What Happened to my Tax Exemptions?

Or: The TCJA giveth, the TCJA taketh away.

One huge change in the tax code as a result of the 2017 TCJA (“Tax Cuts and Jobs Act”) was that there are no longer “personal exemptions”.

Previously, each exemption worked — in addition to either the standard deduction or itemized deductions — to effectively lower one’s taxable income by $4050 (in 2017) per exemption, and you were allowed one exemption for the taxpayer, one for a spouse (if filing jointly), as well as exemptions for dependents (usually children, but sometimes others, too).

So a family of four may have gotten $16,020 in personal exemptions in 2017.

They’ve gone away.  But that doesn’t mean that the family of four in question will necessarily pay any more taxes, because some other changes have been added to offset the loss of these exemptions.  (Aside from all the tax rates being lowered — for the sake of this article, we are going to ignore the tax bracket/rate moves).

The two main offsetting features are (a) the standard deduction has increased substantially — from $6350 (single) or $12,700 (married filing jointly) — to $12,000 (single) or $24,000 (MFJ).

Since the vast vast majority of taxpayers do not itemize, that offsets a lot of this impact for most people, especially folks with 1 or fewer dependents.

The other big change, specifically for folks with children — is that the Child Tax Credit has been expanded very substantially.  First, the Child Tax Credit has been doubled — in 2017, it was up to $1000 per child, and now it’s as much as $2000 per child.  Second, the phaseout has been substantially raised — previously, the credit started phasing out at $55,000 of income ($110,000 MFJ) — now it doesn’t start phasing out until incomes are $200,000 (single) or $400,000 (MFJ).  So vastly vastly more people will be able to take advantage of this credit.  Third, part of the credit is now refundable — meaning that even if you do not owe any taxes, you may still be able to apply for the credit and actually get cash back, rather than only being able to take advantage of it if it reduces your tax liability.

That increase of $1000 in the value of the Child Tax Credit is worth more than it seems at first, too — it can more than offset the loss of a $4050 exemption because a tax credit works very differently from a tax deduction or exemption.  A tax credit lowers the taxes you owe on a dollar-for-dollar basis.  Whereas a deduction or exemption lowers the amount of income on which you owe taxes — so the value of a deduction or exemption depends on your marginal tax rate.  For example, if your marginal tax rate is 25% a $4050 exemption will save you 25% * $4050 == $1012.50 in taxes you actually have to pay.

Using the new 2018 tax brackets — where everyone with taxable incomes below $157,500 (single) or $315,000 (married filing jointly) — has marginal tax rates of 24% or lower — this means that the extra $1000 of Child Tax Credit saves more in taxes than did the $4050 exemption which was lost.

Now, this is not a complete wash.  The dependent exemption was more widely available than the Child Tax Credit because of the rules which determine whether a child is a “qualifying child”.  And there’s still an income phase-out (though it will affect only very very few, high-income people — people who were likely already getting phased out of the exemption anyway (under 2017 law, the personal exemptions started phasing out at $261,500 for singles and $313,800 for married filing jointly).

And the expanded standard deduction also doesn’t work well as an offset to the loss of the exemptions for folks who itemize rather than taking the standard deduction.

However, overall — for most people — it’s likely that under the new rules they will pay less in taxes even after the loss of personal exemptions.  There certainly will be some exceptions.  Everyone’s taxes are unique and we strongly encourage you to have a conversation with your tax professionals and financial advisors to understand the impact these changes will have on your own taxes.

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