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End-Of-Year Deduction Planning

In prior years, December has been a month to make last-minute changes to your current-year tax situation. Specifically, it has been a time to get your itemized deductions in order.

For many people this meant pulling forward medical expenses and property taxes (paying future bills in advance) or making charitable contributions. In 2018 however, the IRS estimates that there will be a 60% reduction in itemizing tax payers. The Tax Cuts and Jobs Act (TCJA) increased the standard deduction for single filers to $12,000 and $24,000 for married filers. Additionally, if you are 65 or older you can increase your deduction by $1,600 (for single, or head of household filers). If you are filing jointly, the deduction increases by $1,300. If both filers are 65 or older you can increase your standard deduction by $2,600!

This, in conjunction with the TCJA’s adjustment and elimination of many deductions, means it may not make sense to increase your deductions, as it may not make sense to deduct them!

To make sense of the changes, let’s start with the old schedule A and work our way down:

Medical expenses will now be subject to a 10% (of AGI) floor instead of the prior 7.5%. For example, if your AGI was $150,000 and your medical expenses were $16,500, you could deduct $5,250 in 2018. This deduction is reduced to $1,500 in 2018.

Additionally, as of 2018 there is a $10,000 cap on state and local income and property tax deductions. Not only does this limit the feasibility of paying taxes in advance, it reduces the impact of these taxes on your federal bill.

For example, a household that paid state income taxes of $6,375 and property taxes of $8,000 in 2017 will only be able to deduct $10,000 in 2018. In prior years the deduction would have been $14,375.

Next is mortgage interest. Under the TCJA, mortgage interest deductions are limited to $750,000 of home indebtedness. It’s important to remember though, mortgages obtained prior to December 2017 are grandfathered in. However, home equity loans are not. Interestingly, the IRC code is based on the use of the debt, not the type of loan. For example, a home equity loan used to build an addition is deductible (up to the $750,000), while an equity loan used to consolidate other debt is not.

A mortgage of $250,000 at 5% will average $7,771.30 in annual interest expenses (much more at the beginning of the loan and much less in the final years).

Finally, there is a small improvement to charitable gifts of cash. Namely, the 50% AGI limitation has been raised to 60%, and carry forward deductions can be moved up at the new rate!

To review, the household given in the example would have itemized its deductions in 2017 with $27,396.30 in total itemized deductions, plus any charitable gifts (please note, there are many other ways to itemize, but for the purposes of the article I am focusing on the big ones). The same family in 2018 would be able to deduct $19,271.30! Making charitable gifts in order to itemize deductions would require a $4,728.70 gift just to meet the standard deduction (more if one or both spouses are over age 65)!

Clearly, there is less tax “mileage” gained from making charitable donations. For many people, the tax break on charitable gifts is simply icing on the cake. However, for people looking to maximize tax savings with a gifting strategy, it may make sense to forgo donating every year and instead give larger gifts, less frequently.

For your consideration, here are several other, smaller changes that will impact individual tax returns in 2018:

  • Pease limitation repealed
  • Advisory fees are no longer deductible (really, no deductions previously subject to the 2% floor remain)
  • Moving expenses are no longer deductible
  • Tax brackets have changed
  • Kiddie taxes will be subject to trust rates, not parents’ rates
  • Recharacterization of roth contributions are no longer allowed
  • 529 account can be used for private school
  • AMT exemptions have expanded

Of special note, personal exemptions are also no longer allowed. To use the prior household as an example, even if there were no minors on the return, each individual could claim an exemption of $4,050 in 2017 for a total of $8,100. For people with children (and income below $313,800) an additional exemption could be claimed for each child. It is important to note for 2018, while exemptions have been eliminated, the child tax credit has been expanded! For each under the age of 17, a married couple can offset their tax bill by $2,000. A family with three children can receive a $6,000 tax credit in 2018. Importantly, the income phase-out range for this credit was previously $110,000 but is now $400,000 for married couples (for single filers it was $75,000 expanded to $200,000).

As always if you have specific questions about your personal finances, please reach out to your Gainplan team. We are not tax advisors and nothing in this article is advice – always consult with a qualified tax professional before making important decisions!


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