Now that we have a final version of the 2017 GOP tax bill, it’s time to talk for reals about the impacts on FIRE (financial independence and early retirement). After the final tweaks to the bill were done in the House-Senate reconciliation process, the result is further moderation of the tax reform. In fact, on the individual tax side, I wouldn’t call this a “reform” at all – more like tweaking of the existing structure.
But there is one big impact that folks in the FIRE community will love: The 2017 GOP tax bill dramatically raises the roof on how much money you can make, and still pay no taxes. It’s a massive expansion of the zero tax bracket, or how much money you can make without paying taxes! Here’s how to pay zero taxes under the 2017 GOP tax bill:
First, What’s New
If you want to do your own homework (highly recommended), see the full text of the conference agreement here (whiskey, not beer).
There are a few things I think the FIRE community should know about what’s coming on the individual tax side. Specifically, things that impact what I call the zero tax bracket, or how much money you can make, and still pay zero income taxes. Here are some highlights:
- There will be minor reductions to the tax brackets. Most people will see a 2-4% decrease in their marginal tax rate.
- The Standard Deduction is (nearly) doubling to $12,000 individual / $24,000 couple. Doubling the standard deduction means very few of us will itemize our deductions in the future.
- Personal Exemptions will be eliminated.
- The Child Tax Credit is not only doubling in size, but it is becoming way more refundable. That means those damn kids might finally start to pay for themselves! In fact, taxpayers with kids can make a lot more money, and still pay zero taxes.
- No major changes to retirement accounts (Yay!).
- The New Pass-Through Deduction is a pretty big deal if you’re a freelancer, consultant, side-hustler, or self-employed. It’s going to make self-employment income much more attractive.
- The Zero Tax Bracket increases for all types of taxpayers (Yay!)
(Mostly) Lower Tax Brackets
There are some minor decreases to the tax brackets – we still have seven of them. There’s generally a 2%-4% decrease for most brackets, but virtually no change in the bottom 10% bracket, and an expansion of the 35% bracket. Here’s a comparison of 2017 tax brackets to the new 2018 brackets for single filers:
And for joint filers:
Deductions and Exemptions
The big change here is that the standard deduction is (nearly) doubling to $12,000 single / $24,000 couple. This means that even more people will be using the standard deduction, instead of itemizing. At the same time, the personal exemptions are being eliminated. The impact of these two changes offset each other.
For people with three or more personal exemptions (e.g. a family of three or more), these two changes would appear to be a tax increase at first glance. However, the child tax credit is also increasing, and will more than offset any increase herein for nearly all taxpayers (see more on that below).
Regarding itemized deductions, the original House bill proposed to severely limit the mortgage interest deduction and the state and local tax deduction (SALT). That didn’t really happen in the final version of the bill. The mortgage interest deduction will be limited to interest on mortgages up to $750k (previously $1M). But existing mortgages are grandfathered in. The SALT deduction will be limited to $10k total of property tax and state income tax or state sales tax.
Those limitations are rather generous, but with increase in the standard deduction, around of 90% of taxpayers are expected to use the standard deduction. I know I probably will.
Increasing The Child Tax Credit + Refunds!
The Child Tax Credit is doubling from $1,000 per child to $2,000 per child. But, what’s more, it’s going to be refundable up to $1,400 per child. Previously the refund on the child tax credit was much more limited. The new law will mean refunds to far more taxpayers.
In fact, you can make more than the median household income and still get a refund! A family of four would get a refund (i.e. pay negative taxes) if they make $60,508 or less. That’s nearly 10% higher than the U.S. median household income! See the new zero tax brackets below to find out how much you can make and still pay zero taxes.
The New Pass-Through Deduction
Perhaps the most enticing change in the 2017 GOP tax bill is the new pass-through deduction. The press coverage I’ve read about it focuses on its benefit for high-income earners, but the deduction can also be used by small businesses, freelancers, independent contractors, and side-hustlers as well. And that’s is why I really like it.
