Today I'm delighted to introduce Riley Adams who blogs at Young and Invested, as a guest writer. Riley is a senior analyst for an energy company and a CPA. In today's post, you'll learn about eight 2018 tax law changes that help save you from paying unnecessary taxes.
As a CPA, Riley has extensive knowledge about taxes. Though he's not practicing, he writes about taxes on his blog. Here are two good examples:
Tax Reform 2018 Explained – Understanding the Tax Reform Changes
How the Earned Income Tax Credit Could Get You More Money
Obviously, this is a timely topic. I realize some of you have already filed your taxes. I also know that many who might read this have not filed. My hope is that Riley's tips introduce you to some things you may not have known or thought about as you prepare to file.
I found the post very helpful. I'm confident you will too.
I'll let Riley take it from here.
Tax Law Changes You Need to Know
Tax reform resulted in multiple changes in the U.S. tax code. Depending on where you live, how much taxable income you make, your filing status, or any number of other items, you either came out ahead or fell behind as a result of the tax changes.
To get an idea of how tax reform changed the treatment of certain items, I’ve gathered some of the major elements which differ this year compared to the past. Let’s take a look and see how these changes impact your tax situation.
What Did Congress Aim to Do with Tax Reform?
When Congress debated changing the tax code in 2017, the aim was to simplify the process for the individual taxpayer. By making itemized deductions harder to claim and instead opting for a larger standard deduction, in theory, far fewer individuals would qualify for itemizing.
The thinking here is this would reduce the time and complexity of preparing your tax return each year. The increase also lowered the taxable income of many filers, thereby allowing for a lower tax bill.
However, while tax reform was a benefit to most, there were others who did not fare as well from the changes. It made the Majority of taxpayers project to pay less over the life of the tax changes, but, as with all policy changes, there are winners and losers.
Let’s walk through some of the changes tax reform has brought and see who’s likely impacted most.
For further reading:
Why You Need to Know the Rules for Net Unrealized Appreciation
1. The standard deduction
Tax reform changed the nature of filing your tax return by increasing the standard deduction and making most taxpayers ineligible for itemizing their tax deductions. As a result, a lot fewer people qualify for taking the most common tax deductions because they are now out of reach.
Therefore, most use the standard deduction instead of itemizing their tax deductions. This should expedite the tax return preparation process, making it easier for taxpayers.
For single filers, the standard deduction almost doubled, going from $6,350 in 2017 to $12,000 in 2018. In 2019, the amount rises to $12,200. For taxpayers filing as Married, filing jointly, they saw their standard deduction go from $12,700 to $24,000 in 2018. This amount increases to $24,400 in 2019.
2. The Personal Exemption
Personal exemptions became a casualty of tax reform. Previously, each person on the tax return (filers and those being claimed) received an exemption to lower the taxable income on the return to the tune of $4,050 in 2017.
For example, if you were a family of four, you received four exemptions worth $4,050 per family member in 2017. Now, you can't claim personal exemptions on your tax return.
The argument here was the higher standard deduction would cover this loss. As you can see, absent any other changes, larger families would stand to lose from this change.
As compensation for this change, tax reform increased the child tax credit and essentially made the loss a wash for families.
You might also like:
16 Ways to Avoid the 105 Early Withdrawal Penalty
3. The child tax credit
The child tax credit was designed to defray costs associated with raising children each year. The attractive nature of the credit came in the form of a dollar-for-dollar credit against your tax liability as opposed to a deduction which reduces your taxable income.
Previously, the child tax credit was available for each child under the age of 17 for $1,000. The tax credit gets reduced by $50 for each $1,000 the taxpayer earns over certain thresholds. The tax credit was also subject to phase-outs.
Now, the child tax credit effectively doubled per child up to $2,000 under tax reform. Up to $1,400 of the child tax credit received is a refundable tax credit (offsets the balance of your tax liability and any excess comes to you via a tax refund).
The new rule also includes a $500 nonrefundable tax credit per dependent other than a qualifying child. Phaseouts also apply to the new child tax credit.
For AGI greater than $200,000 (single taxpayers) and $400,000 for married couples, filing jointly, the phaseout reduces the child tax credit.
4. Tax brackets and rates
In America, the country uses a progressive tax system for income taxes. This means as a taxpayer makes more income above certain thresholds, the amount of tax paid on an additional dollar of income increases.
For example, if you ignore the effects of the standard deduction and you made $25,000 as a single filer in 2018, you would pay 10% on the first $9,525 ($952.50) and 12% on the remaining $15,475 ($25,000 – $9,525) or $1,857. You would not pay 12% on the entire $25,000.
