A big middle-class tax cut was one of the promises central to the campaign of the current President. While politicians are divided on whether the new legislation constitutes a middle-class benefit or a windfall to businesses and the rich, all of us will be affected in some way by the new tax legislation.
Increase in Take-Home Pay
The immediate impact to you will be to your paychecks. The good news is most everyone (the IRS estimates 90% of Americans) will see an increase in take-home pay, with the largest discount going to those in the highest income brackets. Starting immediately in 2018, the new tax law reduces the amount of Federal taxes withheld from your salary, thus increasing your take home pay. The bad news is that depending on your income level and how much deductions you are able take, you could actually end up owing the IRS when you file your tax return because too little was withheld from your paycheck throughout the course of the year.
Changes in Deductions
The new law doubles the standard deduction to $12,000 for individuals and $24,000 for married people. It also eliminates or changes the rules for many itemized deductions. As a result, it is believed that the vast majority of Americans will have to choose to take the standard deduction because the sum total of their itemized deductions will be lower than the standard deduction.
For Californians, deductions will be significantly reduced by two changes. The first is the deduction for local property tax, state and local income and sales taxes (SALT) which is now capped at $10,000. This will increase the tax burden of workers in California because incomes here are in most cases higher than the National Average. In addition, property taxes alone can be well north of $10,000. Prior to 2018, the California state tax and Property tax deduction were unlimited and represented a significant portion of a taxpayer's itemized deductions.
The second is the cap on mortgage interest deductions from home purchases from $1 million down to $750,000 (the new cap only applies to new purchase mortgages, not existing ones). This change will also have a significant impact to Californians where homes easily well above $750,000. Additionally, the new Act eliminates the deduction for interest on home-equity debt, such as HELOCs (home equity line of credits).
Wealth Transfers and Taxes
The estate tax now allows an exemption on wealth transfers of up to $10 million for an individual, double what it was in 2017. The exemption is indexed to inflation after 2011, which means an even larger exemption in this year. The exemption doubles for couples.
Health Care and Taxes
The Act repeals the tax penalty on individuals without health insurance that was part of the Affordable Care Act. However, those who have purchased or currently enjoy high-end health insurance policies can deduct some of the cost. Some economic analysts believe that eliminating the individual mandate will cause health care premiums to rise. While most Americans have health insurance through an employer, those who must buy heath care on the open market could find insurance to become more expensive in a few years.
Corporate and Business Taxes
The biggest change for businesses to come out of the Tax Cuts and Jobs Act (TCJA) is the establishment of a flat 21% tax rate for corporations.
Some small businesses will receive a break as well. Small businesses where the profits “pass through” to the owner were used to be taxed at the individual tax rate. So if your business was doing well, your profits could be taxed at up to 40%. Under the TCJA, the maximum tax rate is now 29.6%.
The Bottom Line
Will the new tax law benefit you, and if so, how much? That depends on what you currently earn, where you live, and whom you ask. Conservative leaning think tanks like the Brookings Institute suggests that the economy will benefit and that after the income tax cuts expire, the deficit will drop significantly, offering a boom to stocks and jobs. On the other side, the belief is that the short-term tax savings will end up costing the middle-class in the long run, and raise the deficit such that no economic boom can make up for it.
The information in this material is not intended as investment, tax, or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information only.