From the moment the 2016 Presidential election occurred, tax reform was anticipated, although the details of any overhaul could only be estimated based on campaign promises. Last week, the Republicans in the House of Representatives put forth a bill that will have some significant changes to the tax code.
Although tax rates (after 2017), estate tax, AMT and corporate taxation are addressed in the bill, we will start by taking a look at the effect of the changes in standard and itemized deductions, two matters that affect every taxpayer.
It should be noted that, if passed, a tax reform bill is likely to look somewhat different than the present version, although it is possible that the general framework will remain intact. That being said, there are a number of proposed changes to standard and itemized deductions:
- The standard deduction will go from $6,350 to $12,200 for single taxpayers and $12,700 to $24,400 for married taxpayers. Single taxpayers with a child (or children) get a standard deduction of $18,300
- Personal exemptions will go away. In 2016, the exemptions were $4,000 and stood to increase to $4,050 in 2017, absent any legislative changes.
- The child tax credit will increase from $1,000 to $1,600, but only the first $1,000 is refundable. The other $600 will only be available if the total tax does not drop below zero.
- State and local taxes are no longer allowable itemized deductions.
- Property tax deductions are allowed only up to $10,000.
- Mortgage interest on debt over $500,000 will not be deductible.
- Charitable donations will remain deductible.
Merely listing the changes is a pretty simple exercise; showing the effects of those change is another matter altogether. Although every person’s personal tax situation is unique, below is an example of married taxpayers with two children under 17 years old. They have a $250,000 house that they purchased a few years ago and have real estate taxes and mortgage interest on it.
|Adjusted Gross Income||150,000||150,000|
|Real Estate Tax||3,500||3,500|
|State & Local Taxes||6,105||0|
|Larger of Above||25,105||24,400|
|Child Tax Credit||0||3,200|
The comparison above assumes that the new post-2017 proposed tax rates of 12%, 25% and 35% are in effect. As you can see, the taxable income will be higher with the new tax legislation, but the total tax is lower by about $2,200.
If the same couple had no children, the personal exemptions would be lower in the old method, and the child tax credit (which they phased out of under existing legislation) would also go away in the proposed model. In this case, the tax savings is reduced to about $1,000.
The illustration indicates that it is important to consider all aspects of the proposed tax overhaul and how it will affect you and not focus on just one or two areas. The elimination of state and local tax as well as the personal exemptions will undoubtedly increase taxable income for many taxpayers. However, the reduction in tax rates may offset the increase in taxable income.
As more information becomes available regarding the potential passage of tax legislation, we will continue to provide examples of the impact to various types of taxpayers.
By Dan Massey, CPA, Manager