Now that the new tax law is official, it’s time to update this post. One of the big changes on the individual side is the $10,000 cap on the state and local income tax and property tax deductions. It’s said to affect primarily people with a high income in states with high taxes and high home prices. Together with the expanded standard deduction to $24,000 for married filing jointly, if your mortgage interest, charitable donations, and other itemized deductions don’t exceed $14,000, you are better off simply taking the standard deduction. It means effectively many people won’t be able to deduct their state and local income taxes, property tax, mortgage interest, and charitable donations.
The Tax Foundation published a map showing the average amount of state and local tax deductions claimed in different areas of the country (see Which Places Benefit Most From State and Local Tax Deductions?). The area I live in is affected the most. It’s one of the top 10 counties, shaded in the bluest of the blue. Because the cost of living here is one of the highest in the country, people with white collar jobs here also have high incomes.
I will be one of those affected the most. I will lose a lot of deductions. For the first time in many years, I will take the standard deduction in 2018.
Lowering deductions isn’t the only change in the new tax law. The rates are also lowered through 2025. Instead of 15% we will have 12%. Instead of 25% and 28% we will have 22% and 24%. The lines aren’t drawn in the same places as before but if the bulk of your income fall in those middle brackets, the tax rates are lowered roughly 3% across the board.
Child Tax Credit Increase
The child tax credit is increased from $1,000 to $2,000 and it also won’t phase out until much higher income thresholds. Many people with high incomes who used to get $0 in child tax credit will now get $2,000 per child.
Together, the increase in the standard deduction, the lower rates, and the increase in the child tax credit would actually more than compensate for losing all of these:
- the personal exemptions
- the state income tax deduction
- the property tax deduction
- the mortgage interest deduction
- the charitable donations deduction
No Marriage Penalty
Another factor that lowers taxes for married couples filing jointly is the removal of the marriage penalty for people with a taxable income under $600,000. That should cover about 99% of people. A part of the income that used to be in the 33% bracket is now in the 24% bracket. That’s a large drop.
Technically the new tax law still has AMT but it won’t affect 99% of people because the AMT exemption amount is increased and the AMT exemption phaseout points are moved further up. People in blue states with a high income (but not a super high income) who used to pay AMT will no longer pay AMT.
Altogether, some people in blue states with a high income (but not a super high income) can see their federal income tax in 2018 go down by about 4% of AGI. This is much larger than I expected.
The new tax law didn’t completely eliminate itemized deductions or marriage penalty or AMT for everyone but it practically did for 90% or 99% of people. They also won’t have to calculate the phaseout in personal exemptions and itemized deductions. Perhaps more people will become comfortable with doing their own taxes when they only take the standard deduction. You won’t miss any deductions because you know you won’t itemize.
Getting out of the mindset of tax deductions puts the focus back on the merit of something itself. You buy a home because you like owning your home not because you get a tax deduction on mortgage interest and property tax. You donate to charities because you care about the cause not because you get a tax deduction.
1. When multiple things change, we have to look at them overall. Remember the story of blind men and an elephant. The media and interest groups will always push us to look at only certain parts. There are always things to rally for or object to. You would think losing any one of the large tax breaks would be a big deal. Actually even losing all of them altogether is really not a big deal when it’s compensated elsewhere.
2. We must quantify the changes, not just look at the direction: higher taxes or lower taxes. We won’t be swayed by forces that try to influence us only until we actually run the numbers.
3. The new tax law is actually very friendly to people with a high (but not super high) income in blue states: lower rates, child tax credit, no more marriage penalty, no more AMT.
4. Our financial success does not depend on paying 1% less of our income or 1% more of our income in taxes. Something is really wrong with your financial plan if paying 1% less or 1% more will make or break your plan.
[Image credit: From Martha Adelaide Holton & Charles Madison Curry, Holton-Curry readers, Rand McNally & Co. (Chicago), p. 108, via Wikipedia.]–