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Copyright © 2018, Michael D. Jenkins, J.D., CPA (Retired)
All Rights Reserved



TAX FACTS VS. SPIN -- THE COLD, GREEN
FACTS ABOUT THE NEW TAX LAW

"You can't tell the people the truth.
If you tell them the truth, they will become fearful and unable to sleep at night.
If they can't sleep at night, they will get up the next morning and vote you out of office."

-- Unknown politician, being truthful (for once)



There is a great deal of controversy over the new tax reform law, the Tax Cuts and Jobs Act of 2017, as to whether it helps or hurts middle-class taxpayers. If you believe the Republicans in Congress, President Trump, and the conservative media, it's a great thing for small businesses and middle-income people, as well as for large corporations and businesses, although even they admit that very high-income individuals in high-tax states or with very large mortgages may actually pay more tax under the new law. That's because the new law limits the total itemized tax deductions for state and local income and property taxes to $10,000 and only allows home mortgage interest to be deducted on the first $750,000 of a home mortgage loan and also takes away a number of "miscellaneous" itemized deductions and the $4,050 per person personal exemptions.

On the other hand, if you believe the Democrats and the other 90% of the media, the new tax law either harms or does almost nothing for the middle class, and is a gift to the rich. (Obviously, the new Act doesn't have much effect on low-income families who don't pay any federal income tax, although with the larger (and refundable) child tax credit, they may receive slightly more of what for them is a NEGATIVE income tax, under the new law.)

Only 13% of Democrats and less than half of all individuals polled believe the tax cuts will benefit their families, according to a Pew Research poll conducted in early 2018, so most minds are already made up, before anyone actually files a 2018 tax return and sees what the real effect of the new tax law is, for them. So what are the actual facts?

For one thing, there can be no doubt that there are some losers under the new law, including some small businesses. For example, any business that operates in corporate form (that is not an S corporation) will actually pay more corporate income tax under the new law than under the old, if its taxable income is less than $90,385 a year.

"How can that be?" you might ask, since we know that the new law reduced the corporate tax rate from about 35% to only 21%. The answer is that the first $50,000 of a corporation's taxable income under the old law was only taxed at 15%, gradually rising to 35% or greater tax rates at higher income levels, while the new law taxes ALL income at a flat rate of 21%. Thus, if your C corporation has exactly $50,000 of taxable income (the worst case scenario), it will pay $3,000 more federal corporate income tax under the new law than before. (Ouch!)

(However, S corporation owners will benefit significantly under the new law, so many small incorporated businesses may simply decide to elect S corporation status for tax purposes. S corporations are generally exempt from state or federal income taxes, since the profits are taxed directly to the owners -- who may get to take 20% of such profits off the top as a tax deduction under the new law, except for some high-income individuals.)

The Tax Cuts and Jobs Act is a very complex law, challenging for even tax professionals to fully understand, so what should you believe, when you hear the arguments pro and con about its effects, especially on the middle class? We think both sides are biased, so we are of the opinion that you should only trust your own, lying eyes -- just the "hard, green facts, Ma'am."

Accordingly, as someone who practiced as a CPA and tax attorney in California in the past, I thought it would be helpful to readers to show the results of some very detailed tax calculations, using examples in a high-tax state like California over a significant range of middle-class incomes (from $52,000 to $127,000) and one very high-income ($520,000) example, using fairly typical or common fact patterns, either for salaried employees or for small business owners with self-employment income instead of salaries.

Thus I have analyzed seven different examples below on this page, at varying income levels, comparing in each case the income taxes owed under 2017 law with what such taxes would be if the new tax law applied in 2017, rather than in 2018. (The calculations also show what the Social Security taxes would be in each case, although those taxes are unchanged by the new law. You may be as shocked to see how far those taxes now exceed income taxes for many middle-income taxpayers.)

