President Donald Trump signed the Tax Cuts and Jobs Act (TCJA) on Dec. 22, 2017. It cut individual income tax rates, doubled the standard deduction, and eliminated personal exemptions from the tax code.
The top individual tax rate dropped from 39.6% to 37%, and numerous itemized deductions were eliminated or affected as well.
The TCJA also cut the corporate tax rate from 35% to 21% effective in 2018. The corporate cuts are permanent. The individual changes expire at the end of 2025 unless Congress acts to renew some or all of the provisions of the TCJA.
- Business tax cuts are permanent while the individual cuts expire in 2025.
- Individual tax rates were lowered, the standard deduction raised, and personal exemptions eliminated.
- Many itemized deductions were removed.
- The maximum corporate tax rate was lowered from 35% to 21%.
- Passthrough companies received a 20% deduction on qualified income.
- The plan encouraged corporations to repatriate foreign earnings.
- The act will cost $1-$2 trillion over the 10 years it's in effect.
How It Affects You
The TCJA is complex and its various terms affect each family differently depending on their personal situations:
When the TCJA was proposed, independent tax policy nonprofit Tax Foundation found that those who earn more than 95% of the population would enjoy a 2.2% increase in after-tax income. Those in the 20% to 80% range would receive a 1.7% increase.
The Tax Foundation said those in the bottom 20% would only receive a 0.8% increase.
Those With Valuable Estates
A larger exemption for the estate tax will benefit you if you leave an estate that's worth a lot of money. The TCJA doubled the estate tax exemption from $5.6 million in 2017 to $11.2 million in 2018. For tax year 2021 the exemption is $11.7 million and for 2022 it is $12.06 million.
Taxpayers Who Claim the Standard Deduction
You'll win on two levels if you claim the increased standard deduction because it's now bigger than your old itemized deductions were. First, it will reduce your taxable income more than past years. Second, you can skip the complicated process of itemizing your deductions. That not only saves you time, but it will also save you money if you no longer have to pay a tax advisor.
You might be hurt by the elimination of personal exemptions under the terms of the TCJA. The increased tax credits for children and adult dependents, and the doubled standard deductions might not be enough to offset this loss for families with multiple children.
You might have benefitted from the 20% qualified business income deduction if you're an independent contractor, own your own business, or are self-employed.
Individual Income Tax Rates
The TCJA lowered tax rates, but it kept seven income tax brackets. The brackets correspond with more favorable spans of income under the TCJA, however, than under previous law. Each bracket accommodates more income.
The highest tax bracket starts at taxable income greater than $523,600 for single filers and $6128,300 for married couples filing jointly in tax year 2021, and $539,900 and $647,850 for 2022. These taxpayers are subject to a 37% rate on incomes over these thresholds after exemptions and deductions.
|2017 Income Tax Rate (Pre-TCJA)||2022 Income Tax Rate||2022 Income for Those Filing As Single||2022 Income for Those Filing Jointly|
|39.6%||37%||More than $539,990||More than $647,850|
These income levels are adjusted each year to keep pace with inflation.
The Standard Deduction vs. Itemized Deductions
A single filer's standard deduction increased from $6,350 in 2017 to $12,550 in 2021 and $12,950 in 2022. The deduction for married joint filers increases from $12,700 in 2017 to $25,100 in 2021 and $25,900 in 2022.
The Tax Foundation estimated in September 2019 that only about 13.7% of taxpayers would itemize on their 2018 returns due to these changes. That's less than half of the 31.1% who would have itemized before the TCJA.
That would save them time in preparing their taxes. It might also hurt the tax preparation industry and decrease charitable contributions, which are an itemized deduction.
Before the TCJA, taxpayers could subtract $4,050 from their taxable incomes each for themselves and their dependents.
That works out to $20,250 for a married couple with three children. Combined with the standard deduction for married taxpayers filing joint returns ($12,700 at that time) and the total deduction would be $32,950.
Now fast forward to a post-TCJA world. There are no more personal exemptions, but the TCJA did provide for a partially refundable credit of up to $2,000 per child, so that couple could claim $31,100 (the standard deduction plus as much as $6,000 for their children) in 2022.
That's $1,850 more income that they'll be paying taxes on, assuming in both scenarios that they're not claiming any other tax deductions or credits.
Fewer Itemized Deductions
The TCJA eliminated most miscellaneous itemized deductions. That includes tax preparation fees, job expenses, and investment fees:
- The deductions for tax preparation fees and most unreimbursed employee expenses are gone under the TCJA.
- The TCJA limited the deduction on mortgage interest to the first $750,000 of qualifying loans. Mortgage holders who took out their loan before December 16, 2017, weren't affected. In addition, interest on home equity loans or lines of credit can no longer be deducted, unless the proceeds were used to buy, build, or substantially improve the home.
- The state and local tax (SALT) deduction remains in place, but it's been capped at $10,000 for all filers except married filing separately. Taxpayers can deduct property taxes, and either state income or sales taxes.
- The deduction threshold for most charitable contributions got better. Generally, you can now claim a deduction for up to 60% of your adjusted gross income (AGI) rather than 50%.
- Deductions for casualty losses are mostly limited under the TCJA to those that occur in federally-declared disaster areas.
- The threshold for the medical expense deduction dropped from 10% to 7.5% of AGI. This change was set to expire at the end of 2019, but the Further Consolidated Appropriations Act of 2020 resurrected it.
Another important change is that the TCJA did away with the Pease limitation on itemized deductions. This tax provision previously required that taxpayers had to reduce their itemized deductions by 3% for each dollar of taxable income over certain limits, up to a total of 80%. This is no longer the case while the TCJA is in effect.
