Tax Reform Law: 7 Ways It Affects Your Personal Finances
Reforms in the Tax Cuts and Jobs Act begin in 2018 and affect virtually every U.S. taxpayer. Find out which changes shake up your personal finances the most so you can prepare, avoid potential pitfalls, and keep your tax liability as low as possible.
New legislation known as the Tax Cuts and Jobs Act became law on December 22, 2017. Starting in 2018, it affects virtually every U.S. taxpayer with dramatic changes including new tax rates, fewer deductible expenses, and a major modification to healthcare.
I’ll cover seven of the main ways tax reform affects your personal finances. Understanding these changes now can help you prepare, avoid potential pitfalls, and keep your tax liability as low as possible.
Buy Now
7 Ways Tax Reform Affects Your Personal Finances
- Income tax brackets and tax rates change.Â
- The standard tax deduction increases.Â
- The personal and dependent tax exemptions are eliminated.Â
- Homeownership benefits are reduced.Â
- State and local tax breaks are limited.Â
- Education incentives are modified.Â
- Healthcare mandate penalty is eliminated.
Here’s more detail about how tax reform changes your personal finances.
1. Income tax brackets and tax rates change.
The Tax Cuts and Jobs Act keeps the basic structure of our progressive income tax system but modifies the brackets and rates. Don’t worry, I’ll explain this tax jargon in plain English.
Having a progressive income tax system means that higher amounts of income are taxed at higher rates. Previously, we had seven brackets or tiers of rates: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
Progressive taxation means that you aren’t taxed at one rate (unless your income is solely in the bottom bracket), but have multiple tax rates applied to your income. For example, under the old system, if you were single and made $60,000, you’d pay three different tax rates:
- The first $9,525 of income was taxed at 10%Â
- The next $29,175 was taxed at 15%, accounting for a total of $38,700Â
- The last $21,300 was taxed at 25%, accounting for the full $60,000
Even though it would be common to say you’re in the 25% tax bracket under this scenario because that’s where your income tops out, you don’t pay 25% on all your income.
Many taxpayers will benefit from the Tax Cuts and Jobs Act, but some high earners will pay more tax.
Under the new law, we have the same number of tax brackets, but the rates assigned to five of the seven tiers are slightly lower: 10%, 12% 22%, 24%, 32%, 35%, and 37%. And the range of income assigned to some of the brackets has changed.
For example, under the old system, a single taxpayer with $40,000 of taxable income topped out in the 25% tax bracket and would pay about $5,700 in taxes. Under the new system, that person would be in the 22% bracket and pay about $4,700, or $1,000 less.
Many taxpayers will benefit from the Tax Cuts and Jobs Act, but some high earners will pay more tax.
The IRS just released new tax withholding guidelines to employers so they can modify paychecks no later than February 15, 2018. So, if you’re an employee, you should see a slight increase in your take home pay by then.
It’s a good idea to review changes in your tax withholding carefully because if too little is taken out, you could end up having to pay more at tax time. And given all the new tax changes happening, which I’ll cover here, I recommend that you review your withholding anyway because you may not get as many allowances on your W-4.
2. The standard tax deduction increases.
The new tax law increases the standard deduction by a significant amount. Before I give you the numbers, here’s a primer: Deductions allow you to subtract certain expenses from your taxable income, which reduces your tax bill.
But even if you don’t have any deductible expenses, our tax system throws you a bone just for breathing! It’s called the standard deduction. You can claim a standard flat amount for your filing status (such as single or married), with no questions asked.
You have another option called itemizing deductions. This means you add up all your deductible expenses and list them on your tax form. Itemizing saves money when the total exceeds your standard deduction, but it’s more of a hassle because you have to prove your expenses are legit.
You can never claim both the standard deduction and itemize deductions in the same year. But you can alternate methods from year to year, depending on which option saves the most. So, it’s wise to run the numbers both ways every year to see which option gives you a bigger deduction.
There are some situations when you can’t claim the standard deduction. One is if you’re married, but file taxes separately, and your spouse itemizes deductions. In that case, you both must itemize.
You can never claim both the standard deduction and itemize deductions in the same year. But you can alternate methods from year to year, depending on which option saves the most.
Here are the new standard deductions under the Tax Cuts and Jobs Act by tax filing status:
- Single: Increases to $12,000 from $6,500
- Head of Household: Increases to $18,000 from $9,550
- Married filing joint taxes: Increases to $24,000 from $13,000
As you might imagine, these higher standard deductions make it more likely that fewer Americans will want to itemize. It’s still a good idea to continue tracking your deductible expenses so you can make the comparison; however, there are many fewer deductions now. I’ll tell you more about what’s changed in a moment.
3. The personal and dependent tax exemptions are eliminated.
Another tax term you hear a lot is the personal exemption. It’s been eliminated under the Tax Cuts and Jobs Act, but I’ll give you a quick explainer.
The personal and dependent exemption was simply an amount that you got to deduct from your income for yourself and every dependent you claimed on your tax return. It was another deduction just for being alive, in addition to your standard or itemized deductions.
Prior to 2018, the exemption reduced your taxable income by $4,050 per person, up to certain income limits. But you probably won’t miss it now that there’s a much higher standard deduction.
4. Homeownership benefits are reduced.
You might be glad to hear that the mortgage interest deduction isn’t going away; however, it has been reduced for new loans.
