In late December 2017, Congress passed the Tax Cuts and Jobs Act, which enacted the most sweeping overhaul of the U.S. tax code in more than 30 years. The law made numerous changes to how individuals and corporations are taxed in the United States starting in 2018.
To help you understand the new law, we outline some of the most significant changes that went into effect on January 1, 2018. We also explain how some of these changes could affect your retirement planning and investment strategy.
CHANGES FOR INDIVIDUALS
Let’s start by examining some of the key provisions of the law that apply to individual tax payers:
Lower tax rates and changed income ranges
The new tax law retains the seven tax brackets found in the previous law, but lowers several of the tax rates and changes the income thresholds at which the rates apply.
Higher standard deduction
The standard deduction—a fixed amount that can be subtracted from adjusted gross income to lower taxable income—was virtually doubled, from $12,700 to $24,000 for married couples and from $6,350 to $12,000 for individuals.
New limits for state, local tax deductions
Under the old tax laws, all property taxes paid to state and local governments could be claimed as an itemized deduction, assuming you didn’t pay the alternative minimum tax (AMT). It was also possible to deduct state and local income or sales taxes. The new law bundles all these so-called “SALT” taxes together and limits the deduction, in total, to $10,000 for both individuals and married couples.
Higher child tax credit
The new tax laws will double the child tax credit to $2,000 per dependent child under age 17, with a refundable portion of $1,400. The refundable portion allows families to lower their tax bills to zero and receive a refund for the remaining value.
Elimination of personal exemption
The $4,050 individual personal exemption will be eliminated—at least temporarily. (It’s scheduled to return in 2026.) Previously, taxpayers who earn below certain income caps could subtract this fixed dollar amount from their adjusted gross incomes to lower their taxable incomes.
Higher estate tax exemption
Previously, the first $5.6 million of each individual’s estate was exempt from federal taxation. This exemption has been raised to $11.2 million (or $22.4 million per couple).
Cap on mortgage interest deductions for high-end homes
For homes bought from January 1, 2018, through December 31, 2025, the new law caps the deduction for mortgage interest at $750,000 in home loan value. After December 31, 2025, the cap reverts to $1 million in loan value.
Limit on deductibility of home equity loans
The new law eliminates the deductibility of interest on home-equity loans, but major exceptions are allowed, including loans taken out to remodel a home or build an addition.
Higher exemptions for AMT
The exemptions and phase-outs have increased for the alternative minimum tax (AMT), which means fewer people will have to pay this tax, while those who still do will take a smaller hit from it.
Tax deduction for “pass-through” businesses
If you run a small business and don’t pay taxes at the corporate tax rate, your net income flows directly (or “passes through”) to your personal income and is typically taxed at your personal tax rate. Under the new tax laws, income from pass-through businesses—such as a sole proprietorship or an S corporation—will now be taxed at your individual tax rate minus a deduction of up to 20%, though the deduction is subject to limits and restrictions.
Expansion of eligibility for 529 plans
The new tax law expands the reach of tax-advantaged 529 plans to include secondary and elementary schools.
Changes for Businesses
In addition to making the changes described above for individual taxpayers, the law also includes several provisions that affect businesses directly and their shareholders indirectly. The most significant of these changes is the reduction of the corporate tax rate from 35% to 21%. Other significant changes include new limits on deductions for interest expenses, a new system for taxing foreign profits of U.S.-based companies, and a lower one-time tax on repatriated income (i.e., income held overseas and brought back to the United States).
How will new laws affect you?
As you went through the list above, you probably got at least a general sense of which elements of the new law will affect you positively, which changes may affect you negatively, and which ones won’t affect you at all. When thinking about what the changes could mean for your investing strategy and overall financial planning as you prepare for retirement, here are a few points to keep in mind:
* Greater investable income – If your take-home pay does increase as a result of the new tax law, you’ll have more money available to invest for your future.
* Possible increase in dividends – Corporate earnings should be helped by the lower tax rates; this could be a tailwind to equity markets. Plus, companies that pay dividends may be more likely to increase their payouts to investors. Much of these anticipated benefits, however, may already be “priced in” to stock prices.
* No significant changes in taxes on capital gains, dividends – The tax brackets for capital gains—such as those realized when you sell stocks—and dividends will remain the same. This means that individuals in the higher marginal income tax brackets will continue to pay 15% to 20% on capital gains and qualified dividends, while taxpayers in the lower brackets generally pay nothing. Also, the 3.8% surtax on high-income tax payers’ net investment income tax was retained.
* Lower tax incentives for charitable gifts – In previous years, your charitable donations might have earned you a tax deduction, but the new tax law, which includes a much higher standard deduction, may keep you from itemizing. But if you’re 70 ½ years old or older, you could move the required withdrawals from your traditional IRA and your 401(k) directly to a qualified charitable group; since the money won’t count as part of your adjusted gross income, you will, in effect, get a sizable tax break for your generosity.
Tax laws shouldn’t drive your investment strategy
These tax changes are the most far-reaching we’ve seen in decades, so you’ll want to consult with your tax advisor about how the new law affects your specific situation. Regardless of the tax environment, though, your investment strategy should be based on your risk tolerance, time horizon, and long-term goals. Ultimately, it’s the moves you make—not those coming from Washington—that can determine your investment success. The Retirement Network is here to help you create an investment strategy that is tailored to your goals.