Article written by:
Brad Merillat, CPA
A few weeks ago Congress passed, and President Trump signed into law, HR-1, more commonly referred to as the Tax Cuts and Jobs Act (“The Act”). The new tax law will have an immediate impact beginning with the 2018 tax year and will have an effect on every business and individual no matter how large or small. GBQ has created an informational gateway called “GBQ Tax Reform Central” that will be your resource for news and updates on what all of this means to you. Today we will look at the major changes made to itemized deductions, which are claimed if the standard deduction is not taken. Because the standard deduction has been increased (to $24,000 for married individuals filing jointly and $12,000 for most other taxpayers), along with new curbs on itemized deductions, fewer individuals will be able to itemize deductions going forward.
STATE AND LOCAL TAXES
One of the most publicized items from the passage of The Act is the new limitation placed on state and local taxes. Under prior law, there was generally no limit to the amount of state and local taxes that could be included on Schedule A as itemized deductions. These state and local taxes include real estate and income or sales taxes. Under The Act, you may no longer be able to deduct the full amount of state and local taxes paid as an itemized deduction on Schedule A, as the total deduction for these types of taxes will now be limited to $10,000 beginning in 2018. While you will still be able to deduct any 2017 real estate taxes paid on or before December 31st, 2017 on your 2017 return, existing tax law and a provision in The Act negate the ability to prepay 2018 state and local income taxes and claim those on your 2017 return. This limitation could have a dramatic effect on high income taxpayers, particularly individuals that live in states with higher tax rates, such as New Jersey, New York and California.
Note that the state and local income tax deduction has historically caused many taxpayers to pay the Alternative Minimum Tax (“AMT”). Given the limitation of the state and local tax deduction to $10,000, along with The Act’s increase in the AMT exemption and the dramatic increase to the income-based phase-out of this exemption, we expect that far fewer taxpayers will be subject to the AMT starting in 2018.
The mortgage interest deduction is also seeing changes resulting from the passage of the The Act. Under prior law, you could deduct interest on your primary residence and a second home if applicable of up to $1,000,000 ($500,000 if not married filing jointly) of mortgage debt. Beginning in 2018, the debt threshold will be reduced to $750,000 ($375,000 if not married filing jointly). However, if you acquired the debt on or before December 15, 2017, you will be locked into the original $1,000,000 threshold. If taxpayers wish to refinance any pre-December 15, 2017 acquisition debt and maintain the original threshold, they will be able to do so as long as the refinanced debt does not exceed the original acquisition debt. Additionally, under prior law you were permitted to deduct up to $100,000 of qualifying home equity debt. This will be completely disallowed beginning in 2018 under The Act. Taxpayers should be aware that if they are using home equity line of credit to pay for other expenses, they no longer will be able to claim the additional interest as a tax break.
Furthermore, miscellaneous deductions included on Schedule A such as tax preparation fees, investment expenses and unreimbursed employee expenses will no longer be deductible. These expenses had been deductible to the extent they exceeded 2% of a taxpayer’s adjusted gross income, but these deductions have now been fully eliminated. Similar to the state and local tax deduction, investment management fees caused many taxpayers to pay AMT. The disallowance of this deduction is expected to cause fewer taxpayers to pay AMT. However, it could also result in significantly lower itemized deductions depending on the extent of a taxpayer’s investment expenses. It would be advisable to consult with your broker and determine if these fees will be adjusted or if they will possibly be included in stock sales or other transactions.
A retroactive adjustment to qualifying medical expenses has been put into effect with the passage of The Act. Unreimbursed medical expenses in 2016 were deductible on Schedule A if they exceeded 10% of a taxpayer’s AGI. This limitation has been reduced to 7.5% of a taxpayer’s AGI and will be allowed beginning in the 2017 tax year. This reduction continues for 2018, but retracts back to 10% beginning in 2019. Taxpayers may find it beneficial to accelerate any medical expenses before the end of 2018, if possible, in order to maximize their deduction.
Finally, charitable contributions remain deductible in the new law and can now be deducted to the extent of 60% of your AGI rather than the previous 50% threshold. Of additional significance is the changes made to the classification of the purchase of seat licenses from an institution of higher education. Prior law permitted an 80% charitable contribution for the payment to an institution of higher education in exchange for which the payer receives the right to purchase tickets or seating at an athletic event. No charitable deduction for this will be allowed after December 31, 2017. If taxpayers are considering this type of activity, it is important that they understand that no tax benefit will come along with it anymore.
Many taxpayers that are on the line between the standard deduction and claiming itemized deductions may find it worthwhile to make charitable contributions differently year to year. A simplistic example: if a taxpayer has $20,000 ($10,000 each) in deductions from state and local taxes and mortgage interest, it may be wise to stagger charitable contributions between two years. If the taxpayer wishes to donate $10,000 a year to charitable institutions, it would be beneficial for them to pay $20,000 in one year and $0 in the next. Their deduction for the year they made the $20,000 contribution would be $40,000 and the other year they would take the $24,000 standard deduction. If they instead made $10,000 in contributions each year, they would get $30,000 in total deductions for both years. By staggering their contributions, they will have a net gain of $4,000 in deductions over the two years. Taxpayers should consult with their tax professional to determine the best method of tax planning in order to maximize their benefit.
GBQ is dedicated to following the impact this bill will have on your business and your personal tax situation. Please reach out to your GBQ tax professional if you have any questions on this topic or any other aspects of The Act.