"You must pay taxes. But there's no law that says you gotta leave a tip." – Morgan Stanley advertisement
The Tax Cuts and Jobs Act is the most significant set of changes to the U.S. tax code in several decades. The vast majority of the changes go into effect for the 2018 tax year, which is the return that you'll file with the IRS in the spring of 2019.
These changes, which are mandated by the new tax legislation for individual filers, are set to expire in 2025, unless they get extended. (Corporate changes made by the new law are permanent.)
Which tax deductions are gone?
› Moving expenses — This was an above-the-line deduction, meaning that it could be taken whether or not a taxpayer itemized, and was designed to offset the costs of job-related moving expenses. Now, this deduction is gone, except for certain moves related to active-duty military service.
› Casualty and theft losses — If your home was burglarized, you formerly were able to deduct the value of the stolen items. Now, the deduction only can be used for losses attributed to a federally declared disaster.
› The “miscellaneous deduction” category — This is one true simplification to the tax code. There used to be a long list of deductions that Americans could take advantage of, to the extent that they exceeded 2% of AGI. This included things like unreimbursed employee expenses, tax preparation expenses, and more. Starting with the 2018 tax year, these deductions are gone, so some taxpayers with lots of these expenses may feel the sting from this.
Tax brackets — Still seven, but with different rates
While the number of tax brackets remained at seven, the rates were generally lowered, with the exception of the minimum tax rate staying at 10 percent for the poorest Americans.
In addition to lower tax rates, the income thresholds were increased, particularly at the higher tax brackets. In other words, the highest tax brackets now apply to fewer (higher-earning) Americans than it did previously. For example, before the passage of the Tax Cuts and Jobs Act, the top tax rate was 39.6 percent and applied to married couples filing jointly who earned more than $480,050. With tax reform, that top rate was lowered to 37 percent and only applies to married couples making more than $600,000 in taxable income, much more income than before.
Higher standard deduction
The new tax law nearly doubles the standard deduction from previous levels. For a single taxpayer, the standard deduction rises from $6,350 for 2017 income up to $12,000 for 2018 income and $12,200 for 2019 income. For married couples, the standard deduction rises from $12,700 in 2017 to $24,000 in 2018 and $24,400 in 2019.
Taxpayers can choose between using the standard deduction or itemized deductions. Itemizing deductions means adding up all of the individual tax deductions to which you're entitled and then subtracting them from your adjusted gross income. But with the higher standard deduction, the IRS estimates 28.5 million filers would be better off taking the newly expanded standard deduction, instead of itemizing various deductions
Historically, about 70 percent of individual tax returns used the standard deduction, while the other 30 percent found it more beneficial to itemize. For 2018 and beyond, experts have projected that roughly 95 percent of individual tax returns now will utilize the standard deduction.
The personal exemption is gone
While the standard deduction has increased, the personal exemption has gone away in an attempt to simplify the tax code. Instead of giving taxpayers a standard deduction and a number of exemptions, the new tax law effectively combines the two into a higher standard deduction.
In the 2017 tax year, each personal exemption was an effective $4,100 tax deduction. Although the higher standard deduction will help most taxpayers, it could hurt those with large families who previously were able to make exemptions for each dependent in the family.
The Child Tax Credit has doubled
The repeal of the personal exemption if offset, to some degree, by a higher Child Tax Credit, which was doubled to $2,000 per qualifying child under age 17.
As much as $1,400 of this amount is refundable — meaning that it can be claimed even if the taxpayer's federal income tax liability is already zero. So even if a parent has little income or otherwise owes no federal income taxes, they could still take advantage and get this money back.
Additionally, the income phase-out thresholds are significantly higher than the previous levels, which makes the credit available to far more Americans than in previous years.
Expanded use of 529 savings plans
The two main college savings accounts, 529 savings plans and Coverdell Education Savings Accounts, or ESAs, provide a tax-advantaged way for parents and other relatives to save and invest money for educational expenses such as tuition, fees, books, and certain other qualifying expenses. While there's no deduction for contributions to these accounts on federal tax returns, any money these accounts earn from investments can be withdrawn tax-free when used for a qualified expense.
The new law allows 529 savings plans to be used for qualifying educational expenses at any level, not just for college. This was already the case with Coverdell ESAs. So if you end up sending your child to a private high school, you could potentially use funds from their 529 savings plan to help pay for it.
Mortgage interest deduction capped
The deduction for mortgage interest is one of the most popular U.S. tax breaks. The tax break for home buyers survived the tax reform changes, but it is now more limited.
The total deduction allowed has been reduced to the interest on up to $750,000 of qualified residence debt, or mortgage principal on a primary or secondary home. This is down from the previous limit of $1 million, although mortgages obtained before December 15, 2017 are grandfathered in to the higher limit.
Second, the previous additional limit that allowed taxpayers to deduct interest on as much as $100,000 of home equity debt has been eliminated. Interest on a home equity loan (such as a HELOC) may still be used as a deduction, but if and only if the loan was used to substantially improve your home. In this case, it becomes qualified residence debt and is counted as part of your $750,000 cap.
The medical expense deductions lower
The new tax law lowered the threshold for medical expense deductions to 7.5 percent of income from the prior threshold of 10 percent. So a taxpayer with an adjusted gross income of $100,000 can now deduct medical expenses exceeding $7,500. The IRS has a long list of expenses that qualify as "medical expenses," so it can be a good idea to start keeping track of yours if you think you may qualify.
However, this change only was made for the 2017 and 2018 tax years. Beyond that time, the threshold is set to increase to 10 percent again unless Congress acts to extend it.
State and local tax deductions
The biggest tax deduction by dollar amount that Americans have taken advantage of in recent years is the deduction for state and local taxes that taxpayers take for property, sales, income and other taxes paid to municipalities, counties and state government.
Starting with the 2018 tax year, the deduction for state income or state sales taxes is capped at $10,000. Since Tennessee is one of the lowest per capita states for taxes in the nation, Tennesseans won't be hit as hard by this change as those living in high tax states.