For 2018 taxes (to be filed starting in early 2019), the biggest change affecting individual taxpayers will be the increased standard deduction and the resultant decreased likelihood of itemizing deductions. Under the changes in the Tax Cuts and Jobs Act, the standard deduction is being increased from $6,350 for a single taxpayer to $12,000, for a married couple the change is from $12,700 to $24,000. Taxpayers that are either blind or age 65 or older get an additional $1,300 added to the standard deduction (if married and both the taxpayer and the spouse qualify, then the amount is $2,600).
What does a standard deduction do for me? Under the U.S. Federal tax system, individual taxpayers are allowed to deduct the larger of standard deduction or itemized deductions to arrive at their taxable income. The taxable income is the figure that income taxes are based on. So for 2018, a single taxpayer will not pay income tax on the first $12,000 of income in that year (assuming they are under age 65 and not blind), a married couple will not be taxed on the first $24,000 in income. Seems pretty straightforward so far, right?
Now you may be asking what are itemized deductions? Itemized deductions are items that Congress has decided are allowed to be tax deductions, if cumulatively those items added together exceed the standard deduction. These deductions are reported on IRS form Schedule A, shockingly named "Itemized Deductions". Included is a draft version of the form for 2018.
The form provides an outline of the items that are allowed to be claimed as itemized deductions: Medical and Dental Expenses, Taxes you paid, Interest you paid, Gifts to Charity, Casualty and Theft Losses (only for Federally declared disaster area now), and Other Itemized Deductions.
The first category is Medical and Dental Expenses. The definition of qualified medical care expenses are out of pocket expenses for "the diagnosis, cure, mitigation, treatment, or prevention of disease, or payments for treatments affecting any structure or function of the body" (from IRS Topic #502). In 2018, if the sum of these expenses exceeds 7.5% of your Adjusted Gross Income (AGI), for 2019 the percentage increases to 10% of AGI.
The next category is Taxes You Paid. These expenses would include state and local taxes (either the larger of state and local income taxes or general sales taxes), state and local real estate taxes, and personal property taxes (ad valorem taxes, for example). These amounts will be capped to the total sum of these amounts or $10,000, whichever is lower.
The third category is Interest You Paid. Home mortgage deductible interest will be limited to loans used to buy, build or improve the home and no longer will taxpayers be able to deduct interest on that amounts representing refinancing that was used to consolidate other debts, used for personal purposes (travel expenses, car purchase, etc.). Other interest that is deducted is investment interest, interest paid on money borrowed to purchase investments or securities. Investment interest is allowed to the extent that there was investment income on the tax return, so for example if you have $1,000 in dividend or interest income and $1,500 in qualifying investment interest expense, the deduction would be limited to $1,000 (there may be other factors to consider but this is a simplified illustration).
The fourth category is Gifts to Charity. This would be donations made to qualifying charitable organizations such as churches, 501(c)3 organizations such as Salvation Army, Habitat for Humanity, Helping Hands for Single Moms, Shoebox Ministry just to name a few among the various, wonderful organizations out there. Charitable donations can be made via cash, check, credit card or may even be donation of tangible goods (i.e. dropping off household items at Goodwill or Salvation Army thrift stores). If you are claiming a deduction for charity, be sure you have proper documentation to substantiate those donations.
The last categories are Casualty Losses and Other Itemized Deductions. Casualty losses are only going to be applicable if 1) the loss occurs in a federally declared disaster area and 2) allowed for loss amounts that exceed reimbursement from insurance. I pray that this will not be a deduction that many will be eligible to claim on their tax return.
As for the Other Itemized Deductions, this category is, in my experience, utilized in rare instances. There may be other qualifying deductions but the example that comes to mind is a deduction for repayment of previously taxed income (referred to as a claim of right deduction). As stated, there may be other qualifying deductions but none that come readily to mind.
If the total of these various categories exceeds the $12,000/$24,000 standard deduction, then that is the amount that will be used to lower your taxable income for federal tax purposes. In states that have an income tax, you may be eligible to itemize deductions even if the total does not exceed the federal standard deduction amounts - please consult with a tax professional to discuss your specific situation.
***NOTE: For those folks familiar with the Schedule A, please note that there is no longer a Miscellaneous Itemized Deductions Subject to 2% of Adjusted Gross Income - this section was eliminated under the Tax Cuts and Jobs Act. This was the section that taxpayers could deduct unreimbursed employer expenses, investment expenses (such as financial advisor fees, financial publication expenses, etc.) and tax advisory and preparation fees as the main examples of items that fell in this category.
If you have any questions, please leave a comment or contact the office to discuss the impact to your situation.
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