Tax Reform: How Will It Affect Me?

In an effort to continue to provide you valuable personal financial information, over the net few months we will have a series of guest bloggers from the tax, insurance, and legal fields. This months guest post is from Megan Hubbard, CPA Senior Tax Manager at Mengel, Metzger, Barr & Co. LLP who specializes in individual, corporate, and partnership taxation and services a variety of industries. 

We’ve all heard the news – tax reform has arrived. For months, talk of possible reductions in federal tax rates, changes to standard and itemized deductions, elimination of certain deductions, and enhancement of tax credits has inundated our news feeds and dominated the world of politics. And with the final approval of the Tax Cuts and Jobs Act in December of 2017, it’s finally time to dive in to the new tax laws and talk about that question you are likely asking yourself about tax reform – how will it affect me?

The answer is – it depends. The most comprehensive tax reform we’ve seen since the mid-1980s, this legislation includes changes that will affect practically every aspect of your tax return, and the impact will depend on numerous factors. What is your adjusted gross income? Do you have dependent children? What are their ages? Do you have income from a business? Do you normally itemize your deductions? Do you make significant charitable contributions each year? Did you receive combat pay while serving in the Sinai Peninsula of Egypt? (Yes, that’s actually in there.) The list goes on and on. With lots of talk about simplifying the tax code, it’s important to understand that tax reform is complicated. Therefore, it will be imperative that you work with your accountant to determine how tax reform will affect you and what planning points you can put in place now to enhance your tax position in 2018.

While there is no simple answer for how tax reform may affect you, there are some aspects of the legislation that will be helpful to understand when having conversations with your accountant in the near future.

·         Tax rates have dropped and brackets have changed. While income tax rates for 2017 will range from 10% to 39.6%, rates for 2018 will range from 10% to 37%. While that may not seem like much of a reduction, the greatest impact will come from the change in brackets and the increase in how much more income you will pay at a lower rate. For example, taxpayers will pay tax of 28% on income from $153,100 - $233,350 if filing married filing jointly for 2017. In 2018, those same taxpayers will pay tax of only 24% on income from $165,000 - $315,000. This means that they will pay not only 4% less tax on all income within that bracket, but income earned from $153,100 to $165,000 will be taxed at the even lower bracket of 22%.

·         Itemized deductions have changed. In the past, you may have been able to deduct all of your property taxes, state and local income taxes, mortgage interest and home equity interest as itemized deductions on your federal return. Starting in 2018, your deduction for property taxes and state and local income taxes will be limited to $10,000 total, and you will not be allowed a deduction for home equity interest unless the funds were used for home acquisition or improvement. For some taxpayers, this is a significant loss of deduction. However, don’t panic yet. The new legislation has introduced a standard deduction of $24,000 for married fling joint taxpayers ($12,000 for single taxpayers) in 2018, which is nearly double the previous standard deduction. When considering the increased standard deduction available, as well as the decrease in tax rates and change in brackets, it is likely that the loss of itemized deductions will not hurt you as much as you might think.

·         Dependency exemptions have been eliminated, but an enhanced child tax credit has been introduced. In the past, you would have received a dependency exemption (a deduction from adjusted gross income) for yourself, your spouse, and each of your dependent children. For 2017, that deduction is $4,050 per person. You would also receive a child tax credit (which is a dollar for dollar reduction in your tax) of $1,000 for each dependent child under the age of 17. However, that child tax credit would phase out once your income reached $110,000 for married filing jointly taxpayers ($75,000 for single taxpayers). Starting in 2018, the dependency exemptions have been completely eliminated, but the child tax credit has been increased to $2,000 per child and the phase out limit has been increased to $400,000 for married filing jointly taxpayers ($200,000 for single taxpayers). So although you may be losing your dependency exemptions, it’s likely that the enhanced child tax credit and the higher phase out limits for that credit with make up for the loss of those deductions.

·         Owners of pass-through businesses (sole proprietorships, partnerships, and S corporations) may receive a Qualified Business Income (QBI) deduction of 20% of their net income from the pass-through. Due to significant decreases in corporate tax rates, the tax reform package includes a new deduction for owners of pass-through businesses that seeks to level the playing field by reducing the amount of business income that individual taxpayers will be paying tax on at individual tax rates that are higher than the corporate tax rate. Regardless of what type of industry your pass-through business operates in, you will be eligible to receive a deduction of up to 20% of the net income from your business if your taxable income is below $315,000 for married filing jointly taxpayers ($157,500 for single taxpayers). Once your taxable income exceeds those thresholds, additional limitations apply. The major caveat for this deduction applies to taxpayers who operate a pass-through business in one of the industries that the legislation has labeled as a specified service trade or business. These include services in the fields of health, law, accounting, financial services, brokerage services, actuarial science, consulting, athletics, investing and investment management. If you operate in one of these fields and your income is the below the $315,000 ($157,500) limit mentioned earlier, you will still receive the benefit of this deduction. However, if your income exceeds this limit, you will not be eligible for the deduction.

While the question of how tax reform will affect you may not be easy to answer, the fact is that everyone filing a tax return in 2018 will be affected by tax reform. For this reason, make sure you reach out your accountant sooner rather than later to discuss the impact this new legislation may have on you.