We’ve already learned the increase in standard deductions had a price–the repeal of personal exemptions. And for taxpayers who 1) don’t itemize deductions and 2) claim no dependents, the repeal always results in a reduction of federal tax. That’s because the new standard deduction is higher than the previous law combination of standard deduction and personal exemption.
What about taxpayers without dependents, but who do itemize? For some of these taxpayers, their taxes will actually increase due to the new tax law. The maximum tax increase without dependents for single filers is $405, and $810 for married filing joint, due to the repeal of personal exemptions.
Example 1: Bob Taxpayer, age 72, has total taxable income consisting of pensions, interest and Social Security totaling $24,000. Bob had $8,000 in out-of-pocket medical expense and health insurance, $2,000 in property and state income taxes, and made $7,000 in charitable contributions (Bob is very magnanimous!)
Under either tax law, Bob’s $8,000 in medical expense is limited by 7.5% of his income. So his total itemized deductions for both years are $6,200 allowable medical, 2,000 taxes and 7,000 charity = $15,200.
Under the old law, Bob’s $24,000 in income would have been reduced by his 15,200 in itemized deductions and 4,050 in personal exemptions, leaving him a taxable income of $4,750, taxed at 10%, or total tax of $475. Under the new law, Bob will still use itemized deductions, since his new standard deduction of $13,600 is less than his total itemized deductions. However, the personal exemption has been repealed, so his taxable income will be $24,000 less 15,200 itemized = $8,800 taxed at 10%, or total tax of $880, a $405 increase!
Bob’s case is unusual, in that he has relatively high itemized deductions compared to his income. In his low level of taxable income, he remains in the bottom (10%) tax bracket, whose rate was unchanged, so he isn’t able to take advantage of the rate reductions in the other tax brackets. If Bob’s total income was $37,500 instead of 24,000, the tax increase because of the repeal of personal exemptions would be $183. At $45,000 total income, the medical expense limitation makes the standard deduction more attractive, and total federal tax is $60 less than under the old tax law, due to the change in tax rates even though his taxable income under the new law is $4,050 higher.
What about some families with dependent children not eligible for the new Child Tax Credit? Let’s say a couple has two dependent children, a 17 year old in high school and a 20 year old in college. In the prior law, the couple could claim personal exemptions of $4,050 (in 2017) for each of them, reducing their taxable income. Under the new law, dependent children not eligible for the Child Tax Credit may be eligible for a new Dependent Child Credit of $500 per child. Their new $1,000 credit is better for them than the deduction in the 10% and 12% tax brackets, but they lose ground when their taxable income exceeds the threshold for the 22% bracket. However, by that time the rate reduction in new 12% bracket made up the difference. Confusing, huh?
Did the tax writers realize the new law would make some lower income taxpayers with large itemized deductions have a higher tax bill? We don’t know, but with an overhaul this massive, there have to be some winners and some losers. As it always will be, with a tax code as complex as ours.