Last January, you were probably getting ready to file for the first time under the new tax law that passed two years ago. Congratulations, the worst part of complying with the new law is probably behind you, and most of you just need to refresh your memory a bit about the changes you wrestled with in filing your 2018 tax return.
Here’s what you need to know regarding the tax law changes that are still in force, those that may apply to you for the first time, and newly enacted or extended provisions that were expected to expire in 2019. I’ve included links to more detailed information for those who want it. My hope is to help you get through your 2019 tax return filing with less anxiety and confusion than last year, and in plenty of time to meet the April 15th deadline.
Note that for brevity, the discussion below only focuses on single and married filing jointly (MFJ) taxpayers. Check with your advisor for all other filing status situations, such as married filing separately, head of household, or qualifying widow/widower, or dependent of another taxpayer.
The Good News
The following changes should add up to lower taxes for many taxpayers:
- Tax rates. Yes, they are still lower by an average 2 to 3 rate points for every taxpayer than they were in 2017 (which translates to an average 15 percent cut in their total tax liability). And these lower rates start to apply at a bit higher income due to inflation built into the taxable income ranges. For example, last year, a couple filing as MFJ with taxable income of $100,000 would have paid $13,879 in federal income taxes. For 2019, their tax would be $162 lower, at $13,717.
- The standard deduction. Tax reform doubled this from what it was in 2017 and it increases a bit more for 2019: For single taxpayers, it increased from $12,000 in 2018 to $12,200, and couples filing MFJ enjoy an increase from $24,000 in 2018 to $24,400. For the 2018 tax filing season, the IRS estimated that the number of tax returns claiming the standard deduction vs. using itemized deductions increased from 70 percent of taxpayers to 90 percent! You may have been one of the 30 million new taxpayers who claimed the standard deduction for the first time last year, and it was probably due to the doubling of that amount from its pre-tax reform level, and to substantial limitations placed on what qualified as an itemized deduction (discussed below).
- Child tax credit. For 2019, it is still up to $2,000 per “qualifying child” (based on several criteria), double what is used to be before tax reform, and up to $1,400 of that can be refundable. Like last year, tax reform greatly expanded the income range at which the credit phases out: The child tax credit phases out for taxpayers with “modified” adjusted taxable income above $200,000, or above $400,000 if MFJ. There is also up to a $500 credit available for other “qualifying dependents,” including elderly parents, but this is also subject to the phase-out at higher incomes. However, remember that the tax law also took away the deduction for personal exemptions. That was done to help pay for the increase in the standard deduction and expansion of the child tax credit.
- Earned Income Tax Credit (EITC). This refundable credit, which can be substantial for “qualifying” lower and middle income taxpayers with “earned” income and “low” investment income, has increased slightly as follows: up to $6,557 if three or more “qualifying” children, $5,828 if two children, and $3,526 if one child, and $529 if no children. The underlying calculation is unfortunately very complex and the credit phases out at certain income levels.
- Alternative Minimum Tax (AMT). The tax law substantially increased the exempted amount of taxable income not subject to the 26 percent and 28 percent alternative minimum tax (AMT), and increases it a bit more for 2019: from $109,400 for MFJ to $111,700, and from $70,300 for single taxpayers to $71,700. The new law also slightly increases the income level at which that exemption begins to phase out, i.e. for 2019, the exemption starts to phase out for singles at $510,300 and $1,020,600 for MFJ.
- Qualifying medical expenses. Although tax reform did allow anything above 7.5 percent of adjusted gross income to be deducted for 2017 and 2018, the law provided that floor to be raised to 10 percent of adjusted taxable income starting in 2019. The good news for taxpayers who intend to itemize their deductions, is that on Dec. 20, 2019, Congress extended the 7.5 percent floor through 2020.
- Kiddie tax. Also on Dec. 20th, Congress restored the method that had previously been in place of using the parent’s highest marginal tax rate in calculating the tax on the child’s unearned income, instead of the method that had been included in the tax law of using the higher trust income tax rates.
