|Taxable income over||Up to||Marginal rate|
Source: Joint Committee on Taxation
The Internal Revenue Service (IRS) issued new withholding brackets to reflect changes to the personal income tax schedule, which employers started employing on February 15, 2018.
The standard deduction was increased in 2018 to $24,000 for married couples filing jointly (up from $12,700), $12,000 for single filers (up from $6,350), and $18,000 for heads of household (up from $9,350). These modifications will expire in 2025. The House bill’s elimination of the increased standard deduction has not been changed. The inflation index used to benchmark the standard deduction changes in 2019, which is anticipated to increase bracket creep (see below).
Personal Exemption and Healthcare Mandate
The legislation extended the $4,150 personal exemption until 2025. The individual mandate, a feature of the Affordable Care Act (ACA) or “Obamacare” that imposed financial penalties on people who did not get health insurance coverage, was also repealed in 2019. (While the rule technically remains in effect, the penalty has been reduced to zero for tax years 2019 and beyond.) If a taxpayer submits a previous year tax return (i.e., 2018 or 2017), the taxpayer will still be subject to a penalty for not having health insurance during the year.
According to the Congressional Budget Office (CBO), repealing the measure is likely toreduce federal deficits by around $338 billion from 2018 to 2027, but lead 13 million more people to live without insurance at the end of that period, pushing premiums up by an average of around 10%. Unlike other individual tax changes, the repeal will not be reversed in 2025.
Senators Lamar Alexander (R-Tenn.) and Patty Murray (D-Wash.) proposed a bill, theBipartisan Health Care Stabilization Act, on Mar. 19, 2018, to mitigate the effects of repealing the individual mandate. The CBOestimated that this legislation would still leave 13 million more people uninsured after a decade. The bill failed to make it into the $1.3 trillion spending bill that was passed on Mar. 23, 2018. As such,the burden of providing affordable health insurance will be on states and health insurers.
The law changed themeasure of inflationused for tax indexing. The IRS’ use of the consumer price index for all urban consumers (CPI-U), was replaced withthe chain-weighted CPI-U. The latter takes account of changes consumers make to their spending habits in response to price shifts, so it is considered to be more rigorous than standard CPI. It also tends to rise more slowly than standard CPI, so substituting it will likely acceleratebracket creep. The value of the standard deduction and other inflation-linked elements of the tax code will also erode over time, graduallypushing up tax burdens. The change isnot set to expire.
Family Credits and Deductions
The lawtemporarilyraised the child tax credit to $2,000,with the first$1,400 refundable, and creates a non-refundable $500 credit for non-child dependents. The child tax credit can only be claimed if the taxpayer provides the child’sSocial Security number. (Thisrequirement does not apply to the $500 credit.) Qualifying children must be younger than 17 years of age. The child credit begins to phase out when adjusted gross income (AGI) exceeds $400,000 (for married couples filing jointly, not indexed to inflation) (for married couples filing jointly, not indexed to inflation).These changes expire in 2025.
Head of Household
Trump’s revised campaign plan, released in 2016, would have scrapped the head of household filing status, potentially raising taxes on millions ofsingle-parent households, according to an estimate by the Tax Policy Center (TPC) (TPC).The lawleft the head of household filing status in place.
Mortgage Interest Deduction
The lawlimited the application of the mortgage interest deduction for married couples filing jointly to$750,000 worth of debt, down from $1,000,000 under the old law, but up from $500,000 under the House bill. Mortgages that are taken out before Dec. 15, 2017, are still subject to the current cap. The change expires after 2025.
State and Local Tax Deduction
The new legislation limits the deduction for state and local taxes to $10,000 per year until 2025. Attempts to abolish the deduction, as the Senate measure would have done, were met with opposition from a number of Republican members of Congress from high-tax states.
On December 1, 2017, the Senate measure was changed to get Susan Collins’ (R-Maine) support:
The Senate tax bill will include my SALT amendment to allow taxpayers to deduct up to $10,000 for state and local property taxes.
— Sen. Susan Collins (@SenatorCollins) Dec. 1, 2017
With modest changes, the statute preserved the charitable donations deduction. As an example, if a gift is provided in return for tickets to a collegiate sporting event, it cannot be deducted. The deduction for student loan interest remained unaffected (see “Student Loans and Tuition” below).
Medical costs in excess of 7.5% of AGI were deductible for all taxpayers, not just those 65 and older.
