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“Be careful what you wish for” is the phrase that comes to mind when I consider the new tax law (bear with me), specifically the significantly higher standard deduction.
Like many Americans, I craved simpler taxes. I wanted a way to streamline tax planning, preparation, and filing. Certainly, the ease of claiming the standard deduction makes taxes simpler for many following the passage of the Tax Cuts and Jobs Act of 2017 (TCJA).
Still, continuing with the cliches, I wanted to “have my cake and eat it too.” That is, while I wanted simpler tax structure, I also wanted to continue to get tax breaks for the good I was contributing to the American way of life, such as becoming a homeowner and giving to charities. But the high hurdle for itemizing deductions (including restrictions in certain categories) makes doing more to save more in taxes more difficult.
For your enjoyment and tax planning purposes, here's what I've learned from my research on the new structure for the standard vs. itemized deduction:
The New Standard Deduction
The standard deduction is nearly twice as high as before. Here's the new standard deduction by filing status:
Filing Status / Standard Deduction
- Single / $12,000
- Married Filing Jointly / $24,000
- Married Filing Separately / $12,000
- Head of Household / $18,000
Filing Status / Standard Deduction for 65 and older
- Single / $13,600
- Married Filing Jointly / $26,600
- Married Filing Separately / $13,300
- Head of Household / $19,600
Note that the standard deduction addition for 65 and older is $1,300 for married couples (married filing jointly, 2x; married filing separately, 1x) and $1,600 for single (filing single or head of household). A similar deduction is available for those who are blind.
Previously, the standard deductions were: $6,350 for single filers; $12,700 married filing jointly; $6,350, married filing separately; and $9,350, head of household.
Limit on State and Local Taxes
A notable change to IRS deductions are caps on state and local taxes, also referred to as SALT (State And Local Taxes). Taxpayers can itemize state and local taxes, up to $10,000 per year for single, married filing jointly, and head of household filing status; the maximum is $5,000 for married filing separately.
Previously, there was no limit but the IRS via the TCJA now restricts this category.
Here's the basic calculation from 2018 Schedule A (Form 1040) Itemized Deductions:
Step 1: Combine the total of these taxes, up to $10,000:
- state and local income taxes OR general sales taxes (not both)
- state and local real estate taxes
- state and local personal property taxes
Step 2: Add other taxes such as taxes paid to a foreign country.
According to an article published by SmartAsset, those most affected by this change are people who make $100,000 or more annually.
More on Expenses that Can Be Itemized
There have been tweaks to the process of itemizing in several categories. Here's more on what I learned:
Medical and Dental Expenses
Medical and dental expenses must exceed 7.5% of adjusted gross income (AGI) to be considered for itemization. The amount you can deduct is the excess of the expenses you paid over this AGI hurdle, not the total of these costs. Note that the threshold has been lowered from 10% to 7.5% for 2018 taxes.
For example, if your AGI is $50,000, then you'd need more than $3,750 in medical and dental expenses to itemize in this category. So, if you incurred $10,000 in expenses that weren't reimbursed, then you'd add $6,250 to your Schedule A amounts. Here's the calculation:
- Income: $50,000
- Medical expenses: $10,000
- Hurdle to qualify for expenses: $3,750
- Excess of medical expenses that can be applied to itemization = $6,250 [$10,000 – ($50,000 x 7.5%) = $6,250]
Note that you can't itemize expenses that have been reimbursed or paid on your behalf by your insurance company.
Interest paid to acquire a home can be itemized to a certain extent. But there are new restrictions in this category.
This section modifies the deduction for home mortgage interest to: (1) limit the deduction to mortgages for a principal residence, (2) temporarily limit the deduction for debt incurred on or before December 15, 2017, to mortgages of up to $750,000 (currently $1 million), and (3) suspend the deduction for interest paid on home equity loans.
Now, I interpret these statements as indicating that I can itemize and deduct mortgage interest for my primary residence only, paid on a mortgage balance of up to $750,000 (down from $1 million). Further, my take is that I can't deduct interest paid on a mortgage for a vacation home or second home. In addition, I can't deduct interest paid on a home equity loan or HELOC.
However, in an article on mortgage interest deductions published on MarketWatch, Bill Bischoff indicates that the interest on HELOCs is deductible if the purpose of the loan is to improve the principal residence. In addition, he writes that mortgage interest on a second home may also continue to be deductible on mortgage balances that fall under the threshold. Michael Kitces concurs with these interpretations in his in-depth article on changes associated with TCJA.
Investment interest on property held for investment purposes is still deductible. For more information on this topic, see this Schwab article on deducting investment interest.
Gifts to Charity
Giving to charitable is still technically deductible. TCJA “modifies the deduction for charitable contributions to temporarily increase from 50% to 60% the income-based percentage limitation for contributions of cash to public charities.”
What charitably-minded taxpayers may discover, though, is that their gifts may not impact their individual tax situations as much as they did in the past. That is, they may be more likely to claim the standard deduction and miss reaping specific tax benefits for giving.
To counteract this change and itemize gifts for tax deduction purposes, some taxpayers may adopt charitable giving “lumping” by contributing large amounts to a donor-advised fund in a particular year. They could then take the standard deduction in years when they didn't contribute large amounts. Whether this approach makes sense depends on many factors, including mortgage interest (if any), state and local taxes, and medical expenses as well as desire and ability to contribute to a charitable account.
Casualty and Theft Losses, Other Itemized Deductions
Casualty losses are now deductible only if they occur in federally declared disaster areas.
Further, the deduction for investment advisory fees has been eliminated. Kitces explains:
the Tax Cuts and Jobs Act went with the Senate proposal, repealing all miscellaneous itemized deductions that are otherwise subject to the 2%-of-AGI floor under IRC Section 67. This includes all tax preparation expenses, various unreimbursed employee business expenses (including the home office deduction), losses on a variable annuity (or losses below the non-deductible “basis” portion of an IRA or Roth IRA), and a wide range of “expense for the production of income” – including trustee’s and other fees paid on behalf of an IRA, safety deposit box fees, depreciation of home computers used for investments… and the deduction for investment advisory fees.”
Again, check with your tax advisor to determine whether and how these IRS changes affect you.
To help with planning, use the IRS's Schedule A for Itemized Deductions or follow this simplified outline:
- State and Local Taxes (maxed out at $10,000)
- Mortgage Interest
- Charitable Gifts
- Unreimbursed Medical and Dental Expenses that exceed hurdle
- Casualty and Theft Losses (associated with federal disaster and/or other requirements)
If the total of these amounts is less than the standard deductions listed above, then generally you'll be better off skipping the itemization process and claiming the standard deduction.
My take is that the new deduction amounts will save some U.S. taxpayers money and time, either due to reduced effort in preparing taxes or because taking the new, relatively high standard deduction will mean lower taxable income compared with previous deductions.
The impact of the new rules on standard vs. itemized deductions will vary by tax-paying individual, couple, and family. For example, those who live in places where real estate prices are high may have been better off itemizing deductions under the old structure because they could deduct all state and local taxes, including property taxes, without limit. In addition, couples or individuals with children could have benefited more under the old structure in which personal exemptions were allowed in addition to the standard deduction (personal exemptions have been “suspended” or eliminated for now).
As of this writing, 1040 forms and instructions have not been updated by the IRS for 2018. In addition, these guidelines have yet to be applied to real-life situations. So, as always, it's best to consult with your tax professional to determine what's deductible and develop a plan to minimize taxes.
How has the new tax bill affected your financial life?