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.]–
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Blue staters prefer higher taxes and will lose tax deductions. I see no problem here.
The media will always stir up trouble by not focusing on the real story (almost no change to tax rates) because they thrive with chaos.
I’m hopeful this simplification of the tax code is only the beginning. Like TFB wrote previously, Americans like getting a tax “deal” over a simple tax code.
Thank you for this excellent write up.
I’m curious, though, how possibly removing the mortgage interest deduction would change the overall economy. I’ve seen this mentioned – not sure what the latest might be. I could see people not borrowing as much money. Some would argue, this would hurt bankers and realtors. However, if people aren’t going into as much debt, is that necessarily bad? I could also see home prices moderating given that purchasing power decreases (especially on the coasts). This would make housing more affordable. Is that a bad thing? I suppose if you’re trying to sell at the top of the market, it might be. Existing homeowners might otherwise choose to pay down their mortgage faster because there’s no incentive to be paying banks interest (and having the deduction).
Harry Sit says
Most developed countries don’t have mortgage interest deduction (Canada is the closest example). They function just fine. Not having a mortgage interest deduction did not hold back the real estate boom in Canada. The economy is complex. It doesn’t follow a “if A then B” simple logic.
M. Anderson says
Harry, actually the lack of a mortgage interest deduction in Canada has held back numerous booms in the real estate market.
There is a boom now in B.C., primarily because of Chinese investment. There’s a great article in Mother Jones about that this month. There’s also a boom in the Edmonton area because of oil and gas. But, those two booms would have occurred regardless. Had there been a mortgage interest deduction, those booms would be worse AND there would have been many others.
Harry Sit says
http://www.housepriceindex.ca/ shows national average 13% increase year over year. It’s not just B.C. Toronto was hotter than Vancouver. Edmonton was actually down (because of oil and gas?). Maybe it would’ve been hotter with a deduction. Just it can still thrive without it.
M. Anderson says
Oh, I agree with your new statement that a market “can thrive without” the mortgage interest deduction. But, that’s very different from “function[ing] just fine,” which is what you said at first.
Right now, the market in B.C. is actually in a crisis. They’ve adopted a 15% tax on non-citizen purchases of real estate in an effort to stem the price increases that make home ownership unavailable to Canadians earning average incomes. A substantial amount of foreign owned real estate is sitting empty. The Chinese owners (often corrupt officials) are using them as foreign bank accounts to hold what is most likely income that was obtained illegally (i.e., graft/bribes/etc). There are whole industries that cater to making those houses look occupied while the foreign owner is away. The ability of Canadians to buy and own homes in any major market is almost non-existent.
These markets are NOT “function[ing] just fine.” Without the mortgage interest deduction, Canada’s market was tepid. That’s one of the reasons that they turned to foreign investment, which has now wrecked their market.
Simply pointing to the fact that market has increased without the mortgage interest deduction does not establish that the market is working “just fine.” To the contrary, instead of adopting policies that would benefit Canadians who purchase homes (such as a mortgage interest deduction), the government adopted policies that allowed non-residents/non-citizens, who pay nothing other than property taxes, to inflate the real estate market to the point that people earning an average income in the markets have little hope of ever buying one. Nothing about that is “just fine.”
M. Anderson says
Here’s a recent article in one of Canada’s major newspapers about the crisis:
Harry Sit says
Opinions differ. Despite problems here and there I see Canada overall is functioning just fine. I don’t know what Canada did when they “turned to foreign investment.” Non-residents/non-citizens can buy U.S. real estate just the same. I heard the same reports about New York and Miami. You said having a deduction would make the boom worse and occur more often. I don’t understand how at the same time it would help affordability. What you get in the deduction you pay in a higher price. Anyway, we are going off topic. Let’s have Canadians worry about Canada.
M. Anderson says
There are no differing opinions. Everyone in Canada agrees that real estate is broken in virtually every major market. Read the Mother Jones article and the article that I linked to from the Globe & Mail. The Mother Jones article explains what Canada did to lure foreign investment: They basically sold citizenship in exchange for a $300,000 zero interest loan with a 5-year term.
Having the deduction would incentivize housing purchases by citizens and residents (as it does in the U.S.), and would have reduced or even prevented the desire to lure foreign investment. Sure, we have foreign investment, but since those people cannot also buy citizenship here, they went to Canada instead.
Here are some quotes from the Globe & Mail Article:
“A couple of weeks ago, U.S. economist Michael Hudson sold out the Rio Theatre to talk about the [Vancouver’s] gone-sideways housing situation, which he compared to “a feudal society.””
“[Another expert] studied the situation and has come to several conclusions: that more supply is nothing but fuel for the unaffordability crisis; that house values that are wildly disproportionate to incomes indicate a high level of tax evasion; that government is failing to institute fair tax regulation to ensure infrastructure needs are met; and that all this “growth” is simply not paying for itself.”
““What would we think of someone who hoarded food? Why is real estate any different?” asks Mr. Wozny. Analyzing data from the Real Estate Board of Greater Vancouver and the Canada Revenue Agency, he found an odd inverse relationship between incomes and housing; the higher the house price, the lower the declared income; the lower the house price, the higher the income. In Vancouver, Richmond, West Vancouver and Burnaby, houses are routinely priced between $1.5-million and $3-million. However, taxpayers report “unusually low taxable median family incomes, well below the regional average.””
M. Anderson says
I inadvertently left this quote from the Globe & Mail article off:
“Obviously something terrible is happening – the money flooding in is not a sign of a healthy functioning capitalist market.”
That pretty much says it all, doesn’t it?
Harry Sit says
Problems. Every country has them. If selling citizenship has undesired consequences, the country will adjust. Once again, let’s have Canadians worry about how to manage their country.
M. Anderson says
You brought up Canada, not me.
The Mortgage Interest deduction is important because it encourage home ownership by residents and citizens who might otherwise not find home ownership to be economically viable. Countries that don’t have it, like Canada, are not doing “just fine.”
Tax deductions that encourage social beneficial activities are a good thing. Eliminating them will cause harms both to the individuals that no longer engage in that activity and the economy as a whole.
You point to the fact that your tax will be roughly the same as evidence that the change might not be harmful. I disagree. The fact that the tax liability will be roughly the same is a reason not to make any changes. The only valid reason for eliminating the deductions would be if the benefits (i.e., lower taxes) outweighed the harms caused by eliminating the deductions. Your initial post demonstrates that there are no benefits to the change (because your tax will be about the same). That seems like a bad reason to lose the societal benefits of encouraging economically productive activity through deductions.
Harry Sit says
Yes I brought up Canada. Despite the undesired foreign investments it’s still functioning just fine. Before the election I heard people say they would move to Canada if Trump was elected. If Canada is such a dysfunctional place people wouldn’t have said so. I don’t buy your theory that selling citizenship is connected to not having a mortgage interest deduction. You can find many research papers on the relationship between mortgage interest deduction and home ownership. This is not the place to debate it.
Thanks for this. I think I live in your state in a county that’s still dark blue, but not a lighter shade than your county. This statement is spot on:
“Something is really wrong with your financial plan if paying 1% less or 1% more will make or break your plan.”
Sadly, this is how a lot of people arrange their “financial plan” (4-5 figure tax refund = savings for the year), hence the freak out over proposed tax changes.
M. Anderson says
Harry, it seems you haven’t considered the loss of your ability to deduct your 401k contribution. There’s every indication that Trump intends to eliminate that deduction as well.
He specifically said “all deductions.” In fact, there’s already legislation in congress to convert all 401ks into Roths, i.e. no deduction for contributions, no tax at withdrawal..
If you can no longer deduct your 401k contribution, I suspect that will make a substantial difference in your tax liability. That’s important to me as well. When I retire, I plan to move to a no income tax state. If 401k contributions are no longer deductible, I’ll lose the benefit of that plan as well.
Harry Sit says
It changes by the day. This Wall Street Journal article said it wouldn’t be eliminated.
Trump Tax Plan Keeps Tax Breaks for 401(k)s
You are still only looking at parts though. Even if it’s eliminated, it can be neutralized in other ways. Reject all effort that pushes you to look at only parts.
M. Anderson says
If you’re excluding the elimination of the 401k deduction, then you’re only looking at parts. I’m interested in seeing your analysis run with all deductions eliminated (including 401k) except for the two that Trump said would remain.
Honestly, I wouldn’t trust anything Spicer or Trump says, and I doubt this plan will ever become law.
Harry Sit says
401k contribution is not a deduction. It’s excluded from your W-2 income. Therefore it’s not affected by eliminating all deductions. No one said the exclusion would be eliminated, only deductions. My analysis already eliminated all deductions by using the standard deduction.
That said, it’s very easy to model the effect of eliminating the exclusion from your income. Assuming 35% tax bracket, adding $18,000 to your income will make you pay $6,300. Double for married couple both contributing the max to their 401k. Add more if you are over 50. Dividing it by your AGI gives you the percentage. Just simple math.
M. Anderson says
I think that’s true of the employer’s contribution, but not the employee’s contribution. However, I’m self-employed (no W-2) and so I’m not sure.
Also, lets hope that Trump is using the technical terms in the same way that they are used in the tax code. Given how loose he can be with language, we cannot be certain that’s the case.
Harry Sit says
As a W-2 employee I can tell you it’s true. Your W-2 Box 1 income number is reduced by your 401k contribution. You do nothing special on your taxes to “deduct” it. It just isn’t seen as part of your income.
As self-employed, if you have a 401k, your contribution is an adjustment to your income (the “A” in AGI). Once again your income is reduced. After your income is adjusted, you then factor in personal exemptions and deductions. Eliminating exemptions and deductions does not change your AGI.
