In the second part of our series, we continue to focus on tax planning strategies for individuals with an emphasis on itemized deductions. Every year a taxpayer is able to deduct either the standard deduction or they can choose to itemize their deductions, whichever is greater. The Tax Cuts and Jobs Act (TCJA) significantly increased the standard deduction, which led to many taxpayers no longer itemizing their deductions. The chart below shows the evolution of the standard deduction for taxpayers who are married and filing jointly under the TCJA.
Overall, the TCJA had a significant impact on itemized deductions, whether it be some of the new limitations listed below or the disallowance of miscellaneous itemized deductions. Even with all the changes, there are still some tax planning opportunities you should consider as we reach the end of the year.
State and Local Taxes (SALT) capped at $10,000
One of the more controversial provisions of the TCJA was the $10,000 cap on a taxpayer’s SALT. Previously, a taxpayer was allowed to deduct all of their SALT, which included state income taxes, real estate taxes, and personal property taxes etc. Under the TCJA, that is now limited to $10,000, which is one of the major reason many taxpayers are now utilizing the above standard deduction as opposed to itemizing their deductions. Please note that this SALT cap is related to itemized deductions but does not relate to taxes that might be deducted elsewhere (such as a business reported on Schedule C or rental property reported on Schedule E).
Many states, including Rhode Island, are trying to come up with a workaround by implementing an entity-level tax for pass-through entities. This requires the entity to pay the tax on the net business income, which would potentially allow the entity a Federal deduction for the state taxes paid. There are some concerns if the Internal Revenue Service (IRS) will allow this as a deduction as they have disallowed similar workarounds. For more information on the new Rhode Island entity level tax, please see our previous article: How Might the New Rhode Island Pass-Through Entity Level Tax Impact You?
Other than taking advantage of an entity-level tax, another planning opportunity to maximize a taxpayer’s SALT is to see if the taxpayer can qualify for the “Business Use of Home” deduction. The TCJA disallows this deduction for employees but business owners can still take advantage of it. The deduction could allow a taxpayer to take a portion of the taxes and home mortgage interest that might not be utilized due to the $10,000 cap or the standard deduction increase.
A final tax planning consideration is for taxpayers who have a second residence. A taxpayer may want to consider renting out their second residence in order to take advantage of deducting taxes and interest that might not be utilized due to the $10,000 cap or the standard deduction increase.
Home Mortgage Interest Deduction
TCJA had a significant impact on the deductibility of home mortgage interest. Before the enactment of TCJA, a taxpayer was allowed to deduct interest on qualified acquisition indebtedness, up to $1 million, as well as interest paid on a home equity loan, up to $100,000. The new law reduces the qualified acquisition indebtedness to $750,000 and suspended the deduction of interest on the home equity loan. However, if a taxpayer used the home equity loan to acquire, construct or substantially improve their home they may still be able to deduct the interest.
TCJA included a “grandfathered in” clause where if the taxpayer incurred the acquisition indebtedness prior to December 15, 2017 they can still deduct interest on the acquisition indebtedness up to $1 million. With current interest rates being low, a taxpayer needs to be careful if they plan on refinancing a property. Refinancing a property that is in excess of the $750K won’t automatically subject you to the new rules but you are only allowed to deduct interest on the refinanced loan up to the balance of the old loan immediately before the refinance.
While the enactment of the TCJA did not make significant changes to charitable
contributions, as the end of the year approaches, taxpayers are wondering how they can meet their philanthropic goals and also integrate those goals with their tax planning strategy. One particular strategy is to accelerate charitable contributions into a year in which you anticipate being in a high tax bracket, as the deduction will be more valuable. This strategy can sometimes be achieved by contributing to a Donor-Advised Fund (DAF). A DAF allows the taxpayer to make a charitable contribution to the fund, receive a tax deduction in the year of contribution, and provide flexibility to support the charities that they are interested in either at the time of contribution or in future years.
Another year-end tax planning strategy involves making charitable donations via a qualified charitable distribution (QCD) from your traditional IRA. A QCD is a direct transfer from your traditional IRA to a qualified charity in which the amount transferred to the qualified charity is excluded from taxable income but the amount transferred counts towards satisfying your required minimum distribution (RMDs). As a result of the distribution being excluded from taxable income, you are not allowed an itemized deduction for the charitable contribution. With the TCJA significantly increasing the standard deduction, this direct transfer could be thought of as an above-the-line deduction. The only downfall is that you are not able to implement this strategy until you reach the age of 70 ½.
The TCJA was some of the most significant tax legislation to be introduced in 30 years. Some of the old tax planning techniques are no longer applicable so careful consideration needs to be given to year-end tax planning. Regardless of the changes, it is still important to understand a taxpayer’s complete tax situation not only for 2019 but also for future years. In the next part of our Year-End Tax Planning Series, we will wrap up our individual tax planning strategies before moving on to strategies businesses should consider.
If you have any questions or would like to discuss how these strategies effect your particular situation, please feel free to reach out to one of our tax specialists at Restivo Monacelli LLP.
By: Ron Dean, CPA/MST, Director of Tax Services at Restivo Monacelli, an innovative tax, accounting and business advisory firm with offices in Providence, RI and Boca Raton, FL. As a Certified Public Accountant (CPA) with nearly a decade of experience, Ron leads the firm's prominent tax practice and provides creative tax strategies that ensure compliance, minimize tax burdens and protect clients' income.
In addition to his client-facing role, Ron oversees a team of managers, supervisors, senior and staff accountants, playing a significant role in their training and development. Ron and his team leverage their depth of expertise to deliver forward-thinking tax strategies and solutions to the firm's growing client base.
After earning his B.S. in Accounting from one of the New England's most renowned business schools, Ron launched his career at Restivo Monacelli as a Staff Accountant in 2008 and steadily climbed the ranks to his current position by taking advantage of the firm's numerous growth and development opportunities.