As summer vacations wind down and the weather begins to turn, it is a good time of year to tackle all those matters that have been put off over the Summer months. For some of us, ‘taxes’ is one of those matters.
You may recall that a new tax law went into effect this year but may be a bit hazy on just what went down. As a refresher, on December 22, 2017, President Donald Trump signed into law a comprehensive revision to the United States Internal Revenue Code known as the Tax Cuts and Jobs Act.
The Act, often simplified as TCJA, made widespread changes to both individual and corporate taxation. Many of the corporate changes were permanent, while most individual changes only apply to years 2018 – 2025.
The TCJA captured the attention of taxpayers across the country as everyone eagerly awaited analysis as to whether or not the law changes would have a favorable or unfavorable impact on his or her tax burden.
Providing thorough commentary on the comprehensive tax consequences to individuals in the form of income, gift, and estate taxation is beyond the scope of this article.
Rather, this post focuses on perhaps the flashiest change within the TCJA: the changes to Form 1040, Schedule A, also known as itemized deductions.
To incentivize the claiming of the standard deduction over itemized deductions, the TCJA raised the standard deduction for each filing status to nearly twice the previous amount.
However, as a counterbalance simplification tactic, personal exemptions for taxpayer, spouse, and dependents were eliminated. The following chart summarizes the difference between the ‘old’ and ‘new’ standard deduction for various filing statuses:
|Filing Status||2017 Standard Deduction||2018 Standard Deduction|
|Married Filing Separately||$6,350||$12,000|
|Head of Household||$9,350||$18,000|
|Married Filing Jointly||$12,700||$24,000|
This means that taxpayers who have been accustomed to itemizing deductions may now be better off electing the standard deduction. This change to the standard deduction amount, although significant, was only the tip of the iceberg as the TCJA also made comprehensive changes to how each subcategory within itemized deductions is calculated.
To better explain this, let us walk through the 1040 Schedule A from top to bottom and highlight the most notable changes to each subcategory of itemized deductions.
Medical and Dental
- Only medical expenses that exceed a threshold—or hurdle rate—are able to be included as an itemized deduction. This threshold was 7.5% of Adjusted Gross Income (AGI) in 2017 & 2018 and has been raised to 10% for 2019 – 2025. This means that fewer medical expenses will be deductible 2019 onward because the AGI threshold is larger.
State and Local/Municipal Taxes Paid
- This includes both income taxes and property taxes. The TCJA initiates a cap on the sum of non-federal taxes paid at $10,000.
- This most notably negatively impact taxpayers in states with high state income taxes (such as New York or California), as well as geographic areas with high real estate taxes (such as Chicagoland).
- The deductibility of mortgage interest has been narrowed as well. For homes with purchase closing date on or after Jan. 1, 2018, interest paid on home acquisition indebtedness is now limited to mortgages of $750,000 or less. Previously, this cap was $1,000,000.
- Additionally, the deduction for home-equity lines of credit has been repealed. These changes to state/local taxes paid & interest paid slightly lessen the income tax incentives of home ownership.
- This is the first taxpayer friendly subcategory law change. Previously charitable contributions were deductible up to 50% of AGI with contributions above this amount carried forward to future years.
- Now aggregate cash/non-property donations are allowed up to 60% of AGI. Note, the 30% deductibility limit of appreciated securities has not changed.
Casualty & Theft Losses
- Previously this had a gross income hurdle limitation (10% of AGI in aggregate, and $100 for each item) which already made it a challenge for taxpayers to receive a benefit. The Act severely narrowed the focus of this subcategory so that now only losses resulting from a federally declared disaster are applicable.
Miscellaneous Itemized Deductions
- The TCJA repealed this subcategory all together. You can no longer deduct items such as unreimbursed business expenses, tax preparation fees, and investment advisory fees that exceed 2% of the AGI threshold.
To bring these changes to life, below are two brief examples of sample taxpayers with identical amounts of income and expenses in 2017 and 2018. The only change is the application of the tax law.
- Single taxpayer, age 62, with adjusted gross income of $60,000, and expenses as follows: medical ($7,500), real estate taxes ($4,000), investment advisory fees: $7,000.
- Married Filing Joint, taxpayer, 42, and spouse, 39, with adjusted gross income of $250,000 and expenses as follows: real estate & state taxes ($18,000), mortgage interest ($5,000), charitable contributions ($12,000), and unreimbursed business expenses ($7,000).
|Example 1||Example 2|
|Sum of Itemized Deductions||$12,800||$7,000||$37,000||$27,000|
In Example 1, we see the taxpayer itemized in 2017, but should claim the standard deduction in 2018.
In Example 2, the taxpayer’s itemized deduction amount has been reduced by $10,000 as a result of the new law, however taxpayer still benefits by itemizing deductions.
Overall, the Tax Cuts & Jobs Act reform means that fewer taxpayers will benefit from itemizing deductions on a consistent yearly basis and will instead find themselves taking the standard deduction.
In our next blog post, we’ll discuss some new long-run tax reduction strategies that have been made available as a result of the TJCA. Stay tuned for a discussion of such strategies, how they work, and which ones may best apply to you.
Reader note: this post is the first of a two-part series discussing the recent tax law changes to the various components of itemized deductions included in the Tax Cuts and Jobs Act.
Jason Hass is a Tax Advisor at Wealthquest, a Cincinnati-based financial planning and wealth management firm that offers a full range of financial services under one roof, for one simple fee.