Changes abound in the new federal tax law that took effect this year. As we begin preparations to file our 2018 tax returns—the first year under the provisions of the new law—it’s important to understand what those changes are, what they mean to us, and what steps we may want to consider before the clock strikes midnight on New Year’s Eve.
First and foremost in the minds of many taxpayers, the good news is that the new law does substantially reduce taxes for most of us. And without going into detail here, it will continue to result in lower taxes for several years.
Let’s review the provisions that should benefit most middle-income taxpayers. All marginal tax rates were reduced by an average of 2 to 3 points, and even more for some taxpayers. For example, a couple who file as married filing jointly with taxable income of $100,000 would have paid about $16,500 in federal income taxes last year, but will only pay about $14,000 this year on that amount of taxable income. That’s a savings of 2.5 points, and it corresponds to about a 15 percent reduction in their tax liability!
Let’s compare that to an upper-income couple with $250,000 of combined taxable income. Their 2017 taxes were about $58,000, but this year, will be about $48,500. That equates to an almost 4 point cut in their tax rate, and a 16 percent reduction in their tax burden.
There are a few more basic provisions that will help lower a couple’s tax liability. For example, if they were using the $12,700 standard deduction last year, the new tax law almost doubles that to $24,000 this year. (And for taxpayers who are single, the deduction increases from $6,350 to $12,000.) This means far fewer taxpayers will need to “itemize” their deductions this year to get above the new automatic deduction levels.
Additionally, the new law expanded the tax credit per qualifying child from $1,000 to $2,000, and added a $500 credit for other qualifying dependents (including elderly parents). It also greatly expanded the income levels to which the credit can be used before being phased out.
A Look at Changes that May Save You Money
Other significant taxpayer-friendly provisions in the new law effective for all of 2018 included:
- An increase in the exemption amount of income subject to the alternative minimum tax (AMT), from $84,500 to $109,400 for married couples filing jointly (and from $54,300 to $70,300 if single). The new law also increases the income level at which that exemption begins to phase out.
- Lowering the threshold at which the medical expense deduction can be taken. Previously, you could only deduct the amount of medical expenses that exceeded 10 percent of adjusted gross income (AGI). Under the law, that threshold drops to 7.5 percent of AGI for all of 2017 and 2018 only. Consider amending your tax return if this applied and you missed it.
- A substantial tax break of exempting up to 20 percent of your “qualifying business income” flowing up to you from a sole proprietorship, an S corporation, a partnership, or your share of an LLC’s profits. There is a large degree of complexity involved in applying this benefit, including complicated income phase outs, restrictions as to types of businesses that can qualify, as well as many unanswered questions, so you should check with your own tax advisor as to how to maximize its applicability.
- The ability to immediately expense 100 percent of all new and used qualifying asset purchases for your business. Prior law limited this to 50 percent and, for the most part, on only new purchases. Now, there is no dollar limit and it can also apply to used qualifying property.
- A continuation of the credit for education tuition expenses and the exclusion of up to $500,000 of gain on the sale of your primary residence; as well as for the deduction for student loan interest, teacher expenses, IRA retirement plan contributions, self-employed health care insurance, half of self-employment taxes, and several other taxpayer provisions.
A Look at Eliminated or Reduced Deductions
However, to help pay for part of the above reductions, and to “simplify” the code, the new law contains some not-so-pleasant provisions. Among them:
- Removes the personal and dependency deduction of $4,050 per taxpayer and per qualifying dependent.
- Eliminates deductibility of moving expenses.
- Caps the state and local income and property or sales tax deduction to $10,000 for married filing jointly and for single taxpayers. However, pass-through businesses can still fully deduct their property and sales taxes.
- Limits your home mortgage interest deduction to interest on the first $750,000 of your mortgage for for those married filing jointly. But this applies to only new mortgages after December 14, 2017, and the prior law limitation of interest up to the first $1 million of your mortgage still applies on mortgages obtained before that date.
- Repeals the interest expense deduction on home equity loans of up to $100,000, i.e. HELOCs, or home equity line of credit. However, if you refinance and use your mortgage proceeds for home improvements, that interest expense is still deductible within the above referenced mortgage limits.
- Eliminates the casualty loss deduction except for federal disaster areas.
- Removes the ability to deduct “miscellaneous itemized deductions” subject to the 2 percent of your AGI floor, such as tax preparation fees and unreimbursed employee expenses.
- Limits the ability to deduct your share of losses from active “pass through” businesses to $500,000 if married filing jointly ($250,000 if single).
- Restores the old tax law and rates beginning in 2025.
Considerations for Year-End Planning
So what does tax reform do to your typical year-end planning maneuvers? Well, in addition to all the normal tax planning checklist you usually see this time of year (such as remembering to “harvest” your investment losses and gains into a tax year that minimizes your taxes since losses can only be used against gains and they cannot be carried back), you may also now want to consider the following:
- Challenge your federal income tax withholding amount for both 2018 and 2019. This will help reduce the penalty for any underpayment for this year and next year, but also allow you to avoid being significantly overpaid into a system that does not give you interest for any surplus amounts you pay during the year.
- Review your level of itemized deductions for 2018 and 2019, compared to your new higher level of standard deduction. Then consider “bunching” the payments of some of these expenses into 2018 or 2019 to avoid “wasting” its tax benefit, e.g. state and local tax payments, charitable contributions and medical expenses.
- If you have a vacation home, challenge how you allocate personal use vs. rental use. Watch for planning opportunities regarding how you allocate mortgage interest and property taxes (e.g. the “Tax Court method” vs the “IRS method”), and pitfalls, such as the $10,000 cap on personal use portion of property taxes.
- If contemplating divorce, consider that alimony will no longer be deductible (and the related alimony income not taxable) for agreements executed after 2018.
- If you or someone close to you is engaging in cryptocurrency transactions, watch out for the IRS rulings regarding when those transactions are taxable and the various complex reporting requirements, including the disclosure of any foreign accounts.
- If you own a business, consider if its legal form is still appropriate given the changes in tax laws (i.e., the lower individual rates, the 20 percent exemption on qualifying pass-through business income, and the new lower 21 percent corporate rate, which was cut from 35 percent in the new tax law). Also consider the timing of year-end expenditures and income in your pass-through type business between 2018 and 2019. That will affect your adjusted gross income each year, and that may impact how much of the 20 percent business income deduction you can use each year, because there are income limitation complexities on that deduction.
Note: Any tax advice contained above is not intended to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the IRS or other applicable laws. This article is intended only for educational purposes and is not intended, and cannot be relied upon, as tax or financial planning advice. Readers should consult with their own advisors to be aware of exceptions and limitations related to the any of the above, and for other tax laws that may affect the reader’s tax and financial position.