Analysis of the Tax Cuts and Jobs Act of 2017: Individuals

The Tax Cuts and Jobs Act of 2017 is a sweeping tax overhaul that is set to enact dramatic changes to individuals on every part of the societal scale in the United States. Much has been said about this giant piece of legislation, and much of what has been said has been exaggerated or is plain wrong. I am a tax accountant, and I have been waiting for the final version of the bill to be released before I released my analysis. However, rather than putting yet another partisan spin on this monster bill, which I am sure you are quite weary of, I want to approach this another way.

Each partisan side has their own cherry-picked changes in this bill, some good and some bad. This blog will show an objective, nonpartisan analysis of the bill. I have created five hypothetical individual taxpayers spanning from poverty to near-extreme wealth, and have included some pertinent information about their hypothetical lives that will be changed by the new tax legislation. The taxpayers are as follows:

  1. Poor – He is single, works 2 jobs, makes $8.46/hr at McDonalds ($17,596.80 a year) and works at church. His income totals $30,000. He has no other streams of income, and pays $695 as an ACA penalty for not affording health insurance. He also rents a 1-bedroom apartment for $930/month.

 

  1. Lower Middle – He is married with 1 child, makes $13/hr at a retail sales job ($26k a year) and $9/hr in fast food part time ($40k total income a year) and his wife makes $20k in retail, giving them $60,000 a year in income. He contributes 5% to his 401(k) plan, has an ACA silver plan for his family for $700/month. He also has student loans of $45,000 at 4% interest, and pays $400 a month in loan payments with interest included of $81 a month.

 

  1. Middle – He is married with 2 children, makes a $35,000 salary as a pharmacy technician. His wife makes $30,000 as a teacher, giving them $65,000 in income. He has a mortgage of $350,000 at 3.75% interest, with a monthly payment of $1,655 and average interest included of $682. He pays $5,000 in property taxes per year, and he has the same student loan situation as #2 above. He has health insurance through work, with a $250/month family plan premium. He also has a $400/month alimony payment. Finally, he lives in Oregon, which has a 9.9% state income tax.

 

  1. Upper Middle – He is married with 3 children, he makes $100,000 as a lawyer his wife makes $50,000 as a nurse, giving them $150,000 in annual income. He has a mortgage of $550,000 at 3.75% interest, making monthly payments of $2,786 with $1,258 of average interest. He lives in California, paying 13.3% in state income taxes and $10,000 in property taxes. He has family health insurance for $300 a month, and the same student loan situation as the previous two individuals. He also has a home equity line of credit (HELOC) of $50,000 with 4.5% interest, with monthly payments of $518 and interest included of $187. He donates $5,000 every year.

 

  1. Rich – He is married with 2 children, with a net worth of $11 million. He works at a Private Equity firm making $350,000 a year base salary, plus 2% carried interest on acquired companies. His wife does not work, and he has paid off his mortgage and his student loans. He lives in New York, paying 8.82% state income tax and $12,000 property taxes. He is a shareholder of an S-Corporation that buys and sells residential real estate that nets him $50,000 a year in capital gain income, and he donates $50,000 every year. He has free health insurance through his executive compensation, has Incentive Stock Options through his firm and pays $3,000 for a CPA to prepare his taxes.

 

Due to the size of this tax bill, this post will focus on the individual side, and the business and foreign side will be covered in a separate post.

The individual income tax rates under the current tax code and the new tax code are compared in the source documents below.


What’s In the New Plan

The new plan takes out many deductions, in order to ‘broaden the base’ of taxable income. To compensate for this, the seven marginal rates are taken down a few percentage points. The full list of individual changes are shown in the source document below, but I will highlight a few major ones that will affect our analysis.

The Standard Deduction, the deduction taxpayers automatically take if they do not itemize, is nearly doubled. The original deduction is $6,350 for single filers and $12,700 for married filers. The new deduction is $12,000 for a single filer and $24,000 for married filers.

The personal exemption, a dollar amount exempted from taxable income for every person on a return, is suspended. The exemption amount under the current system is $4,050 a person, now it is $0.

Above-the-line deductions, like student loan interest, alimony payments, and teaching expenses, are fully deductible under the current plan, meaning you can reduce your gross income by the amount paid on these items. These items will go away under the new plan.

