The internet is full of discussions about the new tax law that went into effect for 2018. In particular, people seem to really dislike the new $10,000 cap on State, Local, and Property Tax deductions. The thinking is that this amounts to “double taxation” on anything over the cap, and that’s just not right.
But we should put this in context of the full changes to the tax code. The standard deduction was also increased substantially and, in general, marginal tax rates went down.
So let’s cut through the hyperbole and run some numbers. How does this actually affect your life? In particular, how much Federal tax do you have to pay in 2018 relative to what you paid in 2017?
An email from my friend’s father on this topic stated:
[I’m concerned about] the impact on double taxation in the high income states and locations that have higher real estate taxes. I have a friend whose income is probably around $200,000 per year, so even assuming that his deductions take him to a reasonable AGI – he probably has around $2500 in state income taxes and his home has $14,000 in Real Estate Taxes (County, Local & School) – so under the new tax law he will pay federal taxes on $6,500 of this $16,500 in SALT [State and Local Taxes].
We’ll use this friend as an example here. We’ll call him Bob. Since Bob owns a home with $14k in property taxes, I’m assuming he’s married and has kids in a good school district. Because he only mentions Bob’s income, I’ll assume that Bob’s wife is a stay-at-home mom. So that $200k is their combined household income.
Let’s start with State, Local, and Property Taxes; we’ll call these “RE/SALT” for this discussion. The standard deduction for a married couple in 2018 is $24,000. In 2017, they would have been able to deduct $16,500 for SALT and $4,350 personal exemptions each for him and his wife, for a total of $25,200 in deductions. So he’ll have to pay tax at his marginal rate on the difference of $1,200.
But his marginal rate has also decreased substantially. With a $200k household income, his marginal rate went from 25%/28% to 22%/24% [1] (depending on whether he maxes his 401k/HSA contributions). Let’s look at an example.
Example: Max 401k and Family HSA
Let’s say Bob maxes out his 401k and a family HSA every year. RE/SALT were his main/only itemized deductions.
2017 Taxes:
Bob has a $150,050 AGI ($200k income – $18,000 401k – $6,750 HSA – $16,500 itemized – 2*$4,350 exemptions).
Bob owes $10,452.50+.25*($150,050-$75,900) = $28,990 in federal taxes [2]
2018 Taxes:
Bob has a $150,600 AGI ($200k income – $18,500 401k – $6,900 HSA – $24,000 standard deduction).
It’s interesting to note the nearly identical AGI. The increase in contribution limits for the 401k and HSA alone account for the difference. But I suspect this is a pure coincidence.
Bob pays $3,979 less in 2018 taxes than in 2017.
Example: No 401k or Family HSA
Okay, this time let’s look at what happens if Bob doesn’t contribute to a 401k or HSA.
2017 Taxes:
He has a $174,800 AGI (200k income – 16500 deduction – 4350*2 exemptions)
He owes 29,752.50+.28*(174800-153100) = $35,828.50 [2]
2018 Taxes:
He has a $176,000 AGI (200k income – 24000 standard deduction)
He owes 28179+.24*(176000-165000) = $30,819 in federal taxes [3]
Bob pays $5,010 less in 2018 taxes than in 2017.
So Bob actually comes out significantly ahead of the game here with the new tax law.
Even with the “double taxation”.
Does this look right to you? Am I forgetting to account for anything here?
[1] 2017 vs 2018 tax bracket comparison: http://www.businessinsider.com/tax-brackets-2018-trump-tax-plan-chart-2017-12
[2] 2017 tax schedule: https://turbotax.intuit.com/tax-tips/irs-tax-return/current-federal-tax-rate-schedules/L7Bjs1EAD
[3] 2018 tax schedule: https://www.fool.com/taxes/2017/12/13/your-guide-to-tax-brackets-in-2018.aspx
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