If you’re like me, you’re sitting down on weekend mornings amongst piles of receipts, tax forms, and medical billing records trying to make sense of just how tax reform will impact my tax return this year. Why? Because it’s tax time and so far, tax reform in 2018 is doing a doozy to my regular tax preparation.
In years past, I always managed my tax withholding aggressively with a target of receiving either a negligible tax refund or owing little to the greedy Feds. I don’t want to give Uncle Sam an interest free loan nor do I wish to pay any underpayment penalties on the taxes I owe.
This year’s tax return preparation is different, however. I didn’t know how my tax situation would change under the new tax laws which came into force in 2018. Not sure of how I should adjust my withholding levels, I left my W-4 filing situation and withholding allowances alone.
After repeated TurboTax sessions I’ve come to my conclusion: roughly $1,000 owed in Federal income tax and a state tax refund of approximately $700. In net, my decision not to rock the boat cost me $1,000 more than I withheld this tax filing season.
Sorting through every income, deduction, and tax credit tab in my tax software, I wanted to make sure I’d done everything correctly. After some consternation, it appeared all was in order.
Now, I’m planning how best to prepare for my tax return next year to redeploy my strategy of $0 refunded or paid. I’m reading articles in search of useful tax tips.
If you share a similar goal or want to learn about how some major changes in the tax code could affect your taxable income going forward, this post is for you.
What is the 2018 Tax Reform and What Did it Accomplish?
When Congress debated changing the tax code in 2017, the intended spirit was to simplify the tax planning process for the individual tax payer. The primary instrument for enacting this change was the increase in the standard deduction.
However, the tax code also discontinued or altered a number of common tax deductions and tax credits, changed the economics behind home ownership in some parts of the country, eliminated personal exemptions, and shifted tax brackets and rates, among other things.
The tax reform bill also included major changes for corporate taxes. The new tax rules benefited businesses immensely by receiving a significant drop in the federal corporate tax rate. The 2017 corporate tax rate stood at 35% but dropped to 21% in 2018 onward.
For individuals, the tax reform law made itemizing deductions harder and pushed many more instead to use a larger standard deduction. In theory, the standard deduction under the new tax plan would make far fewer individuals qualify for itemizing deductions and make tax planning simpler. My wife and I barely managed to itemize, with $50 of deductions above the threshold taken.
For reference, to itemize your deductions, you must exceed the standard deduction. Therefore, if you raise the standard deduction bar, fewer will qualify to itemize. For a view of how the standard deduction changed under tax reform in 2018, have a look at the standard deduction table below.
Filing Status 2018 Tax Year 2017 Tax Year Single $12,000 $6,350 Head of Household $18,000 $9,350 Married, Filing Jointly $24,000 $12,700 Married, Filing Separately $12,000 $6,350
Tax reform was a two-sided coin, however. While it projects to have the U.S. population pay less over the life of the tax changes, there are winners and losers.
Let’s walk through some of the major changes tax reform has brought and see who’s likely impacted most.
How did Tax Reform Change the 529 College Savings Plan?
A 529 college savings plan is a tax-advantaged savings account specifically designed to encourage saving funds for qualified future higher-education costs. These qualified expenses include tuition, fees and room and board. Money in these accounts invest and grow tax free if used for qualified educational expenses.
529 college savings plan funds could only be used on qualified higher education expenses.
New Rule (effective Jan. 1, 2018):
Count another victory for wealthy families who can now use funds from 529 savings plans for private K-12 schooling for their children. The tax benefits from this account now extends to eligible education expenses for all elementary or secondary public, private, or religious schools.
The new rule allows the plan holder to withdraw a maximum of $10,000 per year per student for education costs.
How did Tax Reform Change the Affordable Care Act (Obamacare) Individual Mandate?
