Last week, we discussed the current tax reform proposal in Washington and discussed how it would reduce incentives for homeowners two ways: by increasing the standard deduction and by eliminating the deduction for state and local taxes, including the deduction for property taxes. Recall that itemized deductions only are a benefit if they exceed the amount of the standard deduction, currently $6,350 single or $12,700 married.
While the legislation has yet to be finalized, it appears increasingly likely that we are on the eve of the most significant tax changes in 30 years. The proposals are slated to take effect in 2018, which means that if they are approved, there is still several weeks in 2017 to make use of the old rules.
For many Americans, your taxes will be lower under the current proposal. The biggest tax cuts, however, would go to corporations, with a proposed reduction from 35% to a maximum of 20%. That’s the proposal, but the final version may be different. The advice below is based on the current GOP plan; we would not advocate taking any steps until the reforms are in their final version and passed.
1. Itemized Deductions. The proposal would increase the standard deduction from $6,350 (single) and $12,700 (married) to $12,000 and $24,000. As a result, it is believed that instead of 33%, the number of taxpayers who itemize will fall to only 10%. If you have itemized deductions below $12,000/$24,000, you will no longer receive any benefit from those expenses in 2018.
- Consider accelerating any tax deductions into 2017, such as property taxes, charitable donations, or unreimbursed employee expenses.
- Itemized deductions for casualty losses, gambling losses/expenses, and medical expenses will be repealed.
- Many miscellaneous deductions will disappear, including: tax preparation fees, moving for work (over 50 miles), and unreimbursed employee expenses.
- Investment advisory fees, such as those I charge to clients, will still be tax deductible. However, these miscellaneous deductions only count when they exceed 2% of AGI, which will be more difficult to achieve with so many other deductions disappearing.
- The $7,500 tax credit for the purchase of a plug-in electric vehicle will be abolished. If you were thinking of buying a Chevy Bolt or Nissan Leaf, better do so now! If you are on the wait list for a Tesla Model 3, you probably will not receive one before the credit disappears. Read more: “Is Your Car Eligible for a $7,500 Tax Credit?”
2. Real Estate. The Senate version we discussed last week had completely eliminated the deduction for property taxes and state/local taxed paid. Luckily, this has been softened to a cap of $10,000 for property taxes.
- If your property taxes exceed $10,000, you might want to pay those taxes in December as part of your 2017 tax year. If you pay in January 2018, you would not receive the full deduction.
- The proposal also caps the mortgage interest deduction to $500,000, and for your primary residence only. This is a substantial reduction. Currently, you can deduct interest on a mortgage up to $1 million, and you can also deduct mortgage interest on a second home, including, in some cases, an RV or yacht.
- Many owners of second homes will likely try to treat these as investment properties, if they are willing to rent them out. As a rental, you can deduct taxes and other costs as a business expense. See my article: “Can You Afford a Second Home?”
3. Tax Brackets. The proposal reduces the tax brackets to four levels: 12%, 25%, 35%, and 39.6% (the current top bracket remains). These brackets are shifted to slightly higher income levels, so many taxpayers will be in a lower bracket than today or pay less tax. Those in the top bracket, 39.6%, who also make over $1 million, will have their income in the 12% range boosted to the 39.6% level. So don’t think this proposal is excessively generous to high earners – many will see higher taxes.
The Alternative Minimum Tax (AMT) will be abolished, so if you have any Minimum Tax Credit carryforwards, those credits will be released. The 3.8% Medicare Surtax will unfortunately remain in place, even though Trump has previously promised to repeal it. Capital Gains rates will remain at 0%, 15%, and 20% depending on your tax bracket, and curiously, these rates will be tied to the old income levels, and not to the new tax brackets.
If passed, the tax reform bill will substantially change how we deduct expenses from our taxes. Those with simple returns may find that their tax bill is lower, but for many investors with more complicated tax situations, the proposed changes may require that you rethink how you approach your taxes.
We will keep you posted of how this unfolds and will especially be looking for potential ways it may impact our financial plans. It has often been said that the definition of a “loophole” is a tax benefit that someone else gets. Unfortunately, simplifying the tax code and closing these deductions is bound to upset many people who will see their favorite tax benefits reduced or removed entirely.