The Tax Cuts and Jobs Act came into force when President Trump signed it. It lowered the corporate tax rate to 21% from 35% at the turn of 2018. The highest tax bracket is now 37% for big earners. Other changes include cutting the rates of income tax, doubling standard deductions, but also cutting some personal exemptions.
Take note that everything other than the corporate tax cuts expire in 2025, though.
So how will this change paying taxes for the average American?
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How Income Taxes Change
We still have seven brackets for income tax but lower tax rates. These changes will become apparent in the withholding for February 2018 paychecks. This only lasts until 2026, though.
The standard deduction you can now take has been doubled to $12,000 per single person. Married and joint taxpayers will see their deduction go up to $24,000 from $12,700, but in 2026 it will return to the 2017 level.
This is big news because 94% of taxpayers take a standard deduction.
Personal exemptions, however, are a thing of the past. That $4,150 deduction for each person claimed is a thing of the past. Now families with children may see their tax credits go up.
Most itemized deductions are also gone, which includes moving expenses and those paying alimony (the receiver can still take the deduction). Itemized deductions still apply for people in the military, making charitable donations, saving for retirement, and interest on student loans.
A big change is how the deduction on mortgage interest has been limited. It now only applies to the initial $750,000 of the mortgage. Also, you can’t take a deduction for interest on equity lines of credit. If you already have a mortgage, though, the rules remain the same.
What About at the State and Local Level?
Each taxpayer can deduct a maximum of $10,000 on their local and state taxes. However, they must choose an income, sales, or property taxes. People in high-tax states, such as California and New York, may see their taxes rise because of this.
When it comes to richer taxpayers, they will see the estate tax exemption doubled. Singles can benefit from an $11.2 million tax exemption, and couples will get a $22.4 million exemption. However, it ends in 2026 and will only impact about 5,000 Americans.
Finally, the tax plan maintains the Alternative Minimum Tax. The exemption is now available for singles earning between $54,300 and $70,000. Joint filers can use the exemption if they earn between $84,500 and $109,400.
How Healthcare is Going to be Impacted by the Trump Tax Plan
Healthcare expense deductions have been expanded for both 2018 and 2019. Taxpayers can make deductions if their payments account for more than 7.5% of their income. Previously, this was 10% for people born after the year 1952. Now it applies to everyone, with seniors born before this year still maintaining this deduction.
The Obamacare tax has also been removed. If you don’t have health insurance, you won’t have to pay the extra tax. However, there are fears that 13 million people could drop their insurance entirely for this. Some doctors also say that healthcare costs will rise due to people avoiding preventative care.
What are the Changes for Senior and Child Care
The plan provides a credit for $500 for every dependent who isn’t a child, which is beneficial for those caring for elderly parents.
The Child Tax Credit has been doubled to $2,000. Low-income parents who don’t pay taxes can claim up to $1,400 in Child Tax Credits. Married and joint filers see a big increase in the income level that they can still claim the credit. It moves from $110,000 to $400,000.
How are Businesses Impacted?
The main change is the reduction of the corporation tax rate from 35% to 21%. Another big change is the standard deduction has been raised to 20%. That deduction will be in place for pass-through businesses until 2025.
Anyone who is a sole proprietorship, partnership, LLC, or S corporation falls into this category. It also includes other types of businesses, including private equity funds and realtors.
These deductions have a maximum ceiling of $157,000 for single filers and $315,000 for joint filers.
Corporations have seen their ability to deduct interest expenses limited. They can now only claim a deduction for 30% of interest expenses. It’s important to know that during the first four years, EBITDA will determine income. Only in the fifth year is it based on earnings and how much is paid in taxes.
It’s expected that this will generate additional tax revenue to cover the expense of various other tax breaks.
The Trump Tax Plan also changes the rules on depreciable assets. Now firms can start to deduct the cost of these assets in the first year rather than over several. However, structures are exempted from the changes. Equipment must be purchased after September 27, 2017, and before the start of 2023.
Something else corporations must consider is carried interest profits. These are now taxed at a lower 23.8% rate, but firms must hold the assets for at least three years instead of a year to qualify. Regular traders could take a bit because of this, particularly hedge funds.
But the authors of the bill estimate this could generate an additional $1.2 billion in revenue.
Another rollback of corporate tax legislation is the removal of the corporate AMT. This was a 20% tax rate that applied if tax credits took a company’s tax rate under 20%. They also couldn’t make deductions for research and developments or investments in low-income areas. The deficit will increase by $40 billion due to this change.