The Affordable Care Act (ACA), more commonly referred to as Obamacare, passed Congress in 2009. The law offered access to a national health insurance exchange, standardized levels of insurance benefits, tax credits to subsidize health insurance for certain income thresholds, among many other changes to the existing healthcare system.
In its original form, the ACA required every individual to carry health insurance coverage. Those who chose not to carry coverage and did not qualify for an exemption faced a range of tax penalties, depending on income.
New Rule (effective Jan. 1, 2019):
As of Jan. 1, 2019, there is no more individual mandate. As such, there are no more penalties for not purchasing health insurance. The argument behind this removal is it will decrease spending on tax subsidies offered by the law (if you aren’t required to have health insurance, the government isn’t required to pay tax credits to people who don’t carry it) and balance the rise in premiums seen for ACA enrollees.
However, absent a mandate to carry health insurance, many industry watchers caution young invincibles on high deductible health plans won’t sign up for health coverage. As a result of these individuals being less likely to carry insurance, these experts foresee likely premium increases for those who carry insurance coverage from the ACA marketplace.
If these premium increases occur, some insurers could leave the marketplace altogether. This drop of the insurance mandate is a formidable blow to the primary thrust of the Affordable Care Act.
How did 2018 Tax Reform Affect Alimony?
Alimony is the payment made from one ex-spouse to another in support of their living expenses. Tax reform reversed who could take a tax deduction on these payments.
The person paying alimony could deduct the payments from their income while the person receiving must include them in their taxable income.
New Rule (effective Jan. 1, 2019):
No longer does the person making the payments get to deduct them from his or her income. Now, the recipient does not claim them as taxable income. Any divorce proceedings or separation agreements which were signed or modified before January 1, 2019 were not affected. This rule change becomes effective in 2019.
As you can imagine, if divorce proceedings weren’t contentious enough, many likely attempted to fast track (or delay) to take advantage of this change.
What did Tax Reform Change about the Child Tax Credit?
The child tax credit was designed to offset costs associated with raising children each year. The attractive nature of the credit came in the form of a dollar-for-dollar credit against your tax liability as opposed to a deduction which reduces your taxable income.
The child tax credit was available for each child under the age of 17 for $1,000. The tax credit is reduced by $50 for each $1,000 the taxpayer earns over certain thresholds. The tax credit is also subject to phase-outs starting at a modified adjusted gross income (AGI) over $75,000 for single taxpayers and heads of household, $110,000 for married couples filing jointly and $55,000 for married couples filing separately.
New Rule (effective Jan. 1, 2018):
Effectively, the child tax credit doubled per child up to $2,000 under tax reform in 2018. Up to $1,400 of the child tax credit received is a refundable tax credit (offsets the balance of your tax liability and any excess comes to you via a tax refund).
The new rule also includes a $500 nonrefundable tax credit per dependent other than a qualifying child. Phaseouts also apply to the new child tax credit.
For AGI greater than $200,000 (single taxpayers) and $400,000 for married couples, filing jointly, the phaseout reduces the child tax credit.
How did the 2018 Tax Reform Change Taxes for Homeowners?
Tax reform implemented multiple changes for homeowners, none for the better. Primarily, it changed the treatment of deductions many claim related to homeownership and the hurdle to surpass for itemizing (higher standard deduction).
Old Rule (Mortgage Interest Deduction):
The higher standard deduction created not only a higher hurdle to qualify for the mortgage interest deduction, but tax reform also lowered the levels of mortgage principal and associated interest expense which qualifies for deductibility.
In the past, you could deduct the mortgage interest associated with the first $1 million of your mortgage and the interest associated with the first $100,000 of a home equity loan (assuming the funds are used for qualifying home improvements).
New Rule (effective Jan. 1, 2018)
Tax reform changed this only to allow the interest expense associated with the first $750,000 for taxpayers who are married and file jointly, and $375,000 for single taxpayers. If you originated a mortgage in 2018 above this threshold, it gives you the incentive to pay off your mortgage faster.
