A centerpiece of last year’s legislation is the reduction in income tax rates. While the new law keeps the same number of tax brackets for individuals as there were in 2017, many tax rates are two to three percentage points lower than prior years. The top rate is reduced from 39.6 percent to 37 percent and kicks in at higher taxable income levels – $600,000 of taxable income for joint filers, $300,000 for married taxpayers filing separately, and $500,000 for all other individual taxpayers.
The 2018 tax rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%, compared with the 2017 tax rates of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. However, while applicable tax rates at any given level of income have generally gone down by two to three points, some individuals will see an increase in taxes due to the tax brackets at which the rates apply. For example, the tax rate for single taxpayers with taxable income between $200,000 and $400,000 goes from 33 percent to 35 percent (head of household filers face a similar jump, but at a slightly different breakpoint). However, high-income taxpayers are also subject to a 3.8 percent net investment income tax and/or the .9 percent Medicare surtax. There were no changes made to these taxes in last year’s tax overhaul. In addition, the maximum tax rates on net capital gain and qualified dividends are the same in 2018 as they were in 2017.
For 2018 individual tax returns, two of the most significant changes are the repeal of the personal exemption deductions and the increase in the standard deduction amounts. The standard deduction amounts are almost twice what they were in 2017: $24,000 for joint filers and surviving spouses, $18,000 for heads of household, and $12,000 for single individuals and those who are married but filing separately. Additional amounts for the elderly and blind are also available. Because the standard deduction is generally claimed only when it exceeds available itemized deductions, the increase in the standard deduction will not benefit you if you itemize deductions. The repeal of the personal exemption deductions, by contrast, will affect you whether you itemize or not.
To compensate for the repealed exemptions for dependents, the new law increased the child tax credit from the 2017 amount of $1,000 (which was fully refundable) to $2,000 ($1,400 is refundable). The modified adjusted gross income threshold where the credit phases out has been increased to $400,000 for joint filers and $200,000 for all others (up from $230,000 and $115,000, respectively). The maximum age for a child eligible for the credit remains 16 (at the end of the tax year). In addition, a $500 nonrefundable tax credit for dependent children over age 16 and all other dependents is also available beginning in 2018. Most families with non-child dependents will lose some ground here, as the $500 credit will generally be less valuable than the $4,150 exemption deduction it replaces.
Other Significant Changes as a Result of the New Tax Law
The following are some items we should review in our year-end tax planning session so we can evaluate whether they will impact your 2018 tax return.
- State and Local Income and Property Taxes. New for 2018, there is a $10,000 limit on the deduction for state and local income and property taxes. No deduction is allowed for foreign property taxes.
- Mortgage Interest. The mortgage interest deduction on acquisition indebtedness (e.g., mortgages) of more than $750,000 obtained after December 14, 2017, is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). In the case of acquisition indebtedness incurred before December 15, 2017, the limitation is the same as it was under prior law: $1,000,000 ($500,000 in the case of married taxpayers filing separately). Additionally, no deduction is allowed for interest paid on home equity indebtedness. However, to the extent the debt is used for certain purposes, the interest on the debt may still be deductible.
- Child and Dependent Care Expenses. If you paid someone to take care of your child or a dependent so you can work or look for work, you may be entitled to a tax credit for up to 35 percent of the expenses paid. Various qualifications must be met in order to be eligible for the credit, but if you incurred such expenses, you may qualify.
- Adoption Expenses. If you incurred expenses to adopt a child, you may be eligible for a tax credit of up to $13,810 for some or all of those expenses. The determination of the tax year in which qualified adoption expenses are allowable as a credit depends on whether they were paid before the year in which the adoption became final or whether they were paid during or after the year in which the adoption became final.
