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The GOP Tax Plan and the Zero Tax Bracket

House Republicans released their new tax proposal a few days ago, with the intention of getting a bill passed before the end of the year.  Changes will still inevitably occur before any bill becomes finalized into law, but we can look at the impact of the current proposal on retirement in general, and early retirement specifically. Much of Trump’s original proposal has stayed intact, but the GOP tax plan released this week has moderated some of the proposals. Here’s how the GOP tax plan impacts early retirement:

 

Update: On November 9, the Senate released their version of tax reform.  See 3 ways the Senate tax plan impacts early retirement / FIRE.

 

The good news is that the early retirement and FIRE dream lives on.  The House GOP tax plan doesn’t really alter the popular FIRE tax strategies such as the backdoor roth and ira conversion laddersRetirement account rules are unchanged, except for a few technical changes to some 401(k) administrative rules.  Perhaps the biggest impact for the FIRE community is that the zero tax bracket is expanded for nearly everyone.

 

I would characterize this GOP tax plan as tweaking to the existing tax structure, rather than a major overhaul.  The most significant changes in the bill are related to business taxes, not individual taxes.

 

Here is the full text of the House bill. It’s pretty heavy reading.  Whiskey, not beer.

Here are highlights released by the House Republicans for lighter reading, though it doesn’t mention all of the important changes.

 

Highlights

A few weeks ago, I reviewed Trump’s original tax proposal.  Much from the original proposal has stayed intact in the new House tax plan, but there are a few changes.  Here are some highlights of the current version of the GOP tax plan that are relevant to early retirement dreamers:

  • Doubling (nearly) of the standard deductions to $12,000 individual / $24,000 joint
  • Elimination of all personal exemptions
  • Elimination of many deductions, including the medical expense deduction, the deduction for state and local income taxes, the deduction for work related expenses, and other miscellaneous deductions.
  • Preserves the mortgage interest deduction, but reduces the mortgage limit to $500,000 from the current $1,000,000. However, existing mortgages get grandfathered in with the old rules.  So, the lower limit only impacts future home purchases.
  • Preserves the deduction for U.S. property taxes (not foreign), but imposes a new $10,000 limit.
  • Introduces new tax brackets: 12%, 25%, and 35%, and 39.6%
  • Increases the child tax credit to $1,600 per child, and makes it refundable up to $1,000.
  • Introduces a new “family credit” at $300 per parent for joint filers and $300 per non-child dependent
  • No changes to retirement plans (Yay!)

 

Retirement Accounts

When Trump’s original proposal came out, details were sparse.  Two important things I mentioned we need to watch out for were a) whether there would be any impact on retirement accounts, and b) where the income cutoffs lie for the new tax brackets.  The recently released GOP tax plan has defined both issues.

 

There is no impact on retirement accounts (Yay!).  Of course, expanding or improving retirement accounts would be a great thing, but I don’t think that was on the table at all.  Rumors were that the GOP tax plan might impose stricter limits on retirement accounts.  But so far, it looks like we’re in the clear!

 

New Tax Brackets

Here’s a comparison of the (proposed) new tax brackets to the 2017 brackets under current law.

Single FilersJoint Filers
Single Filers New Tax Brackets Republican House Bill

 

Joint Filers New Tax Brackets 2017 GOP Tax Plan

For lower and middle income taxpayers, the new brackets generally represent either no change or a tax decrease. The current 15% bracket will be reduced to 12%.  Much of the old 25% bracket will stay at 25%, but the lower end is reduced to 12%.  The old 28% bracket will also be reduced to 25%.  The only potential tax increase among lower and middle income taxpayers is for taxpayers in the old 10% bracket, which is increasing to 12%.  However, the increase in the zero tax bracket will more than offset that tax increase in nearly all cases.

 

Increase of the Zero Tax Bracket

The “Zero Tax Bracket” or “Zero Tax Threshold” will increase for virtually all taxpayers.  The Zero Tax Bracket determines the amount of money you can make – via work, retirement income, or investment income – and still pay no income taxes.  It is traditionally calculated as the sum of the standard deduction plus personal exemptions.

 

Thanks to the elimination of the personal exemptions, at first glance, the zero tax threshold appears to decrease for some taxpayers with higher exemptions (e.g. married couples with two or more kids).  But that’s not the whole story, because there are important changes to tax credits that we also need to consider.

