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How the TCJA Tax Law Affects Your Personal Finances [1]
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Date: 2023-02-28 09:25:13.957000+00:00
Status Standard Deduction Increase Personal Exemption Decrease Old Tax Break New Tax Break Single (no children) $6,350 to $12,950 $4,050 to $0 $10,400 $12,950 Married Filing Jointly (no children) $12,700 to $25,900 $8,100 to $0 $20,800 $25,900 Married Filing Jointly (two children) $12,700 to $25,900 $16,200 to $0 $30,900 $25,900
There is another offset for married people with children: an increase in the child tax credit.
Child Tax Credit
The TCJA increased the child tax credit from $1,000 to $2,000 per child under the age of 17. It’s also refundable up to $1,400, which means that even if you don’t owe tax because your income is too low, you can still get a partial child tax credit. The TCJA also makes the tax credit more widely available to the middle and upper classes.
Single parents couldn’t claim the full credit in 2017 if they earned more than $75,000 and married parents couldn’t claim it if they earned more than $110,000. With the TCJA, those thresholds increased to $200,000 and $400,000 through 2025.
As for age, the prior law applied to children under the age of 17. The tax bill doesn't change the age threshold for the child tax credit, but it does change the situation for undocumented immigrant parents.
Under the previous law, undocumented immigrants who filed taxes using an individual taxpayer identification number could claim the child tax credit. The new law requires parents to provide the Social Security number (SSN) for each child they’re claiming the credit for, a move that seems designed to prevent even undocumented immigrants who pay taxes from claiming the credit.
Using 529 Plans for School
One big change: 529 plans have been expanded. In addition to using them to fund college expenses, parents can use $10,000 per year from 529 accounts tax-free to pay for K-12 education tuition at the public, private, or religious institution of choice.
An important point to note for those with 529 plans. The rules were expanded even further after the passing of the Setting Every Community Up for Retirement Enhancement (SECURE) Act. Signed in December 2019, this bill allows 529 account holders to withdraw funds to pay expenses related to a beneficiary's apprenticeship. In order to qualify, the program must be registered with the Department of Labor.
Another addition to the 529 plan is the ability to use funds to pay down student loan debt. Under Section 302, a plan holder can withdraw a maximum lifetime of $10,000 to pay down a qualified education loan for a beneficiary or their sibling. These withdrawals are tax- and penalty-free at the federal level but may count as nonqualified distributions under state tax laws.
Elderly Dependents or Children Over 17
For dependents who don’t qualify for the child tax credit, such as college-aged children and dependent parents, taxpayers can claim a nonrefundable $500 credit, subject to the same income limits as the new child tax credit (this is explained in the "Children Under 17" section above).
Caregivers lost two benefits under the TCJA. With the personal exemption gone, caregivers can no longer claim the $4,050 personal exemption for an elderly parent. In addition, they can no longer claim a dependent care tax credit for qualifying relatives who met dependent standards, which includes having a gross income of less than $4,400 for 2022 (originally $4,050) and living with the taxpayer for at least half the year. The maximum available was $600 to $1,050, depending on the taxpayer's adjusted gross income, and was based on up to $3,000 of expenses for care.
Not being able to claim this credit and getting just $500 instead—and losing the personal exemption of $4,050—is a significant blow to family caregivers.
Buying Insurance Through the ACA
The Republicans got their wish to see the individual health insurance mandate penalty repealed. This change means that people who don’t buy health insurance don't pay a fine to the IRS.
The American Rescue Plan of 2021 reduced the cost of Marketplace plans, increasing the tax credits for many Americans, and expanding eligibility for the tax credits starting April 1, 2021. The average Marketplace user will pay $85 less every month per policy.
Federal and Private Student Loans
Federal and private student loan debt discharged from death or disability will not be taxed from 2018 through 2025. This change will be a big help to families that need it. But the law does not require private lenders to discharge the debt in the event of a death or disability.
Let's say you’re married and have $30,000 in student loan debt. Under the old law, if you died or became permanently disabled and your lender discharged your debt and reduced it to zero, you or your estate would receive an income tax bill on that $30,000. If your marginal tax rate was 25%, your heirs or survivors would owe $7,500 in taxes. The TCJA tax reform eliminated that burden.
$12 Million Estate Tax Relief
The old federal estate-tax exemption thresholds were $5.49 million for individuals. If one died with assets worth less than this amount, no estate tax was owed. The threshold for 2022 is $12.06 million and for 2023 is $12.92 million.
The top estate tax rate remains at 40%. The estate tax uses a bracketed system with increasing marginal rates, just like the individual income tax does. It starts at 18% but escalates quickly. Once your taxable estate, which is the amount beyond the exemption, reaches six figures, you’re already in the 28% bracket.
The TCJA lowered tax rates across income tax brackets with income levels adjusted annually based on the Chained CPI-U.
Changes in the Tax Bracket
Tax rates change through 2025 across the income spectrum. The changes expire in 2026, which means that 2017 rates will return, absent further legislation. The individual cuts were not made permanent. Here's the reason: their effect on increasing the budget deficit.
