It’s Official: Tax Reform Becomes Law

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The House and Senate have approved a significant overhaul of the US tax code.

The three biggest components of the ‘Tax Cuts and Jobs Act’ (from the perspective of US expats) are: (1) doubling of standard deductions, which two-thirds of American households utilize on tax returns; (2) reduction of tax rates in five of seven brackets; and (3) doubling of the child tax credit.

This article analyzes these three components, as well as, summarize some of the other changes.

Doubling of Standard Deductions and Reduction in Tax Rates

Standard deductions will nearly double, but personal exemptions go away. For a single filer, the standard deduction increases from $6,350 to $12,000. The overall impact (accounting for personal exemptions) is $1,600, still a positive for those who use standard deductions.

With respect to tax rates, the changes favor modest and very high-income earners. Those in the “upper middle class” are hurt by the new tax rates (roughly speaking, a single filer with taxable income from $200K to $400K).

For joint filers, it’s a similar story. The overall impact of doubling standard deductions, but eliminating personal exemptions is a positive $3,200.

With respect to tax rates, the changes are favorable across all brackets. However, very high-income earners receive the most benefit (roughly speaking, households with taxable income over $500K).

Families with dependents are negatively impacted by the elimination of personal exemptions. That is because the increase in standard deduction does not offset the loss of personal exemption amounts, which can be significant depending on the size of the household. However, the loss of personal exemptions needs to be considered in combination with other factors (e.g., lower tax rates, child tax credit) to assess the net impact.

Child Tax Credit – A Big Plus

The child tax credit will increase from $1,000 per child to $2,000 (refundable up to $1,400). Many US expats currently take advantage of the child tax credit and receive refunds without ever having paid taxes (i.e., free money from the IRS). Subject to calculation, the refund maximum increases by $400 per child.

In addition, the phase-out starts at $400,000 (AGI) for married filing jointly. The current phase-out begins at $110,000, which means that higher-income earners will be able to benefit from the child tax credit.

Tax Reform – Important Takeaways (with possible political ramifications)

  • Modest income earners benefit
  • Families with children benefit
  • Tax rates favor marriage
  • High-income earners living in low tax states benefit (see below)

State and Local Tax Deduction (SALT)

For taxpayers that itemize deductions, the bill caps the deduction for state and local taxes at $10,000. This is the reason that 12 Republicans in the House (mostly representing California, New York, and New Jersey) voted against the bill.

Estate Taxes

The bill keeps the estate tax at 40%, but doubles the exemption levels (currently $5.5M for individuals and $11M for married couples).

Healthcare Mandate

The bill ends the individual mandate, a provision of Obamacare that puts tax penalties for individuals who do not obtain health insurance coverage (starting 2019).

For information on various tax-related topics, visit us at holaexpat.com.

(Cover Photo: Pixabay)

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John Ohe

This article was written by John Ohe – CFA and IRS Enrolled Agent. John works at Hola Expat, which provides tax services for Americans living abroad. If you would like to submit a question, email: info@holaexpat.com.