The question on many of our minds: Will the changes in tax law affect my household?
As 2017 came to a close, the Tax Cuts and Jobs Act was signed into law by President Trump. The legislation focused on substantive and permanent corporate tax reform. However, the individual tax code received a series of tweaks subject to sunset after 2025. That is, the new individual tax provisions are in place only through 2025 unless Congress takes additional action to extend them further or make them permanent.
While the new law is complex, we’d like to touch on the high points of changes to the individual tax code to help you parse through them and understand how they may affect you.
Over 80% of Americans are expected to receive a tax cut starting in 2018, while just 5% of taxpayers are expected to pay more taxes (sources: Tax Policy Center, Washington Post). In most cases, cuts are expected to be modest; however, much will depend on individual circumstances.
The following are ten changes that apply to tax year 2018:
1. The 10% tax bracket remains unchanged, while the 15% bracket declines to 12%, the 25% to 22%, the 28% to 24%, the 33% to 32%, the 35% holds steady, and the 39.6% slips to 37%. The thresholds are modestly adjusted above the new 22% bracket.
2. The standard deduction nearly doubles to $12,000 for single filers and $24,000 for married filers, reducing the incentive to itemize and simplifying the tax preparation process for some taxpayers.
3. The $4,150 personal exemption is eliminated, and the $1,000 child tax credit doubles to $2,000. In general, rules for charitable contributions remain unchanged.
By itself, the combination of points one, two, and three will likely provide modest tax relief for most families.Those in high-tax states could see the biggest hit, as there will be a $10,000 cap on the total of state, local and property tax deductions.
4. For investors, the preferential tax treatment for long-term capital gains and dividends remains intact, as does the deductibility of contributions to qualified retirement accounts.
5. One important change – the new law repeals rules that allow for recharacterizations of Roth conversions back into traditional IRAs. Once you convert into a Roth, there’s now no going back.
6. The 3.8% Medicare surtax on investment income for high-income taxpayers was retained.
7. The AMT for individuals was not repealed, but exemptions have been widened. Instead of being eliminated from the tax code, the number of people who will be impacted going forward will be greatly reduced.
8. The estate tax still exists, but the exemption amount now doubles from $5.6 million to $11.2 million, and $11.2 million to $22.4 million for couples. This will greatly reduce the number of households subject to an estate tax.
9. The Obamacare mandate that requires all individuals to obtain health insurance was repealed effective in 2019.
10. For business owners, there will be a 20% deduction for pass-through entities, such as S-corps, partnerships, and LLCs which will be a welcome benefit for many business owners, but complex rules may limit the pass-through for some entities. If you’re in this category, you’ll want to visit with your tax advisor to help best position yourself under this new tax provision.
We fully expect that the rewrite of the tax code will produce unintended benefits and unexpected consequences. From an economic standpoint, Congress and the president hope that by lowering the U.S. corporate tax rate from the third highest among 188 nations, the “animal spirits” that have been lethargic for much of the economic expansion will be released. They hope that changes, especially as they relate to business, will encourage firms to open new plants, expand in the U.S., and level the playing field with the global community.
The $64 million-dollar question – will it work? About 90% of economists surveyed by the Wall Street Journal expect a modest boost to growth in 2018 and 2019, but after that, opinions diverge. If tax incentives boost productivity, it could lift long-run GDP potential, which would yield a significant benefit. If the economic benefits end after a two-year sugar high, it will likely be seen as falling short of expectations.
Early anecdotal data offers some encouragement, as several large firms announced year-end bonuses or wage hikes tied to the lower corporate tax rate. At a minimum, the lower tax rate increases longer-run after-tax earnings, which played a big role in the late-year stock market rally. It could also boost corporate stock buybacks and dividends going forward, which could add a tailwind for stocks.
All in all, we’re cautiously optimistic the tax bill will encourage entrepreneurship and economic growth, which would benefit hard-working Americans.
We understand that uncertainty breeds questions and concerns. We’ve only touched the surface and have intentionally chosen not to discuss complexities surrounding changes to the corporate tax code. We encourage you to speak with your tax advisor regarding your specific situation.
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