Taxes are complicated. And, just when you think you have a firm grasp on how to maximize your financial situation due to current laws… a new administration takes over.
We work hard for our money, and there’s no extra credit for paying more taxes than required by the tax code. Now that the 2017 tax season is over, it’s time to set your sights on the 2018 federal tax law changes and how they impact you. Some of the new laws are still up for interpretation because the IRS needs to create 2018 tax forms and instructions. Therefore, CPAs, including myself, are still trying to understand Congress’s exact intentions when passing these new laws.
The following are are some of the most significant tax changes you should be aware of. Learn how you may be able to use them to your advantage, or, at least, which new laws you should start asking your CPA about.
Before we get started
Talking about (or in this case, writing about) taxes requires many references to your adjusted gross income (AGI). AGI is used to determine how much of your income is taxable. It is the starting point for calculating your tax bill and is the basis for many deductions and credits.
AGI takes into consideration everything you earn in a year (called your gross income) — including wages, dividends, capital gains, interest income, self-employment income, rental income and retirement distributions — and factors in allowable deductions, such as HSA deductions, student loan interest, retirement contributions, and more.
To make this easier to follow, see the sheet below and reference it periodically. It provides a sample family, The Johnsons, who are a married couple with one child and examples of how the tax laws may impact them.
1. Increased standard deduction
This is one of the most talked about changes. To start, itemized deductions include expenses like state income taxes, sales tax, real estate taxes, mortgage interest, charitable contributions, and deductible medical expenses. Deductions can lower your taxable income, which, in return, lowers your tax bill.
For example, if you owned property and lived in a high tax state like New York or California, your property taxes may have easily exceeded the standard deduction in 2017 of $12,700 for married couples filing jointly. Therefore, many of these taxpayers chose itemization instead of the standard deduction.
Starting in 2018, the standard deduction is increasing about two-fold to:
- $12,000 for single filers
- $18,000 for heads of household
- $24,000 for married couples filing jointly.
On the positive side, taxpayers who previously took the standard deduction are automatically getting a higher deduction in 2018. And for our example married couple, who traditionally itemized their deductions, it’s now more advantageous to take the higher standard deduction of $24,000 for married filing jointly.
Additionally, for those who take the standard deduction, tax returns may become easier (or less costly) to prepare due to no longer needing to organize a laundry list of expenses and calculations.
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2. State, Local Taxes (SALT) are limited to $10,000 per return
If you determine that it’s still more advantageous to itemize your deductions, the maximum you can deduct for state and local or sales, property, and real estate taxes is $10,000 per return versus deducting the whole amount (though subject to some limitations for high earners) in 2017.
In our married couple’s case, they are still better off with the standard deduction of $24,000 instead of itemizing because the eligible deductions would only add up to $18,500.
Because some taxpayers may lose their state income and property tax deductions, they may choose to take the standard deduction one year and then bunch together substantial charitable contributions or deductible medical expenses all in the following year to take advantage of the itemized deduction.
3. Elimination of the deduction for interest on home equity indebtedness
When most people think of home mortgages, they think of buying, constructing, or substantially improving their home. Home equity loans or lines of credit (HELOC) are commonly used for home-related purchases, but in some cases, they are also used to pay off personal debts or college expenses. While it’s usually better to have a sufficient emergency fund or money saved separately to pay for your child’s college, sometimes this sort of debt is an individual’s only option.
Before 2018, the interest paid on all of the above expenses could be included in your itemized deductions. Now, you can only deduct this interest on your tax return if it was for acquiring, constructing, or substantially improving your home or second home. Therefore, your potential for itemized deductions is lower in 2018.
4. Elimination of personal exemptions and increased child tax credit
The personal exemption of $4,050 for you and each of your dependents is kaput in 2018. For our married couple, that exemption was $12,150, which accounted for both spouses and one child.
To offset the eliminated exemptions, TCJA has increased the child tax credit from $1,000 to $2,000 per qualifying child or $500 per qualifying dependent. At the same time, the AGI phase-out threshold for married filing jointly couples has significantly increased from $110,000 in 2017 to $400,000 in 2018. That means millions of additional parents will be eligible for the higher credit in 2018.
