The US President signed the Tax Cuts and Jobs Act (TCJA) on December 22, 2017. The TCJA introduced the greatest extensive changes to the US tax law since the Tax Reform Act of 1986 (Auerbach, 1). The implemented changes significantly affect individuals, families, businesses, and the corporate sector. This paper summarizes the purpose and objective of the TCJA, some of the significant changes it brought about and their impacts, and recommends appropriate tax planning strategies to maximize tax savings.
Summary of the TCJA
The TCJA was signed and implemented to achieve four chief goals. The act targeted to offer tax-relief for middle-income families and simplify individual taxing. Moreover, the act was meant to boost economic growth and repatriate overseas income. The government projected that reducing the state corporate tax rate by 14%, would permit firms to expense investments in nonstructure capital. Reducing the corporate tax would also increase output by 2%, from 2% to 4%. Subsequently, the act would increase the average household income by $4,000 (White House, 2). The TCJA led America to conform to other Canada and the Organization for Economic Cooperation and Development (OECD) countries that have been steadily decreasing tax rates.
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Significant Changes Introduced by the TCJA
The TCJA introduced significant changes that affected individuals and business owners. One of the most significant changes introduced by the act was the expansion of the standard deduction. Initially, three primary provisions existed that decreased income taxes based on the number of family members. The provision included the standard deduction, the personal exemption, and the child tax credit. Tax filers had the option of reducing their taxable income by a fixed amount or itemizing their deductions. The TCJA expanded the standard deduction for single and joint filers from $6,500 to$12,000 and $13,000 to $24,000. Increasing the standard deduction decreased the essence of itemized deductions, hence encouraging more filers to apply the standard deductions (York, 3). One of the advantages of increasing the standard deduction is that it simplified the filing process by reducing the time and effort exerted in gathering receipts and filling appropriate forms. The changes also reduced tax compliance costs for households.
Secondly, the TCJA limited some itemized deductions, including mortgage interest and state and local taxes paid (SALT) and eradicated other smaller itemized deductions. Initially, filers were allowed to deduct either the state individual income tax or state sales tax and state and local property taxes paid. The deduction disproportionately favored high-income taxpayers. The TCJA limited these deductions to a maximum of $10,000, which is likely to reduce the application of these deductions. Another change to the itemized deductions is the reduction of minimum sum of home mortgage debt that filers can deduct interest on. The amount was reduced from $1 million to $750,000. The TCJA also temporarily stopped the deduction of interest on lines of credit and home equity loans. These deductions will only be permitted when the home equity loans are meant to purchase, construct, or improve the filer’s home (York, 3). The change in itemized deductions will reduce the cost of tax expenditure. Eliminating smaller itemized deductions will also simplify the tax filing process for individuals. Limiting the use of SALT deductions will also offer tax relief to middle-income households.
Another change that the TCJA introduced is eliminating personal exemptions. The former individual income tax code had provisions that reduced household income. The provisions were difficult to navigate due to various complexities, such as different definitions of who qualifies as a child. The TCJA, therefore, eliminated the personal exemption and expanded the child tax credit. Increasing the child credit was favored since exemptions reduce taxable income while credit reduced tax liability. The act increased the child credit from $1,000 to $2,000 for all children under seventeen years. Additionally, the act raised the income threshold for phasing out child credit from $110,000 to $400,000 for joint filers (York, 3). This change is advantageous since it increased the value of the child credit and led to a surge in the number of people able to claim the credit.
