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Let’s Talk Turkey: How Much Will Tax Reform Cost Me?

A news story came out in 2013 that a Canadian man named Norman Feller had just emerged from an underground bunker after 14 years. In anticipation of Y2K, and the disaster that would unfold on January 1, 2000, he built a bunker in his backyard. He abandoned his wife because he didn’t want to share the safety of his bunker, and lived a secluded life in his windowless, makeshift home buried in his backyard. Finally, in late 2013 he emerged from the ground due to complete and utter boredom.

He noticed that his home was in the same condition, his car was still in his garage, and the world was still standing. When he was interviewed, he expressed his bewilderment with the world’s advancements such as the smartphone, Joey from “Friends” getting a spinoff show, and Kentucky Fried Chicken’s “Double-Down,” which is a sandwich formed by two pieces of fried chicken instead of bread. (That’s right, we’ve really progressed as a society. We found a way to make a chicken sandwich even more chickeny).

News of Norman Feller’s adventures set the internet on fire. Unfortunately, as much as I wanted this story to be true more than anything in the world, it was discovered months later that this was in fact a hoax. Norman Feller did not live underground for 14 years. And he didn’t abandon his wife so that he wouldn’t have to share his doomsday bunker. But it’s still possible that he was impressed by KFC’s Double-Down sandwich.

What made this ridiculous story so believable by thousands of people was that we remember the hysteria that led up to January 1, 2000. People went into a panic—every computer was supposed to stop working, planes would fall out of the sky, zombies would take over civilization, aliens would land on Earth and become our masters. You name it, people feared it would happen. Many experts warned officials that people would withdraw all of their funds from their bank accounts, would hoard food and gasoline, cause accidental fires with their newly acquired wood stoves and generators, and there would be a “rise in gun violence stemming from the surge in firearm sales to those fearing civil unrest.” In fact, it’s estimated that we spent between $300 billion and $500 billion globally to prepare ourselves for Y2K. And guess what happened when the clock struck midnight? Well, you know the answer because we’re still here. It was a whole lot of hype for nothing.

When the tax reform bill was passed, we New Jersey residents were told to go into a panic. We pay a lot in property taxes and state income taxes, and now we can only deduct a total of $10,000 for both of those combined. We’re completely messed over, right? Well, before you start building that bunker in your backyard, let’s work together here and figure out how these new tax laws will affect you. Is it another Y2K scare or are the zombies really coming for you this time?

My purpose in this article is not to look at the laws on a macro level. I’m not going to discuss how this will affect the nation’s deficit or how this will affect charities now that most people will not be itemizing their deductions. I’m going to discuss what you care about most—how this will directly affect you. How much more (or less) will come out of your pockets when you file those tax returns in April of 2019.

Tax Law Changes

Before we delve into some calculations, we need to understand a few of the major changes that came with tax reform. There are many changes, but the following are the ones that affect most people and they are relevant for this article:

  1. States taxes: As mentioned above, you may only deduct a total of $10,000 for the state income taxes and property taxes you pay. So you may pay $20,000 in property taxes and $20,000 in state income taxes next year, but you may only deduct $10,000 out of that $40,000. This sounds pretty bad. But here’s the all-important question: Have you even been deducting those taxes anyway? Of course you’ve been deducting those taxes, right? We’ve always consoled ourselves with the knowledge that we may be suckered into paying some of the highest property taxes in the nation, but at least we’re getting a tax deduction for it. Well, guess what. A good number of you have been getting zero benefit for all of those taxes you’ve paid. And that’s because you’re subject to the AMT tax, and under the AMT tax calculation there is no deduction for state income taxes and property taxes. So the good news is that the most-feared provisions in tax reform may not even affect you because you haven’t benefited from them anyway. The bad news is you may have just found out you’ve been paying all those taxes for years and getting no tax break for it, which is quite depressing.
  2. AMT: Speaking of AMT, the new laws increase the AMT exemption amounts to $109,400 filing jointly and $70,300 for single taxpayers. In other words, fewer people will be paying AMT taxes and even those that will still pay AMT tax may pay significantly less. Under the current system, the taxpayers that get hit the hardest by AMT tax are the ones that make in the neighborhood of $200,000 to $500,000. Many of these taxpayers will either pay less AMT tax or none at all in the future. If you want to learn more about the AMT tax, you can read Why Does the AMT Tax Happen to Good People? (https://www.jewishlinknj.com/features/9787-why-does-the-amt-tax-happen-to-good-people) where I discussed it in more detail.
  3. Child tax credit: Under the current law you are eligible for up to a $1,000 tax credit for each dependent child under age 17. The problem is that this credit starts phasing out when your joint income reaches $110,000. This prohibited many taxpayers from claiming the child tax credit. The new laws allow for a credit up to $2,000 per dependent child and it does not start phasing out until joint income reaches $400,000. This will not only allow many taxpayers to claim the child tax credit that they haven’t been able to, but at double the amount, no less.
  4. Mortgage interest: I won’t get into this in our calculations below, but I will mention this briefly. Under current law, you can deduct the interest payments on up to $1 million of your debt. Additionally, you can deduct the interest up to $100,000 of your home equity debt. The new laws allow you to deduct the interest payments on up to $750,000 of your debt and no home equity debt. So if you have a mortgage that is $1 million or more, than using the current mortgage interest rates you lose about $10,000 of mortgage interest deductions. This translates to a maximum of $3,700 out-of-pocket cash if you are in the new highest tax bracket of 37 percent.
  5. Personal exemptions and standard deduction: Under the current law you can exclude $4,050 per household member from your taxable income. This tax break begins phasing out at $313,800 of joint income. The new laws do not allow personal exemptions to be claimed at all. Another change is that the standard deduction is $12,700 for married filing joint and $6,350 for single taxpayers under the current system. The new laws increase this to $24,000 and $12,000, respectively.
  6. Tax rates: There are still seven federal income tax brackets, but the rates are a little lower and the income ranges have been adjusted favorably for taxpayers. The highest tax rate decreased from 39.6 percent to 37 percent. Overall, many taxpayers, especially middle- to high-income earners, will be paying taxes at a lower effective tax rate.

