By: Amie Toyama, CPA
All of the above words seem to be used interchangeably when talking about taxes. All are different, but have one thing in common – they help reduce your tax liability. These are hot topics right now too considering the Tax Cuts and Jobs Act recently put into effect. Let’s first talk about this tax terminology as it relates to your personal (or individual) tax returns.
Deductions: Deductions vary by type, but their commonality is that they are the first subtraction from your gross income. There are a series of deductions that you get first, resulting in your adjusted gross income (AGI), commonly referred to as “Page 1 Deductions.” These deductions include:
- Educator Expenses
- Health Savings Account Deduction
- Moving Expenses
- Deductible Part of Self-Employment Tax
- Self-Employed SEP, SIMPLE, and qualified plans
- Self-Employed Health Insurance Deduction
- Penalty on early withdrawal of savings
- Student Loan Interest
- Tuition & Fees
- Domestic Production Activities Deduction
As a result of the tax reform changes, a few of these have been altered:
Moving Expenses – these used to be deductible when moving for your job. This has been repealed as of 1/1/18.
Alimony Paid – this was deductible for individuals paying alimony and was also included as taxable income to the recipient. For divorce agreements starting 1/1/18, this has been repealed.
Domestic Production Activities Deduction – This was a favorable deduction, usually from flow-through activities, that benefit businesses/individuals for production of goods in the United States. This has been repealed as of 1/1/18.
Standard Deduction and Itemized Deductions. In general, the rules are the same, it’s either/or, you get the greater of the two. How you calculate each of them has changed, so you may want to consult with your tax professional with any specific questions.
The Standard Deduction is a flat amount, based on your filing status, i.e. Single, Married Filing Joint, Head of Household, etc. This deduction was increased significantly in 2018. For a Married Filing Joint tax return, the Standard Deduction increased from $12,700 in 2017 to $24,000 in 2018. This should result in additional tax savings for individuals who have historically NOT itemized (typically tax payers without a mortgage).
Itemized Deductions: These include things like your state and local taxes, home mortgage interest, and gifts to charity to name a few. Each specific category has its own limitations based on varying factors like your Adjusted Gross Income. The most significant changes to mention relate to state and local taxes and miscellaneous deductions. State and local taxes include your state income taxes paid, real estate taxes, and personal property taxes. In 2017, the total of all of these taxes was deductible, without limitation, for Federal tax purposes. Beginning in 2018, the maximum amount allowed as a deduction is $10,000. This will negatively impact many taxpayers paying high income taxes and/or real estate taxes. This has been a highly controversial portion of the tax law and may be a target of changes still being proposed.
The miscellaneous deductions were subject to an income limitation, but allowed for expenses such as tax preparation fee, investment fees, or unreimbursed business expenses for employees to be deducted for tax purposes. This entire section of deductions was eliminated in 2018.
After taking into account all your deductions, calculating your AGI, and taking the greater of the standard deduction or your itemized deduction, you have historically moved on to exemptions. Exemptions were a fixed dollar amount, per person, usually within your household. If you have ever heard of the “tax benefit for your kid,” it was a reference to this exemption. In a household of 4, Dad, Mom and 2 kids, there would be 4 exemptions available to offset your taxable income. The basic exemption amount was $4,050 per individual in 2017, traditionally increasing for inflation every few years. The exemptions were subject to limitations based on your income level, so it’s possible you were not actually getting this benefit at all. But for many, this was a decent offset to your taxable wages. This personal exemption benefit was eliminated entirely for all taxpayers in 2018. . But, not to fear, there could still be potential tax benefits from having children if you are eligible for certain credits.
Which leads us to our last discussion – credits…Dependent Care Credits, Foreign Tax Credits, Education Credits, there are numerous credits all of which reduce your tax liability. Some are refundable even if your tax liability is reduced to zero. Credits are the last mathematical consideration when calculating your tax liability. Notable changes to credits for 2018 include the Child Tax Credit and the Family Tax Credit. The Child Tax Credit increases from $1,000 to $2,000 and the phase out threshold was raised significantly, allowing for more people to qualify for this credit. The Family Tax Credit is an all new credit allowing $500 for qualifying dependents that are not qualifying children of the taxpayer. (Think dependent parents, or dependent children not in college.)
This is a basic overview of what the terminology means and how the recent changes to each tax benefit could potentially affect you. There are many tax planning opportunities available as a result of these changes, and we would highly recommend you discuss your specific situation with a professional if you think these changes may pertain to you. Stay tuned for our next blog which will discuss “write-offs and business expenses” and how it affects your business and potentially your personal tax returns. If you have any questions on the above please do not hesitate to reach out to us. We are always happy to help.