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Tax Planning for Individual Taxpayers: Points to Ponder Regarding the New Tax Law

The Tax Cuts and Jobs Act (TCJA) not only made major changes that grabbed headlines but also made tweaks to hundreds of tax rules, leaving taxpayers overwhelmed with questions about what their 2018 tax bill will look like and what they should do to minimize their taxes in the future.

Sifting through the implications to understand their impact is a daunting task, but the IRS has been busy this year spelling out the new rules in more detail, so taxpayers will know what they can and can’t do going forward.

Let’s examine some of the major tax changes in 2018 and recent clarifications. The good news is there may still have time to benefit despite new restrictions on individual tax breaks.

To Itemize or Not to Itemize

One of the biggest changes for individual taxpayers will be whether they can continue to itemize their deductions going forward. The TCJA increases the standard deduction to $12,000 for single filers and $24,000 for joint filers. The law also eliminates the $4,050 per person personal exemption and restricts or eliminates many itemized deductions. The combined effect of these changes is that many taxpayers will no longer have enough itemized deductions to exceed the higher standard deduction.

Example: If in 2017 a married couple with no children at home had itemized deductions of $22,000 and took two personal exemptions of $4,050 each, their taxable income would be reduced by $30,100. If nothing changed for 2018, this same couple would only see their taxable income reduced by $24,000 because they would no longer itemize, and they would not get any personal exemptions. It is true that their tax rate is likely to be lower, but it is a very custom calculation to determine whether they really come out ahead.

This scenario makes it important for taxpayers to take advantage of any itemized deductions they are entitled to, especially if taxpayers are right on the $24,000 line.

Here are three deductions individual taxpayers may overlook:

Bunched Charitable Deductions

By increasing charitable deductions in 2018 and taking advantage of the increased deduction for public charities, taxpayers can “bunch” their deductions into a single tax year. Under the new law, Adjusted Gross Income (AGI) percentage limitations for donations of cash to public charities have been raised from 50% to 60%.

Don’t count on taking both a full state tax credit and a full federal charitable deduction for contributions to some state programs. The IRS recently released proposed regulations that limit federal charitable deductions if a state tax credit is received in return. The rules are designed to stop taxpayers from getting around the $10,000 limitation on the state and local tax deduction by “donating” money to state programs instead. The rules are not final but could result in lower federal charitable write-offs.

Lower Threshold for Medical Expense Deduction

Congress expanded the availability of the medical expense deduction by lowering the floor on the deduction from 10% of AGI to 7.5% of AGI. This means that taxpayers can deduct medical expenses which exceed 7.5% of their AGI. Unreimbursed medical expenses can add up when you include health insurance premiums, co-pays, deductibles, dental and vision expenses, long-term care premiums, and even mileage driven for medical purposes. Taxpayers may be able to control the timing of these expenditures by scheduling major dental work or elective surgery into a single tax year to get over the threshold.

Don’t Overlook Home Equity Loans

Beginning in 2018, taxpayers may deduct interest on $750,000 of qualified residence loans, down from $1 million for an acquisition mortgage and $100,000 for a home equity loan under previous law. Although the TCJA appeared to repeal the home equity deduction, the IRS has spelled out that home equity loans used for home improvements still qualify for the interest deduction. Note that the $750,000 limit applies to the total indebtedness on the property–both the first mortgage and any home equity loan.

The effective date is important here. This deduction cap only applies to home purchases made after December 14, 2017. If you purchased your home before that time, you still can deduct interest on up to $1 million of debt on a first loan and up to $100,000 debt on a home equity loan. Also, you can continue to take the higher deduction even if you refinance your pre-2018 home loan.

OTHER CONSIDERATIONS

One More Year for Alimony

Taxpayers will need to change their strategies in divorce settlements due to the TCJA’s revision of the alimony rules. After 2018, alimony will no longer be deductible to the spouse who pays it and will not be included in the income of the spouse who receives it. In other words, the spouses will no longer be sharing the income tax burden. Agreements that are finalized before the rules become effective on January 1, 2019, will not be affected by the change. To the extent possible, taxpayers facing a divorce in the near future should time their settlement agreement based on which version of the rules are more desirable, pre-2019 current law or the deduction elimination rule taking effect at the end of this year.

Entertainment Expenses & Deduction for Meals

The new law eliminated the deduction for business entertainment expenses, but taxpayers can continue to deduct 50 percent of the cost of business meals if the taxpayer or an employee of the taxpayer is present, and the food or beverages are not considered lavish or extravagant.

The meals may be provided to a current or potential business customer, client, consultant or similar business contact. Food and beverages that are purchased or consumed during entertainment events will not be considered entertainment if either of these applies:

  • they are purchased separately from the entertainment
  • the cost is stated separately from the entertainment on one or more bills, invoices or receipts

This clarification by the IRS was one of the most welcome IRS Notices this year. (Notice 2018-76). Businesses of all sizes are affected by the new restrictions, so the IRS’s reading of the law preserves the write-off of an important business practice.

Take Advantage of Tuition Plans

Paying for not only college but also for private elementary or secondary schools is tax-advantaged, thanks to the expansion in the TCJA of Section 529 plans. These tuition savings plans allow tax-free compounding in investment accounts and tax-free withdrawals when used to pay qualified educational expenses. Changes under tax reform allow parents to save money for their children’s elementary and secondary educational expenses and withdraw up to $10,000 per year per student tax-free.

The withdrawal dollar limit for elementary and secondary schools is strict, however, and, if it is exceeded, the taxpayer will owe tax on the investment growth and will incur a 10% penalty. Now that the plans can be used for all levels of education, parents may change some schooling decisions. Grandparents get the tax break as well. In short, now is a good time to review your education investment strategies.

Tax Reform 2.0 and Permanent Individual Tax Cuts

Just as taxpayers are getting used to the new law, Congress has been busy making more changes. In September, the House of Representatives passed H.R. 6760, the Protecting Family and Small Business Tax Cuts Act of 2018, which would make many of the individual tax provisions passed in 2017 permanent. Right now, the individual tax cuts and deduction restrictions are set to expire after 2025. The new House bill would make permanent the lower marginal rates, higher standard deduction, higher child tax credit, increased estate and gift tax exemption, and increased alternative minimum tax exemption. The bill also extends the lower 7.5% floor on medical expenses, the $10,000 SALT deduction cap, the repeal of miscellaneous itemized deductions (such as unreimbursed employee expenses), and the repeal of the personal exemption.

The Senate has not taken up the legislation yet but may after the mid-term elections. The problem with passing the extension legislation now is that the budget deficit numbers are not favorable. The federal budget deficit rose 17 percent in fiscal 2018, according to the Treasury Department. The Treasury statement goes on to say that the Trump Administration believes that “America’s booming economy will create increased government revenues…” and reduce the deficit numbers going forward.

The TCJA’s individual tax provisions enacted in December 2017 appear to be here to stay, at least through 2025, so personal tax planning should move forward to avoid new restrictions and take advantage of new opportunities.