The Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017, and it changed federal tax rules to a significant extent when it went into effect in January of 2018. The TCJA's impact on various taxpayers has been highly dependent on their individual circumstances. Two families earning the same income dollar-for-dollar might find that the law impacts them differently.
The Basics of the TCJA
The legislation affected individuals in several ways:
- There are still seven tax brackets, but the tax rates were reduced somewhat.
- The standard deduction effectively doubled for all filing statuses.
- Personal exemptions were eliminated from the federal tax code, although some states still recognize them.
- The amount of the child tax credit was increased, and an additional credit was added for non-child dependents.
- Several tax exclusions and itemized deductions were adjusted. The state income and property tax or local sales tax (SALT) deduction was capped at $10,000.
- Deductions for medical expenses only had to exceed 7.5% of your adjusted gross income in the 2017, 2018, and 2019 tax years. Then the Further Consolidated Appropriations Act extended this threshold through tax year 2020.
- The above-the-line alimony deduction was eliminated. The obligor has to pay taxes on this income, and the recipient no longer has to claim it.
- The TCJA changed the limitations on the home mortgage interest deduction. Interest on mortgage debts of up to $1 million qualified for this deduction in 2017, but the TCJA slashed that to $750,000. It also eliminated this tax deduction for many home equity loans.
But some things remained the same:
- The law didn't make any changes to deductions for 401(k) plan contributions.
- The earned income tax credit was unaffected, except for the usual inflation adjustments that happen every year.
- The terms of the Affordable Care Act weren't subject to change, although the tax penalty for not carrying insurance was eliminated effective January 1, 2019.
The American Rescue Plan in 2021 may have changed some of the provisions of the TCJA permanently or for one year.
How Will This Affect Low-Income Taxpayers?
The changes to tax brackets, the standard deductions, and the loss of personal exemptions have all had an impact on low-income taxpayers.
Suppose a single taxpayer earned $16,000 in 2020. That would have put them in a 15% tax bracket back in 2017. They would have paid 10% in tax on their income, up to $9,325, and 15% on the balance of their income up to $16,000. That’s a pretty significant tax bill of $1,933: $932 on the first $9,325, plus $1,001 of the $6,675 balance, for a total of $1,933.
The TCJA provides for a new 12% bracket for incomes from $9,876 up to $40,125 in the 2020 tax year. This same taxpayer would pay 10% in tax on their income up to $9,875 in 2020, but only 12% on the balance. Their 2020 tax bill would come out to just $1,722, compared to $1,933: 10% of $9,875 or $987, plus 12% of the $6,125 balance, or $735. That's $211 less than they would have paid in 2017.
The Standard Deduction
The above scenario doesn’t take the standard deduction into consideration, and this makes a more dramatic difference.
Under the terms of the TCJA, this taxpayer would not pay taxes on the first $12,400 of their income in tax year 2020, the amount of the standard deduction for this filing status. Their actual taxable income wouldn't be $16,000, but just $3,600 after claiming the standard deduction. Their tax would work out to $380, or 10% of $3,800.
By comparison, this individual would have had a standard deduction of just $6,350 in 2017, so they paid taxes on $9,650 of income—$16,000 less their standard deduction of $6,350. Their total tax bill came out to $980 in 2017 in this scenario: $932 or 10% of the first $9,325, plus $48 or 15% of the $325 balance.
The final result is that they come out very much ahead under the terms of the TCJA. Due largely to the change in the standard deduction, they would pay $380 under the TCJA, compared to $980 under the 2017 tax structure.
The standard deduction is indexed for inflation. It increases to $12,550 for single filers, to $25,100 for married taxpayers who file jointly, and to $18,800 for those who qualify as head of household in 2021.
About Those Personal Exemptions
The TCJA also eliminated personal exemptions from the tax code.
These 2020 thresholds and figures would affect the tax return you'd file in 2021 for the 2020 tax year.
Single taxpayers would have been able to further reduce their taxable income by an additional $4,050 by claiming that exemption in 2017. They would actually have paid tax at the rate of 10% on just $5,600 in income: $16,000 less the standard deduction left $9,650, less the additional $4,050 for the exemption. Their $980 tax debt thus drops from $980 to just $560.
But they still come out ahead in 2020. They would have paid $560 in federal income taxes in 2017, but they'll pay $380 under the TCJA, saving $180 a year.
Supporters of the TCJA say that many low-income taxpayers came out ahead in 2018 and 2019, and will continue to do so in 2020.
Considerations for Families
Of course, this analysis all assumes that a taxpayer isn’t eligible for any tax credits. What if they have a child dependent, so they can claim the Child Tax Credit?
