How the Trump, House Tax Proposal Affects You

Back in late September the Lexington Financial Planner blog wrote about how President Trump’s tax proposal would affect you. Now, the House Ways and Means Committee has revealed their tax bill so let’s take another look. No talking points, no politics, just math. Uh, fun math. No, seriously.

While the income subject to tax may be higher for many of us, at least those of us with those pesky kids, our overall taxes may be changed little because the tax rates are spread out farther among brackets. See below for the proposed new rates based on taxable income:

While it’s impossible to capture every person’s circumstances, let’s take a middle of the road example and apply the new proposal. So, as in September, let’s start with our fictitious couple and how much they pay under current tax law:

Current law:

Chandler and Monica earn a combined $125,000 in salary and each contribute 5% pre-tax to their employer’s retirement plan. For simplicity sake, we’ll ignore other pre-tax deductions like their pre-tax cost of their employer’s health insurance plan, and call their Adjusted Gross Income (AGI) $118,750. (Gross income minus their retirement contributions) Unlike our friends on TV, they have two children.

Under current law Monica and Chandler have a choice between subtracting the standard deduction of $12,700 from their AGI or itemizing deductions. As you can see below, their itemized deductions are more than their standard deduction, so they obviously deduct the larger amount:

• Mortgage interest deduction – $5,578 (Interest paid on their $200,000 house where they still owe $150,000)
• State and Local Income tax deduction – $9,797
• Property tax on their home – $2,000
• Charitable contributions – $1,000
• Total: $18,375 (clearly more than the standard deduction of $12,700)

In addition to their itemized deductions, Monica and Chandler are also allowed to deduct $4,050 each as personal exemptions plus dependent exemptions for each of the kids, for a total of $16,200.

Finally, their AGI of $118,750 minus their itemized deductions of $18,375 minus their personal exemptions of $16,200 equals Taxable Income of $84,175 and Tax Liability of $12,521.

New Proposal:

Although mortgage interest and charitable contributions are still allowable as itemized deductions, state and local income tax deductions are not allowed. Property tax up to $10,000, however, can be included as an itemized deduction.

• Mortgage interest deduction – $5,578 (Interest paid on their $200,000 house where they still owe $150,000)
• Property tax on their home – $2,000
• Charitable contributions – $1,000
• Total: $8,578 (now less than the new standard deduction of $24,000)

Monica and Chandler are no longer allowed to deduct $4,050 for their 4 personal and dependent exemptions because those have been rolled into the proposed standard deduction.

As a result, Chandler and Monica find their itemized deductions are lower than the proposed new standard deduction – $8,578 is lower than $24,000 – so they use the higher number.

Finally, their AGI of $118,750 minus the standard deduction of $24,000 equals their taxable income of $94,750. Based on the new, compressed tax brackets it appears their tax liability would be $11,988 – a tax savings of $533.

In addition, the tax plan highlights indicate an increase in the Child Tax Credit but it doesn’t contain details about how those credits will apply. The credit for their two children could lower their tax liability further.

Key Takeaways:

• Thankfully, and correctly, the proposal keeps the current deduction levels for retirement plans such as 401(k)’s, 403(b)’s, 457(b)’s ($18,000 for those under 50, $24,000 for those 50 and over) and IRA’s and Roth IRA’s ($5500 for those under 50, $6500 for those 50 and over). That’s very good news and good for those of us without a traditional pension (most of us).
• Although a married couple with two children will likely have lower overall deductions than they do now, the lower tax rates may very well lower their overall tax liability.
• Those without children will likely see their deductions increase, and their overall tax liability decrease.
• For those of us with children under age 17, the child tax credit increases but details are still sketchy about any phaseouts based on income.
• The tax rates on capital gains and investment income from taxable investment accounts remains the same.
• For those high earners and those with stock grants from their employers, the Alternative Minimum Tax is eliminated.
• The mortgage interest deduction only applies to mortgages of $500,000 and less where the current amount is $1M.