Last year’s Tax Cuts and Jobs Act (TCJA) outlined the most significant set of changes to the U.S. tax code in several decades. Here's a rundown of the key changes that could affect you this tax season.
Marginal tax rates reduced
Among TCJA’s headline adjustments is a general lowering of marginal tax rates. Five of the seven income tax brackets experienced an average of a 2 percent rate reduction. The top rate will fall from 39.6% to 37%. The bottom rate remains at 10%, but it covers twice the amount of income compared to the previous brackets.
Additionally, the IRS recently announced the updated inflation-adjusted 2019 tax brackets, which will be used on the tax return you'll file in 2020 for income you'll earn during the 2019 calendar year.
Higher standard deduction
TCJA nearly doubled the standard deduction for all filing statuses. Taxpayers can choose to apply the standard deduction or itemize deductions. Itemizing deductions requires totaling all individual tax deductions to which you're entitled and then subtracting them from your adjusted gross income.
Personal exemptions eliminated
A personal exemption is a certain amount of income Americans can exclude from their taxable income each year. Prior to TCJA, taxpayers could claim an unlimited number of personal exemptions for themselves, their spouse and each dependent. Taxes filed for the year 2017 allowed a $4,100 deduction per personal exemption.
In an attempt to simplify tax code, personal exemptions were essentially rolled into a higher standard deduction. While some taxpayers may benefit from the doubled standard deduction, others, particularly large families (who previously claimed a number of personal exemptions and effectively lowered their taxable income), may not reap the same reward.
Child Tax Credit doubled
The silver lining for large families is found in the doubled Child Tax Credit - now $2,000 per qualifying child under 17. Even better, up to $1,400 of the two grand is refundable -- meaning taxpayers can receive a refund even when their tax liability is zero.
Briefly, it's important to mention that a tax credit is very different from a deduction. Deductions lower your taxable income; credits reduce the amount of tax you owe. If you owe $1,000, a $1,000 credit would bring the balance to zero. A $1,000 deduction would reduce your taxable income by that amount. In other words, dollar for dollar, credits are far more valuable than deductions.
Education tax breaks remain unchanged
Popular education tax credits, the American Opportunity Credit and the Lifetime Learning Credit, remain the same under TCJA provisions.
529 savings plans were expanded to allow use of the funds for qualifying educational expenses at any level, not just for college.
Mortgage interest still is deductible, but...
Often a key motivator of home purchase decisions, the mortgage interest deduction, survived tax reform, albeit two major modifications:
- Mortgage interest deductions are now limited to a combined $750,000 of debt for both primary residences and second homes for any loans taken out after Dec. 14, 2017. Current homeowners with loans made before that date, however, are grandfathered into the previous deduction, which allowed a combined debt limit up to $1 million.
- The previous additional limit that allowed taxpayers to deduct interest on as much as $100,000 of home equity debt has been eliminated. To be clear, interest on a home equity loan (such as a HELOC) may still be used as a deduction, but if and only if the loan was used to substantially improve your home. In this case, it becomes qualified residence debt and is counted as part of your $750,000 cap.
Remaining policy changes include a reduced medical expense deduction, elimination of Obamacare penalties (beginning tax year 2019), big changes to the alternative minimum tax, the elimination of several significant tax breaks, and more. Visit irs.gov/tax-reform for complete and up to date information on how TCJA may affect you.
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