The nonpartisan Tax Policy Center projects that everyone, on average, will save money from the tax bracket changes. The top 95% to 99% are the biggest winners, with an average tax cut of about 3.4% while the top 1% will see an average tax cut of about 2.2%.
The new tax brackets eliminate the marriage penalty. The income brackets that apply to each marginal tax rate for married couples filing jointly are exactly double those for singles. Previously, some couples found themselves in a higher tax bracket after marriage.
Read on to see how the changes will affect your bracket. Note that there is some overlap among where people fit in the income spectrum. Also, note that income tax rates will remain through 2025 but qualifying income brackets will be adjusted annually for inflation.
The tax bill also changes how tax brackets are increased for inflation. They are now indexed to a slower inflation measure called the Chained Consumer Price Index for All Urban Consumers (CPI-U).
High-Income Households Tax Liability
The top 25% paid nearly over 88% of all the federal income tax collected by the government, according to the Tax Foundation. The top 1% pay more than 42% of it, and the top 0.1% pay even less.
The table below shows how high-income earners will see their tax brackets change from 2018 through 2025.
Federal Individual Income Tax Rates for High-Income Earners, 2017 vs. TCJA.
Federal Individual Income Tax Rates for High-Income Earners, 2017 vs. TCJA.
Source: U.S. Congress. "Tax Cuts and Jobs Act Conference Report," Pages 2-3 and 191-192.
Middle-Income Households Tax Liability
According to the Tax Policy Center, the second quintile of income earners gets an average tax cut of a little over 1%. The third quintile will get an average tax cut of about 1.4%. Overall, middle-income families save about $900 in taxes.
The table below shows how middle-income earners will see their tax brackets change.
Federal Individual Income Tax Rates for Middle-Income Earners, 2017 vs. TCJA.
Source: U.S. Congress. "Tax Cuts and Jobs Act Conference Report," Pages 2-3 and 191-192.
According to the Tax Policy Center, about 82% of middle-income-quintile households get a lower tax bill, while 9% have a higher one. Households in the third and fourth quintiles pay about 16% of all federal income taxes.
Low-Income Households Tax Liability
The Tax Policy Center estimates that there is no change in the tax bill for over 70% of low-income households under the TCJA.
Note that many in the lowest brackets don’t earn enough to owe federal income tax. The Tax Policy Center says that the lowest 20% of income earners get 0.4% back in total federal income taxes paid each year, with an average tax bill of ~$60. The second-lowest 20% are in a similar situation. However, lower-income workers still pay Social Security and Medicare taxes, even if they don’t always pay federal income taxes. The table below shows how low-income earners will see their tax brackets change.
Federal Individual Income Tax Rates for Low-Income Earners, 2017 vs. TCJA.
Pass-Through Business Taxes
A pass-through business pays taxes through the individual income tax code rather than through the corporate tax code. Sole proprietorships, S corporations, partnerships, and limited liability companies (LLCs) are all pass-through businesses, while C corporations are not.
Under the TCJA, pass-through business owners can deduct 20% of their business income, which lowers their tax liability. However, professional-services business owners such as lawyers, doctors, and consultants filing as single and earning more than $157,500 or filing jointly and earning more than $315,000 face a phase-out and a cap on their deduction.
Other types of businesses that surpass these thresholds see their deduction limited to the higher of 50% of total wages paid or 25% of total wages paid plus 2.5% of the cost of tangible depreciable property, such as real estate. Independent contractors and small business owners benefit from the pass-through deduction, as well as large businesses that are structured as pass-through entities. These include certain hedge funds, investment firms, manufacturers, and real estate companies.
Both pass-through and corporate business owners can write off 100% of the cost of capital expenses from 2018 for five years instead of writing them off gradually over several years. That means it will be less expensive for businesses to make certain investments.
Taxing Multinationals
The TCJA changed the U.S. corporate tax system from a worldwide one to a territorial one. This means U.S. corporations no longer have to pay U.S. taxes on most future overseas profits. Under the previous system, U.S. corporations paid U.S. taxes on all profits no matter where they are earned.
The tax bill also changed how repatriated foreign earnings are taxed. When U.S. corporations bring profits held overseas back to the United States, they pay a tax of 8% on illiquid assets such as factories and equipment, and 15.5% on cash and cash equivalents. The tax is payable over eight years.
Both new rates represent substantial drops from the prior rate of 35%. In addition, the anti-base-erosion and anti-abuse tax intend to discourage U.S. corporations from shifting profits to lower-tax countries moving forward. Although these cuts also affect how much corporate tax is applied to the deficit, they do not expire starting in 2026 as the individual cuts do.
Tax-bill proponents point out that Americans who own stocks, mutual funds, or exchange-traded funds (ETFs) in their retirement and investment accounts will also profit from these changes. That's because their investments rise in value when multinational stocks rise in value.
They also note that the prior system of worldwide taxation harms Americans by sending jobs, profits, and tax revenue overseas by effectively double-taxing foreign-earned income. Most developed countries use a territorial system, and the United States joined them on Jan. 1, 2018.
