How the New Tax Law Affects Your 2018 Tax Planning

Congress has passed, and President Trump has signed into law, a new tax law called the Tax Cuts and Jobs Act of 2017, which took effect on Jan. 1, 2018.

This new tax law includes the most significant changes to the U.S. tax system in 30 years and, although it was partially intended to help simplify the tax code, the short-term effects of the new tax law might be a bit complicated or confusing for many taxpayers.

If you are trying to understand the new rules, limits and effects of this tax law on your personal tax planning strategies, read on for some key insights about what this new tax law means for you — and start making some moves now during 2018 to save more money for retirement and save more on your taxes.

Here are some of the biggest implications of the new tax law:

Lower tax rates

The new tax law is keeping the current system of seven tax brackets, but most of the tax brackets now have lower rates. Which bracket you are in and which marginal tax rate you will pay depend on how much income you earn; the income limits are shifting slightly for each tax bracket. According to analysis from the Tax Foundation, here is how the new 2018 tax brackets compare with the previous tax law:

Single Filer

Previous Law (2017 taxes)                                                        Tax Cuts and Jobs Act (2018 taxes)

Married Filing Jointly

Previous Law (2017 taxes)                                                        Tax Cuts and Jobs Act (2018 taxes)

So if you are a married couple filing jointly with income of $100,000, under the previous law (for your 2017 taxes) you would have been in the 25% tax bracket. Under the new law, for 2018 taxes, you are now in the 22% tax bracket — that's an immediate 3% tax cut off of any income you earn over $77,400. Of course, there are many other factors that make up your final tax bill, but many people will see a top-line tax rate reduction.

Bigger standard deduction

The standard deduction is nearly doubling, from $6,500 for singles/$13,000 for couples to $12,000 for singles/$24,000 for couples. Along with that, the personal exemption (as of 2017, $4,050 for singles and $8,100 for married filing jointly) is being eliminated. For most middle-class taxpayers, this is likely the most immediately consequential change to the tax code in terms of “simplicity."

If you have itemized your deductions in previous tax years (deducting all of the various items like mortgage interest, student loan interest, charitable donations, etc.), in 2018 it may no longer make sense for you to itemize — you may be better off just taking the standard deduction instead.

Limit of $10,000 on state and local tax deductions

Although taxpayers are getting a bigger standard deduction, they are also going to have a lower limit ($10,000 total — for single or married filers) on the amount of state and local taxes (including property taxes) that they can deduct from their federal taxable income. This new limit on the state and local tax (SALT) deduction is most likely to affect people who live in high-tax states where property taxes are high. Depending on where you live and how much income you earn, you might end up owing more federal income tax under this new plan (because you can claim only $10,000 for your SALT deduction).

According to an analysis in Forbes, “Only a handful of middle-income households will pay higher taxes as a result of the new SALT cap, averaging about $800…However, residents of high-tax states, such as New York, California, and New Jersey, generally would face the biggest tax increases from the SALT limit."

For example, according to analysis from CNN Money, a single homeowner in New York City with an income of $500,000 would owe approximately $6,470 more in federal taxes, because of losing $60,000 worth of SALT deductions, while a single parent (head of household) in Kansas City, Missouri, with two children and an income of $45,000, would see an estimated federal income tax cut of $1,802.

Bigger child tax credit

The tax credit is doubling — $2,000 per child, up from $1,000 per child. And higher income upper-middle-class families will now be able to receive the full child tax credit, because the income-based phase-out of this tax credit has also been raised, to $200,000 for singles and $400,000 for couples (formerly, the child tax credit started to phase out for parents who earned $75,000 or more (singles) and $110,000 (couples). This is welcome news for any parents who have children. The new tax law also provides a larger refundable portion of this credit, which will help lower-income families.

New 20% deduction for small business owners

If you are self-employed or a small business owner, and you do business as a “pass-through entity" (that is, an LLC, S corporation, partnership or sole proprietorship), the new tax law gives you a new 20% deduction on your business income — although this deduction phases out for people in professional services industries who have income more than $315,000 for couples and $157,500 for singles.

According to analysis from The New York Times, “More than 70 percent of small-business employers had adjusted gross income below $200,000, so many of them would be eligible for the full 20 percent deduction for pass-through income."

More money in your paycheck

Employers are supposed to start adjusting payroll withholdings to fit the new tax brackets as soon as possible in 2018.   The IRS's new withholding guidance was released on Jan. 11, 2018 and is required to be implemented by no later than Feb. 15, 2018.

You may need to update your form W-4 to adjust your number of allowances, especially if you recently got married, got promoted, started a new job or had a new child — check out this W-4 guide from Forbes for more details. If you are expecting to owe less tax for 2018, you might want to increase your allowances so less money will be withheld for income taxes (increasing your take-home pay).

But beware — if you end up owing more federal income tax than expected for 2018, choosing more allowances on your W-4 might not leave enough income tax withheld from your paychecks to cover your tax bill, which will require you to send a bigger check to the IRS at tax time.

Save more for retirement

Speaking of extra money in your paycheck, one immediate move you can make in 2018 is to use your tax savings to save more for retirement.

According to this article from Forbes, “Given how challenging it is for most middle-class families to fully fund their own retirement, it may be wise to save all of your extra cash before it hits your checking account. You can direct it to your 401(k) or other pre-tax retirement account — which could result in even more tax savings — or to an investment account."

As the Forbes analysis continues, "…a single taxpayer earning $125,000 will save about 3.3% in taxes — which equates to $4,062 per year or $338 per month. At first, $338 per month may not seem like a lot, but for example, a 35-year-old who invests this amount for the next 8 years (until the cuts expire), at a hypothetical compound 6% rate of return until reaching age 67, will see this grow to over $170,000!"

Some people (especially lower income earners) will be largely unaffected by the new tax law, and some people (higher earners in high-tax states like New York and California) may end up owing more money in federal income tax than they did before — but many middle-class and upper-middle-class people will be getting more money in their paychecks as a result of this new tax law. Whether you choose to save or spend it is up to you, but one smart move would be to use that extra money to save for retirement.

Ben Gran is a freelance writer based in Des Moines, Iowa. He writes about personal finance, financial services, technology and business.

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