If you’re like me, then you probably a) know that the US government passed a new tax law and heard it is supposed to greatly reduce your taxes and b) probably haven’t looked much further into it. Falling into that category myself, I decided to do some reading into the subject, to learn more for myself (since I do pay taxes) and to share with others (i.e. you, the reader!) It’s worth noting that I’m not a tax lawyer or a professional accountant, so definitely supplement my thoughts with research of your own. One good way that I’m planning to see how the new law will affect me is to review as I do my taxes this year, and compare it to what I would pay with the new tax law.
How do taxes work again?
Ah, a good question and a good place to start. Taxes in the US start with your gross income, which is the total amount you made over the past year. This includes wages, dividends, gains from the sale of investment, and any other sources of income you may have. From there, you take a number of deductions that you are eligible for. Previously there were lots and lots of deductions, in all shapes and sizes but with one of the goals of the tax law to simplify the code, some of these have gone away. After you’ve subtracted your deductions, you come up with your adjusted gross income, which is what you’ll end up paying taxes on. You’ll fall into one of seven tax brackets and from there you’ll pay anywhere from 10% to 37%. You’ll calculate that percentage and then owe the government that amount of money. Now, you will have paid the government taxes each paycheck (or quarterly if you’re self employed) and hopefully you’ll have paid them more over the course of a year then you’ll actually owe them…and get a refund! If not, you’ll have to write them a check for the difference.
What are the changes for 2018?
I’ll go ahead and call out one of the big tax changes that doesn’t even affect you directly (but maybe indirectly, or so the politicians hope) – the corporate tax cut. The corporate tax rate has been reduced from 35% to 21%. That means that corporations will be paying a lot less in taxes to the government and will be able to in theory spend the more on growing their business, or giving their employees raises. Although we’ll have to wait and see, early speculation is that unfortunately corporations will give money to their shareholders in the form of dividends or buybacks, instead of spending the money in growth and employee development. We shall see! The other big corporate tax change is how overseas profits are taxed. Previously any income earned in the world was taxed when you brought it into the US, leaving companies to park trillions (estimated at $2T) overseas, not wanting to pay the high taxes on it. Now it’s moving to paying a much lower tax rate on overseas profits, in a move to encourage that money to come home.
Onto the personal changes and what’s changed for regular taxpayers like us. Probably the biggest change is the doubling of the standard deduction. Previously, we all got a standard deduction of $6,350 which means we decreased our gross income automatically by $6,350. If your deductions added up to more than $6,350, you’d itemize your deductions and take all of your eligible deductions. If your total deductions were less than $6,350, you still got to deduct the whole $6,350. In 2018, the standard deduction is now $12,000. Assuming your total deductions are above $12,000, in theory your taxes will decrease, as you’re able to deduct more thanks to the standard deduction. Although this may not affect young professionals, families will likely take a hit by losing the personal exemption, which allowed you to deduct $4,050 per taxpayer. Families with a few kids will likely fare worse without that break. Take a look at your taxes this year and see what your total deductions add up to.
The other big change is the decrease in the tax bracket rates. The 2018 tax brackets have shifted down from 10%, 15%, 25%, 28%, 33%, 35%, 39.6% to 10%, 12%, 22%, 24%, 32, 35%, 37%. So if your adjusted income is $50,00, you’ll now pay 22% instead of 25%. Once again, another decrease in your taxes across the board (except for the bottom bracket of 10%). The other change though is the actual tax brackets have changed. Previously making $470,001 would qualify you for the highest tax bracket, now it takes $500,001 or more to fall into. Other noticeable changes are the top end of the 3rd bracket decreasing to $82,500, which if you made $85K you’d jump into the 4th, although the 4th bracket has decreased so in 2017 you’d pay 25% but now you’ll pay 24%. Although it may vary for you depending on your income level, expect a small decrease in the amount you pay by a few percentage points.
There are a couple of other changes that may affect you. One big one that affects taxpayers in high tax states (California, New York, New Jersey, etc) see their state tax deductions capped at $10,000. This potentially will really affect you if you pay lot of state taxes. Previously you could deduct all state taxes paid from your federal taxes, which definitely helped out if you were paying a lot of state taxes. Now they’ll be capped at $10,000. Some states are looking into creative ways to get around this cap; one example is calling your taxes charitable contributions, which would allow you to still deduct them.
Thankfully the student loan interest deduction (up to $2,500, no change) is still there, you can still deduct charitable contributions as well as retirement contributions and the mortgage deduction (although now capped at $750K instead of $1M) is still here. Graduate school students still don’t have to pay tax on tuition waivers. The other big one (for better or worse) is that the individual mandate is now gone, meaning you don’t have to have health insurance, and don’t pay a tax penalty if you don’t get it. Sigh. Probably a topic for another time but health expenses are definitely expensive and although you may not use it, one emergency could bankrupt you. Perhaps still having a catastrophic plan is wise.
How will I fare?
Certain politicians (i.e. those that passed the bill) are praising this bill saying it’ll be a huge tax break for taxpayers in America. I don’t think I’d go that far but there’s a good chance you’ll pay a little less in taxes moving forward. Taxes are pretty confusing and complicated so it’s difficult to flat out say you’ll pay less or more. As previously mentioned, when you file your 2017 taxes, compare the tax brackets, rates and deductions to what they’ll be in 2018 to get a sense of what your taxes will look like!