Personal Exemption Changes
Part 2 of 4
As explained in last week’s blog, the short answer is: YES! The logical second question is: will that impact be to my benefit or detriment? There is no short answer to that question, but we’re giving you the tools to help you determine if you are a big winner…or, a big loser.
FACT: The new tax reform bill will impact every taxpayer in the country due to elimination of the personal exemption.
When it comes to this change, everyone is a loser. The personal exemption was granted to all taxpayers in every tax return. For the 2017 tax year, the personal exemption equaled $4,050 and was applied to the taxpayer, spouse and dependents. For example, a family of four would receive a total personal exemption of $16,200 [calculated as $4,050 x 4]. The personal exemption serves to exempt or exclude that amount from your taxable income. As we described in last week’s blog, your taxable income dictates which tax bracket you will fall into. This change will serve to increase everyone’s taxable income which will impact you in the following two ways.
First, this change will increase the amount of income you have that is subject to tax. Considering only this change, if your income remained the same in 2018 compared to 2017, your tax bill would increase. Using our same family of four referred to above, the loss of the $16,200 exemption would increase the family’s taxable income by that same amount. If we presume this two-income family had taxable income of $150K in 2017, they would fall in the 28% tax bracket. The loss of the personal exemption means their taxable income would rise to $166,200 [calculated as $150,000 + $16,200]. As a result, their income tax bill would increase by at least $4,536 [calculated at $16,200*28%].
Second, this change would also bump the family into the next higher tax bracket. Expanding this same example, the family’s income of $150K in 2017 landed them in the 28% tax bracket. However, based on the new tax brackets, and their new higher taxable income of $166,200, this family would now land in the 32% tax bracket. This would result in a total income tax increase of $5,184 [calculated at $16,200*32%].
In essence, that means even at the lowest bracket you can expect to see your tax bill go up by a minimum of $405 [calculated at $4,050*10%]. According to IRS statistics, the median household contains 3 people and falls into the 24% bracket for 2018. That means the median household would experience an increase of $2,916 in their tax bill based on the loss of the person exemption [calculated at $4,050*3*24%].
Take a look back at last week’s post to identify the ways you can reduce your taxable income using pre-tax contributions. Another approach to reducing taxable income is maximizing your adjustments to income. These are commonly referred to as “above-the-line deductions” or deductions to arrive at AGI. Here are the top 3 adjustments that would serve to reduce your taxable income:
- Individual Retirement Account (IRA) Contributions: If you are not covered by an employer’s plan, you can deduct contributions to a traditional IRA up to $5,500 for 2018, or $6,500 if you’re 50+.
- Health Savings Accounts (HSA) Contributions: Individuals can deduct contributions up to $3,450 for self-coverage, or $6,850 for family coverage.
- Student Loan Interest: You can deduct up to $2,500 of student loan interest paid.
Bear in mind, this post isolates the personal exemption for a simplified explanation of this change. The ultimate change to your tax position must consider all changes in the new bill, including the change to brackets covered last week, and deductions. We’ll go over that element of the new tax bill in next week’s blog. And remember, when you’re ready to do more to reduce your tax bill, contact us to develop a custom tax plan tailored to your specific tax needs. We’ve helped our clients employ tax loopholes that allow them to deduct 100% of their student loan payments, not just the interest!