How Tax Reform Will Impact Deductions & Credits-Individuals
Congress passed tax reform in the week before Christmas of 2017. This was the most sweeping tax law change since the recodification of the tax code in 1986. While it will take some time to determine the finer points of this tax reform plan, we have the nuts and bolts in place to determine what the impact will be for most of our clients.
The act increased the standard deduction for married individuals to $24,000 and to $12,000 for single tax payers. What does this mean for you as a taxpayer? It means that your deductions for things such as state income tax, property tax, mortgage interest, and charitable contributions will have to be higher than $24,000 (married) or $12,000 (single) combined in order to make a difference on your tax return. For the sake of comparison, the standard deduction is $6,350 for single taxpayers and $12,700 for married taxpayers in 2017. That is quite an increase, but the increase in standard deductions is offset by the fact that all exemptions are eliminated.
In addition to the change in standard deductions and exemptions, the new law also makes changes to tax deductions already on the books. The following changes have been made to itemized deductions and credits:
-Medical Expenses-In prior tax years, taxpayers could deduct medical expenses to the extent that those expenses exceeded 10% of the taxpayers Adjusted Gross Income (AGI). That threshhold has been lowered to 7.5% of AGI. Verdict: Favorable towards taxpayers
-State & Local Taxes-In prior tax years, taxpayers could deduct amounts paid for state income tax, real property tax, personal property tax (auto), and miscellaneous other taxes. Early proposals of the tax reform eliminated this deduction in its entirety. Representatives from high tax states such as New Jersey, New York, and California really put up a good fight until a compromise was made. The final bill allows taxpayers to deduct the same tax as in prior years, but the deduction is capped at $10,000. Verdict: Unfavorable and neutral...depending on your circumstance. If you are a taxpayer who has not been subject to Alternative Minimum Tax (AMT) in the past, this change could increase your taxable income. However, if you have been subject to AMT in the past and are likely to remain subject to AMT under old laws in future years, this change won't affect you because state and local taxes deducted to calculate your regular income tax liability are added back in order to calculate your AMT. If you want to know whether you were subject to AMT in 2016, look at line 45 on page 2 of your 2016 Form 1040. If there is an amount on this line, you were subject to AMT and won't be affected by this change in law, assuming no major changes to your tax situation in 2017.
-Mortgage Interest Deduction-In years past, you could deduct interest on home debt used to acquire a home. The debt allowed was capped at $1,000,000. The loans that were already in place prior to Dec 31, 2017 will not be affected. Loans entered into on January 1 2018 and after are subject to a $750,000 cap. Verdict: I classify this as neutral. Taxpayers need to be aware of this threshhold change and make decisions in the future accordingly. If a taxpayer has a home with over $750,000 of acquisition debt, the taxpayer should be careful about refinancing that mortgage without checking with us about the impact. Taxpayers should also factor this change into any decision about future home purchases.
-Miscellaneous Itemized Deductions-In years past, taxpayers could deduct miscellaneous itemized deductions that were greater than 2% of their AGI. That deduction is gone now. The eliminated deduction included unreimbursed employee expenses, investment advisory fees, and tax preparation fees. Verdict: This is unfavorable for taxpayers.
-Alimony-In the past, alimony paid to an ex-spouse was deductible by the spouse paying the alimony, as long as certain criteria was met. Any divorce settlements entered into after December 31, 2017 will not qualify for this deduction. Verdict: This is unfavorable for taxpayers making alimony payments and favorable for taxpayers receiving alimony payments.
-Pass Through Income-This change applies to small business owners operating as sole proprietors, partnerships, or S Corporations. Congress initially wanted to tax income from these forms of business at lower tax rates than ordinary income, but settled on another tax reduction mechanism. Owners of flow-through entities will be allowed to deduct 20% of their business taxable income subject to certain limitations. The limitations in place discourage flow through owners from reducing their W2 income from their flow through business in order to increase their 20% deduction. The restrictions are more stringent on personal service providers such as attorneys, accountants, and health care providers. We will have more details on the mechanics of this deduction as the IRS releases Regulations and Revenue Procedures to clarify the calculation and close any loopholes. This is standard for new tax legislation. Verdict: This is very favorable to small business owners. If you are a small business owner, hug your Senator's neck.
-Child Tax Credit-The new child tax credit will be $2,000 per child, up from $1,000 per child according to the old tax law. Also, under the old law, the credit was phased out for married taxpayers with AGI greater than $110,000. Under the new law, the phase out does not begin for married taxpayers until AGI exceeds $400,000. Verdict: This is favorable for taxpayers.
-AMT-To further confuse the issue, Congress saw fit to raise the exemption for AMT purposes from $84,500 to $109,400 for married taxpayers. Congress also indexed these amounts to inflation for the first time in history. Verdict: While this may confuse some taxpayers when coupling this with the State & Local Tax Deduction, the change is definitely favorable for taxpayers.
-Affordable Care Act-Congress has attempted multiple times this year to repeal the Affordable Care Act (ACA). While it was not successful in its repeal attempts, it dealt the ACA a major blow that arguably all but repeals the act. Congress repealed the additional tax on taxpayers that do not have minimum essential coverage or an equivalent qualifying for an exemption. Verdict: Favorable and unfavorable. If you are a small business owner that has struggled to justify the purchase of an insurance plan you will never use for an astronomical price, this reform greatly benefits you. It could potentially open up new markets for plans more similar to the insurance plans circa 2008. However, this benefit doesn't come without a price to society. Taxpayers who have pre-existing conditions that have greatly benefited from the ACA by gaining access to a product that was previously unavailable to them will likely see a drastic increase to their insurance premiums in the future. In addition, it could lead to the collapse of the health insurance marketplace as more healthy taxpayers leave the marketplace altogether for more affordable options that are more in line with their needs.
While it is clear that quite a few of these tax changes are not taxpayer friendly, we feel that most taxpayers will notice a reduction in their overall tax liability. If you are a taxpayer with W2 income from an employer and you do not own your own business, we believe that this reform will most likely be neutral for you with the slight possibility of a small decrease or increase in liability.
The easiest way to see the law's impact is to calculate your tax return for 2017 two different ways:
1. Using the laws from 2017 and
2. Using the laws from 2018.
That will be the best way to get a good idea of what your tax liability will be under the new laws as compared to the old laws. Please let us know if you are interested in this service when we prepare your 2017 tax return.