Accounting On Us
I can just write it off, right?
Deductions overview under tax reform
Brock R. Yates, CPA, MT
While I have not seen much of the sitcom Seinfeld, I remember one scene in particular in which Kramer, speaking of a piece of damaged equipment he is conning the post office to pay for, says to Jerry, “It’s a write-off for them.” The two then banter back and forth about what a “write-off” is, with no clear answer. Unfortunately, this seems to be common in everyday conversations, with people not exactly sure what can and can’t be deducted on their tax returns. Let’s look at some common misconceptions and touch on how the latest round of tax reform has impacted your deductions.
What is a write-off?
The word “write-off” does not appear in the tax code. It’s a layman’s term for a deduction, or an item we subtract from gross income to calculate your total taxable income. The tax code provides several deductions from income that taxpayers can take advantage of both for businesses and individuals.
Above the line deductions
2018 graced us with many firsts – the first trillion-dollar company valuation (AAPL), the first sports championships for the cities of Philadelphia and Washington, D.C. – even the IRS gave us a first. The first “postcard” tax return was introduced late in the year, and while the form is technically shorter, it is still double-sided, and now requires up to six numbered supporting schedules to report the same information from the original two-page Form 1040.
The new Form 1040 requests personal information for you, your spouse and any dependents on the front side, and has basic data regarding income and deductions, like wages, interest, the QBI deduction, etc. on the back side. There may be additional items of income, such as sole proprietor income, or income from rentals or S Corporations and partnerships that come through on the new Schedule 1. Also on Schedule 1 are the “above the line deductions,” which are even more beneficial in 2018. This is because you do not need to itemize your deductions to claim them, an act which fewer taxpayers will do in 2018 because of tax reform. “Above the line” simply refers to the fact that the deductions are deducted before calculating adjusted gross income (AGI). Some of these above the line deductions include:
- Student loan interest (capped at $2,500)
- HSA contributions (capped for 2018 at $6,900 for qualifying family plans)
- IRA contributions (capped for 2018 at $5,500 for individuals under 50, plus $1,000 catch up if over age 50)
- SEP contributions (capped for 2018 at $55,000 or 25% of SE compensation, whichever is lower)
- Health insurance for self-employed individuals
- Educator’s expenses (capped at $250)
Below the line deductions
Below the line deductions are – you guessed it – deducted below the AGI figure calculated previously. While still valuable, the ability for you to take some of these deductions depends on the dollar amount of all your deductions. Some common below the line deductions include:
- Medical expenses (subject to an AGI floor of 7.5% for 2018)
- Mortgage interest on loans less than $750,000 for loans originating after December 15, 2017 ($1,000,000 for loans originated prior to this date).
- Investment interest expense (to the extent of investment income, generally)
- Income taxes or sales taxes, property taxes and real estate taxes (capped at $10,000 for 2018)
- Charitable contributions
Collectively, these are known as itemized deductions. When preparing your taxes, add up the value of all your itemized deductions and compare them with the standard deduction. For single filers in 2018, the standard deduction is $12,000; for married individuals it is $24,000. If your itemized deductions exceed the standard deduction, you will take the itemized amount. If they do not, you will take the standard deduction.
The tax code generally does not allow a deduction for personal items except in certain circumstances, like those who have a home office for their own business. In general, expenses to maintain and run a home are not deductible. Purchases of assets like vehicles and property generally cannot be deducted through depreciation deductions unless they have a significant business component.
Bona fide businesses that are actively engaged in a trade can deduct all ordinary and necessary expenses. Many are not subject to the caps provided above. For example, an apartment building operating as a rental trade or business can deduct all the interest on its mortgage of $2,000,000 – it does not have the $750,000 cap provided above for individuals. There are rules for certain deductions, like meals and entertainment, which may not allow a full deduction, but those items are outside the scope of this article. You should contact your Henry+Horne professional advisor for more clarification on business deductions.
As previously mentioned, recent tax reform has greatly shifted some of the deductions allowable to individuals. One of the most notable changes was to the deduction for taxes, which is now capped at a flat $10,000. Previously, all state income or sales taxes, property taxes and real estate taxes could be deducted, no matter the value. For certain individuals in high tax states, this can be a large deduction lost.
Another key deduction removed was miscellaneous itemized deductions subject to a 2% floor of AGI. That means, if your income was $100,000 for example, the first 2%, or $2,000 of these types of deductions, would not be deductible. These deductions included things like employee business expenses, CPA tax prep fees and most notably, investment advisory fees.
Tax reform also did away with the deduction for interest on home equity debt. Previously, interest was deductible regardless of the use of the funds, up to $100,000 of principal. Now, the “interest tracing rules” must be applied and the use of the funds must be documented to deduct the interest. If you take out a home equity line of credit to renovate your personal residence, or invest in the stock market, that interest may still be deductible. If you buy a boat or other personal effects, the interest is not deductible. Unfortunately, this provision is not grandfathered either, so taxpayers who took out home equity loans in late 2017 thinking they could deduct the interest under old law are out of luck.
While some deductions are lost, tax reform also did away with a provision known as the Pease Limitation, named after the Congressman who penned the law. Essentially, this limitation reduced the amount of all itemized deductions for certain high-income individuals. With this limitation gone, those who itemize their deductions will notice that, even with some of the above changes, all their allowed itemized deductions are included in calculating taxable income.
It is important to review your individual situation – as even though your taxable income may be higher due to lost deductions, you may still pay less tax overall due to decreased tax rates. You need to review your situation with your CPA to determine what your new tax liability will be – as always, we’re here to help!