[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.
Pease Phaseout
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.
Marriage Penalty
The so-called “marriage penalty” still exists in the tax code, but it has been reduced.
529 Accounts
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!
Just to flesh out the AMT changes mentioned above if anyone is interested in the math…
Even if someone gets hit by the AMT, its going to save them ~$30,000 in taxes this year because the tax rate over $191K in the AMT is 28%.
28% of the $109,000 (married) exemption is $30,520.
As an example:
A married couple filing jointly with no kids who has an AGI of $350K who takes the standard deduction (24K) and fills up the SALT deduction (10K) will expect to pay a tax bill on $316K. (Assuming no other deductions/credits) with the new TCJA brackets that will amount to a federal tax of $67,699.
With the AMT, neither the standard deduction or SALT can be deducted. So this person’s AMTI is $350,000 – 109000 exemption = $241,000. The new AMTI number for 2018 is 191,500. Below this number is 26% tax, above it is 28%. Using the above $241,000 their anticipated AMT would be $63,650.
You pay the higher tax between the two. So, you get to avoid the AMTI ($63,650) and pay the TCJA taxes ($67,699).
Pretty good deal, because last year you’d be paying around $90,000 through the AMT instead. Because you get to use the exemption, that’s no longer the case.
Thanks for the good overview, WCI!
You can’t take standard deduction and the salt deduction at the same time. It’s either standard deduction or itemized deductions
That’s true. I can’t edit my above comment.
I don’t take standard deductions because of charitable giving… So that’s why I add the SALT with my other itemized deductions.
This just makes it even more likely not to get hit by AMT.
Thanks for catching that.
Perhaps I misunderstood, but why did you say in the example, “takes the standard deduction (24k) and fills up the SALT deduction (10k)”? SALT deduction only available if one itemizes, right?
Yes, I should not have combined the two. That’s my mistake. See my comment above (I normally itemize…so I add the SALT to my other deductions; but if you take standard… you cannot add the SALT on top of that).
Thanks for this simple, but not too simple review. Taxes always confuse the heck out of me.
I stopped contributing to my 457 in January but resumed it in March since I’m not seeing any substantive changes to the plan or tax laws.
I think that was wise, but it’s pretty clear now they aren’t affected. No harm done.
If I have 4 professional services LLCs, that I am sole owner of, does it make sense to create a non professional management company that handles operations of the other four, to take advantage of the new tax laws?
Thanks!
Seems like a good idea to me. As long as the IRS doesn’t look at all the companies as one big company, you should save money. Might want to run it by your CPA before going through the hassle of forming a new company.
My CPA handles many health care clients of various stripes. They are looking at the option to create separate layers of business structure to separate out part of the business into a non-health care management entity so that portion of the business will qualify for the 20% pass through deduction. There are national groups of CPAs that handle health care businesses that are looking at these new business structures in order to maximize the pass-through deduction. Our CPA has advised waiting a bit until more details are fleshed out.
Can you please take us through a simple example of the math to demonstrate how you figure the ‘marriage penalty’ is going to be lower under the new code. I would argue that the opposite is true for the vast majority of high income individuals living in any state with even a moderate state income tax. For example, our own situation: As a couple, our combined state income tax hovers around $19K, and we have additional above the line deductions of ~$14K local property/school tax, ~$9K mortgage interest deduction, plus ~$5K in charitable contributions, for a total of ~$47K, that we can typically deduct as a couple. Under the new code, as a couple we’d be limited to $24K ($10K+$9K+$5K), which coincidentally is the same as the standard deduction; but if we were not married (and still living together in the same house), we would EACH be able to deduct $10K in state/local property and income taxes, for a total of $34K. A huge marriage penalty, especially for higher income individuals whose deductions are of greater value due to their higher marginal rates!
You’re looking at one small aspect of the tax code (the limited SALT deduction) and ignoring the rest.
Consider the tax brackets, which generally have a larger effect than your schedule A itemized deductions.
In 2017, two singles making $180K a piece were in the 28% bracket. If they got married, they were in the 33% bracket.
In 2018, two singles making $180K are in the 32% bracket. If they get married they’re still in the 32% bracket.
Now everyone’s tax situation is different and it is always possible that your personal marriage penalty can be higher than it was last year. But in general across most people, the marriage penalty was reduced by the tax law changes. It might even be reduced for you if you look at EVERYTHING instead of just the effect on your itemized deductions.
Hmm…I agree that everyone’s situation is different, but… In your example, the married couple’s marginal bracket moved from 33% before the changes to 32% in 2018, whereas the two singles went from 28% to 32%. So in that case I’d say the logic seems a bit backwards to even refer to this as a marriage penalty…it’s more the case that there was a “singles reward” in the past, which has now somewhat disappeared. The married couple’s marginal bracket hardly moved (just one percent). I mean really, it’s little consolation to be told that the “marriage penalty is less now” if all you mean is that unmarried folks are paying more. (I have a similar hang-up with a similar logic in your alternative minimum tax paragraph where you claim that one is now less likely to pay the alternative minimum tax because of the itemized deduction cap on state/local taxes. Again, very little consolation, because while on the surface of your argument it sounds like you’re saying “congratulations, many people now won’t have to pay the alternative minimum tax”, BUT that’s because the tax burden under the traditional system is now Higher than if it was calculated under the alternative system (largely due to the deduction cap), and of course one always pays the higher of the two. )
We’re not comparing 2017 to 2018. We’re comparing the marriage tax penalty in 2017 to the marriage tax penalty in 2018. That was my statement that you’ve asked me to defend.
If you want to talk about overall tax burden in 2017 vs 2018, we can talk about that as well. It went down for many, is similar for many, and went up for a very few, mostly in high income tax states.
The marriage tax penalty is when two people get married and end up paying more in taxes. That is less likely to happen in 2018 than it was in 2017. Thus my statement. Whether the difference comes from married people paying less or singles paying more, it doesn’t matter. The penalty is reduced in size. My statement is accurate. It sounds like you’re just really ticked off about the SALT deduction limitation, and I feel you there. I lost an $80K deduction, more than my 401(k), HSA, and health insurance combined. I went from a mid 6 figure total of itemized deductions in 2017 to taking the standard deduction in 2018. Pretty weird stuff these tax law changes.
WCI, very helpful summary.
Are you aware that REIT dividends will be included in the pass-through entity deduction? The old “Ordinary” REIT dividends have been renamed “Qualified-REIT” dividends, of which 20% should be deducted from taxable income just like income from pass-through entities. The tax law and tax code are unclear whether these dividends will be subject to the same income restrictions that pass through entities have–the grammar in the texts is really poor. Note: the new “Qualified-REIT” dividend term should not be confused with “Qualified” dividends, which are taxed at the 0/15/20% rates.
Thanks for the article! Josh
I’ve been hearing rumors about that, which of course could really have a big effect for some people on asset location decisions.
If you and your spouse own the building where you practice as a separate rental property (LLC), can the rental income be pass through deduction even though your income is over 415K? It seems this may be a case where married filing separately could help. I am a physician but my spouse is not and manages the property. If we make over 415k jointly, the deduction phases out. However, if I make over that amount and my spouse doesn’t, married filing separately may lower the tax burden. Am I processing this correctly?
What is the best resource to estimate what your taxes will look like for 2018? Any good online references?
https://www.irs.gov/pub/irs-pdf/f1040.pdf 🙂
Seriously. That’s what I use to estimate my taxes.