Tax Cuts and Jobs Act – 2017
By Matthew E. Miller, CPA, MBA
In Part III of our newsletters regarding the Tax Cuts and Jobs Act (TCJA), we are going to cover all the miscellaneous provisions of the Act that can be covered in a single newsletter. Our first letter covered the changes to the deduction of state and local taxes. If you missed it, you can read it here. Our second newsletter covered home mortgage interest deductions. You can read it here. Part IV of our coverage of the Act will cover the Qualified Business Income Deduction.
As we cover miscellaneous provisions of the TCJA applicable to individual taxpayers, our presentation will follow the line order of the individual income tax return, Form 1040, and then the supporting schedules. Our coverage will not be all encompassing. Rather, we’ll focus on changes under the TCJA that we believe are important to our client base.
Alimony – For married taxpayers who enter into a divorce and separation agreement after December 31, 2018, alimony payments between the former spouses will no longer be reported on their income tax returns. The recipient of alimony payments will no longer report alimony income and the payor will no longer claim a deduction for alimony paid. The theoretical reason for the change is the government loses revenue on the income transferred to the lower tax rate of the recipient and the deduction claimed at the higher tax rate of the payor.
For agreements in place by December 31, 2018, the payments received will still be taxable as alimony income. The payments made will still be deductible alimony paid.
Taxable refunds, credits, or offsets of state and local taxes – There actually isn’t a change under the TCJA related to this income, but because of the limitation of the deduction of taxes you paid, undoubtedly, this line item will be affected. Please see Taxes You Paid below.
Moving Expenses – Effective for 2018, taxpayers will no longer be able to deduct moving expenses associated with a change of employment and a move of more than 50 miles.
Itemized Deductions / Standard Deduction
Medical and Dental Expenses – Under the Affordable Care Act of 2010, the phase-out of deductible medical expenses was increased from 7.5% of the taxpayer’s adjusted gross income (AGI) to 10% of AGI. Effective for 2017 and 2018, the phase-out percentage has been temporarily decreased back down to 7.5%.
Taxes You Paid – You have no doubt read and heard much about the new limitation on the amount of state and local tax payments you can claim as an itemized deduction. In the final days of 2017, the media created a tax frenzy by incorrectly suggesting taxpayers prepay their 2018 unassessed real estate taxes before the calendar flipped to 2018. Sometimes it’s hard to fill 60 minutes of news airtime!
Under the TCJA, in aggregate, your real estate tax, your personal property tax and your state income tax deductions are limited to $10,000. Because of this limitation, many economists predict more taxpayers will simply bypass claiming itemized deductions and claim the newly increased standard deduction. I agree. While we still need to see how the regulations read, I’m thinking taxpayers will want to select a particular order of their deductions, if allowed.
I’d first deduct my real estate taxes, then I would deduct personal property taxes or sales taxes, lastly, I would deduct state and local income taxes. The reason for this choice of order is if my combined real estate taxes plus personal property taxes exceed $10,000, I’d stop my tax preparation and I wouldn’t deduct my state income tax payments. Why? Because if I get a refund on my state income tax return, and I previously claimed a deduction for the state income taxes I paid, I would then have to report income in the amount of the refund. So, if I don’t claim the deduction, I don’t have to report my state tax refund as being taxable.
Miscellaneous Deductions – Previously, taxpayers could deduct certain expenses associated with the production or protection of income. Some of the expenses we are familiar with are:
- Investment fees and expenses
- Tax preparation fees
- Job search expenses
- Certain legal fees
- Safe deposit fees
- Job related expenses
The ability to claim a deduction was tested based on your AGI. Taxpayers could claim a deduction in the amount of miscellaneous deductions exceeding 2% of their AGI. Beginning in 2018, miscellaneous deductions are no longer deductible.
Tax Tip: If you are a taxpayer who incurs expenses associated with your job and your expenses exceeded 2% of your adjusted gross income, you are certainly penalized by this law change. Consider having a conversation with your employer about establishing an accountable reimbursement plan where you can submit a monthly report detailing and substantiating your expenses for the month, and then the employer would reimburse you. I would even offer to reduce my salary by the reimbursement amount. It’s a win/win for both parties.
Here is an example:
I’m a sales rep for a pharma company. My base salary is $66,000. I typically incur $6,000/annually of expenses in connection with my job. In prior years, I filed Form 2106 and claimed a deduction on my tax return for Employee Business Expenses. After the phase-out of 2% of my AGI $1,320 (assume $66,000 AGI), I would claim a deduction of $4,680 on my tax return.