What my analyses and examples below DO NOT DO is attempt to take into account the new, liberalized expensing rules, such as 100% bonus depreciation on most business assets, which in many cases will allow businesses making significant capital investments to completely zero out their taxable income. However, that is not a permanent tax benefit, but just a deferral of taxes to future years, in which the businesses would have otherwise had annual depreciation deductions if they had not elected to write off the entire cost of the assets in the year of purchase.

Now, let's take a look at the seven examples and the assumptions used in making the tax calculations.

Here are the assumptions I used for a family of four, except for Example Seven, which is for a single person with no dependents:

  • Our taxpayers are a family of four, living in rural California (which they can still afford), in a house they bought several years go, the assessed value of which, thanks to Prop 13, has only increased 2% a year, to $250,000. Property taxes are a typical 1.25% of value (again, thanks to Prop 13), or $3,125 a year. (However, in our sixth example, for a very high-income couple, we used much larger numbers for everything -- income, home value, mortgage, health insurance, and charitable giving, when making the tax calculations.)

  • They have a $150,000 mortgage on the house at a 4% interest rate. Interest on the loan is $6,000.

  • They have investments that generate $2,000 a year of interest income.

  • They donate $50 a month ($600 a year) to their church. (In the higher income Fourth Example below, we assume they contribute $500 a month to charity, and in the Sixth Example, we assume they contribute $25,000 for the year, and we assume our single person in the Seventh Example contributes $100 a month.)

  • In some of the examples, we assume they can't afford health insurance, and pay $3,000 of medical expenses. In others, we assume they pay either $12,000, $20,000, or $30,000 a year for medical insurance, and have co-pays of $3,000 (which aren't enough to exceed the 7.5% of AGI floor). "AGI" is "adjusted gross income." For self-employed persons, the health insurance premiums reduce taxable income, but don't affect self-employment income or the self-employment tax.

  • The California standard deduction is $8,472 in 2017 ($4,236 for singles), and we use the same figure for our 2018 (new law) calculation, since the 2018 inflation indexed California credits (and tax brackets) won't be announced until late this year by the state. In each example, the taxpayers do better if they itemize deductions on their California tax return, however, so the exact amount of the California standard deduction isn't relevant in any of the examples.

  • The federal standard deduction for a married couple was $12,700 in 2017 and is increased to $24,000 in 2018 under the new law. In some of our examples, the family can itemize under the old law, in other cases the standard deduction of $12,700 is better. Under the new law, the $24,000 or $12,000 standard deduction is better than itemizing in six of our seven examples, for federal tax return purposes.

  • The total California state income tax plus property tax is less than $10,000 in each of the six middle-class examples and thus is not limited by the new law. However, in the Sixth Example, the state and local taxes for a very wealthy couple exceed $10,000 and thus are limited to $10,000 under the new law.

  • The total home mortgage interest expense of $3,125 in our six middle-income examples is not limited by the new law. However, in our sixth example, for a very high income taxpayer with a $1 million mortgage and $40,000 of interest expense, the deduction is limited to $30,000 under the new law, but not limited under the old law.

  • For both federal and California calculations, the hypothetical family will use either the standard deduction or itemized deductions, whichever is larger, in each example, under old or new law.

  • Under the old law, the family gets to take 4 personal exemptions of $4,050 each under the old (federal) law, or $16,200 in total. No deduction for personal exemptions is allowed under the new federal law, which is one of the main criticisms of the new law. California provides small exemption credits in lieu of personal exemption deductions. Both the federal exemptions and the California exemption credits begin to phase out above certain income levels, which only occurs in our Example Six, for very high-income taxpayers.

  • The 2017 California SDI tax rate is 0.9% of taxable wages in the examples involving salary, and is deductible as a tax on federal returns, if itemizing deductions. (We use the same SDI rate for 2018 for comparability, although it increased to 1.0% in 2018, since we are really comparing "old law" with "new law" in our analysis, essentially doing "what if" calculations for 2017.)

  • The Social Security tax on wages is 7.65% and is not deductible, in the salary examples. In the self-employed examples, the self-employment tax is 15.3% of self-employment income, but half the hypothetical tax is deductible in computing actual S/E tax, and half the actual S/E tax is allowed as a deduction that reduces AGI on both the federal and California tax returns.

