2018 Tax Update: Major Changes Affecting Individuals
- Changes in tax rates (0:33)
- Higher standard deduction (5:54)
- Loss of personal exemptions (10:55)
- Doubled child credit (13:03)
Transcript and Slideshow
Download the Slideshow (PDF: 98 KB)
EML: (lower third - Evan M. Liddiard, CPA (first line) Director of Federal Tax Policy, National Association of REALTORS® (second line)
My name is Evan Liddiard of the National Association of REALTORS® and I would like to welcome you to our video series on what you need to know about the new tax law. In this segment, we are going to cover some of the major changes facing individuals and families filing tax returns for 2018.
Joining me is Peter Baker of the Business Planning Group. Peter has decades of experience helping REALTORS® and real estate businesses with their taxes.
PB: (lower third - Peter G. Baker, CPA (first line) Founder of Business Planning Group, Washington, DC (second line)
Glad to be here, Evan.
Let's start out by discussing the individual tax rates and how they're different. Most of you have probably heard by now that in general, the tax rates and brackets went down significantly from 2017. But does this mean that everyone is going to get a tax cut? The answer, unfortunately, is no.
But unlike most pure tax reform bills, this one was also a net tax cut, meaning that not all of the reductions in revenue to Uncle Sam were offset by tax increases on other taxpayers. So it is not a zero sum game. This means that a high percentage of tax filers will either get a tax cut or pay the same as before. But about 5 to 10 percent will be paying more under these changes.
Yes, as I speak with my Realtor clients about the changes brought about tax reform, many are initially skeptical that they are going to come out ahead. But in most cases, when we look closely at their situations, many will result in a net tax cut.
Peter, let me home in on that word "net." This is because the new law is going to lower taxes in some ways and raise it in others, and what that net number will be is going to depend on your individual circumstances.
[suggested graphic - stylized IRS tax rate table or tax brackets]
Let's start out by taking a close look at the tax rates. This is an area where the news is all good because every one of the rates or brackets went down from 2017 to 2018.
[show slide 1 - income tax rate comparison]
Let's look at the tax rates between last year and this year for single people at three different levels of income. The numbers will be somewhat different for married couples filing a joint return or for single heads of household, but the amount of reduction in taxes due to the rate cuts will be similar across the board.
Let's first consider a real estate agent with taxable income of $75,000. If he or she had earned this amount in 2017, they would have a tax bill of just under $14,500. This would be an average rate of just over 19 percent, and they would be in the 25 percent marginal tax bracket, meaning that each additional dollar earned at this income level would be taxed at 25 cents.
But for 2018, that same agent earning that same amount would pay only $12,440 in tax. This is an average rate of 16.6 percent and a marginal rate of just 22 percent. So, if all other things were equal (which they are not, as we will soon discuss), this Realtor would be saving well over $2,000 in taxes because of the new tax law.
Now, let's suppose that the income level were doubled to $150,000. For 2017, the agent would have a tax due of nearly $35,000, which is way more than twice as much tax than at $75,000. This is because our tax rates are still progressive, meaning that the higher the income the higher the tax rate. In this case, the average tax rate is 23.3 percent and the marginal rate rises to 28 percent, meaning that of every extra dollar earned, the filer must now pay 28 cents.
But let's consider what happens for 2018 with this income level. Here the tax is $30,290, which represents just 20.2 percent on average. And this is because the marginal rate is 24 percent, compared with 28 percent under the old law. The bottom line is that the rate changes save this Realtor over $4,700 in just one year. Not bad at all. But again, this ignores other changes that we will soon discuss.
Finally, let's take a look at someone who is doing really well with taxable income of $450,000. In 2017 he or she would have been in the highest tax bracket of 39.6 percent, and their tax would have been just over $134,000. This is an average rate of almost 30 percent.
But in this case, the new tax law doesn't save him or her all that much. It is true that the marginal tax rate drops down to 35 percent, but because of the way the brackets are structured, this person is only going to save about $800.
