How Does the New Tax Bill Effect Me?

The new tax bill,  the Tax Cut and Jobs Act (TCJA), was passed at the end of 2017. It’s the largest tax reform we’ve seen in the U.S. since President Reagan. There are many important changes that will affect your taxes in 2018 and beyond. This article will attempt to shed light on the changes we think will affect most Millennials. Ranging from the positives and negatives, and the opportunities they present in managing your financial plan in the years ahead.


Tax Bracket Changes

First and foremost, individual and married filing jointly tax brackets have been revised. The good news is most taxpayers will receive a reduction in their marginal tax brackets.

Putting more money back in the hands of consumers theoretically should help churn the economic engine. Whether you invest, spend, or save that money, it’s putting more money back into the private sector. Consider using your tax savings for your long-term investments. Whether its a couple thousand dollars, ten thousand dollars, everything counts when you’re investing for the long-term.

Capital gains tax remain the same at 0%, 15%, and 20%. Remember, holding assets for longer than one-year allows you to pay taxes using this lower schedule. If you sell an asset prior to one year, you pay taxes according to your marginal income tax bracket.

New Standard Deduction

When you go to file your taxes, you have two choices when claiming deductions to reduce your taxable income. The standard deduction or itemized deductions. The majority of taxpayers use the standard deduction. Obviously, you would only choose to itemize if it results in a greater deduction.

The new standard deduction amount essentially doubled. Individuals can now claim a standard deduction of 12k, and married couples 24k. This will further reduce the number of taxpayers who actually itemize. This is good news for people who claim the standard deduction because it reduces your overall tax liability even further.

Changes to Itemized Deductions

If you were someone who itemized their deductions in the past, there are changes that could potentially make the standard deduction more beneficial. The home mortgage interest deduction is now capped at $750,000, down from $1m, and the interest deduction on home equity loans has been eliminated.

The biggest and probably most controversial change in this tax bill was the cap put on deductions for state and local taxes. Residents of high-income state tax states such as California or New York will no longer be able to deduct their state income tax fully against their federal income tax. Instead, they’re capped at $10,000. In the past, this has been very beneficial for wealthy people who itemize their deductions in these high-tax states.

Medical expenses not covered by insurance qualify for a deduction only IF medical expenses exceed 7.5% of your adjusted gross income. Adjusted gross income is your income after deducting things like HSA contributions, 401(k) contributions, and student loan interest, in addition to other items.

Removed the Personal Exemption

The personal exemption has been removed going forward. In the past, you could get a personal exemption for yourself, your spouse, and any dependents you claimed in your household. However, in lieu of doubling the standard deduction, Congress has voted to remove the personal exemption. For large families with more than 2 dependents, it would seem this is a net negative to their tax liability. For families of 4 or less, in most cases, the doubling of the standard deduction is still more beneficial.

Roth IRA Change

The new bill eliminates the ability to recharacterize a Roth conversion. Under current law, investors can convert a traditional IRA to a Roth account and then “recharacterize” it back to a traditional IRA. Investors would do this for a few different reasons:

  1. The value of their investments declined since the initial conversion,
  2. They got bumped into a new tax bracket due to unexpected income, or
  3. They do not have enough cash to pay the tax bill related to the initial conversion. Regardless, this will no longer be allowed moving forward. The deadline to complete a recharacterization would be the tax filing deadline for 2017.

New 529 Rules

529’s are used for investing in a child’s college expenses. They’re beneficial to use rather than investing in a normal brokerage account because of their tax benefits. The funds used for qualified educational expenses can be withdrawn tax-free, which ultimately results in more funds being available to pay for college.

The new tax bill allows 529’s to be used for K-12 education. In prior years they could only be used for higher education purposes. It now makes even more sense to use the 529 as the primary vehicle to save for education expenses. Remember, any funds not used by one child can simply be used by their sibling. Grandparents and other relatives can make contributions to a 529 as well, making them great gifting vehicles.

Conclusion

All in all, the new tax bill will reduce the tax liability of the majority of taxpayers moving forward. Remember, you won’t be subject to the new tax brackets until you go to file taxes for 2018. Before you go make it rain, consider funding your IRA or Roth a bit more. Or, if you’re ineligible or have already maxed out your retirement account contributions, consider opening a brokerage account. Pay your future self first before enjoying your tax savings. That way you ensure your future self is happy too.

If you’re looking to find out exactly how much you’ll have in tax savings or potential increase in tax liability, schedule a meeting with us today and we’ll be able to identify that amount.

Levi Sanchez is a CERTIFIED FINANCIAL PLANNER™, BEHAVIORAL FINANCIAL ADVISOR and Co-Founder of Millennial Wealth, a fee-only financial planning firm for young professionals and tech industry employees. He is an avid sports fan, personal finance and investing geek, and enjoys a great TV show or movie. His mission is to help educate his generation about better money habits and provide financial planning services to those who want to start planning for their future today!