Changes to the Deductions
On individual income tax returns, taxpayers are able to deduct the standard deduction or itemized deductions. Itemized deductions include things like medical expenses, state income taxes and real estate taxes, mortgage interest, and charitable contributions, among others. The standard deduction for the 2017 tax year was $12,700 for joint filers, $9,350 for heads of household, and $6,350 for singles and married taxpayers filing separately. Many taxpayers have benefited from deducting itemized deductions instead of using the standard deduction.
The TCJA nearly doubles the standard deduction to $24,000 for joint filers, $18,000 for heads of household, and $12,000 for singles and married taxpayers filing separately. These figures will be indexed for inflation after 2018. Given these increases, many middle income taxpayers who previously used itemized deductions will likely use the standard deduction because it will exceed the total of their itemized deductions.
Also, the new law suspends the deduction for personal exemptions. Therefore, starting in 2018, taxpayers can no longer claim personal or dependency exemptions. For 2017, if a taxpayer’s adjusted gross income (AGI) was less than $156,900, a deduction of $4,050 per exemption was allowed (e.g., family of 4 with AGI of less than $156,900 would receive a deduction of $16,200).
The TCJA has essentially combined the previous standard deduction and personal exemptions deduction into the higher standard deduction. This will be beneficial for some but many taxpayers will find themselves with higher taxable income as a result of the changes to these deductions. For instance, this combination will most likely be beneficial for single or joint filers with no dependents who previously used the standard deduction or who previously itemized but did not exceed the standard deduction by a drastic amount. However, this combination will most likely not be beneficial for joint filers with 3 or more exemptions.
Tax Planning Opportunities
So what should you do to plan for these changes under the TCJA? “Bunching” expenses is a common tax strategy that can be utilized to cause itemized deductions to be larger than the TCJA’s increased standard deduction for a year. This strategy is recommended for taxpayers who could have itemized for 2018 and on if the tax law had remained the same. This strategy involves paying for controllable expenses in alternating years to essentially group two years’ worth of expenses into one tax year. Examples are:
- Make minimal charitable contributions in 2018 with plans to make two years’ worth of charitable contributions in 2019.
- Incur minimal medical expenses in 2018 with plans to purchase eyeglasses and/or contact lenses, purchase hearing aids, incur major dental work, and/or incur an elective surgery in 2019. Note that under the new law (TCJA), for 2017 and 2018, medical expenses are deductible to the extent they exceed 7.5% of adjusted gross income for all taxpayers. Previously, the AGI “floor” was 10% for most taxpayers.
This strategy will not work for everyone and will only be beneficial for those who incur significant expenses of these types or whose total itemized deductions are close to the standard deduction amounts.