The New Tax Law: What Does It Mean for Your Tax Bill?
Does the new tax bill affect all families equally?
The Tax Cuts and Jobs Act (TCJA) became a done deal when President Donald Trump signed it into law on Dec. 22, 2017. The House first proposed its version of the bill in early November 2017, and it was tweaked and changed several times before it went into effect in January 2018.
We've had the better part of two tax years to grapple with all its changes and implications, and to determine what it means to each of our personal financial situations. But some taxpayers are still scratching their heads, so we’ve broken down the final terms to help sort through it all.
The standard deduction increased significantly as originally promised, from $6,350 to $12,000 for single filers in 2018, then to $12,200 in 2019. It went from $9,350 to $18,000 for head of household filers in 2018, then to $18,350 in 2019, and from $12,700 to $24,000 in 2018 for married taxpayers who file joint returns, followed by an increase to $24,400 in 2019.
The TCJA pretty much doubled the amount of your income that gets taken off the board and is not subject to taxation.
An early version of the bill sought to eliminate the advantageous head of household filing status, but that provision didn’t make it into the final approved bill. The head of household status is still alive and well.
You might recall that Republicans initially wanted to pare down the existing seven tax brackets to just four, but that didn’t end up happening, either. There are still seven brackets, but the tax rate percentages have changed and each bracket now accommodates slightly more earnings.
If you earned $35,000 under the 2017 tax system and you were single, you would have fallen into a 15% tax bracket. That dropped to 12% in 2018 under the TCJA. If you earned $75,000, you would have paid 25%. That went down to 22%. At $100,000, you would have paid 28% in taxes, and this was reduced to 24%.
The tax bracket for the very highest earners, those with incomes of more than $426,700, was 39.6% in 2017. It dropped to 37% under TCJA, and it doesn't kick in until individuals reach incomes of $500,000 or more, or $600,000 if you're married and filing jointly.
So Who Benefited?
The Tax Policy Center indicated in 2018 that the TCJA would reduce taxes “on average” for all income groups, and the Tax Foundation said the same thing.
The key word here is “average.” Some taxpayers would fare a little worse while some would fare better. It's important to keep in mind that tax brackets and rates are percentages.
A taxpayer who earns $100,000 and sees a 4% reduction in his effective tax rate would realize a far greater dollars-and-cents increase—$4,000—in after-tax income than a low-income taxpayer earning only $10,000 a year and seeing the same 4% reduction of just $400. It's all relative.
Effective tax rates—the actual percentage of income paid in taxes—dropped from 8.7% in 2017 to 7.1% in 2018 for those with incomes in the $50,000 to $75,000 range after implementation of the TCJA, according to the Tax Foundation.
Here, then, is a quick overview of how much taxpayers in each income group will save under the bill.
If You’re a Low-Income Earner
You should see about a 4% increase in your after-tax income if you earn less than $25,000, somewhere in the neighborhood of $60 annually for most people. Don’t spend it all at once.
If Yours Is a Middle-Income Household
You’ll see an additional $930 a year or so in after-tax income if you earn between $49,000 and $86,000, according to the Tax Policy Center—an increase of about 2.9%. The Tax Foundation has indicated that the “bottom” 80% of American earners, including low income and middle income households, will see an increase in after-tax income of anywhere from 0.8% to 1.7%.
If You're a High Earner
The Tax Policy Center says you should see an additional $7,640 in after-tax income on average, a difference of about 1.6%, if you earn between $149,400 and $308,000 a year. That’s nothing to sneeze at, and it jumps to about 4.1% if you earn more than $308,000—somewhere in the neighborhood of $13,480 in increased after-tax income annually.
But again, the Tax Foundation was more conservative and put the number at only 1.6%.
You Might Not Want to Itemize Any Longer
The 2018 tax bill made changes to several itemized deductions, and this has affected taxpayers who have historically itemized rather than claim the standard deduction for their filing statuses. The itemized deductions that remain might not amount to more than the standard deduction you’re entitled to, especially after the TCJA jacked up the standard deductions so significantly.
The number of taxpayers who itemized in 2018 dropped from 30% to just 10%, according to preliminary data for the tax year released by the IRS in July 2019 and reported by the Tax Foundation.
On the flip-side are those taxpayers whose total itemized deductions typically exceeded the new standard deduction amount for their filing statuses. You might be among the taxpayers who were actually hurt by this legislation if that's you.
TCJA Changes to Itemized Deductions
Ask yourself these questions to determine if—and why—the TCJA resulted in you paying more in taxes in 2018.
How Much Is Your Home Mortgage?
The mortgage interest itemized deduction is now capped at mortgage values of $750,000 instead of $1 million. Unless you have a very expensive home, this shouldn’t affect you. The average mortgage debt was $202,284 as of 2019, according to Experian. There’s still a whole lot of room between that and the new cap.
This is obviously one of those changes that will affect high earners most, but there’s a catch with this tweaked deduction that can affect middle-income families as well...
Interest on a Refinance Loans
The home interest mortgage deduction used to cover both acquisition debt—mortgages taken out to purchase or build a home—and equity debt, such as when you refinance and take some cash out of your home’s value to spend on other things, such as your child’s college education.
The TCJA eliminated this provision for equity debt. You're no longer able to claim the interest on refinance loans as a tax deduction unless you use the proceeds to "buy, build, or substantially improve" a home.
