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By Dr. William Whitley
Faculty Member, Accounting and Finance, American Public University
The Tax Cuts and Jobs Act has been touted as the largest tax cut in modern history. Yet there has been a lot of talk about how some of the changes included in this legislation will result in some taxpayers losing deductions that they have counted on for years.
To start with, Code Section 61 of the Internal Revenue Code states that every source of gross income is taxable unless there is a specific code section that says an item can be excluded from taxation. That includes the following:
- Compensation for services, including fees, commissions, fringe benefits and similar items
- Gross income derived from business
- Gains derived from dealings in property
- Alimony and separate maintenance payments
- Income from life insurance and endowment contracts
- Income from discharge of indebtedness
- Distributive share of partnership gross income
- Income in respect of a decedent
- Income from an interest in an estate or trust
Over the years, Congress has excluded some items from being taxable (life insurance proceeds received, for example). To make sure taxpayers report the items that are taxable, reporting rules have been enacted to provide IRS advance notice that someone has received taxable income.
These rules address requirements to provide 1099 forms, W-2 forms and other documents in electronic format for taxable items such as gambling winnings, discharge of debts, interest income, dividend income, payments to independent contractors and many other sources of income. The effect of these reporting rules allows the IRS to pre-load in their computer system just about every item of income someone receives before that person files the tax return.
New Bill Discourages Itemized Tax Deductions
The new tax bill addresses what someone might claim on Schedule A for itemized deductions. Keep in mind that these deductions are personal expenses allowed as a deduction by Congress and that means that they can be disallowed. But it isn’t easy to pass legislation to make tax deductions completely disappear, because the political fallout might very well cost a Congressmember a chance at being re-elected.
The hidden agenda that the news media has failed to address is this: The changes in the Tax Cuts and Jobs Act that affect itemized deductions were put in place to allow electronic auditing of a lot more tax returns by reducing the number of people who can find enough itemized deductions to file Schedule A. The tax legislation increased the standard deduction to $12,000 for single, $24,000 for married filing jointly and $18,000 for those that can file as head of household. For 2017, the standard deductions were $6,350 for filing as single, $12,700 for married filing jointly and and $9,350 for filing as head of household.
This change alone will keep a lot of people from finding enough itemized deductions to file the “long form.”
Other Tax Deductions Have Vanished
In addition to increasing the hurdle that must be met to file Schedule A, the new tax act includes some changes that reduce or eliminate some of the itemized deductions that were allowed in 2017.
The deduction for state and local taxes (SALT) is limited to $10,000. This was a hotly debated item in Congress, because state taxes in several states can add up to a lot more than $10,000. Taxpayers in those states can very well end up paying more in federal taxes in 2018. Also, foreign real estate taxes are no longer deductible as part of the SALT deduction.
The deduction for home mortgage interest has been limited to interest paid on indebtedness of $750,000 ($375,000 for married filing separately) and home equity interest is no longer deductible. From an audit standpoint, continuing to allow a deduction for mortgage interest is not a problem. Mortgage companies must provide the interest information to the IRS in electronic format, so it can be added to that big computer system they have.
In addition to the changes previously mentioned, moving expenses are no longer deductible. Miscellaneous work-related expenses and tax preparation expenses are no longer deductible. Casualty losses are no longer deductible, unless the losses were the result of a federally declared disaster.
So even though the tax brackets are lower for 2018, some taxpayers will pay more. Apparently, one of the goals was to reduce the number of people filing Schedule A and allow more tax returns to be electronically audited, which should reduce the cost to administer the tax system.
Taxpayers and Exemptions
The new tax legislation eliminates claiming an amount for exemptions. The amount that we claimed last year as exemptions has been included in the total for the standard deduction allowed, which is based on your filing status. It sounds like a good deal, but it is not to our benefit.
For people have been itemizing deductions, that means they will have more taxable income to start with than they would have had under the prior law. For example, people who file as married filing jointly must surpass $24,000 in itemized deductions before they have any tax benefit from itemizing.
In 2017, those taxpayers would have been able to claim itemized deductions if their total deductions on Schedule A exceeded $12,700. Now, they can’t itemize unless they can find more than $24,000 in itemized deductions. This new standard deduction amount has the effect of eliminating $11,300 of deductions.
Changes to the rules for itemized deductions is an issue that has created some controversy. While it is a middle-class tax cut, that does not mean everyone will pay less. People who live in states with state income tax and real estate taxes that would otherwise have added up to a combined total deduction of more than $10,000 will be the taxpayers who will most likely come out owing more money in 2018.
About the Author
Dr. William Whitley has a bachelor’s of science in accounting from the University of Alabama Huntsville, an MBA from the University of Houston and a doctorate in education from the University of Alabama. Dr. Whitley has taught accounting for over 25 years. Dr. Whitley is a CPA and he maintains a small business consulting service and tax practice.