Tax Cuts and Jobs Act: Challenges and Opportunities
March 14th, 2019
Halfway through the 2018 tax filing season we are seeing the fallout of the Tax Cuts and Jobs Act which is now in effect and planned to sunset after 2025. We can now clearly see that the bill impacts employees and homeowners most severely. Corporations, business owners and those employees with a side business either benefit or come away unaffected.
The most devastating loss is for employees who incur unreimbursed employee expenses, as these write offs are no longer allowed at the federal level.
Most impacted are employees such as teachers, actors, public employees who incur union dues, unreimbursed education, supplies, uniforms, mileage and use of home office. Thankfully, many states including CA have not conformed to the new tax bill, permitting these write offs at the state level.
For many employees with high unreimbursed expenses, it is no consolation that the standard deduction has increased to $12,000 for singles, $18,000 for heads of households and $24,000 for married couples filing jointly. These standard deductions can fall far short of the previous years’ itemized deductions when claiming unreimbursed employee expenses was permitted.
The state and local income tax limitation of $10,000 in the itemized deductions calculations impacts homeowners directly.
Many individuals in high income tax states such as CA reach the $10,000 limitation based only on state income taxes. This, in effect negates a write off for property taxes which had been one of the big benefits of home ownership.
Another new provision impacting real estate limits the mortgage interest write off on principal residence loans to only $750,000. This limitation will negatively impact affordability of new home loans. Existing loans, established prior to 2018 are grandfathered to the $1,00,000 level.
The TCJA has also eliminated personal exemption deductions which formerly permitted a $4050 deduction for each member of the household. This provision has been replaced by an increased $2000 tax credit for children under 17 years of age and a $500 credit for other dependents. This trade-off is unfortunate for households with children 17 years of age or older and other dependents. The trade off does not work out in their favor.
Taxpayers affected by one or more of these provisions that in essence raised their taxes are facing another surprise in the form of lower federal withholdings. The payroll formulas used for withholding shifted down, assuming everyone would get a tax cut. This adjustment increased periodic paychecks marginally, but has left many taxpayers with significant under-withholding at tax time. The combination of higher taxes and under-withholding has been the recipe for unpleasant year-end tax surprises.
Everyone has benefitted from lower tax brackets.
The tax brackets which depend on filing status and income have shifted downward. Paired with the virtual elimination of the AMT tax, this combination has helped taxpayers who have been otherwise negatively affected. If you were impacted by the AMT tax in the past, be sure to check for an AMT credit in 2018. It depends on your personal situation whether the AMT “elimination” and the downward shift of the tax brackets can offset the loss or limitation of deductions.
On the other hand, corporations, business owners and those employees with a side business have lost very few deductions and they have benefitted from lower 21% corporate tax rates and the new 20% Qualified Business Income Deduction. Corporations and business owners have lost only one noteworthy deduction for entertainment expenses. You can no longer write off meals and entertainment, only meals.
Most business owners will benefit from a provision that was implemented to provide comparable tax relief as that provided to corporations. The Qualified Business Income Deduction for flow through entities, sole proprietors and owners of actively managed investment property reduces your net taxable income by 20% if your total individual income falls within certain ranges. The deduction begins to phase out for taxable income above $157,000 or $315,000 for joint filers. Make sure you factor these limitations into your tax planning for 2019 and beyond.
The TCJA favors corporations, business owners and the self-employed.
Unlike the employee who has lost the ability to write off unreimbursed employee expenses and possibly face state and local income tax limitations, corporations and business owners have lost little and gained enormous tax relief.
Employees are left with a couple of tax planning tools. One opportunity is to join the business owners by setting up a side business. In order to write off expenses against that entity you must operate with the intent to generate income. This side business must rise above being a hobby, otherwise you will be allowed to write off expenses only to the extent of earnings. There are several ways to operate a business, including in your name, under a fictitious business name or through a state registered entity. Each of these methods of operating have their own advantages and disadvantages. We are available for tax planning to review the most appropriate business structure.
Do not forget retirement planning and other pre-tax contributions.
There may still be opportunities for you to fund deductible retirement plans or health savings accounts for 2018. These last-minute contributions can mitigate taxes and help you to accumulate wealth for retirement. Be sure to review your pre-tax retirement, health savings account and child care funding opportunities for 2019.
Reduced Withholdings & Tax Liabilities
Finally, if your reduced withholdings create significant tax liabilities, we can help you to adjust your exemptions to avoid a high tax payment or underpayment penalties next tax season.
The TaxPlus Team