“The increase in the standard deduction and the lower rates would more than compensate for losing all of these…”
Perhaps if you are in the highest tax bracket now, getting taxed at a lower rate may offset things. So that helps the richest, but what about people in the middle?
I’m squarely in the 25% bracket right now in a deep blue HCOLA (Trump’s hometown!). I ran the same numbers as you and my increased tax burden is 3.6% of my AGI.
Conclusion: You only looked at one situation and drew a blanket conclusion without realizing how people in different situations may actually be affected by a change of this magnitude. Pretty sure Trump ran numbers just like you did to come to his conclusion.
At least we won’t need to see Trump’s tax forms to know that he’ll be paying less at the expense of the middle class.
Just to put this in better perspective since I followed your % of AGI number to illustrate the change in tax burden (which makes change look small), this would be a +26% increase in tax burden from 2016 for someone in my situation (HCOLA, homeowner, single, currently 25% marginal tax bracket).
Harry Sit says
The point of this isn’t that Trump’s tax plan outline is good or bad or something is good if it makes me pay less or it’s bad if it makes me pay more. Any change will affect different people in different ways. You still have to look at the whole picture. You still have to quantify it. The % of AGI is still a good metric because it’s comparable across different income profiles. If we know a single person in New York with $120k AGI used to pay 14% of AGI in federal income tax and now pays 17% of AGI, we can have a discussion on how progressive it is compared to a different profile paying 5% of AGI or 25% of AGI. Just a +26% increase doesn’t give us that picture.
The map on the Tax Foundation’s website reminded me of the map showing how individual counties voted in the 2016 election:
You’re right in that people are often quick to judge and only the see the trees instead of the forest. I say do away with most tax breaks. Individuals have the choice of where they want to live and it doesn’t make sense someone gets to pay less federal taxes because they chose to live in a high tax State.
It also doesn’t make sense that most high tax states are subsidizing low tax states at the federal level. For every dollar NYC residents pay in federal taxes (with all their deductions) they only get 60 cents back from the government in services.
Forest for the trees.
Harry, great idea about making a copy of your tax files then using that as “pro-forma” file version incorporating the major proposed tax changes and its effect on your bottom line tax bill. I often suggest doing this for my friends that are contemplating retirement decisions (IRA distribution amounts, Social Security payouts) so they get a quick look at tax effects of these scenarios. Finally, the tax plan (proposed) includes the doubling of standard deductions, a brilliant way to simplify and get most of us out of the tedious task of itemizing dozens of individual medical, charitable deductions…personally I’ll save LOTS of hours with this one aspect of the tax plan.
Kathryn @ Making Your Money Matter says
I do love a good tax article and this is my first time coming across your site. I’ve never considered the metric of calculating as a percentage of your AGI to be able to compare across income levels. I definitely will be calculating this now.
I created a spreadsheet to be able to calculate my taxes under the current and proposed Trump and House plans and was not pleasantly surprised by the results. In fact, I’d be paying an additional 83% with the Trump plan and 60% with the proposed House plan. I’m definitely not a fan of either.
Joe DeFuria says
Finally, a rational commentary on this (and any for that matter) proposed tax framework. It’s so difficult to get anything reformed in Washington because every piece of tax code has some target beneficiary…so any “change” brings out lobbying wolves demanding that their “piece” be protected.
If I had a nickel every time I tried to explain to someone “even if you lose the state income and property tax deduction, you may personally still come out ahead based on the specifics of the overall plan…final rates, where the brackets land, repeal of AMT, etc.”
To top it all off, many of these “high income blue state” people who are afraid of losing these deductions are paying AMT…which ALREADY does away with those deductions!
With any CHANGE in the tax code there will almost by definition be winners and losers (if measured by individual tax liability). Winners and losers in “comprehensive” reform will be spread all over the map in terms of income level and will depend on specific filer’s circumstances.
You miss the point then of what people are worried about. Most people are concerned not just about them but what this would do to the economy, their neighbors.
But more importantly, telling someone “May” be better off gets translated as still complicated and still not sure. To use myself as an example I still have to go through the standard deduction vs. itemized deduction test with my rental property. So not simple in that regard.
Also, I make six figures so as much as people call AMT as affecting the middle class, most of us still think it is the rich that are affected by that. Most likely they own a Tesla. definition of Rich IMHO. bad joke. I guarantee you it is not someone living in a home with a market value of 200k.
So my point is, the winners (if this is what we have come down to thanks to Trump), are the rich. In the AMT, in the individual taxes, in the pass through business, corporate taxes, etc.
The biggest tragedy will be no matter what happens the media will be blamed if they say anything negative about the taxes whether true or not. And Harry has only helped to pile on to that narrative.
Did you factor in AMT?
Harry Sit says
I did. Once the plan becomes final I will update this again.
Joe DeFuria says
The House and Senate plans are considerably different enough that coming up with a final analysis ins’t really worthwhile. I know for my own situation, my fed tax liability would be reduced between $6 and $11K depending on the plan (House vs. Senate). The (presumably forthcoming) “reconciled” version that will go to the President’s desk will be different than either of those two plans. So per Harry’s comment…until the final version is published all you can really do is take a wait and see approach.
The one thing that disappoints me about the proposed plans is that (as expected) it is going to likley make things more complicated vs. the goal of less complicated. The more they tinker with the plan to appease “lobbying group x” or “congressman Y” or “Senator Z” the more they do things like tack on phase-outs and other limits. This makes it more difficult to answer seemingly simple questions such as as “what is my marginal tax rate?”
True tax “reform” is nearly impossible (politically speaking) because of this.
So I have been going over the text of the just released (Evening of Dec 15) “reconciled” version of the bill that will I presume be signed into law.
I live in NJ…in one of the “Top 10” counties in the US from a state and local / property tax perspective. My household is solidly upper middle class. (Our income does not fall into the highest tax bracket…one or two below that). We are a dual wage household…2 kids.
You would think based on all the “panic” in the media about the “high income blue states”…I would be royally screwed with this tax plan where mortgage interest deduction is reduced, and SALT deductions are limited, right?
But to further Harry Sit’s point in the article…you need to look at the plan as a whole.
When you crunch the numbers …if I did it right….my federal tax burden will be * DECREASED an amount equivalent to by 4.3% * of my AGI. That’s actually pretty huge.
For my situation…what are the key tax reducers in the new plan?
1) Child tax credit. Where I was ineligible before, I am now eligible to take at least some of the $2,000 tax credit for my “qualified” child. I can also take a portion of a new $500 tax credit for my “non-qualified” child.
2) Standard Income Tax Rates. The rates in the standard income tax rate schedule are reduced (and the income brakets also favorably adjusted)
3) Standard Deduction incresae…the limited SALT and mortgage deduction is no longer enough for me to itemize, now that the standard deduction is increased to 24,000.
4) I will no longer pay AMT. While the AMT still unfortunately exists for individuals, they made two key changes…which will at drastically reduce who will be ensnared by it.
a) The personal exemption for 2018 is increased from 86,200 to 109,400.
b) The phaseout floor for Married couples increases from 164,100 to * 1,000,000 *
Because of the changes to AMT…I now fall off the AMT roles completely.
Everyone seems to forget about AMT. The same people who the pundits were fretting about getting shafted by this tax plan (people in high income blue states utilizing the SALT deductions) are the same people who are highest at risk of paying AMT. (Which ironically has NO SALT deduction.)
This plan is not perfect…it does little to “simplify” the tax code…and I am sure there are cases of “losers” depending on circumstances. But this plan is certainly a win for this “high income but not “rich” high income blue state tax payer”
Harry Sit says
Preliminary calculation shows our federal income tax will also go down by close to 4% of AGI, which is much larger than I expected. We will use only the standard deduction. The lower rates make up for it.
I imagine we have similar AGIs.
Yes, the conference bill shaves significantly more tax liability than either the original house or senate plan. The rates are lower than both of those, and with the original senate plan my AMT would be less than it is today, but I would still be paying AMT. The conference bill raised the phaseout floor for AMT which effectively takes me off the AMT roles.
Everyone will need to reevaluate their effective marginal tax rates to see if it makes sense to look at their tax strategy. (How much you are saving in tax-deductible savings plans…if it makes sense and how much to convert to Roths, etc.)
For me, my marginal tax rate situation at current income levels is slightly improved, but not drastically. I would now fall into the 32% marginal tax bracket, and approaching the 35% bracket. Historically I have been solidly in the 35% bracket since I was in the highest AMT rate while the exemption was being phased out at the same time.
That all being said, the new rates may give new opportunities if your employer plan gives you the opportunity to defer income….because of the lower overall marginal rates. For example, the marginal rate of 24% is in effect all the way up to $315,000 taxable income for joint filers. Previously you’d be in a bracket anywhere from 25% to 35%. That is significant.
This can make it much more attractive, for example, to defer wage income in a given year (if your company plan allows that), and take advantage of the relatively low marginal rate to convert pre-tax 401k funds to Roth IRAs.
One other comment on the new tax plan that I haven’t seen getting much (if any) press but is very significant now that I look at the rates:
The so-called “marriage penalty” is essentially eliminated for incomes of up to $600,000.
In other words, all of the tax brackets (except the highest one) are double that of the single filers. (There is not technically 100% true for all brackets…but it is very close). Historically this was not the case and joint filers who had dual incomes were essentially “penalized” for being married vs. if they each remained single and filed two separate returns.
So for those of us (including myself) who file joint returns and are dual income households, this is welcome relief not to mention is arguably now “fair”. This does mean that in general, single filers will not see as great a tax reduction as married filers.
