- Increase In Standard Deduction
- Loss of Personal Exemptions
- Changes to Itemized Deductions
- Bunching Strategy
- Employee Business Expenses
- Business Expensing
- 20% Flow-through Income Deduction
- Change in Treatment of Alimony
- Casualty Losses, Home Equity Interest and Moving No Longer Deductible
Tax reform has changed the way most taxpayers need to think about and plan for their taxes. It is no longer business as usual, and those who think it is are in for a rude awakening come tax time next year.
For most taxpayers, the most significant change is the increase in their standard deduction, which on the surface seems like a big benefit. But don’t overlook the fact that the same tax reform that nearly doubled the standard deduction took away the personal exemption as a deduction. So, for example, under old law for 2018, a married couple’s standard deduction would have been $13,000, and their two personal exemptions would have been $8,300 (2 x $4,150), for a total deduction of $21,300. Under the new law, they will be able to deduct $24,000, the new standard deduction for 2018. So, their total increase over what they would have gotten under prior law is only $2,700. If they have four children, their deductions for 2018 under prior law would have been $37,900 ($13,000 plus 6 x $4,150), as compared to the new law’s $24,000. However, for individuals with children under age 17, the child tax credit for 2018 was increased to $2,000 (with $1,400 being refundable) from the prior $1,000, in many cases making up for the loss in the exemption deduction. Note that a credit is a dollar-for-dollar reduction of the tax, while a deduction reduces the income that is taxable.
Tax reform also placed some limitations on itemized deductions by limiting the amount that can be claimed for state and local taxes as well as totally eliminating the deduction for employee business expenses along with some other commonly encountered deductions. Thus, the remaining allowable itemized deduction categories are medical (in excess of 7.5% of AGI), up to $10,000 of state and local taxes, home acquisition debt interest, investment interest, charitable contributions and gambling losses (limited to the amount of gambling income).
Some taxpayers may be able to employ what is referred to as the “bunching” strategy as a workaround. This strategy has the taxpayer taking the standard deduction one year and itemizing the next. This is accomplished by doubling up charitable contributions in one year and skipping donations the next year, deferring or pre-paying medical expenses where possible, and paying state estimates in advance for the year of itemizing and prepaying all assessed property taxes, while keeping in mind that the maximum deduction for taxes in any year is $10,000. This strategy should only be used if the shifting of deductions results in total itemized deductions being greater than the year’s standard deduction.
Another huge issue is the loss of employee business expenses. This means the likes of long-haul truckers, traveling salespeople and others with large employee business expenses should seek out accountable expense reimbursement plans with their employers, even if they have to reduce their pay to balance it out.
For taxpayers in business, tax reform offers 100% expensing of purchased tangible business assets other than structures. At the same time, it also offers a new 20% flow-through business deduction. The combination of these two deductions must be carefully considered because expensing rather than depreciating the cost of equipment, machinery, etc., will reduce the business’s profit, which will in turn reduce the flow-through deduction. On the flip side, the new 20% deduction is limited for certain higher-income individuals, and reducing income by expensing capital purchases may actually help one to qualify for the deduction.
Married couples contemplating divorce will have to understand how the law changes will affect their situation and whether they should finalize the divorce before the end of the year. Currently, alimony is deductible by the payer and taxable to the recipient. Tax reform has changed that long-standing rule for divorce agreements entered into after December 31, 2018, or pre-existing agreements that are modified after that date, to include a new provision saying that alimony is no longer deductible by the payer and is not income to the recipient. Of course, the treatment of alimony can be adversarial and can also be a planning issue for 2018.
Here are some additional issues of importance:
- Business entertainment expenses are no longer deductible.
- Up to $10,000 of Qualified Tuition Plan (Sec. 529) funds can be used for elementary and high school expenses, if permitted by the plan.
- Taxpayers who convert their traditional IRA to a Roth IRA can no longer change their minds and undo the conversion.
- Casualty losses, other than those incurred in a federally declared disaster area, are no longer deductible, so you should consider whether you have adequate insurance.
- Moving expenses are no longer tax deductible, and employer reimbursement for moving costs is now taxable income. If an employer requires an employee to relocate, consider having the employer provide a tax gross-up reimbursement.
- Taxpayers basing their ability to purchase a home on the tax deduction they will derive from the interest they’ll be paying need to be aware that for homes purchased after 2017, the home mortgage interest deduction is limited to the interest paid on the first $750,000 ($375,000) of home acquisition debt.
- Taxpayers who have tapped their home’s equity in the past should be aware that they can no longer deduct home equity debt interest, even if the debt was acquired before 2018 and is $100,000 or less.
- For taxpayers residing in a state that has a state income tax, some or all of the federal tax reform changes may not apply for state filing purposes, or they may apply only if the state legislature enacts conforming legislation.
As you can see, it is definitely not business as usual.