Most itemized deductions will go away under the new plan. A taxpayer can itemize their deductions if they total more than the standard deduction. These deductions include medical expenses, charitable contributions, State & Local Taxes (SALT), Property Taxes, Mortgage & other loan interest, as well as miscellaneous expenses like Tax Prep Fees and Theft losses. These are subject to various income limitations, with the lowest being 2% of Adjusted Gross Income (meaning if these deductions are less than 2% of your AGI, you cannot take them). Under the new plan, most of these deductions are completely repealed, but you can claim a reduced mortgage interest deduction, a combined deduction of SALT and Property taxes to a maximum of $10,000, and the full charitable contribution deduction. But bear in mind that the standard deduction is doubled, so many less taxpayers will be itemizing.


The Comparison

  1. Poor taxpayer does not have many taxable events. Under the current tax system, his $35,000 of income is taxed as follows:

 

$35,000 adjusted gross income

$6,350 standard deduction          –

$4,050 personal exemption         –

$24,600 taxable income

 

(10% x 9,525) + (15% x 15,075) = $3,213 in tax paid. Add the $695 ACA penalty, Poor owes a tax of $3,908.75.

 

Under the new tax system, his same $35,000 of income is taxed as follows:

 

$35,000 adjusted gross income

$12,000 standard deduction     –

$23,000 taxable income

 

(10% x $9.525) + (12% x $13.475) = $2,569.50 in tax paid. There is no ACA penalty, so this is his total.

 

Poor does indeed get a substantial tax cut in the new plan, of $1,339.25.

 

  1. Lower Middle taxpayer has a few more taxable events, including some deductions both above-the-line and below-the-line (meaning deductions taken both before and after calculating adjusted gross income). His $60,000 in income is taxed as follows:

 

$60,000 income

$972 student loan interest deduction ($81 x 12)               –

$59,028 adjusted gross income

$12,700 standard deduction ($6,350 x 2)                            –

$12,150 personal exemptions ($4,050 x 3)                          –

$34,178 taxable income

 

(10% x 19,050) + (15% x $15,128) = $4,174.20 in tax paid. There is no ACA penalty from this point forward, so no additional taxes are owed because of this.

 

Under the new plan, his same $60,000 of income is taxed as follows:

 

$60,000 adjusted gross income

$24,000 standard deduction ($12,000 x 2)                            –

$36,000 taxable income

 

(10% x $19,050) + (12% x $16,950) = $3,939 in taxes paid. Lower Middle does get a tax cut under this plan as well, but a much smaller one, of about $235.

 

  1. As we get to the Middle income taxpayer, the situation becomes even more complex, with more deductions and additional taxes to consider. Under the original tax plan, Middle’s $65,000 of income is taxed as follows:

 

$65,000 income

$972 student loan interest deduction                                     –

$4,800 alimony exclusion                                                          –

$59,228 adjusted gross income

$16,200 personal exemptions ($4,050 x 4)                           –

$8,184 mortgage interest deduction ($682 x 12)                 –

$5,000 property tax deduction                                                –

$4,558 state tax deduction (9.9% x taxable income)           –

$25,286 taxable income

 

(10% x $19,050) + (15% x $6,236) = $2,840.4 of taxes paid

 

Under the new tax plan, his same $65,000 is taxed as follows:

 

$65,000 adjusted taxable income

$24,000 standard deduction                                                   –

$41,000 taxable income

 

(10% x $19,050) + (12% x $21,950) = $4,539 in tax paid.

 

Middle was able to take advantage of a few deductions under the old code, but most go away under the new one. As a result, his income taxes nearly double, increasing by $1,698.60.

 

  1. Upper Middle has perhaps the most complex tax situation of them all, with even more items to consider: Under the original plan, his $150,000 is taxed as follows:

 

$150,000 income

$972 student loan deduction                                                         –

$149,028 adjusted gross income

$20,250 personal exemptions ($4,050 x 5)                                 –

$15,096 mortgage interest deduction ($1,258 x 12)                 –

$10,000 property tax deduction                                                   –

$2,244 HELOC interest deduction ($187 x 12)                            –

$5,000 charitable contribution deduction                                  –

$12,826 state income tax deduction                                            –

$83,112 taxable income

 

(10% x $19,050) + (15% x $58,350) + (25% x $5,712) = $12,085.50 in taxes paid.

 

Under the new tax plan, the same $150,000 of income is taxed as follows:

 

$150,00 adjusted gross income

$10,000 combined SALT and Property limitation                     –

$5,000 charitable contribution deduction                                 –

$15,096 mortgage interest deduction                                        –

$119,094 taxable income

,

(10% x $19,050) + (12% x $58,350) + (22% x $42,504) = $18,257.88 in taxes paid

 

If you aren’t seeing the pattern forming here, the more deductions you currently take under the current plan, the more your taxable income will increase under the new plan. The lower rates are not enough to compensate for your increased taxable income, and in the case of Upper Middle, his taxes increase by $6,172.38.