The new tax law changed two things about the individual tax rates:
- Different taxable income ranges: The law changed the income brackets for tax filers. Meaning, the income ranges for each tax rate either widened or narrowed, depending on the level of income.
On the low end, the bottom two brackets did not change, while on the upper end, the highest tax rate (37%) does not come into effect until a single taxpayer has earned $500,001 of taxable income as opposed to $426,701 under the old tax brackets.
- Lower tax rates: The tax law kept the seven existing federal income tax brackets. However, it also lowered the tax rate of every bracket except for two. This reduces the amount of money you pay on each additional dollar of income by varying amounts.
Taxes and Social Security:
Is My Social Security Income Tax-Free?
5. Changes for homeowners
Tax reform changed the treatment of deductions many people claim related to owning a home. The higher standard deduction created not only a higher threshold to qualify for the mortgage interest deduction, but tax reform also lowered the levels of mortgage principal and associated interest expense which are eligible for deductibility.
In the past, taxpayers could deduct the mortgage interest associated with the first $1 million of a mortgage and the interest associated with the first $100,000 of a home equity loan (assuming the funds are used for qualifying home improvements).
Tax reform changed this only to allow the interest expense associated with the first $750,000 for taxpayers who file as married, filing jointly, and $375,000 for single taxpayers. If you originated a mortgage in 2018 above this threshold, it gives you the incentive to pay off your mortgage faster.
It is worth noting this limit only applies to new loans originated after 2017. Preexisting mortgages are grandfathered under the old limits.
Given the lower amounts which qualify, higher-income individuals located in non-coastal areas and those in high cost of living areas are disproportionately impacted.
Simply put, tax reform in 2018 has made it less-advantageous to be a homeowner from a tax point of view.
6. New state and local taxes (SALT) cap
Some of the tax reform changes benefited most of America. A higher standard deduction, lower tax rates, and bigger brackets helped many pay less in taxes in 2018.
However, not everyone was as lucky. For those who lived in high cost-of-living areas and paid a considerable amount of money in state and local taxes (SALT taxes), a new cap impacted them considerably.
In 2018, there was a $10,000 cap placed on the amount of SALT taxes which can be deducted from your federal taxable income. Homeowners living in these higher cost areas were hardest hit because many deducted real estate and property taxes as well as other applicable state and local income taxes.
This new cap severely limited their ability to claim these deductions. The only way high cost of living homeowners can come out ahead is if their incomes fall into lower brackets, which would have more of their incomes qualify for lower rates.
7. The 529 college savings plan
A 529 college savings plan is a tax-advantaged savings account designed to encourage saving funds for qualified higher-education costs. These qualified expenses include tuition, fees and room and board. Account holders invest money in these accounts and enjoy tax-free gains if the funds are used for qualified educational expenses.
In the past, 529 college savings plan funds could only be used on qualified higher education expenses. However, families with kids who attend private K-12 schools can rejoice because they may now use funds from 529 savings plans.
Tax reform allowed these tax benefits to extend to eligible education expenses for all elementary or secondary public, private, or religious schools. The new rule allows the plan holder to withdraw a maximum of $10,000 per year per student for education costs.
8. The threshold for medical expenses
For the 2018 tax year, taxpayers can deduct medical expenses which exceed 7.5 percent of their adjusted gross income. In other words, if you had $150,000 of adjusted gross income in 2018 and qualifying medical expenses of $15,000, you can deduct $3,750 from your taxable income (AGI).
Adjusted Gross Income Threshold: $150,000 * 7.5% = $11,250
Deductible Medical Expenses: $15,000 – $11,250 = $3,750 available medical expense deduction
Taxable Income: $150,000 – $3,750 = $146,250
The IRS allows medical expense deductions for qualified, out-of-pocket medical costs. Additionally, you can deduct mileage or other travel expenses associated with medical visits.
If you paid for expensive medical treatment and it counts as a qualified medical procedure, assisted living or other long-term care services, they may tally above the required threshold.
As a note, in the 2019 tax year, this 7.5% AGI threshold increases to 10%.
Thanks, Riley for highlighting and simplifying some of the important 2018 tax law changes. I know I learned a lot. I'm sure our readers did too.
Be sure to head on over to Young and Invested to read more of Riley's in-depth articles on taxes and personal finance.
Now it's your turn. If you have questions for Riley, let him know in the comments below.
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