This is a great article by Deborah Jacobs that gives us a preliminary look at some the possible tax changes that will be officially announced later this week.
Deborah Jacobs - 10 Ways the Tax Overhaul Could Hurt You
EXECUTIVE SUMMARY: The tax overhaul bill recently passed by the Senate and headed to a conference committee with the House, could create long-term hardships for people who made financial commitments based on a tax system long in effect. It also leaves much less room for all of us to employ financial strategies on a yearly basis. By imposing new restrictions on itemized deductions and raising the standard deduction, the tax overhaul would create a system in which there are not as many moving parts. Fewer people will have enough deductions to itemize, and therefore will wind up taking the standard deduction. Those hurt most by these changes are likely to be people who previously itemized, and whose total deductions in previous tax years exceed the new standard deduction. Before the draconian changes take effect, in 2018, there’s time for you to take a few steps between now and December 31 to reduce what you’ll owe in April. But after that, we’ll start feeling the chokehold. How tight things will be depends on the size of your household, where you live, whether you own a home (or would like to someday) and your stage of life. Depending on your situation, this ill-conceived scheme to benefit the rich and worsen income inequality may come between you and the American dream: a home of your own, a living wage and a comfortable retirement.
FACTS: The tax overhaul bill passed by the Senate and headed to a conference committee with the House, eliminates some major tax breaks for individuals. That could create long-term hardships for people who made financial commitments based on a tax system long in effect. It also leaves much less room for all of us to employ financial strategies on a yearly basis. Don’t be distracted by the new brackets (Sec. 1001 of the House bill, Sec. 11001 of the Senate bill, and Sec. 1 of the Code). What I’m talking about are the amounts that get subtracted on your tax return before those rates are used to compute your tax. While the two houses of Congress agree on some of these, others are still in play and headed for reconciliation. The other aspect of the overhaul that will have a crucial effect on individuals is the increase in the standard deduction, which last year was $6,350 for single people and $12,700 for married couples. Both bills would roughly double it: The deduction would increase to $12,200 for singles ($24,400 for married couples) under the House bill; and $12,000 for singles ($24,000 for married couples) under the Senate bill.
COMMENT: Without the income tax deductions and exemptions that Congress would curtail or eliminate, many of us will be worse off, at least for the next eight years. (For budgetary reasons, the provisions discussed here are set to expire December 31, 2025.) Before the draconian changes take effect, in 2018, there’s time for you to take a few steps between now and December 31 to reduce what you’ll owe in April. But after that, we’ll start feeling the chokehold. How tight things will be depends on the size of your household, where you live, whether you own a home (or would like to someday) and your stage of life. To be sure, for decades taxpayers have been using deductions to game the system, and in an ideal world tax reform would put an end to that. But the latest overhaul is not about tax policy, reform, or ideology. Instead, it is a scheme to benefit the top 1 percent, the richest of the rich, being sold to poor and middle-class voters as a simplification and tax cut plan. Lawyers and accountants are already gloating about the hefty fees they’ll collect to help wealthy clients exploit new loopholes. But, like many of the rest of us, the tax geeks may be in for some pain themselves. You’ll want to have your 2016 tax return and latest financial statements handy as you review the following list. It explains how, depending on your situation, the tax overhaul may come between you and the American dream: a home of your own, a living wage and a comfortable retirement.
1. You’re married with kids. Currently you can claim a personal exemption of $4,050 for yourself, your spouse and each of your dependents. The Senate bill repeals that. Figure the amount on line 42 of your 2016 tax return would disappear, making your taxable income on the following line that much higher. An increase in the child tax credit (currently for children under 17 and for children under 18 in the Senate version), from $1,000 to $1,600 in the House bill ($2,000 in the Senate version), does not come close to making up for the loss of the personal exemption.
