Supporters of the Tax Cuts and Jobs Act said the new law would cut taxes for millions of Americans and shrink their returns to the size of a postcard, drastically reducing the amount of time required to file.
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The tax overhaul will indeed lower taxes for many taxpayers, but the upcoming filing season--the first since the tax law took effect--could introduce new headaches, complications and unexpected costs. Deductions and other tax breaks that taxpayers have claimed for years have been capped or eliminated. Self-employed people will probably need to hire an accountant to navigate a new money-saving tax break. And that streamlined tax return? While the new Form 1040 is shorter than the old one, it comes with 117 pages of instructions.
The lengthy instruction manual is a nonissue for most taxpayers because the majority use tax-preparation software or hire a tax preparer. But even if you outsource your taxes, filing your 2018 return will probably require extra effort on your part.
The tax overhaul lowered tax rates across the board and expanded income thresholds, so more of your income will be taxed at the new, lower rates. For example, the top rate was reduced to 37% from 39.6%, and for a married couple, it doesn't kick in until their taxable income exceeds $600,000. In 2017, that couple would have paid the top rate once their taxable income exceeded $470,700.
But the most-significant changes affect personal exemptions and the standard deduction. In 2017, you could take a deduction of $4,050 for each personal exemption claimed on your tax return (one for single returns and two for joint returns, plus one for each dependent). Personal exemptions were eliminated in favor of a larger standard deduction and an expanded child tax credit. The child tax credit, worth $1,000 for each child under 17 in 2017, is now worth $2,000 per child (a credit is a dollar-for-dollar reduction in your tax bill). The tax law also expanded the number of families who are eligible. The credit begins to phase out for couples with an adjusted gross income of more than $400,000 (up from $110,000 in 2017) and $200,000 for all other filers (up from $75,000 in 2017).
The standard deduction, meanwhile, was nearly doubled. In 2018, single filers will be able to claim a standard deduction of $12,000, up from $6,350 in 2017. Married filers will be eligible for a standard deduction of $24,000, up from $12,700 in 2017. Taxpayers who are 65 and older will get an even larger standard deduction. Two 65-year-olds who file a joint tax return will receive a standard deduction of $26,600; an individual 65-year-old filer can claim a standard deduction of $13,600.
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Because of this change, only about 10% of taxpayers are expected to itemize deductions on their 2018 returns, down from about one-third of filers in the past. But if you've itemized in previous years, you'll still need to run the numbers to determine whether you're better off itemizing or claiming the standard deduction. Tax software (or a tax preparer with a software program) will do this for you. You'll need to gather receipts for charitable contributions, property-tax payments, mortgage interest and other deductions in order to determine which option gives you the lower tax bill. (Some deductions have been scrapped or capped, which we discuss below.)
If you fall into one or more of these groups, you may benefit from itemizing deductions:
You have a large mortgage. The tax law took aim at deductions on supersized mortgages. Under the old law, you could deduct interest on a mortgage of up to $1 million, and if you closed on the loan on or before December 15, 2017, you still qualify to deduct interest on that amount. For loans acquired after that, you can deduct interest on up to $750,000. Either way, if you have a fat mortgage, there's a good chance you'll still itemize, says Nathan Rigney, research analyst for H&R Block's Tax Institute. High property taxes could also push you over the threshold, even with a new cap on the amount you can deduct, Rigney says.
You were generous. Charitable contributions alone probably won't get you over the threshold. But if you had significant mortgage interest and high property taxes, your donations could get you over the hump and lower your taxes. Make sure you gather all of your receipts and acknowledgments from the charities you supported last year.
You had a lot of unreimbursed medical expenses. For 2018, you can deduct unreimbursed medical expenses that exceed 7.5% of your adjusted gross income. (The threshold will rise to 10% of AGI for 2019 unless Congress changes it.) If your AGI was $50,000, for example, you would only be allowed to deduct unreimbursed medical expenses that exceeded $3,750. Still, some taxpayers with high medical expenses and modest incomes may qualify. If you had a lot of out-of-pocket medical expenses last year--say, for long-term care or a serious illness--it's worth tracking down your receipts and records. Co-payments, the cost of prescription drugs, and treatments that aren't covered by your insurance (including dental and vision care) are all deductible.
