The Tax Cuts and Jobs Act of 2017 (TCJA) introduced the most sweeping changes to the tax code in decades. It promised to put more money into the hands of individual taxpayers and small businesses, stimulate job creation, and repatriate offshore profits. But, one year later, what has the actual impact of the law been? This author’s firm, a full-service financial management firm located in Rochester, New York, wanted to find out, and conducted a tax analysis of its clients to determine their potential tax liability under the new law. In short, some taxpayers will do better than others, and individual circumstances matter greatly, but in general, married couples filing jointly and high-income individuals will receive relatively greater tax savings under the TCJA.
The author’s firm initially surveyed clients after the TCJA was signed into law to see if they were interested in how it specifically affected them. The newspaper headlines and television spots in upstate New York were very focused on how bad this new law would be for residents of high-tax states due to the capping of the state and local tax (SALT) deduction at $10,000. The clients who assumed the worst wanted to know more. Moreover, those taxpayers who have been able to deduct their investment management fees (IMF) and tax preparation fees in the past [subject to the 2% of adjusted gross income (AGI) limitation] also saw this eliminated by the TCJA. Fortunately, the Alternative Minimum Tax (AMT) was effectively eliminated by the new law, considerably reducing the effect of losing SALT deductions for those previously taxed under the AMT regime.
At the end of 2017, taxpayers had numerous opportunities to capitalize on. For those taxpayers not in AMT, prepayment of 2018 SALT deductions and miscellaneous itemized expenses, such as IMFs, were routinely done prior to the end of 2017. In addition, for itemizers under age 70½, very significant charitable donations were made by December 31, 2017, to take full advantage of their higher marginal tax rates and, more importantly, the ability to deduct 100% in 2017. Many clients opened donor-advised charitable accounts and contributed enough highly appreciated stock into them to fulfill their charitable expectations though age 70.
Thus, to fairly and accurately compare the true impact of the new tax laws on each taxpayer, for the purposes of this survey, itemized deductions were normalized by adjusting the 2017 itemized deductions by taking the average of 2015–2016 deductions for property taxes, charity, and other deductions. For state income taxes, the tax preparation software deducted whatever the actual tax for that scenario was. Without normalizing expenses, the old tax scenario would likely always appear better, if only due to prudent 2017 tax planning. Medical and interest expense deductions, however, were not adjusted, since those were deemed to be generally recurring, although relevant clients were advised to make an extra month’s mortgage payment in 2017, and to pay whatever healthcare expenses they could in 2017. Furthermore, income was not adjusted at all. Clients’ 2017 income was used for both the old and new law cases; as it turned out, this included unusually high amounts of realized long-term capital gains for most clients.
Other issues that were ignored for purposes of this study were the fact that some clients will further benefit from the potential 20% qualified business income (QBI) deduction in the future and that more IRA owners over age 70½ will cease traditional charitable methods and turn only to qualified charitable donations (QCD). Both of these facts qualitatively favor the new tax law becoming even better for those demographics of taxpayers.
The actual process used was to first export actual 2017 data from the CCH ProSystem tax preparation software into BNA Income Tax Planner, then do the normalization described above and review the results. Whenever results seemed unexpected, they were compared to CCH’s very basic estimation computation for 2018 to see if the two calculations were consistent and similar. Once satisfied that each client’s analysis was accurate, results were communicated to that client via email or telephone, or in person. Each client’s results were plotted into an Excel spreadsheet in order to report the results on a more macroeconomic basis. The final number of returns studied was just over 300, with approximately two-thirds being New York residents; 75% of returns itemized deductions under the old law, with that figure projected to drop to less than 25% under the TCJA.
The study set out to determine the following:
- Total amount of incremental tax clients appear to save or owe under the new law
- Average total federal income tax rate under the old and new laws
- Demographics of those who appear to benefit the most under the new law
- Demographics of those who appear to be hurt the most by the new tax law.
Of the entire group of surveyed clients, 72% enjoy a tax savings from the new laws, even with significant lost deductions due to no longer itemizing. The main factors behind this are obviously the reduction of the rates and the way AMT is now calculated (basically rendering it irrelevant). Clients collectively used to pay taxes at the rate of nearly 30% under the old law, while the new law reduces that aggregate average rate to under 27%. In addition, the savings are expected to increase significantly once returns are prepared under the new law, as some clients will further benefit from the QBI deduction and QCDs, as well as the utilization of prior year credits that were previously prevented from being helpful due to the AMT.
The average annual expected savings for the firm’s client base is close to $4,000, with the highest tax benefit being nearly $6,000 on average. For the approximately 21% who pay more in taxes, the average increase is $2,000. Meanwhile, roughly 7% have no change between the old and new laws.
