1. Know the Tax Law Changes
In December 2017 President Trump signed the new tax bill. This new law is known as the Tax Cuts and Jobs Act (TCJA). Much of the discussion surrounding the TCJA is tax cuts for individual taxpayers.
Overall income tax rates were cut. The highest federal income tax rate which was 39.6% has been cut to 37%. This is one of many other changes made that will ultimately impact what each taxpayer will pay. The almost doubling of the standard deduction; the $10,000 cap on state and local income tax (“SALT”); the elimination of the personal exemption; the new limitation on the mortgage interest deduction and the removal of the alimony deduction are among the other major changes of the TCJA. For a summary of these changes see 7 Ways the 2017 Tax Bill Affects Connecticut Taxpayers.
2. Know Your Tax Bracket
The next step in the step process is to know your tax bracket. For this post we are merely referencing the Federal Income Tax.
Here are the Federal Income Tax Brackets for 2018:
Single Married Filing Joint Head of Household
10% up to $9,525 Up to $19,050 Up to $13,600
12% $9,526 to $38,700 $19,051 to $77,400 $13,601 to $51,800
22% $38,701 to $82,500 $77,401 to $165,000 $51,801 to $82,500
24% $82,501 to $157,500 $165,001 to $315,000 $82,501 to $157,500
32% $157,501 to $200,000 $315,001 to $400,000 $157,501 to $200,000
35% $200,001 to $500,000 $400,001 to $600,000 $200,001 to $500,000
37% over $500,000 over $600,000 over $500,000
Regrettably, for many taxpayers there are also other taxes they need to keep in mind. For the self-employed, they also need to pay attention to their Self Employment Tax or (Social Security Tax). Normally if you are employed, your employer will pay one half of any social security tax and the employee (you) will pay the other half. Being self-employed you are required to pay both employee portion of the tax and the employer portion of the tax for a total of 15.3% on your net earnings up to the current limit for the year 2018 of $128,400. Earnings above this amount are only subject to the Medicare Tax of 2.9%. The good news is that self-employed taxpayers are allowed to deduct one half of this Social Security and Medicare Tax against their gross taxable income. Higher income earners also need to be cognizant of their Net Investment Income (NIIT) Tax. This is a 3.8% tax on passive income including interest, dividends and capital gains.
Connecticut taxpayers also need to keep a close eye on their Connecticut Income Tax which tops out at 6.99%.
3. Review Your Withholding and or Estimated Tax
The U.S. tax system is a ‘pay-as-you-go’ system. For employees, this is the easy part. They usually have the income taxes withheld from their paychecks. Many employers adjusted their withholding tables this past February to reflect the tax cuts.
For the self-employed and perhaps retirees, it may be necessary to pay estimated tax to avoid penalties for underpayment of tax. These tax payments are due on a quarterly basis payable in April, June, September and the subsequent January 15 th.
The rules established to avoid an underpayment penalty, for taxpayers with Adjusted Gross Income (“AGI”) under $150,000 is to pay in via withholdings or estimated payments as discussed above, the lesser of 100% of the prior year tax or 90% of the current year tax. For taxpayers with AGI exceeding $150,000 they will need to have pay in 110% of the prior year tax.
4. Run a Tax Projection
Taxpayers can either take the Standard Deduction or Itemize their deductions whichever provides them the larger deduction. Before this legislation it is estimated that about 70% of taxpayers took the standard deduction. With the doubling of the Standard Deduction and the cap on the State and Local Income Tax of $10,000 it is estimated that very few taxpayers will itemize their deductions any more.
One of the more complicated areas is for taxpayers with so-called pass through entities. These include:
- A partner in a partnership
- A member in an LLC
- A shareholder of a Subchapter S Corporation
The TCJA provided for a 20% deduction on the net business income from these pass through entities. While this is great news for taxpayers that have pass through entities, caution should be taken here. The TCJA was passed very quickly at the end of 2017. Taxpayers are still waiting for guidance from the Internal Revenue Service on this new deduction. Certain occupations like health, law, financial services, brokerage, actuarial services and other industries will have income limits with regards to their ability to take this deduction. For taxpayers in these industries, when they are married filing jointly and their taxable income exceeds $415,000 they can’t claim the pass-through deduction.
With a significant amount of taxpayers no longer itemizing their deductions, it will be interesting to see how this pays out with charitable giving. If most folks are no longer itemizing, they won’t be getting an income tax deduction for their charitable donations. It makes you wonder if charitable giving will decline.
Remember to keep take advantage of all of the tax tools available to you. For retirement this includes 401(k) and Roth 401(k) plans, SEP’s, IRA’s, Roth IRA’s and Roth Conversions. For education planning this includes 529 College Savings Plans. Connecticut taxpayers should carefully look at the Connecticut Higher Education Trust (“CHET”) accounts. Capital gains tax rates still remain favorable over ordinary income tax rates. In the past we have 0%, 15% and 20%. Currently we don’t have a 15% income tax bracket to match up with the 15% long term capital gains rate. Again, we will need some guidance on how this will be addressed. Despite the decline in tax rates, tax-free investments like municipal bonds could still remain attractive for some.
Take these Four Easy Steps now to help plan for your 2018 Income Tax or call our office for assistance.