The Tax Cuts and Jobs Act (TCJA) is the largest piece of tax reform legislation in 30 years and was signed into law on Dec. 22, 2017. For most people, these tax changes impact tax year 2018, and overall, the changes associated with this act will lower taxes for individuals and small businesses.
The following article discusses the highlights of the tax reform changes pertinent to those who are semi-retired, meaning they work for themselves or for someone else on a part-time or full-time basis. In the eyes of the IRS, self-employed people are treated as small business owners. Tax professionals can help their clients and prospects by educating them and providing tax planning services around these important changes.
Tax Rates Lowered
On average, each tax bracket has been reduced by about 2 percentage points, and the tax brackets have been widened (new rates: 10%, 12%, 22%, 24%, 32%, 35%, and 37%). This translates into a lower tax imposed on income. The IRS has issued new withholding tables that employers would have incorporated into employee paychecks back in February 2018.
There are no changes to the capital gain rates (0%, 15% and 20%) and the Affordable Care Act surtaxes for high income earners (3.8% net investment income tax and 0.9% additional Medicare tax). The new rules would not change the taxation of Social Security benefits, which are subject to federal income taxes above certain levels of combined income.
Standard Deduction Increased and Personal Exemption Repealed
The standard deduction for folks not itemizing deductions on Schedule A is increased to $24,000 married filing joint, $18,000 head of household and $12,000 for other filing statuses. The additional standard deduction for the elderly will still be available. For 2018, an individual taxpayer receives an extra $1,600 standard deduction if born before 1954 or $2,600 for married couples. Thus, less taxpayers will be itemizing deductions.
For folks who are itemizing deductions, there is no longer a phase-out for high-income earners.
Under prior law, the personal exemption was $4,050. Beginning in 2018, this deduction is no longer allowed.
New Deduction for Self-Employed Workers
Under new law, there is a 20% deduction on business income for small business owners who report their operations on Form 1040, such as sole proprietors who use Schedule C. (As well as income from partnerships, S corporations and limited liability companies) This is a big windfall for small business owners as $20,000 of $100,000 of business income would go untaxed. There are some calculations and limitations surrounding this deduction, including a phase-out of the deduction for high-income earners (over $157,500 for single filers and $315,000 for joint filers).
Here are some other rules surrounding the new deduction:
- It only applies to U.S. based income.
- The deduction reduces taxable income (not adjusted gross income) on the tax return.
- The deductions doesn’t reduce self-employment income.
More Depreciation Benefits
The generous 50% bonus depreciation deduction has been increased to 100% under the new law. This allows business owners to write-off or expense the full amount of capital asset purchases, such as furniture and equipment, in the first year. The depreciation deduction is limited for automobile purchases, but the limits have been raised beginning in 2018. If you choose to take bonus depreciation, the most you can deduct in year one of buying a car is $18,000 ($10,000 if bonus depreciation is not chosen). Sports utility vehicles carry a $25,000 limitation. The bottom line is that additional depreciation deductions translate into a better bottom line for taxpayers.
What Has Not Changed?
- You’re still allowed to deduct medical expenses to the extent they exceed 7.5% of adjusted gross income on Schedule A, if itemizing deductions. In 2019, the AGI floor rises to 10%.
- The rules for required minimum distributions and Social Security taxes.
- The existing rules that allow you to direct IRA distributions to a charity. If you’re over 70½ years old, you can distribute up to $100,000 per year from your IRA to a charity and the money is excluded from income.
As discussed, the new tax reform law introduces multiple changes. Taxpayers need to run the numbers in order to determine the true impact to the bottom line since each situation is different. Although employers would have adjusted employee paychecks back in February 2018, taxpayers may consider adjusting W-4 withholding allowances and/or estimated taxes to fully account for the tax changes. These tax changes provide tax professionals a good opportunity to engage with their clients early to adequately prepare for the 2018 tax year filing season.