I mentioned that for many people, taking the standard deduction (instead of itemizing) may be more attractive because it will be larger starting in 2018. Plus, many itemized deductions are getting reduced or eliminated.
The home mortgage interest deduction is one of the most popular itemized deductions because it can be large, and therefore cut taxes significantly. If you’re a homeowner or want to be one someday, you might be glad to hear that the mortgage interest deduction isn’t going away. However, it has been reduced for new loans:
- Interest on a new mortgage is limited to interest paid on a maximum of $750,000, or $375,000 if you’re married and file taxes separately. That’s down from $1 million, or $500,000 if filing separately.Â
- Interest on a home equity loan or a home equity line of credit (HELOC) is no longer deductible, unless the funds are used to buy, build, or improve the home that secures the loan.
5. State and local tax breaks are limited.
Before the Tax Cuts and Jobs Act, you could include an unlimited amount of property tax and state or local income tax as an itemized deduction. (There are only seven U.S. states that don’t impose a state income tax in addition to federal tax.)
Now, you can only claim up to $10,000, or $5,000 if you’re married filing separately, for all types of state and local taxes. This cap is a huge blow if you live in a high-tax state like California or New York, where your property taxes alone could easily exceed $10,000.
See also: IRA or 529 Plan–Which Is Better for College Savings?
6. Education incentives are modified.
It’s a mixed bag with education benefits because some stay the same, some improve, and others are reduced. But overall, there isn’t much to complain about and I’ll give you the highlights.
Starting in 2018, up to $10,000 of your 529 funds can be used for tuition at any public or private school, per student.
One new benefit is that 529 college savings plans can now be used for elementary or secondary school expenses, in addition to the costs of higher education. Starting in 2018, up to $10,000 of your 529 funds can be used for tuition at any public or private school, per student.
This expanded used of 529 funds is meant to replace Coverdell savings accounts after 2017. If you have a Coverdell, you can spend the funds, but you can’t make new contributions. You can even rollover a Coverdell to a 529 plan, if you want to consolidate your education savings.
There were rumblings that the student loan interest deduction would disappear, but fortunately that didn’t happen. You can still claim up to $2,500 per year of interest paid on student loans, if you don’t exceed annual income limits. Â
See also: How to Get Out of Debt FastÂ
7. Healthcare mandate penalty is eliminated.
Healthcare got thrown into the tax bag because the Affordable Care Act, known as Obamacare, charged a tax penalty if you didn’t have coverage for more than 60 consecutive days. Interestingly, the new tax law doesn’t repeal the Obamacare mandate, but it does reduce the penalty to zero, starting in 2019. So, you could owe a penalty if you didn’t have coverage in 2017 or 2018.
This change is a bit confusing because it means that you’re really supposed to have health insurance, but if you don’t, the administration is going to look the other way after 2019. You might consider that a win if you plan to skip health insurance, which I don’t recommend because medical debt is a leading cause of bankruptcy.
Interestingly, the new tax law doesn’t repeal the Obamacare mandate, but it does reduce the penalty to zero, starting in 2019.
Problem is, health premiums are predicted to rise by about 10% due to fewer healthy people buying coverage once the tax penalty is lifted. If health insurers pay out more in claims than they make in premiums, they’re forced to raise rates for all policyholders or decide not to do business in certain cities, counties, or states.
Another medical issue that the Tax Cuts and Jobs Act changes is the threshold for itemizing medical deductions. Previously, you could claim medical expenses that exceed 7.5% of your adjusted gross income. But starting in 2019, they must exceed 10%, which cuts your allowable deduction.
More Tax Deductions Affected by Tax Reform Legislation
I mentioned that for many people, taking the standard deduction (instead of itemizing) may be more attractive because it will be higher starting in 2018. Another reason is that many itemized deductions have been eliminated.
Expenses for the following are no longer allowable tax deductions:
- Employee business expenses
- Tax preparation feesÂ
- Personal casualty and theft losses (except for certain losses in federally declared disaster areas)Â
- Alimony payments (starting in 2019)Â
- Moving expenses (except for the military)
Here are some deductions you might be glad to know haven’t changed substantially or at all:
- Health savings account (HSA) contributions
- 401k retirement plan contributions
- Traditional IRA contributionsÂ
- Charitable donations
The tax reform changes I’ve mentioned here are not a complete list, but are likely to have the biggest effect on your wallet. The Tax Cuts and Jobs Act is effective through the end of 2025—so, in eight years, we’ll probably see another tax overhaul.
But for now, it’s wise to consult with a tax professional to make the most of your situation. A tax accountant or CPA can help you complete your W-4 correctly and make sure that your payroll withholding or estimated payments won’t leave you owing more.
Get More Money Girl!
If you’re ready for help managing debt, building credit, and reaching big financial goals, check out Laura’s private Facebook Group, Dominate Your Dollars! Request an invitation to join this growing community of like-minded people who want to take their financial lives to the next level.
To connect on social media, you’ll find Money Girl on Facebook, Twitter, and Google+. Also, if you’re not already subscribed to the Money Girl podcast on Apple Podcasts or the Stitcher app, both are free and make sure that you’ll get each new weekly episode as soon as it’s published on the web. The show is also on the Spotify mobile app! Click here to sign up for the free Money Girl Newsletter!
Download FREE chapters of Money Girl’s Smart Moves to Grow Rich
About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