Impacts of the Introduced Changes to Individuals and Families
One of the most significant impacts of limiting itemized deductions is on local home prices, where neighborhoods with a high concentration of itemizers under the new law will face higher marginal costs of homeownership. Limiting the itemized deductions eliminates the tax preference for housing. Consequently, the after-tax price of mortgage interest and property taxes increases. Initially, itemized deductions influenced consumer behavior to maximize deductions. Therefore, limiting these deductions in favor of standard deductions will alter consumer behavior (Tylor, 4). Research shows that child tax credits deliver educational and health benefits to families. Child tax credits are only available to working families. Therefore, increasing the amounts of child tax credit boosts work efforts. The increased income is also likely to improve educational outcomes for children from low-income families (Machin, 5). Subsequently, child tax credits reduce poverty rates in working families. Simplifying the tax compliance process and reducing the associated costs is also likely to increase tax compliance within families. Expanding the standard deductions
Tax Planning Strategies to Maximize Tax Savings
One of the tax planning strategies that individuals can implement to maximize tax savings is taking advantage of the tax credits expanded by the TCJA. Families should ensure that all children in the household have a Social Security number, which makes the child qualify for the increased child tax credits. The child tax credits make it easier for parents to raise their children by reducing the total tax bill for each dollar. Therefore, child tax credits offer more value than tax deductions since deductions only reduce the taxable income. While $1,400 of the total $2,000 offered in child tax credits is nonrefundable, the other $600 is refundable (York, 3). The latter means that the government can reduce the tax liability to negative values and refund the cash difference.
Apart from the child tax credit, another change that individuals and families can take advantage of to maximize tax savings is the introduction of the credit for other dependents. The TCJA implemented the new credit for dependents that do not meet the child tax credit qualifications (York, 3). The credit awarded for other dependents significantly reduces the tax liability for families.
Instead of using the personal exemptions, filers can bulk up on their standard deductions, which have no eligibility requirements. Standard deductions also lack income limitations and do not require filling tedious forms. Taking advantage of the standard deductions is one of the most straightforward tax planning strategies that individuals and families can implement. Implementing the tax planning strategy not only makes filing easy and convenient but also reduced tax compliance costs by saving time. A critical factor that filers should note is that anyone is qualified for the standard deductions even if their expenses do not qualify for itemized deductions.
Individuals can also take advantage of the home mortgage interest, that allows them to count the interest they pay on home loans. As long as the loan was taken out to build, improve, or purchase a home, and exceeds $750,000, tax deductions apply (York, 3). Therefore, families can deduct mortgage interest by up to $750,000, significantly maximizing tax savings.
Conclusion
The TCJA resulted in several changes that impacted filers. The act introduced the most extensive changes to the US tax law since the Tax Reform Act of 1986. Some of the main goals of the act were offering tax-relief for middle-income families, simplifying individual taxing, boosting economic growth, and repatriating overseas income. The TCJA expanded the standard deductions for single and joint filers, limited two itemized deductions, and eliminated personal exemptions. These changes impacted filers in various ways. For example, increasing the child tax credit resulted in higher health benefits to families and boosted work efforts. Individuals and families can implement tax planning strategies to maximize tax savings. For instance, they can take advantage of the expanded tax credits and the decreased home mortgage interest limit.
Sources
Alan Auerbach. 2018. Measuring the Effects of Corporate Tax Cuts. p. 97-120. https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.32.4.97
White House. 2018. The Tax Cuts and Job Acts: The Most Significant Federal Tax Reform Enacted in the United States in Decades. https://www.whitehouse.gov/wp-content/uploads/2018/02/WH_CuttingTaxesForAmericanWorkers_Feb2018.pdf
Erika York & Alex Muresianu. August 7, 2018. The Tax Cuts and Jobs Act Simplified the Tax Filing Process for Millions of Households. https://taxfoundation.org/the-tax-cuts-and-jobs-act-simplified-the-tax-filing-process-for-millions-of-americans/
Lori Taylor. 2017. Are There Benefits to a Higher Standard? The Effects of Raising the Standard Tax Deduction. https://oaktrust.library.tamu.edu/bitstream/handle/1969.1/164756/V8-3%20Raising%20the%20Standard%20Tax%20Deduction.pdf?sequence=1&isAllowed=y
Richard Machin. November 7, 2017. The Professional and Ethical Dilemmas of the Two-child Limit for Child Tax Credit and Universal Credit. https://doi.org/10.1080/17496535.2017.1386227
