It’s not a question of whether the most far-reaching federal tax overhaul in decades will impact you, but how much it will impact you, according to personal finance experts. Here are some notes on the new tax law.
If you earn an income, if you have money invested in the stock market, if you have dependent children, if you’re saving toward retirement or toward a child’s education, if you own a home or a business, chances are your 2018 federal tax returns will look considerably different than the returns you file for the 2017 tax year.
What’s inside the 1,000-plus pages of the Tax Cuts and Jobs Act of 2017 that President Donald Trump signed into law late last year? Which taxpayers are likely to be impacted most by the sweeping new tax policy? And how to take advantage of some of the positives in the policy, while minimizing the impact of the negatives? Read on to find out, then be sure to consult a tax expert to discuss how to handle your specific tax situation in light of the new law, because as CERTIFIED FINANCIAL PLANNER™ professional Evan Beach of Campbell Wealth Management in Alexandria, VA, points out, “With all these new rules, new tax-mitigation strategies will definitely emerge.”
The income tax rate on people in five of the seven tax brackets drops by anywhere from 1 to 4 percent starting in the 2018 tax year. Say you and your spouse were in the 28 percent tax bracket and filed your taxes jointly. The new rate for people in that bracket is 24 percent and breaks at $315,000 instead of $233,000, so you would pay less tax on more income within that bracket.
As with many provisions of the new law, the individual income tax cuts are due to expire at the end of 2025, unless they’re renewed by lawmakers before then. They also could be repealed and replaced well before 2025, if another President comes into office, for example, or if Democrats gain a majority in the U.S. Congress and decide to overhaul tax policy.
The new tax law lowers the tax rate on corporations from 35 to 21 percent, which observers expect will bolster corporate earnings. That in turn could lead stock prices to trend higher, Beach suggests. Thus people who hold investments in the stock market, either in the form of shares of individual company stock, mutual funds, etc., either inside or outside their retirement accounts, are likely to benefit. Corporations that tend to pay the full corporate tax rate — mostly small and mid-sized companies — are likely to benefit most from the lower rate, so investors might be wise to prioritize investing in those types of companies, he says.
One thing that didn’t change in the new tax law is the relatively low rate at which long-term capital gains are taxed. That’s generally a positive for investors.
The new tax law leaves rules governing contributions to, and deductibility of, qualified deferred retirement plans such as 401ks and IRAs largely intact. That, coupled with lower income tax rates, suggests it could be wise in the near term for certain people to prioritize contributing to a Roth IRA, where money is taxed on the way in, unlike with a 401(k) or traditional IRA, where money is taxed on the way out. This strategy may make sense for people who believe the prevailing tax rate that applies to Roth contributions made today will be lower than the rate they’re likely to pay on the distributions they will take later from tax-deferred retirement accounts.
Of course, trying to predict future tax policy is pure speculation. The most effective hedge against uncertainty surrounding future tax policy, says Beach, is to appropriately diversify the tax treatment of investments, spreading them across tax-deferred accounts such as a 401k, after-tax accounts like a Roth, and a taxable investment portfolio.
The new tax law likely changes the entire decision-making dynamic around whether to itemize deductions on your federal tax return. That’s due to several key changes:
A significantly higher standard deduction beginning in the 2018 tax years means many people who formerly itemized their deductions (using Schedule A on their federal tax form) likely will begin taking the standard deduction. Indeed, Beach cites a projection that the share of taxpayers who itemize deductions will drop from around 30 to less than 10 percent. Overall, people who live in places with high state and local income and property taxes will be hit hardest by this shift, according to Beach.
In response to the new deduction dynamics, Beach says he expects more taxpayers to start “lumping” deductions. That is, that people who formerly itemized will lump items such as charitable contributions and expensive medical procedures into one tax year instead of spreading them across multiple years, in order to accumulate enough deductions above the standard deduction threshold to justify itemizing their deductions. People in that scenario would end up itemizing deductions every few years instead of every year.
Previous tax policy allowed people to deduct the mortgage interest paid on first and second homes for mortgages of up to $1 million. Under the new law, that deduction is still available, but it’s capped for new mortgages up to $750,000. This won’t affect home purchases made before Dec. 16, 2017, so long as the home closed before April 1, 2018.
The new tax law also eliminates the deduction for home equity lines of credit on a primary residence, beginning with the 2018 tax year. Also effective in 2018, there’s now a $10,000 cap on the amount of state and local property taxes that are deductible. There was no cap previously. Another change that could impact homeowners and property owners is the elimination of a deduction for unreimbursed losses from flood, fire, burglary, etc. Now that deduction only applies if the loss occurred in a federal disaster area. This change could make it more important to have certain types of property-casualty insurance, such as flood insurance.
As mentioned above, the new law doubles the child tax credit. It also raises the phase-out level for the tax credit to $400,000 of adjusted gross income for couples filing jointly, from $110,000, meaning significantly more families will qualify for the credit. The new law also established a $500 tax credit for dependents who aren’t your children.
The new tax law expands how funds in tax-favored 529 college savings plans can be used. In addition to covering college expenses, beginning in 2018, money from those plans can be used to pay for up to $10,000 of tuition expenses per year, per student, for enrollment at an elementary or high school. So 529 plans aren’t just for higher education anymore.
Besides lowering the corporate tax rate from 35 to 21 percent, the new tax policy could bode well for people who own so-called “pass-through businesses” — LLCs, partnerships, S Corps and sole proprietorships. Effective in 2018, owners of these entities gain the ability to deduct 20 percent of their qualified business income, meaning they essentially will be paying taxes on only 80 percent of their revenue. The benefit of the deduction is phased out for specified pass-through service businesses with taxable income exceeding $157,500 ($315,000 for married filing jointly).
The new tax law is a good news/bad news proposition for the charitably inclined. The good news is that the new tax bill expands the deductible amount for charitable contributions from 50 up to 60 percent of adjusted gross income. However, fewer people are likely to take advantage of this provision, since fewer will have enough deductions to justify itemizing, explains Beach. As a result, people could end up stacking their charitable donations, as discussed in #4.
Under the old tax regime, people who itemized their deductions could deduct medical expenses above 10 percent of adjusted gross income. The new law lowers that threshold to 7.5 percent. However, that change applies only in the 2017 and 2018 tax years; the 10 percent threshold returns beginning in the 2019 tax year.
On the health insurance front, meanwhile, the new tax law eliminates the Affordable Care Act penalty on individuals who lack minimum essential coverage. Repeal of the penalty is effective for the 2019 tax year.
Lawmakers doubled the threshold at which the federal estate tax kicks in, so beginning with the 2018 tax year, it applies only to estates of at least $11.2 million in asset value for an individual, and $22.4 million for a couple. Keep in mind, though, that close to 20 states and the District of Columbia maintain their own estate or inheritance taxes.
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