Happy New Year! 2017 is officially in the books and here we are in 2018. So what do you have to know about filing your 2017 tax return? For the most part, there wasn’t much change in the way of tax laws from 2016 to 2017. Most of the differences between the tax laws affecting 2016 and 2017 are very subtle. For example, there was only a slight adjustment to the tax brackets due to inflation. This means that for those of you in a similar income situation to the prior year, you shouldn’t expect to see much difference in your income tax numbers when it comes time to file your 2017 income tax return this year.
Tax Cuts and Jobs Act
Now let’s talk a little about 2018. As many of you already know, there was a new tax bill signed into law on December 22, 2017 called the ‘Tax Cuts and Jobs Act’. This law comes with many changes in it that could have an effect on your overall tax liability to the federal government. While it was promoted as a ‘tax cut’, the bill in its final stage was much more complicated than that. The bill itself did make changes to the tax bracket and, indeed, the brackets may be lower on an individual’s taxable income. So from that standpoint, it is certainly a tax cut. But the bill doesn’t stop there.
Elimination of Exemptions
There are many changes to the tax law that could affect your taxable income and will cause many taxpayers’ taxable income to change in 2018. One example of a major change is the elimination of exemptions. What does that mean? In the past, an exemption allowed you to exclude a portion of your income from being taxable – up to $4,050 in 2017. You were entitled to one exemption for each person being claimed on your tax return. For example, if you were filing a joint return with your spouse, you would each be entitled to one exemption. These personal exemptions would reduce your taxable income by $8,100 ($4,050 x 2). Now if you were filing a joint return and claiming three dependents, you would claim 5 exemptions (2 personal and 3 dependents), thereby reducing your taxable income by $20,250 ($4,050 x 5). Consequently, by eliminating exemptions in 2018, a family of 5 could now be seeing an increase in their taxable income by $20,250 (depending on their personal tax situation) due to this new tax bill.
Standard vs. Itemized Deductions
Another major change coming from this new tax law includes changes to the standard deduction and to itemized deductions. First, let’s discuss what the standard deduction is, and what itemized deductions are. To start, you have to take one or the other. You don’t get to take the standard deduction and get to itemize your deductions. The standard deduction is simply a set amount that the federal government gives you based on the filing status of your return (e.g. $12,700 for a Married Filing Joint return). This standard deduction reduces your taxable income. So why do people itemize if they can just choose to take the standard deduction? The reason a taxpayer would choose to itemize may be when their itemized deductions exceed the amount of the standard deduction, giving them a larger total deduction. For example, if a taxpayer and their spouse have itemized deductions of $30,000, they will be able to reduce their taxable income by $30,000 instead of only $12,700 (the standard deduction amount). For a taxpayer in the 25% marginal bracket, this could mean a savings in their federal tax liability of $4,325 ($30,000 – $12,700 = $17,300; $17,300 x 25% = $4,325).
With this new tax law, two main changes have taken place here. First, the law has almost doubled the standard deduction from the 2017 numbers. Second, the law has eliminated or capped certain deductions that taxpayers were able to itemize. The most significant change to the itemized deductions is the new $10,000 cap on taxes paid to state or local government. This encompasses items like real estate/property taxes, state income tax paid, and SDI for those of us in California.
How will this affect me?
The question that seems to be on most people’s minds after hearing about these new tax law changes is this: How do these tax laws really impact me? The answer is that it depends. With these changes, some taxpayers might be paying a higher tax payment on the same amount of income they had in a prior year, and some clients might be paying a lower tax payment. If you have concerns regarding how these new changes could affect you, please contact us or your tax advisor to discuss and possibly analyze your personal tax situation.