The Tax Cuts and Jobs Act of 2017: What it Means for You

The Tax Cuts and Jobs Act of 2017: What It Means for You

The first significant overhaul of the United States tax code in more than 30 years, the Tax Cuts and Jobs Act of 2017, is now law. Seven weeks after it was introduced, President Donald Trump signed the hotly-debated bill on December 22, 2017. It has been touted as the first major legislative victory of his administration.[1]

The current body of federal tax law is over 70,000 pages long[2] and includes the tax code, treasury regulations, IRS forms, instructions, publications, and federal court decisions.[3] This sweeping tax overhaul will affect all aspects of the United States economy. While the new laws won’t affect Americans when they file their 2017 tax returns, they are set to kick in as of the 2018 tax year.

This presentation will look at the most important changes that the new tax law makes and how they affect taxpayers.

Individual Tax Rates

The tax code features a “progressive” tax system, which means that higher incomes are taxed at higher rates. The new tax bill preserves the progressive nature of the code, but lowers the rates applied to most tax brackets and increases the income necessary to “progress” to a higher rate at many levels. In all, the tax rates for five of the seven tax rates drop under the new regime and the wealthiest Americans will see some of the deepest tax cuts.

For example, for a single filer, tax rates applicable to various brackets are decreased up to 4% and the amount one needs to earn to be in the top tax bracket increases from $426,700 to $500,000.[4]

Tax rates for married couples filing jointly are also decreased and levels of income necessary to reach the next bracket increased in a similar manner.[5]

Note that individual income tax rate changes are temporary and, unless extended, will expire at the end of 2025.

Deductions

Tax deductions lower taxable income, and thus tax liability. There are two types of deductions that taxpayers may choose from: standard deductions and itemized deductions. The standard deduction allows the taxpayer to deduct a fixed dollar amount,[6] while itemized deductions allow deductions of certain qualified expenses such as mortgage interest and charitable contributions. Taxpayers can choose the standard deduction or to itemize, and this can be changed from year to year. The taxpayer will naturally choose whichever gives her the greatest deduction.

The new law almost doubles the standard deduction. Under the 2017 rules, the standard deduction was $6,350 or $12,700 for married couples filing jointly. The new law almost doubles the standard deduction to $12,000 for single filers and $24,000 for joint filers. Like the individual tax rate decreases, this provision “sunsets” as of 2026.

The increasing standard deduction will naturally cause many more filers to take standard deductions than in past years, but those for whom itemizing is more advantageous may still do so. Most of these itemized deductions (sometimes called “Schedule A deductions” because they are listed on Schedule A of the Form 1040) remain intact, including those that allow deductions for student loan interest, certain medical expenses, charitable contributions and teachers’ unreimbursed classroom expenditures.[7]

Some deductions, however, were eliminated or reduced, including alimony or spousal support payments, tax preparation expenses and most job-related moving expenses.[8] The elimination of the alimony deduction may complicate how child support and alimony are calculated, prolong the divorce process and make it less likely that payor spouses will stipulate to alimony payments.[9]

In addition, deductions for mortgage interest (which greatly incentivizes home ownership) will be limited to the first $750,000 of new mortgages, though it should be noted that only 1-in-25 mortgage loans are for that much.[10] Smaller mortgages and already-existing mortgages are unaffected, and holders can continue to take 100% of the mortgage interest as Schedule A deductions.

Perhaps most significantly is that deductions for state and local taxes, which includes state income or sales tax and property tax, are now limited to $10,000 per year. Many middle-income families who live in high-tax states such as New York and California, will see greatly reduced deductions due to this limitation.

Personal Exemptions and Child Credits

Previously, every taxpayer could deduct a “personal exemption” for herself and for each dependent, in addition to the standard or itemized deductions. Under the old law, the personal exemption was $4,050 per person, which means a jointly-filing couple with two children received an exemption of $16,200.[11] The personal exemption has been eliminated under the new law.

However, to offset this, the child tax credit, a tax credit that one may take for children under 18 living at home, has been increased from $1,000 per year per child to $2,000 per year per child.[12] Note that a credit is more valuable than a deduction since it’s a dollar-for-dollar decrease in taxes, as opposed to a deduction, which just serves to reduce income.

Moreover, the credit is made available to more high-income taxpayers. Whereas the old rule started to phase out the child tax credit for incomes over $110,000, the new rule does not begin the phase out until $400,000 in income.

The new law also provides a $500 credit for each of a taxpayer’s other non-child dependents, such as elderly parents or adult children with disabilities, which was not permitted before. 

