Tax Reform: Itemized Deductions, the Standard Deduction and Personal Exemptions

After a year of congressional debate, the Tax Cuts and Jobs Act was signed, and extensive reform to US tax laws takes effect for 2018 tax returns. This new law imposes certain changes that will last until 2025, at which point Congress will need to take action if they want to keep these new tax rules in place. Changes to itemized deductions, the standard deduction and personal exemptions are significant and will affect the majority of taxpayers.

ECS Financial has highlighted some of these changes below: Medical and Dental Expenses Medical and dental expenses continue to be deductible to the extent they exceed a specified threshold. The threshold for deducting medical and dental expenses was reduced from 10% to 7.5% of adjusted gross income (“AGI”) for 2017 and 2018, but returns to 10% for 2019 and future years.

Taxes You Paid

Real estate taxes, personal property taxes, state income taxes, and sales taxes are all deductions that fall into this category. These taxes all remain deductible, but the combined deduction will now be limited to $10,000 for single filers as well as married filing jointly ($5,000 for married filing separately). This will affect many taxpayers who currently itemize deductions. On the bright side, an individual can still take the full deduction for this category when it relates to income producing activities, like self-employment income or rental property.

Interest You Paid

Home mortgage interest deductions are also subject to major changes in 2018. The deduction prior to 2018 was limited to mortgage interest on acquisition debt of $1 million ($500,000 for married filing separate), and home equity interest on loans up to $100,000. In 2018 the deduction for interest on a home equity loan was eliminated completely, and the acquisition debt limit is being reduced to $750,000 ($375,000 for married filing separately). Home acquisition debt acquired before December 15, 2017 is grandfathered up to the $1 million amount. Taxpayers with home equity debt should trace the use of such funds, as debt that is considered acquisition debt would still be deductible, subject to the $750,000 limit. Additionally, interest from debt used for investment purposes may qualify for the investment interest expense deduction.

Charitable Contributions

Previously contributions to public charities were generally limited to 50% of adjusted gross income. This limit is being increased to 60% in 2018. Certain institutions of higher education offered the right to purchase tickets or seating at an athletic event for individuals that made a charitable contribution. A taxpayer could deduct 80% of this contribution. The new law states that no amount will be deductible for contributions that grant the right to purchase tickets or seating at an athletic event.

Casualty and Theft Losses

The deduction for uncompensated casualty and theft losses is being eliminated. There will, however, be deductions allowed for certain federally-declared disasters. Deductible casualty losses were relatively rare due to the 10% of adjusted gross income floor, so this change may not affect many taxpayers.

Job Expenses and Certain Miscellaneous Deductions

This category of deductions was previously allowed to the extent that the combined total exceeded 2% of adjusted gross income. The new law is removing this deduction completely. Some of the deductions in this category included tax preparation fees, investment expenses and unreimbursed employee expenses.

Other Miscellaneous Deductions

Gambling losses were deductible to the extent of gambling winnings. In certain circumstances, ordinary and necessary expenses associated with these wagers were also deductible, not subject to the same limitation. Under the new law, the deduction is clarified to be the combined total of gambling losses and gambling expenses to the extent of winnings.

Higher-income taxpayers were subject to a limitation on itemized deductions, called the “Pease” limitation. Itemized deductions were reduced by 3% of the taxpayers’ adjusted gross income that exceeded the threshold. The Pease limitation is being removed so that all otherwise allowable itemized deductions will be fully deductible.

Though not an itemized deduction, alimony was previously deductible by the payer, while the recipient would include it as taxable income. This is essentially being reversed, so the payer will no longer be allowed a deduction, and the recipient will not be taxed on alimony received. The new law applies to divorce agreements executed post 2018. Pre 2019 divorce agreements are grandfathered under the old rules.

Standard Deduction and Dependency Exemptions

The following changes to the standard deduction will make it less likely for many taxpayers to itemize.

While these new figures are considerably higher, and appear to be beneficial for many taxpayers, that isn’t necessarily the case. While the standard deduction has increased, the tradeoff is that the personal exemption is being removed. The increased standard deduction will benefit taxpayers that don’t normally itemize. The personal exemption elimination would not be detrimental to taxpayers with AGI greater than $156,900 ($313,800 for married filing jointly) because exemptions were previously phased out beyond this threshold. Those most affected by this change will be families with multiple dependents, that will lose a $4,000+ deduction for each taxpayer and each qualified dependent.

For example, a married couple that did not itemize or have dependents would receive a higher total deduction; $24,000 in 2018 vs. $20,800 in 2017 ($12,700 standard deduction plus two personal exemptions of $4,050). But the married couple with two children taking the standard deduction would receive a total deduction of only $24,000 in 2018 vs. $28,900 in 2017 ($12,700 plus a total of four personal exemptions of $4,050).

These radical tax changes look to make the calculation of itemized deductions considerably simpler. In fact, since many of the common deductions are being limited or removed while the standard deduction has increased, itemizing looks like it may be a thing of the past for some taxpayers.

ECS Financial Services can help navigate through the complex tax reform act and help you understand how it will impact your bottom line. Please reach out to an ECS team member today to discuss your tax profile or to hear more about how the impact to your itemized deductions.

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About the Authors - Justin Irons recently joined ECS as a staff accountant after a successful internship during the 2018 tax season. He graduated with a Bachelor of Science in Accounting from Roosevelt University in 2016. Justin aspires to attend graduate school and then pursue the Certified Public Accountant Designation.

Sanjay Wadhwani received his Bachelor of Science Degree in Finance from University of Florida in 2004 and a Master of Science in Taxation from University of Central Florida in 2006. Mr. Wadhwani is a Certified Public Accountant and a member of the American Institute of Certified Public Accountants and the Illinois Certified Public Accountants Society. Mr. Wadhwani has over 11 years of public accounting and tax experience. His areas of expertise include individual, corporate, and partnership income tax compliance and consulting.