- Abiye Alamina
Scenarios Testing out how the Tax Reform Law impacts Households
I compare the impact of the tax reform law for typical households in Ohio by comparing their tax liability under the now old law with their tax liability when the tax reform law is implemented. The tax liability is how much in taxes the household has to pay for that tax year.
President Trump has signed the Tax Reform bill into law, and while the tax reform provides benefits immediately in 2018 in the form of reduced withholding resulting from the lower marginal rates and expanded income brackets, the 2017 tax returns will still be computed based on the now old law.
In what follows the comparison is made assuming the old law still carried through for 2018 tax return filings (I use the numbers that the IRS had released earlier that would have been applicable for the 2018 tax year under the old law). I compare that with the tax reform law which would then impact the 2018 tax returns.
Scenario 1: A married couple in Ohio, who own a home worth $500,000, with combined income of $250,000 (wages are $100,000 and business income from a partnership is $150,000), filing jointly and itemizing deductions worth $41,000 (with state and local taxes being approximately $17,850, and property taxes at $9,800).
Under the old law the value of the itemized deductions will be subtracted from AGI to arrive at taxable income. Also their business income will be passed through to their wage income and taxed at the corresponding individual rate. Tax liability is $42,819
However under the Tax Reform Law, state and local taxes and property tax deductions together are capped at $10,000. So the couple will have their itemized deductions reduced by $17,650. This will cause their itemized deductions to add to $23,350, so they will have to take the standard deduction which will then be $24,000. Further, their business income will be reduced by $30,000, to $120,000 due to the 20% deduction and this will be added to the AGI on their joint filing. Tax liability is $35,619.
They save $7,200 under the Tax Reform Law.
Scenario 2: The same married couple in scenario 1 with similar situation but their income comes alone from wages and totals $250,000.
Tax liability is the same as in scenario 1 under the old law. It is $42,819.
Under the Tax Reform Law, with the cap still in place for state and local and property tax deductions, tax liability is $42,819.
They experience no change with the Tax Reform Law. It is however interesting to see that the business income deduction provides tremendous benefits to the couple in scenario 1. So we see another instance where Tax Reform heavily favors business owners.
Scenario 3: A single mother in Ohio with 3 kids earning $30,000 and living in a rented apartment. She claims the standard deduction.
Under both the old law and the Tax Reform Law, she will owe no taxes, as her tax liability is negative, however because the Tax Reform Law allows for the child tax credit to be refundable up to $1400, She will get the full refund of $1400 from the IRS.
Scenario 4: A married couple in Ohio, who own a home worth $100,000, earn combined income of $80,000 and have two kids. They claim the standard deduction.
Under the old law their tax liability is $4607.50, however under the Tax Reform Law their tax liability is $2339.00. They save $2,268.50 under the Tax Reform Law.
Scenario 5: Helen a single filer living in Ohio with an AGI of $25,000. She has a home worth about $80,000 and would itemize as follows.
State and Local taxes: $1400
Mortgage interest deduction: $2000
Property tax: $1200
Charitable deductions: $3000
Medical expenses: $1400
Total value of itemizations is $9,000. Under the old law she would itemize as this is larger than the standard deduction of $6,350. Her tax liability would be $1301.30, however under the tax reform law she would be liable to pay $1369.50. This is a loss of $68.20 to her.
Now interestingly data from the Congressional Research Service (CRS) show that for tax year 2014 the average sum of itemized deductions claimed per itemizer for the income brackets of $1 - $20,000, and for $20,000 - $50,000 are $15,857 and $15,641 respectively, much higher than the $9000. I worked with. Other things being the same, with higher values for itemization for the same scenario, the tax reform bill leads to a bigger increase in tax liability.
Adjusting Helen's numbers perhaps for Medical expenses and charitable deductions, so that itemizations sum to $15,000, her her tax liability is now $585 under the old law compared to $1009.5 under the tax reform law, an almost doubling of her tax liability.
Scenario 6: John also a single filer living in Ohio with an AGI of $40,000. He also has a home worth $100,000. He would itemize his deductions worth $12,000 as follows:
State and Local taxes: $2840
Mortgage interest deduction: $2000
Property tax: $1960
Charitable deductions: $5200
Medical expenses: $0
His tax liability under the old law is $3101.30, but under the tax reform law it is $3169.50. This is a loss of $68.20.
Again, if I change up his numbers and assume it sums to the average sum of itemized deductions claimed as stated in the Congressional Research Service (CRS) data analysis for 2014, which is $15,641, his tax liability under the old law is $2,555.10, while it would be $2,732.58 under the Tax Reform law. A loss of $177.48.
Scenario 7: Anne and Phil, a married couple with no kids also living in Ohio and with a combined AGI of $50,000. If they also live in a home worth $100,000 and their combined itemization summed to $18,000, which exceeds $12,700, so under the old law would itemize:
State and Local taxes: $3570
Mortgage interest deduction: $4000
Property tax: $1960
Charitable deductions: $4500
Medical expenses: $3970
Their tax liability when filing as married filing jointly under the old law is $2,602.50, whereas with the tax reform law it is $2,739.00. A loss of $136.50. Again, it is instructive to note that the average itemized for the income category that includes AGI of $50,000 is $19,187. If this was the value of the couple's itemized deductions, the loss gets bigger and is now $314.50.
Scenario 8: Consider the same couple in scenario 7 and same situation but now their combined AGI is $60,000 and the sum of their itemizations is exactly $20,000, about $800 above the average itemizations for this category, just to investigate the possibility of some above average outliers. So let's say they itemize as follows:
State and Local taxes: $3570
Mortgage interest deduction: $4000
Property tax: $1960
Charitable deductions: $5500
Medical expenses: $4970
Their tax liability under the same filing status with the old law is $3,802.50 whereas it is $3,939 with the tax reform law. This gives a loss of $136.50 again. The point with this scenario is that there may be other scenarios as well where with higher incomes and higher than the average itemized deductions, we observe that the tax reform gives a higher liability than the old law.
One related scenario would be the same married couple jointly earning $80,000 and itemizing up to $24,000, which may be plausible if one or both of them has very high medical expenses. In that scenario we also see a loss of $136.50 again under the Tax Reform Law.
Scenario 9: Consider Dwayne and Takeesha a married couple, who own a new home worth $500,000 and have joint income from wages of $250,000. They itemize their deductions, a total of $47,000, as follows:
State and Local taxes: $17850
Mortgage interest deduction: $15000
Property tax: $9800
Charitable deductions: $4350
Medical expenses: $0
Their tax liability under the old law is $41,139, whereas under the new law their deductions from state and local taxes and property taxes would be capped at $10,000, so this reduces the total value of their itemized deductions, and results in a tax liability of $41,535, which makes them worse off under the Tax Reform law. A loss of $396.
Two caveats are in place. First, I have assumed deductions that exceed the average for that income category which is $43,131 for 2014 (CRS). Second, I have ignored factoring in the need to compute the AMT which may change the results. It is however worth noting that the numbers used are plausible and I even kept medical expenses at $0. If the household had high medical expenses, and the deductions were larger, again, ignoring the AMT, the loss from the Tax Reform would even get bigger as reflected in a higher tax liability.