The Tax Cuts and Jobs Act was signed into law by President Trump on December 22, 2017. There have been many opinions shared throughout social media, traditional media, and conversations among friends and family. Sometimes this has remained civil; other times, not so much.
I am going to attempt to keep politics out of this and just highlight how the new tax law may affect typical teachers and their tax return. In doing this, it is important to keep in mind that the tax code is complicated and every family is different depending on size, structure, employment, circumstances, and financial actions. Each family is unique. I am married to a small business owner and have four kids. The new tax changes may impact my us in many different ways compared to you and your family based on your own situation.
I will focus on the things that I think are most applicable to most of us based on our profession.
The $250 deduction for classroom supplies will continue.
There was a discussion of repealing this deduction. Teachers will continue to be able to take an above the line deduction up to $250 on materials they pay for out of pocket used in the classroom. It is important to note that you should keep good records and receipts of these expenses and that you cannot deduct items that you get reimbursed from your employer.
Most of us will be in a lower marginal tax bracket.
My favorite visual of the tax bracket changes come from Michael Kitces at Nerd's Eye View. He shows a comparison of the old and new brackets. The green is a decrease in marginal tax rate based on taxable income and the red shows an increase.
As you can see, almost all married couples will see a decrease in their marginal tax bracket. Single teachers will most likely see a decrease also, considering what teachers make in salary, unless there is significant income from other sources.
I want to pause and make a few points regarding the income tax brackets. Even though you are probably familiar with them, it is common for people to not completely understand how they work.
First, these are marginal tax brackets, which means you are only taxed at the new higher rate on dollars ABOVE the tax line NOT on all dollars earned. For example, the first line on the new tax bracket for a married couple is $19,050 of taxable income. If you as a couple have taxable income of $19,051, only $1 would be taxed at the higher 12%. The rest ($19,050) would be taxed at 10%. Many mistakenly think that all $19,051 would be taxed at the higher 12% rate.
Second, the brackets are based on taxable income, not all income. Below is a very stripped down version of how individual taxes work. (based on IRS form 1040):
Many make the mistake of looking at the tax brackets using their total gross income for the family. After deductions, the actual income that is taxed can decrease quite a bit.
This brings me to a final point. Because there are so many other circumstances that influence the total tax you are required to pay (like tax credits) and your income can be taxed at many different tax rates, just because you see your marginal tax rate increase or decrease with the new law doesn’t mean the taxes your family pays will necessarily do the same.
The standard deduction was increased.
The standard deduction will go from $6,350 (2017) to $12,000 for single filers and from $12,700 (2017) to $24,000 for married filing jointly.
This in itself will help many tax filers, lowering the income that is ultimately taxed. If you already take the standard deduction like 70% already do, it is likely that you will ultimately receive a tax cut in 2018.
Many of you who in the past have been able to take the itemized deduction won’t now because the standard deduction will be higher than the total of your eligible itemized deductions. This is almost certain to be the situation for my family.
For example, let’s say a married couple in the past had $18,000 in itemized deductions. They would have taken that because it is $5,300 higher than the (2017) standard deduction for married couples. Assuming not much has changed for the family in 2018 the $24,000 standard deduction is higher than what they can itemize, so they will automatically take that. Their itemized deductions become irrelevant.
There were some changes to what deductions can be itemized.
Because many of the drastic changes that were being discussed during the legislative process did not make it to the final bill and since the increased amount of tax filers who will no longer itemize deductions, I am not going to address these changes here.
Personal exemptions are dropped.
Remember, your taxable income comes from subtracting the standard deduction AND personal exemptions from your Adjusted Gross Income (see above). Generally, you can take a personal exemption of $4,050 (2017) for each member of your household. For example, in my family, there are six of us. Under the old rules, we could take $24,300 in personal exemptions (6 X $4,050) but now there will be no such thing as personal exemptions.
For single people and couples without kids, this is made up by increasing the standard deduction. For most families with children, this is overcome by an increase in the child tax credit (see below).
The child tax credit doubles.
The 2017 child tax credit is $1,000 per child (under age 17). The new law will double it to $2,000 per child. It also added a $500 tax credit for dependents who don’t qualify for the child tax credit, like children age 17 and older and others who may be living in the home and being cared for.
It is important to understand that tax credits are better than tax deductions. Many get confused between the two. Tax deductions only lower your income that is taxed. Tax credits lower your tax directly.
For example, a married couple with two young children, after figuring out their taxable income, looks at the IRS tax tables and finds that their tax to be paid is $9,000. Because they can take a child tax credit of $4,000 ($2,000 for each kid) their total tax for the year is now $5,000. The tax credit lowered their tax to be paid, dollar-for-dollar.
The new rules also increase the number of families who can take this tax credit. Before, families would be phased out of being eligible for this beginning at $75,000 for individuals and $110,000 for married couples. Now phase outs begin at $200,000 (individuals) and $400,000 (married).
529 savings plans can now be used for K-12 education expenses.
For years, 529 savings plans were considered the best way to save for future college expenses. (And still are!) Now, these accounts can be used for private, public, and religious K-12 education expenses as well.
One area of caution. This is a change in federal rules. But, 529 plans are administered by states so it will depend on the specific 529 plan whether this is ultimately something for which you may take advantage. For an example, see HERE. This is something to check with your tax advisor and watch for updates if this impacts you.
Many of these changes are temporary.
One of the major criticisms of this tax plan has been that many of these changes sunset back to original levels after the year 2025, in order to keep deficit projections at a level to only need 50 votes in the Senate for passage (instead of 60). These include the individual income tax brackets and child tax credit. This (along with a few other things) has led many to conclude that what can begin as a tax cut for families may end up as a tax increase in future years (when compared to the current system).
It will be interesting to see if these changes will be made permanent in the future and/or if there will be yearly patches in order to keep families from seeing these tax increases.
We could go on and on about different aspects of the new tax plan. There are clearly major parts of the plan that I ignored. I tried to highlight the changes that have the most potential to directly affect the taxes of teachers’ families. Whether you feel that this tax plan is good or bad for the United States, it is important to understand how it may affect your family so you can plan ahead and make adjustments.
If you think you will get a tax increase you may want to begin saving a little each month in order to have the money available to pay a larger tax bill at the end of 2018.
If you think you will get a tax cut make sure you take advantage of it. Think about how you can improve your financial situation. In February, you may begin to see more take-home pay each month. Maybe you want to increase your automatic contributions to your Roth IRA by that increased amount. Or if you don’t have a Roth IRA, start one. If you have consumer debt, pay a little extra each month. The important thing is to plan ahead and take action to make your finances better.
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*A.O. Wealth Advisory nor its representatives offer tax or legal advice. Please contact your legal or tax advisor regarding your situation.