New Tax Act Makes Changes to Individual Taxes
The 2017 Act made the most significant changes to the U.S. tax code in over 30 years, impacting virtually every individual and business. Due to political constraints and Senate budget rules, most of the individual provisions became effective in 2018, but revert to prior law before 2025. While there are numerous provisions impacting individuals, some of the most significant include:
Individual Income Tax Rates
While there are still seven tax brackets for individuals, the ordinary income tax rates have decreased to 10%, 12%, 22%, 24%, 32%, 35%, and 37% (compared to 10%, 15%, 25%, 28%, 33%, 35% and 39.6% under prior law) and the income brackets have widened. In future years, income levels will be indexed for inflation using a chained consumer price index (CPI). The IRS estimates that taxpayers will start to see the effects of these reductions in their paychecks as early as February 2018. The Tax Foundation estimates that the 2017 Act will increase the after-tax incomes of all taxpayer groups in 2018 by 0.8% to 2.2% (Source: Preliminary Details and Analysis of the Tax Cuts and Jobs Act, December 2017).
Qualified Dividends and Capital Gains
The tax rates on net capital gains and qualified dividends remain, but the brackets for the different tax rates are indexed for inflation using the chained CPI-U.
As mentioned above, the income levels subject to taxation as well as many other provisions in the 2017 Act are adjusted for inflation using a chained CPI-U rather than the CPI-U, which had been used in the past. Typically, chained CPI-U grows at a slower rate than regular CPI-U, since it considers substitute purchases in reaction to changes in relative prices. Many feel that CPI-U overstates increases in the cost of living because it doesn’t account for the fact that consumers adjust their buying patterns when prices increase, instead of simply buying the same item at a higher price.
The standard deduction nearly doubled to $24,000 for married couples filing jointly, $18,000 for head of household filers, and $12,000 for single individuals, indexed for inflation using the chained CPI-U. Under prior law, the 2018 standard deduction was $13,000 for married couples filing jointly, $9,550 for heads of households, and $6,500 for single filers. This change simplifies tax filing by reducing the number of individuals who itemize deductions by 50%. Approximately nine out of 10 taxpayers will simply claim the new standard deduction starting in 2018 (Source: The Heritage Foundation, December 19, 2017).
Personal Exemption Deduction
The deduction for personal exemptions and the personal exemption phaseout has been eliminated through 2025.
Child Tax Credit
The 2017 Act increases the child tax credit from $1,000 to $2000 per qualifying child, with up to $1,400 being refundable. The adjusted gross income phaseout thresholds are increased to $400,000 for married couples filing jointly (up from $110,000) and $200,000 for all other filers (up from $75,000 for single filers and $55,000 for married individuals filing separately), which is not indexed for inflation. A $500 nonrefundable credit is also available for qualifying dependents other than qualifying children.
State and Local Tax Deduction
Deductions for state and local taxes, including income taxes and property taxes, are limited to $10,000 ($5,000 for married individuals filing separately). Sales taxes can be claimed as an alternative to state and local income taxes. Prepayment of state and local income taxes in 2017 for a future year is disallowed.
Mortgage Interest Deduction
The mortgage interest deduction is limited to interest on $750,000 of acquisition debt ($375,000 for married individuals filing separately). If the debt was incurred prior to December 15, 2017, the prior limitation of $1 million remains ($500,000 for married taxpayers filing separately). Taxpayers can still include mortgage interest on second homes within the lower dollar caps. Interest on home-equity loans is no longer tax deductible.
Charitable Contribution Deduction
The 50% limitation for contributions to public charities and certain private foundations has been increased to 60% of the taxpayer’s contribution base. Contributions exceeding the 60% maximum can be carried forward and deducted for up to five years.
Medical Expense Deduction
For tax years beginning after December 31, 2016, and ending before January 1, 2019, medical expenses in excess of 7.5% of adjusted gross income (AGI) for all taxpayers can be deducted (down from 10% of AGI for all taxpayers except those over age 65).
Personal Casualty and Theft Loss Deduction
Itemized deductions for personal casualty losses, including those from fire, storms, shipwrecks, other casualties, and thefts, are suspended, except for personal casualty losses incurred in a federally declared disaster.
For divorce agreements entered into after December 31, 2018, alimony and separate maintenance payments are not deductible by the paying spouse and not included in income of the spouse receiving the payments.
Miscellaneous Itemized Deductions
The deduction for miscellaneous itemized deductions in excess of 2% of AGI is suspended.
Limitation on Itemized Deductions
Under prior law, itemized deductions for higher income taxpayers were limited (known as the Pease limitation). For taxpayers who exceeded the threshold amount, itemized deductions were reduced by 3% of the amount AGI exceeded the threshold. Under the 2017 Act, the Pease limitation is suspended.
Affordable Care Payment
The individual shared responsibility payment required under the Affordable Care Act (also known as Obamacare) is permanently reduced to zero, effective for months beginning after December 31, 2018. However, both the 3.8% net investment income tax and the 0.9% additional Medicare tax, which were enacted as part of Obamacare, remain in effect.
A child’s earned income is now taxed at the rates for single individuals and net unearned income is taxed based on the brackets for trusts and estates. Under prior law, the child’s net unearned income was taxed at the parents’ rate if that rate was higher than the child’s tax rate, while the remainder of the child’s income (earned income plus unearned income up to $2,100 in 2018 less the child’s standard deduction) was taxed at the child’s rate.
Section 529 Funds
The definition of qualified higher education expenses that can use Section 529 account funds has been expanded to include tuition at an elementary or secondary public, private, or religious school, up to a $10,000 per year limit.
Recharacterization of IRA Contributions
Under prior law, both regular contributions and conversion contributions to a Roth IRA could be recharacterized as having been made to a traditional IRA. The 2017 Act no longer allows recharacterization of conversion contributions to a Roth IRA, although the other recharacterizations are available.
Alternative Minimum Tax (AMT)
The AMT is a separate tax calculation meant to prevent high-income taxpayers from avoiding tax liability by using exclusions, deductions, and credits to reduce income. If the AMT tax is higher than the regular tax, the larger amount is owed. When computing the AMT, only income above an AMT exemption amount is considered. Under the 2017 Act, the exemption amount has been increased to:
- $109,400 for married taxpayers filing jointly and surviving spouses (up from $86,200)
- $70,300 for single taxpayers (up from $55,400)
- $54,700 for married taxpayers filing separately (up from $43,100)
These exemption amounts are reduced (not below zero) to 25% of the amount by which the taxpayer’s income exceeds the phaseout amounts:
- $1 million for married taxpayers filing jointly and surviving spouses
- $500,000 for all other taxpayers All amounts will be adjusted for inflation based on the chained CPI-U.