The State and Local Tax Deduction
Then there’s the matter of state and local taxes. Changes to this itemized deduction caused quite an uproar among citizens and legislators alike in the weeks leading up to the final bill’s passage.
At one point, the deduction for state and local income taxes was on the chopping block, but that didn't end up happening. It escaped repeal...sort of. The total amount you can deduct for all state and local taxes, including sales, income, and property taxes, is now limited to $10,000.
This will almost certainly negatively affect itemizing taxpayers who live in states with high property and income taxes, such as New Jersey and New York. You could end up on the wrong end of the tax bill if you've been paying and deducting more than $10,000 a year in state and local taxes.
The Medical Expense Deduction
The itemized deduction for medical expenses actually improved under the TCJA, at least for a while. This deduction includes out-of-pocket uncovered medical costs, deductibles, co-pays, and insurance premiums that are not reimbursed by your employer.
As of 2016, you were limited to claiming a deduction for only the portion of these expenses that exceeded 10% of your adjusted gross income (AGI)—a pretty high hurdle. That dropped retroactively to 7.5% for 2017, and for 2018 as well. You were able to shave a little more off your taxable income there.
Unfortunately, the threshold goes back up to 10% in 2019.
One senator, Susan Collins of Maine, fought particularly hard for this adjustment. She’s been quoted as saying that approximately 8.8 million Americans claimed this deduction through 2017, and most of them earned less than $50,000 a year. The original House version of the bill wanted to do away with the medical expense deduction entirely, but Collins prevailed in her fight to keep it.
The Alimony Adjustment
This change seems particularly unfair because taxpayers didn't have to itemize to claim this deduction. It was an "above the line" adjustment to income on page 1 of the Form 1040 in 2017 and previous years.
You could subtract alimony payments you made from your taxable income, then claim either the standard deduction or itemize your deductions as well. Meanwhile, your ex had to claim that alimony as income and pay taxes on it.
Not anymore. Now you not only have to pay your ex, but you have to pay taxes on that portion of your income as well under the terms of the TCJA.
As for your ex, she gets to collect that income tax-free.
This change only applies to divorces and divorce agreements finalized after December 31, 2018.
Those Lost Personal Exemptions
Personal exemptions were dollar amounts that taxpayers could deduct from their taxable incomes for themselves and for each of their dependents—$4,050 per person as of the 2017 tax year. They were eliminated in the final version of the tax bill, just as was proposed in initial versions of the bill. This hits large families hard.
Single taxpayers with no children might still come out a little ahead after this change. They’ve lost just the single $4,050 exemption that they were able to claim for themselves, which is more than offset by the standard deduction that increased by $5,500.
But that’s a total of five exemptions that you could have claimed on a joint tax return under the 2017 tax law if you're married and have three kids—a walloping $20,250 more in income that you’ll have to pay taxes on under the 2018 legislation. That's more than the increase in the standard deduction, which was an $11,000 difference between 2017 and 2018.
The standard deduction increased by $8,450 for head of household filers from 2017 to 2018. so losing the exemptions for two dependents would put head of household filers in the hole.
This is balanced somewhat by the altered tax brackets, but it's still unlikely that large families will end up coming out ahead.
The Expanded Child Tax Credit
The Center on Budget and Policy Priorities protested the changes to the Child Tax Credit from the beginning. On the surface, the changes appeared generous. Not so, said the CBPP, at least not for the lowest income families.
This tax credit has always been tricky to calculate. Technically, it’s nonrefundable so all it could do was eliminate any tax bill you might have owed. But there was a tack-on—the Additional Child Tax Credit. This would allow a portion of the credit to become refundable, meaning that after it erased your tax bill, you could expect to receive a check from the IRS for part of the balance.
The nonrefundable part of the old tax credit was $1,000 per child. The TCJA amped that up to $2,000, and it made up to $1,400 of that amount refundable while eliminating the "extra" Additional Child Tax Credit.
Senator Mark Rubio of Florida is credited with forcing the $1,400 provision, but the CBPP maintains that the TCJA still fails to offer any real relief for the poorest American families.
The refundable portion of the credit is 15% of a taxpayer’s or family’s earnings over $3,000 up to the $1,400 limit. You see where this is going. We’re back to percentages again.
A single mom earning $10,000 has less income over $3,000 than does a middle-income family earning $50,000. In fact, she doesn't have enough income to qualify for the full $1,400 refundable part of the credit.
Meanwhile, high-income families used to be unable to claim this tax credit because they earned too much, but the TCJA expanded the income limits so now many high earners will be able to take advantage of it.
It’s Not Forever
These are just a few of the many tax rules that changed under the TCJA. And there’s one more significant change between the first version of the bill and the final version that was ultimately agreed upon by both the House and the Senate: The Tax Cuts and Jobs Act is not permanent.
Many—if not most—of the provisions are scheduled to expire or “sunset” on December 31, 2025 unless Congress rolls up their shirtsleeves once again and renews them or otherwise haggles out a whole new tax bill at that time.
The Tax Policy Center warns that more than 10% of Americans can expect their tax bills to jump again after 2025, even if they receive tax relief between now and then, assuming the provisions are allowed to sunset.
The Tax Cuts and Jobs Act is expected to cost the government some $1.5 trillion in revenues, and that’s obviously not sustainable over the long haul. So, stand by and get ready to revisit this issue again in 2025.