Everything You Ever Wanted to Know About Tax Reform
Most people don't know much about taxes besides the fact that they need to file a tax return every year. Even an individual return can be very complicated, and most people will get more money back after they file if they use a professional tax preparer.
The tax code changes on a regular basis, and even a certified public accountant or tax attorney has to work hard to keep up with all the new laws. The 2018 Tax Reform Bill brought even more changes to the table. Fortunately, we can summarize the most important ways these new reforms will affect an individual filing a tax return.
Paying Taxes
We don't really think about all the ways we pay taxes, but most of us pay taxes throughout almost every day. Most states have a sales tax, and our employers take a big chunk out of our paychecks every time we get paid. Property taxes are often just a part of our mortgage payments, built into an escrow account that also pays for homeowners insurance. Most vehicle registrations include state taxes as part of the payment. It's actually more difficult to think of things we don't pay taxes on.
Where Does My Paycheck Go?
Your employer actually withholds a couple of different kinds of items from your paycheck. There are withholdings, which your employer withholds from you so that the funds can be sent to the government with your information, and deductions, for expenses like health insurance and life insurance premiums. The money which your employer withholds will be credited into the Social Security fund and to various tax agencies. You choose your own deductions, often at your own benefit, for services and benefits, you can get through your employment.
You should become familiar with your paycheck and which numbers mean what. Your gross pay is the total amount you earned, and your net pay is how much you will actually get to take home. If there is a section labeled "FICA," that stands for the Federal Insurance Contributions Act and will include Social Security, if Social Security doesn't have its own designation. You should also see sections for federal income tax, state income tax, and local taxes. Toward the bottom, you will see other designations for items such as retirement benefits.
The 2018 Tax Reform Bill
The new Tax Reform bill is nicknamed the "Tax Cuts and Jobs Act" because its main ambition was to help in those areas. The bill actually went into effect on January 1, 2018, but it won't affect people until they are filing their taxes in 2019, for the 2018 tax year. You may have already felt the effects of the new Tax Reform bill throughout the year, as less money was being deducted from your paycheck on a regular basis. You may have noticed you had more money you could use for purely discretionary spending, or that you were able to keep up with your bills more easily.
Fortunately, since there has been a year during which the law has been in effect, that means that it has been possible to see how the law will affect people and what they should expect to see when they are filing their taxes. Anyone who depends on certain kinds of software to file taxes can rest assured that the companies in charge of those have had time to adapt the programs to guide each person through the process. Hopefully, most people will be glad for the Tax Reform bill and its effect on individual taxes.
The Major Changes
Most of the major changes that people will notice in the Tax Reform bill have to do with the effects on the income brackets and marginal tax rates and changes in deductions, but there are several other changes that are important that individuals should be aware of. Here are the most important changes, as well as what you can expect as long as these changes continue.
Income Brackets and Marginal Tax Rates
If you've never heard of marginal tax rates, you're not alone. You should know about them though because the marginal tax rate is actually what decides how much money you owe in taxes based on your income. You can figure out your base taxes by seeing which income bracket you fall into. It is always a good idea to know which income bracket you fall into, and you will see why soon.
Tax Brackets
Tax brackets are simply income ranges, and there is a chart you can look at which makes it easy to see all the income brackets. There are only seven tax brackets in all, covering the range of possible incomes. Your bracket is also determined by what kind of filer you are. So, for instance, a single filer making up to $9,525 may owe 10% of their taxable income. A single filer making $500,001 or more, on the other hand, has a 37% tax rate. The tax rate gets steadily steeper as the individual earns more, meaning that there is a distinct advantage to staying in a lower tax bracket when possible.
For example, look at Rita. She is married filing jointly and works at a factory where she has been getting a lot of overtime, and she notices that she has earned almost $77,400 at the end of the year. While she was in that lower tax bracket, she only owed 12% of her income to taxes. When she hit $77,401, she suddenly jumped into a tax bracket where she now owes 22% of her income to taxes. It may not always be possible, but if you can stay in a lower tax bracket, you can end up owing a lot less in taxes at the end of the year.
The tax brackets under the new Tax Reform bill allow people to make more money before falling into the harsher tax brackets. The change in tax brackets helps married people, too, because there used to be an unintentional penalty for married filers, since under the 2017 code married couples would be pushed into a higher tax bracket when they combined their incomes. The new tax brackets simply double the amount for married couples, which is actually more fair because they only pay as much as any other individual.
The Standard Deduction
If you have ever filled out your own taxes, you are familiar with the standard deduction. It is the amount you can automatically deduct from how much you will owe in taxes. If you choose not to use your standard deduction, you can itemize your deductions. Most people don't have enough individual deductions that it would help them to use itemized deductions.
In 2017, the standard deduction for a single filer was $6,350, and in 2018 that standard deduction jumped to $12,000. For married couples filing together, the standard deduction was $12,700 in 2017 and $24,000 in 2018, and heads of household went from $9,350 in 2017 to $18,000 in 2018. (A head of household is basically someone who is single but pays for more than half of the expenses to maintain a household with at least one dependent, such as a minor child.)
