Sweeping tax reforms don’t happen often and when they do, they tend to have a big impact on personal finances.
The last major tax reform in the US happened more than 30 years ago so people have developed financial habits based on the previous tax law.
The new Tax Cuts and Jobs Act became a law on the 22nd of December, 2017 and will affect every tax payer in the US from 2018 onwards.
It’s important to understand the implications of the recent changes and adjust your financial habits accordingly.
Here’s a detailed guide on how tax reform will affect your finances:
Changes in Income Tax Brackets
This is one of the most important changes to note and it can be a bit tricky to understand, but a good understanding of it can help you save some money.
Under the previous law, the income tax brackets were 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
The taxation is progressive so your entire income isn’t taxed at the percentage of your income tax bracket. For example, if you fall in the 25% tax bracket, a portion of your income is taxed at 10%, another portion is taxed at 15%, and the rest of it is taxed at 25%.
This system is preserved but the percentages of 5 out the 7 brackets have changed under the new tax reform. The new income tax brackets are 10%, 12% 22%, 24%, 32%, 35%, and 37%.
So, if you are single and have an income of $40,000 per annum, you fall in the 22% tax bracket rather than the 25% tax bracket, and you can save around $1,000 on taxes.
This also means that people with a higher income have to pay more taxes.
Substantial Increases in Tax Deductions
You can deduct some expenses from your taxable income and pay lower taxes based on that. The tax bill offers two types of tax deductions; one of them is a standard deduction and the other is an itemized deduction.
A large number of taxpayers don’t have much to deduct and choose standard deductions. Some taxpayers have a list deductible expenses that exceed the standard deductions amount and can save money on tax by filing them.
It’s a good idea to run both numbers every year and determine which option helps you save more money on tax. You can’t file both deductions in the same year but can alternate between the two types of deductions every year.
The standard deductions have increased for taxpayers of all statuses and they are explained below:
- If the standard deduction for a single taxpayer under the previous law was $6,500. The deduction is increased to $12,000 under the new law.
- The standard deduction for the head of a household under the previous law was $9,550 which will now increase to $18,000 under the new law.
- The standard deduction for a married couple filing jointly under the previous law was $13,000. This deduction increases to $24,000 under the new law.
Make sure you understand the different deductions well and calculate which one works best for you before you file your taxes.
No Personal or Dependent Deduction
Under the previous law, you could claim a personal and dependent deduction for yourself and all the dependents you claimed on the tax return.
That allowed you to get up to $4,050 person up to a certain income bracket.
That has changed now and this facility is no longer available to taxpayers under the new tax reform. However, the higher standard deduction amount compensates for any benefit you might have gained from the personal and dependent deduction.
Reduced Homeownership Benefits
Home mortgage interest can still be deducted from the taxable income, but the interest amount to be deducted has been lowered by a considerable margin. That’s one of the reasons why experts now encourage people to consider standard deductions rather than itemized deductions.
Mortgage interest deduction can still help you save some money on taxes if you plan and file correctly. Here are some details you need to know:
- Interest paid for a new mortgage up to the tune of $750,000 for most and $375,000 for married homeowners who file separately is deductible under the new tax reform. The older tax law allowed taxpayers to deduct interest paid on loan amounts up to a $1 million or $500,000 for married homeowners who file separately.
- The new law doesn’t allow homeowners to deduct interest paid on home equity loan or line of credit. The previous law allowed taxpayers to deduct interest paid on up to $100,000.
A thorough knowledge of how the tax reform affects you will help you plan your finances accordingly and keep your tax obligations as low as possible. It can also help you avoid potential problems and pitfalls so you don’t land in any legal trouble in the future.