Posted by Alicia Waltenberger and Shelly Eweka on Jan 4, 2019 6:45:00 AM
The Tax Cuts and Jobs Act of 2017 could have a major impact on the way you approach your tax return in 2018. It is expected that millions of taxpayers who itemized deductions in 2017 will be better off taking the standard deduction for 2018 returns. Our tax experts Alicia Waltenberger and Shelly Eweka explain why.
Alicia Waltenberger: Overall, income tax rates have decreased—easing the tax burden, somewhat, for most working Americans. For example, if you are single and earned $50,000 in taxable income last year, your marginal tax rate will now be 22% rather than 25%. If you made $100,000, your marginal tax rate has dropped to 24% (down from 28% in 2017). This doesn’t mean that all of your income will be taxed at that rate. The first $9,525 will be taxed at 10%, the next $29,174 at 12%, and so on, as shown below:
These reduced rates do not necessarily mean that you will receive a larger tax break this year. For instance, your taxable income may have shot up, compared to last year—even if your salary remained the same. In other words, you might not be able to deduct as much as before.
When filing your tax return, the IRS allows you to reduce your taxable income by either claiming the standard deduction or by itemizing your deductions (where you add up everything you spent on tax-deductible expenses throughout the year, including charitable donations, mortgage interest payments, and state taxes). For example, if you live in a state with high state and property taxes, you might have gotten a nice big deduction for that in the past. While you can still claim an itemized deduction for state and local taxes, the amount is now capped at $10,000. So, if you are used to deducting significantly more than that, you will take a hit on the deduction side. The mortgage interest deduction is still allowed, but you can only claim it for mortgages up to $750,000 (in 2017, it was up to a million dollars) or $375,000 if you are married filing separately.
The good news is that the standard deduction has nearly doubled—it’s now $24,000 for married couples filing jointly and $12,000 for single taxpayers or married people filing separately. So, while you may have taken advantage of itemizing in the past, it may make more financial sense for you to take the standard deduction this year. Whether you end up with a smaller tax bill overall depends on how much you used to itemize (and no longer can). If, like most taxpayers, you’ve always taken the standard deduction (or you previously itemized an amount less than the new standard deduction), you stand to benefit from the new law.
Shelly Eweka: Don’t count on paying less in taxes. A lot of people are understandably delighted to see their income tax rates going down slightly—and the standard deduction going up massively. But for those of us who don’t normally take the standard deduction route, opting to itemize property taxes and other deductions instead, there’s uncertainty as to how much of a tax cut (if any) we’ll end up getting.
If you are in the habit of deducting a significant amount on your tax return, I encourage you to have a tax advisor give you an overview of your unique circumstances. Since I just sold both my rental property and my primary residence, I needed to get a tax specialist to help me navigate the complex tax implications, because the rulebook has changed so radically. One precautionary step I took last year was to increase my federal withholding drastically (I would rather owe them a little than a lot when tax season comes around).
As 2019 begins, it isn’t too late to go over last year’s finances with a tax expert. Online tools may be less expensive to use, but if you’re an itemizer, they might not give you as sophisticated a tax projection as you need. With fewer deductions available, it’s extra important that you keep track of expenses that are potentially deductible, from education to side business costs. Before-tax retirement plan contributions remain a surefire way to slash your taxable income—maxing them out should become a priority going forward.
To itemize or not to itemize: You may not know until tax time whether it makes more financial sense to take the standard deduction instead.