The Personal Exemption
In the past, everyone could take a personal exemption for themselves and for any dependents they could claim on their taxes. In 2017, the personal exemption was $4,050 for each dependent and tax filer. The 2018 tax reform bill eliminated the personal exemption entirely. For some people, the changes will balance out, as the standard deduction became larger while the personal exemption disappeared. For other people, the changes will allow them to keep more of their own money than they were able to before.
In some ways, this trade-off has simplified the process of handling the exemptions and deductions. However, when it comes to deductions, this is one area where it could benefit you to talk to a tax professional and make sure that you are taking all your possible deductions.
Child Tax Credit
People can get more money just for having children now. In 2017, there was a $1,000 credit allowed for each qualifying child, as long as the parents made $110,000 together and $75,000 individually. That credit went up to $2,000 in 2018, and the income limits were raised significantly, so the parents could still claim the credit even if they earned $400,000 together and $200,000 alone. While this can help significantly reduce your tax bill, you must first determine if you and/or your child are eligible in order to claim this Child Tax Credit.
College Savings Plans
Another important change for taxpayers with children involves the 529 college savings plans. A 529 savings plan is a special kind of savings account used for educational purposes for students at any level of education, from kindergarten through college. Even elementary school tuition could be paid through a 529 plan, and the major advantage is that the 529 savings plan is tax-free.
Most people formerly used the 529 plans to save for college, because it is a great way to achieve dreams over time. The new tax reform bill allows the plan to be used at any level of education, because tuition can be expensive for families in any state. The worst thing that can happen if the money doesn't get used for education is that it gets used for something else. If the money isn't used for educational purposes, there is simply a tax penalty when the money is withdrawn. The real problem with withdrawing money early is that you will miss out on the potential of compound growth, because saving for a long time could result in much better savings.
Homeowners
All homeowners know that the credits they get for their homes are often some of the best and biggest credits they get on their taxes. The effect of the new tax reform bill mainly concerns the homeowners interest deduction. In 2017, as long as the original mortgage principal on a home was less than $1 million, taxpayers could deduct the interest they paid that year on the primary and/or secondary home, as long as they were itemizing their deductions.
In 2018, the principal was lowered to $750,000, but anyone who already had a home with an original mortgage principal of between $750,000 and $1 million was grandfathered in, so they wouldn't lose out on the deduction.
There is bad news for people who get home equity lines of credit though. Formerly, taxpayers could deduct up to $100,000 of interest paid on a home equity debt. The 2018 tax reform bill completely eliminated that credit, so people might want to think twice about taking out that extra line of credit against their home when they aren't getting that former benefit.
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The SALT Deduction
This is an interesting deduction because it allows you to deduct taxes on your federal return that you paid to other localities. SALT stands for "state and local taxes," and if you qualify, you may be able to deduct sales taxes or state taxes, but only if you itemize your deductions.
The former tax code had no limit on the SALT deduction, but the 2018 tax reform bill limits the total amount allowed for the deduction to $10,000. That includes income tax, sales tax, and property taxes. For anyone living in a state with high taxes, this new limitation will be disappointing, but most people probably didn't have more than $10,000 to take off with the SALT deduction anyway.
Estate Taxes
Even people who never expect to inherit anything understand how unfair it is to pay taxes on what is essentially a gift from a loved one who has passed on. Many states no longer have estate taxes, or they have at least severely modified the laws so beneficiaries won't owe as much in estate taxes. The federal estate tax won't affect most people because it only applies if the property is worth over $5.49 million. Once someone inherited that much, the federal tax was 40%. The 2018 tax reform bill raised even that amount significantly. Before the 40% estate tax kicks in, an individual can now inherit $11.2 million throughout a lifetime.
Charitable Donations
Charitable donations have always been a great way to get deductions and feel good about yourself at the same time. Under the former tax code, if you itemized your deductions, you could take a deduction up to half of your total income if you had that many charitable deductions. The new bill has raised that limit to 60%, meaning it is possible to get an even larger deduction.
Know Your Money
Think about what tax bracket you're in, whether you or a loved one will need money for tuition, and many other important factors. The more knowledgeable you are about your taxes, the more money you can save and keep for yourself. Tax management isn't a task you should dread anymore, because that will keep you from being open to new financial information. Never hesitate to ask for advice from a trusted professional if you have questions, but you can protect yourself and be more proactive when you are aware of all the issues yourself.
Medical Expenses
The good news is, you can now get a larger deduction for medical expenses if you itemize. This is especially good considering that it is unlikely you are getting medical bills for services you don't need. One thing it is important to remember is that you cannot take a deduction for an expense that was reimbursed or that you expect to be reimbursed in the future. Under the former tax code, if you were itemizing, you could deduct those medical expenses above 10% of your AGI.
Your AGI is your adjusted gross income, which is basically the amount of your income that is taxable. If you have filled out your own taxes before, or gone through your return carefully, you have seen the line for your AGI.