So now we know the relevant laws, but that still leaves you wondering how much this really affects you. And as I told you from the start, the goal of this article is for you to get a sense as to how much tax reform will cost you. So I decided the best way to demonstrate this is by using four real-life client scenarios. You will likely find yourself resembling one of my four clients below. If you don’t, simply ask your accountant to run some numbers for you. For the purpose of this article, all four scenarios will be cases of married filing jointly. Please note that the results will differ for each specific taxpayer, especially those subject to AMT tax due to the varying specific factors that go into the AMT calculation. Two taxpayers with the same income may have very different AMT tax results based on their specific circumstances.

Scenario #1

Facts: Income of $150,000, two children, $10,000 property taxes, $10,000 mortgage interest, $2,000 charity

Result: They save $2,300 in taxes under tax reform.

Analysis: While the new laws no longer allow them to claim $16,200 in personal exemptions ($4,050 x 4 people), thus resulting in higher taxable income, the $4,000 in new child tax credits more than make up for this.

Scenario #2

Facts: Income of $300,000, three children, $12,000 property taxes, $12,000 mortgage interest, $6,500 charity

Result: They save $11,900 in taxes under tax reform.

Analysis: This couple represents what may be the ultimate beneficiaries under tax reform. Before tax reform, they were not benefitting from their property taxes and state income taxes anyway because they were subject to AMT tax, so no big loss there. Now they are getting $6,000 in child tax credits. Additionally, they are paying $7,900 in AMT tax under the current system and will pay zero AMT tax under the new laws. This equals huge tax savings.

Scenario #3

Facts: Income of $500,000, three children, $20,000 property taxes, $15,000 mortgage interest, $10,000 charity

Result: They save $12,800 in taxes under tax reform.

Analysis: What’s interesting is that this couple still reaps massive tax savings even though they phased out of the child tax credits. The majority of the savings stems from $8,500 in AMT tax under the current system that they will no longer pay. The rest of it comes from the new lowered tax rates working their magic.

Scenario #4

Facts: Income of $1 million, three children, $50,000 property taxes, $35,000 mortgage interest, $25,000 charity

Result: They lose $5,000 in taxes under tax reform.

Analysis: This couple is not subject to AMT tax because their income was too high, so their regular income tax came out higher than their AMT tax. That means they are losing out on over $40,000 in property tax deductions as well as any state income tax deductions. They also phase out of the child tax credit. Although taxable income is significantly higher under the new laws, once again the new favorable tax rates limit the damage.

There are obviously nuances to every scenario that will change these numbers at least slightly. But for the most part, as you can see above, there will be plenty of winners under the new tax laws. So is the hype on tax reform just another Y2K scare? I guess that depends who you ask. If you are one of the lucky ones saving $11,000 in taxes then I think you would say so. Of course, not everyone will be benefitting from these changes.

My advice is to not panic. Instead, get informed. Speak to your accountant. Run some numbers and see for yourself what the effect is. And if you don’t like what you see then I offer you one more piece of advice: Don’t be like Norman Feller. Make sure you share your doomsday bunker with your loved ones. It’s the right thing to do.

By Daniel Magence, CPA, Esq.

 Daniel Magence, CPA, Esq. is a principal at Pristine CPA Solutions, LLC (www.pristinecpa.com). Pristine CPA Solutions offers tax and accounting services to individuals and businesses of all sizes, whether its tax returns, bookkeeping, payroll services, or personal income budgeting. He can be reached at [email protected] or 201-326-6908 if you have any questions or comments, or are interested in using Pristine CPA’s services. Feel free to contact us for a free consultation.

 

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