The passage of the Tax Cuts and Jobs Act (TCJA) has garnered a significant amount of attention within our industry, and with it come questions about its impact, the action steps we might take with our clients and the opportunities or challenges it may create. In order to provide financial professionals with a useful framework to better understand the changing tax environment, let’s look at three types of taxpayers: the average wage earner, the higher-income wage earner and the small-business owner.
The Average Wage Earner
For most clients in this group, the impact of the TCJA will come down to the interplay of four things: more favorable tax brackets, changes in the standard/itemized deduction rules, the elimination of the personal exemption and changes in the child tax credit.
To start with, there are still seven tax brackets, but the rates in each bracket have been reduced. In addition, the standard deduction has been almost doubled from $6,350 for single filer and $12,700 for married filing jointly, to $12,000 for singles and $24,000 for joint filers.
The TCJA also removed the personal exemptions that allowed filers to reduce taxable income by an additional $4,050 for every eligible person. So, if you have clients who are married with two children and taking the standard deduction, instead of reducing their taxable income by $28,900 (or $12,700 which was the old standard deduction, plus $16,200 which was the old personal exemptions of $4,050 X four people), in 2018 they would have a standard deduction of $24,000, with no additional personal exemptions. A single person with no children would go from $10,400 (the old standard deduction of $6,350 plus one personal exemption of $4,050) to $12,000, which is the new standard deduction in 2018 for a single individual.
Before those with children start worrying about losing exemptions, people should know that the child tax credit has been expanded from $1,000 to $2,000 per child. In addition, this credit phases out at higher income levels so it will be available to more people. Previously it started phasing out at $75,000 for a single person and $110,000 for a married couple. The new levels are $200,000 for singles and $400,000 for married couples.
Many taxpayers in this category may pay less tax and can use the additional funds to increase retirement plan contributions or pay off debt. What the government is hoping for, and seems more likely, is that the additional money will be spent on something like dinner out, a new cell-phone or a down payment on a car. Now is the time to talk to your clients who may be seeing more take-home pay in their paychecks—due to the required new withholding tables for employers—before clients get in the habit of spending the additional funds, rather than saving them.
The Higher-Income Wage Earner
In addition to the above-mentioned changes, those with higher incomes will often be affected by the changes regarding itemized deductions. TCJA limits the combined state income and property tax deduction to $10,000. In addition, the ability to itemize the interest on a home equity line of credit may be lost going forward. Existing first and second mortgages are grandfathered in under the old one million dollar limit. Going forward, however, your clients can only deduct interest on the first $750,000 borrowed on a first and second mortgage.
If they are not already doing so, clients who are in this group should be strongly encouraged to visit with their tax professional to find out exactly how the TCJA will affect them. Early awareness of the TCJA consequences will give clients more time to think through their options.