With the close of 2018’s third quarter, taxpayers need to take a moment to determine how their personal income tax situations have been impacted by the Tax Cuts and Jobs Act (TCJA) that Congress approved and President Trump signed into law in December 2017. The White House touted that “the average American family would get a $4,000 raise under the president’s tax cut plan,” while House Speaker Paul Ryan stated that “with this plan, the typical family of four will save $1,182 a year on their taxes.” Most people saw a little extra in their paychecks due to the 1%–4% change in their tax bracket, but you won’t know the full impact until you compare your estimated 2018 tax return to your 2017 return.
So, here are the changes you need to be aware of as a result of the TCJA, which are in effect through 2025:
While you might have seen a slight rise in your net paycheck due to the TCJA’s tax-rate changes, you might not have withheld enough and could end up owing taxes. If you do not make estimated tax payments in addition to the withholding from your paycheck and you are accustomed to getting a refund or owing little on your taxes, you could be in for an unpleasant surprise. Individuals who live in states with high state income and property taxes and/or have more than two children should consider talking to their tax adviser — now — to see if they will be sufficiently paid in by the end of the year.
2. Job Expenses and Itemized Deductions
If you have a job with an employer who requires you to bear the cost of travel, union dues, job education or a home office, those expenses are no longer deductible. Also, deductions can no longer be taken for tax preparation fees, investment advice, safe deposit boxes and estate-planning costs. (These expenses used to be reported as itemized deductions on Schedule A of your personal income tax return.) However, if you are self-employed or an active farmer, you can still deduct many of these expenses through your business on Schedule C (self-employed) or Schedule F (farmers).
3. Child Tax Credit
The child tax credit has been doubled, to $2,000, for each qualifying dependent under 17 years of age. The credit can now add a refund of up to $1,400 for each dependent child. Many more taxpayers are now eligible to claim the credit: The phaseout begins for an individual filer at $200,000 of taxable income (it previously was $75,000) and for a married couple filing jointly at $400,000 (versus $110,000).
4. State, Local, and Property Taxes
Prior to the passage of the TCJA, deductions for state and local income and property taxes were unlimited. Under the TCJA, deductions for those taxes cannot exceed $10,000. This change could significantly impact upper-middle-class and upper-class taxpayers who live in states with high income and property taxes. For taxpayers with lower incomes, the effect of this change may be mitigated or eliminated with the increase in the standard deduction.
5. Standard Deduction
The TCJA made major changes to the standard deduction which, depending on your situation, could result in you paying more to the IRS. For single filers and married couples filing separately, the standard deduction has been raised from $6,350 under the previous tax code to $12,000 under the TCJA; and for married couples filing jointly, the standard deduction has gone from $12,700 to $24,000. On its face, the larger deduction looks like a great deal, but its significance can be eroded by another change in the tax law — the elimination of personal exemptions, which had been $4,050 each. As an example, under the old law a single filer with one dependent could claim the standard deduction of $6,350 plus personal exemptions of $8,100 for themselves and their dependent (2 x $4,050) for total deductions of $14,450; and for a married couple filing jointly, with a dependent, their total deductions — the $12,700 standard deduction plus three personal exemptions totaling $12,150 (3 x $4,050) — would have been $24,850. So under the new law, in these scenarios, the single filer would have $2,450 less and a married couple $850 less in deductions.
6. Credit for Other Dependents
To mitigate, somewhat, the elimination of the personal exemption, Congress created a $500 nonrefundable credit called the Credit for Other Dependents or “family credit” which allows you to claim a credit for dependents in your household who don’t meet the definition of a “qualifying child.” This will enable you to claim the credit for children who were age 17 and over before the end of 2018, and for dependent parents. However, there is one catch: the definition for qualifying relatives remains the same under the new law as it was under the old law. Under the Internal Revenue Code, a qualifying relative is an individual whose gross income during the tax year “is less than the exemption amount.” Since the personal exemption has been eliminated, the exemption amount is zero. Which prompts the question: In order to receive the credit, does your qualifying relative have to have zero income? Stay tuned. Regulations will be issued to clarify this situation.
7. Qualified Business Income Deduction
Owners of pass-through businesses (partnerships, LLCs and S corporations), self-employed individuals and farmers were entitled to the 9% domestic production activity deduction until the end of 2017 if their business generally involved farming, manufacturing, construction, production or mining. The deduction was limited to 50% of W-2 wages. That deduction was eliminated in the TCJA and replaced with the qualified business income deduction.
The qualified business income deduction basically is equal to 20% of the qualified business income of each of the taxpayer’s qualified businesses. The provision is considered a significant tax benefit for many non-corporate businesses and was passed on the premise that a sizable tax rate cut for C corporations (14%) justified a collateral tax benefit to non-C corporation businesses. The full calculation of the qualified business income deduction, however, involves a multi-step process that may phase out some or all of the deduction. This is one piece of the new tax law that you won’t want to navigate on your own. See a tax professional
8. Charitable Contributions
The new tax law made only a minor change in relation to charitable contributions — it raised the adjusted gross income limitation from 50% to 60%. However, due to the significant increase in the standard deduction, many taxpayers will not see an additional deduction coming from their charitable contributions due to the amount of those contributions being under the standard deduction. This has given rise to “bunching” strategies in which taxpayers may not make charitable contributions for two or three years. Instead, saving up to make all of their charitable contributions in a year when the amount is sufficient to itemize and achieve deductions.
However, this scenario creates a potential funding nightmare for charities, as they would be significantly impacted without two or three years of funding from these types of donors. Enter what is called the “donor-advised fund.” These funds allow contributors to donate money and take a tax deduction in the same year, then pay the money to selected charities over time, thereby eliminating a potential funding crisis for charities. A charity would get the same amount each year, even in years when the donor doesn’t itemize deductions.
9. Timing of Income and Expenses
The advent of the qualified business income deduction for non-C corporate businesses turns the tried-and-true, year-end tax advice of tax professionals on its ear. For decades, I have encouraged clients to defer income and accelerate deductions in order to minimize their tax liabilities. The multi-step process involved with the qualified business income deduction and the potential prize of 20% of that income being excluded requires a reboot on that thinking. In a large number of cases, it may make more sense to increase income to maximize the deduction. However, if you are a business owner, I cannot emphasize enough the need to consult with a tax professional so that you can properly determine the best strategy for your unique situation.
10. Job Hunting and Moving Expenses
With the uptick in the economy and wages, many people are looking to improve their position in the job market. However, if you are looking for a new job, you may be better served looking in your local market. Job hunting and moving expenses are no longer deductible. Therefore, if you are being courted by an organization outside of your current metropolitan area, try to negotiate for reimbursement of these expenses as part of your total compensation package. Most human resource departments are acutely aware of the changes in the law and will be receptive to this as part of the negotiations.
Reach out to me if you have any questions at Kevin@santry360.com