President Donald Trump has touted the new tax law, which took effect on January 1, 2018, as the “biggest tax cut in the history of our country.” Like many of Trump’s hyperbolic claims, this one is false—both Presidents Barak Obama and Ronald Reagan presided over tax cuts that exceeded those in the GOP’s Tax Cut and Jobs Act. And, as many critics have pointed out, the cuts in personal income rates are only temporary – they expire at the end of 2025 – while the new law’s reduction of the corporate tax rate is permanent.
But to be fair, the new tax law will reduce personal income taxes for most Americans over the next several years. However, not everyone will get the “big, beautiful tax cut” that the president promised. Among those who might see little benefit under the new law are empty-nesters, especially those who itemized deductions in the past.
Why? Because the new law eliminates personal exemptions, each of which used to lop off $4,050 of taxable income. Under the old rules, you were allowed one personal exemption for yourself, one for your spouse (if filing jointly), and one for each of your dependent children. All these personal exemptions have disappeared under the new tax law, which tries to compensate for their elimination in three ways: (1) by adjusting the tax brackets to lower overall tax rates, (2) by roughly doubling the standard deduction, and (3) by doubling the child tax credit and making it available to far more families.
These changes will likely work out well for families with dependent children, most of whom will qualify for the full child tax credit of $2,000 per kid (provided the family’s taxable income doesn’t exceed $400,000, if filing a joint return). A tax credit of $2,000 per qualified child will more than offset the loss of a $4,050 tax deduction per dependent, even for taxpayers with high marginal rates. (Remember, a tax credit directly reduces your tax bill, while a tax deduction only reduces your taxable income.)
But empty-nesters, who, by definition, have no dependent children living at home, derive no benefit from the increased child tax credit. So, an empty-nest couple stands to lose $8,100 in personal exemptions with only the change in tax rates and the higher standard deduction as possible compensation.
How well will this work? Let’s look at the impact on two hypothetical empty-nest couples.
Our first couple, John and Mary, have a gross adjusted income of $80,000 and do not itemize deductions. Under the old law, their taxable income would have been reduced by their two personal exemptions of $4,050 each, and by their standard deduction of $12,700. So, their taxable income would be $59,200, producing a tax bill of $7,947.50 under the old tax law.
Under the new law, John and Mary lose their personal exemptions but can take a standard deduction of $24,000, so their taxable income is $56,000. Based on the new tax rates, their tax bill is only $6,339, a reduction of $1,608.50. John and Mary are delighted with their (temporarily) lighter taxes.
Now let’s look at Jim and Jane, empty-nesters who also have a gross adjusted income of $80,000, but, unlike John and Mary, itemize deductions. Or at least they used to. With deductions of $24,000, (comprised of mortgage interest, property taxes, state income tax, and charitable donations) it made sense to itemize under the old law. The itemized deductions, together with their personal exemptions, reduced Jim and Jane’s taxable income to $48,900 under the old tax law, resulting in a tax bill of $6,402.50.
Under the new law, however, it makes no sense for Jim and Jane to itemize, since their standard deduction of $24,000 is the same as their previously itemized deductions. (In fact, the new law imposes a $10,000 cap on deductions for state and local taxes, so Jim and Jane’s itemized deductions in 2018 would no doubt be less than $24,000.) So, by taking the standard deduction their taxable income is $56,000, the same as John and Mary’s, and their tax bill, like John and Mary’s, is $6,339 – a saving of only $63.50. That’s about a $1.22 a week – hardly a windfall. Jim and Jane feel betrayed by the new law, which had promised a sizeable tax cut but delivered pocket change. Oh, well, at least they’ve been spared the hassle of filling out Form 1040 schedule A in their tax return.
As this comparison shows, there are winners and also-rans in the new tax law, and empty-nesters who previously itemized have a good chance of falling into the second category. Of course, every couples’ tax situation is unique, so the only way to know if you’re going to see a substantial tax cut or a tax increase is to run the comparative numbers yourself. Calculators like this one make it easy to do.