How the Tax Cuts and Jobs Act (TCJA) May Impact You
So, you think your 2018 tax refunds will be bigger and better with the new tax law? Hold up ...
The Tax Cuts and Jobs Act (TCJA) ushered in immediate tax relief for W-2 workers in the form of reduced withholding from paychecks. For the self-employed, we were excited about the prospect of a tax deduction of up to 20 percent of our earnings. On top of all of that, the standard deduction was nearly doubled. Surely we will pay less in taxes for 2018, we thought. But, not so fast - as with most things, there's a catch. It may be time for a last-minute tune-up. Here's why:
When the TCJA went into effect, the IRS scrambled to create a new tax-withholding table to be used by payroll departments. All W-2 workers saw immediate tax relief with each paycheck. However, the withholding calculations did not factor in each employee's individual situation. As a result, your withholding might not be enough to generate the refund you are hoping to receive. Read on.
For those of us who live in higher-tax states, our deductions are severely limited under the TCJA. Beginning in 2018, we are limited to a $10,000 itemized deduction for state and local taxes, which includes income taxes and real estate taxes. In prior years, we were allowed to take an itemized deduction for 100 percent of these taxes. For many taxpayers, and especially for New York City residents, the deduction could be severely limited.
While the standard deduction has increased to $12,000 for single filers and $24,000 for "married filing jointly" filers, the additional personal exemption was eliminated. The former personal exemption, though subject to a phase-out for higher incomes, was allowed in addition to the higher of your standard deduction or itemized deductions.
For illustrative purposes, check out the following examples of how your deduction may actually be smaller than in previous years:
A New York City resident, filing single with no dependents, pays $25,000 in New York/NYC income taxes and real estate taxes combined, $7,500 in mortgage interest, and $500 in charitable donations. Total itemized deductions are $33,000.
In 2017, this taxpayer would have taken a $33,000 itemized deduction, and an additional $4,050 personal exemption, for a total deduction of $37,050 (assuming no phase-out of the personal exemption).
In 2018, the state and local income tax deduction cap is $10,000 and there is no personal exemption. Now, the total deduction is $10,000 + $7,500 + $500, for a total of $18,000. The deduction is reduced by $19,050 from the prior year.
Now, consider the same scenario for a couple filing jointly, with one child:
In 2017, total deductions would have been $33,000, plus an additional $12,150 in personal exemptions, totaling $45,150.
In 2018, the total itemized deductions are limited to $18,000. Instead, these taxpayers will take the higher standard deduction of $24,000. However, the overall deduction is reduced by $21,150 from the
prior year.
As you can see in both examples above, the taxpayers will be taxed on much more income than in previous years.
What about self-employed workers? Recall that we previously released an article about the "qualified business income" (QBI) deduction of up to 20 percent of self-employment income. As noted, there are complicated calculations involved, and the TCJA imposes many layers of limitations on the actual deductible amount. It is safe to say that a large number of taxpayers will see less than 20 percent or no QBI deduction at all.
Although there are situations in which taxpayers may see some tax relief for tax year 2018, especially with the overall lower tax rates, there are many who are in for a surprise.
What to do now? Walls Financial Group recommends an end-of-year checkup as soon as possible. We can provide you with an up-to-date income tax projection for $90, so you have a better idea of what your 2018 tax liability or refund will be. We can recommend some measures to mitigate any shortfalls in withholding or tax payments, and help you reduce potential interest and penalties for underpayments.
--Brian Walls, Walls Financial