Your Complete Guide to the 2018 Tax Changes

Published December 30, 2017
Motley Fool

President Trump recently signed the tax reform bill into law, and it makes major changes to the U.S. tax code for both individuals and corporations. In fact, the bill represents the most significant tax changes in the United States in more than 30 years.

With that in mind, here's a guide to all of the changes that will go into effect -- the new tax brackets, modified deductions and credits, corporate tax changes, and more.

 

The 2018 tax brackets

In President Trump's campaign tax plan, he proposed reducing the number of tax brackets from seven to three, and the House of Representatives' original tax reform bill contained four brackets. However, the final bill kept the seven-bracket structure but with mostly lower tax rates.

Marginal Tax Rate

Single

Married Filing Jointly

Head of Household

Married Filing Separately

10%

$0-$9,525

$0-$19,050

$0-$13,600

$0-$9,525

12%

$9,525-$38,700

$19,050-$77,400

$13,600-$51,800

$9,525-$38,700

22%

$38,700-$82,500

$77,400-$165,000

$51,800-$82,500

$38,700-$82,500

24%

$82,500-$157,500

$165,000-$315,000

$82,500-$157,500

$82,500-$157,500

32%

$157,500-$200,000

$315,000-$400,000

$157,500-$200,000

$157,500-$200,000

35%

$200,000-$500,000

$400,000-$600,000

$200,000-$500,000

$200,000-$300,000

37%

Over $500,000

Over $600,000

Over $500,000

Over $600,000

For comparison, here are the 2018 tax brackets that were set to take effect under previous tax law.

Marginal Tax Rate

Single

Married Filing Jointly

Head of Household

Married Filing Separately

10%

$0-$9,525

$0-$19,050

$0-$13,600

$0-$9,525

15%

$9,525-$38,700

$19,050-$77,400

$13,600-$51,850

$9,525-$38,700

25%

$38,700-$93,700

$77,400-$156,150

$51,850-$133,850

$38,700-$78,075

28%

$93,700-$195,450

$156,150-$237,950

$133,850-$216,700

$78,075-$118,975

33%

$195,450-$424,950

$237,950-$424,950

$216,700-$424,950

$118,975-$212,475

35%

$424,950-$426,700

$424,950-$480,050

$424,950-$453,350

$212,475-$240,025

39.6%

Over $426,700

Over $480,050

Over $453,350

Over $240,025

The marriage penalty is (mostly) gone

One thing to notice from these brackets is that the so-called marriage penalty, which many Republican leaders (including President Trump) wanted to eliminate, is almost absent.

If you're not familiar, here's a simplified version of how the marriage penalty works. Let's say that two single individuals each earned a taxable income of $90,000 per year. Under the old 2018 tax brackets, both of these individuals would fall into the 25% bracket for singles. However, if they were to get married, their combined income of $180,000 would catapult them into the 28% bracket. Under the new brackets, they would fall into the 24% marginal tax bracket, regardless of whether they got married or not.

In fact, the married filing jointly income thresholds are exactly double the single thresholds for all but the two highest tax brackets in the new tax law. In other words, the marriage penalty has been effectively eliminated for everyone except married couples earning more than $400,000.

Standard deduction and personal exemption

While it's being sold as a tax cut, the higher standard deduction really falls more under the category of a simplification.

Yes, the standard deduction has roughly doubled for all filers, but the valuable personal exemption has been eliminated. For example, a single filer would have been entitled to a $6,500 standard deduction and a $4,150 personal exemption in 2018, for a total of $10,650 in income exclusions. Under the new tax plan, they would just get a $12,000 standard deduction. Is it better? Yes. But it's not really "doubled."

Having said that, here's a comparison between the standard deductions of the new and old tax laws.

Tax Filing Status

Previous Standard Deduction (Set to take effect in 2018)

New Standard Deduction

Single

$6,500

$12,000

Married Filing Jointly

$13,000

$24,000

Married Filing Separately

$6,500

$12,000

Head of Household

$9,350

$18,000

Capital gains taxes

The general structure of the capital gains tax system, which applies to things like stock sales and sales of other appreciated assets, isn't changing. However, there are still a few important points to know.

For starters, short-term capital gains are still taxed as ordinary income. Since the tax brackets applied to ordinary income have changed significantly, as you can see from the charts above, your short-term gains are likely taxed at a different rate than they formerly were.

Also, under the new tax law, the three capital gains income thresholds don't match up perfectly with the tax brackets. Under previous tax law, a 0% long-term capital gains tax rate applied to individuals in the two lowest marginal tax brackets, a 15% rate applied to the next four, and a 20% capital gains tax rate applied to the top tax bracket.

Instead of this type of structure, the long-term capital gains tax rate income thresholds are similar to where they would have been under the old tax law. For 2018, they are applied to maximum taxable income levels as follows:

Long-Term Capital Gains Rate

Single Taxpayers

Married Filing Jointly

Head of Household

Married Filing Separately

0%

Up to $38,600

Up to $77,200

Up to $51,700

Up to $38,600

15%

$38,600-$425,800

$77,200-$479,000

$51,700-$452,400

$38,600-$239,500

20%

Over $425,800

Over $479,000

Over $452,400

Over $239,500

Finally, the 3.8% net investment income tax that applied to high earners remains the same and with the exact same income thresholds. If Congress is successful in repealing the Affordable Care Act, this could potentially go away, but it remains for the time being.

Tax breaks for parents

I mentioned earlier that the personal exemption is going away, which could disproportionally affect larger families.

However, this loss and more should be made up for by the expanded Child Tax Credit, which is available for qualified children under age 17. Specifically, the bill doubles the credit from $1,000 to $2,000, and also increases the amount of the credit that is refundable to $1,400.

In addition, the phaseout threshold for the credit is dramatically increasing.

Tax Filing Status

Old Phaseout Threshold

New Phaseout Threshold

Married Filing Jointly

$110,000

$400,000

Individuals

$75,000

$200,000

If your children are 17 or older or you take care of elderly relatives, you can claim a nonrefundable $500 credit, subject to the same income thresholds.

Furthermore, the Child and Dependent Care Credit, which allows parents to deduct qualified child care expenses, has been kept in place. This can be worth as much as $1,050 for one child under 13 or $2,100 for two children. Plus, up to $5,000 of income can still be sheltered in a dependent care flexible spending account on a pre-tax basis to help make child care more affordable. You can't use both of these breaks to cover the same child care costs, but with the annual cost of child care well over $20,000 per year for two children in many areas, it's safe to say that many parents can take advantage of the FSA and credit, both of which remain in place.

Education tax breaks

Earlier versions of the tax bill called for reducing or eliminating some education tax breaks, but the final version does not. Specifically, the Lifetime Learning Credit and Student Loan Interest Deduction are still in place, and the exclusion for graduate school tuition waivers survives as well.

One significant change is that the bill expands the available use of funds saved in a 529 college savings plan to include levels of education other than college. In other words, if you have children in private school, or you pay for tutoring for your child in the K-12 grade levels, you can use the money in your account for these expenses.

Mortgage interest, charitable contributions, and medical expenses

These three deductions remain, but there have been slight tweaks made to each.

  • First, the mortgage interest deduction can only be taken on mortgage debt of up to $750,000, down from $1 million currently. This only applies to mortgages taken after Dec. 15, 2017, preexisting mortgages are grandfathered in. And the interest on home equity debt can no longer be deducted at all, whereas up to $100,000 in home equity debt could be considered.
  • Next, the charitable contribution deduction is almost the same, but with two notable changes. First, taxpayers can deduct donations of as much as 60% of their income, up from a 50% cap. And donations made to a college in exchange for the right to purchase athletic tickets will no longer be deductible.
  • Finally, the threshold for the medical expenses deduction has been reduced from 10% of AGI to 7.5% of AGI. In other words, if your adjusted gross income is $50,000, you can now deduct any unreimbursed medical expenses over $3,750, not $5,000 as set by prior tax law. Unlike most other provisions in the bill, this is retroactive to the 2017 tax year.

The SALT deduction

Perhaps the most controversial aspect of tax reform on the individual side was the fate of the SALT deduction. Early versions of the bill proposed eliminating the deduction (which stands for "state and local taxes"), which didn't sit well with some key Republicans in high-tax states.

The final version of the bill keeps the deduction, but limits the total deductible amount to $10,000, including income, sales, and property taxes.

Deductions that are disappearing

While many deductions are remaining under the new tax law, there are several that didn't survive, in addition to those already mentioned elsewhere in this guide. Gone for the 2018 tax year are the deductions for:

  • Casualty and theft losses (except those attributable to a federally declared disaster)
  • Unreimbursed employee expenses
  • Tax preparation expenses
  • Other miscellaneous deductions previously subject to the 2% AGI cap
  • Moving expenses
  • Employer-subsidized parking and transportation reimbursement

Itemizing won't be worthwhile anymore for millions of households

While we're on the topic of deductions, many of these may now be a moot point, even to taxpayers who have been using them for years. Even though most major deductions are being kept in place, the higher standard deductions will make itemizing not worthwhile for millions of households.

For example, let's say that a married couple pays $8,000 in mortgage interest, makes $4,000 in charitable contributions, and pays $5,000 in state and local taxes. This adds up to $17,000 in deductions, which when compared with the previous $13,000 standard deduction makes itemizing look like a smart idea.

However, with the new $24,000 standard deduction for married couples, it would no longer be worth it to itemize.

In fact, the Joint Committee on Taxation estimates that 94% of households will claim the standard deduction in 2018, up from about 70% now.

Obamacare penalties will be going away

Republicans were unsuccessful in their efforts to repeal the Affordable Care Act, otherwise known as Obamacare, in 2017. However, the tax reform bill repeals the individual mandate, meaning that people who don't buy health insurance will no longer have to pay a tax penalty.

It's worth noting that this change doesn't go into effect until 2019, so for 2018, the "Obamacare penalty" can still be assessed.

The pass-through deduction -- does it apply to you?

The new tax code makes a big change to the way pass-through business income is taxed. This includes income earned by sole proprietorships, LLCs, partnerships, and S corporations.

Under the new law, taxpayers with pass-through businesses like these will be able to deduct 20% of their pass-through income. In other words, if you own a small business and it generates $100,000 in profit in 2018, you'll be able to deduct $20,000 of it before the ordinary income tax rates are applied.

There are phaseout income limits that apply to "professional services" business owners such as lawyers, doctors, and consultants, which are set at $157,500 for single filers and $315,000 for pass-through business owners who file a joint return.

Alternative minimum tax, version 2.0

The alternative minimum tax, or AMT, was implemented to ensure that high-income Americans paid their fair share of taxes, regardless of how many deductions they could claim. Essentially, higher-income households need to calculate their taxes twice -- once under the standard tax system and once under the AMT -- and pay whichever is higher.

The problem is that the AMT exemptions weren't initially indexed for inflation, so over time, the AMT started to apply to more and more people, including the middle class, which it was never intended to affect.

So, the tax reform bill permanently adjusts the AMT exemption amounts for inflation in order to address this problem, and makes them significantly higher initially in 2018. Here's how the AMT exemptions are changing for 2018.

Tax Filing Status

2017 AMT Exemption Amount

2018 AMT Exemption Amount

Single or Head of Household

$54,300

$70,300

Married Filing Jointly

$84,500

$109,400

Married Filing Separately

$42,250

$54,700

In addition, the income thresholds at which the exemption amounts begin to phase out are dramatically increased. Currently, these are set at $160,900 for joint filers and $120,700 for individuals, but the new law raises these to $1 million and $500,000, respectively.

