The Tax Cuts and Jobs Act of 2017 was signed into law by President Trump on Dec. 22, 2017.
Let’s break it down as it pertains to New Mexican taxpayers.
TIMING: The changes took effect Jan. 1, 2018. When you are preparing your 2017 taxes during the next few months, you will be using the old rules. You will not see the full impact of the tax changes until you prepare your 2018 tax return during early 2019. However, if your employer changes your withholding, you may see slightly more money in your paycheck during 2018.
STANDARD DEDUCTION: The standard deduction for single taxpayers will increase from $6,350 to $12,000 and for married couples from $12,700 to $24,000. In my view, this is the most favorable part of the tax overhaul bill. Many people who previously itemized their deductions will now take the standard deduction. Some tax deductions were eliminated, but others remain, such as the mortgage interest deduction, property tax deduction and charitable deductions. However, if the deductions do not total over $24,000 (for a married couple), people will simply claim the standard deduction.
First, consider a married couple with no children. They will see their standard deduction increase by $11,300 (from $12,700 to $24,000), but they will lose their two personal exemptions ($4,150 x 2 = $8,300). However, they will come out ahead (in terms of the overall deduction) by $3,000.
Now, let’s look at a family with two children. Their standard deduction will increase by $11,300, but they will lose four personal exemptions ($4,150 x 4 = $16,600). Their overall deduction will decrease by $5,300 with the new tax law.
$10,000 CAP FOR STATE AND LOCAL TAXES AND PROPERTY TAXES (COMBINED): This issue is getting the most criticism, especially from states with high income tax rates. In the old law there was no cap, and state income taxes and property taxes were fully deductible on the federal return. Capping the combination of state and local taxes and property taxes at $10,000 will result in many taxpayers paying higher taxes. Here’s where New Mexico’s state taxes are pertinent.
New Mexico’s state income tax rates have a maximum of 4.9 percent. Many states have taxes that hover between 5 percent to 7 percent, so New Mexico’s state tax rate should not be considered high. A review of state taxes across the nation shows that seven states have no state tax. North Dakota has the lowest state income tax rate at 2.9 percent, and California has the highest at 13.3 percent. Several states along the east coast (New Jersey, 8.97 percent; New York, 8.82 percent; and Washington, D.C., 8.95 percent) and California are crying foul at the $10,000 cap. Many of their residents pay far more than $10,000 in state income taxes and property taxes combined, so their federal taxes will be going up.
However, this $10,000 cap may also cause many New Mexicans to pay higher taxes. Some N.M. couples with two significant incomes (or one large income) may pay more than $10,000 in state income taxes. Also, although New Mexico’s state income tax rate seems fair, many would argue that New Mexico’s property taxes are high. The N.M. law that was passed in 2001 specified property taxes cannot increase over 3 percent per year as long as a residence is not sold. However, when a house is sold, increases of 40 percent to 50 percent for the new owner are not unusual. This increase has been termed “tax lightning” and has caused many New Mexico homeowners to consider their property taxes as unjustifiably high.
Any combination of high state income taxes and/or high property taxes can cause a taxpayer to exceed the new $10,000 cap, leading to higher taxes.
States with high income tax rates are researching how to fight the $10,000 cap. Among the ideas being considered are re-categorizing state income taxes to become charitable donations to the state, along with asking corporations to consider allowing employees to pay income taxes on a pre-tax basis through payroll taxes. Stay tuned: This battle will not go away because it will impact many people. It is too early to determine whether any solution will arise.
TAX BRACKETS: There are still seven tax brackets, but the highest federal tax bracket is declining from 39.6 percent to 37 percent. This is another major benefit of the tax overhaul, although we may not be able to determine the impact of the change until we prepare our 2018 taxes in spring of 2019.
MEDICAL DEDUCTIONS: To take a medical deduction on your federal tax return, qualified medical expenses need to exceed 7.5 percent of the adjusted gross income for 2017 and 2018. Beginning in 2019, the threshold will increase to 10 percent. Let’s circle back to an often-missed benefit that New Mexico allows for state taxes. That is, the qualified medical expenses that are not deducted from the federal return can be deducted from the New Mexico return without a threshold. In other words, if your medical expenses did not exceed the 7.5 percent threshold, you can still claim them on your N.M. return. Medical expenses paid from pre-tax dollars are not allowed, but Medicare Part B premiums, premiums paid for long-term care insurance, and unreimbursed insurance premiums and co-payments are eligible deductions.
THE BIG WINNER: Corporations are the big winner in the tax bill, with the maximum corporate tax rate declining from 35 percent to 21 percent. Corporations also have very low tax rates (as low as 8 percent) for repatriation, which is bringing profits currently stashed in foreign countries back to the U.S.
MISCELLANEOUS CHANGES: Changes to personal tax rates will “sunset” (meaning “go away”) at the end of 2025, but the corporate tax rate changes do not have a sunset clause.
The estate tax exemption was raised from $5.5 million to $11.2 million per person. The higher level will “sunset” at the end of 2025.
The preferential tax rate on long-term capital gains and qualified dividends of 15 percent for most taxpayers (20 percent for high-income taxpayers) will continue. The 3.8 percent surtax on net investment income will continue for adjusted gross income of $200,000 for singles and $250,000 for married couples.
Obamacare is not going away. However, the individual mandate (the clause that financially penalized taxpayers if they did not sign up for health insurance) was eliminated. As an added complication, the individual mandate does not disappear until 2019, so it is still in effect for 2018.
The child tax credit was increased from $1,000 to $2,000, and $1,400 of it is refundable.
Some pass-through businesses will benefit from the new tax law, but the details have not yet been clarified.
Alternative Minimum Tax (AMT) is still alive and well. Although it would have been eliminated in one of the versions being considered in mid-December, the final tax bill maintains the AMT.
The new tax law includes changes that are expected to benefit real estate developers, although details are not clear.
The tax law is expected to add to the national debt (currently $20 trillion). Estimates for the increased debt range from $1 trillion to $1.5 trillion over the next 10 years.
IT COMES DOWN TO YOU: What’s the overall impact of the Tax Cuts and Jobs Act of 2017 on an individual or a family in New Mexico? The changes are not within our control, but I am hopeful that many New Mexicans will see a decrease in their 2018 taxes when they prepare them in early 2019. If the $10,000 cap for state income taxes and property taxes combined is not revised, some New Mexicans will see their taxes increase. Overall, it is the factors that you can control that make a difference for your financial security.
If you get a tax refund, I highly recommend you save at least one-half of it. If you do not have a six-month emergency fund, start one and fund it with the tax refund. The long-term tax-free benefits of the Roth IRA have not changed, so I recommend funding a Roth IRA if you already have an emergency fund. You can fund a Roth IRA for 2017 (with $5,500 for someone under age 50 and $6,500 for someone age 50 or over) until April 17, 2018, as long as your income is below $118,000 for singles and $186,000 for married couples. (The limits for 2018 are going up to $120,000 for singles and $189,000 for couples). You can fund a Roth IRA for 2018 from now until April 15, 2019.
If your tax rate declines due to the tax law changes, you may want to consider converting a traditional IRA to a Roth IRA for the future tax benefits. Consult a tax professional for advice regarding your specific financial situation.
Donna Skeels Cygan, CFP, MBA is the author of the multi-award winning book “The Joy of Financial Security.” She has been the owner and financial planner for the firm Sage Future Financial in Albuquerque for 20 years. www.joyoffinancialsecurity.com.