I ran a bunch of scenarios comparing the new plan and existing law. I used joint filing status, 2 dependents (age 16 or younger), mortgage interest of 12,000, and property tax of 17,000, NJ Income tax. Using those figures I ran various levels of AGI across a spectrum from $150,000 to $2,000,000.
What I found is that
1) Federal income tax was reduced across the board.
2) The biggest winners in terms of both % saved of AGI AND absolute tax savings is around $400,000 AGI. This is roughly 4.2% AGI…around $17,000 federal tax savings.
3) As you move away from that “sweet spot”….Tax savings decreased to about 0.3% AGI at $150,000. It also decreased to about 0.5% at 2,000,000. Even in terms of absolute dollars, those with 2,000,000 AGI do not save as much in taxes as those earning between about $300K and $550K.
Clearly one of the major impacts in the new law is the removal of the “reverse AMT Donut” for the upper-middle class. The original intent of AMT is supposed to hit a select few “ultra wealthy” who would use tax loopholes to avoid income tax. But over the years AMT has morphed so that it hits “normal” wage earners in high tax states making between about $200K and $600K. Ironically, once you get past about $600K….the regular rates catch up and you no longer owe AMT. The new law (as far as I’m concerned) fixes this problem. Even though AMT still technically exists it should not impact any typical “wage earners” with common deductions.
My analysis above is somewhat simplistic…(for example, I assumed the same property tax and mortgage interest deduction across the AGI spectrum), and it applies only to joint filiers with 2 kids age 16 and under. But it should give some idea of how the new law impacts “high income earners in the blue states.”
Scott R says
I’ve been “mostly” doing my own taxes over the last several years (basically having a tax pro do the final entry and double-checking), and last year I finally *fully* did my own taxes. In the course of those years I’ve become pretty knowledgeable about how the taxes, deductions, etc. work. I have a complicated spreadsheet I made which I still use to do a rough calculation of things. One thing I still feel confused about is AMT. We’ve been hit with AMT for the last few years and I think I (and my spreadsheet) was smart enough to figure out that it effectively eliminates my exemptions and reduces my state/property tax deduction. So when I read that the new tax plan would be reducing those things but eliminating AMT, my initial thought was that they weren’t eliminating AMT so much as “baking much of it in” for everyone.
But now I read that AMT hasn’t been eliminated after all. I see references to the changes to the AMT exemption and phaseout amounts, but I’m confused about how those work and whether I’m affected or not. JDF/Harry/whoever, if someone would be willing to help me understand that better, I would be greatly appreciative. We could try to converse in the replies here, or do it via email (where I’d feel a little more comfortable disclosing more details about my finances). But here is my basic situation: Wife and I live in CT (dark blue state in the map above), combined AGI in the neighborhood of $350K (we both make > $150K incomes, with me making maybe 25% more than her), property taxes (including car taxes) about $10K, and mortgage interest currently about $12K. Our only child is now > 18. We’ve been itemizing for a while, but it looks like with the new state tax deduction limits combined with the increased standard deduction, that it would be a wash one way or the other.
If I just take the standard deduction of $24K, how can I determine whether or not I might still be impacted by AMT?
Harry Sit says
Scott – At $350k AGI, after $24k standard deduction, your taxable income is $326k. In the 32% bracket your regular tax is $64,179 + 32% of the amount over $315k, which comes out to $67,699. Under the new tax bill, your AMT taxable income is $350k – $109k = $241k. Your tax under AMT would be $241k * 28% – $3,830 = $63.5k, which is lower than your regular tax. As your income goes up from $350k, because your regular tax bracket is higher than your AMT tax bracket, your regular tax will go up faster than your tax under AMT.
Under the new tax bill, due to the increase in AMT exemption and the phaseout point, people who take the standard deduction will not pay AMT at any income level.
Scott R…approximately how much CT state income tax do you expect to pay on that income? If you can tell me that I can try and run a ball-park before and after scenario. In short though, Harry is correct…the changes they made to AMT will exclude you from paying it. Based on the information you provided, you appear to be in the class of filers that will get a substantial tax cut.
In a strange sense, you might consider it “baking in AMT” for everyone…if you think about it in terms of what tax reform is: limiting deductions / loopholes. That what the AMT did…stripped out a bunch of loopholes / deductions to prevent people from avoiding taxes. HOWEVER, when you strip out deductions…but do that in combination with lowering the tax rates, you get a “fairer” tax system without raising tax liability.
Scott R…I did a ball-park CT state tax calc (smartasset.com) which estimated your CT tax at 19,100. Based on that (and my own personal federal tax calculation spreadsheet):
Regular Tax Liability: $73,952 (Includes itemized deductions)
AMT Tax Liability: $78,848 (Since AMT > Regular, this is the tax you would owe)
Regular Tax Liability: $67,699 (No longer itemizing)
AMT Tax Liability $60,179 (This is less than regular, so no “AMT Tax”)
Overall tax savings of over $11,500.
NOTE: The above tax liability does not include the “Obama Medicare Surcharge”…which will I estimate will cost you an additional $1,000 or so.
Scott R says
You guys are smart. Yup, JDF, your CT tax estimates are right on point. Note that I was basically providing rough numbers from last year’s taxes, but this year’s will be about the same.
Harry, thanks for providing those simplified equations for estimating the AMT impact.
So now I see where that new $109K figure (AMT exclusion amount?) would be plugged in. So where would the $1M AMT phaseout come into play?
I will say, that as I learned about how the old tax system work, I got some pleasure in trying to figure out how to maximize my deductions. But I pretty much hit the point where there was nothing more/new that I could do (I’m already maxing out 401K contributions and chose an HDHP for our health coverage and am maxing out our HSA).
One criticism that I’ve seen raised, which sounds like a valid concern to me, is that as more people choose to take the standard deduction, there could be a negative impact to charitable contributions. Mind you, I don’t think that’s a reason to keep the old tax system in place.
Harry Sit says
Under the old rules, after your AMT income exceeds $164k you start losing your $86k AMT exemption. At $350k your actual AMT exemption is more like $40k. Under the new bill you won’t start losing the $109k exemption until your income exceeds $1 million.
The $1M phaseout….
For simplicity we’ll ignore any deductions like mortgage interest….in the following example.
As you’re aware, AMT provides an exemption from income.
For 2018 (under old law), that exemption amount for married filers would have been 86,200. So you might think that your “taxable” AMT income is your AGI – the exemption: 350,000-86,200=263,800.
HOWEVER, there is a phaseout of the exemption. What this means is once your AGI is above a certain level, you are not allowed to take the FULL exemption…it is phased out as your income increases.
For 2018 (old law) the phaseout floor was 164,100. Meaning, every dollar you make above 164,100 reduces the amount of the exemption you are allowed to apply. The phaseout rate is one dollar of exemption is lost for every 4$ of AGI over that floor. So….for AGI $350K:
(AGI-Phaseout Floor ) * 0.25 = the amount of the exemption you are not allowed to take
(350,000-164,100) * 0.25=$46,475
So you must REDUCE your exemption by that amount in order to get your AMT Taxable income:
350,000 – (86,200-46,465) = 310,265
If you’re following, because of the phaseout, you are only getting 50% of the exemption under the old law. Because of the phaseout, your AMT taxable income increases from 263,800 to 310,265.
Now the NEW law….
The personal exemption is raised from 86,200 to 109.400. But not only that, but the phaseout floor is raised to 1,000,000.
So unless your AGI is greater than 1,000,000 you are now entitled to the FULL exemption. Now under the new law, your AMT taxable income is:
350,000-109,400 = 240,600.
The AMT Tax RATES and brackets stay the same under the new law. But since the exemption and phaseout floor are raised, your AMT taxable income is MUCH less: 240,600 vs. 310,265
Scott R says
Thanks for the follow-up. I definitely understand it better now.
David Cantor says
My wife and I make about $70,000 in pensions and interest income. I have run the numbers with the new standard deduction and the new brackets, etc., and calculate that we will owe about $500/year more in the new scheme that we would previously. Obviously not enough to destroy our finances, but certainly not a “middle class tax cut” for us.
Bob Groden says
Thank you for the analysis. Unfortunately the democrats want to dramatize the issue for political gain without putting country first. You have put it in perspective and it is appreciated.
Keep up the good work!
Mark Caspary says
Great info Harry. I’d like to get your opinion on a few other issues concerning the new bill though.
1) Unlike the corporate rates this bill for individuals is temporary. Just playing devils advocate here why is this so if the bill is such a great deal for citizens. It is widely reported that when this bill expires rates will go up. I understand the theory behind the cut for corporate taxes, Make business more competitive globally,possible create jobs in the US. From what I’ve seen most of CEOs interviewed say they don’t expect to do any significant hiring but rather they are more focused on buying back stock.
2) The Republicans in there zeal to abolish Obamacare and anything else with his name on it are eliminating the individual mandate,why do this if it’s going to raise the cost of insurance for most people,indeed why even include it in a tax bill?
3) What are your thoughts that CBOE and other watchdog groups are projecting that this will add over 1 trillion dollars to the deficit in the next 10 years. Maybe that’s why it’s only a temporary tax cut for individuals? There are claims that the economy will boom and GDP will go to 6% as claimed by the president,I have my doubts about that what are your thoughts? Because they are touting this rise in GDP will pay for these cuts.
I am not Harry, but don’t mind me for responding with my own opinion.
1) The reason why personal changes are temporary…in a word: politics. It is politically unpopular to cut corporate rates with the media and democrats beating the “tax cuts for companies and the rich” drum incessantly. So you need to package corporate reform with personal reform and cuts. Because they need to keep the total “cost” of the bill to 1.5 trillion over 10 years (for procedural reasons), there is only so much you can do to permanently cut rates. So in the end you get the corporate cuts to be permanent and as good as you can get them…and then you add in the “temporary” peronal cuts and reform to the extent that you can keep the bill under the spending limit.
