When it was almost “That Time of Year” in December of 2017, my partner Rebecca McElroy posted a blog immediately after Congress passed the Tax Cuts and Jobs Act (“TCJA”). Her blog (linked below) had charts illustrating the tax rates for 2018 without and with the tax rates of TCJA. As Rebecca noted, the new tax rates under TCJA stayed at the same number of tax brackets (7) while offering lower rates. With Congress giving us lower income tax rates, it took away (or limited) many of the personal itemized deductions to which we had become accustomed. The news of these lost deductions led many to think income taxes might be higher in 2018 and beyond. Some of these deductions (and limitations on them) eliminated, trimmed or modified were the following:
1) Home mortgage interest payments on up to $1 million in acquisition indebtedness and up to $100,000 of home equity indebtedness prior to TCJA were deductible. TCJA for the years 2018 – 2025 allow the deductibility of interest payments on up to only $750,000 in acquisition indebtedness for homes purchased after December 14, 2017, and for interest payments on home equity interest up to $100,000, but only if the funds are used to buy, build or substantially improve the home.
2) Prior to TCJA, state taxes (income, property and sales) were fully deductible. TCJA continues to allow such deductions, but caps them at $10,000 per year.
3) Itemized Miscellaneous Deductions (such as Unreimbursed employee business expenses and investment management fees) exceeding 2% of Adjusted Gross Income (“AGI”) are no longer deductible under TCJA.
4) The deduction for charitable contributions remains essentially the same under TCJA with an expanded allowable amount up to 60% of AGI.
5) Many of you will remember that prior to TCJA, all of the allowed itemized deductions were subject to an overall limitation based on income in excess of an inflation adjusted amount. This limitation known as the Pease limitation, depending on one’s income, could eliminate as much as 80% of one’s deductions in a year. TCJA did eliminate this provision so that there are no income limitations now imposed on the allowable itemized deductions.
6) TCJA, also, as Rebecca noted in her blog in late 2017, vastly increased the standard deduction for single filers, married filers and heads of households to $12,000, $24,000, and $18,300 respectively. Congress thought these increased standard deductions would have the effect of eliminating the need for over 90% of filers to itemize deductions thus simplifying the income tax returns of many.
7) Finally, TCJA eliminated the personal exemptions which would have grown to about $4,100 each and yet still have been subject to a phase out based on AGI.
An example of the effect of how the lower tax rates overcome the loss of certain itemized deductions to decrease the overall income tax is shown below. In the example, we have a married couple with no children or other dependents filing jointly and compare the total income taxes under both the TCJA rates for 2018 with the rates that would have been in place without the TCJA. The couple has combined salaries and investment income (no business income; this will be a discussion for a later blog) of $380,000 with deductions as shown.
PRE TCJA TCJA
AGI $380,000 $380,000
Mortgage Interest ( 20,000) ( 20,000)
State & Local Taxes ( 18,000) ( 10,000)
Charitable Donations ( 20,000) ( 20,000)
Net of Limitation ( 5,000) 0
“Pease” limit on
Deductions 2,000 0
Exemptions Net of
Income Phase-out ( 4,000) 0
Taxable Income $315,000 $330,000
Income Tax $ 78,675 $ 68,979
This married couple, in later years, may pay down their mortgage leaving them with the potential of only $30,000 in deductions ($20,000 of which are charitable donations). They could alternate years of itemizing deductions or using the standard deduction. With $24,000 of standard deduction in a year with only the $10,000 capped state and local tax deduction (and no charitable deductions), they could “double up in the ensuing year with $40,000 of charitable plus the capped state and local deduction of $10,000 for total deductions of $50,000 and a 2 year total combination of standard deduction and itemized deductions of $74,000 versus only $60,000 (2 years of $30,000 itemized deductions each).
In my next post, I want to review the provisions of the TCJA relaxing the Alternative Minimum Tax (“AMT”) for certain individuals and how the loss of certain itemized deductions for regular income tax calculation may have had little impact on taxpayers already in AMT in prior years. Later, I will also discuss how Congress attempted to equalize non-corporate taxpayers with regular corporations and the tax rate reduction given corporations.