Tax Cuts & Jobs Act Impacts on Personal Finance Classes
Whether students like the tax reform law or not, the fact remains that we all have a new tax code for the next decade. The following are the tax law changes in effect beginning January 1, 2018 for taxes to be filed by April 15, 2019.
The tax reform law which was recently enacted will change significant portions of tax-related content presented on Personal Finance, Money Management, and Financial Planning classes. The following are the impacts of the tax code on course content.
Reference Text: Personal Finance – Kapoor – McGraw-Hill
Updates are laid out according to the content presented in the tax chapter (chapter 4) of the 12th edition of Kapoor’s Personal Finance book published by McGraw-Hill. Changes to end-of-chapter assignments are also presented. If your college does not use the Kapoor text, these updates will still apply to your course. While the exact page numbers and details may change, the tax changes will have the same effect on the content of any other Personal Financial Planning, Money Management, or Personal Finance textbook.
Key Term Changes
Exemption – PG 116
The new tax law eliminates exemptions from the tax code. While the definition of an exemption has not changed, the concept of the personal exemption is not applicable under the current tax law.
Itemized Deductions – PG 114
While the definition of an itemized deduction does not change, the new tax law eliminates most itemized deductions, including many outlined in the book.
Changes to content are presented in the order the content appears in the book. Students may also use this information for study purposes.
Estate & Gift Tax – PG 111
The gift tax exclusion has increased to $15,000 in 2018. Estate taxes are discussed in this chapter, but the exclusion amounts are not presented until Chapter 19. The details of the changes are listed below in the section titled “Impacts on Other Chapters.”
Income – PG 113
Alimony is no longer taxable as income for the recipient, and no longer deductible for the payor.
STANDARD DEDUCTION – PG 114
- $24,000 – Married filing jointly and surviving spouses (nearly doubled)
- $12,000 – Unmarried individuals and married filing separately (nearly doubled)
- $18,000 – Head of household (nearly doubled)
The standard deduction got a huge boost, which will have a positive impact for taxpayers who don't itemize deductions. The standard deduction is an amount every taxpayer is allowed take as a deduction from their income to reduce their taxable income.
The standard deduction is used by individuals and families who do not itemize or who have itemized deductions less than or near the standard deduction. The purpose of the boost was to eliminate the need for itemizing deductions, by making the standard deduction larger than itemized deductions for all but high-income taxpayers.
ITEMIZED DEDUCTIONS – PG 114-115
- $10,000 - Cumulative Cap for Deductions of State Taxes (new)
- $750,000 - Maximum Loan Amount for which Mortgage Interest can be Deducted (down from $1,000,000)
- 7.5% - Income Threshold for Deducting Medical Expenses (down from 10%)
Itemized Deductions have largely been removed in the new IRS code, which will also help to push more taxpayers to take the standard deduction. Most Schedule A deductions have been removed, including many listed in the chapter.
Eliminated itemized deductions listed in the chapter are:
- Home Equity Loan Interest
- Casualty losses not resulting from a federally declared disaster
- Moving expenses
- Deduction is still allowed for members of the armed forces under specific circumstances
- Job related and other miscellaneous expenses
The charitable deduction has stayed in place, and the limitations related to income have been relaxed. Under the new law, a tax deduction up to 60% of AGI is allowed for cash contributions to qualified charities. Lower limitations still apply depending on the circumstances of the contribution and the charity.
The deduction for Medical Expenses has been expanded, making it easier for families who suffer a major medical catastrophe to get tax relief. In 2016, you could only deduct medical expenses which were greater than 10% of your AGI. For 2017 and 2018 taxes, you can deduct medical expenses once they are greater than 7.5% of your AGI. While this might not seem like a bit deal, a family earning $80,000 a year with $10,000 in medical expenses would see their tax deduction double from $2,000 to $4,000. Unless altered, the threshold will return to 10% in 2019 and beyond.
Mortgage Interest also remains deductible, although the amount you can deduct for a first mortgage has decreased. Interest on Home Equity Loans is no longer deductible, unless the funds were used specifically for capital improvements on the home (repairs don't count). Loans in place prior to the enactment of the law (December 2017) are grandfathered in and the interest will still be deductible.
Prior to the Tax Cuts and Jobs Act, interest on a million dollar mortgage could be deducted. Now, however, you can only deduct interest on the first $750,000 of your mortgage. For the average household, this won't make a bit of difference. But for higher income and higher net worth households, they will see a pretty significant haircut on their Mortgage Interest deduction. Assume you have a mortgage balance of a million dollars at a 4% interest rate. Your tax deduction would drop from about $40,000 to $30,000.
