We’ve barely begun the new year, but you may already have your 2018 tax return on the brain — and for good reason. Between new tax brackets and drastic changes to deductions, you might be wondering: What does all this really mean for my tax bill next year?
Because the tax law changes are so significant, it’s a good idea to think early about what adjustments you should make so that you won’t be taken by surprise come next April. Here are some of the biggest changes that could affect your individual tax return.
LOWER TAX BRACKETS
What’s Changed: While there are still seven tax brackets, they’ve all shifted downward slightly, which means nearly everyone will be in a lower tax bracket for 2018 than they were in 2017.
For the 2017 tax year, the tax brackets were 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent.
For 2018, the new tax brackets, along with their corresponding income ranges, are:
- 10 percent (up to $9,525 for individuals; up to $19,050 for married couples filing jointly)
- 12 percent ($9,526 to $38,700; $19,051 to $77,400)
- 22 percent ($38,701 to $82,500; $77,401 to $165,000)
- 24 percent ($82,501 to $157,500; $165,001 to $315,000)
- 32 percent ($157,501 to $200,000; $315,001 to $400,000)
- 35 percent ($200,001 to $500,000; $400,001 to $600,000)
- 37 percent ($500,001 and up; $600,001 and up)
Lower tax brackets mean a lot of us could see more take-home pay. But with all the other changes to deductions and exemptions, don’t assume that you will owe less in tax. “It could be a false comfort, because you could end up owing more at the end of the year,” says Ken Elbert, an advanced planning attorney with Northwestern Mutual.
What You Can Do: The changes in deductions and exemptions mean that you may need to make adjustments to your withholdings on your W-4. The IRS recently updated its withholding tables for employers and is working on a new tax calculator, scheduled to go up online by the end of February, to help you determine whether you might need to change your withholdings. Watch for updates on this front and make sure you reset your withholding amount correctly. “If you don’t withhold enough, you may owe penalties on top of having to write a hefty check to the IRS,” Elbert says.
HIGHER STANDARD DEDUCTION
What’s Changed: The standard deduction — the amount you can deduct from your taxable income if you decide not to itemize — has doubled, from $6,350 to $12,000 for individuals, and from $12,700 to $24,000 for couples filing jointly.
What You Can Do: Depending on your tax situation, you may want to think in two-year cycles. For example, if you want to itemize deductions in 2018 but don’t have enough to get over the new standard deduction, you may be able to give two years’ worth of charitable contributions before the end of the year, or pay two years’ worth of property taxes if your local laws allow it. You could then itemize your deductions in tax year 2018 and choose to take the standard deduction in 2019. “Traditionally, people have thought one year ahead for income tax planning, but now, it’s a good idea to look at least two years ahead so you can decide when to bunch and itemize,” Elbert says.
Of course, this type of planning has to take your whole financial situation into consideration, so consult with your tax and financial advisor before deciding what to do.
ELIMINATION OF PERSONAL EXEMPTIONS
What’s Changed: Like the standard deduction, a personal exemption is a set amount that helps lower your taxable income, and you can claim a personal exemption for yourself, your spouse if you’re filing jointly, and any dependents. For tax year 2017, the personal exemption is $4,050, which means that a married couple filing jointly with two children could lower their taxable income by $16,200. Personal exemptions have been eliminated under the new tax law for 2018 and beyond.
What You Can Do: Be aware that this change could cause some people’s taxes to go up, particularly people who have children. “The higher standard deduction may not fully offset the loss of personal exemptions,” Elbert says.
While you will lose the ability to take a personal exemption for children in 2018, you can take a higher Child Tax Credit, which has gone up from $1,000 to $2,000, along with a $500 credit for any adult dependents you may have, like an aging parent. But this credit starts to phase out for single parents making $200,000 or more, and married couples making $400,000 or more.
CAPS ON STATE AND LOCAL TAX DEDUCTIONS
What’s Changed: You can deduct a combination of state and local income taxes and property taxes, or, alternatively, a combination of state and local sales taxes and property taxes, up to a total of $10,000. Previously, these deductions were unlimited.
