Many in the US were left surprised when the tax season came to an end on April 15, 2019. Taxpayers noticed that they had to pay more taxes than last year. These taxpayers even complained of receiving considerably lower refund dollars from the Internal Revenue Service (IRS). The 2018 tax reform bill had already left the business leaders in the United States in a fix when the 2019 tax bomb occurred.
Many taxpayers complained that their tax bill was higher, while others said that their refund check was lower than the last year. The tax policy made little sense to many business owners because there is no change in the financial circumstance of the country that justifies the escalation in taxes.
Seeing the trend, all businesses must make adjustments in their business plan. Tax specialists are urging businesses to prepare for the tax season next year by updating their withholding. The IRS provides the users with the W-4 form that you can submit to the payroll department.
Your expectation for the tax season of 2019 should be based upon the economic conditions and the performance of your business. However, some exogenous factors that are beyond your control will affect the tax system too. The economic conditions of the country and the political scenario are two prime factors that affect the tax policy of the US.
Therefore, before we move on to your expectations for the year, we have decided to list down some of the main factors that you should consider. While an economist or a financial expert could name countless factors affecting the taxation system, we have decided to list down three that directly affect the US economy.
Taxable Income
A progressive federal tax system will increase the tax rate in the same proportion as your income. The tax bill determines the amount of taxable income. Since the taxes affect the economy from the supply-side, it is the marginal tax rates that determine how taxable income is taxed. This allows the federal tax authorities to divide the sector that pays income taxes into different ranges known as tax brackets.
After the government identifies a tax bracket for each business or worker, the income is then taxed at a specific rate from each bracket.
Tax Credits
The second major factor that affects income tax is the tax credits. Unlike some of the other factors affecting income tax, tax credits apply to the final tax bill instead of the taxable income. These tax credits are available only to certain taxpayers in a particular circumstance. These are people who earn below a certain amount, or individuals who have childcare expenses they can’t afford or have decided to adopt a child.
Tax credits are also associated with getting a post-secondary education or installing energy-efficient equipment at home. Enrollment in a government health insurance plan also earns individual tax credits. The benefit of these credits is that some of them are even refundable; this means that if the tax credit exceeds the liability, you will get the difference refunded to you.
Tax Deductions
Deductions are a factor that can be very complicated to handle. These tax deductions end up lowering a person’s tax liability by showing a considerable decline in their taxable income. Many taxpayers only claim the standard deductions that depend on their age, income, and filing status.
Taxpayers of today can also itemize their activities by adding all their eligible expenses. Mortgage interest is another example of a deductible expense, as are charitable contributions, and medical expenses. You can decide between standard deductions or itemized deduction depending on what gives you a larger deduction.
By the Tax Cuts and Jobs Act of 2019, President Trump has brought great changes to the tax code. The effect the changes have on a person depends on a variety of factors. The factors mentioned above are some of the primary tax components that determine the impact of changes on a tax entity or a person.
Wealthy banks or corporations, for example, consider the tax reforms as a lopsided victory. Financial services foresee, and in some cases have already seen, huge gains because of the tax reforms. The lower corporate rate and preferential treatment are just the kind of laws the companies were seeking.
Given the nature of the tax reforms, small or new businesses are bound to carry the brunt of the tax burden. This is why they should prepare themselves by being ready for 5 essential things that can happen during this tax season.
1. Annual Adjustments
Before 2018 it was the CPI-U (Consumer price index for all urban customers) which determined inflation adjustments. These adjustments were made in the tax brackets, standard deduction, and many other tax provision types. The CPI-U tracks a basket of goods that are bound to affect the average US household, which made it a natural reason for increasing tax related figures in time.
However, in comparison to the previous year’s taxpayers need to pay special attention to the Chained CPI. The new tax reforms have decided to use the chained CPI as a new metric for adjustments. The chained CPI, according to economists, is much more practical because it takes into consideration a real-life scenario. The chained CPI is a time series measure of price levels of consumer goods and services.
The chained CPI allows economists to make adjustments based on human behavior of rejecting a particular good or service that becomes too expensive. Consumers start buying a cheaper alternative if they notice a sharp rise in the price of a normal good. In comparison, the chained CPI grows at a slightly slower rate than the other forms of CPI.
This subtle change is unlikely to have a big impact on a year-to-year basis. However, since the chained CPI grows at a slower rate, it is bound to have an effect on the inflation adjustments. This means that gradually, with time, the higher tax brackets will begin to apply to lower-income taxpayers. A major reason for this is because the real inflation will rise at a quicker rate than income thresholds of the marginal tax brackets.