It is worth noting this limit only applies to new loans originated after December 15, 2017. Preexisting mortgages are grandfathered under the old limits.
And home equity loan interest also is still deductible if the loan is used to “buy, build or substantially improve” the home which secures the loan.
The IRS provided an example to illustrate these rules to simplify the understanding. If a taxpayer took out a $500,000 mortgage to buy a home valued at $800,000 and subsequently took out a home equity loan for $250,000 to build an addition on the home, the interest associated with both the mortgage and the home equity loan are deductible. This is because the two loans, in aggregate, combine for the maximum of $750,000.
If the taxpayer uses the home equity line of credit (HELOC) for personal expenses other than qualified home expenses, that interest from the loan is not deductible.
Given the higher watermarks of these amounts, higher-income individuals located in non-coastal areas and those in high cost of living areas are disproportionately impacted.
Old Rule (higher standard deduction hurdle):
As stated previously, the standard deduction increase made it harder to qualify for itemizing deductions. Many expenses will be insufficient to itemize and forces the homeowner into the standard deduction because it provides better tax relief.
Many individuals will not be able to claim these tax deductions against their federal adjusted gross income. In some cases, they may still apply against state income tax adjusted gross income.
Simply put, 2018’s tax reform has made it less-advantageous to be a homeowner from a tax point of view.
How did the Home Office Tax Deduction Change?
For many years, many counted on home office tax deductions to reduce their taxable income. Expenses related to maintaining a workspace helped employees who worked at least part-time from home and the self-employed pay less in taxes in each year.
Tax reform in 2018 changed the treatment of home office expenses for Form W-2 employees, however, self-employed individuals retained this benefit and may still deduct qualified home office expenses from their taxable income.
Any expense an employee or self-employed person pays related to a home office used regularly and exclusively for their business, regardless of whether the space is rented or owned, can count as a tax write off.
However, taxpayers claiming this home office tax deduction need to be mindful because it is discretionary how the taxpayers chooses to allocate these expenses. If expenses are toward a space used for both personal and professional use, the taxpayer must use his or her best judgement allocating the expenses appropriately for tax purposes.
Tax reform changed the rule to allow only self-employed persons to claim the home office tax deduction. Employees who work from home, even part-time or as a portion of their full-time position, can no longer claim the home office tax deduction.
Further, beginning in 2013, and continued under tax reform in 2018, there are two methods for calculating your home office deduction: the standard method and the simplified method. Unlike other elections in the tax code, you do not need to use the same method each year.
The standard method requires you to calculate your total home office expenses each year and use this amount as your tax deduction.
The simplified method allows you to multiply $5 per square foot of home used for your business with a maximum allowed amount of 300 square feet. This method might be more efficient if you don’t have time to track your qualified home office expenses for a self-employment tax deduction or understand how to use MACRS depreciation tables.
However, these rates can vary by year depending on the IRS’s wishes and might not be as rewarding as the standard method. The decision is yours about whether you prefer one method to the other.
Tax Reform Resulted in Lowered Individual Income Tax Rates
America employs a progressive tax system for income taxes. This means as a taxpayer makes more income and exceeds certain levels, the amount of tax paid on an additional dollar of income increases.
For example, if you ignore the effects of the standard deduction and you made $35,000 as a single filer in 2018, you would pay 10% on the first $9,525 ($952.50) and 12% on the remaining $25,475 ($35,000 – $9,525) or $3,057. You would not pay 12% on the entire $35,000.
To understand better how your taxable income would be taxed by income bracket under tax reform in 2018, have a look at the 2018 income tax brackets table below.
