During this post, we discuss how the new changes in the tax laws may have an overall positive effect on individual rates and deductions. However, a crucial component of the Tax Cuts and Jobs Act is that the rates and other provisions of the new tax code have a sunset provision, which means that on December 31, 2025, all of the rates are likely to be reinstated unless some legislation is introduced that will retain these rates or lower them even further.
The Tax Cuts and Jobs Act of 2017, otherwise known as GOP tax reform bill, largely went into effect on January 1, 2018. A crucial component of TCJA is that the rates and other provisions of the new tax code have a sunset provision. This means that on December 31, 2025, all of the rates are likely to be reinstated unless some legislation is introduced that will retain these rates or lower them even further.
The following are the list of major changes under the new tax code:
- Brackets Lowered (rates sunset on December 31, 2025)
- Personal Exemptions Repealed
- Standard Deduction Nearly Doubled
- State and Local Tax Deduction limited to $10,000
- 21% flat rate for C-corporations
- Qualified Business Income Deduction for Pass-Through Businesses
- Estate Tax Exemption More Than Doubled
For more on the impact the new laws will have on corporate rates and on pass-through businesses, please refer to our previous material, including “Tax Reform’s Impact On Businesses.”
Nearly all of the rates within each tax bracket have been reduced. The only brackets that have not been reduced under the new law are for those taxpayers who fall within the 10% bracket and the 35% bracket. These rates are the same as prior to TCJA. Additionally, the top rate for individuals has been reduced from 39.6% to 37%.
For middle-income families, the lowering of the rates may have a consequential impact on their lifestyle. For example, a married couple that files their taxes jointly and whose taxable income falls between $156,150 and $165,000, their effective tax rate has been reduced from 28% to 22%. For a married couple whose taxable income falls between $237,951 and $315,000, they would previously pay 33% tax on their taxable income. Now, they will only pay 24% under the new tax code.
Prior to the new law, every person was entitled to an exemption in the amount of $4,050. If such a person also had qualified dependents, each dependent would also qualify for the exemption. This would mean that a family of five could have potentially been entitled to an exemption in the amount of $20,250. However, the lowering of the brackets for the next eight years and the doubling of the standard deduction may offset the losses for such families who would otherwise be adversely affected by the repeal of the exemptions.
The standard deduction has nearly doubled in every category. For single filers, it used to be $6,350 prior to TCJA, now it’s $12,000. For married couples filing jointly, it used to be $12,700, now it’s $24,000.
For married couples filing separately, the rates are the same as for single filers. For those taxpayers who qualify as heads of households, they were previously allowed a deduction in the amount of $9,350, now they can deduct as much as $18,000.
The State and Local Tax deduction, which has been limited to $10,000, was a significant deduction for California residents who were previously itemizing their deductions. California is the highest income tax state in the nation. The top bracket is as much as 13.3% of the Adjusted Gross Income of the federal income taxes.
Previously, a taxpayer who did not elect the standard deduction was generally allowed to deduct all of the amount paid to the state and locality for income or sales tax, in addition to any property taxes the taxpayer might have paid to the state and locality. However, the deduction on both the income (or sales) tax and property tax is now limited to only $10,000.
To illustrate the point, let’s look at a specific example. Assume that Gregory lives in San Diego. He pays $9,000 per year in state income taxes and $11,000 in property taxes. Prior to tax reform, Gregory could potentially deduct $20,000. Now, Gregory can only deduct $10,000, if he chooses to itemize his deductions
There has also been a limit on the mortgage interest deduction for new mortgages. For those taxpayers who had an existing mortgage prior to 2018, they can still deduct the interest they pay on up to a $1 million mortgage. Under the new law, whether the new mortgage is for a new home or an existing home, the limit on the deduction for the interest paid on the mortgage has been limited to only $750,000 of the mortgage amount.
For charitable contributions, where previously a taxpayer could deduct 50% of his taxable income if that amount is directed to a qualified charity, now the taxpayer can redirect 60% of his taxable income to a qualified charity.
As for divorces or instruments of separation that are executed after December 31, 2018, the alimony paid as a result of the divorce or separation will no longer be allowed to be deducted.
Have a tax question? Contact Haik Chilingaryan.