Lots of hubbub and mostly positive press on the new Tax Cuts and Jobs Act lately - but unless you’re a tax pro, reading all of it is dizzying. I wanted to provide a couple of representative examples of families that could be surprised by how the new tax code may change their taxes, since reading the specifics is hard to grab onto without examples.
Enter the Blissful Family
They are a very common family, working parents, three young kids, with pretty simple tax situations. They normally don’t take itemized deductions since the standard deduction has been higher for them, and all their income is from wages. Combined they earn $115,000 per year (I am intentionally selecting an income amount that would not trigger Alternative Minimum Tax, and assuming no other adjustments or credits for simplicity).
Under the old code as it would have been in 2018 without any changes, they would have reduced their taxable income as follows:
$13,000 Standard Deduction
$20,750 Personal exemptions (5 x $4,150 for parents and dependents)
These result in $33,750 subtracted from gross income to arrive at $81,250 in federally taxable income. This income is broken into chunks that are taxed at different rates, but their highest bit of income ($3,850) would have been taxed at the 25% rate, and most of the rest at 15%. Their tax bill would have been $21,196, but they will get a Child Tax Credit of almost $2,250 to offset the tax, so it ends up at about $18,946 – or about 17% of total income.
What will that look like under the new code?
In the new plan, their reductions for taxable income include ONLY the standard deduction, with a larger amount of $24,000, but NO EXEMPTIONS. So they gained $11,000 in income reduction via standard deduction, but lost $20,750 in income reduction via exemptions. Their taxable income is now $91,000 - almost $10,000 more than under the old plan. BUT, with the changes in brackets (their highest is 22% on $3,850 of income and 12% on $58,350) – their tax bill is $9,754. This reduced further by an increased Child Tax Credit AND the fact that they now do not have it reduced due to larger income thresholds, so they get the full $2,000 per child credit for a $6,000 reduction, yielding a tax of $3,754 – about 3% of total income.
Verdict: The Blissful Family reduces their tax bill by $15,000 dollars, an 80% drop in taxes and a 14% drop in effective tax rate! They now love this Congress… maybe.
Enter the Bothered Family
...with a total income of $140,000. Mr. Bothered is a long-haul trucker who works as an employee, earning $80,000 per year. He deducts his travel expenses as unreimbursed employee expenses with other itemized deductions, and these usually total $30,000. Mrs. Bothered is a sales person who travels a lot and uses a dedicated home office to telecommute often, which gives her a $1,500 itemized deduction using the simplified method. She earns $60,000 per year. Combined they have a sizeable nest egg that is actively managed, and typically have investment expenses of about $20,000 in fees per year that are deducted with other itemized deductions. They also deduct about $17,000 in mortgage interest, property taxes, and charitable contributions. They have no children or other dependents.
Under the old code, they would have reduced their taxable income as follows:
$67,825 in itemized deductions
$8,100 personal exemptions
Their taxable income after reductions of $75,925 would be $64,075. They are subject to Alternative Minimum Tax, and their total tax would have been about $11,000 with no offsetting credits – or about 8% of total income.
What will that look like under the new code?
They are no longer allowed to deduct any of the unreimbursed employee / miscellaneous expenses like unreimbursed travel, home office and investment expenses. They will therefore not itemize, but take the new increased standard deduction of $24,000 for married couples. They have LOST almost $52,000 in income reduction for taxable income. Their taxable income is therefore $116,000. They will NOT be subject to Alternative Minimum Tax thanks to the new much higher income thresholds. Their total tax will be $17,400 – an effective rate of 12% on total income.
Verdict: The Bothered family increases their tax bill by $6,400, a 58% increase in tax and a 5% increase in effective tax rate! They can’t wait until mid-term elections?
MANY people are going to come away realizing a real tax cut. Others could get a nasty surprise.
This article focused on families rather than corporations, which is an entirely different discussion (for example, it may make sense for some S-Corps to elect to be taxed as a Corporation now?). How many kids you have, the makeup of your income and itemized deductions, and your income level will all play into how the new code affects you. Lots changed with this new code, more than is reflected in this brief example.
Bottom line – talk to your tax pro so you know what adjustments you may need to make in 2018.
In your corner,