Rate Individuals Married Filing Jointly 10% Up to $9,525 Up to $19,050 12% $9,526 to $38,700 $19,051 to $77,400 22% $38,701 to $82,500 $77,401 to $165,000 24% $82,501 to $157,500 $165,001 to $315,000 32% $157,501 to $200,000 $315,001 to $400,000 35% $200,001 to $500,000 $400,001 to $600,000 37% over $500,000 over $600,000
The new tax law changed two things about the 2018 income tax brackets and rates in 2018:
- Lower tax rates: The tax law kept the seven existing federal income tax brackets. However, it lowered the tax rate of every bracket except for two. This reduces the amount of money you pay on each additional dollar of income by varying amounts.
- Different taxable income ranges: The law also changed the 2018 income tax brackets for filers. Meaning, the income ranges applicable to each tax rate either widened or narrowed, depending on the level of income.
On the low end, the bottom two brackets remained unchanged, while on the upper end, the highest tax rate (37%) doesn’t begin until a single taxpayer has earned $500,001 of taxable income as opposed to $426,701 under the old tax brackets.
How has the Threshold for Medical Expenses Changed under Tax Reform in 2018?
For the 2018 tax year, taxpayers can deduct medical expenses which exceeded 7.5 percent of their adjusted gross income. In other words, if you had $100,000 of adjusted gross income in 2018 and qualifying medical expenses of $10,000, you can deduct $2,500 from your taxable income (AGI).
Adjusted Gross Income Threshold: $100,000 * 7.5% = $7,500
Deductible Medical Expenses: $10,000 – $7,500 = $2,500 available medical expense deduction
Taxable Income: $100,000 – $2,500 = $97,500
The IRS allows medical expense deductions for qualified, out-of-pocket medical costs. Additionally, you can deduct mileage or other travel expenses associated with medical visits.
If you paid for expensive medical treatment which counts as a qualified medical procedure, assisted living or other long-term care services, they may tally above the required threshold.
As a note, in the 2019 tax year, this 7.5% AGI threshold increases to 10%.
What Happened to Personal Exemptions?
A casualty of 2018’s tax reform was the personal exemption. Previously, each person on the tax return (filers and those being claimed) received an exemption to lower the taxable income on the return.
For example, if you were a family of four, you received four exemptions worth $4,050 per family member in 2017. Now, you don’t have the ability to claim personal exemptions on your tax return.
The argument here was the higher standard deduction would cover this loss. Originally, many feared larger families would stand to lose from this change. However, the enhanced child tax credit from above minimized this loss.
Tax filers can reduce their adjusted gross income by claiming personal exemptions, $4,050 per person claimed in 2017. These amounts phased out for taxpayers earning above certain thresholds. The phase out began at $313,800 for married, filing jointly couples, $287,650 for heads of household, $156,900 for married, filing separately, and $261,500 for all other taxpayers.
New Rule (effective Jan. 1, 2018):
There are no more personal exemptions allowed through 2025. If no legislation is passed making the individual tax payer changes permanent, personal exemptions will reappear starting in 2025.
How did 2018 Tax Reform Change the Standard Deduction?
Tax reform changed the nature of filing your tax return by increasing the standard deduction and making most taxpayers ineligible for itemizing their tax deductions. As a result, a lot fewer people qualify for taking the most common tax deductions.
Depending on filing status, standard deduction amounts were almost half of what they are under the new tax rules. In 2017, the standard deduction for single filers was $6,350 and $12,700 for married filing jointly tax payers.
New Rule (effective Jan. 1, 2018):
Because tax reform wanted to simplify the tax planning process, the IRS now has almost doubled the standard deduction for all filing statuses.
For single filers, the standard deduction stood at $12,000 in 2018. Married, filing jointly filers saw their standard deduction go to $24,000. In 2019, the amounts will be $12,200 and $24,400, respectively.
Further, the elderly or blind receive an additional standard deduction worth $1,600 in 2018 vs $1,550 in 2017.
These changes make most people claim the standard deduction on their tax forms because it not only simplifies their return, it is also harder to itemize.
The Contentious State and Local Taxes Cap
Some of the above changes benefited most in America (save homeowners). A higher standard deduction, lower tax rates and bigger brackets helped many pay less in taxes in 2018.
