If you have yet to file your taxes, you will notice some significant changes. I mentioned these a year ago when the new tax laws passed, but now they really go into effect as tax returns are coming due for 2018.
The biggest changes have to do with deductions and exemptions. The standard deduction doubled from $6,000 to $12,000 for single tax filers and from $12,000 to $24,000 for married couples who file taxes jointly. This means fewer taxpayers will itemize their deductions. You will continue to itemize if the sum of things like your mortgage interest and property taxes paid exceed the standard deduction. If they do not, you will claim the higher standard deduction.
The benefit that many will enjoy from the doubling of the standard deduction will be offset to some degree by the elimination of personal/dependency exemptions. Historically you could claim an exemption for you, your spouse and each of your kids (as well as other dependents you care for, such as a grandparent or cousin who lives in your home). In 2017 the exemption was $4,050. So if you were married with 2 kids you could claim $16,200. You were phased out from being able to claim personal/dependent exemptions if you earned too much, but most taxpayers were able to benefit from this.
These exemptions are now gone and while a boost in the standard deduction may compensate for exemptions lost, for many it will not.
The best example of this would be the family whose itemized deductions tally between $20,000 and $25,000. These taxpayers probably won’t see their deduction total change much, only how they arrive there. They will either claim the increased standard deduction of $24,000 or they will claim their typical itemized deduction total, provided it exceeds the $24,000 standard deduction.
This family will feel it when their exemptions go from $8,000 (married couple) or $12,000 (married + 1 kid) or $16,000 (married + 2 kids) to zero. Said differently, the amount of income that is taxed will increase by whichever of these exemption amounts previously applied.
It is worth noting that the marginal tax brackets went down slightly. For instance, where taxable income between $76,000 and $153,000 was previously taxed at 25% for a married couple, taxable income between $77,000 and $165,000 is now taxed at 22%.
It is hard to say just how much the reduction in income tax rates will help in light of the increased standard deduction and removal of exemptions. Frankly, I think the changes in the tax brackets and corresponding rates is mostly window dressing.
The bottom line? Don’t be surprised if your tax bill is different than in years past. In light of the increased standard deduction, next week I will explain why it may be smarter to prioritize paying off your mortgage over saving for college.
In The Market...
The S&P 500 gained +3.0% last week. Let's look under the hood: