Congress labored mightily to produce a compromise version of the House and Senate Tax Cuts and Jobs Act bills. The legislators faced two major challenges: the narrow GOP majority and the Senate limitation of no more than a $1.5 trillion increase in the budget deficit. Here's how the Houses of Congress managed to combine the two bills to get around these limitations.
A top individual tax bracket of 37%
One of the most significant differences between the two versions of the tax bill was in the tax bracket system. House and Senate legislators have compromised on a 37% top tax bracket, which is actually lower than the top tax bracket in either of the two initial versions of the bill (and also significantly lower than the existing 39.6% top tax bracket).
Changes to the alternative minimum tax (AMT) rules
The AMT is quite possibly the least popular part of the tax code. It was created by Congress to plug tax loopholes that allowed certain high-income individuals to pay practically nothing in income taxes, but because the AMT income limits weren't pegged to inflation, middle-class households have increasingly been affected by it. In essence, AMT means that you have to do your taxes twice: once using the standard tax rules and again using the AMT rules. Whichever approach produces the higher tax bill is the one you have to use for your tax return that year. Taxpayers get an AMT exemption, which allows them to subtract a chunk of income when calculating these taxes; however, the exemption phases out at higher levels of income.
The new tax bill repeals the corporate AMT and significantly raises the income limits for the individual AMT to protect less-than-wealthy households. The 2017 AMT exemption for single filers was $54,300, and the exemption started to phase out at an income level of $120,700; the new tax bill changes the single-filer exemption to $70,300 and starts the exemption phase-out at $500,000. For married couples filing jointly, the exemption threshold is rising to $109,400, while the phase-out will kick in at $1 million.
A corporate tax rate of 21%
The current tax code pegs the top corporate tax rate at 35%; adding in the average state corporate tax brings the total to 38.91%, which is the highest corporate tax rate out of all industrialized nations and the fourth-highest corporate tax rate in the world. Both the House and Senate tax bills originally set the corporate tax rate at 20%; the final version increases that rate slightly to 21%, which is still a significant reduction. This change will take effect in the current tax year.
Medical expense deduction and student loan interest deduction will stay
One of the most controversial provisions of the House tax bill was the repeal of the medical expense deduction. In the interest of compromise, Congress has removed that provision, as well as the one repealing the student loan interest deduction. The medical expense deduction will continue to be subject to an adjusted gross income (AGI) reduction of 10%, meaning that taxpayers must subtract 10% of their AGI for the year from their medical expenses before deducting what's left over.
State and local taxes and mortgage interest deductions will be capped
Rather than repealing the state and local taxes (SALT) deduction as originally proposed in the House bill, legislators have decided to keep this deduction but cap it at $10,000. This will allow residents of states that charge high income taxes to continue to enjoy a significant deduction. The mortgage interest deduction will also remain in the tax code but the limit on those mortgages will be reduced from $1 million to $500,000.
Now that the Tax Cuts and Jobs Act has passed Congress, taxpayers will see significant changes to their tax returns in the next few years. If you're not sure how the new rules will affect you, consider finding a reputable tax professional to prepare your return -- you'll avoid the risk of making major errors on your return that will draw the wrath of the IRS down on your head.
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