 

New Tax Credits

Under the GOP tax plan, the existing Child Tax Credit is increasing from $1,000 to $1,600.  Plus, the proposed plan introduces a new type of credit – the “Family Credit”, at $300 per parent on a joint return and $300 for non-child dependents.  A joint filing couple with two kids would thus have $1,800 of additional tax credits ($600 increase x 2 kids, plus $300 x 2 for the parents).  And up to $2,000 ($1,00o per child) would be refundable.

 

Tax credits reduce your tax bill dollar-for-dollar.  As such, these credits will more than offset the elimination of the exemptions, for any taxpayers in the new 12% bracket (up to $45k single/ $90k joint).  

 

If you include the tax credits in the zero tax threshold calculation, here’s what the zero tax thresholds look like:

 

The Zero Tax Threshold (including child/family tax credits)

Taxpayer StatusCurrent Law, 2017GOP House Proposal
Single$10,400$12,000
Single, 1 kid$24,450$25,333
Single, over 65$11,650$12,000
Married, no kids$20,800$29,000
Married, 1 kid$34,850$42,333
Married, 2 kids$48,900$55,666
Married, no kids, over 65$23,300$29,000

Note: Zero Tax Threshold including new child tax and family credits is calculated as Standard Deduction + Exemptions + (child & family tax credits)/0.10 for current law, and Standard Deduction + (child & family tax credits)/0.12 under proposed law.  

The more dependents you have, the more the zero tax threshold increases when we consider the credits.

 

Deductions

Many traditional deductions are being eliminated: the medical expense deduction, the miscellaneous expense deduction, the student loan deduction, and the deduction for state and local income taxes, among others.  The only deductions specifically kept are the mortgage interest deduction and the deduction for property taxes. But both will be capped, at $500,000 (of mortgage value) and $10,000, respectively.  Though existing mortgages will be grandfathered in.  The $500,000 mortgage limit will only apply to new home purchases.

 

The mortgage interest deduction and the property tax deduction are both heavily used by taxpayers in high cost of living states, such as California and New York.   Because these are being preserved in the GOP tax plan, the current proposal won’t cause such dramatic tax increases in those states as Trump’s original proposal.  Nevertheless, the impact of eliminating many deductions and increasing the standard deduction will move more taxpayers onto the standard deduction.

 

Impact On My Own Personal Taxes

This GOP tax proposal will definitely reduce my taxes.  Like many California taxpayers, I currently itemize deductions.  Under the GOP tax plan, the new standard deduction of $24,000 per couple will be about the same as my previously itemized deductions.  So, I’ll probably adopt the new standard deduction, but I won’t benefit from it much.

 

The big benefit in my case will be the changes to the child tax credit and the new family credit.  Those will reduce my taxes by $1,800 straight up.  With a higher zero tax threshold ($55,666 in my case), and my plan to earn no more than about $50,000 by working only part-time in 2018, I probably won’t pay income taxes at all next year (Yay!).  With a refundable child tax credit, I may even get paid some money back, rather than pay any taxes!  I knew those kids were good for something!

 

Final Thoughts

The House GOP Tax Plan has moderated much of the original proposal from Mr. Trump, at least on the individual tax side.  I would characterize the plan as tweaking the existing structure, rather than a major overhaul. The business tax side is different – there are some major changes impacting businesses.

 

There are no big changes in the GOP tax plan that jeopardize the tax strategies that we’ve come to rely on for early retirement.  Retirement account rules are untouched.  Most middle and lower income individual taxpayers will see a tax reduction from the House GOP tax plan. But, the biggest boon to early retirement dreamers is probably the increase in the zero tax threshold (when including the child and family tax credits).  It means we can make more money via investments, real estate, or part-time work, etc, to support our retirement lifestyle, and still pay no income taxes.

 

Keep in mind the House GOP Tax Plan is only a proposal at this point. Still much can change. It will be interesting to see how it evolves.

 

Cheers,

Jojo Bobo

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3 Responses
  • Ann
    November 6, 2017

    Thanks for the excellent explanation of what they are considering now. Heaven knows by the time it gets through all our politicians, if it ever does – what it will be like by then. You may be better off living the simple life in Bolivia!!

  • Rosie
    November 7, 2017

    But the Family Credit expires in 5 years?

    • JoJoBoBo
      November 8, 2017

      Yes, the current proposal has the new Family credit expiring in 2023. Expiring credits are a budget trick to get the bill to score better. Good chance the credit won’t actually expire in 2023. -JB

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