If you’re like most people, you’re fully in the swing of preparing your taxes for the upcoming tax deadline. For those who have already prepared their returns, they’re likely to have encountered some differences this year compared to last.
In fact, many have found changes resulting from tax reform which have affected how certain items are treated. Further, how tax reform has affected the calculation of their taxable income compared to previous years.
If you find yourself having questions, this post is a discussion of three major changes seen in the tax law because of tax reform followed by three changes which did not occur, even though people think they did.
What Did Tax Reform Accomplish?
Congress set out on a mission to simplify the tax code during its deliberations on the 2017 tax reform legislation. The intention was to make it easier for the individual tax payer to spend less time preparing a tax return as well as lower taxes overall for individuals and businesses.
Congress did so primarily by making itemized deductions harder to claim due to the creation of a larger standard deduction. Pursuing this strategy would result in far fewer individuals qualifying for itemizing.
Some of the other sweeping changes seen include wider income tax brackets and lower rates, an expanded child tax credit, loss of personal exemptions, added ability to claim student loan interest deductions, loss of moving expense deductibility and home office deductions for employees, among many others.
These numerous changes resulted in trade-offs. While the entire population in aggregate will pay less in taxes during the life of the changes, there will be winners and losers.
On the whole, less tax revenue will come through Uncle Sam’s door if economic growth doesn’t hasten as a result of these changes. Time will tell if more robust growth will arrive, bolstering the Treasury’s overall take.
Now, let’s take a look at three major changes seen under tax reform, beginning first with the most impactful change to the individual taxpayer, the augmented standard deduction.
Increasing the Standard Deduction
Tax reform made it more difficult to itemize deductions as an individual taxpayer. It did so by increasing the standard deduction.
Because it only makes sense to itemize when your deductions exceed the standard deduction, a lot fewer people will need to spend time claiming the individual tax deductions. Therefore, most will simply use the standard deduction.
For single filers, the standard deduction almost doubled, going from $6,350 in 2017 to $12,000 in 2018. Married, filing jointly filers had their standard deduction increase from $12,700 to $24,000.
These changes will remain in effect through the life of the legislation, which is set to expire through 2025. As currently scheduled, the standard deduction would revert to a lower level and personal exemptions would return.
Tax Reform Changed the Mortgage Interest Deduction
Tax reform changed the treatment of deductions many claim related to homeownership. The higher standard deduction created not only a higher threshold to claim the mortgage interest deduction, but tax reform in 2018 also lowered the levels of mortgage principal and associated interest expense which qualifies for deductibility.
In many ways, tax reform has made it less-advantageous to be a homeowner from a tax point of view. This is especially true for high cost of living areas with more expensive home prices.
In the past, taxpayers could deduct the mortgage interest associated with the first $1,000,000 of a mortgage and the interest associated with the first $100,000 of a home equity loan (assuming the funds are used for qualifying home improvements). In other words, most people across the country were fine.
Now, taxpayers can only deduct interest expense associated with the first $750,000 for taxpayers who are married and file jointly, and $375,000 for single taxpayers. While many around the country remain unaffected by this change, those on the coasts will feel the impact of this full-on going forward.
If you originated a mortgage in 2018 or later above this threshold, it gives you the incentive to pay off your mortgage faster. It is worth noting this limit only applies to new loans originated after December 15, 2017. Pre-existing mortgages are grandfathered under the old limits.
Because of the higher levels of these amounts, higher-income individuals located in non-coastal areas and those in high cost of living areas are disproportionately impacted by the change.
The Contentious State and Local Taxes Cap
Prior to tax reform, taxpayers could deduct many types of taxes paid at the state and local levels without limit. This included real and personal property taxes, income taxes, and/or sales taxes.
While still able to deduct most of these items, tax reform placed a $10,000 cap on the amount of state and local taxes (SALT taxes) taxpayers can claim on a tax return. This cap is a major source of revenue to offset the losses from the changes made elsewhere in the tax code.