As the personal tax cuts approach expiration…THEN it becomes politically * much * easier to write new law to “make the cuts permanent.” This is exactly what happened with the Bush tax cuts. They were also temporary on the personal side when originally enacted…and then in the Obama administration they were made permanent, because it was near political suicide not to. So in short: if the main goal is to do corporate tax reform and personal tax reform…this is really the best political approach to doing so. Yes, there is a risk that the permanent cuts won’t be renewed, but that’s a risk they are willing to take in order to make the cuts larger.
Oh…and don’t believe the bull-crap about CEOs “only interested in buying back stock”. For example, we had AT&T come out today and promise increased investments and bonuses to 200,000 employees as a direct result of the plan. Bottom line…when you have more money you have more options of what to do with it. Buy back stock, expand your business, hire more employees, more capital expenditures, etc. No different than if you get a big raise as an employee.
2) The reason why the mandate was included in the tax bill is actually due to economics. The way the CBO scores, removing that mandate is a revenue generator. That is, by including that removal, it allowed them to spend more money on the rest of the bill (personal reform, etc.). So this was almost a win-win: they get to remove a tax on the low income families, and they get more money to spend on tax reform.
3) There is no doubt in my mind that the corporate reform will lead to higher GDP. How much is anyone’s guess. Even in 10 years (looking back) we won’t know. The economy may go gangbusters for 10 years, but we still would not know how much is due to tax reform itself vs. other factors.
JDF only a republican thinks like this and why I would never understand my relatives who do:
“1) The reason why personal changes are temporary…in a word: politics…So in the end you get the corporate cuts to be permanent and as good as you can get them…and then you add in the “temporary” peronal cuts and reform to the extent that you can keep the bill under the spending limit”
And this why everyone goes to their own corner. Because my kind of thinking believe individuals should get the large cut and corporations not. I do not need AT&T to give me 1000 dollar one time bonus that comes out to 700 net.
“As the personal tax cuts approach expiration…THEN it becomes politically * much * easier to write new law to “make the cuts permanent.”…”
-much easier for who? the new party voted in to clean up the mess? Like what Obama had to do and got no praise for it at least not the likes of Trump’s praise for supposedly giving us this great Tax Reform?
“Oh…and don’t believe the bull-crap about CEOs “only interested in buying back stock”….”
sure you have more options, but it s not guaranteed and only republicans think corporations are smarter than individuals to do with the money as they please. So again why we go to our individual corners. I trust an individual to stimulate an economy more than I do an Entity.
“2) The reason why the mandate was included in the tax bill is actually due to economics…” jesus, well we know where you stand on healthcare. win-win? Until Americans understand that providing healthcare should not be driven by a job the closer we can get to making “America Great again”. well I know who you voted for now.
“3) There is no doubt in my mind that the corporate reform will lead to higher GDP…. How much is anyone’s guess. Even in 10 years (looking back) we won’t know”
And this is the beauty of being in politics and picking a side. You can say and do anything you want, blame the other side and still sleep at night. Hence why democrats believe it is far better to help from the bottom up at least then we know there is a fighting chance. On one had we say we as individuals should not be so concerned about the net tax effect yet when it comes to corporations and the GDP so much can be gained by it? As a whole it is big effect? individually nothing? corporations huge? just do not buy that. In my earlier point my ilk believe the individuals should get more than the entity. There is no guarantee or proof that the entity will provide in jobs, salary, bonus. AT&T for all we know is expecting some break from Trump. We need all corporations to be altruistic.
” Because my kind of thinking believe individuals should get the large cut and corporations not.”
That’s fine to have your opinion. Others looking for jobs might feel otherwise. But I forgot…you are looking at the “big picture” wheras nobody else possibly could be.
“much easier for who?”
Much easier for whomever is in office and controlling congress. You are exhibit A. Here you are whining about how you (“individulas”) are not getting “your fair share” of the tax cut. So whoever is in office / controlling congress will have a much easier *political* effort to make the personal tax cuts permanent.
“And this is the beauty of being in politics and picking a side. You can say and do anything you want, blame the other side and still sleep at night.”
Yup…that’s pretty much politics in a nut-shell. I just hope you don’t think one side or the other has a monopoly on political posturing.
“AT&T for all we know is expecting some break from Trump. We need all corporations to be altruistic.”
Yes Steven… Trump is *colluding* with these corporations to pay bonues to employees and expand their businesses….I’m sure a special investigation is warranted…
Dads Dollars Debts says
Man nice article. I am in Cali and seriously considering moving back to my home state with lower housing cost and no state income tax. Right now in Cali I am hit harder by some of these changes.
There are many people who will suffer real pain from this. I for one will have to move. My real estate taxes are $25k, my state income taxes $14k. I will still itemize because my interest on mortgage exceeds the standard deduction. Due to very limited supply when I bought I had to overstreach but was ok because of the deductions.
Changing the rules in the middle of the game is unconscionable, but what do you expect from Republicans. They love to steal from the middle class to payoff the mega wealthy.
I am curious. If you don’t mind sharing
1) What is your ballpark AGI,
2) and your mortgage interest
3) Marital status
4) Number dependents age 16 or younger
5) Number of dependents age 17 or older.
6) What state do you file in?
I can run a ball-park scenario just to see if it agrees with your own calculations / impact of the new law.
If you looked at my prior analysis, you would see that this is NOT a cut for the “mega wealthy.” The largest recipients of the cuts are middle and upper middle income married filers in high-tax states.
I hate the terms “rich” / “wealthy”, etc…because no one defines what they mean and folks typically conflate “income” with “weatlh”.
I’m not going to give out my personal details, but my accountant has run the numbers and they are correct. Many people in my situation will get absolutely hammered. You can claim all you like that this is NOT a cut for the mega wealthy but that’s just like one of Trump’s hundreds of bald faced lies. You can hate the terms “rich”/”wealthy” all you like, but I will continue to use them. Only the mega wealthy seem to dislike them.
Just trying to help. Though I suspect the reason you don’t want to give out any “personal details” (I’m just asking for ballpark numbers here) is that you will either be exposed as a fraud, or even worse….you’ll be exposed as being “rich.”
That’s right…go ahead and ask joe six-pack what he thinks of someone like you who’s home is worth enough to pays $25,000 in property tax and who’s income is enough to pay $14K in state tax….YOU’RE FILTHY RICH DUDE! Don’t deny it. You’re probably sitting pretty in your 7 figure home….and you have your own accountant!? You should be HAPPY to pay more income tax.
So pony up Zong…pay your “fair share!!”
Now…for the record…yes. I’m sure there are scenarios where the new plan is not favorable. I am genuinely curious if this is one of them. But unless we have some figures to work with we can’t see what the situation is and how common it might be. I truly am interested in your case and if you want to provide more details as requested above I will run the numbers.
You claim “many people in your situation will get hammered” and yet you fail to explain what your situation is. That’s no help to anyone.
Why would I provide some stranger my personal details, only a moron would do that? I don’t need your help, I’ve run the numbers and if you can’t figure out that many people get hammered by this bill it’s due to your incompetence. I don’t have a problem paying my fair share, I do have a problem with bald faced liars like you trying to pretend that millions of people will not get hammered by this bill. By the way, Joe sixpack hates this bill, because he gets hammered too.
That’s what I thought…more hyperbole from you and no facts. I do understand you not wanting to post just a couple more figures as it pertains to your situation…you don’t want to reveal to us all that you are “rich”.
Again, there will be cases where some folks will have an increase in tax liability. No one is claiming that 100% of the public will see a cut.
But if “so many” people get “hammered” by this plan then please present such a scenario for public scrutiny. Your own personal scenario or any other theoretical one. Put up or shut up. We can then rationally discuss if the results lead to
1) being “hammered” by a tax increase (vs. something nominal) and
2) how likely that scenario might be to occur in the real world.
So please, enlighten us, zong. I’m just an “incompetent bald faced liar and moron” after all…
There are hundreds of calculators online which will easily explain who pays more. Try educating yourself. I’m not going to do that for you, take some personal responsibility.
The problem is the Republicans are claiming this is a giant Christmas present for the American public, thankfully few seem to be buying their BS for a change.
It is YOU who came here whining about how “hammered” you and others “like you” are going to get. You claimed you will have to move out of your house for goodness sake. So therefore it is YOUR personal responsibility to explain your case. Again, no one is claiming that some folks will end up paying more depending on the circumstances. There’s a big difference however between “some will end up paying nominally more” and “OMG I have to sell my house!”
Now, as much as I enjoy a good political debate, this is not really the forum for it. I’d rather not dilute the intention of this blog and have it devolve into yet another ideological war. You’re a liberal (I presume) and I’m conservative. That’s cool.
For the last time…make your case here so we can discuss it otherwise we will all just assume that you have no case to make.
Harry Sit says
JDF – Here’s a “hammered” case for your model spreadsheet: someone single with modest income relative to the value of the home (“house rich”), who pays huge property tax, the “right” amount of mortgage interest plus interest on a HELOC, and escapes or pays very little AMT.
– Single, no dependent
– $100k AGI
– $3k state income tax
– $25k property tax
– $14k mortgage interest
– $4k HELOC interest
My rough calculation shows a tax increase of 4.x% AGI or +50% relative to the old law.
Interesting. I’m in roughly the same boat. We bought a big house in 2000 after getting hammered with federal income taxes the previous two years. I still can’t sell the house for what I paid. Even so, I agreed to an 8.25% mortgage back that. Ouch. The crash at least helped cut that way down.
