Changes in the Tax Law
The Tax Cuts and Jobs Act (TCJA) has brought many changes to the tax code. The most notable of these changes is related to the standard deduction, a fixed dollar deduction that you do not have to pay taxes on. You are allowed to either itemize your deductions or take the standard deduction, whichever is higher. The TCJA has nearly doubled the standard deduction for all filing statuses:
|
Filing Status |
2017 Standard Deduction |
2018 Standard Deduction |
|
Single |
6,350 |
12,000 |
|
Head of Household |
9,350 |
18,000 |
|
Married Filing Jointly |
12,700 |
24,000 |
The TCJA has removed various deductions to offset this benefit:
- The largest deduction removed is the personal exemption deduction. This deduction was $4,050 for every individual claimed on the tax return. This may mean large families will have fewer deductions, but the TCJA also expanded and enhanced the Child Tax Credit to offset any losses those families would have received.
- The TCJA has limited the State and Local Tax Deduction (SALT). You could previously deduct as much state and local tax that you paid. Now there is a $10,000 cap on SALT deduction for all filing statuses.
- The new tax law completely eliminated the Miscellaneous Itemized Deductions. Before 2018, you could deduct a laundry list of miscellaneous expenses that exceeded 2% of your Adjusted Gross Income (AGI).
Opportunities
There is a much higher threshold to benefit from itemizing deductions versus taking the standard deduction due to these changes. You may be on the cusp of benefiting from itemized deductions if you live in a high tax state or had high itemized deductions in the past. Deductions like real estate property taxes and state taxes paid are not eligible for timing or stacking. However, deductions like charitable giving and sales tax paid do have a degree of timing flexibility that you can utilize to your benefit. Stacking deductions in one year and then taking the standard deduction in subsequent years may let you benefit from tax savings that you would have otherwise not been eligible for.
Strategies
Charitable giving is by far the biggest item that you control and is also the easiest deduction to time. A charitable gift is considered deductible as long as it is irrevocable and the money eventually goes to a qualified 501(c)(3) organization. This allows you to open up a Donor Advised Fund and receive a tax deduction for the donation to the account this year even if the money goes to a charity in a following year. The Donor Advised Fund is essentially a checking account that can only send money to charities. This gives you the ability to stack years’ worth of charitable giving into your account now while retaining control of the money to send to charities at your discretion.
You are eligible to take a deduction based on sales tax paid throughout the year if you live in a state with no income tax. This gives you some flexibility in taking the deduction in regards to large purchases like boats or cars. Consider stacking high sales tax purchases in a single year or in years where you will have other high itemized deductions.
Prepaying mortgage points may make sense now if you are eligible and able. Prepaid mortgage points allow you to receive a lower interest rate over the term of your home loan at the expense of a higher upfront payment. The amount that you pay upfront can be deductible in the year that you pay the expense if it meets a list of criteria. Be sure to discuss this tax opportunity with both your mortgage broker and your tax accountant.
Medical expenses are not always controllable but there are definitely circumstances where they can be. If you have high-cost medical equipment that needs to be replaced every three or five years, try to make the purchase in the same tax year that you are stacking other deductions. Don’t forget that medical expenses must exceed 7.5% of your AGI in 2018 and 10.0% for 2019 and on for you to be able to deduct the expenses.
Example
Andrew and Linda have itemized expenses of $23,000 this year and they are subject to a 30% tax bracket for federal and state combined. Their itemized deductions include $10,000 of state and local tax deductions (the cap), $10,000 of mortgage interest expense, and they give $3,000 each year to local charities.
If Andrew and Linda decide to stack two years’ worth of charitable giving into a Donor Advised Fund this year and then take the standard deduction next year, they would save an additional $600 every two years.
Conclusion
Taking the time to determine your itemized deductions for the year and the flexibility in the timing of those deductions can reap large tax benefits where none previously existed.