By now, most people are aware that President Trump signed into law the Tax Cuts and Jobs Act on December 22, 2017. There are major tax reforms in this bill that will significantly affect corporations, businesses, trusts, estates, charitable organizations and high net worth individuals in 2018. And, of course, the average taxpayer will be considerably impacted as well. For them, the largest impact is likely to come from the dramatic increase in the standard deduction and the repeal of the personal exemption.
Prior to the new tax reform law, the standard deduction for single taxpayers and those who are married and file separately was $6,500. Now, beginning in 2018, those taxpayers will benefit from a $12,000 standard deduction. For heads of households, the standard deduction will now be $18,000, up from $9,550. And finally, for those who are married and filing jointly, the new standard deduction will be $24,000, up from the $13,000 it was in the previous tax year.
In addition to the dramatic increases in the standard deduction amounts, the new tax plan also substantially reduces the value of some of the deductions that taxpayers have been accustomed to claiming in the past. For example, the new plan would limit deductible mortgage interest to loans worth $750,000 or less, down from the current $1 million cap. In addition, it would cap the state and local tax deduction at $10,000 for property or income taxes.
The consequence of all these changes is that taxpayers who itemized their deductions in the past are now far more likely to utilize the new, increased standard deduction instead. In fact, according to the Tax Policy Center, it is estimated that the number of U.S. taxpayers likely to itemize would fall from 46.5 million to 19.3 million in 2018, the first full year that the new tax law is in effect.
No Personal Exemption
As I mentioned above, there are also no personal exemption amounts for 2018. As a result, it is relatively straightforward to determine whether or not taxpayers will be obligated to file a return. Individual taxpayers will be required to file a tax return if their gross income for the taxable year is more than the standard deduction.
Married taxpayers will be required to file a tax return if their combined gross income is more than the standard deduction for a joint return.
Other Deductions Eliminated in 2018
Another consequence of the Tax Cuts and Jobs Act is that all kinds of previous itemized tax deductions have been eliminated. Moving expenses, home office use, unreimbursed travel and mileage, unreimbursed job expenses, job search expenses, tax preparation fees, legal fees, and investment fees and expenses are just a few of the deductions that are no longer available to a taxpayer.
For those taxpayers who have been accustomed to claiming those deductions in the past, the fact that they are no longer available can be a source of some frustration and confusion. It would only be natural to assume that with their elimination, the taxpayer might be subjected to a higher tax bill.
But that is not necessarily the case. With all the other new provisions in the tax law including the standard deduction increase:
- the elimination of the marriage penalty
- the reduced exposure to the Alternative Minimum Tax
- the reduced tax rate for married filing jointly for all incomes, except a small subset beginning at 400k
All of these factors might very well leave a taxpayer in the same, or even in an improved situation, tax-wise.
Naturally, as a Financial Life Management company, we encountered some of our clients expressing their concerns about the elimination of being able to deduct investment management fees and expenses. But for all the reasons mentioned above, even though that specific deduction has gone away, the net result of all these new tax provisions may very well result in the same, or even more, dollars for them.
Needless to say the tax reform overhaul is significant and presents challenges and opportunities. It’s in situations like these, where our clients may realize how critical our Financial Life Management practices may be. We help them to navigate through all the important tradeoff discussions, and we advise them on what we believe are decisions that represent the best course of action. In the absence of this, inaction might be the course they choose, and we have seen how negatively, if not disastrously, that decision may impact them.