I did run some numbers and we will for sure save under the new law. With AMT, we are basically losing all of the state an local tax deduction anyhow. With mortgage interest on two houses, and the 10k, we will barely be able to itemize. So the total deductions are about the same. Then the new tax rates are all a net savings.
On the politics, in the big picture I accumulate more money when a Democrat is president. That is running a series of 3 year averages. I suspect that is mainly because there are only recessions when a Republican is president – at least since I’ve bene alive – 50 years now. Seems weird, but look it up.
I’ve seen some pretty big deals go down. CEOs taking out 80M at the expense of a lot of jobs for upper middle class guys. I’d like to see the top rate stay at 39.6%, even if that is for over 1m. Those guys really don’t need a break. They just don’t.
In Michigan, we had a tax on the gross for a long time. 1-1.25%. It was called single business tax. Then changed to Michigan business tax, but the same basic structure, except it was worse to have pass though income. It was a cliff too – so under 250k in revenue was exempt. The it kicked in for everything. So insurance agents would divide up their revenue into multiple companies. Whatever. We paid it for years. The new(er) Republican governor got rid of it completely. OK, so that will stimulate the economy, right? Not really. We had a huge shortage of money for roads. So those stink, but are finally under way for long needed repairs – years later. The city of Detroit went bankrupt. Flint had the water issue as a direct result of trying to “save” money. So the costs of starving the Gov’t were high.
School budgets were cut at the state level too. So local cities either cut services, or added to property taxes – like ours did. Higher taxes without even the write off (due to AMT) – not the best.
My theory is that everyone working should make more money. Then they should spend more, then we will all make more. Taxes are a sideline. It’s the gross that matters the most.
On those lines, the best places I’ve been to are NYC, Chicago, San Fran and DC. They all have the highest taxes too. Hmmm.
Using your numbers:
– Single, no dependent
– $100k AGI
– $3.4k state income tax (see below)
– $25k property tax
– $14k mortgage interest
– $4k HELOC interest
In my state (NJ) this could describe this tax-payer as follows:
– House Value, $1,000,000. (This would be about $25K property taxes in my town)
– Primary Mortgage…to get interest to $14K, one scenario could be about 20 years into a 30 year mortgage (originally taken at $800K value) at 4% rate.
– HELOC interest of $4K…I assume this is not tax deductible under the new law.
Using those numbers, I come up with the following:
OLD LAW Fed Tax: $8,016
New Law Fed Tax: $8,739
(FYI NJ State tax would be about $3400 in my scenario)
So an increase of about $725, or not quite 1% of AGI. I would be interested to see how you got to 4%…so I can see if my calcs are off.
Note, my scenario indicates a situation where the person is SO “house rich” that roughly 77% of this person’s AGI is going solely to mortgage payments and property taxes.
Scratch that last calc…I was using married rates for the new law (forgot to update them from my base calc). When I fixed my error that I get a federal tax increase in line with Harry’s.
In this “hammered” scenario, I would calculate the fed tax increase to be about $4,750, so over 4.5% AGI increase, or a 50%+ increase in federal tax liability.
the absolute numbers:
Old Law: $8,016
New Law: $12,780.
Again though, while the increase is real…the scenario indicates someone who is “house rich” to the extreme…currently paying over 77% of their AGI for mortgage and property tax payments. That 77% doesn’t even include homeowner’s insurance. Once you factor in federal and state tax, this person (under the OLD law) would be living in a million dollar house, but only have $11,000 a year of after tax income to “live” on. Does not seem to be a likely scenario unless they are drawing down principal from outside investments or earning other tax free income.
I have made my case exposing you and the Republicans for the bald faced liars you are. Every scumbag Republican who goes on TV talks about this being a giant Christmas present but never once mentions the millions who face a tax increase. JUST LIKE YOU A BUNCH OF BALD FACED LIARS.
WHEN YOU FIND A SCENARIO WITH HIGHER TAXES YOU DISMISS IT AS UNLIKELY. WHAT A DISINGENUOUS PHONY.
I like the second chart in the WaPo’s calculator, if you believe the Census Current Population Survey:
I don’t understand the “changing the rules in the middle of the game” comment. Whose game, yours? Any policy passed is going to negatively affect some people and ideally its a small proportion of the population…I’m sorry to hear that you are one of them. I have a friend moving to NYC that bought a house who will be hurt by this as well.
By the way, give me you address and phone number and I’ll be happy to forward you my details including my tax bill which you can then pay any increase vs the current law. Since you think there won’t be any, you should be quite happy to do so.
Zong…take a deep breath.
1) I did not say you would not see any increase. I’ve repeated probably a dozen times in so many posts that of course, some people will see increases. That is the nature of tax *reform*.
(As opposed to tax “cuts”). It depends on specific circumstances.
2) We cannot confirm your increase and more importantly discuss the specifics around it unless you tell us what your specifics are.
With no help from you we have at least outlined a scenario where large (in terms of % AGI) tax increase can occur.
1) A situation where you are single with no dependents
2) while being EXTREMELY (as in, 75%+ of AGI being spent on mortgage and property taxes) “house rich.”
3) Not enough AGI that would traditionally put you into the AMT roles under the old law.
Yes, I would stand by my assertion that this scenario is uncommon.
This does NOT mean that it doesn’t happen or there are actual people impacted by it.
I still don’t understand why you seem so furious. You must own in the neighborhood of a million dollar home….you’re “rich”, “mega wealthy” or whatever term you want to ascribe to it. I guess maybe you just feel guilty?
Scott R says
Zong, I don’t get the extreme anger here. Might be a first in the reply section of Harry’s blog? Maybe I’m wrong, but I think Harry did a good job of “just stating the facts” as he put it, and leaving politics out of it. And JDF has come across as polite and genuinely interested in exploring the scenarios where certain categories of people will be hit negatively.
Zong, I know you don’t want to share rough estimates of your personal financial details (if your real name isn’t Zong then I don’t see how anyone would be able to trace it back to you – and why would anyone want to?), but if you don’t fall into the scenario as Harry/JDF provided, then why don’t you at least provide some hints as to what sort of scenario you *are* in. If you’re not willing to do that, then don’t expect anyone to give your accusations much credence.
Harry Sit says
Zong – Having made a “hammered” case, I’m not able to reproduce your claim for a hypothetical person. In California, one of the higher tax states, someone filing as Single needs about $180k in taxable income in order to pay $14k in state income tax. When someone’s mortgage interest is larger than the new $12k standard deduction, I’m just using $13k as an example. Because property tax and mortgage interest are still deductible for state income tax, that puts this person’s AGI at $180k + $13k + $25k = $218k. At $218k AGI, AMT kicks in under the old rules. This person’s federal income tax will actually go down by 2.x% of AGI under the new law.
Increasing the mortgage interest from $13k to $30k doesn’t make it flip. Short of having more information I would say you don’t have your facts correct. Making unverifiable claims doesn’t help anyone.
Again this doesn’t say anything about taxes going down for this hypothetical person is good or bad, with or without regard to some other people’s taxes going up or down by how much.
Harry…I am having the same difficulty in replicating Zong’s claim using NJ rates. In short, in order to get NJ taxable income to a point where the state tax liability is $14K, we’re talking about $260K in federal AGI. NJ doesn’t allow mortgage interest deduction, and quite ironically NJ caps property tax deduction at $10K…
In this scenario (and using $13K mortgage interest), I’m seeing a slight tax win under the new law, but essentially break-even.
Harry, JDF, Scott R
Send me your addresses and phone numbers and I will forward you all my information and you can pay my excess taxes for 2018 and beyond. I have all my accountant’s documentation which I would be happy to share.
I have tried to explain my frustration but you seem to ignore it. This law was never proposed as tax reform, always as a tax decrease. I have never seen a single Republican go on TV and say people will be hurt by this. All I see is them saying this is a Christmas gift. For anyone who has to pay higher taxes this is not a Christmas gift. If someone has a rare disease we don’t just say oh it’s rare so it doesn’t matter. You are not willing to acknowledge the real pain this will cause, just saying it’s uncommon so it doesn’t matter, and if you don’t like my tone, sorry too bad.
Scott R says
Zong, we’re trying to engage in a serious discussion here, but your responses amount to zingers. No one here is offering to pay your tax bill. And if your tax bill is going to increase as a result of these changes, you have my sympathy. I’d be upset too if my taxes were going to go up as a result of any tax law changes. If my taxes went up a little, I’d be a little upset. If my taxes went up a lot, I’d be upset a lot.
But I think that Harry and JDF and I are honestly curious about what your circumstances are that result in you getting a big tax increase. Unfortunately, you don’t seem willing to share that info, even though none of it would be particularly “private” since you’re just an anonymous person here. No one is asking you for your SSN, the specific town you live in (knowing the state is sufficient), or even what company you work for.
The following web page someone above mentioned doesn’t have enough options, IMO, but it’s better than nothing. How about starting with that? Plug your general numbers into it and see what it comes back with:
Zong, we are not “ignoring” your “frustration.” The plain and simple fact is we cannot *understand* what your frustration is because you continually fail to provide enough information so that it can be factually illustrated.
Until you do that, there is no real point in continuing the discussion.
I am a tax preparer for a major firm. The nativity of some folks is incredible. The “hammered” scenario Harry described is one faced by millions of our clients (sorry JDF you just don’t know the facts). There are also many other scenarios which will hurt millions of middle class taxpayers.
Harry Sit says
TaxPreparer – Great to have you here. Can you give us some more of these scenarios?
Scott R says
Another question for Harry or JDF (or anyone):
I’m running out of time, but I was likely planning to do a backdoor Roth IRA contribution/conversion before the end of the year. Was there anything new in this tax reform that would impact that?
