The 2017 Tax Cuts and Jobs Act (TCJA) implemented the most comprehensive federal tax reform since 1986. Beginning in 2018, the TCJA introduces sweeping changes to individual and corporate tax rates, deductions, and credits. These will affect taxpayers in various ways, complicating tax planning in the first year the changes take effect. As 2018 draws to a close, we highlight a few of the individual reforms and offer some thoughts and recommendations as you plan for year end.
Changes for Individual Taxpayers
- Rates and Alternative Minimum Tax (AMT).
- Marginal Rates Reduced. The TCJA adjusted tax brackets and rates, retaining the total number of brackets (seven) but lowering tax rates overall. The top tax rate was lowered to 37% and applies to income exceeding $500,000 for single taxpayers and $600,000 for married taxpayers filing jointly.
- AMT Exemption and Phase-Out Thresholds Increased. The TCJA increased the AMT exemption amounts and phase-out thresholds, making fewer taxpayers subject to its effects. The new thresholds are $70,300 for single taxpayers and $109,400 for married taxpayers filing jointly, up from $54,300 and $84,500 respectively, and the phase-out thresholds are increased to $500,000 and $1 million, respectively.
- Deductions and Credits
- Standard Deductions Increased. The TCJA nearly doubled individual standard deductions from $6,350 to $12,000 for single filers, and from $12,700 to $24,000 for married couples filing jointly. As a result, fewer taxpayers will itemize.
- Personal Exemptions Eliminated. The TCJA eliminated personal deductions, formerly $4,125 per taxpayer.
- Family Credits Increased. The TCJA doubled the child tax credit to $2,000 per child and added a new $500 credit for other dependents. These credits phase out for higher income taxpayers.
- Itemized Deductions Changed
- “Pease” Limitation Repealed. The TCJA eliminated the Pease “haircut” on itemized deductions, which formerly reduced the value of itemized deductions certain high-income taxpayers could claim. The repeal will increase the value of itemized deductions for those taxpayers.
- Deductibility of Charitable Cash Contributions Increased. The TCJA increased the income-based limitation on deductions for cash contributions to public charities. These deductions may now be claimed up to 60% of modified adjusted gross income (AGI) annually, up from the prior 50% limit.
- Deduction for Contributions to Purchase Athletic Tickets Eliminated. The TCJA eliminated charitable deductions for contributions made to universities in exchange for preferential rights to purchase tickets to athletic events. Under prior law, those contributions could be deducted at 80% of their value. The deductibility of other contributions to universities to benefit athletic programs has not changed.
- Medical Expense Deduction Floor Raised in 2019. Starting in 2019, qualified medical expenses will be deductible only to the extent they exceed 10% of AGI. The prior 7.5% floor was retained for 2018.
- SALT Deductions Limited. The TCJA limits deductions for state and local income, real, and personal property taxes to $10,000 in the aggregate. Under prior law, these “SALT” deductions were unlimited.
- Mortgage Interest/HELOC Deduction Limited. For mortgage debt incurred after December 15, 2017, a taxpayer’s mortgage interest deduction is limited to interest paid on acquisition debt of $750,000 for qualified residences (primary and second homes, but not investment properties). According to a February 2018 IRS press release, the $750,000 limit “applies to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home.” IR-2018-32, 2/21/2018. Acquisition debt incurred prior to that date is still subject to the prior $1.0 million limit.
- Home Equity Loan Deduction Eliminated. Interest paid on home equity loans and lines of credit is no longer deductible regardless of when the loan originated unless the loan is used to pay for home improvements (essentially converting the amount used for improvements to a “qualified residence loan” described above).
- Miscellaneous Itemized Deductions Eliminated. The TCJA eliminated all miscellaneous itemized deductions, including tax preparation fees, unreimbursed employee business expenses, and investment expenses. Formerly, miscellaneous itemized deductions were deductible to the extent they exceeded 2% of AGI.
- Estate and Gift Tax Exclusions Increased. For individuals dying after December 31, 2017 and before January 1, 2026, the federal estate and gift tax unified exclusion, and the generation-skipping transfer tax exclusion, have increased to $10 million adjusted annually for inflation, double the prior $5 million (pre-adjustment) amount. The exclusion is $11.18 million in 2018, up from the $5.49 million exclusion in effect for 2017, and will increase to $11.4 million in 2019. The top marginal rate remains 40%.
- 2025 Sunset. Most of the individual tax reforms expire at the end of 2025 and will revert to prior law levels absent further legislation.
