This is our only example that doesn’t include itemized deductions. It does illustrate the new Child Tax Credit (CTC) amounts, the essentially unchanged Earned Income Credit (EIC)1 and self-employment (S/E) tax, and the new Qualified Business Income (QBI) deduction.
In this scenario, we have a hard-working self-employed taxpayer who is the custodial parent of 4 children. The taxpayer is divorced, and grants two of the dependents to the ex-spouse in accordance with their divorce decree utilizing Form 8332. Itemized deduction totals were less than the standard deduction for both 2017 and 2018.
Let’s look at three scenarios, adjusting only for the net profit from self-employment as the variable.
|1/2 S/E tax||-2,656||-2,656|
What if the taxpayer’s business generated $20,000 more in net profit?
|1/2 S/E tax||-4,069||-4,069|
What if the self-employment enterprise was less profitable by $20,000 than the first example?
|1/2 S/E tax||-1,243||-1,243|
|Net tax (refund)||-5,832||-6,023||191|
Often attributed to Mark Twain (although he did not say it) is the quote, “There are lies, damned lies, and statistics”. One could accurately look at the last two tables above and say, ‘You mean the person who earns $40,000 more got $2,806 (7.02%) more in benefit on that income difference from the new tax law?’ While that is true, that is a function of our system of graduated tax rates–that is, higher income taxpayers pay at a higher rate on their upper levels of income than do lower income taxpayers. So, across-the-board tax cuts should generate a greater dollar amount of reduction to taxpayers in a higher tax bracket. In this example, $852 of the difference is attributable to the new Qualified Business Income deduction.
One could also accurately state, ‘You mean the person who earned $40,000 more had to pay $13,310 (33.26%) more in net taxes in 2018 on that income difference than the other one?’ Yes, that’s also true. In addition to progressive tax rates, our tax code is highly tilted toward families with children under age 17 with at least one parent who is working. The refundable Earned Income Credit and partially refundable Child Tax Credit are tied to earnings from work. Tax writers have long recognized that effort with tax credits for low-income working families.
Is this fair? You might ask if your glass is half full or half empty.
1We did not compensate for 2018 inflation adjustments in the EIC calculations.