Not that I am aware of. (But I am far from a tax expert.) I did read somewhere that as of 2018, “recharacterization” of IRA / Roth IRA will no longer be allowed. But that is (from my understanding) “undoing” a conversion. Conversions themselves are unaffected as far as I know.
Scott R says
Are you both active/contributing members of the bogleheads forum? I’ve started some threads there in the past (it’s been a while), and I’d love to know your usernames to converse about various things there in the future. FYI, my username there is CT-Scott . Or maybe Harry would be interested in starting up a full-fledged forum here. 🙂
Harry Sit says
I’m tfb on Bogleheads.
I’m not on Bogleheads. I will need to check it out…as you can tell I tend to “get my nerd on” when it comes to personal income taxes. 🙂
I did not read all the comments, but I don’t think the AMT was cut back as much as you think (“will not affect 99%…). The exemption was only raised to $109k for married filing jointly. The $500k/$1 M thresholds are simply where the exemption starts to phase out, not cut offs for when the AMT applies.
Harry Sit says
I haven’t seen any reasonable case that makes someone pay AMT under the new rules outside having income only subject to AMT but not the regular tax, such as exercising ISO and holding the shares. Not having the exemption phased out makes a big difference. At the lower end the larger exemption makes your TMT lower than your regular tax. As your income goes up, your regular tax goes up faster than your TMT. Either way you are not paying AMT.
Larry…You are correct on those numbers. Yes, we understand that the threshold is the phaseout “floor” (where the exemption starts to phase out.)
However, you are forgetting the effect of the 10,000 cap on SALT on the regular tax code. It is the SALT CAP on the regular code, combined with the increased exemption and phaseout floor for AMT that will limit exposure to a very small minority. Basically, for anyone who’s only deductions are SALT and Mortgage interest….I’m not sure it’s even possible to be hit by AMT.
You would need to be taking significant amounts of OTHER deductions that are disallowed under AMT rules in order to be hit by AMT.
I don’t know what the actual stats are…but I’m sure the vast, vast amount of itemizes have the bulk of their itemization in SALT and mortgage interest.
Thank you both for the replies. I don’t have a good calculator to run the numbers, so I’ll take your assessment at face value. The interesting thing is that means that the cap on SALT will actually be $10k in deductions under the new law not previously available to those upper middle class earners hit by AMT under the old law. I can see now how your calculations for modest tax savings will work out based on lower tax brackets and removal (limitation) of the AMT.
My first reaction was to unsubscribe from your blog but have since thought better of it. Same reason why I still watch Foxnews. Keep your friends close and….
I have been a subscriber of yours for at least five years and today was a sad day for me. Your post is completely slanted to justifying the temporary benefits of the individual tax side. You do not even get into the corporate side at all which is where most of the reputable media and tax payers are concerned about. The unfair advantage that corporations AND pass-through entities have with these new tax cuts vs. individuals. They are not only larger but permanent (if one more person tells me well Congress just needs to make it permanent I am going to scream). And in the end it is about honesty, if Trump said yes we believe in trickle down economics and want the companies to give back to employees and jobs and growth I can agree to at least the honesty but this tax cut is masquerading as a middle class tax cut which YOU are directly piling on to.
Now I do agree with you that the media should look at the tax cuts in totality and report on it but let’s be real trying to go explain all the details and come up with a conclusion on a media show is not only difficult but counter-productive to a 5-minute segment.
sad day indeed. I like my financial blogs to be politically-agnostic. If that was not your intent well it did not happen your republican readers are ecstatic with your post and us more democratic folk are not. The back and forth with your Canadian reader was uncalled for. I have many relatives in Toronto, Canada (a true melting pot) and I can tell you from empirical evidence they think 2x, 3x before buying real estate there if they cannot pay it outright. a sad day, Harry Sit.
For the record I do want this to pass for two reasons:
1. the devil is in the details so until you see it and feel it hard to say how things will be impacted. in the end human reaction is not predictable. e.g. can the tax changes affect the housing market?
2. as you have stated, a net change of a +/- a couple percentage points should not impact ones financial moves (but a double-digit swing that pass through’s get, now you are talking!).
one last thing, i think the most dishonest statement of them all is that this was first sold as simplifying the tax code and you are adding to that lie. standard vs. itemized deductions do not make things easier. Forms 1040A vs. 1040EZ does and that hasn’t changed, about the same people get to use the 1040EZ in the new tax code (an educated guess on my part)
Steven…A few of my own reactions to your comments (not that you asked!)
First, as I mentioned in an earlier post I agree 100% that this is not a simplification of the code and it is my biggest disappointment. I would have loved that to happen. Maybe someday it will, but right now it is politically impossible. I would personally love a “flat” (relatively speaking) tax. Just something like one standard deduction, and a few tax brackets. I see no problem with a moderately progressive system.
However, true tax reform means there will be winners and losers. You can’t do away with deductions / breaks in today’s code and “simplify it”…even if you keep the changes overall revenue neutral…and not have winners and losers. And the media is all to happy to parade around the perceived “losers” and decry how “unfair” it is. (Nevermind that the “winners” would be people are are CURRENTLY the losers with existing tax code…)
Second…you mention the impact of the tax code on specific industries or markets. From where I sit that’s part of the problem. Specific industries should not IMO be considered as part of tax reform. Whatever happens, happens. The guiding principle should be what is “right”…not what specific impacts are. If the housing market happens to react “negatively” to a change in the code…that would only be because they have been getting a benefit to date to prop up the industry to an extent.
I say this as someone who works in the corporate relocation business….and this law is removing the deduction for moving expenses. This can only have a negative impact on our business because it is going to be more expensive for companies to move employees now. Just because it may negatively impact my business…doesn’t mean it’s not the right thing to do.
The purpose of tax code is simple: to raise revenue for the government as efficiently as possible. Somewhere along the line we have lost sight of that and the tax code became a way to in effect “buy votes” and perform “social engineering” experiments…
So I think this is overall a good day. The personal tax code is “overall fairer” IMO (though not simpler), and they at least hacked away at some of the deductions.
Harry Sit says
Steven – You are reading much more than I wrote. This specifically addresses concerns from some readers who thought limiting or disallowing deductions would lead to a large increase in their income tax. It doesn’t pass judgement on who should receive how much in tax cuts. It doesn’t address whether tax cuts are good or bad regardless. It’s more about facts than opinion. If you see any factual errors please point them out.
The tax code itself isn’t simplified but calculating taxes is simplified for many people in practice. I for one will no longer perform these tasks:
1. Find out how much I paid in state income tax
2. Find out how much I paid in property tax
3. Find out how much I paid in mortgage interest
4. Find out how much I donated to charities throughout the year
5. Find out how much my personal exemptions should be phased out
6. Find out how much my itemized deductions should be phased out
7. Find out how much my AMT exemption should be phased out
8. Calculate twice knowing full well that AMT will dominate anyway
That’s simplified. I didn’t add to any lie. You can argue simplified isn’t necessarily better when some other people are getting a much larger tax cut or that higher deficits are bad for the country. I can be convinced of that opinion. However, simplified is still simplified. That’s a fact.
Thanks for the response-
“And the media is all to happy to parade around the perceived “losers” and decry how “unfair” it is. (Nevermind that the “winners” would be people are are CURRENTLY the losers with existing tax code…)” To me the media is not the enemy here and that is my concern. To me as Harry said I am reading between the lines and anyone that blames the media has another agenda altogether. I have friends in the media. Do you? Are the trying to be dishonest? rhetorical question.
“Second…you mention the impact of the tax code on specific industries or markets.” So I agree with you so I wish they handled and stated the corporate tax in the same way then. Instead of claiming corporate deserves a huge cut because they can help. Yet, when it comes to individuals it is implied they should get less. Top-down approach is a recipe for disaster with this and in most cases even in my line of work.
“The purpose of tax code is simple: to raise revenue for the government as efficiently as possible.”
I think this is the only thing we can agree on.
“So I think this is overall a good day. The personal tax code is “overall fairer” IMO (though not simpler), and they at least hacked away at some of the deductions.”
A bad day IMO because we again want to try the trickle down approach which does not work (early 70’s, 80’s, 2000’s) and when the deficit increases, republicans will blame democrats when they try to fix it (raising taxes in 10 years) and in the meantime they will cut health care. I cannot say this enough i am looking at this totality I do not need $500 dollar tax cut nor my company who makes billions and is getting a bigger one than me.
“Steven – You are reading much more than I wrote.”
I agree with you. What one writes and says to me is only half the story. Until Trump that has been the way to understand most people.
“If you see any factual errors please point them out”
What I see are things left out to make a point. Much more clever than just untruths. It is how smart people make a point. Basically exactly what you claim the media to be doing. But for what it is worth I will take you at your word that you did not think this was in anyway slanted in one way which to me implies you bleed deep red. pun.
“The tax code itself isn’t simplified but calculating taxes is simplified for many people in practice. I for one will no longer perform these tasks”
Which is great for you but the deductions still exist. I am also looking at it in totality for others as well. I suppose I could just go by the standard deduction and ignore my rental property to make it simple so I will give you this one.
“I didn’t add to any lie…..However, simplified is still simplified. That’s a fact.”
Except that what you call simplified is an opinion. The tax code still exists in all its glory. we till have many tax tables, we still have the deductions. Whether one chooses to use it or not is the question. Are you not going to have to check each year whether or not your deductions go over the standard deduction or not? If you are saying you are going to take the standard deduction no matter your itemized deductions then that is not simple that is simply Sitting out. pun again.