 

  1. Rich taxpayer is on a level unlike the previous four. He does not have as many deductions, but he has more streams of income, and that gets him preferential tax treatment under some provisions in the new law. Under the current law, his exemptions begin to phase out after $145,000 of income, and he has none remaining. His income is taxed as follows:

 

$350,000 adjusted gross income

$12,000 property tax deduction                                                –

$3,000 Tax Prep Fee deduction                                                 –

$50,000 charitable contribution deduction                            –

$25,137 state income tax deduction                                        –

$256,863 taxable income

 

(10% x $19,050) + (15% x $58,350) + (25% x $78,750) + (28% x $81,850) + (33% x $21,863) = $60,463.79 in ordinary taxes paid, and (15% x $50,000) = $7,500 in capital gains taxes paid, netting a total of $67,963.79 in total taxes paid.

 

Under the new system, his income is taxed as follows:

 

$350,000 adjusted gross income

$10,000 SALT & property tax deduction limitation              –

$50,000 charitable contribution deduction                           –

$290,000 taxable income

 

(10% x $19,050) + (12% x $58,350) + (22% x $87,600) + (24% x $125,000) = $58,179 in ordinary taxes paid, and (15% x $50,000) = $7,500 in capital gains taxes paid, netting a total of $65,679 in total taxes paid.

 

Rich taxpayer has deduction limitations under both plans, but his top rates are significantly lower than the top rates of the three middle income taxpayers, giving him a significantly more favorable overall tax, and a savings of $2,284.79. The higher in income you go, the more you will be able to save through the lower top marginal rates.

 

As you can see, the results of the new tax plan’s changes are varied, and do not fall neatly within one particular set of political talking points. The working poor will see a tax cut under this plan, as will the very rich. Those in the middle, the taxpayers who can use the most deductions and who all of us consider the Middle Class, would see their taxes go up, significantly in some cases. Obviously this depends on the particular circumstances of each taxpayer, but that seems to be the trend. We will cover the rest of the changes in the next post, but hopefully this analysis will help us understand exactly what changes we can expect.

 

Sources:

 

Individual changes write up: https://docs.google.com/document/d/1StjeoOmJdLPyZDbxQMHuMYGSD1VrxQAPbFz0yveX24E/edit?usp=sharing

 

Joint Explanatory Statement (Final version of Tax Plan): http://www.wsj.com/public/resources/documents/JointExplanatoryStatement121517.pdf

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6 thoughts on “Analysis of the Tax Cuts and Jobs Act of 2017: Individuals

  1. Hello, fellow redditer!

    I think you have a new subscriber. This is awesome. Please keep posting about the new tax bill and taxes.

    Curious about the difference between a corporation vs a passthrough (as an LLC can be elected as a C corp right?) so that one can get the 21 percent cap for taxes instead of the 20 percent non-taxed portion of income.

    Liked by 1 person

    • Thank you so much for reading and for the kind words!

      This post was focused on the individual side of the bill, and I left out the 20% deduction for Qualified Business Income through a passthrough when I did the math on Rich taxpayer. Rest assured, it will be gone over in detail when I make the business analysis!

      Like

      • Awesome! Super excited for that post! I think if you keep proving that you’re really good at taxes and explaining things (which you clearly are) you could have an awesome little side hustle where you do blogging taxes for people? If I read right, you’re an accounting professional.

        Like

      • Yes, I work in tax and hope to be certified in a few years. This blog is for economics in general but certainly does include all things taxes! That is a big part of the picture.

        Like

  2. Hi, Thanks for the analysis, it was helpful for my situation. But, why no inclusion of the child tax credit on these families? It looks like you are factoring in the loss of the children’s exemptions in the current tax code, but not the increasing CTC in the new law.

    My category most closely matches your Upper Middle category, and I will see benefit from the larger CTC. It is phased out for me currently, but I will get it starting in 2018. My own back of the napkin calculation shows a benefit of several thousand dollars, but I have less deductions that your case study, who will likely still show a not loss with the new tax code. Thanks

    Liked by 1 person

    • Thank you for reading! I did not include the expanded Child Tax Credit because that carries a sunset provision, and would also require inclusion of the current credit as well.

      Like

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