As we prepare our federal income tax returns, we may want to be aware of some of the changes in the Internal Revenue Code. Few of us are affected by the federal estate and gift tax exemptions (now $11,400,000 per person or $22,800,000 per married couple) – except in the way that further depletes the U.S. Treasury, strengthening calls for “reform” of such “entitlements” as Social Security and Medicare, benefits we pay for with every paycheck deduction. But there are other changes which may affect the way we provide for ourselves and our families.
Changes to the Standard Deduction
How will the changes in the standard deduction and the itemized deductions will affect us now that personal deductions have been removed? Because Texas does not have an individual income tax, this largely depends on whether you have children and whether you are supporting an elderly relative.
If you have no children, the standard deduction of $24,000 for a married couple benefits you more than the 2017 combined standard deduction and exemptions of $20,800. If you have two children, the $24,000 benefits you less than the 2017 combined standard deduction and exemptions of $28,900. This gap is lessened a bit by the $2,000 per child tax credit.
There is no longer a deduction for supporting an elderly relative (an inexplicable and likely wrong-headed policy decision). There is merely a $500 tax credit.
Changes to Itemized Deductions
Itemized deductions have changed, too. The 2% miscellaneous deduction was eliminated. After a brief respite, the medical expense deduction will be reduced to 7% of adjusted gross income. Deductions for state and local taxes (including property taxes) are capped at $10,000. The mortgage interest deduction is capped at $750,000 of indebtedness. Unless you are in the military, there is no longer a deduction for moving expenses.
When thinking of our children’s and grandchildren’s education, we may want to give smaller gifts to them, at least directly. Previously children were taxed on unearned income over $2,100 at their parent’s tax rate. Now they will be taxed like trusts and estates: income over $12,500 will be taxed at 37% with a net investment income tax of 3.8%. A contribution to a 529 plan or a college savings account now makes more sense for most people – even if the student someday ceases being a student and takes the money out to spend on other things, with a 20% penalty.
Changes to Expensing Depreciable Property
If you have a rental property or a small business and have been expensing depreciable property the year you bought it, you can now do this not for $250,000 but for $1 million in property. You can now also expense non-residential real estate improvements. When you have done this for a total of $2.5 million in property, the benefits decrease.
Changes for Small Business Owners
All small business owners can benefit from Internal Revenue Code Section 199A. This allows a 20% deduction for business income reported on the individual return (Schedule C). Sole proprietorships, rental real estate, partnerships, single member LLCs and S-corps are all eligible. The computation differs for different types of business. There is also a taxable income threshold, phasing out at $315,000 for married couples and $157,000 for individuals, estates and trusts. For service businesses other than architects and engineers, the deduction is eliminated at $415,000 for married couples and $207,500 for individuals. If you own another type of business, after passing the taxable income threshold you can choose between deducting 50% of wages or deducting 25% of wages and 2.5% of the unadjusted basis of business property – reduced if you expense depreciable property and reduced by bonus depreciation adjustments. Note that S-corporations have an added bonus: wages paid to shareholders are included in determining limitations. This is all new and can be more than a little confusing. It may be a good year to work through your taxes with your CPA and, if you would be better off as an S-corporation, file to change the form of your business.
If you own a business which employs you, you can also reduce your taxable income by maximizing your retirement plan contributions. If you have a defined contribution plan, such as a 401k, you can remove up to $56,000 from taxable income for an employee under 60, with a “catch up” for older employees. The amounts are even higher for a cash-balance defined-benefit plan. Again, given the variations, it is a good idea to consult your CPA.
Changes for Retirement
It isn’t all sunny on the retirement front. You can no longer recharacterize a Roth IRA as a traditional IRA. Be careful if you are approaching the income limit on making Roth IRA contributions.
There is good news for people who inflation has gradually sucked into the advance minimum tax. Phaseouts are now $1 million for married couples and $500,000 for individuals. Exemption amounts and regular tax deductions have increased.
Will you pay less under the new federal tax regime? The answer varies. But you may want to rethink how you contribute to your childrens’ and grandchildrens’ education, how you treat expenses for a rental property and wages and retirement contributions for a small business. You may also want to look more closely at a Health Savings Account.
Elder law attorney, Terry Garrett, is a member of the National Academy of Elder Law Attorneys and is an Approved Guardianship Attorney. She assists people in elder law, estate and special needs planning, guardianship and settling estates. She graduated with honors from Cornell University. She was on the Dean’s List at Wharton Business School. She earned her J.D. at Columbia Law School, receiving the Parker Award and a Mellon Fellowship.