However, this is just an anomaly. If we were to look at someone making $600,000, they would save over $5,700. Someone making over $800K would save over $11,000, and a million-dollar earner would bank over $16,000 in savings from these rate changes alone. Peter, what do you think about this?
None of my clients can complain about this rate& bracket aspect of the new tax law, this area alone highlights the importance of advance tax planning. This one change saves every income tax payer money, and if this were all there was to the changes, everyone would be pretty happy and we could turn off the camera now. But, as you know, things are hardly ever that simple.
Let's now turn to two of these other changes that happen to go in opposite directions from each other. In other words, one of these changes tends to lower the tax owed for the majority of filers, but certainly not everyone, and the other will cause almost everyone to have to pay more. I call them dueling tax changes because they will be fighting it out in most tax returns to see who wins.
[show slide 2 - dueling tax changes]
The concepts here are just a bit more involved and will take a little background explanation. The first change, which will be a positive one for most tax filers, is that the new tax law almost doubled the standard deduction. Peter, would you take a couple of minutes and give some background on the standard deduction?
Historically, more than two-thirds of all tax filers have claimed the standard deduction instead of itemizing their deductions. The way this deduction works is "greater of" calculation; everyone is given a set amount of assumed deductions (known as Standard Deduction), alternatively, you have actual deductions which can be itemized, such as mortgage interest and charitable contributions, and additional activity as gathered on Sch. A of the 1040; if actual deductions are greater than the standard, this is the amount you claim.
To illustrate under the old law (2017), the amount of this standard deduction was $6,500 for single filers and twice that amount for married couples, or $13,000. So, if a married couple had mortgage interest totaling $10,000 and also gave $5,000 to charity, they would have $15,000 in total deductions, so in this example they would itemize because that would result in greater deductions over the standard, lowering their tax bill. In this manner, approximately a third of all tax filers would itemize their deduction.
But if that same couple had donated only $2,000, their itemized total would be just $12,000, which of course is below the old standard amount of $13,000. In this case the married couple would claim the greater standard deduction to lower their tax bill.
In contrast, today's new tax law nearly doubles these standard deduction amounts to $12,000 for singles and $24,000 for couples. And for obvious reasons, this really shakes the planning process up when it comes to the incentive effect and timing of tax deductions. We will talk more about this in a later segment.
So for a moment, to think about those two-thirds of filers who have been using the Standard Deduction. If you are a single tax filer who usually has only $2,500 in actual deductions, let's say it is for state income taxes, then, under the old law, you would always be claiming the $6,500 standard deduction. The tax system was giving you an extra $4,000 in deductions not actually incurred.
But now, with a new standard deduction of $12,000 for singles, the new tax law is giving you an extra $9,500 in tax deductions not actually spent. Therefore, for taxpayers whose actual deductions have been lower than the standard amount, this change is an additional tax cut.
But not everyone will find this to be a benefit. Remember that Peter said about two-thirds of filers claimed the standard deduction under the old rules. For the other one-third of filers, the ones who had more deductions than the standard amount, some will also get a benefit to the extent that their actual deductions are still less than the new higher standard deduction.
But those with itemized deductions higher than the $12,000 or $24,000 amounts will not receive any extra tax benefit from this change. The congressional Joint Committee on Taxation estimates that this will be only about 10 to 12 percent of all tax filers.
So, to sum up this part, this first change is another big plus to most people, but not for all. Those who still itemize will not get any tax reduction benefit from this change.
But remember I said there were two big changes in this section. The first one we just discussed is positive to most people but not all. But the second one is a negative for everyone.
Most of you will recognize that the tax law has long provided some big exemptions for you, for your spouse if you have one, and for each dependent in your family. These are called the personal and dependency exemptions. Under the old rules each exemption was worth $4,150. In other words, you could generally deduct this much from your income for yourself, for a spouse, and for any dependents you could claim.
The big change is that these personal and dependency exemptions have been repealed. This is a major change and one that many people are still not aware happened.
[show slide 3 - standard deduction bait and switch]
Many tax filers heard plenty about the positive changes that reduced their taxes through lowering the rates and increasing the standard deduction. But not too much was said about the loss of the personal and dependency exemptions. Thus, what might seem like a great deal all around was not such a bargain, at least not for everyone.