If you claimed the standard deduction in the past and your situation hasn't changed much, it's unlikely you'll itemize now. But that doesn't necessarily mean filing your taxes will be a snap, because in recent years, Congress has enacted a raft of tax breaks for non-itemizers, and most of them survived the tax overhaul. Ignore them and you could end up paying more than you should in taxes.
Some of the most generous tax breaks available to non-itemizers are for families who have kids in college. The American Opportunity tax credit, which you can claim for students who are in their first four years of undergraduate study, is worth up to $2,500 for each qualifying student. You don't have to itemize to claim the credit, which represents a dollar-for-dollar reduction in your tax bill. Married couples filing jointly with modified adjusted gross income of up to $160,000 can claim the full credit; those with MAGI of up to $180,000 can claim a partial amount.
You may also be eligible for the Lifetime Learning credit. It isn't limited to undergraduate expenses, and you don't have to be a full-time student to claim it. The credit is worth up to 20% of your out-of-pocket costs for tuition, fees and books, up to $2,000. Married couples filing jointly with MAGI of up to $112,000 can claim the full credit; those with MAGI of up to $132,000 can claim a partial credit.
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Non-itemizers may also be eligible for several "above the line" deductions. In addition to lowering your taxes--if you're in the 24% tax bracket, for example, $1,000 in above-the-line deductions will save you $240--these deductions will shrink your adjusted gross income, which could make you eligible for other tax breaks tied to your income.
You can deduct up to $2,500 in student-loan interest for you, your spouse or a dependent if your modified adjusted gross income is less than $65,000 if you're single or $135,000 if you're married and file a joint return. The deduction is phased out above those levels, disappearing completely if you earn more than $80,000 if single or $165,000 if filing jointly.
If you're not covered by a retirement plan at work, you can deduct contributions to an IRA, even if you don't itemize. You can make contributions to a 2018 IRA until April 15, 2019.
Roughly two-thirds of taxpayers will see their taxes go down this year, the Tax Policy Center estimates. About 29% of taxpayers will see no change, and 6% are expected to pay more. Popular tax breaks that were eliminated or curbed include:
State and local property taxes. The tax overhaul capped the amount of state and local taxes you can deduct at $10,000. In the past, these taxes were generally fully deductible. This could increase the tax bill for residents of states with high state income and property taxes. In high-tax states such as California, the deduction for state and local taxes was often the largest deduction taxpayers claimed, says William Norwalk, tax partner with Sensiba San Filippo in San Francisco. Norwalk adds, though, that lower tax rates for high-income taxpayers could help offset the loss of the deduction.
Moving expenses. In the past, people who relocated for a job and paid the moving costs could deduct most of their expenses, even if they didn't itemize. The tax overhaul eliminated that deduction unless you're an active-duty member of the military.
Interest on home-equity loans. You can deduct interest on loans or lines of credit only if the money is used to buy, build or improve your home. If you use a home-equity line of credit to pay for college tuition, for example, the interest isn't deductible.
Alimony. If you're paying alimony under the terms of a divorce finalized or modified before December 31, 2018, go ahead and deduct your payments. For divorce agreements reached after December 31, alimony is no longer deductible.
Unreimbursed casualty losses. If a tree fell on your home last year, you probably won't be able to deduct losses that aren't covered by insurance unless a hurricane knocked it down.
Miscellaneous itemized deductions. These deductions included the write-off for tax-preparation fees, investment fees and unreimbursed business expenses. Previously, taxpayers could deduct these expenses if they exceeded 2% of their adjusted gross income. This change could be particularly costly for employees with significant unreimbursed business expenses. An employee who drives a lot to visit clients--and isn't reimbursed for the mileage--could end up with a higher tax bill this year, particularly if the individual also pays state and local taxes that exceed $10,000, says Lisa Greene-Lewis, a certified public accountant with TurboTax. The change could also raise taxes for employees who work remotely and can no longer deduct the cost of maintaining a home office (the tax law won't affect the ability of self-employed workers to claim a home-office deduction).