However, the bill does ban a number of minor itemized deductions until 2025, including:
- except for active-duty military personnel, no deductions for moving costs
- home office expenses
- laboratory breakage fees
- licensing and regulatory fees
- Dues for unions and professional societies
- business bad debts
- Work attire that aren’t appropriate for daily usage
Alimony payments will no longer be deductible beginning in 2019.
Alternative Minimum Tax
The bill temporarily increased the exemption amount and phase-out level for the alternative minimum tax (AMT), a system designed to reduce tax evasion among high incomes by requiring them to estimate their responsibility twice and pay the greater amount. The exemption for married couples filing jointly increased to $109,400, and the phaseout increased to $1,000,000—both amounts are adjusted to inflation. The provision is set to expire in 2025.
Retirement Plans and HSAs
The bill had no effect on health savings accounts (HSAs), and the regular 401(k) plan contribution maximum in 2019 rose to $19,000 and $25,000 (a $6,000 catch-up) for individuals 50 and over. The bill maintained these restrictions but eliminated the option to recharacterize one kind of contribution as the other, i.e., to retrospectively classify a Roth contribution as a regular contribution, or vice versa. People may now contribute to their individual retirement accounts (IRAs) beyond the age of 7012, according to the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in December 2019.
Student Loans and Tuition
The House measure would have abolished the deduction for student loan interest expenditures as well as the exclusion of qualifying tuition reductions from gross income and earnings. The new legislation preserved these tax incentives while allowing 529 plans to be used to cover K–12 private school tuition—up to $10,000 per year, per kid. The advantages of 529 plans were enhanced by the SECURE Act of 2019, enabling plan holders to withdraw a maximum lifetime sum of $10,000 per beneficiary penalty-free to pay off eligible school debt.
The measure eliminates the Pease limit on itemized deductions. This rule did not capitemize deductions, but progressively lowered their value when adjusted gross income exceeded a set threshold—in 2018, $266,700 for single taxpayers. The reduction was restricted to 80% of the total amount of the deductions.
The measure temporarily increased the estate tax exemption for single taxpayers to $11.2 million, up from $5.6 million in 2018. After 2025, this alteration will be reversed.
Corporate Tax Rate
The bill established a single 21% corporation tax rate and eliminated the corporate alternative minimum tax. These provisions, unlike individual tax incentives, do not expire. The new law’s statutory rate, when combined with state and local taxes, is 26.5%. This puts the United States marginally below the weighted average for EU nations (26.9%).
According to the Congressional Budget Office, the effective tax rate for US corporations in 2012 was 18.6%, defined as the tax paid on assets earning the market rate of return after taxes (CBO).That was the G20’s fourth-highest rate.
Supporters of lowering the corporation tax rate believe that it would diminish incentives for business inversions, which occur when companies relocate their tax base to low- or no-tax countries, often via mergers with foreign enterprises.
For five years, the enabled full expensing of short-lived capital expenditures rather than requiring them to be depreciated over time, but phased out the modification by 20 percentage points each year after that. The section 179 deduction maximum increases to $1 million, and phaseout occurs after spending $2.5 million on equipment, up from $2 million.
Pass-through business owners (sole proprietorships, partnerships, and S-corporations) received a 20% deduction for pass-through income. Certain sectors, such as health care, law, and finance, are exempt from the preferred rate unless their taxable income is less than $157,500 for single taxpayers. The deduction is set at 50% of wage income or 25% of pay income plus 2.5% of the cost of qualified property to deter high earners from recharacterizing normal salaries as pass-through income.
The net interest deduction was restricted to 30% of profits before taxes, depreciation, and amortization (EBITDA).It will be limited to 30% of profits before interest and taxes after four years (EBIT).
Businesses having average annual gross revenues of up to $25 million over the previous three years are entitled to employ cash accounting, up from $5 million under the former tax legislation.
Net Operating Losses
The lawscrappednet operating loss (NOL) carrybacks and capscarryforwards are set at 90% of taxable income until 2022, when they will drop to 80%.
In response to the economic consequences of the COVID-19 pandemic, the 2020 CARES Act temporarily restored a carryback period for any net operational losses incurred in years commencing after December 31, 2017, but before January 1, 2021. (i.e., for tax years 2018, 2019, and 2020).Under the CARES Act, the carryback period for those tax years is five years (including for farming and non-life insurance losses).As a result, if there was taxable income in 2013, a NOL created in the 2018 tax year may still be carried over to the 2013 tax year. Because the highest corporation tax rate was 35% previous to the TCJA’s drop to 21% for tax years beginning after 2017, carrying back a NOL from 2018, 2019, or 2020 may provide a higher advantage than carrying the NOL forward.