For example, if you are a single filer, you still came out a clear winner under this analysis. If you add up the prior law's standard deduction of $6,500 and the personal exemption you get for yourself, you would have a total amount of $10,650 of your income exempted from tax. Now, under the new law, with a total standard deduction of $12,000, you still come out ahead by $1,350. This alone is worth almost $300 in tax savings.
However, what if you are a family of five? Under the old law, you and your spouse received not only a standard deduction of $13,000, but also additional exemptions totaling $4,150 for each of the five members of the family. This gave you a total untaxed amount of nearly $34,000 under the old law.
Compare that with a relatively measly $24,000 from the higher standard deduction. Here is a shortfall over more than $10,000 of deduction or exemption. Again, if this family were in the 22 percent tax bracket, this would mean a tax increase of over $2,100.
But wait. There is more to this story - at least for tax filers with young children.
The new tax law doubles the tax credit for children, and makes it much more accessible to those with higher incomes. Thus, most tax filers with children under the age of 17 will find that this change will more than compensate for the loss of the dependency exemptions. Let me turn it over to Peter.
Historically, for tax filers with young (under 17) children, the child credit has been a meaningful benefit IF you met the income and other restrictions. The benefit started out as a $500 credit back in the late 90s (1997), and then, in 2001, it was increased to $1,000 per child but subject to income limits.
The value of the credit was fully phased out once adjusted gross income reached
1. $95,000 for singles and
2. $130,000 for married couples.
The new tax law doubled the tax credit to $2,000 per child, and also significantly increased the income level where the credit is fully phased out to
1. $240,000 for single filers and
2. $440,000 for married couples.
As a result, the child tax credit is going to be a much greater benefit for even more people.
And remember, a tax credit is much more valuable than is a tax deduction. A deduction only lowers the amount of income that is subject to tax, while a credit is a dollar-for-dollar offset against the tax ultimately due.
We hope it is becoming obvious that there are many moving pieces to this tax law, and while most people will get a tax cut, the amount will vary by a great deal, and some will even have to pay more.
I would like to drive this home by showing you how your family circumstances can shape how you fare.
[show slide 4 - doubled child credit]
Let's first assume the case of Andrea Agent, who lives with her young son, making her eligible for head of household filing status. She makes $100,000 per year and this tax law is good to Andrea. In total, she will be enjoying a tax cut of almost $4,600.
Every change we talked about so far is helpful to Ms. Agent. The increase in the standard deduction will lower her taxes, and so will the lower tax rate, where much of her income will be taxed at the 22 percent rate instead of 25 percent rate.
But it is the increased child credit, and especially the fact that the income cutoff has been raised, that delivers the $2,000 cherry on top, as Andrea was not able to claim this credit at all last year, since she made over last year's income limit.
Now, let's look at Bill and Beverly Broker, a married couple with three young children. The Broker Family brings in $175,000 per year, and they are also treated very well by the tax law. Compared with last year, Bill and Bev will see a tax cut of almost $7,700 each year.
As with Andrea above, the Brokers enjoy the benefit of the lower tax rate, which fully overcomes the loss of the personal and dependency exemptions. But by far the biggest benefit for them is the doubled child tax credit, for which they are now eligible now that the income phase-out level has gone up.
But it's a different story for Randy and Rebecca Realtor, who are also married with three children. This family earns $125,000 per year, just $50,000 less than does the Broker Family. But unlike Bill and Beverly, however, Randy and Rebecca's three kids are all over the age of 16, even though they are still dependents. Therefore, they do not qualify for the child tax credit. And while they still get a tax cut, it is miniscule compared with what the other families receive.
This shows the impact of the changes will depend on your own family situation. I have talked with impacted clients about this new law already, and there have been a lot of surprises, some good, some not quite as good, but that is the tax planning process in motion.
This concludes this section of our video series. In the next one, we are going to talk about the big changes the new tax bill offers for the tax incentives of owning a home, and especially for the deductions for mortgage interest deduction and for state and local taxes. Thanks for watching