JoeTaxpayer

The 2018 tax rates below are as proposed in the bill that will be voted on tomorrow.

The tables aren’t the actual tax you pay on gross income, but on taxable income which is gross less a number of items, including the standard deduction for single $12,000 or joint $24,000. You’ll note, there’s no mention of personal exemptions, the $4,050 per person, including dependents in your household, that’s gone, in favor of this higher standard deduction. Yes, this means that if you itemized in 2017, that (a) you might not be itemizing any longer, and (b) those who still itemize don’t see the benefit of the higher standard deduction, only the loss of exemptions.

Last, if the bill doesn’t pass, I’ll return and edit, so this page will accurately reflect the 2018 rates, once they are certain. Along with a follow up post discussing highlights of the rest of the bill and the impact of the new tax code details.

I’ll be referring back to this article over the next year whenever the tax table is part of the conversation. Check out the new rate table and start planning for 2018.

If you haven’t noticed, one thing that has reared its head again is tax reform. The ‘plan’ hasn’t been made public yet, only a one pager, a summary of the goals. The lack of details hasn’t kept our government from starting the marketing ball rolling on this one. Marketing is the word I’m using here, and I’ve chosen this word carefully. Products can be sold 2 ways. The ‘just the facts’ approach is one. It’s a bit boring, I’ll admit, but it’s how I prefer to discuss most financial topics.

The other way is the ‘marketing’ way, giving bits and pieces of information that appeal more to one’s emotions than to their logic. The slide I show here? It’s what the House Ways and Means Committee published last week. It’s not just marketing, it’s a lie. And it’s not a reason to repeal AMT.

First, let’s take a step back. What is the AMT? Do you know? Do you care? 37% of people thought AMT meant a cash machine, confusing this with the acronym ATM. (I made that last line up. But now that I read it twice, I believe it) AMT is the alternative minimum tax. Some time ago, congress realized that there were people who managed to come up with so many deductions that they paid little, and in some cases, no tax at all. The AMT forces tax payers, in effect, to phase out their deductions when at a certain level compared to their income. I’ll offer one example. A couple with $212K gross income. With itemized deductions of $57K, and their 4 exemptions, they have a taxable $139K, and a tax bill of $26K. Keep in mind, they are in the 25% bracket. This means if I go back to the tax return (I’m using 2016 tax software to run these numbers) and drop the income $1000, the tax bill drops $250. But, even though there’s still room in the 25% bracket, the next $1000 of income will show a rise of $325. $75 of which is due to the AMT effect. The taxpayer sees a phantom 32.5% tax rate even though they are the 25% bracket. 

Let’s talk for a moment about the lies. I have never done my taxes by hand. I could, I suppose, but I’ve always bought tax software. In fact, I just threw out my copy of the MacInTax (later taken over by TurboTax) from 1985. It was on a floppy disc, and my wife said it was strange to keep it. My mementos should be about people not 32 year old tax software. But I digress. I’d also guess that few people are doing it by hand. The DIY means using one of the tax softwares each year. There is no ‘double time,’ the software just does it. Those who go to a storefront or individual preparer are also shielded from the efforts, I assure you, they are using software as well. As far as “double tax” is concerned, the incremental tax looks like a higher marginal rate, nothing is doubled. and the overall tax has the smallest of impacts. Except, of course, for even higher level earners who had far more in the way of deductions.

I’ll admit, the AMT calculation is a bit convoluted regarding how different deductions are eliminated as income rises. In general, it will take over $100K in gross income, and a lot of itemized deductions to put you into AMT land. The exemption amount is $84K for a married couple. Whether that number is fair is up for debate. When our politicians want to make some change to the tax code, they should just be honest, they object to the tax and its impact on their constituents, for whatever reason. The way they are marketing their cause is just a smokescreen.

Tax reform is on the table again, and it’s time to start looking at the individual parts of the code up for discussion. Today, I’d like to look at the estate tax. Those who want to repeal it entirely are fond of calling the ‘Death Tax’, as that will stir up some repulsion in their constituents, and support for them.

First, let’s look at a bit of the history of the estate tax. In 2001, shortly after my daughter was born, the exemption was $675K. At that time, my wife and I were going to do the ‘responsible’ thing and get life insurance, term policies. $1M each, which was pretty cheap at the time as we were still young. But this meant that if we died, we would leave our child $2M of which $700K would be subject to tax. On top of that, our 401(k) and IRAs would add to this number, and every bit of it taxed. Even at that earlier stage of investing, I knew enough to start planning. $2000 and one trust later, we did not own the insurance, it was owned by the trust, and bought with money gifted to our daughter. The estate tax was always up for discussion and it quickly was raised in the late 2000’s. In 2017, it’s $5.49M per person. And there’s a little additional benefit, the preservation of the exemption for the second to die spouse. This means that if I die tomorrow, in effect, my wife can leave our daughter the $10.98M with no tax due. Just a form to send in when I meet my maker. No need for any lawyer or trust. And no, we’re nowhere close to worrying about hitting that number. Further, we can gift her $28K/year from now until we pass. That’s close to another million dollars. And $28K/yr to her spouse if and when she gets married, or even to her ‘special friend’ if she stays single, and we’re generous. When you bring on the grandkids, the numbers multiply up fast. A couple with 2 children and 4 grandkids has 8 people to gift to (including the spouses) which adds to $224K/yr under the current limits. If one has the money and sufficient offspring, it’s not tough to gift away another $6M or so depending on the situation.

