The 9 Biggest Ways Trump's Tax Reform Hits Your Wallet
HAPPY NEW YEAR!
With the recent, yet surprising, cooperation between the White House and Congress, the Trump tax reform bill is set to take effect starting this new year. Don't worry your 2017 tax returns are not impacted. However, the tax law changes will affect personal incomes for the next 8 years, starting in 2018 (tax laws for personal incomes are sunsetting in 2025). So the question many of my clients have been asking me is, how does tax reform impact our personal bottom line? I wish there was a simple answer to the previous question.
To get a quick idea, I highly recommend to download my 3-page Tax Reform Guide to see what kind of savings or losses are in store for you.
Specifically, refer to page 2 if you are single and page 3 if you are married. The good news is that the scope of the tax changes will benefit the financial welfare of more Americans than not. That being said, outlined below are the 9 most meaningful ways the Trump tax plan hits your wallet.
9 MAJOR CHANGES AFFECTING YOUR PERSONAL TAX RETURNS
1) 6 OUT OF 7 TAX BRACKETS ARE REDUCED
To better understand the tax changes across the board, refer to the figure below for a side by side comparison of the old rates versus the new rates.
Benefits are two-fold. First, tax rates are reduced on all but 1 bracket (10%), and secondly, the income thresholds have been increased. The most positive takeaway is that married couples and families stand to benefit from the tax changes in a significant way. For example, a couple with $300,000 in taxable income saves about $13,000 per year on their tax liability. Even at $150,000, married couples save nearly $4,000 per year. Just think what an extra $333 - $1,083 per month can do for middle-class families!
The highest tax rate is reduced from 39.6% to 37%. That may not sound like much, but the Lebron James' of the world, who earns $71M per year, would see an annual savings of roughly $1.8M on his taxable income. This part of the plan has obviously irked the left, and rightfully so in my opinion. I think even Lebron James would agree that multi-millionaires, like him, really don't need more money. Besides, isn't the wealth gap between the rich and the poor at all-time highs?
2) STANDARD DEDUCTION INCREASED AND PERSONAL EXEMPTION ELIMINATED
The standard deduction for single taxpayers goes from $6,500 to $12,000 and from $13,000 to $24,000 for couples. Given the higher deduction, modest incomes and those who don't itemize their deductions will benefit from this change the most. Albeit not by much when you consider that the personal exemption is going away. The difference for single taxpayers is only $1,350 and $6,850 for couples without kids. So for taxable incomes of $100,000, that is a savings of $246 for individuals and $950 for couples with no dependents.
The $4,150 exemption is eliminated and can no longer be used when claiming dependents. While the enhancements to the childcare tax credit (discussed later) offset this issue, a higher standard deduction and elimination of the personal exemption means taxpayers have a higher hurdle to overcome for their itemized deductions to produce any financial benefit. Therefore, mortgage interest and other tax-deductible incentives have less impact.
3) SIGNIFICANT CHANGES TO ITEMIZED DEDUCTIONS
The overall limit on itemized deductions has been eliminated. The limit used to be $266,700 for single filing incomes and $320,000 for married filing incomes. Another itemized deduction we can put in the win column is the one for medical expenses. The amount you were allowed to deduct for medical expenses used to apply towards expenses exceeding 10% of Adjusted Gross Income (AGI), however, that threshold is now reduced to 7.5% of AGI.
State income and property tax deductions are now capped at $10,000. Also, the mortgage interest tax deduction only applies up to loan amounts of $750,000, instead of $1,000,000. To residents in states without an income tax, like Florida and Texas, these changes are less of a concern. However, states with higher income tax rates and higher property values, like California and New York, are up in arms because the wealthy 1% types are likely to pay higher Federal income taxes under the new plan.
4) CHILD TAX CREDIT DOUBLED
For anyone with children, the change to the child tax should bring a smile to your face. Why? The child tax credit goes from $1,000 to $2,000. More importantly, the ability to benefit from the credit is more inclusive. The income phaseout used to begin hitting single incomes at $75,000 and married incomes at $110,000, however, those amounts have since been pushed up to $200,000 for singles and $400,000 for couples. Furthermore, the refundable amount used to be limited to 15% of earnings over $3,000 but is now allowed up to $1,400. One final benefit is that a $500 credit is available for other dependents (i.e. an elderly parent).
