxes.
Mortgage and Home Equity Interest Deduction
2017: You could have a mortgage of up to $1 million and an equity credit line of $100,000, both of which allow you to deduct interest paid on the loan.
2018: All mortgages are limited to deductibility of interest only if used for acquisition or improvement purposes, and are only deductible up to the first $750,000 combined. Interest on mortgages taken out for any other reason cannot be deducted.
Exception: The new $750,000 lower limit and acquisition and improvement requirement do not apply to home equity debt obtained before Dec. 15, 2017.
Alimony Deduction by Payor/Inclusion by Payee
2017: Following a divorce, alimony payments were considered deductible by the payor spouse and includable as income by the recipient spouse.
2018: If a divorce was executed or modified in 2018, alimony payments are no longer deductible by the payor spouse and no longer included in the recipient spouse’s income. The income used for alimony is now taxed at the rates applicable to the payor spouse.
Moving Expenses Deduction
2017: Taxpayers could claim a deduction for moving expenses due to acquiring a new job. The new workplace was required to be at least 50 miles farther from the taxpayer’s former residence than their former workplace.
2018: This deduction for new job moving expenses is suspended, with the exception of Armed Forces on active duty who move following a military order.
Miscellaneous Itemized Deductions
2017: Taxpayers were allowed to deduct miscellaneous itemized deductions if they were greater than 2% of the taxpayer’s AGI.
2018: This deduction for miscellaneous itemized deductions is suspended.
What we have discussed above are what we consider to be the primary changes that will affect most taxpayers. However, there are other changes that may impact your tax situation. Keep in mind, all of these changes will revert back to the laws in place prior to the Tax Cuts and Jobs Act after Dec. 31, 2025.
If you have any unanswered questions regarding these changes and how they impact you, please call us to schedule an appointment.