Itemized Deductions

By: Carlos Nazario CPA, JD, Tax Director at Millan and Co, PC, Austin, TX. April, 2019. carlos@millancpa.com

Tax Cuts and You

Itemized deductions vs. standard deduction

The Tax Cuts and Jobs Act or “TCJA” of 2017 made multiple changes to the individual income tax, including changes limiting significantly the itemized deductions and increasing the standard deduction.

Itemized deductions are expenses allowed by the IRS that can decrease your taxable income. The standard deduction is a flat-dollar, no-questions-asked reduction in your taxable income. You can either take the standard deduction or itemize on your tax return. You can’t do both. The question is which method saves you more money by reducing the tax.

The standard deduction for married filing jointly increased from $12,700 to $24,000 from 2017 to 2018. The standard deduction for singles increased from $6,350 to 12,000 from 2017 to 2018.

The Tax Cut and Jobs Act (TCJA) changed materially the 1040 itemized deductions for 2018 in the following manner:

Deduction for personal casualty and theft losses suspended (unless incurred in federally-declared disaster area)

Limitations to the deduction for state and local taxes

Limitations to the deduction for home mortgage interest in certain cases

Eliminating most miscellaneous itemized deductions such as:

Deductions for employee business expenses

Tax preparation fees

Investment expenses, including investment management fees

Employment related educational expenses

Job search expenses

Hobby losses

Safe deposit box fees

Investment expenses from pass-through entities

Eliminated the limitation on itemized deductions for certain high-income taxpayers.

Limitations to the deduction for state and local taxes

If you itemize deductions on Schedule A, your total deduction for state and local income, sales and property taxes is limited to a combined, total deduction of $10,000 ($5,000 if married filing separately).

You have the option of claiming either state and local income taxes or state and local sales taxes (you can’t claim both). If you saved your receipts throughout the year, you can add up the total amount of sales taxes you actually paid; however, your deduction is limited to $10,000 ($5,000 if married filing separately) for a combined, total of state and local income, sales and property taxes.

Limitations to the deduction for home mortgage interest in certain cases

There are limitations on the deduction for home mortgage interest based in dollar limits of the mortgages you (or your spouse if married filing a joint return) took out after October 13, 1987, and prior to December 16, 2017, to buy, build, or substantially improve your home (called home acquisition debt), but only if throughout 2018 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately). Also, mortgages you (or your spouse if married filing a joint return) took out after December 15, 2017, to buy, build, or substantially improve your home (called home acquisition debt), but only if throughout 2018 these mortgages plus any grandfathered debt totaled $750,000 or less ($375,000 or less if married filing separately). These dollar limits apply to the combined mortgages on your main home and second home.

The state and local tax (SALT) deduction has been one of the largest federal tax expenditures, with an estimated revenue cost of $100.9 billion in 2017. The estimated revenue cost for 2018 drops to $43.1 billion because the Tax Cut and Jobs Act (TCJA) significantly increased standard deduction amounts (thereby reducing the number of taxpayers who will itemize deductions) and capped the total SALT deduction at $10,000.

State and local taxes have been deductible since the inception of the federal income tax in 1913. Initially, all state and local taxes not directly tied to a benefit were deductible against federal taxable income. In 1964, deductible taxes were limited to state and local property (real and personal property), income, general sales, and motor fuels taxes.

Congress eliminated the deduction for taxes on motor fuels in 1978, and eliminated the deduction for general sales tax in 1986. It temporarily reinstated the sales tax deduction in 2004, allowing taxpayers to deduct either income taxes or sales taxes but not both. Subsequent legislation made that provision permanent starting in 2015. Starting in 2018, taxpayers cannot deduct more than $10,000 of total state and local taxes. That provision of the law is scheduled to expire after 2025.(1)

Example #1 of itemized deductions before and after the TCJA

Old Law TCJA
State taxes paid $11,000 $10,000
Mortgage interest 4,000 4,000
Charitable contributions 500 500
Itemized deductions 15,500 14,500
Standard deduction 12,700 24,000
Max. deduction 15,500 24,000
Item. Std.

