Individual Taxpayers and the Tax Cuts and Jobs Act
By James Rinier, CPA, EA, and Erica Chase
The Tax Cuts and Jobs Act of 2017 aims to simplify taxes for many individual taxpayers by increasing the standard deduction, eliminating the personal exemption, and lowering the tax rate brackets. The net result is taxpayers are less likely to itemize.
Signed into law on December 22, 2017, the Tax Cuts and Jobs Act (TCJA) (PL 115-97) is changing the tax landscape for both business and individual taxpayers beginning in 2018. The new law has introduced some simplicity into the tax system by eliminating certain tax provisions, but assessing the overall impact on individual taxpayers is difficult given the breadth of changes. A look at some of the key issues impacting individual taxpayers provides just a glimpse into the changes individual taxpayers can expect. Whether the new law is friendlier or not may vary depending on the taxpayer's circumstances, and any evaluation of that change may depend more on your point of view, state of residency, or even your general perspective toward taxes.
CHANGES TO TAX LIABILITY
There are three relevant factors that affect an individual's tax liability: the tax rate, tax brackets, and taxable income. The TCJA made changes to all three.
Five of the seven tax rates changed. The lowest rate (10%) remains unchanged, as does the second-highest rate (35%). The rest were reduced. The final result is tax rates of 37%, 35%, 32%, 24% 22%, 12%, and 10%. Formerly, they were 39.6%, 35%, 33%, 28%, 25%, 15%, and 10%.
For tax brackets, the two lowest brackets (now taxed at rates of 10% and 12%, respectively) remain unchanged when compared to the inflation-adjusted brackets for 2018, and the five highest brackets are expanded. For example, the highest rate (37%) now applies to taxable income greater than $600,000 for married filing jointly and greater than $500,000 for single and head of household filers. Although there's some separation between these starting points for the 37% tax rate, the marriage penalty is still present. In addition, the $500,000 break point is the same for the single and head of household brackets, which is different from prior law.
Assessing the new law's impact on taxable income, the third and most critical piece to the tax liability calculation, is a bit tricky. In this case, we look to two competing elements: standard deduction and itemized deduction. The new law nearly doubles the standard deduction to $24,000 (from $13,000) for those married filing jointly, $18,000 (from $9,550) for head of household filers, and $12,000 (from $6,500) for single filers. By increasing the standard deduction, the net effect is to reduce the number of taxpayers that otherwise would be eligible to itemize.
The ability to itemize is further reduced by other changes. Beginning in 2018, a taxpayer is limited to deducting up to $10,000 of the combined amount of state and local property taxes and state and local income taxes (or state sales taxes, if applicable). In addition, a taxpayer is limited to deducting interest on acquisition debt of up to $750,000 from the primary and secondary residence that is incurred after December 31, 2017. The deductibility of interest associated with equity debt and miscellaneous deductions subject to the 2% floor are eliminated; and casualty losses are similarly eliminated, except for those attributable to a disaster declared by the U.S. President under §401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act. Finally, the annual limit on deducting charitable contributions to public charities is increased to 60% (from 50%), and no deduction is permitted for those making contributions in exchange for seating rights at college athletic events.
At first blush, these changes appear to preclude most individuals from itemizing. In part, this is correct. But the across-the-board limit that applies to state and local tax deduction appears to provide individuals filing as single or head of household with a greater opportunity to itemize.
For example, consider a couple and a single individual who are neighbors. The two households both have mortgage interest of $8,000, charitable contributions of $1,200, and state and local taxes of $12,000 (limited to $10,000 for both); as a result, the taxpayers have itemized deductions of $19,200 ($8,000 + $1,200 + $10,000). Yet the couple—who file as married filing jointly—would elect the standard deduction of $24,000 since that's greater than the itemized deduction of $19,200. The single taxpayer, on the other hand, would elect to itemize since $19,200 is greater than the standard deduction of $12,000.
The TCJA also made other changes related to calculating the taxable income. It eliminates the $4,150 personal and dependent exemption deduction that would have been allowed for 2018 under the old law. This change eliminates, for example, a $16,600 deduction for a family of four.
Other tax items changed by the TCJA will also affect its impact on individual taxpayers. First, the “Pease limitation” provision on excess itemized deductions (also known as the cut-back rule) is eliminated. Thus, taxpayers who are still eligible to claim itemized deductions because they exceed the new standard deduction amount will be able to claim the full amount, regardless of their adjusted gross income (AGI).
The child tax credit is significantly improved for many taxpayers. The credit is increased to $2,000 from $1,000 per qualified child. This change is seen to offset the loss of the dependent exemption. More important, the phase-out threshold is increased to $400,000 for married filing jointly taxpayers and $200,000 for all other taxpayers. Under the prior law, the child tax credit was phased out for each $1,000 of modified AGI more than $75,000 for taxpayers filing as single or head of household and more than $110,000 ($55,000) for taxpayers filing as married (either jointly or separately). This change is applicable for tax years 2018 through 2025 and will apply to a significant number of taxpayers. Finally, a new $500 credit is made available to taxpayers providing for qualifying dependents who aren’t qualifying children.
It’s too early to tell if the new law will be beneficial to individual taxpayers. On the surface, the drop in the tax rates, increased standard deduction, and the increase and expansion of the child tax credit appear to be friendly for lower- and middle-income taxpayers. But the loss of the deductibility of interest on equity debt and the limitation on the deductibility of state and local taxes reduces the friendliness of the new law. Hence, the general conclusion seems to be that a case-by-case analysis would be necessary.