There is a lot of talk on the news, social media and through heresy about the tax reform (some good, some bad). Are you confused? I don’t blame you. I’m here to unravel this complex new tax law with you. At the end of this article, I’ll also let you in on a little secret that I noticed while preparing tax projections for 2018.
Let’s start by answering the most common question I get. Will my 2018 tax return be effected by this law? The short answer – Yes! Everyone’s tax return will be affected by this. Now let’s get down to the nits and grits of the TCJA (officially called the Tax Cuts and Job Act – for all the tax nerds out there like myself).
Tax Rates Lowered
This is great news for most. Even though majority of rates lowered, beware that the brackets also changed. So pay close attention to your bracket. Note: Capital gains and qualified dividend tax rates did not change. Check out the federal income tax calculator (creds to tax foundation) to see how the tax rate change affects your return (remember this is an estimate).
2018 Rates and Brackets Compared to 2017 Rates and Brackets
Personal exemptions and the child tax credit
☹The deduction for personal exemptions ($4k/dependent) is gone, adios, Bye Felicia!
😁However, they expanded the child tax credit to $2k for children under 17 and $500 for older, which will help make up for the loss of personal exemptions for some families. In addition, the phase-out limits for these credits have increased to $400k for joint filers ($200k for others), so that more people will be able to take advantage of this credit. Give your fellow parent a high five.
Standard deduction almost doubled
😁 Yup, you’ve read it correctly. They doubled the standard deduction (the crowd goes wild). The higher standard deduction ($12k for singles, $18k for heads of household, and $24k for married filing joint) means two things. 1. The standard deduction you were using just doubled. 2. That fewer taxpayers will benefit from itemizing deductions. Not familiar with this concept – you get the higher deduction of the two: standard or itemized. Most people itemized if they own a house, have high medical bills, donate, etc. See below on changes to itemized deductions that may affect whether you are above the standard deduction.
For tax years 2018 through 2025.
- 😁The overall phase out of itemized deductions has been revoked
- ☹Itemized deductions for all state and local taxes, including property taxes, are capped at $10k.
- ☹The limit on mortgage debt for purposes of the mortgage interest deduction is reduced from $1M to $750k for loans made after Dec. 15, 2017. Loans made before Dec. 15, 2017 are grandfathered at the $1M debt limit.
- ☹The interest on home equity loans is no longer deductible, unless the debt is actually used for home improvements.
- 😁The threshold for medical expense deductions is lowered to 7.5% of adjusted gross income (from 10%) for tax years 2017 and 2018. This limit is set to change back in 2019.
- ☹Miscellaneous itemized deductions subject to the 2% of AGI limitation are gone. This includes unreimbursed employee business expenses, investment adviser fees, union dues, and tax preparation fees.
20% Deduction for Businesses (also known as the 199A deduction)
😁For tax years 2018 through 2025, business owners may be able to deduct 20% of their qualified business income from a partnership, S corporation or sole proprietorship. There are many limitations and restrictions to this provision, so reach out to a tax professional (hyperlink to my website) for the impact on your situation. To show how much this could save you…say you have profit of $100k. You would get a $20k deduction. Lowering your taxable income and potentially putting you in a lower tax bracket.
Meals/Entertainment for Businesses
☹Entertainment is no longer deductible for all businesses. This means when you take your clients or a potential client golfing, to a concert, a sporting event (Go Eagles!), a spa, and so on, it’s no longer a deduction. On a positive note, food and beverages are still deductible if purchased separately from the event. Be sure to break these out in your records.
Employee, client, and prospect business meals are 50% deductible, as long as they aren’t considered lavish and extravagant. If you provide food and beverages to the general public, they are still 100% deductible.
😁☹For divorce agreements signed after Dec. 31, 2018, alimony is no longer deducible for the payer and tax-free for the recipient. So depending on which side of the agreement you land on, you might want to consider getting divorced by the end of the year or pushing back to 2019.
😁Alternative minimum tax (AMT) exemption is increased from 2018 to 2026. The increase in the exemption, as well as the elimination of major tax preferences (such as state/local taxes and miscellaneous itemized deductions), means that fewer people will be subject to AMT under the new law. So far in the projections I prepared, there were no client’s subject to this tax that were subject in prior year.
😁Funds in a 529 plan can now be used to pay for grades K to 12 private school tuition. The above-the-line deduction for college tuition expenses was renewed, but only for 2017. The American Opportunity and the Lifetime Learning credits continue to be available.
Roth IRA conversions
☹Recharacterization of Roth IRA conversions are no longer available. A conversion of a traditional IRA to a Roth IRA may still be beneficial, but once the conversion is completed, it can’t be undone. No more redos.
Individual shared responsibility payment
😁The individual shared responsibility payment for failure to have minimal essential healthcare coverage is eliminated. However, this repeal does not take effect until Jan. 1, 2019. This means that if you did not have minimal essential healthcare coverage in the 2018, you will still be subject to the penalty if you do not meet one of the exceptions.
Whew!! That was a lot and surprisingly only a few of the changes.
Now a little practical insight I noticed while preparing tax projections for 2018:
- Only two clients, out of hundreds were negatively affected by this new law.
- On average, my nonbusiness clients get back $1k more compared to last year (more green in their pocket)
- With tax planning, we saved our business owners thousands of dollars, using this law to their advantage.
There are many other rules and regulations and each person’s tax situation is unique, so please consult with your trusted CPA.