Estate and Gift Tax

            The estate tax is a tax on the transfer of property at death. The gift tax is a corresponding tax on large gifts during lifetime. Together, they make up “federal transfer tax.” The estate tax taxes the gross estate, which includes the fair market value of personal property, real estate, securities, trusts, annuities and most other interests controlled by the taxpayer upon death.[13]

Previously, individuals could transfer almost $5.5 million free of transfer tax over the course of a lifetime and after death, and this amount is doubled for married couples. The new law doubles the exemption amounts to almost $11 million for individuals and almost $22 million for married couples. The effect is that far fewer estates will be subject to the tax, as the Joint Committee on Taxation estimates the number of taxable estates would drop from about 5,000 per year under current law to only about 1,800 in 2018.[14]

Health Insurance Individual Mandate

While efforts to repeal the Affordable Care Act failed earlier in 2017, the tax bill eliminates the “individual mandate” that was a central feature of the ACA. The individual mandate assessed a tax penalty of about $700 on taxpayers who met certain income thresholds and chose not to purchase health insurance.[15] Many argue that the individual mandate is needed to prop up insurance markets by incentivizing healthy people to purchase insurance, thereby keeping premiums down. Because some healthy people will choose to drop their coverage after the mandate repeal, thus causing premiums to rise and possibly more people then dropping coverage, it is estimated that as many as 13 million Americans will become uninsured over the next ten years due to the mandate repeal.[16]

Alternative Minimum Tax

            The Alternative Minimum Tax requires taxpayers to pay a certain minimum percentage of their income in taxes even if Schedule A deductions would result in lower tax rates. Originally intended to prevent perceived abuses by a handful of the very rich, it affected roughly 5 million filers in 2017.[17] Whereas the old AMT could affect taxpayers with as little as $70,000 in income, the new bill eliminates the AMT for individuals earning less than $500,000 per year or joint-filers earning under $1 million.

Corporate Taxes

The new laws have a powerful impact on corporate and business tax. First and foremost, corporations will see a permanent, massive tax cut, reducing the corporate tax rate from 35% to 21%,[18] the lowest corporate tax rate since 1939.

The corporate income tax is the third largest source of federal revenue, after the individual income tax and payroll taxes, bringing in over $350 Billion per year. The federal government taxes a corporation after it calculates earnings and deducts expenses.[19]

Tax revenue generated by the corporate income tax are projected to drop by over $600 billion over the next decade due to the rate reduction, though proponents of the bill hope that economic growth stimulated by the tax cut will cause businesses to earn more money, partially offsetting the rate cut. For example, as soon as Congress passed the bill, AT&T and Comcast announced new $1,000 bonuses to a combined 300,000 employees,[20] while Fifth Third Bancorp announced it was raising its minimum hourly wage to $15 an hour and providing 13,500 employees with a one-time bonus of $1,000.[21]

The Act also eliminates the corporate AMT, which previously taxed all corporations at a minimum rate of 20%, regardless of certain deductions.

Territorial System of Taxation

The Act moves the United States to a “territorial system” of taxation, meaning that multinational corporations will not be taxed on offshore-generated income. Under the old tax code, the federal government imposed the 35% corporate tax rate on all earnings.[22] Under the new bill, multinational corporations will only pay taxes in the nation where earnings are generated.[23] The goal is to allow corporations to bring their earnings generated abroad back to the United States without fear of additional taxes.[24] Companies will have to pay taxes on this income, but at much lower rates.

Pass-through Businesses

The new law lowers taxes on pass-through businesses, which means any business income not earned through a standard C-corporation. Examples include income earned by sole proprietorships, partnerships, most LLCs and Subchapter S corporations. These comprise about 95% of businesses in the U.S.[25] While income from these businesses are “passed through” to the owners, the new law, allows a 20% deduction on all such business income. If a taxpayer working as a service provider earns more than $157,500 (or $315,000 for a married couple), the 20% deduction has certain limitations and phaseouts designed to prevent ordinary wage income from being “repackaged” as pass-through business income to take advantage of the deduction.[26]

Expense Deduction

Under the prior tax laws, a business owner that purchased assets necessary for the operation of their business, such as computers, copiers, and other equipment, could write off, or “depreciate,” these assets over time.[27] Under the new law, a business owner can deduct the entire cost of a capital asset immediately. This is designed to encourage investment in business infrastructure and equipment.[28]

Overall Impact on The Economy

            While debate continues to rage over the tax bill, studies indicate that the new tax laws will increase the long-run growth of the economy and result in lower long-term unemployment.[29] Still, the tax cuts will lead to likely lead to an increase in federal debt of about $1.5 trillion over the next decade.[30]

Moody’s chief economist, Mark Zandi, has attacked the law, saying “It’s a very costly way to go nowhere. It’s creative in a Machiavellian way.”[31] On the other hand, Brandon Arnold, the executive vice president of the National Taxpayers Union has written, “The Tax Cuts and Jobs Act would offer victories for taxpayers across the country.”[32] Regardless of what side one is on with the new tax code, one recommendation endures: brush up on the laws and consult with a tax professional.