Some of the biggest news of 2018 is that the GOP-led Congress, with the support of President Trump, passed the largest change to the tax code in 30 years. What the new tax reform bill means for your own taxes will largely vary depending on your income and whether you live in a high tax state such as New York or California.
Most individuals and corporations will see a reduction in their tax liabilities this year. The tax cut for individuals will end by 2025 unless Congress extends the reductions. The tax cuts for corporations, on the other hand, are permanent. This is a huge change to the tax code which may seem overwhelming. That’s why we’re here to help break down the new federal income tax brackets for 2018.
How Will Your Tax Bracket Change?
The final version of the Senate and House passed tax bill is known as the Tax Cuts and Jobs Act. This bill keeps seven income tax brackets while increasing the standard deduction and eliminating the personal exemption.
Most individuals will see an initial decrease in their tax contributions since the new tax bill doubles the standard deduction. Most Americans, almost 70%, file taxes using the standard deduction. This means that many Americans could see thousands of dollars in savings, at least initially. Income levels for each tax bracket will be adjusted up for inflation each year. This adjustment relies on the chained consumer price index rather than the previous laws, which used the traditional CPI. The chained CPI generally shows a slower pace for price increases and inflation than the traditional CPI. This has caused some concern that using the chained CPI rather than the traditional one will lead to bracket creep, where tax filers are ‘passively’ moved into higher tax brackets.
Let’s start with the single taxpayer. In 2017, single filers could use the standard deduction of $6,350 as well as one personal exemption of $4,050 for tax savings of $10,400. The new Republican tax bill combines the standard deduction and one personal exemption into one larger deduction of $12,000 for individual taxpayers.
Joint filers and married couples stand to see their standard deduction increase by almost 20%, from $20,800 in 2017 with the personal exemption and standard deduction to a single deduction of $24,000 in 2018.
The new tax bill has also effectively eliminated the marriage penalty.
To understand how, take this example of two individuals who file taxes as single filers and each earns a taxable income of $90,000 in 2017. Their tax bracket in 2017 (under the previous tax rules) would land them at a tax rate of 25%. If these two individuals were to get married and file taxes jointly, their combined income of $180,000 would mean their effective tax rate would jump up to 28%.
Under the Tax Cuts and Jobs Act, the income thresholds for married individuals who file jointly is exactly double the amount of the income threshold for individuals who file single. For example, a single filer who lands in the 10% tax bracket can make an income of up to $9,525 to stay in that same bracket. A married couple in the 10% bracket can make up to $19,050, double the $9,525 for single filers, to stay in the same 10% tax bracket.
The only exception to this rule is for married couples that earn more than $400,000. Married couples who make between $400,000 and $600,000 can stay in the 35% tax bracket while the threshold for singles is $200,000 to $500,000 for the 35% bracket. In the previous tax rules, married couples making anything over $470,000 would have immediately graduated to the higher 39.6% tax bracket. This means that married couples making between $470,000 and $600,00 get a tax break compared to the previous tax rules, essentially reducing their tax contribution thanks to the lower rates for both singles and married couples and the near elimination of the marriage penalty.
2018 Itemized Deductions
The tax reform bill makes several changes to itemized deductions including capping state and local taxes as well as limiting deductions for interest on mortgages (including property taxes) and medical bills. Individuals and married filers are still able to itemize state and local taxes; however, these deductions are now capped at $10,000. This concession was added to the bill in order to address concerns from states with high-income tax rates that worried constituents would be paying a great deal more under the new bill. If you live in a high tax state, you’ll largely be affected by this new $10,000 limit although that could be offset since the standard deduction has been doubled.
Americans can also still deduct the interest on their mortgages for primary or secondary residences with the limits coming down from $1,000,000 to $750,000. In 2017, filers were able to deduct medical expenses that exceeded 10% of gross adjusted income, while changes in the new bill allow for deductions of medical expenses that exceed only 7.5% of income.
Some itemized deductions that have been eliminated include:
- Theft and casualty losses
- Tax prep expenses
- Moving or relocation expenses
- Employer-subsidized parking and transportation payments
Child Tax Credit
Without the personal exemption, there was a great deal of concern that larger families would be disproportionately affected under the 2018 tax rules. Thanks largely in part to the efforts of Sen. Marco Rubio (R-Fla.) and Sen. Mike Lee (R-Utah), the new GOP tax bill now includes an expanded Child Tax Credit for children who qualify and are under the age of 17. The final version of the tax bill increases the Child Tax Credit from $1000 to $2000 and also includes a stipulation that increases the amount of the refundable credit to $1,400. The limits of the tax credit thresholds have also been increased for both individuals and married couples that file jointly as reflected in the table below.
The bill has also preserved the Child and Dependent Care Credit, which allowed parents to deduct childcare expenses and caregivers to deduct elderly or disabled care expenses. Taxpayers can claim $1,050 for one child or up to $2,100 for two children and you can set aside up to $5,000 in a dependent care FSA to make child care more affordable pre-taxes. You must choose one of the two breaks, as they cannot be combined.
Alternative Minimum Tax Exemption
The Alternative Minimum Tax, know more commonly as the AMT, was first created to ensure that higher income individuals pay their fair share of taxes, irrespective of how many deductions they could use to lower their contributions. The AMT requires higher income individuals to calculate taxes twice – first using the standard tax system and deductions and second by using the AMT, which was levied at two different rates in 2017 – 26% and 28%. Once these higher-income individuals processed their taxes through the two systems, they were required to pay whichever amount was higher. The problem with the ATM arose from the fact that it wasn’t pegged to inflation. Thus, more and more individuals, including those in the middle class, had to use the AMT rules to file taxes. The tax reform bill aims to address this problem by adjusting the AMT exemption for inflation, making the threshold where AMT is required higher in 2018.
As you can see in this chart, in 2017 the income thresholds where exemptions were phased out was at $120,700 for single or head of household filers and $160,900 for married and joint filers. The new tax bill increases these rates dramatically by changing the single threshold to $500,000 and the married filing jointly threshold to $1,000,000.
Take Charge Of Your Taxes
While the tax reform bill was passed at the end of 2017, these changes shouldn’t affect your 2017 returns and will only be applied to income in 2018. If you’re looking for tax prep programs to guide you through the process, you can check out our comparisons on H&R Block, TurboTax, and TaxAct to help find the right online tax software for your needs.
It can be hard to figure out how much your taxes will change thanks to the new tax reform bill without using a tax software to sort out the small details. While a lot of people in high tax areas may pay more since they can no longer deduct all of their state and local taxes, filing using the increased standard deduction can offset these increases. Shop around for tax software and make sure to start taxes early so you can get the most out of your tax returns and get any answers to your questions before filing.