Breakdown of the Tax Bracket changes from the GOP House Tax Cuts and Jobs Act

[EDIT FROM MIKE 2/20/2018: This article was an analysis of the initial proposal for a tax reform plan that passed in late 2017. Some or all of this information may be outdated at the time of reading, but remains here for historical purposes.]

Quick version: the tax reform plan that purports to cut taxes for the middle class may actually cause many middle class taxpayers to see an increase in taxable income and possibly even up to a 10% tax rate jump.

————————-

This morning the House GOP announced its long-awaited tax reform plan – the Tax Cuts and Jobs Act. It includes major tax code changes, including a complete overhaul of the tax brackets. The plan would create four tax ranges, down from the current seven brackets.

In addition, the TCJA would double the standard deduction, removing about $6,000 of taxable income from individuals and about $11,500 from married couples filing jointly.

Eliminated Deductions

The Act also removes many popular taxable income deductions that are used by millions of taxpayers. Tax deductions lower the amount of taxable income – the income figure used to calculate how much tax you owe.

Here’s a short list of some of the deductions that would disappear under this plan:

  • state and local taxes paid
  • employment-related expenses
  • vehicle use and mileage
  • medical expenses
  • equipment purchase and depreciation
  • business losses
  • lottery losses
  • job relocation/moving expenses

The plan would keep the popular mortgage interest, charitable giving, and 401(k) retirement contribution deductions. Education credits will be “streamlined” (which could impact tuition support and student loan interest deductions) and the child credit will be increased.

Why this matters: This all directly impacts how much of your income is taxable (when you apply it to the new tax brackets, below). You will actually lose money (through an increase in taxable income) if you currently itemize your deductions using the eliminated deductions in excess of the new standard deduction (since the standard deduction is what you’ll be forced to use under the new plan, instead of itemizing deductions with the above options).  In other words, you will likely pay more tax if you currently itemize a lot of common deductions because under the reform plan those deductions simply won’t exist anymore.

Example: Let’s say you are an individual that takes $15,000 worth of deductions from the eliminated deductions listed above. The proposed plan’s new individual standard deduction is $12,000 (up from $6,350).  $15,000 – $12,000 = $3,000, so under this plan you would have $3,000 more of taxable income due to the lost deductions  (say you’re in the 15% bracket,  that’s $450 more in taxes you have to pay).

Tax Bracket Changes

Once you figure out your new taxable income with the changes in deduction options, you can apply that amount against the new tax brackets.

Below are tables containing taxable income ranges and their corresponding current and proposed tax rates.

Individuals

Taxable Income Old Tax Rate New Tax Rate
0-10K 10% 12%
10-38k 15% 12%
38k-92k 25% 25%
92k-192k 28% 25%
192k-417k 33% 35%
417k-420k 35% 35%
420k-500k 39.6% 35%
500k+ 39.6% 39.62%

Married Filing Jointly

Taxable Income Old Tax Rate New Tax Rate
0-19k 10% 12%
19k-76k 15% 12%
76k -153k 25% 25%
153k-233k 28% 25%
233k-260k 33% 25%
260k-417k 33% 35%
417k-471k 35% 35%
470k- 1 million 39.6% 35%
1 million + 39.6% 39.62%

Initial Observations – Winners and Losers

Here’s what we can take away from just these aspects of the tax reform plan (we don’t have time to get to the corporate tax changes, the estate tax repeal, or other organizational credits and deductions).

The Savers
People with taxable income in the following ranges will likely favor the proposed changes, as they’ll see a reduced tax rate:

  • Individuals
    • $10,000 – $38,000
    • $92,000 – $192,000
    • $420,000-$500,000
  • Married Filing Jointly
    • $19,000 – $76,000*
    • $153,000 – $260,000
    • $470,000 – $1 million

*People near the top of this bracket often fall into this range only because they itemize a long list of deductions. As a result of the eliminated deductions, it’s very likely they will have then enough taxable income to be bumped up into the next bracket – a 10% tax rate increase from current rates.

The Taxed
People with taxable income in the following ranges will likely oppose the proposed changes, as they’ll see an increased tax rate:

  • Individuals
    • $0 – $10,000*
    • $192,000 – $417,000
  • Married Filing Jointly
    • $0 – $19,000*
    • $260,000 – $417,000

*Don’t fret too much about seeing the lowest income ranges with a tax rate increase. First, it’s only a 3% rate increase; and second, the doubled standard deduction should negate any actual tax increase by significantly reducing those taxpayers’ taxable income by $6,000 (individual) or $12,000 (married filing jointly).

The *Unaffected
Let me preface this section by saying that these taxable  income ranges are only unaffected by tax bracket changes – they aren’t changing rates with the new plans. However, and it’s a really big HOWEVER here, the elimination of many popular income deductions (explained above) will cause many people in this section to have a higher taxable income, and as a result experience a virtual tax rate increase.

The more deductions you itemize currently,  the more you will be affected by this change. Here are the taxable income ranges for this situation:

  • Individuals
    • $38,000 – $92,000
    • $417,000 – $420,000
    • $500,000 +
  • Married Filing Jointly
    • $76,000 – $153,000
    • $417,000 – $471,000
    • $1 million +

The highest income brackets are virtually unaffected by this part of the tax proposal, as their tax rates do not change (although they could still be impacted by the deduction eliminations which would expose more income to taxation).

Conclusion – The Middle Class Lie

Based on all the data above, this plan does not actually accomplish what its creators advocate. This is not a massive tax break for the middle class, as the middle class will likely pay more taxes under this proposal.

We can agree that the common definition of middle class sits around $50,000 – $150,000 in household income. On its face, Married couples with taxable income $19,000 – $76,000 will see a 3% tax rate reduction, and married couples making $76,000 – $153,000 will see no tax rate change at all.

However, these two brackets also commonly itemize the deductions that this plan will eliminate, resulting in an increase in taxable income. If you are married and currently sitting around $70,000 – $76,000 in taxable income and rely heavily on itemized deductions to lower your income into that range, then there is a really high chance that you will be bumped into the higher tax bracket  – a 10% rate increase (25%, up from 15%). 

[Example: You and your spouse made a total of $100,001 last year. You have $25,000 worth of itemized deductions which makes your taxable income $75,001 (a current tax rate of 15%). Under the new plan, you’re only allowed the new standard deduction of $24,000. If you don’t have any of the few remaining additional deductions (like the mortgage interest and charitable contribution deductions kept in the proposed plan), your taxable income would be $76,001 (a proposed tax rate of 25%). If all things stayed the same, the new plan taxes you 10% more than the current structure.]

Middle class individuals could also see increased taxes due to more taxable income, again the result of lost deductions. The $38,000 – $92,000 individual tax bracket will not see a rate change, but likely will see increased taxable income and thus a higher tax bill. The exact impact is entirely based on how many deductions you currently take.

The good news is that if you don’t itemize deductions, you would see an automatic decrease in taxable income because of the doubled standard deduction. That’s about a tax savings of $600 to $4,000 per household (depending on income range and married vs. individual). The expanded child credit would add even more savings to your simplified tax return.

So it’s not all bad, it’s just really bad for a big chunk of people in the middle, while being a small relief deal for everyone else. Middle class tax break, though? More like a middle class break-even plan.

Leave a Reply

Your email address will not be published. Required fields are marked *