On Friday, President Trump signed into law the the 2017 Republican Tax Bill (formally the “Tax Cuts and Jobs act of 2017”), which many consider to be the largest corporate tax overhaul in US history. The bill’s effects reach far beyond corporations however, as many of the provisions will directly affect individual households in the coming years. Fortunately, the overhaul did not come as a surprise to most due to the heightened media attention it received as it made its way through Congress and the likelihood of it passing increased. Yet, many are still scrambling to figure out just how the bill affects them and their family. Unfortunately, due to the complex nature of US tax law, the bill’s effects vary widely, even between two individuals with similar incomes, living in the same state, making it impossible to summarize the individual effects within the lines of an article. But, by examining some of the bill’s most controversial changes, we can better inform our financial decisions going forward, and ultimately decide which groups are most helped and which groups find themselves holding the short end of the stick.
In general, just about everyone will see an immediate benefit from the bill in the form of lower taxes paid to the IRS, regardless of which of the seven taxable income levels they fall into according to CNBC and per the Washington Post as many as 86% of American will see slightly larger paychecks after January 1st, 2018.
The picture illustrates that while just about everyone will benefit, those that make the most money, stand to benefit most next year, but more on this later. While most, if not all, of the corporate tax saving provisions, were made permanent, just about all of the provisions directed at individuals were implemented with a “sunset clause” meaning that many of the tax savings we’ll see next year will go away if Congress fails to protect them in the future. Even with this protection, many of us that see a benefit next year will still pay more in taxes as early as 2021.
You’ll notice that the reversal becomes even more prominent in 2027 as more income classes become subject to tax hikes. You’ll also notice that in each year, the country’s highest earners are protected from adverse effects.
This brings us to the next point, that while just about everyone will benefit from the tax cuts in the near future, high earners stand to gain disproportionately because the bill takes into account not only how much someone makes, but also how the money the is earned. As mentioned above, two individuals earning similar income’s can pay very different tax amounts, and one reason is due to the way the income is earned. People owning businesses considered “pass-through” entities (think S-Corporations, partnerships, etc.) are entitled to deduct 20% from the taxable income earned through these businesses. To illustrate the potential difference, imagine Michael and Sarah are two professionals both earning $250,000 per year. Michael, a VP at a tech startup, earns his wages the same way that most of us do – by trading his hours for dollars in the office. Sarah however, has done really well for herself and has started a successful sports marketing agency, which she uses to pay herself each year. If we assume that the typical effective or average tax rate for someone in their income level is 30%, both would pay $75,000 in taxes and take home $175,000. However, because Sarah is a business owner, and entitled the 20% deduction, she would only pay taxes on $200,000 (or 80% of the $250,000 her business earned). She would then pay $60,000 in taxes and take home $190,000. As you can probably imagine, the differences are even greater with more successful companies which could be saving millions in taxes, barring certain limits that are in place regarding wages paid and assets in place.
Wealthy families should also consider taking advantage of another benefit afforded to them under the new bill. Unfortunately again, this will not apply to many of us, but families can now pass down about $22 million annually if married, or $11 million if single, to their heirs – free of taxes. This is up from the $11 million and $5 million exempt from taxes under the current plan for married couples and individuals, respectively. This is one of the provisions that is set to “sunset” so if you find yourself in this fortunate situation, I would recommend taking advantage of this change before it goes away.
High earning and wealthy families will undoubtedly reap massive benefits from the tax changes, but others will be happy to know that many provisions will work in their favor as well. For instance, the number families that will owe nothing in taxes will increase from about 44% under the current plan to 47.5% under the new, in the first year. Working class and low-income families will also find that the refund they are entitled to increases significantly from $1,000 per child to twice that amount, and because this is a refund, even families that do not owe the government at tax time will still receive some benefit. Perhaps most notable for millennials is that the standard deduction that most of us claim because we don’t like keeping track of itemized receipts throughout the year, will double. The downside here is that people have lost the option to claim many of the deductions that they otherwise would have. These include many of the deductions that fall under State and Local Tax or “SALT” umbrella, which are limited to $10,000 under the new tax plan, but which are currently unlimited and often provide families with more than a $10,000 benefit.
Regardless of which side of the table you find yourself on, wealthy, middle class, or lower income, the ultimate takeaway should really be this: To the extent possible, do not rely on the government (or anyone else) for the future of your financial well being. This applies not only to tax policy, but also to pensions (companies and governments, alike, occasionally fail), social security (which may or may not be around when many of us retire), and any other benefit that you may be counting on. So what can you do? Start by taking advantage of the policies we have in place now. One of the reasons financial security is so difficult to achieve is because it’s game with changing rules. Just as we get close to the goal, the target changes and forces us to reevaluate our approach. Today’s tax policies differ from yesterday’s and I’m sure future policies will differ from those today, but we can’t rely on this excuse. Regardless of government policy and who is in office, we always have control over our spending and saving habits. By making sure these are aligned with our long-term goals, we’ll be best prepared the next time the bull’s eye moves.