The Biggest Tax Changes in 2018 — New Income Brackets, Deductions and More

At the tail end of 2017, Congress passed a tax reform bill that drastically changed the tax code for Americans. President Donald Trump signed this bill into law -- meaning 2017 was be the final year under the old tax code. Going forward, American citizens and businesses will be subject to the changes included in the bill.

Taxes are a highly complicated subject, just think about how long it takes to file your taxes every April. The law updating the tax code numbered 600 pages, so it’s understandable to be confused about what the changes mean for you.

Learn about the important changes and new rules to watch out for. Here's a quick review followed by the exact changes:

• Increased standard deduction, but personal exemption removed
• Loss of other useful deductions
• Revamped income tax brackets
• Reduced marriage penalty
• Increased child tax credit
• Changes to medical insurance rules
• Pass-through businesses pay less taxes

The Standard Deduction Has Increased, at the Expense of the Personal Exemption

Under the old tax code, taxpayers received both the standard deduction and personal exemption. You subtracted the amount of the deduction and exemption from your income when calculating your taxes.

The standard deduction is a flat amount you can subtract from your taxable income when calculating what you owe. You also have the option of itemizing your deductions. Under the 2017 tax code, you could deduct mortgage interest, medical bills, and certain other expenses. If your itemized deductions exceeded the standard deduction you were best served itemizing. If the standard deduction is higher, than the amount you can itemize, you would take the standard deduction.

In effect, this meant that you had to calculate your itemized deductions no matter what. In most cases, taking the standard was best, so you were likely to calculate itemized deductions you’d never use.

Under the 2017 rules, the standard deduction for a single person was $6,500. That meant that if you made $50,000, you would report only $43,500 in taxable income. You could also subtract the personal exemption of $4,150. This would reduce your taxable income further, to $39,350.

Under the new rules, the standard deduction has doubled to $13,000. This means a worker who earns $50,000 only reports $37,000 in taxable income at the end of the year. To compensate, the personal exemption has been removed. Overall, workers can deduct an extra $2,350 from their income when calculating their taxable earnings.

Changes to Standard Deductions in 2018

Other Deductions Have Been Changed

To go along with the new standard deduction rules some other deductions have been changed.

One of the biggest changes is the elimination of state and local tax deductions. Previously, taxpayers could deduct any amount of tax they paid to the state they lived in from their income. Under the new rules, you can only deduct $10,000 in state and local taxes from your income.

This primarily hurts high-income taxpayers and homeowners in states like New York and California. People who pay less than $10,000 in state and local taxes aren’t affected.

People who own expensive homes will also lose a deduction. Previously, you could deduct any interest paid on a mortgage of your primary residence. Going forward, you will only be allowed to deduct interest on the first $750,000 of the loan. This change does not affect existing mortgage-holders.

Many other tax deductions have also been removed, such as:

• Losses due to theft
• Unreimbursed employee expenses
• Tax preparation expenses
• Moving expenses
• Employer-subsidized parking

Removing and limiting many deductions, combined with increasing the standard deduction, results in fewer people itemizing their deductions. The goal of this is to reduce the complexity of filing taxes at the end of the year.

The Joint Committee on Taxation estimates that the new rules will cause 94% of households to take the standard deduction (versus 70% before).

Changes to Tax Rates and Brackets

Now that we’ve covered the changes to how you calculate your taxable income, we can discuss changes to the actual rates.

2020 Tax Bracket

Under the old rules, there were seven tax brackets based on income. The lowest rate applied was 10% and the highest was 39.6%

2022 Tax Bracket

Under the new rules, the highest rate has been reduced to 37% and other rates have also been adjusted down.

It’s important to remember that the U.S. tax system is progressive. You pay the tax rate listed for your income that falls into each tax bracket.

For example, let’s say you are a single person who will make $85,000 after all deductions in 2018.