- 20 percent deduction from Qualifying Business Income (QBI). You can continue to deduct up to 20 percent of your QBI flowing up to you from a sole proprietorship, an S corporation, a partnership, or your share of an LLC’s profits, depending on the nature of the business and your income levels. Although there is still considerable complexity and uncertainty regarding many of the provisions of this new deduction from the tax law, the IRS issued several pronouncements in 2019 to help guide taxpayers, especially for owners in real estate activities.
- 100 percent expensing of machinery and equipment. The ability to immediately expense 100 percent of all new and used qualifying asset purchases for your business continues in 2019. Prior law limited this to 50 percent and, for the most part, on only new purchases. Now, there is no dollar limit and it can also apply to used qualifying property.
- Various other expenses and credits. Taxpayers can continue to take advantage of:
- The American Opportunity Tax Credit. Up to $2,500 credit for “qualifying” expenses for each “eligible” student, subject to income phase-out.
- The Lifetime Learning Credit. Up to $2,000 of credit for “qualifying” expenses for each “eligible” student, subject to income phase-out.
- Student loan interest deduction. Up to $2,500 of deduction for “qualifying” expenses for each “eligible” student, subject to income phase-out.
- Qualified tuition and related expenses. Congress brought back for tax years 2018 through 2020 the deduction for eligible education expenses of up to $4,000 as part of the December Extenders package. However, this is phased out at certain income levels, and cannot be used in conjunction with the education credits described above.
- Elementary and secondary school teacher expenses. You can still deduct up to $250 of qualifying expenses, with no income phase-out.
- Adoption credit. The maximum credit allowed for adoptions of an “eligible” child is now $14,080, up from $13,810 for 2018, subject to income phase-out.
- Exclusion of gain on the sale of your primary residence. Up to $500,000 (if MFJ) or $250,000 (if single) of “eligible” gain on the sale of your primary home is still eligible for exclusion in 2019.
- IRA contributions. The limits for 2019 contributions to all your traditional or Roth IRAs are $500 higher than they were for 2018. They are now at $6,000 (or $7,000 if age 50 or older). The contributions can still be made by April 15, 2020. Contributions to traditional IRAs may be deductible depending on your income level and if you or your spouse participate in an employer retirement plan.
- Gifts. The exclusion from gift tax imposed on the donor is still $15,000 per donee for 2019 gifts, the same as 2018. This means that a married couple can gift up to $30,000 tax free to each donee.
- Standard mileage rates. For 2019, the standard mileage rate is 58 cents per mile for deducting auto expenses in a pass-through business (up 3.5 cents from 2018); 20 cents per mile if incurred for medical needs (up 2 cents from 2018); and is still 14 cents per mile if incurred for charitable purposes.
- The SECURE Act. Effective January 1, 2020, the newly signed “Setting Every Community Up for Retirement Enhancement (SECURE) Act” provides that the start date for distributions from qualified retirement plans can be delayed until 72 years of age instead of the prior law date of 70 ½ years of age, and provides that taxpayers can continue to contribute to traditional IRAs after they reach 70 ½. However, to help fund that loss in tax revenues, the new law also provides that beneficiaries (other than certain designated beneficiaries) who inherit the balance of these retirement plans, must spread the distributions over 10 years, instead of the prior law that allowed the balance to be spread over their lifetime.
The Not-So-Good News
If you can “itemize” your qualifying deductions because they exceed your standard deduction, here’s what you should know for 2019. Be forewarned: With the doubling of the standard deduction, most of the news is unfavorable:
- State and local tax (SALT) deductions. Tax reform capped the state and local income and property or sales tax deduction after 2017 to $10,000 for both MFJ and for single taxpayers. Despite several efforts by Congress and several high tax states to repeal this, or create “workarounds,” these efforts have largely failed, and with a couple exceptions beyond the scope of this article, most have attracted IRS notices that they will not work.
