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“There’s just one thing I can’t figure out. My income tax.” – Nat King Cole

“The hardest thing to understand in the world is the income tax.” – Albert Einstein

This past year, Halloween was barely over when House Republicans introduced their version of tax reform. Among those who understand the complexity of the tax code, as expressed by Nat King Cole and Albert Einstein, few observers thought such a massive undertaking could be signed into law within seven short weeks.  Yet that is exactly what happened. In the hectic days that preceded Christmas, the president signed into law the Tax Cut and Jobs Act, the most sweeping change in the tax code since 1986.

We know the often-stated goal of tax reform is simplification. But simplification means that lower tax brackets can only be achieved if cherished deductions and credits are done away with.  It’s easier said than done.  Congress heard and listened to several of those pleas.  While some deductions will disappear, others remain or have been reduced.

Sharpen your pencils – the new tax code and tax planning

In terms of income tax alone, over 80% of Americans will get a tax cut this year, while just 5% of taxpayers are expected to pay more.  In most cases, cuts are expected to be modest; however, much will depend on individual circumstances.  Due to the complexities of the new law, we are always happy to talk with you, but we also encourage you to check with your tax advisor.  What we would like to do here is touch on the high points of the income tax. It’s not all-inclusive and not a deep dive, but given many of your questions lately, we believe an overview is in order.

  1. The 10% bracket remains unchanged, while the 15% bracket declines to 12%, the 25% to 22%, the 28% to 24%, and the 33% to 32%. The 35% holds steady, and the 39.6% slips to 37%. The thresholds are modestly adjusted above the new 22% bracket.
  2. The standard deduction nearly doubles to $12,000 for single filers and $24,000 for married filers, reducing the incentive to itemize and thereby simplifying the process for some taxpayers.
  3. The $4,150 personal exemption is eliminated, and the $1,000 child tax credit doubles to $2,000. In general, rules for charitable contributions remain unchanged. By itself, the combination of points one, two, and three will provide modest tax relief for most families. But we must caution, it depends on your individual circumstances.

Before and After Rate Change – Joint Return

Taxable Inc 2018 Pre-TCJA Rates 2018 TCJA Rates Tax Savings
$19,050 10% $1,905 10% $1,905 $0
77,400 15% 10,658 12% 8,907 1,751
156,150 25% 30,345 22% 26,232 4,113
165,000 28% 32,823 22% 28,179 4,644
225,000 28% 49,623 24% 42,579 7,044
  1. For investors, the preferential treatment for long-term capital gains and dividends remains intact, as is generally the case for retirement accounts. But there is one important change: the new law repeals rules that allow for recharacterizations of Roth conversions back into traditional IRAs. Once you convert into a Roth, there’s no going back.

In all likelihood, most of our clients and their families will see a lower income tax this year.  What do you plan to do with your tax savings?  Increase your retirement savings?  Lower or pay off debt faster?  Take a trip?

Final Thoughts

We fully expect that the rewrite of the tax code will produce unintended benefits and unexpected consequences. About 90% of economists surveyed by the Wall Street Journal expect a modest boost to growth in 2018 and 2019, but after that, opinions diverge. If tax incentives boost productivity, it could lift long-run GDP potential, which would yield a significant benefit. If the economic benefits end after a two-year sugar high, it will likely be deemed a failure. Early anecdotal data offer some encouragement, as several large firms announced year-end bonuses or wage hikes tied to the lower corporate tax rate.

At a minimum, the lower tax rates increase after-tax earnings. It could also boost corporate stock buybacks and dividends going forward, which would create an added tailwind for stocks. Yet, low unemployment and wage growth might lead to higher inflation. That said, we’re cautiously optimistic it will encourage entrepreneurship and economic growth, which would benefit hard-working Americans.

As always, we are honored and humbled that you have given us the opportunity to serve as your financial advisor. Nonetheless, please reach out to us if you have any questions or if you would like to discuss any other matters. We would be happy to talk with you.