If you've ever listened to the classic Christmas carol and thought, "Thank goodness nobody ever bought me three french hens or seven maids a-milking," we understand. But Congress just gave America an even more complicated present, and there's no gift receipt.
So in this episode of Motley Fool Answers, Alison Southwick and Robert Brokamp are here to help you install that brand new tax code with an even dozen tips. And to put them in an even more user-friendly format, we've divvied them up. The first four cover timing, tax brackets, Congressional trickery, and the odds that you'll itemize in April 2019.
A full transcript follows the video.
This video was recorded on Dec. 26, 2017.
Alison Southwick: The U.S. is passing the most significant reform of our tax code since 1986.
Robert Brokamp: Can I just dispute that?
Southwick: Oh! Really?
Brokamp: Yeah, I would put it more along the lines of the 2001-2003 Bush tax cuts that were also pretty significant.
Southwick: OK. Well, I only researched 1986. Do you know what was the No. 1 song in December of 1986?
Brokamp: Um, "Der Kommissar."
Rick Engdahl: "Take On Me."
Southwick: It was The Bangles, "Walk Like an Egyptian."
Brokamp: Oh, good!
Southwick: Yup, those were the days, huh?
Brokamp: Those were the days. It's a good song.
Southwick: I digress. But fast-forward 31 years -- yes, 31 years -- and now all we listen to is Ed Sheeran, apparently? Get off my lawn, Ed Sheeran. Anyway, what was I saying? Someone hand me my cheater so I can read my notes here. Oh, yes, tax reform. It's been more than 30 years -- oh, Bro's going to argue that -- since a big overhaul of our tax system and Bro's going to help us break it all down. But first, you have a word of explanation for our listeners? A disclaimer, if you will?
Brokamp: Yes, well, a couple of disclaimers. First of all, as we are recording this, it's still not officially law yet. It hasn't been signed, so things can change. Who knows what will happen? The bill itself is very long. We're boiling it down to the things that we think are most applicable to our listeners, but you definitely want to do some more research. Maybe consult a tax pro before you make any major changes.
Also, some of the most significant changes affect businesses, but we're not going to talk about that. We're going to talk about the stuff that affects most individual taxpayers, but if you own a business you definitely should consult a tax pro, because there's a lot of stuff in there and you want to understand how it will affect your business.
Southwick: All right. We are calling this "The 12 Days of Taxmas," because, of course, it's the holidays and we were able to scrounge up 12 things that people need to know.
Brokamp: Yes, absolutely.
Southwick: Credit to Mrs. Brokamp for coming up with that name.
Brokamp: It was her idea.
Southwick: It's pretty great. All right. So, on the first day of Taxmas, you need to know that any changes begin in 2018.
Brokamp: Right. So virtually all these things are happening in the future. Very few things -- in fact, only one thing that I know of -- is retroactive. The only thing that is retroactive is the medical deduction. You can deduct -- current law; this is before the new law takes place -- medical expenses that exceed 10% of your adjusted gross income.
This law, the new law, actually lowers it to 7.5%, and as far as I know the only thing that's retroactive -- I was trying to think who in Congress is getting a lot of medical expenses this year that they want to write off. But anyway, everything else happens for 2018. So as you prepare your 2017 taxes, don't worry about this new law. It doesn't affect you.
And by the way, your 2017 taxes are due April 17 of this year, not April 15. We get two extra days because April 15 happens on a Sunday and Monday is a holiday in the District of Columbia. So two extra days to get your taxes done.
Southwick: Not bad. On the second day of Taxmas, Bro wants you to know that your tax bill will probably be lower next year.
Brokamp: Yes. Most analyses find that for the vast majority of Americans, their taxes actually will go down. Depending on which analysis you read, it's about 10% or so of people whose taxes will go up, but for most people they'll go down.
Why will they go down? Well, it starts with new tax brackets. The tax brackets, first of all, are lower, and it takes more income to get into a higher tax bracket. I'm not going to go through all the tax brackets. I'll just give one example that probably applies to a lot of our listeners.
Let's say in 2017 you're married, and your taxable income is greater than $77,000 but less than $156,000. You're in the 25% tax bracket. Next year, in 2018, that will be 22%, so it's lower for that, plus you stay in that tax bracket up until you earn $165,000. And again, I say "earn," but this is really your taxable income. So it's your gross income minus all your deductions and all that stuff.
So the tax rates are lower, plus as you earn more, it takes more to get into the next tax bracket. The biggest difference is the highest tax bracket. To be in the highest tax bracket in 2017 and married, you needed about $480,000. Starting in 2018, to move to the highest tax bracket you have to get over $600,000.
Also, one thing that's mostly eliminated in the new tax law is the marriage penalty. That basically means that as a married couple, combining your incomes you probably paid more in taxes than you did if you were separate individuals, but that's disappearing for most people with this new tax law.
So who are the type of people who are likely to pay taxes? Generally speaking, it's probably people who live in high-tax states, because they're limiting the deduction for state, local, and property taxes to a combined $10,000. The people who are most likely to pay more taxes are those who are not going to be able to deduct as much of those taxes.
But some analyses have found other situations where people will be paying more. One analysis I read about today said about 7% of middle-income taxpayers will actually be paying higher taxes, too.
The solution for anyone who wants to know where they are is just google something along the lines of "new tax law calculator." Lots of folks are coming out with calculators where you put in your information and it gives you a good idea of what your taxes will be under the new tax law.
Southwick: So while chances are your tax bill will be lower next year, it's not going to stay lower forever.
Brokamp: No. The lower tax rates for businesses are actually permanent, but the reduction in tax rates for individuals will, as they say, "sunset" after 2025. In other words, they just go back to what they were in 2017. They did this because, as most of us know, they had to keep the cost of the bill under $1.5 trillion over 10 years, and one of the tricks they did was to say some of these things sunset or go away eight years from now, with the belief that before that happens, a future Congress will make these tax cuts permanent. Who knows? Historically it's sort of a mixed record on whether such things happen, but generally speaking, you should know that the individual changes do go away after 2025.
And one other thing they changed was how they adjust tax brackets. According to prior law, tax brackets are adjusted for the Consumer Price Index or inflation, so they go up a little bit every year. The tax brackets are now going to be changed to a different measure of inflation called the changed CPI. They're not going to rise as much, so as your income increases, more and more people are going to creep into the higher tax bracket than under the former formula.
Southwick: On the fourth day of Taxmas, Bro wants you to know that fewer taxpayers will itemize.
Brokamp: Right. A lot of the deductions that people take are going to go away -- many of the miscellaneous itemized deductions like casualty losses, and tax-prep fees, and advisor fees. They're going to eliminate personal exemptions. However, they're also going to nearly double the standard deduction that anyone gets just for being a taxpaying American. They're going to double it to $12,000 for individuals and $24,000 for married couples.
Because of the higher standard deduction, fewer people will itemize. Currently about 30% of people itemize. Once this bill is enacted, the estimates are that only about 10% of people will itemize. What that means is for many people who now get value from some itemized deductions -- one of the biggest being mortgage and another one being charitable contributions -- chances are, depending on your situation, you may no longer get a tax benefit from that, because it doesn't benefit you to itemize.