It’s no secret how impactful the new Tax Cuts and Jobs Act (TCJA) has been, and will be, for taxpayers and accountants alike. Many taxpayers are analyzing what it means for their personal tax position. For one of the most important parts of an individual return, there are two options to consider: Utilize the “standard deduction” amount or itemize various deductions on Schedule A. As may be obvious, the option that offers the most tax savings should be used. Calculating your tax liability each way is simple; however, there are tricks available that can sometimes control which route you go.
Under the TCJA, the standard deductions have nearly doubled from 2017 (now $24k married filing jointly, $12k single, and $18k for head of household filers in 2018), and personal exemptions have disappeared. And for each spouse over 65, add $1,600 more to the standard deduction amounts. For most people, the higher standard deduction will more than offset the loss of their personal exemptions. This also means fewer taxpayers will itemize deductions because it is less likely the sum of their itemized deductions will exceed the large standard deduction, especially with new limitations on certain itemized deductions. For example, state and local tax (SALT) deductions, which can include property, income, and sales tax, are now capped at $10,000 for any given year. Deductible mortgage interest also has new rules discussed in another article in this newsletter.
One of the most commonly claimed itemized deductions are your contributions to charities. For any one year, the TCJA allows these donation deductions up to 60% of adjusted gross income (AGI) – up from the old 50% limit. Excess amounts carry over five years. An unfortunate side effect of the expected drop in “itemizers” is that these taxpayers may decide to forego donations when they are no longer receiving a tax benefit. A strategy to work around this lost benefit is to “bunch” donations in specific years to help meet the itemizing threshold. This means people can combine multiple years’ worth of contributions into a single year to increase the likelihood of exceeding the standard deduction and thus achieve more tax savings. This method will obviously result in less chance to itemize deductions in the following year. If your standard deduction exceeds your itemized deductions, any unused amounts are lost forever; they don’t accumulate and carry over to future years.
An anticipated consequence of this accelerated giving idea, however, is that nonprofit organizations could experience revenue shortfalls in the coming years, or possible surpluses in others. These organizations may need to budget differently in order to maintain their missions.
One valuable trick with the TCJA is the ability to phase yourself back into the Qualified Business Income (QBI) deduction (a highly complicated piece of the tax law discussed in previous newsletters) by making charitable donations. If a business owner’s taxable income is too high for the new 20% deduction, they can take advantage of additional charitable deductions and reduce their income enough to allow the QBI deduction. This potential double benefit lowers taxable income AND provides the extra deduction.
Another way to maximize itemized deductions in a specific year is to pay as many medical expenses as realistically possible. This deduction is subject to a 7.5%-of-AGI floor going forward that is sometimes difficult to beat. By “bunching” costs into one year, you are more likely to exceed this threshold. If someone in your family is considering an elective surgery or expensive procedure, combine them into the same year you plan to itemize. Consider stocking up on prescriptions, buying new eyeglasses, and making medically-advised home improvements. This can allow a greater possibility of itemizing deductions and taking the standard deduction in alternate years. All miscellaneous itemized deductions, such as tax preparation fee, unreimbursed employee expenses, hobby costs, theft losses, and investment management fees, have been eliminated under the TCJA.
If you are an employee with high unreimbursed expenses, you should negotiate with your employer to receive reimbursement in return for a lower reported W2 wage. That way you effectively receive the deduction.
Many cash-basis taxpayers used valuable timing techniques last year to boost their 2017 deductions. Several taxpayers nationwide took advantage of the opportunity (if applicable in their state) to ‘prepay’ their previously-assessed 2018 real estate taxes by the end of 2017. After the TCJA passed and it was announced that SALT would be limited to $10,000 starting in 2018, taxpayers who did not want to lose future deductions essentially “doubled up” payments. Several taxpayers also reportedly made large personal purchases while the sales tax deduction was still unlimited in 2017.
At Ketel Thorstenson, LLP, we are here to help with any uncertainties regarding the new tax laws. Please contact us if you have any questions.