Above-the-Line Adjustments to Income
The above-the-line deduction for moving expenses has been eliminated, except for active-duty members of the military.
Those paying alimony can, generally speaking, no longer deduct it as an adjustment to income. This change is effective for divorces granted on or after Jan. 1, 2018.
The TCJA keeps the deduction for retirement savings. It also allows those age 70½ or older to directly transfer up to $100,000 a year to qualified charities from their individual retirement accounts.
Changes to Tax Credits
The TCJA increased the child tax credit from $1,000 up to $2,000. Even parents who don't earn enough to pay taxes can claim a refund of the credit up to $1,400.
The TCJA also introduced a $500 credit for other dependents, which helps families whose dependent children no longer meet the strict criteria of child dependents because they've aged out, as well as families caring for elderly parents.
These tax credits are fully available to taxpayers with modified AGIs of up to $200,000 for single filers and $400,000 for married taxpayers who file joint returns. They were phased out and eliminated at $75,000 and $110,000 respectively before the TCJA.
The Obamacare Tax
The TCJA repealed the Obamacare tax penalty that was charged to those without health insurance, effective 2019.
The Alternative Minimum Tax
The plan keeps the alternative minimum tax (AMT). The 2021 exemption is $73,600 for single filers and $114,600for joint filers. The exemptions phase out at $523,600 for singles and $1,047,200 for joint.
Business Tax Rates
The tax plan lowers the maximum corporate tax rate from 35% to 21%, the lowest since 1939.
Pass-through businesses get a 20% standard deduction on qualified income. This deduction ends after 2025. Pass-through businesses include:
- Sole proprietorships
- Limited liability companies
- S corporations
- Certain trusts and funds
The deductions phase out for service professionals once their income reaches $157,500 for singles and $315,000 for joint filers.
The TCJA limits certain corporations' ability to deduct interest expense to 30% of their adjusted taxable income. For the first four years, income is based on EBITDA. This acronym refers to earnings before interest, tax, depreciation, and amortization.
Starting in the fifth year, it's based on earnings before interest and taxes, which makes it more expensive for financial firms to borrow. Companies would be less likely to issue bonds and buy back their stock and stock prices could fall. But, the limit generates revenue to pay for other tax breaks.
Businesses can deduct the cost of certain depreciable assets in one year instead of amortizing them over several years. To qualify, the equipment must be purchased and placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
The tax act stiffens the requirements on carried interest profits. Carried interest is taxed at 23.8% instead of the top 39.6% income rate. Previous to the TCJA, firms had to hold assets for a year to qualify for the lower rate.
Now, the requirement extends to three years. That might hurt hedge funds that trade frequently. It would not affect private equity funds that hold on to assets for around five years.
The TCJA also cut deductions for client entertainment from 50% of the cost to zero. It retains the deduction for 50% of the cost of client meals.
Other Changes to Corporate Taxes
The TCJA eliminated the corporate AMT. The corporate AMT had a 20% tax rate that kicked in if tax credits pushed a firm's effective tax rate below 20%. Under the AMT, companies could not deduct the cost of research and development.
Trump's tax plan incorporated elements of a territorial tax system in what was previously a "worldwide" taxation of companies operating abroad. Under the worldwide system, multinationals are taxed on foreign income earned.
They don't pay the tax until they bring the profits home. As a result, many corporations leave their revenue parked overseas.
The adoption of elements of territorial taxation allows companies to repatriate the approximately $1 trillion they hold in foreign cash stockpiles. They pay a one-time tax rate of 15.5% on liquid assets and 8% on illiquid assets.
The Federal Reserve found that U.S. firms repatriated $777 billion in 2018; that was around 78% of offshore cash holdings. Instead of investing those funds, corporations increased buybacks of their stocks to improve share prices.
The TCJA also allowed oil drilling in the Arctic National Wildlife Refuge. The drilling provision is estimated to add around $1.8 billion in revenue from 2019 to 2029. Half of that goes to the state of Alaska.
Impacts on the Economy
The tax plan made the U.S. progressive income tax more regressive. Tax rates are lowered for everyone, but they are lowered the most for the highest-income taxpayers.
The Trump tax cuts were estimated to cost the government $1 trillion, according to the Joint Committee on Taxation. The $1 trillion figure is the result of the overall $1.5 trillion the TCJA would cost minus the roughly $456 billion it would create via an annual 0.7% growth in gross domestic product.
The Tax Foundation made a slightly different estimate. The tax cuts themselves would cost $1.47 trillion but savings would offset that figure by $1 trillion. The plan was expected to boost gross domestic product by 1.7% a year, create 339,000 jobs, and add 1.5% to wages.
The U.S. Treasury estimated that the bill would bring in around $1.8 trillion in new revenue and projected economic growth of 2.9% a year, on average.
With the likely outcome of the tax cuts being increased debt, it's important to understand how that debt affects the GDP. The World Bank estimates that for every percentage point that a nation's debt-to-GDP ratio increases above 77%, that nation's GDP will decrease by 0.017 percentage points.
The U.S. debt-to-GDP ratio was 104% before the TCJA took effect and 108% of GDP a couple of years later (and prior to pandemic-era spending that pushed the ratio over 135% by mid-2020).
Frequently Asked Questions (FAQs)
Who passed the Trump tax cuts?
President Trump signed the Tax Cuts and Jobs Act into law after its passage by the two Republican-controlled chambers of Congress. At the time, Sen. Mitch McConnell was Senate majority leader, and Rep. Paul Ryan was Speaker of the House of Representatives.
How much is the deficit going to increase with the Trump tax cuts?
The Tax Policy Center noted that, before the TCJA passed, the Congressional Budget Office and the Joint Committee on Taxation estimated that the TCJA would add $1-$2 trillion to the deficit.
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