Hypothetical 1040, page 2 - the primitive red line is the author's poor mouse handling abilities.
Another tax season come and gone. Now, finally, us CPA’s get to digest and discuss the various components of the new tax law that affects 2018.
I want to start with dependents and the increased standard deduction. It impacts just about everybody who pays taxes.
Under Old Law - If you’re looking at your 2017 form 1040, you want to look at page 2, line 42.
Along with your standard or itemized deductions, there is a concept known as an exemption. In 2017, an exemption was worth $4,050, and it was given for virtually every single person in the country. A single person got 1 exemption. A married couple had 2 exemptions. A married couple with 2 children had 4 exemptions, because of their 2 dependent children. There was only one exemption to go around per person, so there were various rules in place for allowing others to claim your exemption. My 3 year old had an exemption, but under the rules, she was my dependent, therefore I was able to use her exemption on my joint return with my wife. I “claimed my daughter” as the parlance goes. I reduced my income by $4,050 x 3 (me, my wife, my daughter), or $12,150. A nice break for expanding families.
There were various rules on who could claim the exemption. Parents had to stop claiming their kids when they turned 18, unless they were still in college, in which case we could go up to the age of 24. After that, the child starts claiming “themselves” on their own returns.
There were phaseouts so that those with high-income didn’t get as much benefit for these deductions. Sometimes, the parents wouldn’t get any benefit for this deduction due to the AMT, even if their income was low enough to still allow it for regular purposes.
There were other rules that allowed the ability to claim elderly parents or other family members, usually subject to an income and support test.
Under New Law - The exemption goes away completely.
There will be no reduction of $4,050 per person that is used to reduce your taxable income. This is a pretty big shock to a lot of people. So let’s explain who this impacts (virtually everybody)
1. It probably won’t hurt parents of children who are aged 16 or younger. There is a newly expanded child tax credit that a lot more parents will be eligible for. The value of this new credit almost always will make up for the loss of the exemption. I'll put up another post about the new rules to the child tax credit and its limitations.
2. It will “hurt” parents who have more than 1 child over the age of 16, comparatively. However, the “pain” that we’re talking about it all relative. They’ve changed so many other things in the tax law that you may end up paying less tax anyway due to a variety of other factors. There may be other changes that still cut your taxes.
3. If you have no kids, and generally took a standard deduction, this should have little/no impact on you. The nearly doubled standard deduction should work out in most cases.
4. It “hurts” folks who are supporting elderly parents or other family. There is no equivalent of a child tax credit to make up for this.
I know many are asking why Congress would pass this. Why is this a good thing? It reduces complexity for a lot of parents with children who are entering the workforce. There are going to be fewer efile rejections about the proper coordination of when a child should or should not have claimed themselves (usually they should not have). It reduces the complexity of coordinating benefits in the case of unmarried or divorced parents, and the remaining benefits available (child tax credit, head of household status, college write-offs) have clearer tests that determine when the taxpayer is eligible. It makes tax administration a little easier in this area.
Meanwhile, don’t panic that your taxes are going up just yet - tax rates went down, brackets expanded, eligibility for other benefits became more generous - you may still see a net decrease. But there are definitely winners and losers in the new tax reform, and how much is the big question for everybody.
If you need to know how tax reform affects you for 2018, be sure to call us and let us help you understand your return.