The other lie that you gave credence for is that the media is out to get you. Why do people blame the media? To me that is piling on to the current President. I think it is best you talk to a friend in the media. You must have one. They are humans who want to do a good job like you and me.
If this article was only to discuss the individual side (and not what was done to corporate taxes or the insurance mandate) then you have done the exact same thing that the media has done that you claim is wrong. I call it lies if you did not use that term that is what I heard. Not sure what else it could be. misinformed? ignorant? Lies at least shows intellect, IMHO.
Harry Sit says
Steven – This is after all a personal finance blog. It’s not a corporate finance blog, nor a political economics blog. If you are accusing me of showing my limits, I’m guilty as charged. To answer your question, I’m not going to check each year whether my deductions go over the standard deduction or not because I know it’s not even close. When it’s that obvious, it’s simplified for me. I don’t think I’m alone. Someone with a larger mortgage will still itemize. Even for them, items 5-8 in my list are still gone.
“To me the media is not the enemy here and that is my concern. ”
To me the media does a disservice when it’s obvious that their purpose is to get an emotional charge out of the public so that they tune in. This is an a-political comment. What do you think makes for more riveting and must-see TV? A 30 minute look at the ins and outs of the tax law and how it really works? Or a 2 minute sound bite about how “your tax deductions are going away!”
“I have friends in the media. Do you?”
Nope. Although in an earlier life I used to date a Squakbox co-host…does that count?
“Are the trying to be dishonest? rhetorical question.”
It shouldn’t be rhetorical. I would say that there is obvious *bias* in either their methods or reporting. But again, the largest single thing they are guilty of is sensationalism.
“Yet, when it comes to individuals it is implied they should get less. Top-down approach is a recipe for disaster with this and in most cases even in my line of work.”
I’m not sure what you mean there. The main purpose of this bill is corporate reform and job creation. The personal cuts are a bonus. Of course the administration is going to tout the personal side…because that is politically popular message. This doesn’t change the facts on what is changed on the personal side.
“I think this is the only thing we can agree on.”
A bad day IMO because we again want to try the trickle down approach which does not work…”
We will never settle a political disagreement here. Suffice to say we don’t agree.
“I cannot say this enough i am looking at this totality I do not need $500 dollar tax cut nor my company who makes billions and is getting a bigger one than me.”
You may not need or want your cut…but if this bill helps with the creation of jobs (which I don’t think anyone disputes…just at what level)…I’m guessing that the difference of having a job or not is likely what that person cares about. Looking at totality indeed.
And finally, since you don’t care about your $500 cut…then I assume you (and those who side with you poltically) also would not mind if you got a $500 tax increase? Tax reform should be simple then…just check the box for what political affiliation you have…and apply separate tax rates. 🙂
Are there any changes to medical insurance premium? especially the ones with HSA?
Harry Sit says
There are some changes to the floor at which medical expenses are deductible. The new temporary lower floor is still high enough that doesn’t affect most people. Removing the penalty for not having insurance may indirectly affect insurance premiums. There are no changes to the HSA.
Does anyone know what this means:
20% of pass-through income can be deducted
Say you had 100k in pass-though income and is was not phased out. Does that mean you take 20K off the bottom line of your taxes? Or does I mean you don’t pay any tax on 20k, then normal rates on 80k?
I suspect it is the second. So then say 33% of 100k is 33k. But 33% of 80k is 26.4k. So you save 7.6K? What a weird way to state the law.
Then on the phase out for Professional Service companies is 315k. Is that wage income? I remember when John Edwards ran for president, he took something like a 500k salary, the 4,5M of pass though income. Could he have just made that 315K of salary and taken the pass-though rate on the rest?
Is the 315K before or after the standard deduction or itemized deductions? Before or after HSA? Before of after Stock gains/losses?
Harry Sit says
The latter. You get a deduction equal to 20% of the pass-through income. The $315k threshold for phaseout is taxable income, which I guess includes the pass-through income and all other income, adjustments, and deductions but before this 20% deduction. Otherwise we get into a circular situation.
I wonder if personal service income from one entity over the cap will hurt pass-through income from another non-personal services entity?
Harry Sit says
From what I read they are added together.
Mark Caspary says
Wow! Some of the comments on this blog have gotten pretty political! To be honest I really don’t care if the people posting are Democrats, Republicans or Independents, I subscribe to this blog because the info Harry makes available helps me with my finances. His blogs are timely and relevant and for that I commend him. People can argue all day about which party is doing the right thing,personally I think both parties have some good ideas and at times have done some good things. The purpose of this blog is not political. To me the purpose of this blog is to understand personal finance issues and then try to figure out how to use the information learned tothe best advantage. That’s what I’m trying to do now with the new tax law and what I did before when the Affordable health care act was passed. If our politicians in Washington can’t be civil then maybe we can set an example for them by trying to be civil here. Politics should best be dealt with in the voting booth. Sorry for the rant but I hate to see something as good as this blog be diminished by politics. Personally I’m just trying to survive financially in this ever changing world and once again I think Harry has been a big help in this regard.
Harry’s blog discussed that the media is at fault for perpetuating only one side (or one part of the tax code) that is against the next tax code yet he only discusses one side. Both he and JDF claim it is fair when it is in fact not fair when you see how much higher income can save more percentage wise than lower incomes and the large tax cut corporations get vs. individual, the fact that corporation tax cuts are permanent and individual tax returns are temporary (done during a 10 year cycle – which is a political stunt – since history shows the parties swap control during those durations). I read a lot of blogs and they do not leave out one side so in my opinion it is an obvious political slant and hard pressed to believe it is by accident. Simply put, intellectually dishonest.
Harry Sit says
I didn’t say anything about fair or not fair.
Fair enough, my last pun. maybe.
Harry’s blog said nothing of the sort. His blog merely addresses the question that was oft posed to him (ever since the framework of Trump’s tax plan was made public) “what will happen to my taxes since they are proposing getting rid of deductions X, Y, Z”. If you care to read his blog post again, the point is you can’t just look at the loss of a deduction and start to panic. You need to look at the tax code as a whole to determine the impact on your individual taxes.
It’s simply the facts. He is not “taking a side.”
Now, if you want to ask another question “why is it that everyone was panicked about the loss / limitation of the SALT deductions in the first place?”, then you will get into the politics of the situation…which is not really appropriate for this blog / forum.
Scott R says
Steven, at the risk of getting us into a political discussion, what is “fair” about a higher income person paying more in taxes percentage-wise? For that matter, how is it “fair” for taxes to be paid based on a percentage to begin with? If person A makes $100,000 and pays 20% in taxes ($20,000) and person B makes $50,000 and pays 10% in taxes ($5,000), how is that “fair”? Does person A cost the government $15,000 more per year?
A “fairer” tax might be one where everyone pays the same *amount*.
Harry Sit says
Fair or not fair, good or bad, how will something affect different parts of the economy, … these will never be resolved here, or anywhere else for that matter. That’s why I just don’t go there. We have enough difficulty in just getting to the bottom of facts.
How you can interrupt what I said about the poor getting less of a tax cut to it being ok that the rich getting a bigger tax cut. Rhetorical question.
You are the one that needs to read Harry’s post again; his words:
“…The media and interest groups will always push us to look at only certain parts. …”
The people who were pushing this as tax reform (which it is not) and a tax cut for middle class (which it is not) were the Republicans. Anyone else pushing back was against the American people and Harry’s comment above justifies the lie that the media is at fault for the hysteria. If you read the comments of the others you will see the Trumpers are ecstatic of this post and the rest of us not so much. Just as Harry focused on the personal side the media focused on specifics that made sense for a 5-minute TV show. Are for one knows that having a media presence poking at tax reform bill is necessary and important and should not be accused of another agenda. I would expect someone who writes as a “hobby” would respect that. From what my reading comprehension gleaned in this post that is not the case. And the trumpers on here loved it. Harry showed his hand you two are not only ones that can think for themselves.
1) This is tax reform. It may not be reform the way you would like it to be reformed. It may not be reformed the way I would like it to be reformed. But is is reform. This is just a fact.
2) I am part of the middle class…I am getting a tax cut. Most people (including middle class) are getting a tax cut. Again, a fact.
I am really not sure what point you are trying to make. But the fact that you see a blog post that does nothing but explain the facts of the situation…and you see that post as somehow “exposing” what…a political bias or something….says more about YOUR political bias than anyone elses.
No one claimed that you can’t think for yourself. We all have our opinions. The point is, can you present *facts* that challenge Harry’s conclusions?
Scott R says
So, another question…I know that the personal tax changes expire in 2027 (?), and I get that that’s a political procedural thing related to how they decided to get this through quickly. I’m not worried about the future…we’ll see what happens as that date approaches.
But I was just reading an article which stated that they “reduce over time” up to that 2027 date. They offered no further explanation, so I’m wondering ‘how so’? I *believe* it has to do with certain changes not being tied to the rate of inflation and/or being tied to a *different* rate of inflation going forward.
Can someone provide more details/thoughts on that? How noticeable of an impact would you expect that to have in year 2 (2019)?
Harry Sit says
It refers to the tax brackets being indexed to the chained CPI versus the “regular” CPI. The difference is very small. In 10 years maybe 2% of your income will be in this bracket versus that bracket, increasing your taxes by maybe 0.2% of your income. That’s another thing where the magnitude must be considered together with the direction. Directionally taxes go up over time but hardly noticeable.
multiple times you referred to “high income but not super-high income” comparison. Could you give me an idea where the border between these two is in your mind? At least approximately, on ball-park level?
Based on information in other articles, I am guessing it is likely to be around $400K per joint return, but interested in your opinion.
