Tax Cut and Jobs Act (TCJA)… translated into non-tax speak

Every once in awhile, Congress does… well… something. Despite efforts by both parties at times, Congress managed to pass legislation in late December of last year that will have a real impact on most Americans. These changes, which took effect January 1^st of 2018, will, in many cases, mean reduced tax rates for most, though not all taxpayers.  However, it’s the other, less well-publicized changes that will keep the accountants (and planners) busy for months and even years to come. Below, I’ll try to highlight many of the changes in “non-tax speak”, with an eye toward what I think is most relevant to those reading.

Brackets:

“You get a cut, you get a cut, you get a cut!!!” –

Presumably, this would have been the headline if Oprah had announced the cuts.  Under the Tax Cut and Jobs Act (TCJA) the tax system retains it’s 7 brackets for Individuals and 7 for Married couples filing jointly (MFJ) though most brackets have been adjusted downward, requiring higher incomes to pay slightly less taxes. Of note, only two brackets, 10% for those earning up to $9525 ($19,050 MFJ) and 35% (those earning 200K-500K (400K-600K MFJ) are nominally the same, though the income required to pay them has changed.  Under the old law, the top tax bracket of 39.6% was for those earning over $480,050.  Under the TCJA, the top bracket is 37% for those earning in excess of $600K. I won’t post a chart of the new tax brackets as they’re easily google-able, but as you can see from the 35% bracket example above, there is a significant “cost” to getting married for those tax payers in the higher income brackets.  In non-tax speak, that means two individuals claiming as individuals can earn substantially more than what those two individuals could earn (and still pay a lower tax rate) if they were married filing jointly.

Deductions and Exemptions…

24K …Sort of…

If you’ve heard one thing about the TCJA, you may have heard about the increased standard deduction:  the minimum amount the government allows each person to claim as a deduction against their income. This was also the amount you need to exceed for it to make sense to itemize, i.e. list- your deductions instead of taking the standard.   Not to be confused with this deduction, is the personal exemption.  The personal exemption was just over $4K per individual and was separate and in addition to the standard deduction.  In non-tax speak, that means a married couple filing jointly with 3 (dependent) children would have had an Exemption of over $20K!

Moving forward, the TCJA has removed exemptions.  They have however increased the standard deduction to 12K and 24K for those MFJ.  Clearly, some families, smaller in number probably, may benefit from these specific changes, though larger families with a higher number of dependents will not.  Some of this discrepancy is addressed by the Child Tax Credit adjustments.

Child Tax Credit

To address part of the problem large families might face as a result of removing the personal exemptions, the TCJA increases the child tax credit to 2K from 1K previously per qualifying child.  Additionally, the threshold at which you earn too much to claim this credit has been raised from 110K for MFJ to 400K for MFJ!

Other Itemized deduction changes

Given the increased standard deduction, more people will likely not be itemizing and will use this larger standard deduction- it’s expected 90% of filers will take the standard deduction.  For those with significant deductions, meaning over 12K for individual 24K for MFJ, they would likely choose to itemize these deductions on schedule A and should note the following changes:

1. SALT – State and local taxes: previously there was no cap on the ability to deduct these.  Under the TCJA these taxes, combined with property taxes, are capped at $10K.  For those living in higher tax states this change may be significant.
2. Mortgage Interest – Under the TCJA, interest on loans issued after December 15^th of 2017 are deductible on loans up to $750K, down from $1MM under the prior code. Of note, Home Equity interest, to the extent it was not used for what the IRS calls “acquisition debt”, is no longer deductible and there is no grandfathering provision for existing loans.    In most cases, this means HELOCs and Home Equity loans- now and in the future, are no longer deductible.
3. Charitable Contributions – Under the TCJA, charitable contributions are now deductible up to 60% of your adjusted gross income (AGI), up from the 50% previously allowed.
4. Medical Expenses – These are deductible!!! The only catch is your medical expenses need to exceed 7.5% of your adjusted gross income (AGI) for you to be able to deduct them in 2017 and 2018.  While this is below the 10% under the previous tax code, this is expected to return to a 10% threshold in 2019.
5. Miscellaneous Deductions – in technical terms, there’s a whole lot of stuff you could have deducted in the past if they all added up to over 2% of your AGI. Now you can’t.
6. No more Phaseout! Previously for those earning over ~$313K, many of the itemized deductions were phased out. There is no longer a phase out (excluding those people subject to the AMT which is a whole different blog post!)

529s…

529 plans were created in 1996 and were designed to encourage families to start saving for college. With the passage of the TCJA, students (parents) can now take a tax-free distribution for college expense and private elementary and secondary schools of up to $10K per year per student. For example, if you have 2 children, 1 in public schools and 1 at a private school with tuition of $17K per year, the max you could withdraw tax-free from the 529 would be $10K.

Qualified Business Income… You can probably skip this if you’re not a business owner

Given the widely publicized slashing of the corporate tax rate, mostly for “C” corporations, Congress wanted to do a little something for the “little” guy.  As such, they’re allowing certain pass through entities, including LLCs and S-corps, a 20% below the line deduction with this deduction phased out (you can’t take it) beginning at 315K for MFJ.  There are some professions that were expressly exempt from taking this deduction so it does not apply to all sectors or businesses.

Things to keep in mind:

While the corporate AMT has been removed, the personal AMT is still alive and well. While the standard deduction has gone up, the above changes may not apply if you are subject to the AMT or even all taxpayers. If you’re subject to AMT, this will reduce or eliminate your ability to use many of the deductions listed above.  In other news, we are not an accounting firm.  At Oak Street Investments, we have software that has been updated to reflect the TCJA and can illustrate the impact of these changes on your financial goals.  If you want to know the impact the TCJA will have on your particular situation, call us or your financial planner or accountant.  We have tried to remain politically neutral in our assessment of the TCJA.  Our apologies if we did a poor job of that.