Families with children (or other dependents) who are 17 or older could also end up paying more. The tax law provides a $500 credit for each dependent who is 17 or older. The income thresholds for this credit are the same as those for the child tax credit (couples with AGI of up to $400,000 and all other filers with AGI of up to $200,000), but the smaller credit may not be enough to offset the loss of the $4,050 personal exemption for dependents claimed on your tax return.
Only about 200,000 taxpayers are expected to pay the alternative minimum tax in 2018, down from more than 4 million in recent years. The AMT is a parallel tax system initially designed to prevent the uber-wealthy from avoiding taxes. The tax law significantly hiked the exemption for the AMT and eliminated or limited deductions that typically trigger it, such as deductions for state and local taxes and miscellaneous business expenses.
Taxes on investments
Investors who cashed in some of their winners last year in anticipation of a bear market will be happy to learn that the tax overhaul didn't boost taxes on investment gains. On the other hand, it didn't lower them, either. And some new quirks in the law may prompt a review of whether or not you should give some of your investments to your kids.
The new law retained the favorable tax treatment granted to long-term capital gains and qualified dividends, imposing a rate of 0%, 15%, 20% or 23.8%, depending on your total income. But the capital gains rate, which used to be based on tax brackets, is now tied to income thresholds. To qualify for the 0% capital gains rate, for example, you'll need to have 2018 taxable income of less than $38,600 if you're single or $77,200 if you're married and file jointly. You can still offset capital gains with losses and, if losses exceed gains, use the excess losses to offset up to $3,000 of regular income.
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If you owe the kiddie tax, which applies to investment income of more than $2,100 earned by children under age 19--or, if full-time students, age 24--you may owe more this year. Or not. In the past, a child's investment income that exceeded the $2,100 threshold was generally taxed at the parents' rate. Starting in 2018, it is taxed at the same rates as trusts and estates, which range from 10% to 37%, depending on the amount of unearned income your child has.
That doesn't necessarily mean you'll pay higher taxes on a child's investment income. Consider a situation in which a child has $5,000 of income subject to the kiddie tax, and the parents have taxable income of $150,000. In 2017, applying the parents' 25% rate to the $5,000 would have cost $1,250. If the old rules still applied, the parents would pay $1,100, based on their 22% tax rate. But because they're using the trust tax rates, their kiddie tax bill would be just $843.
However, the change could boost taxes on the sale of securities owned by your children, says Tim Steffen, director of advanced planning for Baird Wealth Solutions. Under the trust tax rates, children with unearned income of more than $12,700 will pay the top long-term capital gains rate of 20%. Parents don't pay the top long-term capital gains rate until their income exceeds $600,000 for a married couple, or $500,000 for singles. If you expect to sell a large number of securities from your child's account soon after transferring them to your child--to pay for college, for example--you may be better off selling assets from your own account and giving the child the proceeds, Steffen says. Likewise, grandparents who want to give appreciated stock to their grandchildren may want to give it to their adult children instead.
New break for the self-employed
If you're self-employed or have a side gig, you may be eligible for a generous new tax break. Starting this year, many taxpayers who report their business profits (or losses) on Schedule C of their individual tax returns will be allowed to deduct up to 20% of their qualified business income (net income after business deductions) before they calculate their tax bill. For example, if you're self-employed and earned $100,000 in qualified business income in 2018, you could be eligible to deduct $20,000. If you're in the 24% tax bracket, that would reduce your tax bill by $4,800.
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You don't have to itemize to claim this new tax break. The deduction won't reduce your adjusted gross income, nor will it reduce your earnings for purposes of calculating taxes for Social Security and Medicare. (Self-employed workers must pay the full 15.3% of self-employment taxes, although they can deduct half of the amount from their AGI.)
