Trumps Tax Changes: And What They Mean for You

From our resident CPA and guest blogger today - Chad Elkins:

I've got a slight lull today from my busy season so I thought I'd share some insights into how my clients here in the U.S. have been affected by the Tax Cuts and Jobs Act (a.k.a. tax reform) this tax season so far. For those who aren't familiar, 2018 was the first year of major tax law changes here in the U.S. and it's been interesting to say the least. I've prepared about 150 individual tax returns and around 50 business (S-Corporation, Partnership) tax returns so far, and here are some of the winners and losers from my observations:

WINNERS

1) Small Business Owners. Whether you have a Small Business Corporation (S-Corp), an LLC, or are just a sole-proprietor (Schedule C), the new tax regulations are a boon. There is a new 20% deduction for QBI (Qualified Business Income) under section 199A, which is a bit complicated but is essentially the net profit you make on your business, among a few other factors. So if your net profit is $100,000, you can generally take a $20,000 (20%) deduction ON TOP of all of your other business deductions, resulting in only $80,000 in taxable income. Many of my business clients are seeing some great results from this new feature and it should really help increase small business growth, which is never a bad thing. The media likes to hype up how large corporations (C-Corps) benefited from their permanent tax rate decrease (from 35% to 21%) as a result of the new laws and while I have some mixed feelings about that, one thing that can't be denied is the net positive it will have for small business corporations going forward as well.

2) Real Estate Investors. People who earn real estate (rental) income generally have it categorized as passive income, meaning it's subject to various limitations concerning deductions and losses. The new tax regulations allow real estate investors a "safe harbor" designation that basically requires 250 hours of work a year on each set of rental real estate activities for it to qualify for the 20% section 199A QBI deduction (see above). So many of my clients who are landlords have been taking advantage of this new clause, resulting in an extra 20% reduction in rental income just like the business owners I mentioned above. Also, the work hours required for this safe harbor designation may be performed by the owner or agent, and logging of work hours must be maintained but only starting in 2019 so a number of my clients are seeing some great write-offs for 2018 as a result of this. There is also no limitation for state and local real estate tax deductions on rental properties, which is very important (keep reading to find out why). 

3) Those With Children in Private Schools. Parents who have children in private schools can now use 529 plans to pay for them (up to $10,000 per year). This includes K-12 education tuition and related educational materials and tutoring, and it's a huge benefit because it's tax free. These used to be reserved for college tuition payments, but tax reform allowed many of my clients to pay for their children's 2018 private school tuition expenses using 529 distributions, totally tax free. It makes a difference when you live in a high-cost area with lousy public schools such as where I am, and I've definitely seen a number of my clients take advantage of this benefit since the regulations took effect last year. 

LOSERS

1) Salaried (W2) Employees Who Have Unreimbursed Employee Expenses. Prior to 2018, if you worked for a company and had a lot of out-of-pocket expenses required for your job you could claim these as deductions on your tax return. They would first be reported on Form 2106, which would then flow into Schedule A miscellaneous itemized deductions (subject to 2% of your adjusted gross income). Tax reform completely eliminated this and I've had a few clients get absolutely screwed as a result. It's usually those in sales who have to travel a ton and pay for gas mileage without any employer reimbursement who got crushed with this. They used to be able to claim thousands worth of mileage deductions on Schedule A to help get them sizable refunds, but now....nothing. Raising the standard deduction to $12,000 (single)/$24,000 (joint) would seem to offset this, but....see the next few paragraphs.

2) Married Property Owners in High-Tax States. Tax Reform now limits state and local tax deductions to $10,000 on Schedule A (itemized deductions), which means you get royally fucked if you live in a state like California, New York, or Illinois. I live in one of these states and so do my clients, and many of them are feeling the burn from this new regulation. 

Let's say in 2017, you had $7,000 in state income taxes withheld/paid from your W2 and your spouse had another $6,000 in state tax withholding, and you own a house with total annual real estate taxes of $15,000 (very common where I live). You add this up and it results in $28,000, a healthy chunk of state and local tax deductions to write off on Schedule A. Under the new 2018 regulations, this deduction gets capped at $10,000 and you are now out $18,000 in Schedule A deductions. 

The common retort to this is that the standard deduction was doubled to $24,000 under the new regulations for married couples (as I mentioned above), but when you combine high mortgage interest payments (tax deductible) with all of the above these couples are now getting a raw deal compared to prior years. In my example here, the married couple paid mortgage interest of roughly $13,000 so they would have exceeded the $24,000 standard deduction limit regardless, but now they have to claim $18,000 less in itemized deductions compared to 2017. Funny how the Republicans knew this would screw over people in high tax states. I wonder what those states have in common with each other.....

3) Those Who Are About To Be Divorce Raped. Some of you on this forum will undoubtedly already know what I'm talking about here. Taxpayers who get divorced after 12/31/18 will no longer be able to deduct alimony payments. That's why there was an uptick of finalized divorces towards the end of last year - not only are alimony payments not deductible starting in 2019, but those who receive alimony still have to claim it as ordinary taxable income so that side of the equation didn't change at all. 

I've already had a slew of (male) clients come in telling me that they divorced their spouses since I last saw them, and this regulation was one of their major reasons why they knocked it out as quickly as they could once they determined a separation was inevitable. If you are currently married and foresee a divorce that will involve alimony payments in your future, Sorry....I don't know what to tell you. You missed the boat. 

One other note - many of my clients are getting smaller refunds this year, and they think it's because the new tax regulations increased their taxes. This is not usually the case, because in most instances their employers withheld less in taxes throughout the year (in response to the new regulations) so their paychecks were subsequently increased throughout 2018. Keep in mind that your refunds are only one part of the equation, so don't freak out if you're getting less back than you did in prior years. 

Lastly, don't believe the CNN/MSNBC/NY Times, etc. hype about taxpayers getting screwed due to smaller refunds. That's just typical NPC media hysteria trying to cause an uproar so don't pay any attention to it. As I outlined above, some people were worse off, but many, many regular American citizens benefited from the new tax laws and it remains to be seen what will happen in the future as a result of these changes.