Paul’s Introduction…
I’m ‘The Tax Guy’ in our RWS partnership. So I was surprised when, after going over the topics I planned to cover at an upcoming RWS webinar on the changes to tax law in 2018, Sean said, “I’m going to write a blog article about this.” At first I thought he had taken leave of his senses. The more I thought about it, the more the idea grew on me. His point of view might be highly useful.
I have immersed myself in the new tax laws since last April. I went to conferences in May and September to learn more about this topic. I’ve spent hundreds of hours reading, analyzing, and discussing the topics with other tax professionals. While this focused effort has honed my technical proficiency, I may have lost some perspective. I can discuss at length the aspects of the new laws that are most interesting to tax professionals, but that might not be the stuff that is most interesting to YOU. That’s where Sean’s perspective is so valuable – he knows enough about it to write a useful article, but not so much that it’s dreadfully boring to read! Have a go, and see what you think.
Sean’s Article
This topic has been kind of quiet since Congress passed the first significant change to federal tax law in a generation late last year. And it’s kind of natural that it’s gotten quiet. We’re several months past all of the breathless political “analysis” and commentary, and most of the day-to-day impacts happened fairly seamlessly for most of us. Most significantly, most of us who have federal income tax withheld from our paycheck had those adjustments made by our employers without us having to lift a finger. In many cases we didn’t know it was coming…and maybe you didn’t even notice it after the fact. But soon our calendars are going to flip from 2018 to 2019, and not long afterward many of us will start paying attention to our federal taxes again. And that’s when many of us will feel the bill’s impacts most significantly, both for better and worse. (Speaking of for better or worse, my examples below all pertain to married couples filing jointly.)
“How’s this going to affect me?”
There are a few big factors that will affect nearly everyone, and there are a few seemingly small “one-offs” that may be quite impactful for just a few of us. We’ll get into a handful of them here. The main thing to keep in mind up front is that you may need to pay a little extra attention, when you file your 2018 federal and state income taxes, to whether or not to itemize. As we get into the biggest factors affecting your income taxes, it should become reasonably clear why that is. So let’s get into them…
Your income tax bracket
We’re going to get this out of the way first, and quickly. This is the first thing most of us look at, because we all understand “bigger” or “smaller” pretty quickly. And for the vast majority of us, the percentage of tax owed on taxable income at every level of income has decreased. That said, it’s almost certain that this won’t be the most impactful change for most of us. For most of us, where the brackets did shrink, it typically wasn’t by much–maybe a few percentage points. Here’s a quick look at 2017 and 2018 brackets side-by-side:
| Married Filing Jointly & Surviving Spouses | |||
|---|---|---|---|
| 2018 Tax Rates | 2017 Tax Rates | ||
| 10% | 0 to $19,050 | 10% | 0 to $18,650 |
| 12% | $19,050 to $77,400 | 15% | $18,650 to $75,900 |
| 22% | $77,400 to $165,000 | 25% | $75,900 to $153,100 |
| 24% | $165,000 to $315,000 | 28% | $153,100 to $233,350 |
| 32% | $315,000 to $400,000 | 33% | $233,350 to $416,700 |
| 35% | $400,000 to $600,000 | 35% | $416,700 to $470,700 |
| 37% | Over $600,000 | 39.60% | Over $470,700 |
Now, if you were in the 28% bracket or higher last year and are still earning that kind of money–first, congratulations. And second, we’ll get back to you in a bit. For “the rest of us,” there’s not a whole lot of needle-moving going on with the change in the brackets. At least not much that’s evident anyway. This is where we get to the bigger deal…
Personal exemptions, standard deductions & child tax credits
For quite a few of us, this is where the real action is. The first thing to understand is that some these things work opposite each other. The personal exemption in 2017 was $4050 for everyone on your tax return. In 2018 it’s zero. Now if you see this and think, “But that means more of my income is exposed to taxation,” you’d be absolutely correct, BUT the next two things are going to work in your favor. The standard deduction for married joint filers last year was $12,700. This year it has nearly doubled to $24,000. Additionally, the child tax credit has become much more powerful in 2018, both doubling from $1000 to $2000 per child 16 and under and phasing out at much higher levels of income than it did in 2017. And while the personal exemption and standard deduction decrease(d) the amount of income exposed to taxation, the tax credit reduces your tax bill outright. And the movement of the phaseout threshold from $110K to $400K will have enormous impacts. In other words, if you were married joint filers last year with $155K in taxable income, you might think losing the personal exemption for your one child “cost” you money…and you’d be wrong. You may have “lost” $1134 (28% of the $4050 personal exemption for your offspring), but between the doubling of the child tax credit and the dramatic northward movement of the phaseout threshold, you’ve “gained” a $2000 credit. Out of all this, we get three main tips:
- Pay attention to the new rules. They’ve changed enough to matter.
