[Editor's Note: This is one of my recent columns from ACEPNow and originally ran here. It provides a good overview of The Tax Cuts and Jobs Act. I published a blog post about the TCJA a few months ago, but there are so many important changes for 2018 that I thought it would be good to hit it again and hopefully on a slightly simpler level so am republishing this one here. I made one minor edit as the concern I had about 457s back when I wrote this seems to have become a non-issue. Enjoy]
Q. I know there are a bunch of changes to the tax system this year, but I get confused when I read about them. Can you break it down to just the stuff I need to know as an emergency physician?
A. I’ll discuss the major changes in the tax code that will affect you and try to explain how it was before and why it is different now. We don’t have the space to be comprehensive, but I’ll try to hit the major points in a simple, easy-to-understand way. Bear in mind that the largest changes to the tax code are on the corporate side, but I’ll only be outlining changes to the individual tax code.
A quick aside: basic financial literacy must include at least the basics of the tax code (eg, how tax brackets work; the difference between gross income, adjusted gross income, and taxable income; and the difference between an above-the-line deduction, a below-the-line deduction, an exemption, and a credit). There is no better way to learn the tax code than to do your own taxes by hand, although that is admittedly a rather painful process. At a minimum, try to look over your tax forms (Form 1040 and Schedule A if nothing else) when they are returned to you by your tax preparer.
What You Need to Know About the Changes to the Tax Code
Lower Tax Rates
The most significant change to the tax code is that the tax rates applied to your income have gone down. The 15 percent bracket is now the 12 percent bracket, the 25 percent bracket is now the 22 percent bracket, the 39.6 percent bracket is now the 37 percent bracket, and so forth. This single change will cause most people, in all brackets, to have a lower overall tax bill.
Higher Standard Deduction
The standard deduction has been nearly doubled, from $6,350 ($12,700 if married) to $12,000 ($24,000 if married). This will result in many more people taking the standard deduction who used to itemize their below-the-line deductions (like state taxes, mortgage interest, and charity) on Schedule A (itemized deductions). Estimates are that 70 percent of Americans used to take the standard deduction and that 90 percent of Americans will do so now. Even many physicians will now choose to take the standard deduction at least some of the time.
State and Property Tax Deduction Limits
The amount of state income and property tax that can be deducted on Schedule A will be limited to just $10,000 total. Combined with the higher standard deduction, this will push more physicians to take the standard deduction. A very small percentage of Americans will see their tax bill actually go up in 2018, and it is primarily due to this change. These folks, some of whom will be physicians, mostly live in high-tax states with a high cost of living, such as California and “blue” states in the Northeast.
Changes to Dependents
Exemptions (a $4,050 reduction in taxable income in 2017 for you, your spouse, and each of your children) are now gone, but many emergency physicians were phased out of those previously anyway. However, the child tax credit ($2,000 per child) phaseout was increased significantly, from $75,000 ($110,000 married) to $200,000 ($400,000). So many emergency physicians who could not take this credit before will now be able to. There is also a new, smaller credit ($500) for college-age children and adult dependents that you may qualify for.
Alternative Minimum Tax
Many emergency physicians in the past have been caught up in the alternative minimum tax (AMT) system. The AMT is actually a completely separate tax system, not an additional tax. You are required by law to calculate your tax due under both the regular system and the AMT and pay the higher of the two amounts. Three changes went into place that make you less likely to have to pay under the AMT system on your 2018 taxes. The first is that the state income tax deduction has been severely limited, as discussed above, and this was a major reason some people owed more under the AMT, where this deduction is not allowed. The second is that the exemption amount under the AMT was increased from $55,400 ($86,200 if married) to $70,300 ($109,400 if married). The third, and perhaps most significant, is that the phaseout of the exemption was increased from $123,100 ($164,100 if married) to $500,000 ($1 million if married). When you look at all three of these changes, the bottom line effect is that many emergency physicians who used to pay under the AMT no longer will.
The Pease phaseout of your itemized deductions is now gone. This had the effect of adding an extra 1 percent to 1.2 percent tax on the tax bill of anyone with a taxable income of more than $261,500 ($313,800 if married). If your marginal tax rate (tax bracket) used to be 39.6 percent, it was really 40.6 percent, and now it will be reduced to 37 percent.
The so-called “marriage penalty” still exists in the tax code, but it has been reduced.
529 accounts can now be used to pay for K–12 education tax-free.
Estate Tax Exemption Doubled
Few emergency physicians ever accumulated enough wealth so that their estates would owe federal estate tax. That is even more unlikely now as the exemption amount has been doubled to $11 million ($22 million if married).
Deferred Compensation Changes
If you use a 457(b) plan or other similar retirement plan, you will want to pay attention to any changes your plan may make this year in response to this law. If your distribution options become less favorable, you may wish to invest in a simple taxable nonqualified account instead. It won’t affect 401(k)s or 403(b)s.[Update prior to publication: After a few months of experts reviewing this act, it looks like it isn't going to affect your 457s, so if a 457 was right for you before, it still is right for you. If you're not sure, this post can help.
Alimony Tax Treatment Reversed
In what is basically a new tax on divorce, alimony will no longer be deductible to those who pay it and taxable to those who receive it. The reverse will apply: Alimony payments will not be deductible, and they will not be taxable income for the recipient. Previous divorce agreements are grandfathered in under the old rules, however.
Pass-Through Entity Deduction
There is a new deduction for pass-through businesses such as sole proprietorships, LLCs, and S corporations. However, this deduction is specifically limited for physicians and similar professionals who have a taxable income of more than $157,500 ($315,000 if married). Some self-employed emergency physicians will be able to get their taxable income below this amount by maxing out retirement accounts and thus receive this deduction, but many will not. Employed physicians are not eligible. If you own a nonprofessional service business on the side, this may be a significant deduction for you going forward.
Overall, most emergency physicians will see their tax bill decrease in 2018, but as with any change to the tax code, some people will benefit more than others. As you learn more about the tax code, you will be able to make changes in your financial life that will allow you to minimize your tax burden going forward.
What do you think of the new tax law? Did I miss anything? Do you think it will affect you for the better or worse? Comment below!