In 2017, Congress passed the Tax Cuts & Jobs Act (TCJA), which represents the largest tax reform since the 1980s. This reform is so wide-sweeping that it affects virtually everyone, usually in more ways than one. Given that, it’s difficult for many people to figure out whether they’re better off or worse off than before.
There are many aspects of TCJA that may impact each taxpayer, it’s important to understand each aspect in a little more detail, as opposed to trying to put it all together at one time. This article explores how TCJA affected individual taxpayer deductions.
Deductions Before TCJA
The tax code before TCJA allowed for individual taxpayers (which includes individuals AND families, as opposed to businesses, trusts, or estates) to deduct a certain amount of their income from tax calculations. The intent of this deduction process was to allow a certain income ‘floor,’ below which the taxpayer would not have to pay taxes. This could be done by either standard deduction or itemized deductions.
Standard deductions, which have existed in some form since World War II, are straightforward. For any given year, the standard deduction is the amount of income that a taxpayer is able to exclude from their adjusted gross income (AGI) as they calculate their tax liability. If the standard deduction exceeds income, then the taxpayer owes nothing. In the 1970’s, this was also known as being in the ‘zero-percent tax bracket.’
Itemized deductions have been around since the federal income tax system was created in 1913. Basically, the tax code allows for certain expenses to be added together (itemized) to lower a tax bill. These expenses are itemized on what’s called Schedule A of a tax return.
Over the years, deductions have been changed for a variety of reasons. For example, charitable contributions and home mortgage interest have been incentives for people to contribute to charity and to own a house. Others, such as the deduction of extraordinary medical expenses, aren’t an incentive, but a reflection of a taxpayer’s ability to pay taxes.
In most cases, it is the taxpayer’s choice on whether to itemize deductions or to choose the standard deduction. It’s in the taxpayer’s best interest to go with the larger of the two deductions, since doing so will result in the lower tax bill. For example, a homeowner who lives in a high income tax state, pays a lot of medical expenses & contributes to charity might be better off itemizing deductions. That’s because state income taxes, charitable contributions, mortgage interest & real estate taxes, and medical expenses (above a certain amount) are all itemizable deductions. Conversely, a renter who lives in a low tax state, doesn’t see a doctor, and doesn’t contribute to charity would probably be better off taking the standard deduction.
So how does TCJA change all of this?
Change 1: The Standard Deduction Increase
This is the easy part. The standard deduction is now:
- Single taxpayers: $12,000 (instead of $6,350 in 2017)
- Head of Household: $18,000 ($9,350)
- Married filing jointly: $24,000 ($12,700)
This is almost double the previous standard deduction. So what does this mean? It means that more taxpayers will be inclined to take the standard deduction instead of itemizing them, especially when you look at the changes to the itemized deductions.
Change 2: Changes to Itemized Deductions (general terms)
This is where it gets a little tricky. Schedule A contains 7 different sections. Each section contains various types of deductions, all of which would be added together to determine the total amount of itemized deductions. While each of these sections would warrant its own article, we’ll take just enough time to briefly explain each section and how it was impacted by TCJA.
Many of these deductions haven’t been eliminated. Instead, Congress enacted a temporary suspension, from tax years 2018-2025, on them. If no new law is passed before these suspensions expire, then the previous deductions are back in force. Confused yet?
Medical & Dental Expenses. Unreimbursed medical & dental expenses can be itemized as deductions. But only if you spend so much money on health care. While Uncle Sam wants you to take care of yourself, the government isn’t going to give you a tax break just because you get a check up every once in a while.
So you can only itemize medical expenses if they’re above 7.5% of your AGI. This limit, also known as a floor, means that you can only deduct the expenses above 7.5% of AGI. TCJA did not change this at all. However, starting in 2019, this limitation goes up to 10% of AGI.
Taxes You Paid. This includes either income or sales tax (you have to choose one or the other, but not both), real estate taxes, personal property taxes, as well as other miscellaneous taxes you may have paid throughout the year.