- At any bracket, whether it’s “the same” or “less,” a really important question is “__% of what?”
- Don’t get distracted by what you “lost” or “gained.” We all owe what we owe.
Qualified Business Income Deduction
This is the one no-kidding brand-new wrinkle to the new tax law, and it may be one of the more powerful pieces for our transitioning military tribe because it provides a powerful incentive for self-employment. Whether that self-employment is a second income being earned in a portable business by a spouse or a more compelling case for self-employment in a “second act” career for someone retired or getting ready to retire is immaterial here. The math is the math, and your reasons are yours. But the tax advantage is undeniable. And the upshot is that not all earned income is created equal. That was already the case for self-employment, for a variety of reasons. Now it’s even more so.
Your state matters
Though we serve clients from all over, since we live and work in Virginia we tend to look at Virginia more closely. And while the federal government has made substantial changes to how your income is taxed, Virginia hasn’t. Here’s why it matters. Because of the significant increase in the personal deduction, tax analysts have estimated that only about half as many people will itemize on their federal returns for 2018 as did so for 2017. But they’re looking at federal taxes in a vacuum. Because Virginia hasn’t changed anything and because of some important differences between what’s deductible at the federal and state levels, we’ve already identified scenarios in which it’s to your disadvantage for your federal income taxes to itemize…but to your overall advantage to itemize anyway. Why? Because you can only itemize your deductions on your Virginia return if you itemize on your federal return. And in some cases itemizing on your Virginia return will overcome the “disadvantage” to itemizing on your federal return. For those of you who are do-it-yourselfers, keep an eye on this, and maybe give some consideration to running both scenarios–itemizing and not itemizing–before you file. (We have not analyzed for impact for state income taxes other than Virginia. If you file in another state we encourage you to assess the impact the new federal laws have on your state tax return.)
“Okay, so what’s the big deal?”
Simply put, there’s a distinct possibility that your tax bill this April is going to be very different from your tax bill last April. You have two important opportunities between now and then:
- You have between now and then to figure out what those differences are, and if necessary to start saving to meet any additional obligations you may not have previously counted on. While most of us will pay less in annual taxes for 2018 than we did in 2017, the adjustments that most employers made to federal income tax withholding may mean you owe more in April 2019 than you did in April 2018.
- You have between now and the end of 2018 to make adjustments to eliminate or reduce an unpleasantly large tax bill next April. Just a few examples would be increased contributions to your TSP or 401(k)–or maybe even establishing a solo 401(k) if you’re self employed and have no employees–or maybe making some temporary but substantial increases to your federal withholding between now and the end of the year.
If you’ve already dug into this, digested it and have a plan, good. Because “what’s your plan” is where the rubber really meets the road on any financial issue. For anyone who’s interested in learning more about this stuff, we’ll be doing a webinar on November 14th that’ll go deeper into everything we’ve discussed here and introduce a few new things as well. (Paul’s doing the webinar. I haven’t taken enough leave of my senses to take that on.) And of course if you’re interested in professional help with any of this, you’re always welcome to give us a shout.