  • The federal child credit is $1,000 per child in 2017. Under the new law, it is $2,000 per child, and up to $1,400 per child is allowable as a refundable tax credit, if there is no income tax to offset the tax credits against.

EXAMPLES:

Here are the results of our calculations in the seven examples, using the above factual scenario, except to the extent of changes noted in each example, Two to Seven:

EXAMPLE ONE: Using all the above assumptions and assuming the couple have salaries totaling $70,000, the California income tax is only $627 and SDI is $630. (The income tax might be only $590 if California allows the SDI as a deduction -- we don't remember if it does. In any case, it doesn't affect the federal calculation if the California income tax is only $590 instead of $627.) This example assumes that the couple have no health insurance. Thus, for federal purposes, total itemized deductions would be, at most, $10,982, so the federal standard deduction is better under both the old law and new, but itemizing is better for the California returns.

Results Under Old Law: Federal income tax is $3,533
Results Under New Law: Federal income tax is $1,379
Tax Saving Under New Law: $2,154 (a 61% reduction)

Under both old and new law, the FICA (Social Security) tax on the $70,000 of salary is $5,355, which doesn't change.

EXAMPLE TWO: Same facts as in Example One, except that the family has a $70,000 profit from a small business, instead of receiving salaries. The self-employment tax applies, instead of FICA tax, and is $9,890. The California income tax is $415 and there is no SDI tax. However, this doesn't affect the decision to use the federal standard deduction, which is better than itemizing under both the old law and new. Under the new law, the taxpayers now get to deduct 20% of their business profit ($14,000) from tentative taxable income, under new Section 199A.

Results Under Old Law: Federal income tax is $2,791
Results Under New Law: Federal income tax is zero, and the taxpayers receive a $894 refundable child tax credit
Tax Saving Under New Law: $3,685 (more than a 100% reduction)

Under both old and new law, the self-employment tax on the $70,000 of business profit is $9,890, which doesn't change. Half of that tax is a deduction for income tax purposes on both the California and federal tax returns. (The 20% business income deduction under the new law is $14,000, but only reduces income tax, not the self-employment tax.)

EXAMPLE THREE: Same facts as in Example Two, except the couple pay $12,000 in health insurance premiums, which for a self-employed person reduces AGI, but not self-employment tax. Standard deduction is still best, under both old and new law ($12,700 and $24,000). (California income tax is still zero after exemption credits, and SDI is zero.)

Results Under Old Law: Federal income tax is $991
Results Under New Law: Federal income tax is zero, and the taxpayers receive a $2,294 refundable child tax credit
Tax Saving Under New Law: $3,285 (more than a 100% reduction)

Under both old and new law, the self-employment tax on the $70,000 of business profit is $9,890, which doesn't change. (The 20% deduction is again $14,000, but it only reduces income tax, not self-employment tax.)

EXAMPLE FOUR: This is more of an upper-middle class example, same as Example Three, except that 3 assumptions are changed:

  • Net profit from the business is $125,000, not $70,000.
  • Charitable contributions are $500 a month, not $50.
  • Health insurance is $20,000 instead of $12,000.
As a result of the above changes, the California income tax is now $2,640, and with the increased charitable deduction, it is better under the old law to take $17,765 of itemized deductions, instead of the $12,700 federal standard deduction. But under the new law, it is still better to take the new $24,000 standard deduction. Self-employment tax under old or new law is $17,662. The Section 199A deduction for 20% of business income under the new law is $25,000, on the $125,000 of profits.

Results Under Old Law: Federal income tax is $6,698
Results Under New Law: Federal income tax is $1,519
Tax Saving Under New Law: $5,179 (a 77% reduction)

Under both old and new law, the self-employment tax on the $125,000 of business profit is $17,662, which doesn't change. (The 20% deduction is now $25,000, but it only reduces income tax, not self-employment tax.)