What You Can Do: As mentioned above, you may be able to pay two years’ worth of property taxes in the year that you plan to itemize your deductions. For instance, if you receive your 2018 tax assessment in December 2018, you could pay the bill in 2019. Then when you receive your 2019 tax assessment the following December, you could pay that before the new year rolls around. Just wait until you actually receive an assessment, Elbert says, because the IRS says prepaying an estimate of anticipated taxes is not deductible. Also, the benefits of bunching your deductions really depends on the state you live in — in some states where property taxes are really high, it may not make much sense. So be sure to talk to a tax professional before deciding what to do.
Also worth noting: The cap on state and local property tax deductions only applies to personal residences, so if you have a second home that you don’t use very often, consider renting it out. “If you have a rental property that you treat as a business,” Elbert says, “you may be able to deduct your expenses against that income.”
MODIFIED AMT THRESHOLDS
What’s Changed: The alternative minimum tax, or AMT, is a separate tax that is calculated for higher-income households. If you’re subject to it, you’ll pay the higher of either your regular income tax calculation or the AMT. The new tax law keeps the AMT, but raises both its exemption amount (to $109,400 if you’re married filing jointly, and $70,300 for other types of filers) and the income at which the exemption starts to phase out ($1 million for those married filing jointly, and $500,000 for other filers). This means fewer taxpayers should be hit with the AMT.
What You Can Do: Because the AMT is so complicated, it’s worth consulting a tax professional to see how, or whether, the new changes will impact you. If you’re no longer subject to the AMT, then it may be a good time to consider exercising some incentive stock options (ISOs), Elbert says. That’s because ISOs aren’t subject to ordinary income tax but are taxable under AMT rules.
ELIMINATION OF ROTH RECHARACTERIZATIONS
What’s Changed: Roth recharacterizations are when you decide to convert a traditional IRA (an individual retirement account you fund with pre-tax dollars) to a Roth IRA (an IRA you fund with post-tax dollars), but then change your mind and revert, or recharacterize, the money back to a traditional IRA. Recharacterizations might happen if you decide the tax burden of the conversion is too high or if your accounts lost too much value. Starting in 2018, Roth recharacterizations are no longer allowed.
What You Can Do: Although you can’t recharacterize in 2018, there’s still time to do it for your 2017 tax returns, Elbert says. Talk to your tax and financial advisors — if it makes sense to recharacterize a Roth conversion you made in 2017, you have until October 15 to do so.
HIGHER ESTATE TAX EXEMPTION
What’s Changed: The estate tax exemption has doubled to about $11.2 million for individuals and $22.4 million for couples. The estate tax exemption is the amount of money you can leave to heirs without paying federal estate taxes.
What You Can Do: Remember that the current estate tax exemption is scheduled to revert back to its previous levels (although adjusted for inflation) in 2026, to about $6 million for individuals and $12 million for couples. So review your current estate plan with your financial advisor to make sure that you take advantage of the new exemption levels if it makes sense for your situation.
LOWER FLOOR FOR MEDICAL-EXPENSE DEDUCTIONS
What’s Changed: In order to itemize medical expenses in the past, your costs had to have exceeded 10 percent of your adjusted gross income. In the new tax law, that floor was lowered to 7.5 percent. (Plus, there is no longer a tax penalty for not having health insurance.)
What You Can Do: If your medical expenses don’t normally exceed 10 percent of your income, you may want to see if it makes sense to pay any potentially expensive medical costs in 2018 — for example, an elective medical procedure or a pricey prescription drug purchase. That’s because the 7.5 percent threshold is only for tax years 2017 and 2018. It will revert back to 10 percent in 2019.
Overall, as you’re thinking about ways to adjust your tax strategy, remember that there will always be an element of the unknown, such as what a future Congress may decide. “Do the best you can on the decisions that are in your control, and let go of what’s outside your control,” Elbert says. “And don’t wait until next April to find out what the impact is. You should check in with your advisors now to see what adjustments you can still make for the rest of the year, while there’s still time to make them. It’s all about being proactive.”