- Medical, Dental, and Vision Expenses. For 2018, you can deduct medical, dental, and vision expenses to the extent they exceed 7.5 percent of your adjusted gross income (AGI). In order to take this deduction in following years, such expenses must exceed 10 percent of your AGI. Thus, to the extent you are planning any elective medical, dental, or vision procedures, the expenses of which you can accelerate into 2018, the bunching up of those expenses in 2018 may help reduce your taxable income if you will be itemizing deductions. Such expenses must be primarily to alleviate or prevent a physical or mental defect or illness. They do not include expenses that are merely beneficial to general health, such as vitamins, or the costs of cosmetic surgery, unless the surgery is necessary to ameliorate a deformity resulting from a congenital abnormality, a personal injury, or a disfiguring disease
- Casualty and Theft Losses. If you incurred a casualty loss in a presidentially declared disaster area, it may be deductible. Any other casualty loss, along with all theft losses, are not deductible.
- Charitable Contributions. Whether it makes sense to take an itemized deduction for your charitable contributions depends on whether your total itemized deductions exceed your standard deduction. It’s also worth noting that a new change in the law increases the maximum contribution percentage limit from 50 percent of your contribution base to 60 percent for cash contributions to public charities.
- Taxpayers 70 1/2 years old and older who own an IRA are required to take minimum distributions from that account each year and include those amounts in taxable income. If you are in this category, a special rule allows you to make a charitable contribution directly from your IRA to a charity. This has several benefits. First, since charitable contributions deductions are usually only available to individuals who itemize, individuals who take the standard deduction instead can benefit from this rule. Second, making the contribution directly to a charity counts towards your required minimum distribution but that amount is not included in income and thus reduces your taxable income and adjusted gross income. A lower AGI is advantageous because it increases your ability to take medical expense deductions that you might not otherwise be able to take. For example, medical expenses are only deductible to the extent those expenses exceed 7.5 percent of your AGI and a lower AGI means you can deduct more medical expenses. In addition, as AGI increases, more of your social security income is subject to tax. Finally, the 3.8 percent net investment income tax applies to the extent your AGI exceeds a certain level.
- Miscellaneous Itemized Expenses. If you deducted miscellaneous itemized expenses in prior years, such deductions are no longer available for 2018. The miscellaneous itemized expense deduction has been eliminated for tax years 2018 through 2025.
- Education-Related Expenses. If you have any student loans outstanding, the interest you paid on those loans may be deductible. A deduction of up to $2,500 of interest paid on a qualified student loan is deductible in computing adjusted gross income. The deduction is phased out if your modified adjusted gross income is between $65,000 and $80,000 ($130,000 and $160,000 if filing a joint return).
- If you are an educator and spend your own money on school supplies, up to $250 may be deductible from gross income.
- Moving Expense Reimbursement. If you received a reimbursement from your employer for moving expenses incurred in 2018, the reimbursement is taxable income. However, if you receive a reimbursement in 2018 for 2017 moving expenses, that is not taxable income. While taxpayers could previously deduct employment-relating moving expenses, this deduction is no longer available for moves taking place in years 2018-2025, unless the taxpayer is a member of the U.S. Armed Forces on active duty who moves pursuant to a military order to a permanent change of station.
- Alternative Minimum Tax. If you were subject to the alternative minimum tax in prior years, you may get a break this year as the result of increases in the alternative minimum tax (AMT) exemption amounts as well as the increases in the income level at which the exemption is phased out.
- Distributions from a 529 Plan. New for 2018, if you have a 529 Plan, you can use up to $10,000 in aggregate 529 distributions per year for elementary and secondary school tuition. Previously, 529 distributions could only be used for higher education expenses.
- Individual Healthcare Penalty. While the tax penalty on individuals who fail to carry health insurance, which was enacted as part of the Affordable Care Act, has been eliminated for tax years after 2018, the penalty still applies for 2018 unless a taxpayer is exempt from the penalty because the taxpayer’s income falls beneath a certain level.
- Passthrough Tax Break. Another change in the law, effective for 2018, allows a 20 percent deduction for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. If you qualify for the deduction, which is available to both itemizers and nonitemizers, it is taken on your individual tax returns as a reduction to taxable income. The new tax break is subject to some complicated restrictions and limitations, but the rules that apply to individuals with taxable income at or below $157,500 ($315,000 for joint filers) are simpler and more permissive than the ones that apply above those thresholds.
- It’s worth noting that the effective marginal tax rate on qualified business income for individuals in the top 37-percent tax bracket who are able to fully apply the new deduction will be 29.6 percent – a full 10 points lower than the top rate under prior law.