State and Local Taxes
State and local taxes paid are still deductible, but only up to $10,000. The cap is cumulative, meaning if you have $5,000 in property taxes, you could only deduct another $5,000 in state income taxes. For most taxpayers, this will have little impact on their taxes as state taxes are often below the $10,000 threshold. If you live in a high-tax state, such as New York or California, or if you are a higher-income household, the cap could impact you significantly.
EXEMPTION – Pg 116
- $0 – Personal Exemption (eliminated)
- Compensated by a boost to the Child Tax Credit
The Personal Exemption was repealed with the new tax law, which offsets some of the benefit of the boosted Standard Deduction. Taxpayers without children will only see a two to three thousand dollar boost in the deduction they would have otherwise received. Taxpayers with children, however, will receive a big bonus through the Child Tax Credit.
For example, a married couple under the old law would have received a $13,000 Standard Deduction plus two $4,150 Personal Exemptions for a total reduction of taxable income of $21,300. Now the married couple will receive just a Standard Deduction of $24,000. Still an improvement, but not quite the doubling touted by those in favor of the reform.
INCOME TAX BRACKETS (Tax Rates) – PG 117
The most important update for many Americans are the changes to the income ranges for the marginal tax rates as well as changes in most of the marginal rates themselves.
The image shows the 2018 tax brackets which you will use to calculate your taxes to be filed in 2019. Every tax bracket got a little bump up in size, allowing more of your money to be taxed at lower rates.
Understanding the tax brackets will help you to estimate your potential tax liability next year. Armed with your estimated taxes, you then have until December 2018 to make charitable contributions, invest for retirement, or do other things which can help manage and lower your tax liability.
Also included in the table is the actual income taxes a student will owe based on their income level. The table provides the two most common filing statuses: Married Filing Jointly, and Single Individuals.
Tax Credits – PG 118-120
Tax credits outlined in the book remained largely unaltered. The Child Tax Credit, however, has been expanded dramatically. Now, most families will be able to claim the Child Tax Credit, and since it offsets the loss of exemptions, the Child Tax Credit is important to include in a discussion of personal taxes.
CHILD TAX CREDIT
- $2,000 - Child Tax Credit (doubled)
- $1,400 - Refundable Portion (new)
- $400,000 - Income Level Phase Out (significant increase)
- $200,000 - Single Filer Phase Out
For families with children, one of the biggest benefits of the 2017 tax reform bill is the huge boost to the Child Tax Credit. Tax credits are more valuable to taxpayers because they reduce your taxes dollar-for-dollar, while tax deductions reduce it only by your marginal tax rate. As a result, all but high-income families will receive a full $2,000 tax break for each child they have.
Additionally, $1,400 of the tax credit is now refundable, meaning low-income families can receive a $1,400 refund of taxes they never paid for each child in the home. This provision effectively provides an additional $1,400 in federal welfare aid per child to poor families.
Tax Planning Strategies – PG 134-139
The tax law impacted numerous tax planning strategies explained in the book. Students should be encouraged to seek the advice of an accountant or a financial planner before implementing any textbook strategies. Specific strategies which were altered are outlined below.
Exhibit 4-10 – PG 135
For divorced parents, alimony is no longer tax deductible by the payer and does not need to be included as income by the recipient. Exemptions are no longer relevant, but custody rules still impact the claiming of the Child Tax Credit.
Place of Residence – PG 135
The tax advantages of owning a home have been reduced due to the increase in the Standard Deduction. Under the old law, owning a home usually increased a person’s itemized deductions above the standard deduction based on the mortgage interest and taxes alone. With the new law, the Standard Deduction will likely be well above deductible home-ownership costs. The increased Standard Deduction and $10,000 deduction limitation on state and local taxes will mean most homeowners will benefit more from taking the Standard Deduction. A taxpayer who doesn't itemize in effect loses the benefits of home ownership.
Consumer Debt – PG 135
This strategy is no longer valid for claiming tax-deductible interest. Home equity loan, or second mortgage, interest is no longer deductible on the tax return unless the money went to improving the home. Even if the credit card debt you paid off was incurred because of home improvements, you will not be able to deduct the interest on the home equity loan.
Job-Related Expenses – PG 135
This strategy is no longer valid due to the elimination of job-related expense deductions.
Self-Employment – PG 137
This strategy is much more desirable under the new tax code, due to the ability to deduct 20% of your self-employed income. The deduction comes off of taxable income, it doesn’t reduce AGI. So the deduction will not help a taxpayer qualify for any tax credits, other deductions, or other tax benefits which are limited by AGI.
