Merry Tax Reform Christmas: How Your Taxes Change

Taxes Change

Hello folks and Merry Tax Reform Christmas! Did Santa Trump…I mean Santa Clause leave you a nice tax reform package under your Christmas tree this morning? I’m here today to break down my view of the 2017 tax reform bill that was recently signed into law (and going into effect January 1, 2018!!) and how taxes change going forward.

How Will My Taxes Change?

For the question on everyone’s mind, let’s see how your taxes change! I can’t speak for everyone, but for most of us common folk we will see our taxes change in just a few key areas. I’ll tackle each one briefly below: 1) the standard deduction is going up, 2) personal exemptions are going away, 3) the child tax credit is going up as is the income level to which it begins to phase out and 4) the tax bracket rates are moving down, of course!

Standard Deduction

If you normally itemize your deductions (e.g. property taxes, state income taxes, mortgage interest, donations, etc), you may not anymore and instead you’ll rely on the Standard Deduction. For a married couple filing jointly, this will increase from $13,000 to $24,000 in 2018.

For clarity, the deduction is what you use to lower the amount of income that is taxable.

For me, this is a relatively moot change to my taxes as I’ve historically itemized which took me to an approximate $24,000 deduction anyway (coincidentally). Over the long-term (including retirement), it’s too early for me to guess if this is a good thing or not (hard to speculate my itemized deductions in 20 years…).

Personal Exemptions

You know the benefit you get for having kids…? That’s the personal exemption that you use to lower your taxable income beyond your deductible. Today that exemption amounts to $4,050, meaning each kid (and you and your spouse get an exemption too) lowers your taxable income by that amount. If your marginal tax rate is 25%, then this saves you $1,013 in federal taxes each year. So kids can pay for themselves to an extent :)…at least they used to.

Now personal exemptions are going away completely, for you and your kids. If you’re a married couple with two kids like me, that amounts to $16,200 of increased taxable income now!! You’re probably thinking the same thing as me…WTF!!!

If you don’t itemize your deduction, having the standard deduction raised to $24,000 partially offsets the personal exemptions going away. But if you are married an have even one kid then it doesn’t help enough. I thought taxes were supposed to go down with this reform!!

As I mentioned above, the increased standard deduction does me no favors, so pairing these changes together is a negative for me! This is definitely not a good thing for folks. Someone has some explaining to do on this.

Child Tax Credit

Another big one for folks is the child tax credit. Today it is $1,000 and will be raised as part of the tax reform to $2,000! And even better news for those toward the higher income end of the middle class is that the point that it phases out increases from $110,000 to $400,000 of income.

For example, I couldn’t ever claim the full $1,000 per kid because of the phase-outs and not many folks in the upper middle class really could. $110,000 of income for a family carves out a good chunk of the population from getting this benefit historically. Increasing the phase-out to $400,000 now is certainly really high, but it is nice for more folks to get the full benefit of this especially considering the personal exemptions for said kids is going away.

For clarity, tax credits reduce dollar for dollar the tax you have to pay which is different than the deductibles and personal exemptions discussed above which lower the income that is used for the basis of applying the tax rate and determining the amount of tax owed. If, based on your income, you owe $10,000 in tax, a $2,000 tax credit (e.g. the child tax credit) would then reduce this to $8,000. Thinking of it another way, the value of the tax credit in terms of a pre-tax deduction (like the personal exemption going away) is to divide the tax credit by your marginal tax rate. If you’re in the 25% tax bracket, a $2,000 tax credit reduces the tax you owe just as much as an $8,000 reduction to taxable income ($2,000 / .25)…or nearly twice the personal exemption.

Where this comes in handy particularly is when in low income tax brackets (e.g. in early retirement, see case study below) as the value of the credit stretches farther. For example, in a higher 25% bracket the value is $8,000 (as calculated above) whereas in lower brackets such as 12% the value is equal to a $16,667 reduction of income…over four times the personal exemption ($2,000 / .12)!

Tax Brackets

The last change, and probably the headliner of the group, is the change to the tax brackets. Currently there are 7 brackets or tiers of tax rates based on income, and in all the effort of Congress to simplify the tax code they managed to reduce this to…7 brackets still. WTF, seriously Congress? Simplifying the tax code via a 500+ page tax law which leaves us with just as complicated tax brackets.

Sorry, I just have to take my jabs. Not saying I could do their job better, but it is a little comical.

