In December 2017, a new income tax law went into effect. This new tax law maintains the seven federal income tax brackets, but sees a change with slightly lower rates and adjusted income ranges. The standard individual deduction has increased from $10,400 to $12,000, and the standard deduction for joint filers has increased from $20,800 to $24,000, meaning a 15 percent difference for both. However, personal exemptions have been eliminated.
The new tax law is set to expire Dec. 31, 2025. Some additional highlights include an individual deduction of 20 percent of qualified business income from a Partnership, S Corporation, or Sole Proprietorship. And the progressive corporate tax rate structure of 35 percent is now replaced with a flat tax rate of 21 percent.
There hasn’t been a major tax reform at this level since 1986’s Tax Reform Act, which was signed by President Ronald Reagan. Why now?
“Since that time, our 75,000 page federal tax code has become increasingly complex and imposes high marginal tax rates on its taxpayers, fostering a system of avoidance and evasion and undermines what should be simple financial planning for households and businesses,” said Suzie Muñoz, a local CPA with The Numbers Company. “At the corporate level, the United States has become uncompetitive internationally due to a high corporate tax rate, corporate income that is subject to double taxation, a poor cost-recovery structure, and a worldwide tax system.” This prompted a call to simplify the tax code, Muñoz explained, along with instituting a more competitive corporate tax rate that would boost U.S. business.
The new changes have the potential to result in broad benefits. Muñoz points to the fact that the new bill “lowers the corporate tax rate from 35 percent to 21 percent, gives pass-through businesses a 20 percent tax deduction, increases the standard deduction, expands the child tax credit, and temporarily lowers individual rates across the board.”
But who, exactly, stands to benefit? That answer depends on which tax bracket the person belongs to.
“In Texas, over 9 million taxpayers already take the standard deduction, so the increase under the new plan would further benefit them,” Muñoz said.
While there are benefits to some, Muñoz said that the elimination of personal exemptions will likely hurt larger families who rely on them.
“Lower rates should generally mean a lower tax bill,” she said. “However, since the calculation of taxable income would also change, not all taxpayers will experience a lower tax liability. In short, this provision lowers tax rates in exchange for the elimination of certain tax benefits. For some taxpayers, those tax benefits helped them more than the increase in the standard deduction or the slight decrease in rates. Unfortunately, there is no “one size fits all” response to federal tax reform and it is difficult to predict how it will benefit or impact individual taxpayers. These federal changes will affect everyone differently based on the taxpayer’s particular situation, filing status, and income.”
As with any change, Muñoz advises individuals to “focus on the positives of tax reform.” It can be confusing to navigate income tax.
“Any new tax legislation causes a great deal of excitement and anxiety for taxpayers, but remember that changes to the tax code often lead to different opportunities in strategically planning your finances,” she said. “Having a clear framework on how to navigate the ups and downs of tax reform can help you maximize those potential benefits.”
Two things to keep in mind:
1. Keep political and financial views separate. Regardless of whether a Republican or Democrat is in office, it is important to be aware of your bias and focus on making rational decisions that are going to meet your financial goals.
2. Start small. There are going to be many changes and areas to plan. Start with what is reasonable and feasible for you to take. Making extreme changes to your lifestyle or business just to save a few tax dollars may not be worth it when you step back and do cost-benefit analysis. Changes can end up costing more in tax-filing costs, complexity, and time. Get with your tax preparer and take on financial actions that are within your control and don’t require you to jump through hoops.
Online resources are available to help clarify these new income tax bill changes:
For those who are interested in reading the new bill, visit https://www.congress.gov/115/bills/hr1/BILLS-115hr1enr.pdf