2. Higher Standard Deduction
The Tax Cuts and Jobs Act doubled the standard deduction from the previous year. Taxpayers are given the option of choosing from standard deductions and itemized deductions. As mentioned before, itemized deductions imply the addition of all tax deductions that the user is entitled to. The cumulative figure is then subtracted from the adjusted gross income.
The standard deduction, on the other hand, is a set amount that Americans can choose to deduct. The taxpayers can choose whichever of the two methods is more beneficial to them. Since the majority of households in the US use standard deduction, this change is bound to affect them.
As a result of this change, more and more companies will end up using the standard deduction on their tax returns. Historically around 70% of American chose standard deductions as a tool of payment; however, the other 30% considered it beneficial to itemize. However, from now on, experts believe that more than 95% of tax returns will look to utilize standard deductions.
3. Modifications in Mortgage Interest
The deduction in mortgage interests was one of the leading tax breaks in the country. It was one of the major supporting pillars that encouraged people to buy homes. Many homeowners and owners of the property were pleased to find out that the mortgage interest deduction was safe during the tax reforms. However, there were two major modifications in the mortgage interest law that everyone should know of.
The first relates to the limit allowed on total deduction. The considerable decrease in total deduction is down from the previous figure of $1 million.
The second change is in the additional limit that allows taxpayers to deduct interest on as much as $100,000 of home equity. The tax reforms have eliminated the luxury of tax deductions on interest. The interest on home equity loan is still deductible only if considerable improvements are made in the home. In such a case the loan becomes a qualified residence debt and is considered to be part of the limit allowed.
4. Changes in the Alternative Minimum Tax
Legislators were initially pondering repealing the alternative minimum tax; however, it still exists today. The AMT is explicitly designed to ensure that high-income taxpayers pay their fair share of taxes, even after deductions and credits.
This means that all taxpayers will have to calculate their taxes twice, once under standard method and then by using the AMT. For this to happen smoothly, you will need the help of efficient tax calculating software or the assistance of tax officials that can estimate the exact figure for you.
However, the new tax reforms have suggested some significant changes in the tax reforms. One such change is by the inability of the AMT to change over time with purchasing power. This means that the base affected by the AMT will increase, the AMT was not designed to affect the middle class, but it has started to do so. From now onward the exemptions amount of the AMT will have an impact on the middle class as well.
5. No More Personal Exemptions
Although the standard deductions have doubled, people are not getting the same levels of tax breaks. An increase in the standard deduction is followed by a decrease in the valuable exemption. Policymakers claim that lawmakers were looking for ways to simplify the tax code in addition to the tax cut. Therefore, rather than giving the taxpayers a standard deduction and an exemption, a combination of the two was levied that is essentially a higher standard deduction.
The personal tax exemption is not a gift for people with larger families. Before the tax reforms, you could cut $4050 off your taxable income for yourself. The same amount could be deducted from the income of your spouse and each of your dependents. This meant that a married couple with three children could earn a tax exemption of $20,250, a fair deal for most American middle-class families.
There were limitations before, too, as taxpayers who were earning too much were not allowed to claim personal exemptions. The elimination of this exemption is bound to hit the average American family and owners of small businesses. An amount as high as $4050, is bound to have its toll on business owners too.
One significant uncertainty in the economic sector is regarding the future of the tax code. The design of the Tax cuts and job ensures that permanent changes are made in the corporate side; however, the individual taxes are set to expire by 2025. The shift from CPI-W to chained CPI is a significant exception, however.
If the tax changes expire after 2025 and the individual tax code reverts to its previous form, then the lower inflation calculation will make taxes even higher. Efforts are underway to ensure that the tax changes are permanent, but a division in the Congress makes it a challenge to pass any more tax bills.
The tax changes are very complicated, and if you look to steer the ship alone in this storm, you are bound to drown. A better idea is to use the help of accounting software or that of individuals who are an expert in the field to drive home a point. Tax preparation software, or the assistance of a professional, will free you from the stress of the tax laws.
No one likes to pay taxes, but to survive in a globally competitive environment, it is imperative to understand them.
Chris Giorgio is the President of Fully Accountable. Fully Accountable is an outsourced accounting firm specializing in eCommerce and digital businesses. Chris has served as a CPA, CFO and has over 14 years of experience in the accounting and finance industry. Chris has dedicated his career towards helping entrepreneurs and high-level business owners achieve greater profitability through specialized outsource accounting functions.
