You’ve probably heard a lot of noise about tax reform, but what does it mean for you? Here are the most impactful changes from a CFP® professional’s POV.
Have you heard anything about tax reform over the past six months? Between all of the media coverage, bickering politicians, and social media rants, it’s often difficult to figure out what it all means. Yes, in late 2017, @POTUS signed a new tax bill. And of course it was controversial. But no matter what side of the fence you’re on, it’s important to understand how the new tax plan affects you.
You’re probably not dying to research the tax changes, but as a CFP® professional I was more than eager to. And here are the three ways that the new tax plan can have the biggest impact on you:
1. Your paycheck (if you’re not a freelancer)
In fact, most Grownups may have already noticed a change in their paychecks. Luckily, most Grownups will experience an increase in their take home pay (aside from a possible increase in salary or bonus from your employer). It’s because the amount of your paycheck that’s withheld for Federal taxes will change. One of the major aspects of the new tax plan is the implementation of new tax brackets. Your payroll department was required earlier this year to adjust their systems to reflect the new tax brackets. The result is a different amount of Federal income tax withholding on your paystub, which directly impacts the amount hitting your bank account every pay period.
2. Businesses (this one could impact you, freelancers)
Another major change is to the corporate tax rate, which was decreased from 35% to 21%. Many people have shared their opinions about how this change is going to affect consumers and the economy, but the truth is the impact is yet to be determined. Some employers issued bonuses or other benefits to their employees because they predicted a positive impact from the decrease in the corporate tax rate. But that’s the only immediate impact Grownups may have experienced from this particular change. If Grownups were to experience any additional impact from this change it may take years to play out.
There’s another change included in the Trump Tax Plan that may have a more immediate impact on Grownups who are freelancers and/or own a small business. The tax plan essentially allows certain small businesses (specifically “pass through entities”) to take a deduction of 20% of their income for the year, so in other words, only claim 80% of their business income for the year. And less income claimed means lower tax paid and therefore more money you may be able to keep in your pocket. But keep in mind that, as with any tax law, there are plenty of exceptions, rules, and limitations regarding the ability to take this deduction. So it’s important to either perform your own due diligence or consult with a tax professional to see if your situation applies.
3. Your 2018 Tax Return
I’ll be the first to admit that it’s difficult to understand the timing of these changes. The President signed the bill in 2017, but the rules went into effect in January 2018. That means you’re following the former tax rules when you’re filing your tax return for last year (2017—remember that even though you’re filing your return by April 17, 2018, it’s for the year prior). You won’t see the impact of most of these rule changes until you complete your tax return for 2018.
The major changes are to personal exemptions and standard deductions for 2018. Wait, what are those again?
Intuit, Inc., the company who provides TurboTax services, defines a personal exemption as “an amount you get to deduct from your income for every taxpayer and most dependents claimed on your return. For 2017, the exemption is $4,050 per person, which means a jointly-filing couple with 2 dependents get an exemption of $16,200 (4 people x $4,050).” Keep in mind that the exemption is subject to a phase-out that begins with adjusted gross incomes of $261,500 ($313,800 for married couples filing jointly).
Intuit defines the standard deduction as “a fixed dollar amount that reduces your taxable federal income. Think of it as tax-free income that you get to keep before taxes are applied to the rest.” The standard deduction is $6,350 for most single filers in 2017 and $12,700 for a couple who is married filing jointly.
The new tax plan eliminates personal exemptions and essentially doubles the standard deductions to $12,000 for most single filers and $24,000 for married couples filing jointly.
So losing personal exemptions negatively impacts almost all tax payers, but the same taxpayers may benefit from the increase in the standard deductions. For example, a single person in 2017 would get a $4,050 personal exemption and a standard deduction based on their situation of $6,350, meaning $10,400 of their income is not federally taxable. The same single person in 2018 does not get a personal exemption, but the new standard deduction would give them $12,000 of their income that’s not federally taxable.
But that’s only one example. With the new tax laws come a different set of rules, so Grownups with different circumstances will experience different outcomes. Some Grownups, for example, may have itemized their deductions in 2017 but choose to take the standard deduction in 2018. Check out my prior post on choosing the standard deduction vs. itemizing, but know that’s based on the 2017 tax rules. Keep the same concepts in mind but remember the 2017 standard deduction amounts are less than what they’re going to be in 2018.
So what should Grownups do?
- If you’re an employee (not a business owner or freelancer), complete the updated W-4 form. Your W-4 gives your employer instructions on how much to withhold for taxes from your paycheck. The IRS created an updated form reflecting the new tax law changes, so it’s a good idea to complete a new form to make sure your withholdings are accurately accounted for.
- Don’t be afraid to seek advice from a tax professional. Taxes are complicated, and it’s OK if you don’t fully understand how these changes can impact you. A tax professional can help you plan for any changes this new plan can have on your personal situation. This may be an especially good idea for business owners and freelancers who want to understand if they qualify for the 20% business income deduction.
Tyler is a CERTIFIED FINANCIAL PLANNER™ practitioner who believes financial education can empower people to reach their goals.
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While Society of Grownups hopes the information is useful, it’s only intended to provide general education. It’s not legal, tax, or investment advice, and may not apply or be useful to your specific financial situation. If you need recommendations geared to your personal financial situation, schedule time with a financial planner.