One of the biggest stories of 2017 was the sweeping changes to United States federal tax laws. However, much of the mainstream coverage of the law was confusing and conceptual. So using my own tax return as an example, I will illustrate how the new rules may affect an average American family.
I have recalculated my family’s 2016 taxes under the new rules. We are a family of four and our income places us in the middle of the middle class, so while this may not be a perfect exercise, it may give you a sense of what to expect next year and also give you some ideas on what questions to ask your tax professional.
I should take this opportunity to mention that in a former life I was a tax accountant. I hold an inactive CPA license in the state of Colorado, and though I moonlight as a freelance writer, I keep busy during the day as the operations manager for a mid-market Denver CPA firm. With that said, keep in mind this article is not intended to be financial or legal advice, and I encourage you to talk to your own CPA—or find one if you don’t have one. Don’t assume your situation will be exactly like mine. And don’t sue me.
The three biggest changes most average families will notice is the elimination of the personal exemptions, the increase to the standard deduction, and the expansion of the child tax credit.
Let’s start with the child tax credit—the game changer in the new law for middle class families is the expansion of this credit. Under the old law, the credit was $1,000 per child under the age of 17. For a married couple filing joint, the credit was reduced (“phased out”) if their adjusted gross income (AGI) was over $110,000. Under the new law, the credit doubles to $2,000 per child under 17, and the new income limit for a married couple filing joint is $400,000. In 2016, we were able to take an $800 child tax credit for our two young children; in 2018, we will take a full $4,000.
A credit is a dollar for dollar reduction in tax, as opposed to a deduction that only reduces taxable income. For a family with an effective tax rate of 15%, a $1,000 credit is equivalent to a $6,600 deduction. The effect the new child tax credit will have on families cannot be easily understated. This is the only change to the tax law that will have a significant positive effect on my family’s total tax liability—reducing it by a whopping 24%. In fact, families with multiple children who qualify for the child tax credit may end up being the only ones benefiting from the new tax law’s provisions for individual taxpayers.
The two other changes are more subtle. The personal exemption was approximately $4,000 per family member in 2017; a family of four would have a $16,000 personal exemption. Though the personal exemption is being eliminated, the standard deduction is doubling—from $12,700 to $24,400 for a married couple filing jointly. The net effect of these two changes results in slightly higher taxable income—a family of four with AGI of $50,000 would have $21,300 of taxable income under the old tax law, and $25,600 under the new law. My family noticed a similar effect. In recalculating our 2016 tax return under the new rules, our total deductions decreased from $34,079 to $24,400, and our taxable income increased almost ten percent.
The obvious caveat here is families who have more than two children and who do not itemize their deductions will likely see their taxable income increase dramatically. A household with two parents and four dependents, for example, will lose $24,000 of personal exemptions while their standard deduction increases by only $12,700. In effect, their taxable income will increase by about $12,000. That’s not chump change for most families. And the larger the family, the greater the increase to taxable income.
Congress did adjust tax rates and tax brackets under the new law, lowering the effective tax rates for virtually all taxpayers. For my family, recalculating our 2016 taxes under the new law resulted in an almost $400 reduction in tax (before the child tax credit). However, families with more than two children may not see any reduction in tax—and may even see their tax increase before the child tax credit is applied.
Despite many Congressmen advertising this law as a “simplification” of the tax code, it creates quite a few complexities that didn’t already exist. Not to mention it’s 500 pages long. While many taxpayers will no longer need to itemize deductions and complete a form Schedule A, certain taxpayers (especially small business owners) will find their tax preparation bill will be larger because their accountant’s job just got much more difficult. If you receive a W-2 and have some mortgage interest, but don’t have much else on your tax return, you may find this new law makes your tax return easier to complete. You may find you can now prepare your own taxes instead of having them done by a CPA or a tax service like H&R Block. The new law is even more impactful for businesses and small business owners—and will likely make their tax returns more complex. It will have the most impact on large businesses, but small businesses may or may not notice any significant change to their tax expense.
Every taxpayer’s situation is different, and the law will affect us all in varying ways and degrees. This only serves as a brief overview of some of the more impactful changes for families, with my family as an anecdotal example. Additionally, I did not analyze how state taxes may be affected—many states base state AGI on the federal number, and since many of us will have a larger AGI, our state taxes will likely increase. Again, I encourage you to speak with a CPA about how the new laws will affect your tax return.
Months after the law’s passage, the accounting industry is still trying to understand some parts of the law and how to apply its provisions. Time will tell if the law helps our economy more than hurts our federal government’s deficit. It is expected to add about $1.5 trillion dollars to the deficit over the next ten years. Historically, the impacts of tax policy on the economy is mixed and complex—tax cuts don’t always spur economic growth, and tax increases don’t always curtail it. But the positive impact on middle class families with children under 17 years old (at least until the law expires in 2026) will be powerful.