What Does Tax Reform Mean for the Average American?

Markets Motley Fool

President Trump released his new tax plan, dubbed the Tax Cuts and Jobs Act, on Thursday. If you're like most Americans, you're probably wondering how the proposed changes might affect you. Though the plan's proponents intend to lower individual tax burdens and simplify the tax code itself, skeptics have been quick to argue that it favors the wealthy and corporations much more so than the typical household.

Continue Reading Below

So just how will the Tax Cuts and Jobs Act impact the average American? To get a clear snapshot, let's talk about what the typical household looks like today from a tax perspective:

  • The median income among U.S. households is $56,516, according to the most recent U.S. Census estimate.
  • The average U.S. family size consists of 3.27 individuals.
  • The average American claims the standard deduction when filing taxes.
  • Because the tax code is so complex, the average U.S. adult can only answer about 50% of common tax questions correctly.

With all of this in mind, let's explore the new bill and how it might impact the average filer.

1. Increasing the standard deduction -- but eliminating the personal exemption

The majority of taxpayers opt to claim the standard deduction on their tax returns, as opposed to itemizing deductions. Currently, the standard deduction is valued at $6,350 for single filers, and $12,700 for joint filers, but these numbers were slated to increase to $6,500 and $13,000, respectively, come 2018. The good news is that the Tax Cuts and Jobs Act seeks to nearly double the standard deduction to $12,000 for single filers and $24,000 for joint filers. However, it also calls for the elimination of the personal exemption, which will be worth $4,150 for taxpayers and their dependents come 2018.

Continue Reading Below

Now with the average American household having 3.27 individuals, so if we round down to three -- say, two parents and a child -- that family will actually lose under the new tax plan when you look at total deductions and exemptions. That's because under the current system, that household would be eligible for a $13,000 standard deduction next year, plus $12,450 in exemptions for a total of $25,450. With the exemption gone, however, that family would be left with just a $24,000 standard deduction to claim.

2. Fewer tax brackets

At the core of Trump's proposal is a simplification of the current tax code -- and that itself might benefit the average American, since 90% of U.S. adults currently require outside help to prepare their returns. But it's the details of that simplification that have Americans most concerned, since the plan effectively reduces the number of existing tax brackets from seven down to four.

Here's how the current federal tax brackets for 2017 read:

Tax Bracket

Income Range: Single Tax Filers

Income Range: Married Filing Jointly

10%

$0-$9,325

$0-$18,650

15%

$9,326-$37,950

$18,651-$75,900

25%

$37,951-$91,900

$75,901-$153,100

28%

$91,901-$191,650

$153,101-$233,350

33%

$191,651-$416,700

$233,351-$416,700

35%

$416,701-$418,400

$416,701-$470,700

39.6%

$418,401 and above

$470,701 and above

With the average household income of $56,516 and combined standard deduction and personal exemptions of $25,450, taxable income of $31,066 would put our hypothetical average American family in the 15% tax bracket. So how would the new tax brackets work in the typical American's favor? Here's what they look like:

Tax Bracket

Income Range: Single Tax Filers

Income Range: Married Filing Jointly

12%

$12,000-$45,000

$24,000-$90,000

25%

$45,001-$200,000

$90,001-$260,000

35%

$200,001-$500,000

$260,001-$1 million

39.6%

$500,000 and above

$1 million and above

Here, note that the new standard deduction is incorporated into the tax brackets. The $56,516 amount is squarely within the 12% bracket, which is lower than the 15%. 

Bear in mind, though, that tax brackets only tell you your marginal tax rate, not your effective tax rate. The typical American family described above would have a tentative tax of $3,727 under the current tax system, but under the new system, that same family would have a figure of $3,902. 

3. Reducing the property tax deduction

Another thing the Tax Cuts and Jobs Act seeks to do is limit the property tax deduction to $10,000 -- a move that's unlikely to impact most typical Americans. That's because across all U.S. taxpayers, the average property tax deduction is $1,250, but among the 25% to 30% who itemize, the average deduction is closer to $5,000. The only people who do stand to lose out on the property tax deduction cap are wealthy Americans who live in expensive parts of the country.

4. Limiting the mortgage interest deduction to loans up to $500,000

The Tax Cuts and Jobs Act also looks to retain the mortgage interest deduction, but limit it to loans worth $500,000. Since the average household with a mortgage owes $172,806, this shouldn't impact the typical American. Of course, that figure speaks to what homeowners currently owe on their mortgages, and not the original loan amounts they took out. But more recent data tells us that U.S. adults who applied for mortgages in January 2017 were looking at loans averaging $309,000. This means that the aforementioned cap is likely to impact only the wealthy.

5. Tax relief via the Child Tax Credit

The Child Tax Credit is designed to provide tax relief for low-to-middle income households. Currently, qualifying families get a $1,000 credit per child under the age of 17, and the average American earning $56,516, whether single or married, is eligible for the credit in full. Under the new tax plan, the credit will increase to $1,600, which means households with at least one child will benefit. Remember, unlike a tax deduction, a tax credit is a dollar-for-dollar reduction of your tax liability, so that extra $600 is apt to make a difference. Indeed, in the example above, it would mean saving under the new plan as opposed to paying more. The new tax bill also includes a $300 credit for non-child dependents for five years, after which that provision would go away.

At the end of the day, it's clear that while many middle-income Americans will benefit from the new tax plan, there are also some who stand to get hurt by it. Let's just hope that if the bill does go through, we'll see more winners than losers. 

The $16,122 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,122 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.

The Motley Fool has a disclosure policy.