I can’t speak for Harry of course and his subjective thoughts about where that boundary lies…but he seemed to draw the line around those paying AMT (under the old plan) and those that make so much income that AMT would no longer impact them. So that becomes an interesting data point.
This will vary depending on individual circumstances…but in the scenarios I ran:
– Married / joint return
– 2 children (1 qualifying, 1 non-qualifying)
– NJ Income Tax
– Property tax of $16,000
– Mortgage interest of $12,000
You start paying AMT at around $209,000
You stop paying AMT around $625,000
So then somewhere around $625K is “the line” between “hgh” and “super-high” earners. This is about where I would personally draw the line….for my state.
At $400K, you are actually right in the middle of AMT land, and this is where the new plan actually delivers the largest tax cuts for the scenario above.
Harry Sit says
Certain breaks mentioned in the post start going away at higher income levels. For MFJ, the $2,000/child tax credit disappears at mid-$400k. The marriage penalty starts again at $600k. AMT may reappear after $1 million (although the regular tax at that point may be so high that makes AMT still not an issue). I would say at maybe $750k someone can see a net negative.
A lot of overly dramatic posts here. As a resident of a blue state, I kept hearing about the doom and gloom from the media. I pulled out my latest tax return and did my calculations using the new tax law. My tax is lowered even accounting for the $10 K ceiling for SALT and property taxes.
Are you sure about the cap of 10,000 that includes all deduction? I think that cap is only for SALT (state and local taxes) and mortgage interest deduction is not part of it. For mortgage interest deduction the loan value is capped at 750,000. That’s what I gathered from the what I read.
Harry Sit says
Where did I say the cap of $10,000 includes all deductions? You are correct. It only applies to SALT.
Just so there’s no confusion , the reduction of the mortgage interest deduction (from a max principal of $1M down to $750K) applies to new mortgages. Existing mortgages are grandfathered at the $1M cap. (You may be aware of this, but just for the sake of anyone reading along.)
M. And says
Just wanted to jump in here to remind everyone that corporate tax cuts actually decrease the incentive to create jobs.
The reason? Corporations already get a 100% tax break for every dollar that they pay in wages. If they hire a worker and pay him, that money is an expense and is not subject to corporate income tax. When corporate incomes taxes are high, a corporation has an incentive to hire more people because, if they don’t hire and pay the money out in wages, some of it is going to be paid in taxes anyway.
However, when taxes are low, the incentive to hire changes. As it becomes cheaper to hold onto the money and pay the corporate income tax, the incentive to hire is reduced, and there’s actually an incentive to fire and layoff people.
Now obviously, these incentives must interact with the needs of the market. A company that really needs more employees is going to hire, regardless of the tax incentives. And a company that really doesn’t need as many employees is going to lay people off.
But, the impact of taxes do matter. Several years back, lots of small business owners were buying SUVs that weighed more than 5,000 pounds, becuase the IRS allowed you to depreciate them 100% in the year bought. People spent $50k (and more) on a gas guzzler solely because it allowed them to take the tax deduction sooner than they otherwise would have.
There’s simply no doubt that reducing the corporate income tax will make laying off workers more desirable and make hiring workers less desirable, all other factors being equal.
This new tax plan is really designed to benefit corporations and shareholders (who are the real beneficiaries of higher corporate incomes). Their tax reductions are much larger, both in terms of percentage and real dollars, and are permanent. The individual reductions are smaller, both in terms of percentage and dollars, and are only temporary.
“There’s simply no doubt that reducing the corporate income tax will make laying off workers more desirable and make hiring workers less desirable, all other factors being equal.”
I can agree with that…however…all other factors are not equal. They never are. The bottom line impact of getting a reduction in taxes is you have greater net profit. So now corporations have to decide what to do with the extra cash.
I fully agree higher or lower tax rate in and of itself is not a major factor to hire or fire people. A company will react to the market and hire accordingly (as you said.)
But having more money to spend gives the corporation more options. You may accelerate plans to expand your business…which in turn requires more employees sooner rather than later.
It’s no different than in a private household that receives an unexpected bump in net income. You have more options. You might accelerate retirement…plan to save more for kids education…pay off the mortgage sooner…do a home improvement sooner rather than later…contribute more to charity….or buy shiny toys.
M. And. says
“The bottom line impact of getting a reduction in taxes is you have greater net profit. So now corporations have to decide what to do with the extra cash.”
No, you’ve got it wrong. When a corporation realizes a profit, it has already decided not to do **anything** with the cash. If the corporation wanted to do something with the cash, it would have spent the cash on an expense (salaries, automation, or whatever), realized no profit, and paid no tax. The existence of the tax creates an incentive for the corporation to spend its income so that it realizes no profit and pays no tax. The higher the tax rate, the greater the incentive is.
It is the exact opposite of the situation with human beings. For human beings, most expenses are NOT deductible from income. Human beings pay income taxes whether they spend the money or not. Giving a human being a tax break means that the human being actually has more money to spend.
M. And. says
Stated another way, corporations have their entire revenue to spend. If they spend it all on expenses they pay NO TAX. They only pay tax if, at the end of they year, they have money left over. That’s because for corporations, almost all of their expenses reduce their taxable income, i.e. rent, supplies, raw materials, electricity, natural gas, cars, etc. For corporations, all of those things are bought with pre-tax income. The existence of the tax encourages a corporation to spend its money NOW, rather than realize the income and pay the tax. The greater the tax, the greater the incentive.
The exact opposite is true with human beings. Human beings income is measured generally by take home pay. Most of the expenses that humans incur, i.e. food, clothing, rents, cars, etc., are paid with post-tax income. You only have what is left over after taxes to pay for those things. As a result, a tax reduction actually gives a human being more money to spend.
There are a few examples of where humans are allowed to spend pre-tax income. You can contribute to retirement accounts and pay mortgage interest (up to $750,000 now) with pre-tax income. The effect of allowing those deductions is that it encourages humans to spend their money on those things and avoid the tax. But, the incentive to do so varies with the amount of the tax. If the income tax on human beings was only 1%, there’d be very little reason to put money into a retirement accounts or take out a mortgage. If, on the other hand, the top income tax rate was 90% (as it was in the early 1900s), there would be a very high incentive to take advantage of those deductions.
Since most corporate expenses are also pre-tax, the same principles that I discussed above with respect to humans applies to corporations. The higher the corporate income tax rate is, the more incentive corporations have to spend the money pre-tax, i.e. by creating jobs, buying machines and materials, expanding operations, etc. As the tax goes down, the incentive to do those things goes down as well.
And I haven’t even gotten to the fact that when corporations (and people) pay taxes, the money doesn’t just go into the toilet. The government spends 100% of every tax dollar it gets. So, every dollar that is paid in tax actually gets injected back into the economy.
And government tends to spend it on things that have an economic multiplier effect that truly does benefit the entire economy more than private spending. But, that’s really off-topic of the initial point, which is that high corporate income tax rates incentivize corporations to incur expenses (wages, etc) and avoid the tax, and low corporate income tax rates do just the opposite.
Scott R says
I couldn’t disagree more. The government spends money inefficiently and spends a significant amount of money on things I disapprove of. The less of my money the government gets, the better, IMO.
Also, you sure paint a beautiful picture of how wonderful it is to tax corporations at a high rate. I guess it would be even better to tax their profits at 100%.
M. AND, says
There are sound reasons not to go to 100%, or to not get there until profits are fairly high. But, the US has had tax rates as high as 90% and still had very strong growth. These kind of taxes are typically called windfall profits taxes.
The fact that you disapprove of certain spending doesn’t mean that the spending is inefficient, it is more likely that your disapproval is wrong. Government is a far more efficient spender of money than individuals, and even corporations. To be sure, governments waste money. But, so do individuals. And corporations waste even more, see e,g, Enron and The Wolf of Wall Street,
And it is a fact that the places in the world with the highest total tax burdens (taxes of all kinds) are the nicest places to live, while the places with the lowest taxes are the worst. Compare Haiti (low tax) to Switzerland (high tax), or even California (high tax) to Mississippi (low tax). The differences in quality of life can be explained almost entirely by government spending levels on education, infrastructure, and social welfare.
Would anyone care to comment on capital gains taxes under the new law? I believe the rates are the same, but I thought I saw one WSJ article that the brackets expanded, so the 15% rate applied to higher incomes. I’ve gone back to look but could not verify that.
Harry Sit says
They will stay the same. The article you read probably referred to the brackets for long-term capital gains stay at the old levels and therefore the cutoff for the 0% rate will be different than the top of the new 12% bracket. The starting point of the 20% rate will be different than the top of the new 32% bracket or the top of the new 35% bracket. Those cutoff points stay the same as before in dollars. They are just no longer linked to the new brackets for ordinary income.
Ah, thank you for the confirmation and clarification.
I just saw a note on Vanguard that confirmed my earlier impression. As you say, the capital gains rates are the same and delinked from the tax brackets. But the 15% bracket now applies up to $479K of AGI. Pretty significant increase if I am reading it right.
Harry Sit says
It’s already $470,700 for married filing jointly in 2017. Increasing to $479k is just normal adjustment for inflation.
I just figured out my mistake: the 2017 table reads “above $76k” for 15% and “above $470k” for 20%, whereas the 2018 table reads “below $479k” for 15%. I was just reading it wrong. Thanks for your patience.
Looks to me like middle class families up to about $200-$250k who already itemize will pay about the same. This is due to loss of personal exemptions offsetting the small rate reduction. In my case, I pay a little more because I’m a family of five. If I was a family of four, then I’d pay a little less.
Many similar families making upwards of $500k could save much more as the small rate reduction nets them more cash. Some of them will see their gains offset by the new SALT limits though depending on locality.