2. You own a home – or aspire to. The ability to deduct property taxes and interest paid on a mortgage have long been crucial to figuring out how much one could afford to spend on a home. Both these deductions are at risk. And the overall economic effect could be disastrous. Proposed changes could deter new home building and purchases – both of primary residences and vacation homes; drive down real estate values; make it unaffordable for current homeowners with large mortgages and high property taxes to continue living in those homes; and make it more difficult to finance renovations. The effects could trickle down to all the businesses that help you feather your nest, from contractors, to granite fabricators, to plumbing supply stores. How bad it will get depends on how discrepancies between the two bills are resolved during reconciliation, but it is almost certain that the deduction for property taxes will be capped at $10,000. With respect to debt on a home, the bills differ in significant ways. The House bill would reduce the amount of debt for which mortgage interest can be deducted, from $1 million to $500,000 (mortgages obtained on or before November 2 of this year would be grandfathered at $1 million), and the interest would only be deductible on a personal residence (not a vacation home). Both bills would eliminate the deduction for interest on a home equity loan. Not surprisingly, the National Association of Realtors is already projecting the adverse impact on home prices. One example: If deductions for both mortgage interest and real estate taxes are eliminated, they predict that prices in New York will fall between 10 and 15 percent! While mortgage interest deductions get hashed out in reconciliation, consider the effect of the cap on real estate tax deductions. If you own your home (or apartment) and itemized deductions in 2016, check Schedule A, line 6, to see what you paid for these taxes. Assume that, instead of itemizing, you’ll be taking the standard deduction for your 2018 tax return. To get some idea of how much worse off you might be, start by subtracting from whatever standard deduction applies to your situation (it doesn’t really matter whether you use the House or the Senate amount) what you are now paying in real estate taxes. If the result is more than zero, multiply this amount by the tax rate that you expect will apply to you in 2018. That’s roughly how much more you will pay in taxes just because of the new limitations on real estate tax deductions. At one end of the demographic spectrum, this affects empty nesters like those in the New York City suburbs whose property taxes alone exceed the new standard deduction. At the other end, it impacts their children, like a millennial who, after getting his first job, bought an apartment in Portland, Maine. “His budget is already tight,” his concerned mother said in an email, when I alerted her to the tax break he is about to lose. With this in mind, consider prepaying your real estate taxes for 2018. If you do that before December 31, you can deduct whatever you paid in 2017 on this year’s tax return. After that, your deduction will be limited to $10,000 and won’t count at all unless you itemize. Figure you’ll “wait and see” if the law passes? Consider this: Even if that doesn’t happen until early next year, it is likely to be made retroactive. If, in reconciliation, deductions for loans secured by a personal residence are curtailed (whether for a mortgage or a home equity loan), another strategy to consider is paying off those loans more quickly than the bank requires. This is a great investment, because your rate of return equals the interest rate on the loan. Not persuaded? Think of it this way: When you’ve paid down a dollar of debt, that’s a dollar you no longer owe. When you invest a dollar, you can’t be sure whether it will grow or shrink.
3. You need to sell your house. Under current law, if you lived in the house for at least two of the five years before the sale, you qualify for a special break that is available to homeowners who sell their principal residence (but not vacation homes): The first $250,000 ($500,000 for married couples) of their capital gain on the sale is not subject to tax. The tax overhaul will make it harder to qualify for this benefit, because you must have lived in the house for longer – five out of eight years – to qualify for the break. And the exclusion only applies to one residence every five years. For empty nesters, an alternative strategy to consider is renting out your primary residence and downsizing to smaller quarters that you rent, rather than own. This made tax sense even before the latest congressional fiasco, as I wrote here, but it could be even more attractive going forward. A growing number of people like me are leveraging their homes in this way to finance long stints overseas. (High-speed internet access, now available all over the world, makes it possible to work remotely.) Though sharing economy websites are not hospitable to older hosts, I have found that real estate agents, who may see home sales go down as a result of the tax overhaul, are happy to help. But this provision doesn’t just concern people who are downsizing. It also “will make it harder for people to move for a job, and potentially harder for employers to recruit good employees who would have to move,” says Wendy S. Goffe, a lawyer with Stoel Rives, in Seattle. If that young executive in Portland gets transferred by his company a few years from now and needs to sell his apartment (all of which could easily happen), he’ll have to pay tax on any appreciation.
4. You live in a state or city that has an income tax. This deduction, too, will be eliminated next year. To measure the impact, check Schedule A, line 5, of your 2016 return. Add that to whatever you’re spending on real estate taxes. Then, as described in No. 2, above, figure out whether your current itemized deductions exceed the new standardized one. If they do, you’re worse off. If you find that to be true, try to pay all the state and local taxes you owe for 2017 before the end of this year. If, instead, you wait until tax time, it counts as a payment in 2018, when it can no longer be deducted.
5. You have children or grandchildren who attend public school. By eliminating the deduction for state and local taxes, and capping the one for real estate taxes, the overhaul hurts public education, which relies on these revenues for funding. As taxpayers who have lost the deduction resist tax increases, funding for public education will constrict. Again, this will frustrate financial commitments people made based on certain assumptions: For example, buying a home in a certain community, even though the property taxes there are high, because it has a good public school system. Meantime, the overhaul contains incentives to send children to private or parochial school. Those who’ve been using 529 plans to save for higher education could withdraw up to $10,000 per year to pay for elementary or secondary education. It’s a provision that will only benefit parents who opt out of public education, and have the means to pay the rest of the tab; In New York City, where I live, kindergarten at a private school costs as much as a year at many colleges. Under the Senate bill this provision would also include certain home school expenses. One of the more penny-ante provisions of the tax overhaul applies to teachers, whose wages tend to be pathetically low, especially considering their important role in educating the next generation. The House Bill would repeal the $250 above-the-line (non-itemized) deduction they can currently take for spending their own money on “educator” expenses, such as books or classroom supplies. The Senate Bill would increase this deduction to $500.
