A major goal of the new tax reform law is to stimulate economic growth by lowering taxes. The bill’s reduction in the corporate tax rate from 35 percent to 21 percent is designed to support this goal by making America more competitive worldwide as a location for corporations. Another significant aspect of the law aimed at boosting economic activity is the substantial increase in the standard deduction for individual taxpayers. This change will deliver a tax cut to a majority of Americans, giving them more spending money at tax time or in their paychecks through reduced withholding.
In addition to reducing taxes as a means of stimulating the economy, another goal of tax reform was to simplify the tax code. Raising the standard deduction means that fewer taxpayers will need to navigate the complexities of itemizing deductions, making it feasible for an increasing number of Americans to complete their tax forms without outside assistance.
The new tax rates became effective on Jan. 1, 2018. The nonpartisan Tax Policy Center projects that as a result of tax reform, 80 percent of taxpayers will see a tax cut in 2018, with only 4.8 percent experiencing a tax increase. The think tank estimates that the average household will see a tax savings of $1,610 in 2018. This represents an approximate 2.2 percent boost in the average household’s income.
The increase in the standard deduction will see it rise from $6,350 to $12,000 for individuals, and from $12,700 to $24,000 for married couples filing jointly. Currently, around 70 percent of Americans use the standard deduction rather than itemizing. The latest changes make it likely that this percentage will rise significantly. It should be noted, while the changes to the corporate taxes are permanent, the individual tax rates in the bill are slated to expire in 2025. However, the sponsors of the bill expect that rather than raise taxes substantially for individuals by letting them expire, Congress will extend these changes or make them permanent before 2025.
The new tax law keeps the seven tax brackets in effect currently but reduces some of the tax rates and adjusts the income thresholds at which these rates are applied. Notably, the current top tax bracket of 39.6 percent for single taxpayers making more than $418,400 and joint filers making more than $470,700 has been lowered to 37 percent, while the threshold for falling into this bracket has been raised to $500,000 for single filers and $600,000 for those filing jointly.
Besides the increased amount of the standard deduction, another reason that more individual taxpayers are likely to use it rather than itemize deductions is the provision in the bill limiting State And Local Tax (SALT) deductions to a maximum of $10,000. Previously SALT deductions were not capped. As a result, taxpayers in states with high income or property tax levels such as New York, New Jersey, California, etc. may find themselves better off taking the standard deduction than itemizing in the wake of these changes. Individual circumstances will differ, of course, and there are many other itemized deductions available that may still make it advantageous for an individual to itemize. The mortgage interest deduction is still in effect, for instance, although the maximum amount of a loan for which mortgage interest can be deducted has been reduced to $750,000 from $1 million. There have been no changes to another popular item, the charitable contributions deduction.
Whether you decide to itemize deductions will depend on how close you fall to the $12,000 or $24,000 standard deduction limit. If your itemizable deductions only slightly exceed the standard deduction limits, you may want to consider if saving a small amount on taxes is really worth the extra effort involved in itemizing deductions. For instance, if your itemizable deductions as a married couple filing jointly are $24,600, the small amount in tax savings you will gain from itemizing may be eclipsed by the extra time spent documenting those deductions. Another factor to take into account is that certain deductions may increase the likelihood you will be audited by the IRS. Additionally, itemizing deductions can result in higher tax preparation fees.
The tax reform bill will lead to lower tax withholding for many Americans. When calculating withholding, the first step is to determine how many withholding allowances you can claim. A single person with no children, for example, would typically be granted one allowance. The IRS is still working on updating its Form W-4, which is used by employees to determine the correct number of withholding allowances they should claim according to their specific situations. When the new W-4s are released, be sure to complete one to ensure that your withholding is correct. Please note that because withholding tables are provided for general usage, your actual tax liability may differ from what the tables predict.
The bill has expanded the child tax credit so that individuals with children can receive a tax credit of as much as $2,000 per child. Even individuals with no tax liability can receive these credits, albeit at a reduced rate of $1,400 per kid. There is also a new, nonrefundable credit of $500 that applies to dependents other than children. The income threshold where these benefits are phased out rises from $110,000 per couple to $400,000. Employer tuition assistance of up to $5,250 per year remains tax free to you on qualifying continuing education programs. In addition, the student loan interest deduction of up to $2,500 per year was left untouched. This benefit phases out completely for single earners making more than $80,000 or couples earning $165,000 or more. The Alternative Minimum Tax (AMT) will affect fewer taxpayers after tax reform now that the amount of income exempt from the AMT has been raised from $84,500 adjusted for inflation to $109,400 for married filing jointly, and from $54,300 adjusted for inflation to $70,300 in the case of single taxpayers.
The tax reform bill eliminated the deduction for moving expenses, other than certain exceptions for members of the military. It also removed the bicycle commuting deduction as well as the deduction for hiring a tax preparer to do your taxes. Additionally, the bill eliminated the tax penalty for not purchasing health insurance, which had been in force under the Affordable Care Act (also known as Obamacare).
Individuals who participate in pass-through entities such as LLCs, S corporations or real estate investment trusts have been granted a 20 percent deduction in the new tax law. Unlike corporations, with pass-through entities, as the name suggests, income flows through the entity to be taxed at the owner’s personal tax rate. However, there are several exceptions that may prevent you from taking full advantage of this deduction. Lawyers, accountants, doctors and financial advisors are prevented from using it on income of over $160,000 for single filers and $320,000 for those filing jointly. Broadly speaking, if a business is connected to the person running it so that he or she is integral to the business’ operation, as with a doctor or lawyer, the pass-through deduction is not allowed above the aforementioned phase-out limits. Businesses that are not dependent on a single individual don’t face any such restrictions.
Overall, there is a lot to like about the new tax bill. While it is by no means a perfect piece of legislation, the fact that it will reduce the yearly tax bite for most Americans should, along with the reduction in corporate tax rates, help stoke the economy as a whole in addition to helping most Americans by putting more money in their pockets. The use of the increased standard deduction for this purpose also has the benefit of making the average individual’s taxes easier to compute. Once Congress sees the benefits provided by the bill, we can hope that they will either make the changes to individual taxes permanent or at the very least extend them beyond their scheduled expiration date in 2025.
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