The overall point of this tax plan for business is to switch from a worldwide tax system to a territorial tax system. That means money is only taxed where it’s earned, rather than when it enters the country. It’s designed to encourage companies to avoid leaving their profits overseas where it can’t be taxed.
Companies will be able to bring home up to $2.6 trillion at a simple 15.5% tax rate on cash and 8% on any equipment assets. But a similar tax holiday in 2004 did almost nothing to improve the economy as cash was simply redistributed to shareholders.
What are Some Specific Changes to Businesses?
- The Arctic National Wildlife Refuge now has legalized oil drilling. However, that won’t be profitable unless oil prices rise to at least $70 per barrel.
- Wind farms and electric vehicles maintain their tax credits.
- Orphan drugs, which are designed to cure rare diseases, have seen their tax credit go down by half to 25%.
- Sin taxes on alcoholic drinks have been cut.
Where Does This Leave You in the Grand Scheme of Things?
Understand that this bill is mainly designed to benefit businesses, especially corporations. The business tax cuts remain in place and don’t expire in 2025. So far, Walmart has already pledged to raise the wages of its employees as a result. It’s also giving out $1,000 bonuses to its workers.
The individuals who benefit are mainly high net worth individuals. Those at the top will receive roughly a 2.2% increase in income after tax, according to the Tax Foundation, with everyone else getting a 1.7% increase if they fall into the 20%-80% income range.
The important thing to note is that the US tax system has become a little more regressive as practically everyone will see their tax rates go down. But those who see the biggest decreases are the wealthiest.
The biggest change for individuals is the increase in the standard deduction, as this will impact almost half of all filers. But for many, this is not going to make up for the deductions that were eliminated.
The Trump Tax Bill and the National Debt
One of the things commentators have focused on following the unveiling of the Trump bill is how it will impact the national debt.
The bill will increase the deficit by about $1 trillion over ten years, according to data put out by the Joint Committee on Taxation.
But economic growth is expected to increase regardless. The US Treasury claims that the average per year economic growth will rise to 2.9%. In these lean economic times, this would be significant. But this figure has been assessed based on President Trump’s other plans making it through Congress, including deregulation of industry and changes to the welfare system.
The fact is that even some Republicans who traditionally support defaulting on the national debt over increasing it have got behind the tax bill for one reason or another. The belief that additional revenue through economic growth will offset the increase in the national debt harkens back to Reaganomics.
But non-partisan studies reveal that the increase in the current $20 trillion debt will be much greater than the Republicans are anticipating. There’s already a belief that the current tax cuts will be extended to drag out the perceived increase in economic growth.
There’s a Reason for This.
When a country sees its debt increase, it diminishes economic growth in the long-term. It’s why many opponents of the bill say that letting the debt increase is effectively taxing future generations, as they will one day have to deal with increases in the tax rates.
The World Bank believes that the tipping point for debt to GDP is 77%. Right now, the debt to GDP ratio for the US is 104% before the tax cuts. And every percentage point above 77% costs a country 1.7% in growth. So, do the math, and you’ll see how much the US is losing out on in growth terms.
The Trump Tax Bill is using the theory of supply-side economics. That’s the belief that tax cuts spur economic growth. And it has worked in the past. It worked throughout the Bush tax cuts, and it worked under Reagan when he made major cuts.
The problem is that taxes under Reagan were as high as 70%, which was prohibitively high from an objective economist’s standpoint. This is the essence of trickle-down economics in a nutshell. But it has been debunked many times, and tax cuts from an already low tax rate will make little difference in growth terms.
Unsurprisingly, few corporations have said they’re going to create jobs with the money they’ll gain from these tax cuts. Estimates state that corporations could be sitting on a huge $2.3 trillion vault in cash reserves, which is up 100% from the rate in 2001.
Coca-Cola and Cisco are just some of the corporations that have said they’re going to use the cuts to increase shareholder dividends instead. Some companies, like Amgen, are using the money to fund stock buybacks.
So, where should the tax cuts really fall if the government wants to boost growth?
The wealthy mainly save the money or invest it elsewhere. Instead, the middle class would use the money in a far better way because they’re more likely to spend the money, which would stimulate the economy and create more jobs as there would be more demand in a variety of industries.
Don’t worry, online tax software helps you claim all the new tax breaks, by searching for all available tax credits and deductions, putting the numbers on the right form, and then computing just how big your refund will be.