Changes in Deductions
Part 3 of 4
As explained in last two week’s blogs, the short answer is: YES! The changes described last week resulted in everyone being a loser. Fortunately, the changes in deductions will cause some winners and losers. Read on to see if you’ll land in the winner’s column.
FACT: The new tax reform bill will impact every taxpayer in the country due to increases in the standard deduction, and new limitations on itemized deductions.
One of the most talked about changes in the new tax bill is the change in deductions. If you’re a taxpayer who takes the standard deduction, you’ll be excited to learn the standard deduction has doubled! Here is the change in the standard deduction related to each filing status:
The intention behind the new increased standard deduction is to be greater than the 2017 standard deduction plus the 2017 personal exemption. Therefore, if you use the standard deduction, you will see a net tax decrease as a result of this change. However, if you itemize deductions, this change will have the opposite effect.
Itemized deductions are those that appear on schedule A. The most common itemized deductions in 2017 were:
- Mortgage interest
- State income taxes or sales tax
- Real estate taxes
- Charitable contributions
- Medical/dental expenses
The new tax reform bill made changes to the deductibility of all 5 of the most common itemized deductions.
Changes to #1 will likely have minimal tax increasing impact to a limited number of taxpayers. Mortgage interest remains deductible for 2018, and the amount to be deducted will not change for most taxpayers. The change to this deduction applies to homes purchased after December 14, 2018. New purchases will only qualify for the deduction for mortgages amounts up to $750K. The prior limit was up to $1M. Further, taxpayers who financed their home with a traditional mortgage and a home equity line of credit (HELOC) can no longer deduct the interest related to the HELOC.
Changes to #2 & #3 will likely have a significant tax increasing impact to many taxpayers. State income and real estate taxes items will remain deductible for 2018, however the amount of the deduction will be limited. The amount deductible for all taxes will be reduced to $10K. This will impact a substantial number of taxpayers who itemize. There are only seven states that do not have a state income tax. Taxpayers who are upper middle-income wage earners will likely pay state income taxes that exceed this limit. Further, this limit is for the combination of state income taxes and real estate taxes. Again, for higher valued homes, the real estate taxes alone may exceed the limit. This may result in a large reduction in the itemized deductions for taxpayers with higher income levels and higher property values. Do a review of your schedule A from 2017 to determine if this limitation will affect you. If the amount that appears on line 9 is greater than $10K you can expect a tax increase this year.
Changes to #4 will likely have a modest tax reducing impact to minimal taxpayers. The limit on amount of charitable deductions increased. In 2017, you could only deduct up to 50% of your adjusted gross income (AGI) as a charitable deduction. Meaning if your total income was $160K, the maximum deduction was $80K. This limit was increased to 60% of your AGI, therefore at $160K of income your maximum deduction is now $96K.
Changes to #5 will likely have a modest tax increasing impact to minimal taxpayers. The medical and dental expense deduction is not utilized by most taxpayers because the amount spent on these expenses has to be significant to be deductible. In 2017, medical and dental expenses were not deductible until they exceeded 7.5% of your AGI. The new tax reform now requires the expenses to exceed 10% of your AGI before any can be deducted. Most tax payers did not qualify for this deduction at the 7.5% rate of phase out, therefore it is not anticipated that many will be affected by this change.
Fortunately, there are other ways to obtain an equal (or greater) tax deduction for some of the expenses subject to new limitations. There are too many variables for each taxpayer to provide viable options in this context, but just the awareness of the changes will serve to equip you to manage your tax liability. If your deductions will decrease this year, contact us to learn more about your options to find new ways to reduce your tax liability.