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How will the changes in the U.S. tax law affect us all?

Part 2 of a series

The 2018 Tax Act limits the deduction of state and local income, real estate, personal property and sales taxes to a total of $10,000 per return, regardless of filing status or amount paid. It also eliminates exemptions and gives a break to the self-employed. 

I tested four wide-ranging scenarios for the effect of the tax act. Here are the results:

Ramon is married and is the sole breadwinner. He works in a factory and makes $39,000 a year. He has two children in college (by the skin of their teeth.) He loses their exemptions, but his standard deduction goes up. His IRS tax bill would go up by $479.  

Charles and Mary are self-employed, but they live in New York state and have high property taxes. They have two children. Their total taxable income last year was $200,000. Because they are self-employed, they get a 20-percent reduction in their self-employment income of $175,000, or a deduction of $35,000. They lose several significant itemized deductions and the exemptions of their two children. Their IRS taxes would increase from $24,300 to $28,300.

Harry is retired. He and his wife have taxable income of $143,500. Harry has significant state and local taxes and substantial miscellaneous expenses for investment advice. His itemized deductions are reduced by nearly $30,000 under the new law. Harry’s IRS taxes would increase from $11,600 to $22,000 for 2018.  

But how about someone more middling?  

Louise has a taxable income of $71,000. She is also self-employed. Because of the 20 percent reduction in self-employment income, and because the standard deduction for a head of household is now $18,000, more than her $12,000 in itemized deductions, her tax actually goes down from $7,100 under the previous system to $5,600 under the new one that goes into effect in 2018.  Say she has two children in college. She would lose their exemptions. If she did not have the allowance for self-employed person, her tax would go up to $8,685 for 2018. 

These are tests. I don’t guarantee my math as it has been decades since I hand-calculated a tax table.  But I did check my math, and this is the result of the very different tests that I did. I was actually trying to have some examples of people who did better under the new law, but that just didn’t happen. 

My opinion is that self-employed persons will do marginally better under the new tax act, but that others will take a blow straight to the pocketbook.  

I anticipated, based on news reports, that business restructuring would be needed for self-employed people to take advantage of the 20-percent reduction, but the new law appears to apply to all “pass-through” business forms, even sole-proprietorships. So there is no need to run frantically to your lawyer.  (My condolences to my fellow members of the Bar.)  The new law does not apply to “C corporations,” which are not pass-throughs, but instead pay their own taxes.  

Of course, the application of the tax law is more complex than presented here, but my test cases give you an outline and some expectation of results in different situations. For specifics, see your own tax specialists.  

 

Martha Miller is a tax attorney who lives and works in Lime Rock.  None of the information presented here should be seen as an endorsement of her business.