The Broke Professional - Optimize Your Financial Life

Big Tax Changes You Need to Know About

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA) into law.  This was one of his pet projects and something he has promising since his campaign.  He also promised that this law would give middle class families a huge tax break.  That remains to be seen.

The TCJA went into effect on January 1, 2018 and it comes with many big changes.  For some people, the effect will be large and there will be lots of planning that needs to get done.  For others, there might be a small change here and there but nothing that would require any real behavior change.

The TCJA provides the first sweeping tax change since the Reagan era.  So it’s important to know how it will effect you.  In this post, I’m going to go over some of the biggest changes in the tax law and what changes you need to make, if any.

If you want to read the bill in its entirety, be my guest.  Otherwise, here are the biggest changes you need to know about.

Much Bigger Standard Deduction

When you file your taxes at the beginning of the year, you have the option of taking the standard deduction or itemizing your deductions.  I’ve written about this before here, but the most common itemized deductions are mortgage interest, property taxes and charitable contributions.  If you have a high amount of these types of payments during the year, chances are you will save more on taxes by itemizing.

This will change for a lot of people this year.  For 2017, the standard deduction amount for single filers was $6,500 ($13,000 married).  The new standard deduction for 2018 will be $12,000 ($24,000 married).  Meaning there will be many more people choosing to take the standard deduction.  This simplifies the tax code in general, but it comes at the expense of other favorable tax treatment as I will explain below.

Behavior change: Most homeowners choose to itemize based on their mortgage interest deduction.  If you won’t be able to do that for 2018 because of the new standard deduction amounts, then the popular mortgage interest deduction doesn’t really provide any benefit.  Depending on your financial plan, it might be time to consider paying your mortgage off early.

State Income and Property Tax Limits Imposed

In 2017, you could itemize your deductions by writing off your state income tax and property tax.  This was an unlimited deduction for the most part.  Helpful for everyone, but especially for those with high state and property taxes.  But change is afoot.

For 2018, you can only deduct a maximum of $10,000 combined state income and property tax.  This is a huge change and will hit those who live in big coastal cities the hardest.  Homeowners in high tax states can easily pay $20K in state income tax and property tax combined.  This rule puts them in a real bind.

Behavior change:  Move or start renting.  For those who live in states like California or New York and have been contemplating a move to a cheaper part of the country, this will give you a little more motivation.

Elimination of Personal Exemptions

This is a key change that will hurt many working professionals with kids.  In 2017, for every member of your family (including yourself), you could take a tax deduction just for being alive.  The value was $4,050 for each family member.

So a family of 4 could take a deduction of $16,200.  This deduction is completely eliminated for 2018.  This is one reason the standard deduction for 2018 will be higher.  It will make the tax code simpler, but will hit couples with children the hardest.  It is slightly offset by the next change I will discuss.

Behavior change:  Not really much you can do here.

New and Improved Child Tax Credit

Tax credits are much better than deductions.  They provide a dollar for dollar reduction in the tax you owe, while a deduction simply adjusts your income a little lower.  The Child Tax Credit has been a nice one that has been around for about 20 years.  It provided families a $1,000 credit for each eligible child.

The problem was, the income phaseout limits were pretty restrictive for many professionals.  For married couples, once their income hit $110,000 the credit was reduced.  For high income professionals, the Child Tax Credit was a pipe dream.

But it is getting a big face lift for 2018.  The Child Tax Credit will now be worth $2,000 per eligible child.  Also, the income limit increases from $110,000 for married couples to $400,000.  

This will make the Child Tax Credit a reality for many couples.  It will also lessen the sting of the personal exemption elimination.  This change is a nice win for all.

Behavior change:  Have more kids!

Tax Bracket Adjustments

The tax bracket changes are another big one.  Essentially all the tax brackets (except the 10%) will be reduced.  And the 35% bracket is widened considerably, which will help high income couples.  Here is the old 2017 bracket:

Here is the new 2018 bracket:

So most people will see a slight decrease in their taxable income.  Not too bad.  This will be the way most people will see some tax savings.

Behavior change:  Employers should be adjusting paychecks to reflect the new tax changes by February.  Just take any extra money you find and add it to your savings and investment plan.  There is no use to have savings if you don’t use the money right?

Student Loan Interest Deduction

Just kidding!  No changes here thankfully.  The deduction maximum of $2,500 remains the same.  Though it would be nice if it was a little higher since tuition rates, and thus student loan balances, are constantly increasing.

Conclusion

The big winners of this tax reform seem to be large corporations, who saw their maximum tax rate changed from 35% to 21%.  Whether this will translate into more cash for employees and a healthier economy, only time will tell.  Families who can take advantage of the Child Tax Credit will also win.

The big losers are high income single filers who own homes in a high cost of living area.  They get hit on so many levels, but especially the state and property tax limit.  Another thing to consider is that these changes are not permanent for the most part.  Many of the big changes will “sunset” in 2027, which will then revert back to the old tax laws.  Nothing in politics is permanent after all.