The 10% tax bracket applies on your first $9,525 of income. That means you’ll pay $952.50 in tax on that amount of your earnings. The next $29,175 of your income falls into the 12% bracket, so you’ll pay $3,501 for that portion. The next $43,800 of your income falls into the 22% bracket, so you’ll pay $9,636 on that part of your earnings. Finally, the last $2,500 of your income is taxed in the 24% bracket, so you’ll pay $600 on that.

Overall, you’ll pay $14,689.50 in taxes. Just because your annual income exceeded $82,500 does not mean it is all taxed at the 24% rate.

Generally, you'll get to keep more of the money that you earned -- better make sure they go toward savings.

Reduction of the Marriage Penalty

Under the old tax rules, couples, where both people earned high incomes, could pay more in taxes if they got married. This was caused by the income brackets for couples who filed jointly not being double that of single earners.

For example, under old rules, the 25% tax bracket for single earners went up to $91,900. For married couples, it only went up to $153,100. If it was double the single filer amount, it would be $183,800.

To see how this could affect a couple, consider this example:

Two people make $85,000 each after deductions. When they file as singles, the highest tax rate they’ll pay is 25%. If they then get married, they’ll file jointly and report $170,000. Because the 25% tax bracket for married couples maxed out at $153,100, the extra $16,900 would be taxed at the higher rate of 28%.

The new tax bill has removed this penalty for married couples in all but the two highest tax brackets. So long as your combined income does not eclipse $600,000, you and your spouse will not pay extra taxes for getting married.

Increases in the Child Tax Credit

Large families stand to benefit from increases in the child tax credit. Previously, you could receive a $1,000 credit per child in your household. The new rules double that credit to $2,000. As a bonus, up to $1,400 of that credit is refundable.

The income thresholds for the phaseout of the child tax credit have also increased. Previously, individuals started losing the credit when their income passed $75,000. Married couples saw the phaseout begin at $110,000.

Under the new rules, the phaseout starts at $200,000 for singles and $400,000 for married couples. That means that many families will see a huge decrease in their taxes thanks to this credit.

Credits work differently than deductions. Deductions reduce your taxable income. This reduces the amount that you owe once your tax bill is determined. A tax credit pays a portion of your tax bill for you. Put simply, a $1,000 deduction could reduce your taxes by as much as $370, if you fall into the 37% bracket. A $1,000 credit reduces your tax bill by $1,000 exactly.

The refundable portion of the tax credit is the amount that you are eligible to receive in your tax refund. If your credits reduce your tax bill to zero or less, any refundable credits will be sent to your bank account. The non-refundable portion of credits is lost.

Changes to Medical Insurance Rules

Another major change in the 2018 tax plan is the removal of the health insurance mandate. This does not go into effect until 2019 but means taxpayers will not pay a penalty if they go without health insurance.

It is estimated that this change will cause 13 million Americans to forgo insurance. It is expected that this will increase overall health care costs.

To compensate somewhat for the increased costs, the bill expands health expense deductions. If you spend more than 7.5% of your annual income on medical expenses, you can deduct the excess. Previously, the cutoff was 10%.

Overall, this will help Americans who don’t have easy access to insurance save some money, so long as they stay healthy. People who get sick and need care could face higher costs.

Reduced Taxes on Pass-Through Businesses

Small business owners may benefit from a deduction on pass-through business taxes.

Businesses like sole proprietorships, LLCs, and S corporations are known as pass-through businesses. This means the businesses don’t pay taxes. Instead, the income that the business makes appears on individuals’ tax returns and that taxes are paid by the individuals.

The new plan allows people who earn money from a pass-through to deduct 20% of the pass-through income.

That means if you run a small business that makes $50,000, you can deduct $10,000 from your taxable income.

This deduction phases out for high-income “professional services” business owners, such as doctors and consultants. The phase-out starts at $157,500 for single filers and $315,000 for married couples.

Conclusion

All told, the majority of taxpayers will see lower tax bills from 2018 onwards.

These tax changes are set to expire in 2025 unless they are extended. That means you can expect further debate and potential updates to the tax code in the next seven years.

Related: 2018 Tax Deductions Changes for Freelancers