2018 tax changes you need to know

2018 Tax Changes You Need to Know

It’s a new year, and with a new year comes tax season.

But unlike prior years, this tax season brings a slew of changes to the tax code that will likely alter your expected tax returns.

Major tax reform is unusual, with the last overhaul happening around 30 years ago.

With so many changes taking place it’s important to know exactly what has changed, and more importantly, how those changes might affect your tax returns.

For most, these changes will likely decrease the taxes you pay, while for others it may increase them. It all depends on your filing status, itemized deductions, and the tax bracket you fall into.

While we can’t cover every little change, I (Sebastian) have spent the last couple of weeks combing through the new tax code in order to understand the changes most likely to impact you.

The following represents a summary of the basic changes that may affect your 2018 tax return, and what you can expect as a result of these changes.

But first, some general information about taxes that you need to know.

Note: This article is intended to provide a general explanation of some of the changes in the 2018 federal tax law. You are advised to review your individual tax situation with a professional tax preparer.

What Determines Your Taxes?

Your tax liability (the taxes you pay) are based on your taxable income.

Taxable income is the income used to determine how much you owe in taxes in a given year, and is calculated by taking income and subtracting qualified deductions.

In other words, out of all the money you earned in a year, what portion of those earnings are taxable?

The next thing you will need to determine is your filing status. You can file as single, married (jointly or separately), and head of household. Head of household is typically used for unmarried people who are caregiving for a qualified individual (children, elderly parent, disabled individual, etc.).

Your taxable income and filing status will then determine your tax bracket. Tax brackets consist of seven income ranges that determine your income tax rates. All taxpayers fall into one of these segments, but the income ranges for each segment will differ depending on your filing status.

Tax brackets for 2018 for each filing status are shown below.

 

2018 tax changes you need to know

 

Once you determine your tax bracket you can determine your tax rate, but it’s important to know that not all your taxable income will be taxed at that rate.

The reason is our tax system is graduated, meaning taxpayers will pay an increasing tax rate as their income increases. Thus, you will pay various tax rates only for the income that falls into that bracket, and not for your total income.

For example, let’s say an individual is filing as single with a taxable income of $50,000. Their taxes would be calculated as follows:

  • The first $9,525 would be taxed at 10% ($952.50 in taxes)
  • Income up to $38,700 ($29,175) would be taxed at 12% ($3,501 in taxes)
  • The remaining income ($11,300) would be taxed at 22% ($2,486 in taxes)
  • Add the taxes from each bracket to get $6,939.50 total taxes owed

Now that you know the basics for determining your taxable income and tax bracket, let’s get into the changes you’ll see to the tax law and how those changes may affect you.

2018 Tax Changes You Need to Know

Redesigned 1040 Form

Many may not even notice this change, but it’s one you should know about nonetheless.

The IRS has redesigned the 1040 filing form, which is the one most taxpayers will use to file their tax returns. In prior years there were two other versions of this form, the 1040A and 1040EZ, but both have been eliminated.

What Does This Mean For You?

The new form is shorter in length because many line items have been consolidated or moved to other forms or schedules. Additionally, 6 new schedules will appear on the form designated with numbers rather than letters.

Although the form has been redesigned, those who file their taxes electronically will be minimally impacted because the software will automatically use questions and your answers to address these changes and find the best possible solution for you.

Similarly, those who use a tax preparer will also be minimally affected by these changes.

Tax Rates and Brackets

One of the major changes that will affect you this tax season is the restructuring of the tax rates and brackets.

With the new tax law, tax rates have actually decreased, meaning you’ll be taxed less overall no matter what bracket you fall into.

While the first tax bracket rate remains at 10%, the highest bracket tax rate has dropped from 39.6% to 37%, with most brackets seeing a drop in interest rate of around 3%.

In addition, the ranges for the tax brackets have mostly been adjusted upward. This means that your taxable income now must be higher before you will reach the next tax bracket.

The chart below shows the difference in the max income needed to reach each bracket for each filing status from 2017 to 2018.

2018 tax changes you need to know

 

As you can see, the max income needed to reach most tax brackets has increased.

What Does This Mean For You?

How these changes affect you will really depends on your taxable income and filing status.

The max income needed to reach most tax brackets increased, while the tax rates either decreased or stayed the same.

This means that the majority of people will pay a lower tax rate on more of their income, which means less taxes overall.

However, the income ranges for some tax brackets actually decreased, meaning you’ll pay a higher tax rate on more of your income. As you can see from the chart above, those who are the most negatively affected fall into the 32% tax bracket.

On the other hand, those most positively impacted by these changes fall into the 35% and 37% tax brackets, which represent the highest income earners.

Increase in the Standard Deduction

Another major change that will affect your taxes is an increase in the standard deduction.

If filing as single, the standard deduction has increased to $12,000 compared to $6,350 in prior years.

