2018 Year-end tax letter | Tax reform and the individual

TCJA-imposed limitations on itemized deductions

The Tax Cuts and Jobs Act (TCJA or the Act) made sweeping changes to the itemized deduction landscape, suspending several and modifying the rules governing many of the rest. Absent the Tax Reform 2.0 legislation being signed into law, the following modifications will expire and pre-TCJA law will again apply after Dec. 31, 2025, unless noted otherwise.

State and local taxes. Without question, the TCJA’s most controversial individual tax change is the $10,000 cap ($5,000 for married taxpayers filing separately) it places on the deduction for state and local income, property and/or sales taxes paid or accrued in the aggregate during the year. In addition, foreign real property taxes are no longer deductible. It is important to note that the aforementioned changes do not apply to taxes paid or incurred in a trade or business, including those reported on an individual filer’s Schedule C (profit or loss from a sole proprietorship), E (income and loss from rental real estate, partnerships, S corporations, etc.) or F (profit or loss from farming).

As detailed in our August release of the Tax Reform Progress Report, several high-tax states attempted to circumvent the cap by implementing government-operated public purpose foundations, to which taxpayers could make contributions in exchange for credits against their state income or property tax liabilities. These contributions would then be deductible as charitable donations on the taxpayers’ federal income tax returns, unencumbered by the $10,000 limit. The IRS and Treasury Department responded to these initiatives by issuing proposed regulations declaring the workaround would constitute a quid pro quo, and taxpayers would only be allowed a federal deduction to the extent the contribution exceeded the state credit received in return.

While the regulations mark a significant blow to these high-tax states’ efforts to preserve the deduction for their residents, the fight is likely to continue as many of these states are considering their options for response, including challenging the validity of the regulations in the courts. Other states are considering workarounds that involve shifting from an individual income tax to a payroll tax regime or imposing entity-level taxes on pass-through entities. Whether or not these approaches will result in further IRS regulations designed to limit these states’ tactics remains to be seen.

Mortgage interest. The Act retained the deduction for mortgage interest in its previous form with respect to debt incurred on or before Dec. 15, 2017. However, for debt entered into thereafter, the amount that can be considered acquisition indebtedness for the purpose of determining the deduction is reduced to $750,000 from $1 million (for married taxpayers filing separately: $375,000 from $500,000). A binding contract exception is available to allow prior law to apply to taxpayers who entered into a written binding contract before Dec. 15, 2017, to close on the purchase of a principal residence before Jan. 1, 2018, and purchases such residence before April 1, 2018. Refinanced debt is deemed to be incurred when the original debt was incurred, to the extent the resulting debt does not exceed the amount refinanced.

The Act suspends the deduction for interest paid on home equity indebtedness; however, the IRS clarified earlier this year this interest is still deductible if the loan is used to buy, build or substantially improve the taxpayer’s home that secures it.

Medical expenses. For tax years beginning after Dec. 31, 2016, and before Jan. 1, 2019, the floor for determining the deductibility of medical expenses is reduced to 7.5 from 10 percent of AGI, regardless of the taxpayer’s age. During this period, the rule limiting the deduction to the extent such expenses exceed 10 percent of AGI for AMT purposes is not in effect. After Dec. 31, 2018, the floor reverts to 10 percent of AGI for all taxpayers, for both regular tax and AMT purposes.

Miscellaneous itemized deductions. The TCJA suspended miscellaneous itemized deductions subject to the 2 percent-of-AGI floor. Commonly deducted expenses include unreimbursed employee business expenses, tax preparation fees, investment fees, safe deposit box rental fees, etc.

Overall limitation on itemized deductions. The rule commonly referenced as the “Pease limitation,” which either reduced the total of certain otherwise allowable itemized deductions by 3 percent of the amount a taxpayer’s AGI exceeded a certain threshold or limited the deductible amount to 80 percent of the total expenditures, has been suspended.

Charitable contributions. Under previous law, the deductibility of contributions to public charities, educational organizations, churches, hospital and medical research organizations, certain private foundations and other specified charities was limited to 50 percent of the donor’s contribution base (broadly, AGI without regard for any net operating loss carryback to the tax year of the contribution). The TCJA increased the contribution base limitation percentage for cash donations to such charities to 60 percent.

The Act additionally eliminated the deduction for 80 percent of a payment to a higher education institution in exchange for the right to purchase seating at an athletic event. Note: this deduction is not restored after Dec. 31, 2025.

Personal casualty and theft losses. Only such losses attributable to a federally declared disaster are deductible under the new law. However, in the case of a taxpayer with personal casualty or theft gains, any personal casualty or theft losses not attributable to a federally declared disaster are still available to the extent they do not exceed the aforementioned gains.

Pre-Act limitations, requiring losses to exceed $100 per casualty or theft and in the aggregate to exceed 10 percent of the taxpayer’s AGI to be deductible, remain in effect.

TCJA changes to above-the-line deductions, exclusions and personal credits

Tax reform additionally resulted in changes to above-the-line deductions to arrive at an individual taxpayer’s AGI, exclusions from taxable income and personal credits available to reduce their tax liabilities. Once again, disregarding any potential for new legislation, the modifications discussed below will no longer be in effect after Dec. 31, 2025, unless noted otherwise.

Standard deduction and personal exemptions. The Act increases the standard deduction to $24,000 for joint filers and surviving spouses, $18,000 for head-of-household filers, and $12,000 for all others; these amounts will be indexed for inflation for tax years after 2018. The additional standard deductions for the elderly or blind ($1,250 for joint filers per spouse and surviving spouses, $1,550 for all other filers) remain unchanged. Personal exemption deductions for a taxpayer, spouse and dependents are suspended outright.

Deduction for moving expenses and exclusion for qualified moving expense reimbursements. With the exception for members of the Armed Forces on active duty, the TCJA suspends the above-the-line deduction for moving expenses and the exclusion for qualified moving expense reimbursements. However, the IRS recently clarified that qualifying reimbursements a taxpayer receives from his or her employer in 2018 for expenses incurred in connection with a 2017 move remain excludable from income.

Deduction of alimony by payor. The Act does not suspend but eliminates the deduction for alimony paid pursuant to a divorce or separation decree executed after 2018 or to a modification to an existing agreement made after 2018 (if the modification expressly provides for the new law to apply). Accordingly, alimony under post-2018 agreements or modifications is no longer includible in the recipient’s income.

Child tax and qualifying dependents credits. The TCJA increased the child tax credit to $2,000 per qualifying child from $1,000, with a maximum refundable amount of $1,400 per credit. Taxpayers must provide a Social Security number for each qualifying child for whom the credit is claimed. The Act additionally increases the AGI threshold at which the credit begins to phase out to $400,000 from $110,000 for joint filers and to $200,000 from $75,000 or $55,000 for all other filers. These thresholds are not indexed for inflation.

The Act additionally introduced a $500 nonrefundable credit for qualifying dependents other than qualifying children.

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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.