I have had a number of questions recently from federal employees and middle-class families wondering how they will be affected by the new tax law. There are a few changes that are going to affect federal employees, and the end result will likely be a reduction in the amount of taxes paid.
Corporate Tax Rates
The biggest change in the new tax law is a reduction in corporate taxes. Corporate taxes have been lowered significantly which makes the U.S. more competitive with the rest of the world.
Even though this doesn’t directly affect most of us, it should indirectly affect us by boosting corporate profits and encouraging companies to build infrastructure and hire domestically.
In regard to personal taxes, the changes are set to revert back to the old tax rates in 2025. Translation: this is a politician’s way of getting around things. Because of spending limitations, they couldn’t make the changes permanent. We will have to see what happens in 2025, but for the next seven years we have some changes to address.
Tax brackets have been lowered, and here is a look at what they have been changed to. This will be a positive impact on all of us.
I would say the biggest change is removing the dependent deduction and doubling the standard deduction. Due to this combination, many of us that previously itemized our taxes will be taking the standard deduction in 2018. For most people the overall result of this change will be a tax savings.
One change that will impact many individuals in high tax states such as Illinois is the limitation on state and local taxes. These taxes are now capped at $10,000 per year. Unfortunately, these taxes include real estate taxes, making the $10,000 limit very easy to reach.
Under the old tax law, a family with 3 kids would start out with a deduction of $20,250. Then they can add on real estate taxes of $7,000, state taxes of $2,000, and charitable giving of $5,000. Their total deductions are already over $30,000 which is well above the standard deduction of $12,000 for married couples.
For 2018, the dependent deduction of $4,050 is removed and the standard deduction has been increased to $24,000 for married filing jointly. If you remove the dependent deductions in the above scenario, the family only has $14,000 of deductions. In that case, the standard deduction will be more beneficial.
- Child tax credit has increased from $1,000 to $2,000 and the income phase out has been raised to $400,000 for the credit
- Meals and entertainment expenses have been eliminated for business owners
- IRA recharacterizations are no longer allowed
- Changes should result in fewer individuals paying AMT this year
- The estate tax has been significantly increased for 2018
- Some miscellaneous deductions have been eliminated such as investment fees, tax preparation fees and moving expenses
What does this mean to you?
The biggest change that I see for families is that if they are take the standard deduction, they won’t get any tax benefit from things like charitable donations and mortgage interest. People that itemized in the past were able to deduct their charitable giving. To put it in real terms, if your family gave $5,000 to charity and you were in the 25% tax bracket, then you would get a tax savings of $1,250. I find it a lot easier to donate money when I get a tax break!
This is very unfortunate for charities as I believe it will impact their funding, but I hope that people still continue to give despite having less of an incentive to do so.
If you will be taking the standard deduction and have a business, you may want to talk to your accountant and the charity about relabeling those monies as advertising dollars. An accountant once told me that if your name is listed somewhere by the charity as a sponsor, or advertiser, and you receive a benefit then it is considered advertising --and therefore a deductible expense. But I’m not a tax advisor so please check with your own sources.
If you find that you are close to being able to itemize but not up to the $24,000 deduction, you may want to consider “bunching” your deductions this year. This would involve strategically giving to charities and paying taxes early to gain tax advantages.
There are a number of other changes as well, but I believe these are the ones that will directly affect most of us. The new tax law changes can add even more complexities to the financial planning process. Tax planning is one of the facets that we address with our clients. You are welcome to schedule an introductory call to discuss how we can help you.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.