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Loss of exemptions could cost some taxpayers

Family photo vintage_Forks Timber Museum-Flickr-4647372649
U.S. families have been getting smaller in recent years, but some still have lots of children and they could end up being adversely affected by the tax law changes now under consideration. (Photo from the Forks Timber Museum Collection via Flickr)

In selling their tax cuts to the American public, Republicans emphasize that the standard deduction amount is almost doubled.

That sounds good. But that's not the whole story.

You'll lose personal exemptions.

For taxpayers, exemptions are excellent. That's especially the case for filers who have lots of dependents.

Under current law, a tax exemption helps reduce your income so that you get to a smaller taxable amount. And exemptions — dollar amounts allowed for a filer, his/her spouse if married and qualifying dependents — are in addition to the deduction method, either standard or itemized, that you use.

Trading exemptions for upped deductions: H.R. 1, the Tax Cuts and Jobs Act, that both the House and Senate have passed in different forms, does away with exemptions in order to increase the standard deduction amount.

While the proposed larger deductions are impressive when compared with the current (or inflation adjusted for tax year 2018) amounts, they aren't so appealing when you count the loss of exemptions.

Under the tax bill approved by the House, the standard deductions would be $12,200 for single filers, $24,400 for married couples filing a joint return and $18,300 for head of household taxpayers. The Senate's numbers are slightly less: $12,000 for singles, $24,000 for couples and $18,000 heads of households.

And here are the 2018 standard deductions under the current tax laws, which I'm using since any tax changes would take effect next year:

  • $6,500 for single filers,
  • $13,000 for married joint filers and
  • $9,550 for head of household taxpayers.

So yes, the proposed tax changes for standard deductions would be substantially larger.

How exemptions add up: But you also have to take into account the personal exemption amount, which is $4,150 in 2018.

Under the tax code now in effect, if you are married and filing a joint return, have three kids and claim the standard deduction, you'll get to subtract $33,750 from your adjusted gross income to get to the earnings amount upon which your tax bill is calculated.

That $33,750 comes from the $13,000 married filing jointly standard deduction plus five exemptions ($4,150 x 5 for the children and parents) totaling $20,750.

But if the tax changes that are being hammered out do become law, you would get the proposed larger standard deduction amounts — in this family scenario $24,400 (House) or $24,000 (Senate) — but no exemptions, either personal as a taxpayer or for dependents.

Credits could help, but…: The tax changes propose to make up the loss of dependent exemptions by offering filers some new tax credits.

The House bill says taxpayers with children younger than 17 would get a $1,600 per-child credit. A $300 credit would be allowed for children older than 17 and non-child dependents, such as an elderly parent who's part of your household. Both these credits would phase out for joint taxpayers earning over $230,000 and single taxpayers earning over $115,000.

The Senate's dependent tax credit would be $2,000 and available to taxpayers with children younger than 18. A $500 credit would be allowed for non-child dependents. These credits would phase out for taxpayers earning more than $500,000.

True, a tax credit is more valuable than deductions or exemptions that simply reduce taxable income. A tax credit is a dollar-for-dollar reduction of any tax bill you owe.

And yes, lower tax rates could mean that a taxpayer's eventual tax liability under the proposed changes would come out with a smaller tax liability even with the loss of exemptions.

But generally speaking the loss of exemptions even with an increased standard deduction would have negative tax results — and not in the good tax math way, but rather as a tax bill increase — for larger families.

Undercutting simplicity: It also would belie the tax simplification process for these bigger broods.

They would face more paperwork, actual or digitally via tax software, in calculating credits for dependents versus the current system of simply entering family members on tax returns (along with their Social Security numbers) and multiplying that number by the exemption amount.

And then there are the folks who now itemize. The elimination of most Schedule A claims will push them into the standard deduction category.

But if it turns out their itemized claims are more even under tax reform's larger standard amounts, they still will be out the exemptions they now use to reduce their income.

Know your numbers: The bottom line is that taxes are intensely personal.

The New York Times analyzed how the House bill would affect a wide range of taxpayers classified as middle class. CBS News looked at how four different hypothetical households would fare under the Senate's bill. And a CNBC look at possible changes indicates that single parents may lose out under proposed tax changes.

Some folks will do better under the House and Senate tax bills than under the current tax system. And some will, despite promises during the presidential campaign, from the Trump Administration and during the tax debate, do worse.

Some more tweaks could come once House and Senate conference committee members meet to reconcile the two bill's differences. But in a couple of weeks, we'll likely know where we stand as far as future taxes go.

And before you can say whether you will or won't benefit, you need to know what you've been paying in taxes, what'd you'd pay if no changes are made and what you are likely to pay once a tax bill.

The only thing for sure is that tax professionals are going to be busy in 2018 explaining the intricacies of any tax changes to their clients, both current and the new ones they'll probably get next year.

You also might find these items of interest:

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Henry

"The only thing for sure is that tax professionals are going to be busy in 2018 explaining the intricacies of any tax changes to their clients, both current and the new ones they'll probably get next year."

Very busy… I agree. Tax software producers will also have a lot of work to do, and little time to take care of all the necessary calculations.

James

"But generally speaking the loss of exemptions even with an increased standard deduction would have negative tax results — and not in the good tax math way, but rather as a tax bill increase — for larger families."

By my calculations, I don't see how this could be true with the large increase in child tax credit unless you're income is more than $344k in the Senate plan, or more than $114 in the House plan (assuming married filing jointly in both cases), when taking the standard deduction. The income threshold would increase if you itemize. These income thresholds are less if filing single. For starters, all non-itemizers are going to benefit with the increase in standard deduction over the old personal exemption, no matter which bracket you're in.

In the case of the Senate plan, most families would do better with an increase of CTC of $1k per child, than a personal exemption of ~$4k per child.
If you're in the 10-12% bracket (up to $77k after deductions for married filing jointly, so over $100k before deductions), the increase of the CTC is hugely advantageous over the personal exemption. Namely, you're getting $400-480 per child with the personal exemption, as opposed to $1,000 with the increased CTC).
If you're in the 22-24% bracket ($77k+ after deductions for married filing jointly), there are some savings with the increased CTC, but not a lot.
If you're in the 32% or higher bracket ($320+ after deductions for married filing jointly), then you start losing.

In the case of House plan, it's not as good, but for married-filing-jointly, those who make less than $90 after deductions, still make out positive.
If you're in the 12% bracket, a $600 increase in CTC per child is more valuable than a $4k personal exemption per child (you're knocking off $480 per child with the exemption, as opposed to $600 per child with the increased CTC).

No?

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