The pass-through deduction will give a 20% deduction for income earned by partnerships, S-corps, LLCs, and sole-proprietorships. Essentially, any small business, consultant, freelancer, or side-hustler that is not incorporated as a C-corp will be able to use it. It’s like getting a 20% discount on your small business or consulting income.
If you have a service-oriented business, the deduction can only be taken in full for income below $157,500 individual or $315,000 couple, and is phased-out above those thresholds. As defined, “service businesses” includes the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or any service provider “where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners”.
This new pass-through deduction is a huge bonus for 1099 consultants, side-hustlers, freelancers, and sole-proprietors. Yet another reason to start a side-hustle or just completely leave the employee life behind. In my case, my wife has a small home business, and I also plan to seek temp/contract work in the future (early retirement is dead to me). So, this could be a huge benefit to us.
The 2017 GOP Tax bill makes no major changes to retirement accounts (Yay!). Probably the biggest change is that Roth recharacterizations will no longer be allowed for Roth conversions. A recharacterization is essentially “undoing” or reversing money you converted into a Roth. If you perform a Roth conversion, and subsequently decide that you made a bad choice – perhaps because your taxes are higher than you anticipated – you could undo the conversion in the same year via a recharacterization. These takebacks will no longer be allowed for Roth conversions.
Of note, recharacterizations will still be allowed for Roth contributions or rollovers – just not conversions. As a refresher, a “contribution” is the new money you put into retirement accounts each year. A “rollover” is when you move money from a 401k or similar employer-sponsored account into an IRA, and a “conversion” is when you move money from a pre-tax IRA to a Roth IRA. Recharacterizations are still allowed for contributions and rollovers – just not conversions. See more about recharacterizations here.
The New Zero Tax Bracket
So, with all those changes, here’s what the new zero tax brackets will look like – i.e. how much money you can make and still pay zero taxes. It makes sense to consider the zero tax brackets while including the impact of the child tax credit, because that’s a credit that you essentially don’t have to do anything to receive – just be who you are. So, I’m presenting this for various taxpayer types, considering whether they have qualified children.
The Zero Tax Threshold (including child tax credit)
|Taxpayer Status||Old Law, 2017||New Law, 2018|
|Single, 1 child||$24,450||$30,254|
|Single, 2 children||$42,550||$48,508|
|Single, Over 65||$11,650||$12,000|
|Married, no child||$20,800||$24,000|
|Married, 1 child||$34,500||$43,842|
|Married, 2 children||$48,900||$60,508|
|Married, no child, over 65||$23,300||$24,000|
Note: Zero Tax Threshold including the child tax credit is calculated as Standard Deduction + Exemptions + (child tax credit)/0.10 for current law, and Standard Deduction + ((child tax credit)/marginal tax rates) under the new GOP tax bill. Assumes children are qualified for child tax credit.
The more (qualifying) dependents you have, the more the zero tax threshold increases when we consider the child credit.
Impact On My Own Personal Taxes
My own personal taxes are going down for sure. My family of four plans to make about $50k or so next year through a combination of side-hustles and part-time or temporary work. With the refundable child tax credit, I’ll qualify for a refund of around $1,200 under the new law. Under the old law, I would have paid zero taxes, but no refund. So this is a nice tax decrease in my case. That’s great, because it means I can work even less and still cover my costs! Yay!
Or, I can work more (boo!). I could make about $10k more and still pay no taxes. Beyond that, nearly all of my income will qualify for the new pass-through deduction. That means my marginal tax rate will still be quite low. If I have an opportunity to make more money (without working too much), I may want to take it.
The 2017 GOP tax bill means a massive increase in the zero tax threshold for nearly everyone. That’s a huge boon to early retirement dreamers who may want to continue earning a bit on the side or through part-time work. Not only does the new tax law keep the dream alive, it gives it a massive boost!