A different way to calculate inflation

Perhaps one of the most significant, but least talked-about, provisions in the new tax bill is the switch in the way inflation is calculated.

Under the previous tax law, inflation is measured by the consumer price index for all urban consumers, also known as the CPI-U, which essentially tracks the cost of goods and services that affect the typical household.

The new law adopts a metric called the Chained CPI. My colleague Sean Williams does a great job of explaining the Chained CPI, but essentially the key difference is that the Chained CPI assumes that if a particular good or service gets too expensive, consumers will trade down to a cheaper alternative.

The effect is that the Chained CPI grows slower than the traditionally used CPI-U. This means that tax bracket thresholds will rise slower, as will other IRS inflation-sensitive numbers, such as eligibility limits for certain deductions and credits.

The estate tax exemption

The estate tax already applied to a small percentage of households. Essentially, the 40% estate tax rate applied only to the portion of an estate that was valued at $5.6 million or more per individual, or $11.2 million per married couple.

However, the new tax law exempts even more households by doubling these exemptions. Now, for 2018, individuals get a $11.2 million lifetime exemption and married couples get to exclude $22.4 million. As you can probably imagine, this won't leave too many families paying the estate tax.

Most of the individual tax breaks are temporary

So far, we've discussed the tax changes that will affect individuals. It's also important to point out that most of the changes to individual taxes made by the bill are temporary -- they're set to expire after the 2025 tax year.

The notable exception is the change to the Chained CPI as a means to calculate inflation. In simple terms, this means that the income thresholds for each marginal tax bracket will rise more slowly than they previously would, which will presumably make a greater portion of each worker's income subject to higher marginal tax rates over time.

The combination of the temporary nature of the tax cuts and the permanent switch to the Chained CPI is expected to have the eventual effect of higher taxes on the middle class, as compared to current tax law.

Corporate tax rates

So far, we've discussed individual tax reform, but the most dramatic changes made by the bill are on the corporate side.

For starters, the bill lowers the corporate tax rate to a flat 21% on all profits. This is not only a massive tax cut, but is a major simplification as compared to the 2017 corporate tax structure.

Taxable Income Range

Marginal Corporate Tax Rate (2017)

$0-$50,000

15%

$50,000-$75,000

25%

$75,000-$100,000

34%

$100,000-$335,000

39%

$335,000-$10,000,000

34%

$10,000,000-$15,000,000

35%

$15,000,000-$18,333,333

38%

$18,333,333 and above

35%

The global average corporate tax rate is about 25%, so this move is designed to make the U.S. more globally competitive, which should in turn help keep more corporate profits (and jobs) in the United States.

In addition to these changes, the corporate AMT of 20% has been repealed.

A territorial tax system

The tax reform bill also changes the U.S. corporate tax system from a worldwide one to a territorial system. Currently, U.S. corporations have to pay U.S. taxes on their profits earned abroad, and the new system will end this effective double-taxing of foreign profits.

Repatriation of foreign cash and assets

As a result of the worldwide tax system, which makes foreign profits subject to the 35% top corporate tax rate, there is about $2.6 trillion in U.S. corporations' foreign profits held overseas.

In order to bring this money back to the United States, the new tax law sets a one-time repatriation rate of 15.5% on cash and equivalent foreign-held assets and 8% on illiquid assets like equipment, payable over an eight-year period.

This could be big news for companies like Apple, which has more than $200 billion parked overseas.

When all of this goes into effect, and when you'll notice the changes

To be clear, unless I've noted otherwise, the changes made by the tax reform bill go into effect for the 2018 tax year, which means you'll first notice them on your tax return that you file in 2019.

However, you can expect to see a change in your paychecks after Jan. 1, as employers will modify their withholdings to adapt to the newly passed 2018 tax brackets.

 

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Matthew Frankel owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.