However, not everyone was as lucky. Many who lived in high cost-of-living areas paid a considerable amount of money each year in state and local taxes (SALT taxes) and a new cap impacted them considerably.
No limit on amount of state and local property, income, and sales taxes as itemized deductions.
New Rule (effective Jan. 1, 2018):
In 2018, there was a $10,000 cap placed on the amount of SALT taxes which can be deducted from your federal taxable income. Homeowners living in these higher cost areas were hardest hit because many deducted real estate and property taxes as well as other applicable state and local income taxes.
This new cap limited their ability to do so. The only way high cost of living homeowners can come out ahead is if their incomes fell into lower brackets, which would have more of their incomes fall into lower rates.
By placing a $10,000 cap on SALT taxes, the argument to be made for economic efficiency. Not every American takes the SALT tax deduction. High-income filers are much more likely to itemize and therefore more likely to claim the SALT deduction on their returns.
Further, the higher your income, the more valuable tax deductions become because that income is being reduced from your top marginal tax bracket.
In the past, the SALT tax deduction effectively subsidized high earners in high-cost of living areas, namely on the coasts. Those with high incomes logically claimed higher SALT deductions for things like property tax, real estate, and state and local income taxes.
However, for very high earners, limiting these deductions could be made up for with lower federal income tax rates. Whether you view this in a favorable light likely stems from how you will be impacted.
If you earn above $100,000 but you’re not close to $500,000, you likely come out behind. This is because you don’t earn enough income to benefit from lower income tax rates to offset the impact from capping the SALT tax deduction.
From a purely economic perspective, the cap reduces cross-subsidization and relies more on cost-causation principles to have citizens bear more cost of the policy choices made by their state. This lessens the subsidization made by lower tax states to higher tax states.
How did Tax Reform in 2018 Affect Student Loan Interest Paid by Your Parents?
While not a new deduction, the ability to claim a tax deduction for student loans did become easier after tax reform. In years past, when parents paid money toward a child’s student loans, no one could claim a tax deduction. The money paid toward the loans was lost in space from a tax perspective.
The borrower couldn’t claim to have made a payment and therefore couldn’t claim a tax deduction against their taxable income for the student loan interest paid. And the parent(s) couldn’t claim a tax deduction either because they weren’t liable for the student loans in the first place.
Under 2018 tax reform, the new rules changed this scenario. Originally, the IRS mandated you must pay for your own loan and be liable for it in order to qualify.
Now, your parents can pay off student loans and you get a tax deduction for it. If you’re the student loan borrower, you just got double the benefits: money toward the loans AND a tax deduction.
The finer details behind the change are that the IRS now treats money gifted to you by your parents to pay for the student loans as though they gave you money and you then used it to pay the debt. In essence, a child who isn’t claimed as a dependent can qualify for tax deductions worth up to $2,500 per year for student loan interest paid by Mom and Dad.
Readers: How did the 2018 tax reform affect your tax situation? Are there any surprises you discovered based upon these changes above? Are you happy with tax reform in 2018 because you came out a winner, or did the new tax law shortchange you? I’d enjoy hearing your comments below. If you find this post helpful, sharing on social media is always appreciated.
About the Author and Blog
In 2018, I was winding down a stint in investor relations and found myself newly equipped with a CPA, added insight on how investors behave in markets, and a load of free time. My job routinely required extended work hours, complex assignments, and tight deadlines. Seeking to maintain my momentum, I wanted to chase something ambitious.
I chose to start this financial independence blog as my next step, recognizing both the challenge and opportunity. I launched the site with encouragement from my wife as a means to lay out our financial independence journey to reach a Millennial retirement and connect with and help others who share the same goal.
I have not been compensated by any of the companies listed in this post at the time of this writing. Any recommendations made by me are my own. Should you choose to act on them, please see my the disclaimer on my About Young and the Invested page.