So, I have a conversation with my boss to explain the new tax law. I explain that beginning in 2018, I can no longer deduct my unreimbursed employee business expenses. I offer the following amendment to my employment agreement, “lower my base salary to $60,000 and pay me $500 per month as an expense allowance.” “Each month, I will give you a full accounting of my expenditures. If I spend less than $500, add the difference to my gross wages next month. If I spend more than $500, it will be my cost.”
Here is where you win – $6,000 x your tax rate is your tax savings.
Here is where your employer wins – $6,000 x 7.65% (combined social security and Medicare rate) is the employer savings.
Elimination of Itemized Deduction Limitation – The TCJA repealed the overall limitation on itemized deductions for taxpayers with a higher AGI. The reduction of allowed itemized deductions due to income thresholds of the taxpayer has been suspended for tax years 2018 through 2025.
Standard Deduction – For tax year 2017, for taxpayers not claiming itemized deductions, the standard deduction amounts are $6,350 (S/MFS), $12,700 (MFJ), and $9,350 (HOH). For tax years 2018 and forward, the standard deduction has increased to $12,000 (S/MFS), $18,000 (HOH) and $24,000 (MFJ). If you are 65 or over, blind, or disabled, you can increase the standard deduction by $1,300.
As mentioned above, given the new limitation on some itemized deductions, economists are expecting more taxpayers to file claiming the standard deduction. Younger taxpayers beginning their careers and retired taxpayers are most likely to benefit from the increase in the standard deduction amounts. If you’re in one of these two classes, start making rough calculations now on where you think your deductions will be by the end of the year. Plan your deductions into the calendar year that will give you the best tax result.
Personal Exemption – This one hurts! For tax year 2017, taxpayers will claim a $4,050 personal exemption for themselves, their spouse, and their qualifying dependent(s). A family of four would be entitled to a deduction in the amount of $16,200. Beginning in 2018, the personal exemption deduction is eliminated. Ouch! No matter how you structure your itemized deductions, losing a $16,200 personal exemption is going to have a tax impact.
An Important Point
Taxpayer confusion with the law is going to put further pressure on the question – Who is my dependent? For our young adult children, when do we stop claiming them as a dependent on our returns? Moms or Dads will prepare their children’s tax returns and will no doubt have a question as to whether the child is still their dependent. Please take time to read our article Can I Still Claim My Graduate?
If I don’t get a personal exemption deduction for my qualifying child, why even report my dependents? Good question! There are still provisions in the law that will be applicable to having a dependent. The filing status Head of Household, the child tax credit, and the child and dependent care credit all require that the taxpayer have a dependent.
Child Tax Credit – To replace the lost benefit of claiming an exemption for your dependent child, the child tax credit increases from $1,000 to $2,000 per qualifying child in 2018. The Act also added a new $500 credit for qualifying dependents who are not qualifying children. In 2018, the income threshold for which the credit begins to phase out is increased to $400,000 (MFJ) and $200,000 for other taxpayers.
Alternative Minimum Tax (AMT) – AMT is part two of the dual tax system of our US tax code. It’s a significant revenue generator for the federal government, bringing in almost $38 billion from individuals in 2017. I always thought there was no way legislators would repeal AMT because of the revenue it generated. Politically, it was nearly an ignored tax because citizens hardly understood the tax and they incorrectly assumed it was a tax applicable to only the “rich”. The fact is, two of the largest deductions taxpayers claim on their tax returns, state and local taxes and personal exemptions, usually subjected the taxpayer to AMT.
While alternative minimum tax for individuals was not repealed, in a hope to minimize the number of taxpayers who become subject to the tax, legislators increased the amount of income exempt from the tax from $84,500 to $109,400 (MFJ) and $54,300 to $70,300 for other filers. Combine these higher thresholds with the limitation on the deductibility of state and local taxes and the elimination of the personal exemption, and most assuredly, fewer taxpayers will be subject to the tax. I think this is a plus!
If you would like to get a better understanding of AMT, please read our article What Is AMT & Why Do I Have to Pay It?
From our newsletters and from news commentators, you are certainly sensing one of the objectives of tax reform, postcard filing, wasn’t achieved. Whether the objective of simplification was met is debatable by some. If legislators eliminated some deductions, flattened or expanded tax brackets, and increased exemptions, policy arguments aside, a step forward in simplification has been made and possibly, America is inching closer to flat tax!
The Tax Cuts and Jobs Act was significant legislation impacting every taxpayer who files a tax return. Many planning opportunities are available to everyone. Whether you’re an employed taxpayer who realizes a decrease in your tax rate which may allow you to increase contributions to your retirement, or if you’re a small business owner developing strategic plans for growth, there are positive, impacting actions you can take.
If you would like to meet with one of our tax advisors to discuss aspects of the new tax law in the greater detail, we would be delighted to do so. Please contact our office at 703-591-9280 to schedule an appointment.