EXAMPLE FIVE: This is a lower middle-income example, where we use the same facts as in Example One, except the salary received is only $50,000, not $70,000.

Results Under Old Law: Federal income tax is $533
Results Under New Law: Federal income tax is zero, and the taxpayers receive a $1,021 refundable child tax credit
Tax Saving Under New Law: $1,554 (more than a 100% reduction)

EXAMPLE SIX: We have added this very different example, for a very high-income couple, again assuming they have two children and live in California, but using much larger numbers for everything, as follows:

  • One spouse has a salary of $500,000, while the other does not work.
  • They have interest income of $20,000, so total income and AGI is $520,000.
  • Medical insurance costs are $30,000, co-pays are $3,000, but the total of $33,000 is not enough to exceed the 7.5% floor for medical expenses (7.5% of $520,000 is $39,000).
  • Their home's assessed value is $1.2 million, and they have a $1 million mortgage loan at 4%, so that property tax is $15,000 and home mortgage interest is $40,000 (only $30,000 of which is federally deductible under the new law).
  • They make charitable contributions of $25,000.
  • Their itemized deductions are much greater than the standard deduction under both old and new law, so they choose to itemize in both cases.
  • FICA taxes on the $500,000 of salary would be $17,386, using the 2017 taxable wage base in both calculations, for comparability, and including the 0.9% Medicare tax surcharge under ObamaCare.
  • California SDI tax (at 2017 rate and wage limit) is $998, though we assume it is not deductible in California and doesn't increase the $10,000 limit on the federal deduction for state and local taxes, so it has no effect on the federal tax in this sixth example. (We may be wrong as to whether California allows a deduction for SDI tax, but if so, it has little effect on the California tax number and would have no effect on the 2018 federal tax calculation in this example, since our couple is already far over the $10,000 tax limit. If SDI is deductible for state purposes, at a 9.3% marginal rate, it would only decrease the state tax by $93, increasing the federal tax in 2017 by 33% of that, or $31.)
Based on the above facts, their California income tax is $36,445 (after phase-out of all exemption credits and $8,735 of California itemized deductions), and is deductible on a federal return in 2017 (before phase-out of some federal itemized deductions), but that tax plus property tax and SDI greatly exceeds the new $10,000 limit on state and local tax deductions. Thus, the 2018 deduction for state and local taxes is limited to only $10,000 under the new tax law. Under prior law, all the couple's personal exemptions (federal) are phased out, because of their high income, and $6,186 of their itemized deductions are also phased out in 2017. Under the new law, there are no personal exemptions and there is no longer any phase-out of itemized deductions. Under both the old and new law, the child tax credits of $2,000 and $4,000, respectively, are fully phased out, due to the high income level.

As a result, 2018 federal taxable income would be much higher than 2017, due to the loss of interest and state tax deductions: $455,000 new versus $408,743 under the old law. However, due to the lower tax rates under the new law, the wealthy couple's total federal income tax (including the 3.8% ObamaCare tax of $760 on investment income in both cases) would only be slightly higher under the new law, as follows:

Results Under Old Law: Federal income tax is $110,862
Results Under New Law: Federal income tax is $111,389
Tax Saving Under New Law: NONE. Tax would increase by $527 (by 0.5%)

COMMENT: Therefore, we can see that it is true that some high-income taxpayers in high-tax states like California can in some cases pay MORE, not LESS, tax under the new law, which may explain the law's unpopularity among high-income salaried taxpayers in states like California and New York. Self-employed individuals, even in those states, would benefit to some extent from the new business income deduction, unless they were engaged in a service business and their taxable income (before the 20% deduction) exceeded $207,500 ($415,000, in the case of married couples filing jointly.

EXAMPLE SEVEN: In this final example, we analyze the impact of the new tax law on a single individual, a self-employed owner of a small landscaping business that nets $60,000 a year, with no dependents. He has $2,000 of interest income, a $150,000 mortgage at 4%, contributes $100 a month to charity, pays $3,125 of property tax and $12,000 for health insurance.

Based on those facts, California AGI is $45,761 and he claims itemized deductions of $10,325 (which is more than the California standard deduction of $4,236) to arrive at California taxable income of $35,436, resulting in California income tax of $1,039 before credits. That is reduced by a $114 exemption credit, for a net California income tax of $925 each year in 2017 and 2018.

Self-employment tax on $60,000 of business income is $8,478, half of which ($4,239) is deductible for income tax purposes on both the federal and California returns. Federal AGI is also $45,761 in both years, comprised of $60,000 of business income and $2,000 of investment income, less $12,000 of self-employed health insurance and $4,239 of self-employment tax. There is no SDI tax, since he receives no salary.

Total itemized deductions for the federal tax return are the same as for California ($10,325), plus the California income tax of $925, or a total of $11,250. That is more than the $7,900 2017 standard deduction, so he itemizes deductions in 2017, but takes the larger $12,000 standard deduction in 2018. His AGI in 2017 is $45,761 minus itemized deductions of $11,250 and a $4,050 personal exemption, resulting in taxable income of $30,461. The 2017 federal income tax is $4,103 and the total federal taxes are $12,581, when self-employment tax is added in.

For 2018, AGI is $45,761, but taxable income is that amount minus the 20% business income deduction ($12,000) and the $12,000 standard deduction, resulting in taxable income of $21,761 and federal income tax of $2,421. The total federal taxes in 2018 are $10,899. (Self-employment tax is $8,478 both years.)

Results Under Old Law: Federal income tax is $4,103
Results Under New Law: Federal income tax is $2,421
Tax Saving Under New Law: $1,682 (a 41% reduction)

BOTTOM LINE: Examine the seven examples above, six of which we believe are reasonably typical situations for middle-class residents of a high-tax state, California, and one is an example of a couple with very high income in that state. We suggest that you ignore the spin from either side, and decide for yourself whether the tax savings in each case are "great" for a person at that income level, or are simply "peanuts," as described by one member of Congress. Or somewhere in between. (I suppose it all depends on your perspective.)

If you want to read the new tax law (nearly incomprensible for civilians) or read the Joint Committee's explanation of all of the new features in the 2017 Act (more readable), go to the following link for both. (Note that the Joint Committee also gives an excellent summary of how each part of the tax law worked before the changes were made to it.)

Text of the Tax Cuts and Jobs Act of 2017

We have based all of our calculations and everything we say on this page about the new tax law on our reading of the actual text of the law and the Joint Committee explanation, which we've studied in detail since enactment on December 22, 2017. You will note that in each of our six "middle-income" examples, there was some tax savings under the new law, though amounts saved were much greater for self-employed individuals. There was a very small tax increase in Example Six, for a very high-income family, on salary. If self-employed, and if their business income qualified for the 20% deduction, they would have also benefited under the new law.

If you wish to do your own calculations, once you understand the old law and the law changes, you will need to open up the tax rate schedules for 2017 for California (or your state) and the 2017 federal tax rate schedules, as well as the new federal rates for 2018, which are set forth in the text of the new tax bill. (Our new 2018 Kindle ebooks for Alaska, Arizona, Arkansas, and California all contain the federal tax rate schedules for both 2017 and 2018.) But be warned, if you are using adjusted gross income (AGI) amounts higher than about $187,000 -- various California or federal deductions and credits begin to phase out, so it gets rather complex. (None of the phase-outs apply in any of our six "middle-income" examples shown here; only in the high-income Example Six.)

(Thanks to the reader who checked my calculations, as previously posted, and found an error in Example Six, which changed the result from a small tax decrease to a small increase for the high-income family, as is now shown.)

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Send Mail to:   mdjenk@aol.com with questions or comments about this page. If you think any of the information presented is inaccurate, please let us know, and we will provide you a copy of the underlying calculations. If you can point out any error at that point, please do so and we will make the appropriate correction, if needed.

(We are retired from law and CPA practice, so please do not contact us for tax, business or legal advice.)



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Last modified: February 21, 2018