When you look at the distribution of wealth, the data show that only the top .2%, 1 in 500, estates owe any tax at all, and for those who just go over, the tax is minimal. It gets to be quite a bit when billionaires pass away. Say someone worth $10B passes. The $10.98M exemption is tiny compared to this number, and the estate can owe close to $4B.

When politicians push for this cut, until now, it wasn’t because they were rich, that tax wasn’t likely to affect them either. They had some very large donor whose money they wanted to keep flowing. The politicians are great marketers, talking about the ‘small farms and family businesses’ hurt by the estate tax. Let’s talk about farms for just a moment.

Exact numbers aren’t easy to come by, but we have a good hint. Only 3% of family farms have sales over $1M. This results in a value of $5M or so, given that $1M isn’t profit, but gross sales. This type of business is typically valued at 7X profits. It’s not hard to assume that to get past $11M in value we are at fewer than 1% of farms. Now, if the whole point is that the kids want to keep the farm and stay with the business, it would be easy to use the strategies I suggested above. Giving not money, but a percentage each year. Yes, it takes a tax attorney, and yes, the tax code is convoluted, but we are back to the “family farm” rarely being lost to estate taxes. The repealers post, tweet, and write about it as if each and everyone in the country should be outraged over this tax, while 41% of us are not even making $15 per hour. They would like to give their wealth patrons this windfall, but will look to cut SNAP funding by $125B, cut Pell Grants and other pro-college funding, and perhaps worst of all, repeal the ACA.

If you are in favor of repeal, would you mind dropping me a note and explaining why you support it? Given how few will benefit from repeal, I’m very curious. I’ve never heard a real legitimate reason.

It was one thing to start writing about Social Security and Retirement when I was still over a decade away, and quite another to write as a retiree with Social Security just a few years away. College is in that same category and my topic today.

I started saving for my daughter’s college the month she was born. We started to save all we could, as I had a forecast, from a spreadsheet I pulled up from then – the cost then was $20,000, as listed on one of the college planning sites, and with a 5% annual increase, this year would cost $48,000, and the 4 year bill, $208K. The cost I tracked was for private, out of state, schools. Better to plan for the high end than to assume a closer state school and come up short.

In the back of my mind, I knew that I was planning to retire early, but looking nearly 20 years out, I made the assumption that we’d both be working until college graduation. This assumption meant we shouldn’t plan to get any aid. In hindsight, we hit a bit of a Catch-22. By saving for college, we pushed ourselves into a situation where we wouldn’t qualify for aid. To be clear, had we planning for the “retirement before college” we might have paid off the mortgage and lined up an equity line for some of our spending over the 4 years. This is the irony to how aid is given. You can own a home with a $200K mortgage, and have $200K in the bank. In this case, that $200K is fair game, you’re paying tuition. But, no mortgage, no savings, you’re likely to get some aid. I’m not advocating this approach, but I am certain there are many who manage to game the system this way.

I do want to look at two things that can snag you, no matter how good your intentions. Both are related to the American Opportunity Credit (AOC). This is a credit of $2500 against college expenses. Not a tax deduction, a credit. It’s calculated as 100% of the first $2000, and then 25% of the next $2000 of college cost. The first potential snag is related to the 529 College Savings Account. This account allows you to save money post tax, and then use the money for college with no tax on the gains. A bit similar to the Roth IRA as far as tax treatment goes. But, here’s the rub. If you take the money for all college expenses from the 529 account, you have no expenses left to claim the AOC. What if you have the exact amount saved? You are still better off using $4000 cash to pay for school. You get back $2500, and can easily afford the tax if you withdraw from the 529 after school is over. In my case, I came very close to using money from a tax-favored Coverdell Education Savings Account (which is pretty similar to the 529) for the full first semester tuition, until I realized this. It would be awful to hit this issue and lose $2500 due to this.

The other AOC issue has to do with MAGA MAGI, Modified Adjusted Gross Income. The ability to take this credit is phased out over the MAGI between $80K-$90K if filing single or $160K-$180K if joint. If you are nowhere near this range, either low or high, you may not have any decision to make. On the other hand, say you were going to be at exactly $90K and filing single. Consider, you are in the 25% bracket, but with the loss of the AOC, the last $10K really cost you $5K. If you can plan ahead and bump your 401(k) or IRA deduction by $10K, your tax bill will be $5K less. Even a stock loss of up to $3K will help you along. For joint filers, the range is $20K wide, so the impact is a bit less dramatic. The $2500 difference over $20K of income feels like a phantom 12.5% vs the 25% for a single filer.

For further reading IRS Publication 970 is a great read to end your exciting summer.

Any questions or comments? Feel free to leave them below.