The bill repealed the section 199 (domestic production activities) deduction for enterprises engaged in domestic manufacturing and certain other types of production operations. This is sometimes referred to as the domestic manufacturing deduction, the U.S. production activities deduction, or the domestic production deduction.
The bill established a presumed repatriation rate of 15.5% for cash and equivalents and 8% for reinvested earnings.
The statute established a territorial tax system in which only domestic profits are taxed. Companies with yearly gross revenues of more than $500 million are subject to the base erosion anti-abuse tax (BEAT), which is intended to prevent base erosion and profit shifting, a tax-planning tactic in which taxable earnings are moved from one jurisdiction to another with little or no taxes. BEAT is determined by deducting a company’s usual corporation tax burden from 10% of its taxable income while disregarding base-eroding payments. Tax credits may be used to offset up to 80% of BEAT obligations.
The statute changed the status of intangible property held overseas. It did not define “intangibles,” although it is most likely referring to intellectual property like patents, trademarks, and copyrights. Nike (NKE) stores its Swoosh trademark in an untaxed Dutch subsidiary, for example. When the foreign tax rate on surplus foreign profits above a 10% standard rate of return is less than 13.125%, the law taxes these excess returns at 21% after a 50% deduction and a deduction worth 37.5% of FDII (see below).This surplus revenue, which is presumed by the law to be generated from intangible assets, is known as global intangible low-taxed income (GILTI).Credits may be used to offset up to 80% of GILTI obligation.
Foreign-derived intangible income (FDII) is revenue produced from the export of intangibles held in the United States, and it will be taxed at a 13.125% effective rate, increasing to 16.406% after 2025. The European Union has accused the United States of subsidizing exports via this preferential rate, which is illegal under World Trade Organization standards.
According to Harvard Law School senior professor Stephen Shay, a former Treasury official in the Obama and Reagan administrations who assisted in the development of the 1986 tax reform, considered repatriation created a loophole for multinational firms with fiscal years starting before January 1. Apple, for example, could save $4 billion by taking advantage of the oversight, according to Shay.
According to Shay, corporations with offset fiscal years may move capital to the United States via tax-free dividends, paying the 8% rate on remaining overseas assets rather than the 15.5% cash rate.
Growth and Budget Impacts
Treasury Secretary Steven Mnuchin said that the Republican tax proposal will generate enough economic development to pay for itself and more, citing the “Unified Framework” presented in September 2017 by Senate, House, and Trump administration negotiators:
“On a static basis our plan will increase the deficit by a trillion and a half. Having said that, you have to look at the economic impact. There’s 500 billion that’s the difference between policy and baseline that takes it down to a trillion dollars, and there’s two trillion dollars of growth. So with our plan we actually pay down the deficit by a trillion dollars and we think that’s very fiscally responsible.”
The argument that lowering taxes improves growth to the point where government income actually rises is nearly unanimously disputed by economists, and the Treasury has long refused to share the study on which Mnuchin relies his projections. On Nov. 30, 2017, the New York Times reported that a Treasury official, speaking anonymously, said that no such study existed, leading Sen. Elizabeth Warren (D-Mass.) to urge that the Treasury’s inspector general investigate.
Based on high growth estimates, the Treasury produced a one-page study on December 11, 2017 stating that the bill would raise revenues by $1.8 trillion over ten years, more than paying for itself:
- 2.5% real GDP growthin 2018
- 2.8% in 2019
- 3.0% over the next eight years
In contrast, the Federal Reserve forecasts 2.5% growth in 2018, 2.1% in 2019, 2.0% in 2020, and 1.8% in the long term.
The Treasury’s one-page analysis, according to Scott Greenberg, an analyst at the think tank, “does not appear to be a projection of the economic effects of a tax bill,” but rather “a thought experiment on how federal revenues would vary under different economic effects of overall government policies, which is, needless to say, an odd way to analyze a tax bill.”
The Tax Foundation forecasted a 1.7% rise in long-run GDP in 2017, emphasizing that the majority of this additional growth is expected to be front-loaded: “Economic growth is borrowed from the future, but the plan, in aggregate, nevertheless enhances economic growth over the long term.”