Losing the ability to claim the dependent exemption is the biggest casualty of increasing the tax credit. Actually, when framed the right way, eliminating this exemption is not all that bad because a $2,000 child tax credit is a dollar for dollar reduction in your tax liability. To compare, a $4,150 dependent exemption for a family with a marginal tax rate of 24% saves those taxpayers $996. In other words, $2,000 is a greater benefit than $996.
5) TUITION BENEFITS OF 529 PLANS EXPANDED
529 plans are no longer just for college. These tax-sheltered vehicles have been expanded to allow funds to be used to pay private school tuition at the K-12 grade levels.
Paying yearly expenses for a shorter-term expenditure, like a private school, may not be beneficial when the timeframe between when the money is saved versus spent is less than 3-5 years -- depending on your risk tolerance. Besides, the underlying investments will fluctuate in value (except for money market funds) and those type of instruments are better suited for longer-term investors. Regardless, these changes create new planning opportunities if your kid attends private school, but beware that a 529 plan is not a one-size-fits-all solution for paying tuition expenses.
6) 20% TAX DEDUCTION FOR PASS-THROUGH INCOME
If you are a sole proprietor or own a small business as an LLC, partnership, or S-Corp, you may deduct up to 20% of your "pass-through income." What's most stunning about this provision is that landlords, who own rental properties through one of the entities mentioned above (almost all landlords), are able to take advantage of this tax deduction. In addition, small business owners are able to further offset the pain of paying the self-employment tax (15.3%), which is double what W-2 employees pay.
It's perceived to be a loophole. Everyone and their cousin is going to reclassify themselves as an independent contractor or set up an LLC so that they can have their income qualify for the 20% tax deduction. Okay maybe that is a gross over-exaggeration, but the worry here is that such a loophole creates a world where landlords begin to rule and homeownership declines. Also, bear in mind that the 20% tax deduction begins phasing out at $157,500 for singles and $315,000 for joint incomes.
7) ESTATE TAX LIMIT UPPED BY 2X
The estate tax exemption is now $11.2M for individuals, which is double the previous exemption of $5.6M. Furthermore, the estate of a married couple is exempted from paying estate taxes on their first $22.4M in assets. One of the reasons the estate limit has been raised is to help family businesses more easily pass a business on to the next generation. Too often the value of a family business, at the time of the owner's death, requires the children inheriting the company to sell all or part of the business. The new owner(s) do this to pay the estate tax because most of the estate's value was tied to the business and the estate lacked proper liquidity to pay the tax.
Less wealth is taxed and shared by the rich because, with a good financial planner and estate attorney, more money is kept within their families. Some think it's a bit fishy that Donald Trump's family is one of the major beneficiaries of this tax change.
8) AMT EXEMPTION INCREASED
The much-hated AMT tax exemption limits have been increased from $54,300 to $70,300 for a single filer and $84,500 to $109,400 for married filers. Another benefit is that the associated income phaseouts have increased from $120,700 to $500,000 for single taxpayers and $160,900 to $1,000,000 for married taxpayers.
The AMT was originally set to be abolished, per the House version of the tax bill. However, the Senate version added the AMT provision back for personal tax returns, but not businesses. In 1969, Congress instituted the AMT tax in order to stop the rich from taking advantage of loopholes to pay less than their fair share of taxes. However, the AMT tax thresholds were never properly indexed for inflation until 2012. Consequently, over the span of the 43 years it wasn't indexed, middle-income families gradually became adversely affected by the AMT tax.
9) REMOVAL OF MANDATORY MEDICAL INSURANCE PENALTY (2019)
Most young and healthy millennials will appreciate the fact that they can once again self-insure without being punished financially. Starting in 2019 there will no longer be a mandatory penalty for not having medical insurance. Amen to that!
You are SOL in the event a catastrophic health event occurs without insurance coverage. Although, many young professionals with student loans need every dollar they can get. Just know the risks you are taking before you make such a decision.
If you have further questions: