However you feel about the politics of tax reform, the Tax Cuts and Jobs Act is now law and 2018 is the first year you will be dealing with the majority of those changes.
While it’s rarely a good idea to make financial decisions solely based on taxes, it is smart to be aware of the tax consequences of your decisions so that you can avoid any unnecessary costs and take advantage of potential tax savings available to you.
With that in mind, here’s a quick rundown of some of the major changes included in this new law and how those changes might affect your personal financial situation.
Trickle down from Larger Standard Deduction
Tax filers can now take advantage of a larger standard deduction, which is the amount that everyone is allowed to subtract from their taxable income. For married couples filing jointly, this is increasing from $12,600 in 2017 to $24,000 in 2018. For single filers, it is increasing from $6,300 to $12,000.
This is certainly a welcome change for some. However for many people, especially here in California, this will serve to decrease the value of itemized deductions they were already taking.
The mortgage interest deduction, for example, will take a hit. This deduction is only valuable to the extent that it, along with your other itemized deductions, exceeds the standard deduction, and a larger standard deduction therefore serves to decrease its value.
The state and property tax deductions will also be affected. Like the mortgage interest deduction, these are itemized deductions whose impact is lessened by the increased standard deduction. There is also a new $10,000 annual cap on this deduction that hits high-tax states like California especially hard.
I’ve written about why the tax benefits of owning a home are overrated, and that was before this new law was passed and made them less valuable. That doesn’t mean you shouldn’t buy a home. It just means that you should buy when it fits into your overall financial situation and not because of the assumed tax benefits.
Child Tax Credit in Lieu of Personal Exemptions
Previously, families were allowed to deduct an additional $4,050 per person in their household as a personal exemption. This was especially helpful for families with multiple children, as each child served to reduce their taxable income.
The bad news is that those personal exemptions are no longer allowed. The good news, for families with children, is that an expanded child tax credit should make up for some or all of that loss in many cases.
You are now allowed a $2,000 tax credit per child under the age of 17, $1,400 of which is refundable. And the income phaseout has also been increased – from $110,000 to $400,000 for married couples filing jointly and from $75,000 to $200,000 for single filers – making it easier for more families to qualify.
Updated Tax Brackets
The tax brackets have changed, and this should result in lower taxes for most people (at least until they sunset in 2025). You can see the detailed brackets here.
This could potentially affect your decision to contribute to a Roth IRA instead of a Traditional IRA, especially if you expect taxes to increase again in the future. That’s a decision that needs to be made within the context of your entire financial situation.
529 Plans Are More Flexible
Previously, 529 plans were specifically designed to be used for qualified higher education expenses. But the new law now allows up to $10,000 per year, per child to be withdrawn tax-free and penalty-free for K-12 education expenses as well.
This significantly increases the flexibility of these accounts and decreases the risk that you won’t be able to use the money you contribute. It also largely negates the value of contributing to a Coverdell ESA, since the primary advantage of those accounts was the ability to use the money for K-12 expenses.
AMT and Stock Options
While the new tax law didn’t completely eliminate the Alternative Minimum Tax (AMT), a combination of changes made it so that fewer people are likely to qualify.
One consequence of this change is that it could open up opportunities for people to exercise stock options without facing as much exposure to the AMT. But this is a complicated topic that is dependent on a large number of variables, so it’s worth consulting with a tax professional before making any final decisions.
The More Things Change…
While this new tax law certainly brings about plenty of changes, the fundamentals of a good financial plan are still the same.
It’s still a good idea to live within your means. You should still be contributing to your 401(k) and IRAs (and taking advantage of the tax deductions!). You should still build an emergency fund, get insurance when appropriate, and only buy as much house as you can afford.
While you may stand to gain or lose some money from these changes, and while you may be able to play around at the margins to optimize your finances, at the end of the day most of the financial decisions that were smart last year are still smart this year.
Image courtesy of: https://cst-cpa.com/news/blog/new-tax-law-changes-mean