The $2 Trillion Scenario
The Committee for a Responsible Federal Budget (CRFB) provided the most negative assessment of the legislation’s budget implications on December 18, 2017, arguing that Congress is using a poor baseline to analyze the law’s budget consequences (their baseline assumes, for example, that current policies with set expiration dateswould continue indefinitely).
According to the think tank, these “gimmicks” disguise $570 billion to $725 billion in additional expenditures over ten years, raising the total cost of the legislation to $2 to $2.2 trillion. When predicted economic growth is taken into account (the CRFB uses the JCT’s feedback projections for the Senate bill), the cost decreases to $1.5 trillion to $1.7 trillion, which is three times the Tax Foundation’s dynamic estimate. However, this does not include any extra debt service charges. The bill might cost $1.9 trillion to $2 trillion in interest.
The Oil Addendum
The continuing resolution that enabled the use of reconciliation to overhaul the tax code allowed the Senate Finance Committee to enact legislation that would increase the federal budget by up to $1.5 trillion over a ten-year period.
The Senate Energy and Natural Resources Committee was charged in the same budget resolution with saving at least $1 trillion over ten years. The bill does this by permitting oil and gas extraction in the Arctic National Wildlife Refuge, which is situated in the home state of committee chair Sen. Lisa Murkowski (R-Alaska). Murkowski voted against many Obamacare repeal plans over the summer, so Republicans must obtain her support for tax reform.
Automatic Spending Cuts
On procedural grounds, the concept of a fiscal “trigger,” a device to execute automatic tax rises or expenditure cutbacks that some senators advocated for if rosy growth expectations did not materialize, was rejected. In any case, the measure might result in automatic expenditure cutbacks. However, the 2010 Statutory Pay-As-You-Go Act imposes government program cutbacks if Congress adopts laws increasing the deficit.
The Office of Management and Budget, an executive agency, is in charge of determining these budget effects. Medicare cuts are limited to 4% of the program’s budget, and some programs such as Social Security are protected entirely, but others could see deep cuts.
On Dec. 1, 2017, Senate Majority LeaderMitch McConnell (R-Ky.) and former House Speaker Paul Ryan (R-Wis.) promised that across-the-board cuts “will not happen,” but waiving “Paygo” would require Democratic support, meaning that was a tough assertion for GOP congressional leaders to make.
Whose Tax Cuts?
According to an analysis released by the Tax Policy Center (TPC) on Dec. 18, 2017, the law was expected to raise the after-tax income of 80.4% of households in 2018, but that cut was not distributed evenly or progressively. The analysis revealed that the tax break would hit 93.7% of taxpayers in the highest-earning quintile, and only 53.9% of those in the lowest quintile. Even so, on average, every quintile was expected to receive a tax break.
That is no longer expected to be true onceindividual tax cuts expire after 2025. At that point, the TPC estimates that the majority of taxpayers—53.4%—will face a tax increase: 69.7% of those in the middle quintile (40th to 60th percentile) will pay more, compared to just 8% of the highest-earning 0.1%.
With the exception of that top 0.1%, higher earners will enjoy largertax breaks as a proportion of their income:
The Joint Committee on Taxation echoes this conclusion, estimating that the 22,000households making $20,000 to $30,000 will collectively pay 26.6% more in 2027 than they would under the previous statutein that year. The 629 householdsmaking over $1,000,000 will pay 1% less.
Those Who Benefit
These were not the results Republican backers of the tax overhaul promised. Speaking at a rally in 2018 in Indiana shortly after the release of a preliminary tax reform framework in September, President Trump repeatedly stressed that the “largest tax cut in our country’s history” will “protect low-income and middle-income households, not the wealthy and well-connected.”
However, in its ultimate form, the Tax Cuts and Jobs Act reduced the corporation tax rate, favoring shareholders, who tend to be higher incomes. It only reduces individual taxes for a short time. It reduces the alternative minimum tax and the state tax, as well as the taxes charged on pass-through income (70% of which goes to the top 1%). The carried interest loophole, which advantages professional investors, is not closed. It repeals the individual mandate, which is expected to raise prices and make health insurance unaffordable for millions.
These measures, taken combined, are projected to benefit wealthy earnings disproportionately while harming certain working- and middle-class taxpayers, especially as a consequence of the repeal of the individual mandate.