The new brackets are below. Keep in mind, these are based on taxable income. This is your income after the standard deduction is applied. This is also income after other pre-tax factors such as 401k contributions, pre-tax health insurance premiums, health savings account contributions, etc.

All the Single Ladies (and men…):

Taxes Change

Married Filing Jointly:

Taxes Change

While not simplified, all brackets have been lowered meaning this change standalone is beneficial for everyone.

Other Changes

There’s a lot more to this bill than just the four main topics above. Click here for a great article that highlights the numerous tax changes in detail.

Case Studies

Let’s walk through some case studies. I apologies in advance, but the focus is on married folks filing jointly. It’s what I know the best and it’s the category I presume most of my readership falls into or expects to fall into at some point, so it should be the most applicable. And for ease and simplicity across the case studies, I’ll assume two kids. This may not be your exact situation, but hopefully it is closely representative and can be easily adaptable to you. If you have questions or comments, let me know below.

Under Current Tax Law

Taxes Change

Under New Tax Reform

Taxes Change

Net Decrease in Taxes!

Taxes Change

While this make look rosey, these are simplistic cases. In my case, for instance, in which the increased standard deduction is a moot point since I current itemize to a coincidentally similar level, the reduction in my taxes is diminished from what’s shown above. The same case may be for you as well, but you’ll have to adapt these cases slightly to fit your specific situation.

Early Retiree Case Study

And how about for early retirees? I’m just as focused on how this tax code affects me now while I’m still working as I am once I’m retired. If you saw my post last week on announcing my retirement date, I plan to retire in the near term. I’m supremely focused on how tax reform affects my retirement situation. As you may know from a previous post, my goal is to pay no taxes in retirement. Refer to that post as to my specific strategy, to which the tax reform hasn’t impacted thankfully.

My main source of taxable income in retirement (as it is for many early retirees) is taxable conversions from pre-tax retirement accounts (my 401k and subsequently my traditional IRA as I roll it over upon entering retirement) to my Roth IRA and thereby making those proceeds fully available for early withdrawal (before age 59.5) without penalty. Those conversions would be reported as normal income and taxable in the year converted.

Hypothetically, if I convert $100,000 annually, how would my taxes change under the new tax reform? Let’s check out the before and after scenarios!

Under Current Tax Law

Taxes Change

Under New Tax Reform

Taxes Change

Net Decrease in Taxes!

Taxes Change

Flying Under the Radar

When it comes to taxes, another item hits close to home. Did you remember how I bought solar panels two years ago? While you may not have solar panel tax credits to worry about, perhaps you have other special circumstances to consider? With the standard deduction going up and less of a likelihood for folks to itemize, there are decisions that folks may have made for tax purposes that may not be financially prudent going forward. Like mortgage interest…

Buying a home? Your mortgage interest that is tax deductible is now being capped at mortgages of $750K and may not push you above the $24,000 standard deduction anyway. That’s the case for me. There is no tax benefit for me owning a home anymore. Personally, I’ve never been a fan of the incentive for many reasons. I would vote for it going away completely, but that’s a topic for another day.

Similarly, state and local taxes can not be deducted over $10,000 anymore.

Fortunately, regarding my solar tax credits, I’ll still be able to achieve the full value I expected when I made the purchase. The federal portion of the credits were received when I filed taxes for the 2015 year (because I could itemize it), but the state portion of the credit is paid out over time.

North Carolina, where I live, limited the state portion of my credit to 50% of my state tax due in the first year (2015), with any remaining benefit to be achieved up to 20% of the original state credit annually for at most the next 5 years thereafter.

With a big portion of the state credit received in 2015, the majority of the remaining credits accrued in 2016 and 2017 tax years. So thankfully tax reform isn’t affecting me or this big decision I made, but how will it affect folks who want to buy solar panels or other tax incentivized activities going forward if more folks don’t itemize their deductions?

As folks dig into the 500+ page bill in the coming months (and years), there will be many unknown ripple effects.

Concluding Thoughts

All in all, tax reform as it relates to individuals is generally beneficial to me while still working as well as in retirement. It isn’t perfect, but you take the good with the bad I guess. I’m not happy about the personal exemptions going away, but I am happy with all the tax brackets being reduced as well as being able to fully utilize the child tax credit now. How about you?

Corporate Tax Ramble

While all of the ramble above is focused on the individual side, how about a brief ramble on corporate taxes?