If you’re filing status is married filing jointly, the standard deduction increased to $24,000 compared to $12,700 in years past.

What Does This Mean For You?

How this change affects you depends on the number of deductions you can claim.

If you have a large amount of qualified deductions (more than the increased standard deduction) then you won’t see any added benefit.

On the other hand, if you don’t have many deductions you will likely come out ahead because the standard deduction has doubled, bringing your taxable income down by a large amount.

Elimination of Personal Exemptions

While the increased standard deductions will likely benefit many taxpayers, it comes at the cost of personal exemptions.

In prior years, a personal exemption of $4,050 was deducted from you taxable income for every qualified individual.

If you filed as single you would receive a deduction of $4,050, and you would receive $4,050 for each individual if jointly filing as married. Furthermore, you would receive a $4,050 deduction for each dependent.

Thus, although the standard deduction is higher, you will no longer receive a personal exemption for each qualified member of the household.

What Does This Mean For You?

For most taxpayers the elimination of personal exemptions, along with the increase in standard deductions, actually means you come out slightly ahead.

If filing as single, your 2018 standard deduction of $12,000 is $1,600 more than your standard deduction plus personal exemption from 2017 ($6,350 + $4,050 = $10,400).

In other words, your taxable income will decrease by $1,600 and you will save roughly $160 in taxes from this change alone.

However, this change may work against you depending on the size of your family and the number of dependents you have.

For example, if filing jointly with 3 children your standard deduction for 2018 will be lower ($24,000) compared to your standard deduction plus personal exemptions for 2017 ($12,700 + $4,050(5) = $32,950 in deductions).

As a result, families with several dependents will likely have less in tax savings compared to years past.

Increased Child Tax Credit and Added Non-Child Dependents Credit

While the personal exemption deduction will no longer benefit families with several dependents, you’ll make up some ground with increased child tax credits.

The child tax credit will now be $2,000 per qualifying child as opposed to $1,000 in previous years.

Additionally, there is now a $500 credit for non-child dependents.

What Does This Mean For You?

Credits are different from deductions in that they are a dollar-for-dollar reduction on your tax bill, while deductions simply lower your taxable income.

Thus, while the standard deduction of $24,000 will lower your taxable income by that much, a $2,000 child tax credit will lower your actual tax bill by that amount.

This means that your tax bill will be lowered by $2,000 for every qualified child, which could significantly help families.

The new $500 non-child dependents credit will also help families who care for a disabled or elderly relative.

Changes to Itemized Deductions

The new tax law also brings changes to many itemized deductions. While not an exhaustive list, the main changes are listed below:

  • The interest deduction for mortgages is limited to mortgage debt up to $750,000, which is down from $1 million. This cap applies to loans established after 12/15/17, whereas those established prior will still be capped at $1 million.
  • The charitable contribution deduction has been increased so that taxpayers can deduct donations of as much as 60% of their income.
  • The threshold for the medical expenses deduction has been reduced to 7.5% of your adjusted gross income.
  • The state and local taxes (SALT) deduction has been limited to $10,000, including income, sales, and property taxes.

Additionally, the following deductions have been eliminated:

  • Interest on home equity loans.
  • Casualty and theft losses (except when attributed to a federally declared disaster)
  • Tax preparation expenses
  • Moving expenses
  • Unreimbursed employee expenses

What Does This Mean For You?

As with most of these categories, it depends.

The extent to which these changes benefit you or not will depend on the amount of expenses you have in each deduction category. Most will see no major difference unless you spent a lot in the categories that were eliminated or have expenses that exceed the new caps and limits.

Contribution Limits for Retirement Plans

Another change that will benefit taxpayers is an increase in contribution limits to retirement plans such as 401(k) and 403(b). Employees who participate can now contribute up to $18,500 a year, which is a $500 increase from the limit for 2017.

What Does This Mean For You?

If you’re saving for retirement with an employer-sponsored retirement account (and you should be), you can up your contribution an extra $500 a year. While that may not seem like a lot, over time that $500 will add up when you include the compound interest it will help generate.

Moral of the Story

It’s been 30 years since congress passed any major tax reform, and thus it’s likely that your 2018 tax returns could also see major changes.

Remember that your tax rate is determined by your taxable income and filing status, and that your income is taxed in a graduating fashion. The higher your income, the more income that will be taxed at a higher rate.

While not an exhaustive list, the major tax changes affecting taxpayers this year are a change in tax rates and brackets, an increase in the standard deduction, and the elimination of the personal exemption. Other changes that might affect you are an increase in the child tax credit and the addition of a non-child dependent credit, as well as changes to itemized deductions and an increase in contribution limits for retirement accounts.

Although most will likely benefit from the increase in standardized deductions, it’s important to note that those that will benefit most from these changes are the highest income earners.

Love it or hate it, you’d do well to learn the changes to the new tax law and how you might benefit, at least until it expires in 2025.

Talk about Money Saved.

 

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