I frequently recommend to my clients with complicated tax situations to do a summertime checkup to see if they are paying sufficient amounts through withholding or estimated payments in order to avoid a negative surprise at tax time. This year that activity is especially important because of the various changes made to the tax law last December. Because tax rates dropped for virtually everyone, nearly all wage earners are having less federal withholding from their pay than last year. However, not all taxpayers will see an overall reduction in their tax liability for 2018. Tax rates dropped and there are some new and expanded tax credits, but some deductions also went away. The standard deduction nearly doubled, exemption allowances were eliminated, the child credit was expanded and there is a new credit for all other dependents that don’t qualify for the child credit.
The IRS has a calculator available to help people in determining the correct number of withholding allowances to claim on their W-4 forms. I have heard various complaints about the limitations of this IRS tool, but it works well for fairly simple situations. If you have multiple sources of income or other factors that make it more difficult to estimate your tax liability, you probably should consult with a competent tax advisor such as an Enrolled Agent to help you with this task. Proper tax planning can avoid that negative surprise when you file your taxes next spring.
Many health professionals recommend limiting our salt intake but to tax professionals, SALT limits have a different meaning. SALT refers to State and Local Taxes which have been deductible for many taxpayers in the past but are now limited to a maximum of 10,000 dollars under the new tax reform passed last December. There are a large number of taxpayers who won’t be affected by this limitation but for high earners especially in high tax states such as California, this could amount to a significant change to their tax liability going forward. However, many people with 6 figure incomes end up paying the AMT (Alternative Minimum Tax) and the new tax bill grants some relief from AMT.
So, what is AMT? The minimum tax was originally enacted in 1969 and has evolved into what is now called the Alternative Minimum Tax. Congress was concerned that there were some high income earners who were ending up paying absolutely no income tax because they were taking advantage of so many tax breaks that they were completely eliminating their tax liability. The AMT is a parallel tax system that eliminates most deductions and credits available for income tax purposes and calculates the tax due under AMT rules. Then you compare the amount due under both methods and pay the higher of the two amounts. State and local income taxes are deductible in calculating income tax but not for AMT.
Married couple makes a little over 224,000 per year and pays roughly 12,000 in property taxes and 22,000 in state and local taxes. For 2017 they ended up with a federal income tax liability of just over 30,000 dollars and an AMT of a little over 5,000 dollars for a total tax liability over 35,000. For 2018 using these exact same figures the clients would owe slightly over 35,000 in income tax but no AMT. In this case their tax liability dropped by 19 dollars.
Another couple made roughly 485,000 in 2017 and had a SALT deduction of just over 64,000. For 2018, the SALT deduction is limited to only 10,000 but they also get significant relief from AMT. Their total federal tax liability will increase by just under 400 dollars.
As the income level rises, the benefits of the AMT reduction tend to diminish so if your income is high enough, the SALT limitation could cause a significant increase in federal tax liability. If you have concerns about how this new change will affect your individual situation you can contact us or a competent tax professional such as an Enrolled Agent in your local area.
During the 2018 tax season one of the most common questions I got from clients had to do with whether they will lose their mortgage interest deduction in 2018. Many of them had heard incorrect information about what is changing and not changing in the new law.
Under the new law, the limit for acquisition indebtedness does not change on any existing mortgage, but for new mortgages the limit for acquisition indebtedness has dropped to 750,000. As under the old law, you can still deduct interest on up to two personal residences as long as the total acquisition debt for the two does not exceed the 750,000 limit.
Equity interest, on the other hand, is no longer deductible. It’s important to remember that what determines whether a mortgage loan is deductible under the new law is how the funds were spent and not the title of the loan. For example: let’s say that you have a 500,000 balance on your mortgage and then you take out an equity line of credit and borrow an additional 30,000. Let’s say you spend the 30,000 to remodel your home. In that case the 30,000 spent would qualify as acquisition indebtedness and would be fully deductible. If you then borrow another 30,000 on that same line of credit and take a vacation with the funds, the interest on that 30,000 is not deductible under the new law.
If you are confused about any provisions in this new law, we would be happy to answer your questions regarding how it will impact your individual situation.
Last fall congress passed a tax bill granting special tax relief for anyone who suffered a casualty loss as a result of the devastating hurricanes that impacted the US in 2017. In the budget deal agreed to last month, congress has finally extended those same benefits to victims of the California wildfires.
The special tax benefits have to do with being able to deduct a personal casualty loss. Normally, to deduct a casualty loss you must itemize deductions, the loss has to exceed 10% of adjusted gross income and you then subtract a 100 deductible from the loss. Here’s an example: let’s say your adjusted gross income is 100,000 and you sustain an economic loss from a casualty of 11,000 dollars. You would first deduct 10% of AGI or 10,000 and then you would subtract 100 as a deductible so your loss would be 11,000 – 10,000 – 100 = 900. This 900 would only be a deduction if you itemize deductions on Schedule A.
The special rule for deducting a casualty loss due to the wildfires is that you don’t have to deduct 10% of AGI and you can take the casualty loss whether or not you itemize deductions. However, the 100 deductible is raised to 500. So, if the above 11,000 loss occurred as a result of a California wildfire or the 2017 hurricanes you would now calculate the loss as follows: 11,000 – 500 = 10,500 as a deductible casualty loss. This loss can be taken as an itemized deduction or for those who don’t itemize deductions, the deduction would be added to your standard deduction.
Another important point to remember about casualty losses is that there must be an actual economic loss. In other words, if you were reimbursed for your loss fully by insurance, you have not sustained an economic loss. There are a couple of other tax breaks associated with casualty losses that occur in any federally declared disaster area. For any questions on how to deal with this situation, you can contact us or a competent tax professional such as an Enrolled Agent in your area.