If you watch a glimpse of the news you will see everyone talking about how this is tax reform for the middle class. Let’s cut right to the chase though, this is a tax reform for major corporations. Put another way, the main dish served is large corporate tax reform with a side-dish of individual tax reform. Large corporate tax rates are falling from 35% to 21%. That’s a huge drop. We didn’t see individual tax rates change that much above…did we?  And what gets lost in the shuffle is how this impacts small businesses (like mine…).

Talk about not getting any simpler. The small business tax code, which is governed predominantly by pass-through taxes, just got much more complicated. But upon my initial review, taxes on most small businesses should drop. This affects my business as well as many others organized in a similar manner (such as partnerships, LLCs, sole proprietors…).

However, for small businesses that make a lot of money (which I hope mine does one day…) and small businesses that rely heavily on intellectual capital rather than human capital (mine is mostly human capital with a number of employees we rely on), taxes may go up. The tax rate could possibly be even higher than the large corporate tax rate (does that make any sense…?). This is definitely something to look into more. As a matter of fact, I could see us consider changing our small business from an LLC to a C-Corp someday.

Large corporations will see a massive benefit, which will largely flow to the equity owners (why do you think the stock market has done so well the last month?). And these are the job creators? Not the small businesses? Hmm, maybe it is the skeptic in me, or just my career experience in banking these large corporations, but the “trickle down” benefit touted for giving this corporate tax cut won’t come to fruition. Just my opinion, feel free to disagree. Those tax savings (and now being able to repatriate foreign cash in a tax efficient manner) will fuel share repurchases or acquisitions of other businesses. Those aren’t job creating activities…acquisitions more or less just lead to rationalizing the labor force and job cuts…not more jobs and higher wages.

On the other hand, my small business and I presume other similar small businesses, will use tax savings to be more competitive on wages (so we don’t lose the smaller, but more impactful and meaningful labor force we have), to pay down the debt we raised to get into business in the first place, and for business expansion and growth. That’s the name of the game for my biz. There isn’t much wiggle room for small business, so any savings would most certainly go to improving the business itself rather than taken out via financial engineering (share repurchases) and job rationalization (acquisitions) which it largely will be used for by large corporates.

For the sake of clarity though, I’m not against tax reform for large corporations. We need to be competitive globally at that level. But I have two bones to pick: 1) call a spade a spade, this is large corporate tax reform; and 2) the focus should be on middle class and small businesses because on the margin those tax savings will be more impactful to the economy.

Again, feel free to disagree with me in the comments below.

Did I say the corporate tax talk would be brief…😊? This post has officially gone long as I knew it would. Such a big topic after all! But let’s put a bow in it there, shall we? We can always finish the discussion in the comments. Also, you can check out my post on how tax reform impacts health insurance as there may be some more options for early retirees now!

Thanks for taking a look!

The Green Swan

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  1. Thanks for the post. Please double-check the mortgage interest deduction proposal. I’m pretty sure you can still deduct mortgage interest on the first $750,000 of debt. I think you were referring to the SALT (state and local taxes) provision when you mentioned the $10,000 cap.

  2. My example is as you would expect, is different. Kids are to old for tax credits, but we still get personal exemptions to help pay for college. The existing home loan and reduction of deducting salt taxes mean, I will not be itemizing, and losing probably 16k in deductions. Very sad. The thing I disagree with most is how the high tax states subsidize so many low tax states, by watching our tax $ go to states that barely send any $ in taxes to Washington. Now the high tax states are asked to pay even will be receiving a couple dimes for every $1 sent to Washington, very sad. Why is this tax cut, benefiting corporations, stock owners, and not giving them less of a cut, while fixing SS or actually making sure our veterans have timely access to healthcare with real DR’s, not ones who have lost state licenses. The trickle down will never be seen, and in 5 years they will just reduce “promised” and paid for benefits after the corporations and millionaires get even more $$$. After all the millionaires, get richer and have no inheritance tax or AMT, the Gov’t will just institute a nat’l sales tax to make it a even more recessive tax. Negative, YES. Very sad, YES. Very happy to be living within my means, and retiring soon, Yes. I don’t understand how when we are $20t in debt, we can afford to give millionaires tax breaks and run up the debt. Why are we also using our tax $$ to pay for our “allies” defense at no cost to So. Korea, Japan, France…. Wouldn’t it be nice if the US didn’t have to pay for our defense because another country was going into debt and defending the US. It’s time to let our “allies” start chipping in. Think about the tax cut you would get if Washington didn’t have to pay for the defense budget. WOW

  3. The child tax credit is huge for us. Like you, I’ve never benefitted from it before. First world problems, but I was completely phased out of that benefit and at least partially phased out of the personal exemptions, as well.