TCJA still allows taxes to be deducted, but placed an upper limit on how much is deductible. That limit is $10,000 per year, for income/sales tax AND real estate tax. So for folks in high tax states, or who own large (or multiple) houses, this becomes a concern. At least until 2025, when it’s set to expire.
Interest You Paid. Basically, this includes interest on home mortgage interest and investment interest. TCJA doesn’t take anything away from this. However, it does place some limitations on the deductibility of home mortgage interest that you need to know.
While these home mortgage interest changes are detailed enough to warrant their own article, it’s notable that mortgage interest deductions were one of the biggest itemized deductions, second only to state & local taxes. As more people will be inclined to take the standard deduction, it will be interesting to see how this might impact the home mortgage industry.
Gifts To Charity. Charitable contributions have long been an important aspect of the tax code. As an incentive to promote charitable causes, Congress passed the War Resolution Act of 1917, allowing wealthy donors to deduct charitable contributions from their taxable income. A century later, the IRS estimates that 36 million taxpayers deducted $221 billion in charitable contributions on Schedule A of their tax return.
Historically, the deduction for charitable contributions has always been limited to a certain percentage of AGI, either 30% or 50%, depending on the type of charity receiving the contribution. TCJA raised the upper limit to 60%, from 50%.
However, with fewer people inclined to itemize their tax deductions, it’s estimated that up to two-thirds of taxpayers will stop taking the charitable contribution deduction on their tax return. Only time will tell what impact that will have on the various charities that depend on donor contributions.
Casualty & Theft Losses. Historically, taxpayers have been able to deduct property loss that wasn’t otherwise covered by insurance. However, this deduction requires some fairly high hurdles as outlined in the IRS calculation worksheet, so relatively few taxpayers have actually used this deduction.
Even fewer taxpayers will do so now, as TCJA now allows this deduction only if it’s a loss due to a federal emergency declared by the President.
Job Expenses & Certain Miscellaneous Deductions. Prior to TCJA, people who had significant job expenses (exceeding 2% of AGI), were able to itemize and deduct job-related expenses that were not reimbursed by their employer. For example, nurses who would purchase scrubs, or skilled tradesmen who purchased their own tools, would be able to deduct these costs.
This deduction has been eliminated for individual taxpayers. However, businesses are still able to deduct many of these costs. Taxpayers who see a significant impact to their deductions might want to discuss with their employer how they might be able to help offset the costs of these expenses. There are many ways in which employers can help their employees in a tax-advantaged manner.
There are a slew of other miscellaneous deductions that were previously allowed (subject to the 2% AGI floor). This includes things like: investment expenses, tax-related expenses, hobby expenses (yes, the IRS has a definition for hobbies, which makes them different from businesses), etc. These deductions are pretty much gone, at least until 2025.
Other Miscellaneous Deductions. Yes, the IRS has ‘Certain Miscellaneous Deductions,’ and ‘Other Miscellaneous Deductions’ in Schedule A. But unlike ‘Certain Deductions,’ these are not subject to the 2% AGI limit. And the only way to know the difference is to go to the IRS Schedule A Instructions.
After TCJA, these deductions should remain. Two of the most notable of these deductions are:
- Gambling losses (but only up to the amount of gambling winnings that you received that year)
- Amortizable bond premiums. What? Exactly.
Confused yet? Don't be. For most people, the increased standard deduction will probably make tax returns a lot simpler. However, for those who used to itemize deductions, it might be worth talking with a tax professional to see how your tax bill is going to change (that's us!).
Or, just as importantly, you may need to discuss how your significant financial decisions, such as buying a home or making charitable contributions might be affected. After all, it’s better to be informed BEFORE you make that big financial decision than find out after the fact that a tax deduction you were counting on isn’t as good as you thought.
We are your neighborhood fiduciary. And, we're an Enrolled Agent so we can represent you to the IRS. If you have any tax questions, we are glad to answer them. Go ahead and take the first step and schedule your free 30 minute consultation now.