In the example #1 the old law provided for more itemized deductions than the TCJA, since the state taxes paid were not limited to $10,000. Nevertheless, under TCJA the standard deduction is greater than the itemized deductions even with the new limitations. The TCJA is therefore promoting the use the standard deduction which will make easier to prepare and audit future income tax returns.

What to expect

TCJA changes are expected to simplify the individual income tax return of 2018 for millions of households, as 28.5 million filers would be electing taking the newly expanded standard deduction, instead of itemizing various deductions, reducing compliance costs.

The Internal Revenue Service estimates the average time to complete an individual tax return will decrease by 4 to 7 percent. Converting this to dollar terms, compliance savings could range from $3.1 billion to $5.4 billion.

In all, the Joint Committee on Taxation (JCT) estimates that the number of itemized filers will decline from 46.5 million in 2017 to just over 18 million in 2018, implying that nearly 30 million households will now find it more advantageous to take the standard deduction. In total, now 88 percent of filers will use the standard deduction to complete their taxes.(1)

Other relevant considerations

TCJA will discourage the purchase of a house, since the standard deduction will usually be greater than all the itemized deductions in most cases and any mortgage interest paid will not be used as a deduction.

The 2017 Tax Cuts and Jobs Act increased standard deduction will discourage charitable giving by reducing the number of taxpayers claiming a deduction for charitable giving and by reducing the tax saving for each dollar donated.

The Urban-Brookings Tax Policy Center estimates that TCJA will shrink the number of households claiming an itemized deduction for their charitable gifts from about 37 million to about 16 million in 2018, and reduce the federal income tax subsidy for charitable giving by one-third, from about $63 billion to roughly $42 billion. Overall, the TCJA will reduce the marginal tax benefit of giving to charity by more than 30 percent in 2018, raising the after-tax cost of donating by about 7 percent. Unless taxpayers increase their net sacrifice—that is, charitable gifts less tax subsidies—charities and those who benefit from their charitable works, not the taxpayers, will bear the brunt of these changes.(1)

New 2018 1040

There are several changes to the 2018 Form 1040. However, taxpayers who file electronically may not notice the changes as the tax return preparation software guides people through the filing process.
The IRS worked closely with its partners in the tax return preparation and tax software industries to prepare for tax reform and tax form changes affecting tax year 2018, including the Form 1040. This ongoing collaboration ensures that taxpayers can continue to rely on the IRS, tax professionals and tax software programs when it’s time to file their tax returns.

Here are five things taxpayers need to know about the 2018 Form 1040.

  1. The 2018 Form 1040 replaces Forms 1040,1040A and 1040EZ with one 2018 Form 1040 that all taxpayers will file. The 1040 layout changed significantly.
  2. Forms 1040A and 1040EZ are no longer available. Taxpayers who used one of these forms in the past will now file Form 1040.
  3. The 2018 Form 1040 uses a “building block” approach and allows taxpayers to add only the schedules they need to their 2018 tax return.
  4. The most commonly used lines on the prior year form are still on the form. Other lines are moved to new schedules and are organized by category. These categories include income, adjustments to income, nonrefundable credits, taxes, payments, and refundable credits.
  5. Many taxpayers will only need to file Form 1040 and no schedules. Those with more complicated tax returns will need to complete one or more of the 2018 Form 1040 Schedules along with their Form 1040. These taxpayers include people claiming certain deductions, credits or owing additional taxes.

Electronic filers may not notice any changes because the tax return preparation software will automatically use their answers to the tax questions to complete the Form 1040 and any needed schedules.

For taxpayers who filed paper returns in the past and are concerned about these changes, this year may be the year to consider the benefits of filing electronically. Using tax software is convenient, safe and a secure way to prepare and e-file an accurate tax return.(2)

Please contact our Tax Director Carlos Nazario carlos@millancpa.com to discuss how to maximize your 2018 deductions. At Millan and Co. we are business consulting CPAs who can help you in your income tax preparation and overall tax compliance.

Notes: (1) From Tax Policy Center, (2) From IRS notices.

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