    I chose a great time to go part-time. I expect my marginal tax bracket to be 24%. Under the current system, the same income would put me in the 33% bracket.

    Finally, the 20% pass-through deduction will be awesome for profitable blogs.


  4. I believe there is essentially a grandfather clause in the mortgage interest section of the new law. I’ll look at RIA tomorrow to see if they have any clarification on that.

    1. Confirmed; RIA says cutoff date is indebtedness incurred before Dec 15, 2017 to which the new limitation doesn’t apply

      *Consult your tax professional for more details about your specific situation.

  5. Many are focusing on the child credit. No help for me. I’m interested to see if there is a noticeable change in my paycheck. I’m not expecting much, and if it makes a difference, more to save.
    I do my side hustle as a SP, so it will also be interesting to see if that makes much of a difference.
    I will also be waiting for how long it takes to see any changes in my paycheck. I know with the late in the year signing, radio news reported the IRS may be playing catch up with getting info to companies and then the companies to their payroll department / check issuing service.
    Then the corporate rate change is permanent but the personal items are set to phase out in the next 5-8 years if Congress doesn’t update them. Which I feel like further complicates things, and makes me think of someone trying to play billiards on a sail boat in rough seas. It’s a bait and switch, people see more $ now so politicians can feel like the good guy, leaving the next set of officials to feel the pain of discontent in 5-8 years. Unless they get re-elected, and may end up the bad guy anyway.

    1. Great points. The child tax credits help offset my child personal exemptions going away. I too will be interested to see when my paycheck is boosted which will hopefully be a hundred dollars or so.

      I hear ya on the personal rates phasing out. It’s always reassuring to know politics will be getting involved again! My thought process is that it’ll be hard to not extend the tax reduction for middle class either way, it’s just political suicide. But higher income brackets could potentially be bumped up to shore up the federal budget if necessary. So my hope will be to retire by then and thereafter live in the lower two income brackets.

      1. I tried a few calculators and come up with $36 to 106 more dollars per paycheck. I’ll be down a few $ per paycheck for the increase in HSA. $2 ish x 24 paychecks to get me close to the $50 more.
        I’ve been looking at about 10 more years til FI / ER. Who know what the future holds!
        Mega millions & powerball are each over 300 million. I don’t have a ticket, but that much would be life changing.

  6. “Hmm, maybe it is the skeptic in me, or just my career experience in banking these large corporations, but the ‘trickle down’ benefit touted for giving this corporate tax cut won’t come to fruition.”

    Agreed. I don’t believe in “trickle-down economics” or “trickle-down government.” The only trickle-down that truly works in trickle-down selfonomics.

    On the personal side of the new tax law, however, it looks good for me. My federal taxes will be going down by 35%. Will it work for others, especially those in high-tax states? I don’t know. I fear for some of my friends back on Long Island. I have one friend, for instance, who has a property tax bill of over $36K. Ouch!

    Thanks for this overview, JW. Very informative.

    1. Ouch, that’s a massive tax bill! Folks like that may need to jigger their budget or they may not be able to afford those houses without the tax savings. Crazy!

      On the personal side you may also benefit by the individual health insurance mandate going away and freeing up more insurance options. I’ll have a post on that in the next month, so stay tuned.

  7. So if the kids can’t be used as personal exemptions I wonder if it makes more sense for kids to not be claimed at all once they are college age. I mean I could get $2000 for 1 more year assuming it’s still under 17. Maybe if my college age kids fill out the fafsa on their own without my income they might actually get some help? I haven’t filled out the fafsa for a few years because it was a lot of work to get nothing. Curious if anyone else has older kids has thought about this.

  8. College age kids can’t fill out FAFSA on their own until 25 or independent student—and just because a parent doesn’t claim them as a dependent doesn’t qualify their child as independent. This change was made at least 10 years ago—but your college student dependent does qualify you for up to $4000 tax credit for tuition, so it’s not all bad news…..

  9. Based on multiple calculators, as well as my own napkin calculations, I stand to to pay $20-25K less in taxes thanks to child tax credit, decreased rates, wider tax brackets, and the pass-thru business all playing some role.

    1. That’s pretty huge! Is it your doctor practice that has the pass-through income? I know there are certain income caps and limitations on the pass-through deductions which many doctors will be negatively impacted by. Complicated changes to the tax code, so it may take some time to shuffle through it all and fully understand the impact. I haven’t analyzed the potential impact / benefit to my small business with the new pass-through rates yet. Thanks for sharing!

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