The new tax law now allows you to deduct your unreimbursed medical expenses up to 7.5% of your income, which means that you can now deduct more of your medical expenses on your tax return if you itemize. While most people wouldn't benefit from itemizing when it comes to medical deductions, it is definitely a good thing that anyone who does have a lot of medical expenses is allowed to deduct that amount from taxes.
The Health Care Penalty
Under the Affordable Care Act, which many also call Obamacare, anyone who didn't carry health insurance was required to pay a penalty unless they could prove that their income was so low that they couldn't afford health insurance. The new tax bill takes away the penalty, but that won't take effect until next year. This year, the penalty could be $695, and you may have to pay it or at least some of it if you didn't have health insurance for all or part of the year.
Getting rid of the penalty is a good thing, because if you can't afford health insurance you can't afford a penalty, and if you can afford health insurance, you hopefully have it. But don't look at removing the penalty as a reason to drop your insurance; healthcare is important, and you will regret it if you don't have insurance when you need it. Taking care of yourself should be your first priority.
Moving Expenses
Under the former code, you were allowed to deduct moving expenses as long as you were moving to a full-time job and the job was at least a certain distance from where you were starting. The new code eliminates that deduction until 2025, unless you are a member of the military. Luckily, there are still many ways to finance your moving expenses, whether you are trying to lower your overall moving costs or need a residency relocation loan. You can even get a moving loan if you have bad credit.
Student Loans
This one actually seems a little crazy. Most student loans are automatically discharged when the borrower dies or becomes disabled. Under the old tax code, that discharged debt was taxed as income. The new tax code eliminates that tax, at least until 2025.
Self-Employed and Small Businesses
There are a lot of changes for businesses, and if you are a small business owner or if you do independent work, you should keep in mind that there are some changes. The single biggest change is a reduction in the top corporate rate to 21%, which is a huge change from the former rate of 35%. This is one of the key parts of the tax bill which is meant to help stimulate growth in small businesses by allowing businesses to keep their money and invest it for growth.
Another important change involves Section 179, which allows small businesses to take a depreciation deduction for certain assets in a single year, rather than forcing them to deal with the depreciation over a longer period of time. If the deduction is taken in the first year, it is referred to as a 179 deduction. The 2017 code only allowed for $510,000 for that particular deduction, but the new code allows a business to take up to $1,000,000 for the 179 deduction.
The corporate alternative minimum tax is like a second tax that runs parallel to the regular corporate tax, and that tax is being entirely eliminated in 2018, as the corporate alternative minimum tax has been repealed.
Alimony
Not all states have alimony, but in the past, someone receiving alimony could count that cash flow as income. Under the new reforms, individuals will no longer be allowed to deduct alimony payments from their income if they are making the payments, and anyone receiving alimony will no longer be allowed to count it as income. Some are concerned that this will put women at a large disadvantage, as they are often financially vulnerable after a divorce. Research has found that, after a divorce, a woman's income typically falls by more than a fifth, while men with children typically see their incomes rise by a third. Though this has been seen by some to be controversial, the IRS is expected to raise $6.9 million in the next 10 years from this new tax reform measure.
Future Taxes
Tax reform isn't stopping with the new rules. There are already plans to increase the tax brackets in 2019 to account for inflation, and the standard deduction will go up to $12,200 for anyone filing as a single taxpayer and up to $24,400 for married couples filing together. Of course, starting with the next year, the penalty will be gone for not carrying health insurance. For the latest tax reform news, including tax reform news releases, fact sheets, statements, tax tips, tax reform publications, and the answers to frequently asked questions over current tax reform, then regularly check the IRS website for updates.
Take Control of Your Taxes
Taking control of your financial situation can seem difficult at first, but once you get started, you will see how easy it can be. It all starts with building -- and sticking to -- your budget. Budgeting is so important because it causes you to be more conscience of all of your financial decisions, as well as gives you a framework to follow to make sure you stay on track.
If you are on a low income, then there are specific things you can do to get back in control of your financial situation. Whether you need help with prioritization or organization, there are many people you can ask for help when getting started. If you are more of a do it yourself -- DIY -- person, then you should consider reading one of the many helpful personal finance books for beginners.
One big mistake people make is thinking that it's good to get a really big refund. While it's definitely good to get a big chunk of money, it's even better if you figure out how to manage your finances so that you have your own money throughout the year to live your life. If you're getting big returns at the end of the year, you might want to check out how you filled out your W-4 and see if it would be better to change it so you keep more money with every paycheck and get a smaller tax return at the end of the year.
To Sum up
Most people wait until April of every year and panic because they know they will need to file their taxes soon. You don't have to do that. Instead, take control of your finances and learn about how the tax laws affect you as a person. Once you are more knowledgeable, you can make changes that will help you to save money down the road and plan for bigger tax breaks on next year's return. It never hurts to have more money in your pocket, and the better you understand your financial situation, the better you can work to strengthen your financial future.