6. You have high medical expenses – or might someday. The House bill repeals the deduction for unreimbursed medical expenses, which last year were deductible if they exceeded 10 percent of adjusted gross income (7.5 percent if at least one spouse was older than 65). The Senate bill would retain this deduction, but lower the floor to 7.5 percent for the 2017 and 2018 tax years. But of course you need to itemize for it to do you any good.
7. You’re career-oriented. It’s bitterly ironic that the bill is called the “Tax Cuts and Jobs Act,” because in fact it eliminates a bunch of deductions for money we might at various times spend to advance our careers. These are expenses that get lumped together on Schedule A under the heading “Job Expenses and Certain Miscellaneous Deductions.” Examples include unreimbursed job travel, training or moving costs. It has always been hard to get much juice out of these deductions, since you can claim them only if they total more than 2 percent of your adjusted gross income. But in some years that could certainly be the case. And the tax law, especially one with this title, ought to provide financial incentives for self-directed career growth rather than take them away. In a similar vein, the House bill would make it necessary for employees to pay tax on education expenses paid for by their companies. Currently $5,250 of these expenses are excluded from income.
8. You’re in debt for your education. Before you blink, a handful of tax goodies that are less than a rounding error in the federal budget, but help people struggling with the high cost of education, would go poof if the House draftsmen have their way. One that could affect many people is the repeal of the deduction for interest on a student loan. Currently, up to $2,500 of that interest can be deducted each year. (The higher your adjusted gross income, the less you can deduct.) This is another provision that could hurt millennials who previously had enough deductions to itemize – like the young executive who recently bought an apartment in Portland.
9. You’re retired – or nearing retirement. As our earned income declines, those of us who saved money in retirement accounts will start to take withdrawals to meet current expenses. When we do that from traditional IRAs or 401(k)s (as opposed to Roths, which are funded with after-tax dollars), the money is taxed at ordinary income rates. In an environment in which fewer deductions are available to offset that income, more of our retirement savings will go to taxes and less will be available for personal use. Knowing that, and with the stock market at an all-time high, you may want to skim off some of the growth in traditional IRAs before year-end, and load up on as many itemized deductions as you can possibly take before they disappear. (Warning: To do that without penalty, you must be older than 59 1/2.) Of course, people who converted traditional IRA assets to Roths will be able to take withdrawals from those accounts tax-free in future years. If you were clever enough to do that a couple of years ago and have benefited from this year’s stock market run-up, give yourself a big hug. The Roth strategy will become more risky under the tax overhaul because it would repeal a special rule that allows the conversion to be reversed, or “recharacterized.” If you converted IRA assets to a Roth this year, figuring you could undo the conversion if the stock market tanks – say in January – and later reconvert the assets at a lower tax cost, you will be out of luck. Though the bills are inartfully drafted, the Ways and Means Committee report clearly indicates that you will no longer get another bite at the apple: “Recharacterization of IRA contributions may enable an individual to avoid tax by retroactively manipulating the amount of income that must be recognized for tax purposes. The Committee intends to repeal the recharacterization rule in order to prevent such manipulation.” In a footnote, the Committee notes that it will not restrict the use of socalled backdoor IRAs (though it does not use this term): “The provision does not preclude an individual from making a contribution to a traditional IRA and converting the traditional IRA to a Roth IRA. Rather, the provision would preclude the individual from later unwinding the conversion through a recharacterization.”
10. You own low-basis stock. Currently when you sell stock, you can choose which blocks to liquidate, in order to minimize capital gains or take advantage of capital losses. The Senate bill would require that you use the first-in, first-out method instead: sell the shares in the order in which you acquired them (whether by purchase, reinvestment of dividends or the exercise of stock options). This could result in your taking a big tax hit when selling shares with a low basis – for example, those acquired early in the life of a company or shortly before an IPO. If you hold a lot of stock in a particular company, you might want to engage in some year-end tax planning in anticipation of possible changes. That might involve harvesting gains and losses on certain shares yourself, and donating others to charity. Just be sure you will not regret this strategy if the provision in the Senate bill is dropped during reconciliation. Even when the state of the law is clear, it’s usually better not to let the tax tail wag the investment dog.
I still hope our legislators will take all the commentary to heart, slow down and come up with a significantly less “one-percent sided” tax law. Not wanting to lose the support of wealthy donors, most of them rushed to vote for a bill that they couldn’t begin to understand (or perhaps did but thought the public would not). We will spend years suffering the consequences of their senseless and self-serving haste.