It's been a year since President Trump signed the tax reform bill into law. The legislation included plenty of favorable provisions, including lower tax rates and boosts to standard deductions and tax credits for families. However, it also eliminated or scaled back some tax breaks that many people took advantage of, and even some upper-income taxpayers pointed to those offsetting provisions as potentially causing them to pay more under tax reform.
It's impossible to generalize about the effect of tax reform, because every individual taxpayer's situation is unique. But by making a few assumptions, we can take a look at how tax reform would affect upper-income earners making $250,000. Then, it's up to you to decide whether the assumptions fit your financial situation -- or whether the details could turn what looks like a promising result into a tax nightmare.
Image source: Getty Images.
The simplest cases
Let's start out with an example that's about as simple as possible. Say that you're single and had income of $250,000. You take the standard deduction and have no dependents. Here's what tax reform looks like for you.
|
Item |
2017 Tax Year |
2018 Tax Year |
|---|---|---|
|
Gross income |
$250,000 |
$250,000 |
|
Standard deduction |
($6,350) |
($12,000) |
|
Personal exemption |
($4,050) |
N/A |
|
Taxable income |
$239,600 |
$238,000 |
|
Tax |
$65,900 |
$58,990 |
Calculations by author based on IRS rules.
As you can see, tax reform would save this taxpayer almost $7,000. The reason is simple: Under old law, a lot more of this income got taxed at 25%, 28%, and 33%. Even though the brackets for 2018 tax some of this income at a higher 35% rate, most of it is subject to lower rates of 22%, 24%, and 32%. The higher standard deduction offsets the loss of the personal exemption.
Now, let's take a look at a typical family situation. Say you're married and file jointly, with total income of $250,000. You have two children who are young enough to qualify for the child tax credit, but you are entitled to no other credits and take the standard deduction.
|
Item |
2017 Tax Year |
2018 Tax Year |
|---|---|---|
|
Gross income |
$250,000 |
$250,000 |
|
Standard deduction |
($12,700) |
($24,000) |
|
Personal exemption |
($16,200) |
N/A |
|
Taxable income |
$221,100 |
$226,000 |
|
Tentative tax |
$48,793 |
$42,819 |
|
Tax credits |
$0 |
$4,000 |
|
Net tax owed |
$48,793 |
$38,819 |
Calculations by author based on IRS rules.
Here, the savings is almost $10,000. Roughly $6,000 of that comes from the lower tax rates that apply to income under the new tax laws, but another $4,000 comes from the fact that this upper-income family now gets to claim the child tax credit, because of the big increase in the income threshold that used to prevent many high-income taxpayers from getting it.
Your mileage may vary
However, it's dangerous to draw too many conclusions from these two examples, because they're too simple to be realistic for most people. Among the reasons why are:
- Once your income gets this high, you're much more likely to itemize your deductions. As a result, the boost in the standard deduction did many high-income taxpayers little or no good in terms of seeing any additional tax savings.
- Adding insult to injury, provisions that limited the use of popular itemized tax deductions like the state and local tax deduction might actually reduce total deductions available to many taxpayers, especially in high-tax states. Again, the wealthy are more likely to own expensive real estate and the high real-estate tax bills that come with it, and state income taxes are often structured progressively to charge higher rates to upper-income residents.
- On the other hand, the examples above don't involve any liability for the alternative minimum tax. Many real-life situations do, and for many, revisions to the AMT will lead to its no longer affecting many taxpayers earning around $250,000.
- The size of one's family also makes a difference. The more children you have, the greater the impact of losing personal exemptions to reduce tax liability. Whether the child tax credit makes up for that depends on the age of those children and other factors.
Be smart with tax reform
Although many upper-income taxpayers making $250,000 per year will see savings from tax reform, you'll need to take a close look at your own situation. Some could save even more from tax reform than the examples above suggest. But for some, the new tax laws could end up costing them money. Given all the complexity that wealthier individuals have in their financial lives, what holds true for some won't necessarily be the case for you, and you'll want to assess the results to see how you can plan better for your taxes in 2019.
