Two of the changes brought about by the new Tax Cuts and Jobs Act are the increase in the size of the standard deduction and the elimination of the personal exemption.
How do these two changes work, and do they offset each other? Will the change in the law benefit you?
First. let's get some clarity about these terms and what they mean. A personal exemption is the amount by which is excluded your income for each taxpayer in your household and most dependents. Exempted income is simply not considered a part of your income. In 2017, the amount of the personal exemption was $4,050 per person. If you and your spouse have two dependent children, that means that the amount of your income would be reduced by $16,200. The personal exemption has been eliminated for tax year 2018, and through tax year 2025.
That sounds like bad news for taxpayers, but there is good news, too: the standard deduction is nearly doubling in tax year 2018. The standard deduction is the amount that you get to subtract from your taxable income. In other words, the amount of your deduction is initially included in your income. Then you are able to deduct the amount from their gross income before income tax rates are applied.
For tax year 2018, the standard amount of the standard deduction increases to $12,000 for individuals or married people filing separately, $24,000 for married couples filing jointly and surviving spouses, and $18,000 for heads of household. There is also an additional standard deduction for the aged or blind; this deduction is $1,300. Individuals who can be claimed as a dependent by another taxpayer may claim a deduction which does not exceed $1,050 or the total of that person's earned income plus $350, whichever amount is greater.
This is quite an increase from 2017 standard deduction amounts. For that tax year, the standard deduction was In 2017, the standard deduction for single or married filing separately was $6,350. For heads of household, the deduction amount was $9,350, and for married couples filing jointly it was $12,700.
One benefit of the increased standard deduction for taxpayers is that it is likely to simplify their tax filing without costing them money. Itemizing deductions means determining what actions you have taken that will allow you to claim a deduction on your taxes, and for how much—like adding up all of your donations to charity over the year and then subtracting that amount from your income. There are dozens of deductions that you could itemize, making tax preparation complex; this is why most people choose to itemize only if the total of their itemized deductions would exceed their standard deduction. In fact, fewer than half of Americans itemized in 2016.
With the increase in the standard deduction, those people who previously itemized because doing so reduced their taxable income more than taking the standard deduction may change their approach. Let's say you are married and your household's taxable income is $100,000. You were able to itemize deductions of $15,000 in 2017, Because this was greater than the $12,700 standard deduction available that year, it made sense for you to itemize and reduce the amount of your taxable income by another $2,300.
In the same situation in 2018, the standard deduction will be $24,000. That means if you are able to itemize deductions of $15,000, it still makes more sense for you to take the standard deduction, because doing so will reduce your taxable income by $9,000 more than itemizing deductions.
Of course, some of the benefit of the increased standard deduction is blunted by the loss of the personal exemption. Imagine that all the money on which you pay taxes goes in a big metal pot. In 2018, by virtue of the increased standard deduction, you may be able to pull more money out of the pot before tax is assessed. But when you had the exemption, you wouldn't have had to put as much money in the pot to begin with. Remember, too, that you could claim an exemption for each child, but your standard deduction does not increase with each child you have.
Your next door neighbor, a single mom with two kids, might be even worse off. She might be able to claim the head of household standard deduction, but she can no longer shield from taxes the amount of income that used to be covered by exemptions for herself and her two children.
There are mitigating features to the new tax bill, called the Tax Cuts and Jobs Act (TCJA), such as an increase to the Child Tax Credit. Exemptions and deductions are not the only relevant considerations. Still, so much has changed this year that it would be a good investment to consult with an experienced tax planner in 2018 to make sure you are able to get the maximum benefit from the TCJA.
If you are concerned about how the new tax law might affect you, we invite you to contact our office so that we can help you to get on the right track as early as possible.
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