This credit was $1,000 per child under age 17 in 2017. The TCJA pushed it up to $2,000 per child, an increase of $1,000. The first $1,400 is refundable, which means that a parent with zero tax liability would receive a refund from the IRS for $1,400 for each dependent child they can claim.
The tax credit would wipe out our individual's tax debt so they would end up not owing the IRS anything at all, assuming their tax bill was $380 and they could claim the Child Tax Credit for one child. This leaves $1,620 remaining of the $2,000 credit, of which $1,400 is refundable subject to certain rules, so this taxpayer would actually receive a $1,400 refund.
The Effect of Lost Personal Exemptions on Families
Now suppose that an individual is married and has four kids. They earn $50,000, and their spouse earns $25,000, for a total joint income of $75,000. This still keeps them in a 12% tax bracket under the TCJA, because this bracket stretches up to $80,250 in joint incomes in 2020. They paid 15% in tax in this bracket back in 2017—an additional 3%.
But they’re losing those six personal exemptions under the TCJA, one for each of them, and one for each of their children, for a walloping total of $24,300—the $4,050 exemption amount in 2017 times six. So, they would end up paying taxes on $24,300 more in income, which more than neutralizes that 3% break they’d get on their tax rate.
Of course, they’d potentially get $8,000 of that back—$2,000 per child—thanks to the revamped Child Tax Credit, but they'll still be paying taxes on more income than they did in 2017.
The Law's Effect on the Middle Class
Middle-class taxpayers haven't fared too badly under the TCJA, but once again, it depends on personal circumstances. The math on the tax brackets pretty much works out the same way as it does for low-income taxpayers. The income parameters reduce the tax percentage for many middle-class filers.
The 25% tax bracket began for single filers with incomes of $37,950 in 2017. Under the TCJA, a single taxpayer can earn up to $40,126 in 2020 before landing in a higher tax bracket—not a huge difference. But again, the tax rate for this bracket drops, in this case from 25% to 22%.
The Standard Deduction vs. Itemized Deductions
Historically, a significant percentage of middle-class taxpayers have chosen to itemize their deductions rather than claim the standard deduction for their filing status, and the TCJA has affected them in this respect.
Their total itemized deductible expenses might well exceed their standard deduction under 2017 tax law, because the standard deduction was roughly half of what it is in 2020.
A single taxpayer who averages about $12,200 in itemized deductions would be in a similar tax situation under the TCJA in 2020 whether they itemized or claimed the standard deduction for their filing status. But someone who has historically claimed $15,000 in itemized deductions would pay tax on an additional $2,600 if they were to choose to claim the standard deduction rather than itemize.
Itemizing probably won't reap the same tax savings under the TCJA, because the increased standard deduction also interacts with the cap on state and some local taxes and limitations on mortgage interest deductions, which are both itemized deductions.
Other TCJA Adjustments
As for that revamped Child Tax Credit, more middle-income earners will qualify for it under the terms of the TCJA. The credit used to begin phasing out at incomes of $75,000. Our taxpayers in this scenario would have just made it in under the wire at a joint income of $75,000.
The TCJA increased this limit significantly to $200,000 for single filers, and $400,000 for those who are married and filing joint returns. This allows many more middle- and upper-income families to take full advantage of the credit.
So, does a middle-income taxpayer win or lose under these changes? It depends. Do they have children? How many? Were they claiming a lot of itemized deductions that have been reduced or eliminated?
The Effect on High Earners
Opponents of the TCJA have long argued that it unfairly favors the wealth, which might appear to be true in some cases.
Many of these taxpayers will fall into a 37% tax bracket in 2020 rather than the top tax bracket of 39.6% that existed in 2017 before the TCJA took effect. That 2017 bracket kicked in at incomes of $418,400 or more for single filers. The 37% bracket provided for by the TCJA doesn't begin until incomes of $518,401 for single filers in 2020, or $622,051 for taxpayers who are married and filing joint returns.
The wealthy can pass more of their largess to their heirs tax-free as well. The TCJA provides for an $11.58 million estate tax exemption in 2020. The exemption was just $5.49 million in 2017 before this legislation. Low- and middle-income taxpayers have generally not faced this tax, so there’s no change for them here unless, perhaps, they are inheriting.
What Happens Next?
These changes aren't necessarily permanent. The TCJA applies to tax years 2018 through 2025, but then it sunsets or expires if Congress doesn't act to breathe new life into it for another stretch of years. Congress might also elect to retain just some portions of the TCJA, allowing others to expire.
NOTE: Please consult with a tax professional for the most up-to-date advice and answers to any specific questions you might have. The TCJA includes many more changes that are not summarized in this article and that could potentially affect your tax situation. The information contained in this article is not intended as tax advice and is not a substitute for tax advice.