In December 2017, the Tax Cuts and Jobs Act was signed into law which resulted in some major changes to how Americans would pay their taxes.
For example, the 1040EZ form no longer exists. Taxpayers who used to fill out that form will now fill out a 1040 form – a postcard-sized form that is deceptively simple to fill out. Most taxpayers will have to fill out anywhere from 1 to 6 additional sheets, or “schedules” to complete their taxes fully.
But that’s a discussion for another time.
Another consequence of the tax plan is that the standard deduction has been raised considerably.
Single tax payers had a $6,350 standard deduction in 2017. In 2018, that deduction will be $12,000 – practically double! Married filing jointly? It used to be $12,700, in 2018 it will be $24,000.
However, the personal exemption, which in 2017 was $4,050 per family member, has been eliminated entirely.
This “personal exemption” was actually a deduction that a taxpayer could use to lower his or her taxes.
Let’s say your income in 2017 was $35,000. You were able to deduct a personal exemption for yourself, and one for your dependent child, so you subtracted $8,100 from $35,000, leaving you with a total taxable income of $26,900.
At $26,900, you were in a tax bracket as head of household, where your liability was determined to be $1,335 plus 15% of the amount over $13,350. So, you would have a tax liability of $2,032 + $1335, or $3,367.50
Now, because you have a dependent child, you were eligible for a Child Tax Credit. In 2017, let’s say you were eligible for a credit of $1,000.
You did not subtract this credit from your taxable income, on which you had to pay taxes. Instead, you subtracted it from the amount of taxes you owed. So instead of having to pay $3,367.50, you paid $2,367.50.
In other words, deductions affect how much income you make, that in turn will be taxed at a certain percentage.
Once you know how much money you owe in taxes – your tax liability, a credit will reduce how much you have to pay by a dollar amount.
Who gets to take deductions?
Now that the personal exemption no longer exists, the only taxpayers who can take deductions over and above the standard deduction are those who can itemize their taxes. Costs that can be deducted include certain medical expenses, state income taxes (if you’re in a state where you have to pay them), property tax, mortgage interest and charitable contributions. Interest on student loans can also be deducted, as well as medical savings accounts.
Only 30% of Americans itemized their taxes in 2017, and fewer still will do so in 2018 because they no longer qualify. The standard deduction is so high that it will not be necessary for most Americans.
Having said that, just because you don’t qualify to itemize in one year doesn’t mean that you won’t qualify to itemize in the next year – although again, because of the increased standard exemption, only a few people (percentage-wise) will benefit from this.
Tax credits may still be taken
Tax payers can still benefit from tax credits, if they qualify.
- Child tax credit
- Earned income tax credit
- Adoption credit
To put it bluntly, the new tax plan was supposed to simplify taxes. However, most Americans will find that they are more complicated than ever.
It’s best for tax payers to visit a qualified tax preparer to ensure that they do not miss out on the deductions or tax credits that they deserve.