Corporate Tax Rates
Corporations pay taxes under a bracketed system with increasing marginal rates the same way individuals and estates do. In 2017, those rates were as follows:
The corporate tax permanently became a flat rate of 21% as of 2018. Since it’s a flat rate that’s lower than most of the previous marginal rates, most corporations end up with a lower federal tax bill. Those with profits under $50,000 have a higher tax bill because their rate increased from 15% to 21%.
According to an analysis by The Wall Street Journal, the types of companies most likely to benefit from the lower corporate rates are retailers, health insurers, telecommunications carriers, independent refiners, and grocers.
For instance, Aetna had a median effective tax rate of 35% over the last 11 years. Time Warner paid 33%, Target paid 34.9%, and Phillips 66 paid 31.3%.
The way corporate profits are taxed affects everyone who owns shares of a corporation through stocks, mutual funds, or ETFs the same way foreign profits are taxed.
The top marginal tax rate for U.S. corporations under the former law was 35% and the global average was 25.44% when weighted for gross domestic product (GDP). Critics have long contended that America’s high corporate tax rates put the country at a competitive disadvantage compared to lower-tax nations such as Ireland, pushing American corporations’ profits overseas.
In theory, now that rates are lower, companies may allow more profits to be earned domestically and they might spend fewer resources lobbying for lower tax rates and more resources on improving their products and services. The corporate alternative minimum tax of 20% was repealed under the TCJA.
When the law was passed, the Tax Foundation’s models, however, found that the tax plan would:
Increase GDP by 1.7% over the long term
Increase wages by 1.5%
Add 339,000 full-time equivalent jobs
The organization expected GDP to grow by an average of 0.29% per year over the next decade, which is an increase from 1.84% to 2.13%. It also expects the growth generated by the tax cuts to increase federal revenues by $1 trillion.
You're a Tax Professional
Tax preparers, tax attorneys, and accountants were busy in 2018, helping people set up pass-through businesses and reevaluating their clients’ circumstances in light of all the tax changes. Tax preparers who primarily work for low- and middle-class taxpayers may see a drop in business, however, since fewer of those households will benefit from itemizing their deductions.
What's Permanent, What Isn't
All the individual changes to the tax code are temporary, including the 20% deduction for pass-through income. Most changes expire after 2025. The corporate tax rate cut, international tax rules, and the change to a slower measure of inflation for determining tax brackets are permanent.
The House released the first version of the tax bill on Nov. 2, 2017. Different groups who stood to gain or lose significantly fought hard to protect their interests:
Graduate students felt threatened that their tuition waivers would be taxed. Many graduate schools don’t charge tuition to students who teach or who work as research assistants. Students were opposed to getting tax bills for the income they never received. Depending on what tax bracket the grad student fell into, the tax bill may have been several thousand dollars. Grad students will continue to receive this tuition benefit tax-free
Anyone with student-loan debt will still be able to deduct the interest, even if they no longer itemize because of the higher standard deduction.
Teachers also worried about losing their up-to-$250 deductions for expenses related to their classrooms and jobs but they didn't. They can take this deduction whether they itemize deductions or take the standard one.
The low-income housing tax credit was also saved. The president of the National Low Income Housing Coalition told NPR that a provision of the bill that would have revoked the tax-exempt status of private activity bonds, a benefit that encourages investment in affordable housing construction by lowering its cost, would have meant “a loss of around 800,000 affordable rental homes over the next 10 years." These bonds also finance infrastructure projects such as roads and airports.
The act also failed to eliminate the individual alternative minimum tax (AMT). But it did increase the threshold for paying the AMT so fewer taxpayers will be affected by it.
The House bill wanted to eliminate medical-expense deductions, but the final bill keeps them and provides a small boost for two years, as noted above in "You Itemize Deductions and File Schedule A."
The earned income tax credit, which gives a tax break to the working poor, was not expanded.
And, in the end, the expansion of 529 plans to cover K-12 education did not include homeschooling.
How Did the TCJA Change the Way Taxes Are Prepared? The TCJA got rid of certain deductions related to preparing taxes such as tax preparation fees. It also did away with deductions related to unreimbursed employee expenses and other miscellaneous deductions.
How Did the Tax Cuts and Jobs Act Change Business Taxes? The Tax Cuts and Jobs Act changed business taxes by reducing the top corporate tax rate from 35% to 21% and eliminating the graduated corporate rate schedule.
How Long Does TCJA Last? The tax cuts implemented through the TCJA will expire at the end of 2025.
The Bottom Line
The Tax Cuts and Jobs Act will have an effect on tax payments for all Americans from the 2018 tax year and primarily lasting through 2025. Overall, the TCJA lowers tax rates across income levels helping reduce Americans' income tax burden. Individually, understanding how the Act affects taxes in your tax bracket and individual circumstances that affect you directly can help you to ensure you are taking advantage of all the deductions you deserve and ultimately paying the lowest tax bill available to you.
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