Much like the lower mortgage interest deduction limitation described above, those living in high cost-of-living areas with substantial state and local tax burdens suffered from this change. These individuals pay a considerable amount of money each year in SALT taxes and may end up paying more tax as a result.
In 2018, there was a $10,000 cap placed on the amount of SALT taxes which can be deducted from your federal taxable income. Homeowners living in these higher cost areas were hardest hit because many deducted real estate and property taxes as well as other applicable state and local income taxes.
This new cap limited the ability of high-cost of living area homeowners to deduct their real estate and property taxes. The only way high cost of living homeowners can come out ahead is if their incomes fell into lower brackets, which would have more of their incomes fall into lower rates.
Home prices in expensive areas are already showing a slowdown because of this change. When added with the lower mortgage interest expense allowed, the incentive to be a homeowner lessened.
What Didn’t Change Under Tax Reform
Multiple changes under tax reform benefited Americans, while others served to increase the tax burden of some in higher cost-of-living areas. As a result, the new tax law didn’t receive complete fanfare.
Leading up to the bill’s passage, many items were announced as being in the bill but were left out at the last minute. Here are three major tax items which did not change due to tax reform.
Home Sale Gain Exclusion
When a homeowner sells a home and the property has appreciated in value, current tax law allows for the exclusion of part of the gain if certain conditions are met. The first $500,000 of gain can be excluded from your sale if you file jointly, or $250,000 if filing as single.
During the tax reform debate, much discussion surrounded whether the residency requirement should extend from living in the home two years of the last five to five years of the last eight. The logistics behind the change would have impacted me dramatically.
I chose to purchase a condo vs. apartment renting in my mid 20’s and occupied the unit for two and a half years. When I moved out, I decided to rent out the space and earn a return on my investment.
In the five years since purchasing the condo, the property value has appreciated because I chose a rapidly-improving area of town. Now, the time has come to sell the condo so my wife and I can buy a place of our own.
If the home sale gain exclusion had changed to the longer residency requirement, my gains would have fallen squarely outside of the exclusion. Fortunately for me, and many other homeowners, this change did not happen. We will have more money to use on our down payment.
Earned Income Tax Credit
The earned income tax credit has served as the most effective antipoverty program for working-age people according to the Center for Budget and Policy Priorities. It has lifted nearly 6 million people from poverty, half of which are children.
This credit has been a powerful tool for decreasing poverty in America and did not experience any changes under tax reform. The tax credit continues to serve as an incentive for low-to-middle wage taxpayers to work.
In the past, legislative efforts attempted to make the tax credit more readily-available to people without children but so far have been unsuccessful.
For now, the credit remains unchanged and available to those aged 25 – 65 with earned income ranging from $1 – $54,884. The credit is refundable in nature and can pay out $1 – $6,431 in 2018.
Tax reform debated making a change to the tax treatment of charitable contributions taxpayers could make to qualified organizations. Many warned of the impact this would have to organizations would rely heavily on donations to operate.
While considered for a brief while during the debate, changes did not happen to how charitable contributions could be claimed on tax returns.
When making donations to a charity, make sure the organizations are qualified under section 170(c) of the Internal Revenue Code. Also, you may deduct these charitable contributions of money or property (sadly, not your time), up to 50 percent of your adjusted gross income, but 20 percent and 30 percent limitations apply in some cases.
You cannot claim any of these charitable contributions, however, if you do not itemize your tax deductions. Blame the standard deduction increase. Uncle Sam changed the tax rules which made donating less attractive for tax purposes, but it did not change the ability to claim charitable contributions as itemized deductions.
How Did Your Taxes Turn Out?
Now that you’re better-equipped with knowledge about changes seen (and not seen) under tax reform, know your taxes are due to the IRS by April 15. As you can see from above, some filers face an unwelcome surprise this year while
Bio: My name is Riley Adams and Iam a licensed CPA working as a senior financial analyst for a Fortune 500 company in New Orleans, LA. I write for Young and the Invested, a site dedicated to helping young professionals find financial independence and live their best lives.