Tax Reform 101
The Tax Cuts and Jobs Act of 2017 officially starts affecting tax returns this year, so your taxes next January will look a bit (or a lot) different. Let’s walk through some of the most significant changes to the tax law, so you know what to expect.
The tax brackets have gotten a facelift. The tax rate for the 10% bracket and the 35% stayed the same, but the income amounts for both were raised. A raised income amount in a tax bracket means that you can earn more money before moving up to a higher tax rate.
In the other 5 brackets, the tax rate was lowered, and the income amounts were adjusted. In general, it means more income will be taxed at lower rates, so virtually everyone will be subject to lower taxes in 2018. You can compare and contrast tax brackets in the tables below.
2017 Tax brackets
2018 Tax brackets
New Standard Deduction Amounts and the Personal Exemption
Until the new tax bill, you would get a personal exemption for yourself, your spouse and each dependent in your household. The personal exemption amount, $4,050 per person in 2017, would reduce your taxable income. The personal exemption has been repealed in favor of raising the standard deduction, which also reduces your taxable income but only applies to each filer, not each person in the household.
Taxpayers can still itemize deductions, but many won’t have enough individual deductions to merit itemizing. This is also because all itemized deductions have been repealed except state and local income taxes (capped at $10,000), mortgage interest, medical expenses, disaster losses (attributable to a federally declared disaster), charitable contributions (up to 60% of income), and other deductions not subject to the 2% floor. Deductions for unreimbursed employee expenses, tax preparation fees and safety deposit boxes have been eliminated.
Here are the new standard deduction amounts for each filing status:
Child Tax Credit
Taxpayers with kids, or any qualifying dependents, will get a boost from the new Child Tax Credit (CTC) rates. The credit amount per child is doubling from $1,000 to $2,000, and $1,400 of that amount will be refundable (meaning that, if your tax liability is reduced to zero, you could still get up to $1,400 in refund money). Plus, qualifying dependents who are not children now qualify for a temporary $500 nonrefundable credit.
But there are phaseouts for the Child Tax Credit: married taxpayers filing jointly with an AGI greater than $400,000 and all other taxpayers with an AGI greater than $200,000 will not qualify for the credit.
Affordable Care Act
The penalty on individuals for failing to maintain minimum essential health coverage was repealed, but does not take effect until 2019. The penalty, or shared responsibility payment, still applies for 2018.
There are also changes to claiming medical expenses as a deduction: Through tax year 2018, you can deduct expenses that exceed 7.5% of your income, and in 2019 that number goes up to 10%.
Through tax year 2018, single taxpayers can deduct interest up to $750,000 on new mortgage debt (down from the former $1,000,000 limit), and married couples filing separately can deduct up to $350,000 (down from the former $500,000 limit). The amount you can deduct will be smaller, in either case.
Any interest paid on home equity loans will no longer qualify for the deduction.
Mortgage loans that started before December 15, 2017 will not be affected by the new deduction limit.
Moving expense reimbursements
Unless you are an active duty member of the Armed Forces who moves due to military orders, you can no longer claim the exclusion for moving expenses.
Alimony payments will not be deductible or taxable to the recipient beginning with new divorces in 2019. Divorces during or before 2018 will be grandfathered in.
Section 529 plans
The new distribution limitation of $10,000 now applies on a per-student basis instead of a per-account basis. These distributions can now be used for public, private, or religious education in elementary or secondary schools, and can also be used for homeschool-related expenses.
Qualifying expenses include:
- Curricular courses and materials
- Books or other instructional materials
- Online educational materials
- Tutoring or educational classes outside of the home (provided the instructor is not a relative of the student)
- Dual enrollment in an institution of higher education
- Educational therapies for students with disabilities
The new vehicle depreciation limits (which only apply to vehicles placed in service after December 31, 2017) are higher and take inflation amounts into consideration. Vehicles for which additional first-year depreciation was claimed do not qualify for these depreciation amounts.
- 1st year: $10,000
- 2nd year: $16,000
- 3rd year: $9,600
- Each following year until cost is fully recovered: $5,760
Qualified Business Income (QBI) 20% deduction
Since corporations got a significant tax rate reduction, Congress needed to provide some form of tax break for the other business types where income tax is calculated and reported on individual tax returns (1040s).
Enter the QBI deduction for individuals who have partnership, S corporation, LLC, or sole proprietorship income—which includes the millions of freelancers and contractors out there working for themselves and filing a Schedule C to report income on their tax return. The QBI deduction is worth 20% of your “qualified business income” (essentially your net profit), and it reduces your taxable income.
You don’t have to itemize your deductions in order to claim the QBI deduction, but the business must be conducted in the U.S.
For pass-through entities, such as partnerships and S corporations, the deduction has some extra limitations. Your total deduction amount cannot exceed the greater of:
- 50% of the W-2 wages paid, or
- 25% of the W-2 wages paid, plus 2.5% of the unadjusted basis of all tangible, depreciable trade or business property that is:
- Available for use at the close of the tax year
- Used at any point during the tax year in the production of qualified business income
- Still depreciable before the close of the tax year
The QBI deduction phases out for businesses defined as a Specified Service Trade or Business (SSTB). An SSTB is any business activity where the revenue is generated from a specialized skill or service (health, law, medicine, etc.). Their QBI phases out at $315,000 for joint filers, $207,500 for head of household filers, and $157,500 for single filers.
Additional first year depreciation is now available on used property. Prior to the new law, only new property qualified.