The House of Representative unveiled its tax reform legislation, the Tax Cuts and Jobs Act (TCJA), last week, setting off a barrage of articles, analysis and social media posts.
The bill would affect many elements of tax planning and filing, but today I want to focus specifically on its impact on itemized deductions. Itemizing is a pretty big issue for a lot of you. So I want to use this opportunity to help you understand a bit more about your return and how things may change for you if some of these provisions become law.
But before I get into that, I want to emphasis that this legislation is just a proposal. It’s the first step in a long and somewhat tenuous law-making process. So don’t be overwhelmed or anxious. The final bill, if there is one, may be very different from the one the House proposed.
What’s the Difference?
Let’s start by understanding the difference between standard and itemized deductions.
As the name implies, the standard deduction is a standard amount that you get to subtract from your Adjusted Gross Income (AGI). Here are the amounts allowed for 2017:
- Single or Married Filing Separately – $6,350
- Married Filing Jointly or Qualifying Widower – $12,700
- Head of Household – $9,350
Your standard deduction is based solely on your filing status. In other words, you can deduct this amount without proving that you spent a specific amount of money.
Standard deductions are simple, but many people can save more on their taxes by itemizing deductions. Your itemized deductions appear on your schedule A and currently include:
- Medical and dental expenses above 10% of your AGI (or 7.5% if you’re above age 65)
- Taxes you’ve paid such as state and local income tax, property taxes, real estate taxes, or personal property taxes
- Interest you’ve paid on your home mortgage, mortgage insurance premiums, or investment interest
- Gifts to charity
- Casualty or theft losses
- Other miscellaneous deductions like unreimbursed employee expenses, tax preparation fees or investment expenses
It would only make sense to itemize if all of those expenses added up to more than your standard deduction.
The TCJA purposes to increase the standard deduction to $12,000 for an individual and $24,000 for a married couple for 2018. That sounds great, right? Not so fast. TCJA also eliminates your personal exemption ($4,050 per person). However, a single individual stills gets an additional $1,600 deduction ($12,000 – $6,350 – $4,050) and a couple $3,200 ($24,000 – $12,700 – $8,100) when combining the two. This result changes if you have children and additional exemptions.
The increased standard deduction means that you need a lot more itemized deductions in order to benefit. As I said above, you choose the deduction that benefits you the most. With the standard deduction being so high, fewer people will itemize.
Itemized Deductions on the Chopping Block
A bigger standard deduction will curtail itemizing all by itself. However, in addition, TCJA proposes to eliminate or reduce many of the itemized deductions. Let’s take a closer look at these changes, and how they’ll affect you. I’ve included the line number on your 2016 return that corresponds with each type of deduction. You can pull out your tax return and find out how much this deduction means to you.
Medical and Dental Expenses (Lines 1-4)
The TCJA eliminates deductions for medical and dental expenses. Not many currently use this deduction because the expenses have to exceed 10% of your AGI. So if your AGI is $100,000, you would need to have expenses above $10,000 to benefit from this deduction. The change does affect, however, those families with low AGI and high medical expenses (e.g., the elderly).
Taxes You Paid (Lines 5-9)
Deduction of State and Local Taxes (line 5): These include state and local income tax or state and local sales tax for those of you who live in states without income tax. This deduction would be eliminated entirely.
Real Estate Tax (line 6): This deduction is for taxes paid on your primary residence and/or vacation homes. This deduction remains in tact, but can’t exceed $10,000/year (regardless of filing married or as an individual). The limit does not apply to investment property (Schedule E) or other business property.
Interest You Paid (Lines 10-15)
If you’re following along on your tax return, you’ll likely find a significant deduction here. The TCJA only permits the deduction on the first $500,000 of mortgage debt (reduced from $1,000,000 today). Plus, the deduction only applies to your primary residence. Under current law, you can also deduct interest on second/vacation homes.
Lastly, you will only be able to deduct interest on “acquisition indebtedness,” meaning debt you incurred to acquire, build or substantially improve your primary residence. That means you would say goodbye to any deduction for “home equity indebtedness” (debt incurred for other than the purpose stated above. Also of note, this would be one of the few provisions that take effective “immediately” as of November 2, 2017, if the bill becomes law (as opposed to 2018).
Gifts to Charity (Lines 16-19)
Unlike most of the changes we’re discussing, this one actually increases the amount you can deduct. Currently, your cash contributions to a public charity can’t exceed 50% of your AGI. Under the TCJA, that amount increase to 60% of AGI. Both provisions have a 5-year carryforward for unused deductions. The deduction for charitable mileage also gets a boost. Currently $.14/mile, it will be increased for inflation. Lastly, the TCJA will also require written documentation for all charitable contributions, rather than those that exceed $250 as they do now. So make sure to hold on to your receipts.
Casualty and Theft Losses (Line 20)
Currently, you can deduct “casualty losses.” These are losses incurred in events like fires, storms or theft, that are not reimbursed by insurance. The TCJA eliminates this deduction unless, specifically authorized with special disaster relief legislation from Congress.
Job Expenses and Certain Miscellaneous Deductions (Lines 21-27)
Lastly, we get to the deductions that must exceed 2% of your AGI in order to benefit you. The TCJA eliminates the deduction for any tax preparer (or tax prep software) expenses, and the deduction for unreimbursed business expenses for employees. Investment management fees are still deductible, but you should remember those are not the same as financial planning fees.
As you can see a lot of changes seem to be in the works, and this is just for your schedule A. I’ll discuss a couple more next week when I talk about adoption and the adoption credit (both being eliminated under TCJA). But, again, don’t let the possible changes overwhelm you. If you’re more excited than overwhelmed and want to learn more, you can find additional reviews on the bill by Michael Kitces’ on The Nerd’s Eye View, Ron Liber at the New York Times and Tony Nitty on Forbes.
In the meantime, keep me posted on your specific issues and questions at the links below.