Tax credits lower your tax bill dollar-for-dollar. So even if you were eligible for the $1,000 child tax credit in the past, the additional $1,000 credit per child (not to mention the higher standard deduction and changes to the tax brackets), may offset the eliminated exemptions in most cases.
5. Expansion of 529 plan distributions for private elementary and secondary school expenses
Under TCJA, 529 plan distributions can now be used tax-free for private elementary and secondary school expenses. The limit is $10,000 in qualifying expenses per student each year. This includes both public, private, or religious schools, which is great if you weren’t sure whether your child would attend college. However, not every state will follow the new tax provisions, so you should make sure your state 529 plan conforms to federal changes before pulling out money for Junior’s high school tuition.
6. Elimination of the miscellaneous itemized deduction
This deduction relates to common expenses like unreimbursed employee expenses, tax preparation fees, investment advisor fees, job search expenses, union dues, work uniforms, and hobby expenses. Before 2018, the aggregate of these expenses needed to exceed 2% of AGI, or $2,000 for our sample couple, in order to include them as itemized deductions. In 2018, these miscellaneous itemized deductions have been completely eliminated.
Only a small percentage of my clients were eligible to claim miscellaneous itemized deductions. However, some professions, like traveling sales reps, who aren’t reimbursed by their employer could be adversely affected.
If you had significant unreimbursed employee expenses in the past, consider speaking with your employer about whether they will reimburse or give you an allowance for work-related expenses going forward. And at least for teachers, the $250 deduction for educator expenses on Line 23 of Form 1040 is still in effect.
7. New Qualified Business Income deduction for pass-through businesses
The new Qualified Business Income (QBI) deduction is one of the changes I’m most excited about with TCJA. Pass through entities (i.e., partnerships, S Corporations, and sole proprietorships) are generally allowed a deduction equal to the lesser of:
- 20% of QBI (not including net capital gains) or
- 50% of W-2 wages paid by the partnership, S corporation, or sole proprietorship.
But the deduction can’t exceed the taxpayer’s taxable income, reduced by net capital gains. The calculation is also based on your combined taxable income and whether the business is a “specified service business.” Keep in mind, this deduction only impacts your income tax calculation, and 100% of QBI is still subject to self-employment taxes.
If you’re looking for a more detailed analysis of this new deduction, Forbes has a fantastic piece with more than you’d ever want to know about the 20% QBI deduction.
8. Reduced threshold for the medical expense deduction in 2018
Previously, to include qualified medical expenses in your itemized deductions, they needed to exceed 10% of your adjusted gross income (AGI). Therefore, our sample couple with AGI of $100,000 could only deduct qualified medical expenses in excess of $10,000.
In 2018, the threshold decreased to 7.5% of your AGI for qualified medical expenses. Thinking about our sample couple again, they could include qualified medical expenses in excess of $7,500 in their 2018 itemized deductions calculation.
Keep in mind, this threshold will revert back to 10% in 2019. Therefore, you may want to schedule any major surgeries or trips to the doctor for 2018 when the AGI threshold is lower, and you have a higher likelihood of including these in your itemized deduction.
Federal versus state laws
Keep in mind that the Tax Cuts and Jobs Act of 2017 (TCJA) changes are on the federal level. Each state and Washington, DC has its own unique sets of income tax laws. Some conform entirely to the federal code, while others use the federal tax laws as a starting point for their calculations. For example, some high-income tax rate states like New York and California are proposing changes to their calculations to account for the new state and local tax deduction cap discussed earlier.
A post like this can’t begin to cover the entire US tax plan. (But, this one comes close.) Therefore, be sure to consult with a tax professional about any changes to your financial situation throughout the year. You’ll be much happier with the results of your 2018 tax bill if you perform a little preventative maintenance, consider new tax-advantaged opportunities, and even check in to ensure if you have the appropriate tax withholdings. Plus, you may save your CPA from needing to have the awkward conversation about an unexpected 5-figure tax bill.
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Cathy Derus is the founder of Brightwater Accounting. As a CPA and financial planner, she helps individuals and business owners eliminate stress and worry over taxes, business finances, and more. Anyone can throw numbers into tax software. She’s here to help her clients make sense of those numbers and create a better financial strategy for their businesses and lives. Her expertise has been featured in Entrepreneur, CNBC, US News & World Report, The Washington Post, Real Simple and Cosmopolitan.
Haven Life Insurance Agency does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.