Tax Cuts & Jobs Act – How will it affect your taxes
On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act. It cuts individual income tax rates, doubles the standard deduction, and eliminates personal exemptions. The top individual tax rate drops to 37%. The Act cut the corporate tax rate from 35% to 21% beginning in 2018. The corporate cuts are permanent, while the individual changes expire at the end of 2025.
How It Affects You Personally
The Tax Act is so complex it affects each family differently depending on their personal situation. Here is a broad description of how it might affect the following seven groups:
High Income: If you have a very high income, the tax plan helps you the most. The Tax Foundation said those who earn more than 95% of the population would receive a 2.2% increase in after-tax income. Those in the 20% to 80% range would receive a 1.7% increase. The Tax Policy Center said those in the bottom 20% would only receive a 0.4% increase.
Heirs to Wealth: If you inherit a lot of money, the larger exemption for the estate tax will benefit you.
Few Deductions: If your itemized deductions are less than the new standard deduction, you win on two levels. First, the larger standard deduction will reduce your taxes. Second, you can skip the complicated process of itemizing. That not only saves you time but also money if you no longer need to pay a tax advisor.
Large Families: You may be hurt by the elimination of personal exemptions. The higher credits for children and elderly dependents may not be enough to offset that loss.
Homeowners: If take out a new home equity line of credit, you can only deduct the mortgage interest if you use it to buy or improve a home. If you take out a new mortgage or refinance an existing one, you can only deduct the interest up to the limit. If you live in a state with high property taxes, you can only deduct the first $10,000.
Young People: Since young people are generally healthier, they are more likely to benefit from the elimination of the Obamacare tax.
Self-employed: If you are a 1099 contractor, own your own business, or are self-employed, you may benefit from the 20% deduction on qualified income.
How It Affects Businesses
The tax plan helps businesses more than individuals. Business tax cuts are permanent, while the individual cuts expire in 2025. Here are some highlights:
The Act lowers the maximum corporate tax rate from 35% to 21%, the lowest since 1939. The United States has one of the highest rates in the world. But most corporations don't pay the top rate. On average, the effective rate is 18%. Large corporations have tax attorneys who help them avoid paying more.
Business Deductions: It offers a 20% standard deduction on qualified income for pass-through businesses. This deduction ends after 2025. Pass-through businesses include sole proprietorships, partnerships, limited liability companies, and S corporations. They also include real estate companies, hedge funds, and private equity funds. The deductions phase out for service professionals once their income reaches $157,500 for singles and $315,000 for joint filers.
The Act limits corporations' ability to deduct interest expense to 30% of income. For the first four years, income is based on EBITDA. This acronym refers to earnings before interest, tax, depreciation, and amortization. Starting in the fifth year, it's based on earnings before interest and taxes. That makes it more expensive for financial firms to borrow. Companies would be less likely to issue bonds and buy back their stock. Stock prices could fall. But the limit generates revenue to pay for other tax breaks.
It allows businesses to deduct the cost of depreciable assets in one year instead of amortizing them over several years. It does not apply to structures. To qualify, the equipment must be purchased after September 27, 2017, and before January 1, 2023.
The Act stiffens the requirements on carried interest profits. Carried interest is taxed at 23.8% instead of the top 39.6% income rate. Firms must hold assets for a year to qualify for the lower rate. The Act extends that requirement to three years. That might hurt hedge funds that tend to trade frequently. It would not affect private equity funds that hold on to assets for around five years. The change would raise $1.2 billion in revenue.
The bottom line
The Tax Cut and Jobs Act significantly changed personal and corporate taxes. Corporations benefit more since their cuts are permanent while the individual cuts expire in 2025. The Act is so complex that it affects each taxpayer differently. Consult a tax expert to determine the Act's impact on your personal situation. At VA Accounting and Income Tax, we have over 15 years of experience working with individuals and businesses focusing on ensuring they make the best financial and tax-related decisions based on their unique situations. We’d love to help. Please get in touch for a free consultation.