- Mortgage interest. For taxpayers filing as MFJ or single, the tax law limits the interest deduction on “qualifying” first or second homes to only the interest associated with the first $750,000 of a mortgage. But this applies to only new mortgages after Dec. 14, 2017, and the prior law limitation of interest up to the first $1 million of your mortgage (if single or MFJ) still applies on mortgages obtained before that date. Also, these limits apply to loans used for acquiring, constructing, or substantially improving a qualified home.
- Home equity loan interest. The tax law repealed the interest expense deduction on home equity loans of up to $100,000 after 2017. However, if you refinance your existing home or mortgage and use some or all of the proceeds for home improvements, then the interest expense associated with the home improvement should still be deductible within the new $750,000 mortgage limits.
- Charitable contributions. For 2019, “qualifying” charitable contributions can be deducted up to 60 percent of adjusted gross income (vs. up to 50 percent before the tax law changes).
Alimony. New for 2019, effective for divorces granted after 2018, alimony will no longer be deductible (but the related income will not be taxable.)
Excess business loss disallowance. The tax law limited the ability to deduct your share of losses from active “pass-through” businesses. For 2018, these limits were $500,000 if MFJ and $250,000 if single. Any loss in excess of those limits could be carried forward for use in a future year, subject to similar limits. For 2019, the limit increases to $510,000 for MFJ and $255,000 for single.
A reminder about previously repealed deductions. The following itemized deductions were repealed effective after 2017: the casualty loss deduction, except for federal disaster areas, and most “miscellaneous itemized deductions,” such as tax preparation fees, investment expenses, hobby expenses except cost of goods sold, and unreimbursed employee expenses. The tax law also repealed the (pre-AGI) moving expense deduction (except for members of the Armed Forces).
Some final thoughts:
- After you have completed your 2019 tax return, you should challenge your federal income tax withholding amount on Form W-4 filed with your employer for 2020. This will help reduce the penalty for any underpayment for 2020, but also allow you to avoid being significantly overpaid into a system that does not give you interest for any surplus amounts you pay during 2020.
- Project your level of itemized deductions for 2020, compared to your level of standard deductions. Then consider “bunching” payments of some of these expenses into 2020 or 2021 to increase the chances you will have sufficient itemized deductions to be able to avoid simply taking the standard deduction each year. You may be able to do this for state and local income and property tax payments, charitable contributions and medical expenses—to the extent they are optional, to some degree, as to amount or timing.
- If you have a vacation home, challenge how you allocate personal use vs. rental use. Watch for planning opportunities regarding how you allocate mortgage interest and property taxes (e.g. the “Tax Court method” vs the “IRS method”), and pitfalls, such as the $10,000 cap on personal use portion of property taxes, and the cap on personal mortgage interest expense.
- If you own a business, consider if its legal form is still appropriate given the changes in tax laws (i.e., the lower individual rates, the 20 percent exemption on qualifying pass-through business income, and the new, lower 21 percent corporate rate, which was cut from 35 percent in the old law).
- One last point related to the actual 2019 basic 1040 tax form: Last year, the IRS rolled out a two-sided, large postcard-sized basic form. However, the IRS realized that shrinking the basic long form the way they did created too much confusion since up to six more basic schedules were needed just to detail out what used to be on the previous two-page longer format. So they redesigned the basic tax form to now include only up to three more basic schedules.
Note: Any tax advice contained above is not intended to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the IRS or other applicable laws. This article is intended only for educational purposes and is not intended, and cannot be relied upon, as tax or financial planning advice, and does not necessarily represent the views of Lehigh University or any other party affiliated with the author. Readers should consult with their own advisors in the application of any of the above to their own circumstances, and be aware of exceptions and limitations related to any of the above, and for other laws that may affect the reader’s tax and financial position.