Why do some taxpayers benefit while others do not? The first differentiator has to do with filing status (Exhibit 1). Somewhat surprisingly, married people who file jointly prosper the most from the new tax law. This is especially true for those joint filers with taxable income of over $315,000, since the new tax rate is 9% lower on approximately $80,000 of their taxable income. In addition, if modified adjusted gross income (MAGI) is under $400,000, many of these married filers can now take advantage of the $2,000 child tax credit, which used to only be $1,000 and phased out at MAGI levels above $110,000. Approximately 80% of joint filers surveyed save under the new tax law and account for over $1.1 million of the total $1.2 million of aggregate tax savings for the entire surveyed group; the average joint filer saved $5,962. Conversely, single and head of household taxpayers only saved taxes approximately 60% of the time, with an average savings of less than $300. The authors urge readers not to conclude from this study that married is now better than single (i.e., no marriage penalty); rather, analyze each such scenario based on the facts and circumstances presented.
Filing Status Breakdown of Surveyed Clients
The second major differentiator is level of income (Exhibit 2). Predictably, as income goes up there is more taxable income, exploiting the lower tax rates under the TCJA. Thus, approximately 200 clients with AGI of less than $200,000 only benefit 65% of the time, with average savings of only about $740; as income rises, the savings rate increases to 80% for those with AGI in the $200,000–$400,000 range and 90% for AGI over $400,000 (and clients formerly subject to the AMT). The average savings/cost is approximately as follows:
- Income of $200,000–$400,000: an overall average tax decrease of $5,908, with savings of $7,820 on average and increase of $1,740 on average
- Income of $400,000–$1 million: an overall average tax decrease of $11,084, with savings of $13,494 on average and increase of $6,989 on average
- Income over $1 million: an overall average tax decrease of $24,066, with savings of $26,493 on average and increase of $5,058 on average.
Income Level Breakdown of Surveyed Clients
A third demographic was age (Exhibit 3). Acknowledging that there is a lot of cross-correlation at play, the very young (under 30) and the elderly (over 70.5) saved less on average than those in their prime earning years (31–70) and would tend to file under the single status more often.
Age Breakdown of Surveyed Clients
Comparing past itemizers to past standard deduction taxpayers produced expected results; both groups save on taxes (Exhibit 4). None of the people who historically took the standard deduction were worse off, saving an average of approximately $1,400. Fewer than 30% of taxpayers who historically itemized were worse off (with over 70% better or unchanged), but the overall average change in the group was $4,712, with the average savings being $7,582 while the average increase was only $1,956. Again, this is likely affected by the strong correlation of itemization to higher incomes, as past itemizers had average AGI of nearly $400,000, while standard deduction clients only averaged AGI of approximately $63,000.
Itemized vs. Standard Deduction Breakdown of Surveyed Clients
The fifth and final demographic analyzed was dependent on the taxpayer’s state of residence (Exhibit 5). The data was broken down into three main categories:
- High-tax states (e.g., CA, CT, ME, MA, NJ, NY, OR)
- No-tax states (e.g., FL, NV, TX)
- Other states (e.g., AZ, MD, NC, PA, VA)
State Breakdown of Surveyed Clients
The results were quite interesting; clients residing in no-tax states actually saw mixed results, with 37% worse off and a net average savings of only $2,995. Clients residing in “other states” were only worse off approximately 22% of the time (basically the same as the entire group) and enjoyed average savings of $7,721. The vast majority (almost 80%) of clients reside in New York and other high-tax states, yet they are also only worse off 20% of the time, with 75% saving taxes under the new law at an average amount of $3,225. Thus, the new tax law appears to benefit even those taxpayers who reside in high-tax states.
The authors also attempted to isolate the impact of residency by taking the analysis in a different direction. Residency was adjusted for a small sampling of clients moving from New York to a no-tax state like Florida or vice versa. The software made the adjustment from high-state income taxes for a New Yorker to only using the sales tax deduction when in a no-tax state; property taxes were held constant. The results should not be surprising, although they are interesting. Under the TCJA, the federal tax for both New York and Florida were identical in each case studied, while the old tax laws considerably favored New Yorkers, who could deduct so much more SALT than otherwise identical Floridians. In other words, 2017 tax was a lot higher for a Floridian than for a New Yorker, all else being equal. Thus, a high-income taxpayer should generally save more under the new tax laws if residing in a no-tax state than in a high-tax state, because the TCJA minimizes the federal tax impact of residency.
Finally, one demographic was clearly not better off under the new laws: clients whose 2017 taxable income consisted of at least 50% long-term capital gains or qualified dividends. In this scenario, 57% should expect to be worse off under the TCJA, since those preferred rates did not change very much at all. The average amount of extra tax, however, is only $600.
The Exhibits provided include greater details on the surveyed clients. The authors hope this study will help tax preparers make general inferences while also dispelling some of the myths surrounding the impact of the tax law’s many changes.