Year-End Tax Planning
Because the tax law changes are far-reaching, it is nearly impossible to generalize the impact on taxpayers – even those in similar income brackets. Most taxpayers are aware of the new rate reductions, standard deductions, and limits on deductions for things like mortgage interest and state and local taxes, but the TCJA’s overall tax reform was much larger and includes many provisions whose impact may be less well understood. There’s no way to be sure of how the TCJA reforms will affect you without crunching the numbers. For many taxpayers, it will be worthwhile to consult with a tax advisor to determine how the new tax law will affect their 2018 tax liabilities and whether any end-of-year adjustments are in order. A few steps you might consider taking include:
- Double check withholding and estimated taxes. Because the individual federal tax changes cut both ways, it’s hard to know how the various changes will interact with the rate reductions. If you are at risk of incurring penalties for underpayments, consider increasing your withholding rate in your December paychecks or bumping up an estimated tax payment. The IRS offers a withholding calculator that can help you evaluate your situation:
https://www.irs.gov/individuals/irs-withholding-calculator. You will need to evaluate your state income tax situation as well, so please check with your advisors to determine how your state will treat the new federal tax rules for state income tax purposes.
- Evaluate whether you will itemize deductions. With higher standard deductions and limits on (and repeal of) certain itemized deductions, experts predict that millions of taxpayers who formerly itemized will begin claiming the standard deduction. The answer to whether you will claim the standard deduction or itemize will inform whether, when, and how to generate additional itemized deductions. If you claim a standard deduction, you will not reduce your taxable income with additional itemized deductions unless the aggregate of those deductions exceeds the standard deduction.
- Charitable planning for 2018 and 2019. Itemized deductions for charitable contributions remain unlimited under the TCJA, so if you are philanthropic and want to be able to itemize despite the higher standard deductions, you can be strategic about the timing and amount of your charitable contributions to maximize tax benefit.
- Gifts of appreciated securities. The TCJA retained the fair market value deduction for charitable contributions of appreciated property (like stock and real estate), and you can still avoid capital gain tax on the appreciation when you contribute appreciated property to charity outright. You can avoid part of the gain and defer the rest if you use the property to create a life income gift.
- “Bunching” charitable deductions. If you plan to make regular gifts to particular charities, you can double (or triple) contribution amounts in 2018 and notify each charity that you intend the contribution to be credited for more than one year. You can take the standard deduction in 2019, then itemize with “bunched” charitable gifts again in 2020, and so forth. You can also consider creating a donor-advised fund with a large 2018 contribution and then ask the fund administrator to distribute amounts to your desired charities in later years. (Note that there is no guarantee that the donor-advised fund administrator will follow your recommendations.)
- Life income gifts. Charitable remainder trusts and charitable gift annuities often are funded with larger initial contributions and thus yield large income tax charitable deductions that can be itemized. These “life income” gifts provide a reliable payment stream to you, in many cases for the rest of your life, and then distribute what’s left to charity as your charitable legacy. If you are philanthropic but also interested in creating a new income stream for yourself or someone else, you can consider creating a charitable trust or annuity before December 31.
- Qualified charitable distributions (QCD) from IRAs — a “universal charitable deduction.” Taxpayers who are 70 ½ or older can distribute up to $100,000 in the aggregate per year from traditional IRAs to qualified charities. The distribution amount will be excluded from federal taxable income and will count against the taxpayer’s required minimum distribution (RMD) for the year. Because the distribution reduces taxable income, it acts like an itemized deduction that can be used even when the taxpayer will claim the standard deduction.
- Retirement accounts. The TCJA did not change the tax incentives for contributions to qualified plans and IRAs. Contributions can still be made pre-tax, which reduces taxable income dollar-for-dollar. The 2018 contribution limits are $18,500 for qualified plans and $5,500 for IRAs, with additional catch-up contribution amounts permitted for taxpayers age 50 or over at the end of the calendar year.
- Gift and estate tax planning. Consult with your estate planning attorney to determine whether the time is right to update your estate plan in light of the new basic exclusions. The annual gift tax exclusion, which increased in 2018 to $15,000 per recipient, remains in place, so tax-free gifts to children, grandchildren, and others can be made before year end up to the new limit. With the lifetime gift tax exclusion at an historic high ($11.18 million in 2018), it may be time for high net worth taxpayers to undertake wealth transfer planning. Note that these higher exemption amounts, like the other individual provisions, will expire at the end of 2025.
For information about charitable giving options, please contact the University of Virginia Office of Gift Planning at firstname.lastname@example.org, 434-924-7306, or 800-688-9882 (toll-free).
This information is provided in summary form and is compiled from many sources. It is not intended as tax, financial planning, or legal advice and should not be relied upon as such. The University of Virginia does not provide tax or legal advice, and we encourage you to consult with your advisors to determine how this information will affect your personal situation.