The Tax Cuts and Jobs Act (TCJA), passed in December 2017, made several significant changes to the individual income tax. These changes include a nearly doubled standard deduction, new limitations on itemized deductions, reduced income tax rates, and reforms to several other provisions. In all, these changes simplify the individual income tax by eliminating the need for millions of households to itemize their deductions.
In fact, when individuals fill their tax declaration early in 2019, major changes in US tax policy last year —the biggest reform in 30 years— that will apply in the IRS tax declaration for 2018 are giving tax payers a respite and have given them a lot to consider in their financial planning.
The most direct impact for individuals, couples and families has been the decline in tax rates for most tax brackets, including a move down to 22% from 25% for the lower middle bracket, to 24% from 28% for the higher middle bracket and down to 37% from 39.6% for the top bracket.
In addition, the tax declaration to be filed for this 2018 year, includes one of the major benefits for many individual taxpayers. The higher standard deduction, which is now $12,000 for individuals — up from $6,350 last year — and for married couples filing jointly, that deduction is $24,000 now, up from $12,700 in 2017.
With nearly double the standard deduction, taxpayers who itemize should consider whether that strategy is still in their best interest or they should instead simplify their tax declaration. If taxpayers deductions —such as charitable donations, medical expenses or interest on student loans, among others— exceed the higher standard deduction, it pays to itemize, but tax payers should compare the arithmetic for either choice. In other words, evaluate how your itemized deductions compare to the standard deduction. Some taxpayers may find that itemizing is no longer necessary with the higher standard deduction. Those who have deductions that total more than the new standard deduction might consider checking to see if itemizing may provide a better benefit for them.
On the average, low middle class households with incomes between US$50,000 and US$75,000 – within the 22% third bracket – are among the ones with a higher tax cut proportional to their income. They will get between 2.2% and 2.5% tax cuts, representing over $1,300 savings on the average.
There’s another change that only affects tax payers owning their own home: homeowners can only deduct interest on mortgages of up to $750,000, down from the $1 million amount allowed by the previous tax policy. This also applies to home equity loans if they are used to purchase a second property. In addition, interest paid on home equity lines of credit is no longer tax deductible. Who is likely affected: Higher income homeowners with an outstanding mortgage exceeding $750,000, plus anyone who may have counted on taking a deduction for money drawn from a home equity line of credit.
In short, we can say that the Tax Cuts and Jobs Act of 2017 made several significant changes to the individual income tax, including reforms to itemized deductions and the alternative minimum tax, an expanded standard deduction and child tax credit, and lower marginal tax rates across brackets. These changes simplify the individual income tax for millions of households, as 28.5 million filers would be better off taking the newly expanded standard deduction, instead of itemizing various deductions.
The Internal Revenue Service estimates the average time to complete an individual tax return will decrease by 4 to 7 percent. And for those opting to use the standard deduction instead of itemizing their tax return, the simplified method would save for many of them the need to hire an expensive accountant.
Business Income Deductions
In addition, the tax reform also brings major changes for the way business income is taxed. For C corporations, in which the business income is taxed separately from owners’ income, the tax reform represents a big benefit that entices many operating overseas to come back to the United States. For them the tax rate was cut to 21% from 35%.
Other businesses, or “pass-through” entities —sole proprietorships, LLCs, partnerships, and S corporations (which have fewer than 100 shareholders and are typically taxed as a partnership)— are also affected. Many of these business owners will see a new deduction of 20% for qualified “pass-through” business income, a popular form of business income that is not taxed at the corporate level.
For many business owners, the revised deduction would reduce their taxable income and provide tax savings found in a lower tax bracket. For example, those in a high tax bracket with a 37% tax rate could possibly bump down to a tax bracket with the lower rate of 29.6%.