Minimizing surprises at tax filing time

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When Congress passed the recent $1.5 trillion tax bill (The Tax Cuts and Jobs Act or TCJA), it triggered the first comprehensive revamp of the U.S. tax code in more than three decades. As we prepare to file our 2018 tax returns, Americans will feel the effects of this legislation for the first time. For most, the effects will be positive. In fact, 80 percent of Americans will see their taxes drop. However, not all the news is good. There will be inevitable surprises as 2018 taxes are filed with one particularly nasty “gotcha” that will likely catch many taxpayers off guard.

Despite the government shutdown earlier this year, the IRS has said it will process refunds on time and it called 46,000 of its furloughed employees back before the shutdown officially ended. While this commitment was encouraging, close to 43 percent of the agency’s workforce remained sidelined until January 25 when the shutdown officially ended. Even though the IRS is now fully staffed and up and running, there is a large backlog of work that built up during the 35-day shutdown-the longest in our nation’s history.

Taxpayers who received refunds in previous years are the ones most likely to get caught by that nasty “gotcha.” The IRS adjusted its tax withholding tables based on the premise that most working Americans should see their paychecks increase after the tax overhaul. However, the adjusted withholding tables did not align with the tax cut. As a result, employees who did not carefully review their withholding and make appropriate adjustments, if needed, could find themselves owing taxes, not receiving refunds.

All of these changes prompted the IRS to waive penalties for taxpayers whose underpayment is less than 15 percent of their tax bills for tax year 2018. However, we do not expect this more lenient approach to continue, making it imperative to review your withholding with your tax professional and make needed adjustments for tax year 2019 as early as possible in the year.

Special alert for small business owners

Small business owners will be facing a more restrictive approach to the pass-through deduction than originally anticipated as a result of the tax law changes. Unfortunately, it was not until January 18 of this year that the IRS clarified the pass-through deduction eligibility for Sub S corporations, sole proprietorships, and partnerships with a 200-page explanation of qualification guidelines. As expected, the eligibility guidelines were fairly restrictive and not nearly as sweeping as many originally had hoped. 

Not only do small business owners have to manage their way through the restrictive eligibility scenarios, but in addition, some of them will find that language mistakes in the tax bill will take a financial toll as well. For example, clients owning restaurants and hotels will find that language errors in the new tax bill will force them to amortize their renovation costs over several decades rather than taking the immediate write-off previously allowed. It is unclear whether or not these errors will be amended in future legislation.

Summary of major tax changes

There were numerous changes in the tax overhaul that impacted standard deductions, personal exemptions, child tax credit and elder care, medical expenses, mortgage interest deductions, and state and local taxes. This high-level summary recaps those main points:

1. Standard deduction

Fewer taxpayers will elect to itemize deductions as the standard deductions have increased to $12,000 for individual filers and $24,000 for joint returns. Taxpayers who make charitable donations need to pay attention to this revision. Unless other itemized deductions put you over the standard deduction threshold or charitable gifts are grouped into a single year instead of made over multiple years, this change will minimize the tax advantages previously associated with charitable giving. College students and their parents, however, need not worry because this change does not affect the allowed $2,500 student loan interest deduction.

2. Personal exemption

The pre-tax personal exemption of $4,050 for the taxpayer, spouse, and each dependent, which previously lowered taxable income, is gone as well. Middle- and lower-income families will likely be adversely affected by this revision. 

3. Child tax credit & elder care

The new law doubles the child tax credit to $2,000 per child, while raising the income cap to $400,000 for married couples filing jointly. Taxpayers caring for elderly parents can claim a $500 credit for non-child dependents as well. 

4. Medical expenses

For 2018, you can deduct medical expenses that equal or exceed 7.5 percent of your adjusted gross income. However, beginning in 2019, that threshold has increased to 10 percent. Be aware that you need to itemize your deductions to take this deduction.

5. Mortgage interest deduction

Homeowners with new mortgages can deduct only the interest paid on the first $750,000 of the home’s value, down from $1 million. Existing mortgages are grandfathered, however. Interest paid on home equity lines of credit are no longer deductible unless the funds were used to “buy, build or substantially improve” the home that secures the loan. 

6. Treatment of state & local taxes

The deduction for state and local income taxes (including property taxes) is now capped at $10,000 under the new rules. However, this deduction is available only to taxpayers itemizing their deductions.  

Monitor withholding closely in 2019

Finally, if you thought the TCJA’s effects would be over when you filed your 2018 return, think again. According to the General Accounting Office, taxpayers will need to closely monitor their withholding status throughout the 2019 calendar year. Keeping your withholding aligned with your actual income will go a long way towards keeping you out of the group of 32 million taxpayers who are expected to owe taxes in 2019. That figure, which is based on a taxpayer universe of 150 million, is 21 percent higher than in previous years.

This year more than ever, a sound financial move would be to sort through these new rules carefully with your tax professional to determine exactly how they will impact you and identify smart moves for 2019 and beyond.

Julianne Andrews, MBA, CFP®, AIF®, is a principal and co-founder of Atlanta Financial Associates. She specializes in working with physicians and top executives in the healthcare industry. Her passion for working with physicians comes from being a pediatrician’s spouse for more than three decades. Her experience as a wealth manager in combination with her first-hand view as the spouse of a physician provide Julie with a deep understanding of the challenges the changing healthcare landscape presents and how they impact a physician’s financial well-being. Julie’s financial acumen has been recognized nationally, and she has been featured on Forbes’ list of America’s Top Women Wealth Advisors since 2017 as well as Forbes’ Best-in-State Wealth Advisors since 2018. Julie can be reached at jandrews@atlantafinancial.com.