The weeks leading up to April 15th often are filled with anticipation and one looming question - will I have to stroke a check to the IRS or will I receive a welcomed tax refund? Oftentimes, it's not until the email or call is received from your CPA that the anxiety produced by tax season begins to subside.
As we near the tax filing "home stretch," we wanted to suggest that in this first year of the Tax Cuts and Jobs Act, you may want to brace yourself for some surprises. While many provisions of the Act were designed to reduce overall income taxes, other aspects of the new laws could actually cause that number to go up. If that unwelcome surprise happens to you, here's a list of possible explanations:
Anyone involved in tax preparation faced numerous delays in the rollout and understanding of how the new tax provisions were applied. These delays impacted the availability of the tax withholdings tables used to guide payroll deductions.
Withholdings approximate your expected tax liability and, as such, need to incorporate expected changes in tax rates and tax brackets. With the new law officially enacted on December 22, 2017, and 2018 withholdings starting January 1, 2018, it's no wonder that the tables initially issued by the IRS in early 2018 were incorrect. The result is that many employees are just now learning they've been under withheld for the entire year. Even if your total tax owed is less because of the new tax code and brackets, you could end up owing money if you underestimated your withholdings. Remember, that isn't necessarily bad news because it means you kept more of your money throughout the year rather than "loaning" it interest free to the IRS! Also, the IRS has waived underpayment penalties for all individuals who have at least 80% of their total tax withheld in 2018.
Harkening back to the days when this tax reform was debated in Congress, one of the stumbling blocks to passage was that some lawmakers viewed the bill as overly focused on benefitting the rich. It's true that taxpayers formerly in the top tax bracket of 39.6% in 2017 were granted a significant potential benefit when the top bracket was reduced to 37% for 2018. That means single filers who made more than $500,000 and couples with income above $600,000 in 2017 saw their marginal bracket decline from 39.6% to 37%.
As a single tax filer myself, I noticed that unmarried taxpayers may actually suffer "bracket creep" that may translate into a higher tax liability in 2018. For example, if you're a single person making over $157,500, in 2017 your marginal tax bracket was 28%; whereas in 2018 your marginal bracket increases to 32% at that same level of income. Interestingly, if we look at a married couple with taxable income of $165,000, their 2017 bracket was 28%. Unlike their single counterparts, the couple would have the good fortune of moving into the 24% bracket for 2018.
While it's true that the standard deduction for single taxpayers nearly doubled, the increase to $12,000 may not necessarily compensate for the effects of bracket creep on single taxpayers. This is one reason to pay attention to your deductions and manage your income by accelerating or deferring bonuses or commissions with an eye on these new brackets.
State and local income taxes (SALT) are deductible and helpful in reducing your total taxable income. Property taxes that you pay on your home are also included in this deduction. In prior years, you may have chosen to pull ahead your property tax payment into December in order to take the deduction in that tax year. Now that the new tax law caps this deduction at $10,000, there may not be a benefit in pre-paying property taxes. Many have argued this unduly punishes taxpayers in high income tax and high property tax regions like New York City. If this change affects you, you're not alone. Nearly 11 million people are expected to be affected by this new cap. While it may be too early to understand all the implications, real estate brokers in these higher tax regions are noticing buyers are paying more attention to taxes on housing alternatives and are considering the potential impact when making buying decisions.
Taxpayers in high income tax or high property tax states may be further negatively impacted by the reduction of the mortgage interest deduction. Whereas in prior years you could deduct all interest incurred on a mortgage balance of up to $1 million, starting in 2018, the deduction for married couples is limited to interest on debt up to a mortgage balance cap of $750,000. Fortunately, this change applies only to new home buyers with transactions after December 15, 2017. If you recently purchased a home and you're carrying a higher balance mortgage, it may be worth reassessing whether to keep any incremental debt above the $750,000 or to pay it off if you have sufficient cash reserves.
Home equity lines of credit are also impacted. Interest on HELOCs is no longer tax-deductible unless the loan is being used to “buy, build or substantially improve the taxpayer’s home.”
In prior years, fees for professional services such as tax preparation and investment advice were deductible if they exceeded 2% of your adjusted gross income. You guessed it—this provision was eliminated for 2018. This deduction elimination also means unreimbursed work expenses and job search expenses also can no longer be deducted to reduce taxable income.
It can be disappointing to discover that you owe taxes especially if you thought that the new tax laws would bring good news. Now is the time to use what you learned from this year’s tax return to make adjustments for 2019 and hopefully avoid unwanted tax surprises next year.
Consider this your training manual to get and stay financially fit for life!