Nor was Trump the only one to propose a tax reduction for average Americans. On November 4, 2017, McConnell said that no one in the middle class would face a tax increase:
McCONNELL: “At the end of the day, nobody in the middle class is going to get a tax increase.”
A bold promise the House bill doesn’t keep.
— Sahil Kapur (@sahilkapur) November 4, 2017
Less than a week later, he admitted to The New York Times that he “misspoke”: “You can’t guarantee that absolutely no one sees a tax increase, but what we’re doing is targeting income levels and looking at the average in those levels, and the average will be tax relief for the average taxpayer in each of those segments.”
The Estate Tax
The estate tax exemption has been doubled. In a speech in Indiana in September 2018, Trump lashed out at “the crushing, the horrible, the unfair estate tax,” describing scenarios in which families are forced to sell farms and small businesses to cover estate tax liabilities: under the old law, the 40% tax only applied to estates worth at least $5.49 million.
The measure does not shut the carried interest loophole, which Trump threatened to fix in 2015, calling the hedge fund managers who profit from it “pencil pushers” who “get away with murder.”
Hedge fund managers often charge a 20% fee on gains that exceed a particular threshold rate, which is typically 8%. Those fees are considered as capital gains rather than normal income, which means they are taxed at a maximum rate of 20% rather than 39.6% as long as the stocks sold are kept for a specific minimum time. (High incomes are also subject to an extra 3.8% tax on investment income, which is related with Obamacare.)
In his 2018 Indiana address, Trump said that lowering the highest corporation tax rate from 35% to 20% (the planned rate at the time) would result in jobs “pouring into our nation, as firms compete for American workers and salaries start going up at levels you haven’t seen in many years.” He went on to say that the “greatest beneficiaries will be average American workers.”
The following day, The Wall Street Journal reported that the Treasury Department had removed a document off its website that said the exact opposite. The document, which was written by non-political Treasury personnel under the Obama administration, estimates that workers pay 18% of corporation tax via lower salaries, while owners pay 82%. Other research conducted by the government and think groups has confirmed those conclusions. Mnuchin promoted the Big Six concept in part by claiming that “over 80% of corporate taxes are carried by the worker,” as he said in August in Louisville.
According to a Treasury spokesman, “The report included an out-of-date staff analysis from the previous administration. It does not reflect our current thinking and analysis,” he continues, adding that “studies reveal that 70% of the tax burden falls on American employees.”” The Treasury did not answer to Investopedia’s request for the names of the studies in issue. Other documents going back to the 1970s are also available on the department’s website.
The White House, on the other hand, persisted in pressing the case, producing an estimate in October 2017 estimating that cutting the highest corporation tax rate to 20% would “raise average family income in the United States by, very conservatively, $4,000 annually.” The executives who were supposed to give these raises, on the other hand, showed some reluctance at the Wall Street JournalCEO Conference in November 2017, when the paper’s associate editor John Bussey asked the audience to raise their hands if they planned to increase capital investment as a result of a corporate tax cut. Few hands were raised, leading National Economic Council Director Gary Cohn (who was there) to inquire, “Why aren’t the other hands up?”
What’s Wrong With the Status Quo?
People from both political parties believe that the tax law should be simplified. According to the House GOP’s 2016 reform plan, the corpus of federal tax law has swelled from 26,000 to 70,000 pages since 1986, the last time a comprehensive tax overhaul became law. According to the Tax Foundation, American families and businesses spent $409 billion and 8.9 billion hours doing their taxes in 2016. Almost three-quarters of respondents told Pew four years ago that the complexity of the tax system disturbed them “some” or “a lot.”
An even larger majority was bothered by the belief that certain firms and rich individuals pay too little: 82% for corporations and 79% for the wealthy. While the new tax code eliminates certain itemized deductions, most of the loopholes and giveaways that were targeted for elimination in previous versions have been preserved in some form.
Individual tax rates remain at seven, despite Trump’s proposal to reduce them to three. To put it another way, this law may accomplish nothing to streamline the tax system. Other concerns raised by the Pew study, such as taxes on rich persons and businesses, are expected to be worsened by the bill.
The Bottom Line
Did the new tax system deliver on its promises to Americans? Depending on who you ask. According to the Tax Policy Center, the new tax law resulted in a tax savings for 65% of Americans. According to H&R Block, the average tax decrease was almost $1,200 based on the forms the business handled. However, according to some sources, the tax plan has not lived up to the anticipation.