After what seemed like many months of debate, tax reform has been passed into law for 2018. This is not a political blog, so I will not be sharing my opinion on any of these changes. The purpose of this post is to just share some of the highlights that will be useful for people who are interested in reaching financial independence.
This post does not cover every change. The bill is more than 1,000 pages, so that would be impossible. Plus, I am not an Accountant. Trying to read the whole 2018 Tax Reform Law would be as painfully difficult as trying to read Ulysses by James Joyce. This post just covers some of the main changes that have the greatest impact.
The marginal tax rates have been lowered. There was much debate on reducing the number of tax brackets. In the end, seven tax brackets remained. The lowest tax bracket is 10% and 37% is the new highest tax bracket.
|Rate||Single||Married Filing Jointly|
|10%||Up to $9,525||Up to $19,050|
|12%||$9,526 to $38,700||$19,051 to $77,400|
|22%||$38,701 to $82,500||$77,401 to $165,000|
|24%||$82,501 to $$157,500||$165,001 to $315,000|
|32%||$157,501 to $200,000||$315,001 to $400,000|
|35%||$200,001 to $500,000||$400,001 to $600,000|
|37%||Over $500,000||Over $600,000|
The standard deduction was increased. Individual/married filing separately is $6,350 in 2017 and will be raised to 12,000 in 2018. For those who are married filing jointly or are a surviving spouse, the standard deduction is $12,700 in 2017 and will increase to $24,000 in 2018. Head of household will increase to $18,000 from $9,350 in 2017.
There are additional deductions for those over age 65, blind, or disabled. The deduction is $13,000 per individual if married. The deduction is $16,000 per individual if unmarried.
The personal exemption of $4,150 has been eliminated for 2018. The Child tax credit, however, was increased to $2,000. The tax credit is $500 for non-child dependents.
The State and local tax (SALT) deductions are capped at $10,000. This drastically impacts homeowners in states with high state and local taxes. States like New York, New Jersey, and Connecticut will be impacted the most. It might be a good time for those living in these states to make like Mr. and Mrs. Groovy and move to North Carolina.
The Alternative Minimum Tax changes reduce the likelihood of paying AMT. The income threshold was raised. It has been raised to $1,000,000 from $$160,900 for joint filers. For single filers, it has been increased to $500,000 from $120,700. The number of families who paid the AMT will be drastically reduced to 200,000 from more than 5,000,000.
The ability to re-characterize a TIRA was removed (Roth Conversion). Contributions can still be re-characterized. This eliminates the horse race strategy of Roth conversions. On the bright side, the ability to do “backdoor Roth contributions” has been retained.
Mortgage interest deductions are now limited to newly originated loans up to $750,000. The previous limit was $1,000,000. Mortgages that were taken out before December 15, 2017, can continue to deduct the higher amount.
Home equity loan deductions have been eliminated. That Is for both new and existing loans. There is not a grandfathering provision for any current home equity loans. There is no longer a tax benefit for taking a home equity loan to purchase a vehicle like some people used to do.
Medical expenses can still be deducted, but changes are coming. Medical expenses above 7.5% of AGI for 2017 and 2018 can be included in itemized deductions. This reverts to 10% in 2019.
The Affordable Care Act (ACA) mandate has been eliminated in 2019. There will no longer be a penalty for not having health insurance. This does not go into effect for two years. Please remember that having health insurance is still a vital part of your financial plan.
The 2% AGI deduction will be eliminated in 2018. Investors can no longer deduct investment fees and expenses. The ability to deduct the convenience fees to pay taxes with a credit card has also been eliminated.
The Surtax of 3.8% does not change. There is an indirect change, however. As stated earlier, the 2% floor for investment expenses will no longer be deductible.
The estate tax exemption has been doubled. The new limit is roughly $11,000,000 for individuals and $22,000,000 for those who are married. This provision remains in effect until the end of 2025. Please note that these changes do not affect state-level estate taxes.
The new tax law helps people save on school costs. Up to $10,000 can be distributed annually from a 529 plan to cover the cost of sending a child to a public, private, or religious elementary or secondary school. More than 30 states offer income tax deductions for 529 plan contributions.
Kiddie tax (i.e. unearned income by a child under age 19 or a full-time student under age 24) is now subject to trust tax rates instead of their parents’ tax rate. In the past, the kiddie tax applied to earnings that were taxed at the parents’ tax rate. In 2018, the rate that applies to the parent does not matter. Moving forward, investment earnings that exceed $2,100 will be taxed at the rates that apply to trusts and estates:
- Up to $2,550 = 10%
- $2,550 to $9,150 = 24%
- $9,150 to $12,500 = 35%
- More than $12,500 = 37%
Charitable contribution deductions can be impacted. Since the standard deduction has doubled from $12,000 to $24,000 for married couples, it is expected that fewer filers will itemize in the future. This can cause charities to take a hit in 2018 because most Americans will have less incentive to give.
There is still a justification to buy a Tesla Model S other than the cars impressive zero to sixty time. The tax credit for electric vehicles has been retained. The $7,500 tax credits are available for the first 200,000 electric vehicles that a manufacturer sells. Once that quota is met, the incentive stays in place until that calendar quarter ends. After that, it is reduced by 50% every six months until it is ultimately eliminated.
The Medicare surtax of 0.9% on earned income has been retained. This only applies to employees who earn more than $200,000. That includes wages, income from those who are self-employed, and railroad retirement compensation (RRTA). The threshold is $250,000 for those who are married and filing jointly.
Again, this is not a comprehensive review of the 2018 Tax Reform Bill. It is more of a quick and dirty overview. These are just some of the highlights that I found important for myself and for other people who are working to reach financial independence. Understanding the tax laws might be boring unless you are a CPA. However, creating an optimized tax strategy will greatly impact your financial plan. Everyone who is planning on reaching financial independence should at least be aware of the basics.
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