As you likely know, in the final days of 2017, Congress passed, and the President signed, a new tax law. It substantially changes the federal income taxation of individuals and couples. As I blogged last year (i.e., last month), the biggest changes are the near-doubling of the standard deduction amount and the cap on the state and local income tax deduction. The result is that most taxpayers who found it advantageous to itemize their deductions on their federal income tax returns will no longer find it helpful to do so.
Let’s take a look at a typical example:
John and Mary are a married couple, file a joint tax return, own their own home, and have a mortgage. They paid $10,000 in mortgage interest last year. They had real property taxes of $6,000. They each paid $5,000 in state and local income taxes. They made $3,000 of charitable contributions.
In 2017, the standard deduction amount for a couple filing jointly was $12,700. John and Mary had actual deductions of $10,000, plus, $6,000, plus $5,000, plus $5,000, plus $3,000, for a total of $29,000. Clearly, they are better off itemizing their deductions and taking $29,000 of deductions, rather than the standard deduction of only $12,700.
Assuming the same taxpayers and expenses in 2018, the result after the passage of the new tax law, would not be the same. The standard deduction amount under the new law is $24,000 for the couple. However, their itemized deductions would drop even though their expenses did not. They had the same expenses of $5,000 for his state income tax, $5,000 for her state income tax, and $6,000 for local property tax. However, they are now limited to a maximum of $10,000 for state and local taxes. They still have the other deductions of $10,000 for mortgage interest and $3,000 for charitable. However, these only add up to $23,000, because of the cap. Thus, if they choose to itemize, they’d be significantly worse off for federal purposes than if they took the new $24,000 standard deduction.
However, in some states, if you don’t itemize federal income taxes, you cannot itemize state income taxes. Thus, when filing taxes for 2018, they’ll need to consider the impact of their decision to itemize on both their federal and state income taxes. It’s possible that some taxpayers will find it advantageous to itemize due to the impact on their state income tax return. For example, if the standard deduction amount for state income tax did not go up, the taxpayer would be better off, for state purposes itemizing deductions. Especially in 2018, taxpayers will need to think carefully about the best way to proceed because the decision on one return may impact the other.
Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128