Be advised, though, that this provision of the tax overhaul contains a host of caveats that could disqualify you for all or part of the deduction. If your total taxable income--including interest, dividends and income reported on Form W-2, if you also have a regular job--is less than $157,500 on an individual return or $315,000 on a joint return, you can deduct 20% of your qualified business income no matter what type of business you're in. At higher income levels, the calculation gets more complicated.
To prevent affluent professionals, such as doctors and hedge fund managers, from gaming the system, Congress created a higher standard for people who provide personal services. For these business owners, the deduction phases out once total taxable income exceeds $157,500, or $315,000 for married couples, and disappears once taxable income tops $207,500 for singles and $415,000 for couples.
Last-minute tax breaks
Although the door closed on most tax-saving strategies on New Year's Eve, there are still ways to lower your 2018 tax bill:
Contribute to a health savings account. You have until April 15 to set up and fund a health savings account for 2018. To qualify, you must have had an HSA-eligible insurance policy at least since December 1. The policy must have had a deductible of at least $1,350 for individual coverage or $2,700 for family coverage. You can contribute up to $3,450 to an HSA if you had single coverage or $6,900 if you had family coverage. You can contribute an additional $1,000 if you were 55 or older in 2018, or another $2,000 if you were married and both of you were at least 55. Contributions to an HSA will reduce your adjusted gross income. The money in your account will grow tax-free, and withdrawals used to pay medical expenses are also tax-free.
Contribute to an IRA. You also have until April 15 to contribute to an IRA for 2018. If you're not enrolled in a workplace retirement plan, you can deduct an IRA contribution of up to $5,500, or $6,500 if you're 50 or older. Contributions will reduce your adjusted gross income on a dollar-for-dollar basis, which could make you eligible for tax breaks tied to your AGI.
Workers who have a company retirement plan but earn less than a certain amount may qualify to deduct all or part of their IRA contributions. For 2018, this deduction phases out for single taxpayers with AGI of between $63,000 and $73,000; for married couples who file jointly, the deduction phases out between $101,000 and $121,000. If one spouse is covered by a workplace plan but the other is not, the spouse who isn't covered can deduct the maximum contribution, as long as the couple's joint AGI doesn't exceed $189,000. A partial deduction is available if the couple's AGI is between $189,000 and $199,000.
Disasters may no longer be deductible
In the past, when disaster struck your property, you could take comfort knowing that some of your losses were deductible. But that may no longer be the case.
The Tax Cuts and Jobs Act eliminated the deduction for unreimbursed casualty losses unless they occur in a federally declared disaster area. If an electrical fire destroyed your house last year, for example, the losses aren't deductible. Even losses from natural disasters, such as damage from a hailstorm, aren't deductible if they failed to receive the federal designation, says Tim Steffen, director of advanced planning for Baird Wealth Solutions.
If your losses were the result of a federally declared disaster, such as hurricanes Michael and Florence in the Carolinas or the Camp Fire wildfire in northern California, you can still deduct some of your unreimbursed losses. You must itemize to claim this deduction. If you have enough deductions to get over the threshold for the higher standard deduction, you must reduce the amount of your unreimbursed losses by $100. Once you've done that, you can only deduct unreimbursed losses that exceed 10% of your adjusted gross income. If, say, your adjusted gross income last year was $150,000 and your total net loss was $83,000, you would first reduce it to $82,900, then knock off $15,000, leaving you with a net deduction of $67,900.
As was the case in the past, taxpayers who are eligible for the casualty-loss deduction will have the option to claim the loss in the year it occurred or for the previous year. That allows you to choose the year that will give you the biggest tax break.
If your losses were caused by a weather-related event, don't assume you're ineligible for this deduction just because your local disaster didn't make the national news. "You'd be surprised how many areas receive the federal designation," Steffen says. Go to www.fema.gov/disasters for a complete list of disaster declarations by state.
Copyright 2019 The Kiplinger Washington Editors