These changes will affect our returns we do in 2019, so we still have some time to see what the effect on the country as a whole will be.  But it’s important to know the big changes and how you will have to change the way you approach money.  Stay tuned!

(Micheal Kitces CFP provides a great and detailed overview of the tax changes here.  If you want to dig in a little more, this is a great resource.)

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Start Tracking Your Net Worth in the New Year

This post contains affiliate links

Everyone has heard the stat about the high failure rate of New Year’s resolutions:

8% of New Year’s resolutions fail

80% fail by February

Greater than 90% failure rate

So if you’ve made a New Year’s resolution for 2018, your chances of achieving it look grim.

The two most common New Year’s resolution goals are health and money.  Which means that there are a lot of failed financial New Year’s resolutions year after year.

My thought is that many people make very vague resolutions.  Goals like “I need to save more” and “We need to spend less on eating out” sound very nice in theory.  But are very hard to put into practice.

Along with being too vague, many resolutions fail because we don’t have an understanding of where we are.  It’s a cliched example, but you need a destination and a starting point in order to have accurate directions.

Making vague resolutions is like picking out a destination without knowing where the starting point is.  So you have no way of knowing if the direction you’re taking is going towards your goal or completely away from it.

You need to know where you stand financially before you can make an effective goal, let alone reach that goal.  I feel the best way to find your financial starting point is not by seeing how much you have in your checking or savings account.  It’s not the equity you have in your home.  And it’s definitely not how flashy your car is.

The best way is finding your net worth.  With the technology available today, calculating your net worth is very simple.  If this is the only financial resolution you make this year, you will be much better off than you were last year.

Why Net Worth Matters

The net worth calculation is very simple:

Assets-Liabilities=Net Worth

There is always discussion about what is considered a liability or an asset.  Some people consider home value an asset.  Some people don’t consider home value since it takes a lot of work to get money out of a home.  The details are endless.

But in general, as asset is something that adds to your wealth while a liability is something that takes away from it.  Common assets include your checking and savings accounts and retirement accounts.  Liabilities include credit card debt and student loans.

So net worth is basically a snapshot of your financial health.  But just like any snapshot, one picture doesn’t tell the story.

A new medical school graduate has little in savings and hundreds of thousands in student loan debt.  That will give him a large negative net worth.  A high school student probably has some spending money but very few liabilities since he lives with his parents.  So he would have a slightly positive net worth.

Does that mean the high school student is more wealthy than the new doctor?  The answer is no because net worth should be used to measure your financial GROWTH rather than a static number that looks at your wealth.  In 10 years time, the new doctor will likely have a net worth light years ahead of the high school kid.

So the key to wealth creation is to grow your net worth over time and grow it quickly.

My Net Worth Tracking Strategy

There are so many different opinions about how often you should track your net worth.  Some say every month (some people even track it every day!).  While others say once a year is enough.  The key is to find a pace you’re comfortable with and keep it consistent.

Personally, I check my net worth every quarter.  I actually enjoy checking up on my accounts and seeing how they’ve changed.  It also allow me to make sure there’s no fraud or any funny business going on in any of my accounts.

And doing it quarterly is enough time to see if new strategies I’ve implemented are actually making a difference.  Plus, most companies operate in quarterly statements so there must be some wisdom in it.

As far as what high tech tools I use, an Excel spreadsheet and a Word document are my weapons of choice.  I use the Excel document to help me calculate my net worth and I record the values over time in my Word document.  Easy peasy.

But one piece of technology that helps check my work and give me more insight into my net worth and retirement is Personal Capital.  I’ve been using it for years to view my net worth and they have been getting better over time.

All you need to do is connect your various accounts and Personal Capital will monitor them.  They can’t make any transactions so there is no need to worry about security.  They simply monitor your account value and have your net worth displayed nicely in graph form.

Which is great since net worth growth is the true measure of financial wellness.  Physically seeing it as a graph really drives it home.

Other cool features of Personal Capital are the Investment Checkup and Retirement Fee analyzer tools.  They can analyze the holdings in your investment accounts and tell you where you may be over or underweight.  And they will also check the fees in your accounts so you can make sure you’re not paying too much.

And it’s all free.  There is an option to talk to a real financial adviser for a fee but that’s completely up to you.  Most of the powerful features of the program are no cost.

Conclusion

Deciding to grow your net worth is the best thing you can do to turn your financial life around.  Thinking in terms of net worth rather than just making and spending more money will allow you to see your finances in a whole new way.

Suddenly, paying a huge monthly bill for that fancy luxury car when a regular old Toyota will do just fine doesn’t seem that enticing.  A decision like that can keep your net worth from growing the way you would like.  Thinking in terms of net worth rather than just focusing on your checking account is the real way to get wealthy.

Tracking your net worth consistently with Personal Capital is an excellent way to start the journey towards real wealth.

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