The value of this deduction, however, is not as great as many pundits have argued. There are significant limitations on the use of the deduction to prevent abuse of the provision. Creating a “fake” business just to transition your job into self-employment will likely result in your losing the deduction.
The strategy to turn your job into a business won’t work for many. Service trade or businesses are not allowed to get the deduction if they earn more than $207,500 as an individual taxpayer or $415,000 as a married taxpayer. Businesses in health, law, consulting, performing artist, athletics, financial services, brokerage services or any business that depends on the reputation of the owner or owners are subject to these income limitations. There are also limitations which eliminate the deduction based on the size of the company regardless of the industry.
Additionally, the self-employment tax will eliminate much of the benefit of the tax deduction. Self-employment taxes are the employer-side Social Security taxes which would now be paid by the self-employed individual. Losses of vacation time, healthcare, and other benefits should also be considered.
Children’s Investments/Kiddie Tax – PG 337
This strategy was made even less desirable under the new tax law as a result of a beefed-up Kiddie Tax. Children with income above the $2,100 threshold will now pay taxes at the trust tax rates, which reach the top tax brackets at extremely low income levels. In 2017, trusts hit the top tax bracket at $12,500. This rule is an expansion of the Kiddie-tax rule which was enacted to stop wealthy taxpayers from avoiding taxes by passing income-producing assets to their children.
Coverdell & 529 Plan – PG 138
No changes were made to Coverdell plans, but the changes to the 529 Plans have made Coverdells less appealing. Up to $10,000 of 529 plan money per beneficiary (not account) may now be used for elementary and secondary school expenses. The money may be used for home school expenses including curriculum, books or other instruction materials, online education, and tuition for tutoring fees if paid to an unrelated party. The money can also be used to pay for dual enrollment with a college or be used for educational therapies if the student has disabilities.
401(k) Plan – PG 138
The 2018 employee contribution limit for 401(k) plans has increased to $18,500 and to $24,500 for earners over age 50. This also impacts information presented in the retirement chapter, chapter 18 on page 608.
Changes to End-of-Chapter Assignments
Financial Planning Problems
The changes to the tax brackets and tax rates will impact the answers to most of these questions. Below, however, are specific tax law changes which will impact the correct answer.
1 – The person would no longer benefit from itemizing deductions and would instead take the Standard Deduction.
2 – Job-related expenses is no longer tax deductible
3 – For 2017 and 2018, the calculation would use the 7.5% medical deduction threshold. For 2019 and beyond, the threshold is returned to 10%.
6 – Personal Excemptions are no longer in the tax code so that amount is gone. We can assume they have one child based on the exemption amount given, meaning they would qualify for a $2,000 Child Tax Credit.
12 – The penalty for not having health insurance is now set to $0 for all persons
Financial Planning Case
The exemptions are no longer available, and the head of household standard deduction is $18,000. We can also assume $4,000 in child tax credits based on three exemptions and filing status
Changes Impacting Other Chapters
Healthcare – Chapter 11, PG 377
The law still requires every individual to have healthcare, but the penalty for not having a health insurance policy has now been set to $0 (zero dollars).
Estate & Gift Taxes – Chapter 19, PG 650-652
The gift tax exclusion has increased in 2018 to $15,000 per person, $30,000 for a married couple. The estate tax exemption has nearly doubled to $11,200,000. For married couples, the exclusion is $22,400,000 with portability.
The estate tax exemption has doubled under the new tax law, making estate planning for tax purposes unnecessary for all but the ultra-high net worth taxpayer. Students will still need estate planning for other purposes, however, including caring for minor children, passing assets to whom they wish, charitable giving, medical planning, and much more.
About the author
Joshua Escalante Troesh is a tenured professor at El Camino College teaching business courses including Personal Finance. He is also the founder of Purposeful Finance. Currently, he is pursuing the CFP designation, completing the additional education requirements at UCLA.
His professional background includes having been a Vice President of Marketing & Business Development for a credit union leading up to the 2008 mortgage/financial crisis and the Director of Marketing for a technology and internet stock research firm leading up to the tech bust in 2000.
About Purposeful Finance
Purposeful Finance is a financial literacy and education organization which provides free and low-cost resources to the public. Purposeful Finance articles are also distributed through Apple News. We are currently pursuing non-profit status with the IRS.
Purposeful Finance also offers a free financial challenge to help individuals and families develop and update their financial plans yearly. Each week participants will receive a simple action item to take to improve their financial situation. Visit our financial challenge page for more information or to take the challenge yourself.