Most middle-income taxpayers will likely enjoy lower taxes this year because of the Tax Cuts and Jobs Act, but that doesn't mean tax planning is any easier.
Signed into law by President Donald Trump in December, the Tax Cuts and Jobs Act (TCJA) includes lower tax brackets and a nearly doubling of the standard deduction. But some taxpayers who are doing their tax planning for 2018 are hitting complications, thanks to several provisions that remain unclear.
Changes to withholding
First, since the TCJA included lower marginal tax rates and expanded the income amounts to which the new lower rates apply, most middle-income taxpayers will have more of their income taxed at lower marginal tax rates. That means employers will typically need to reduce the tax that's automatically withheld from workers' paychecks.
But because the new tax code was enacted so late in 2017, the new withholding tables weren't put into effect until March 2018. It's likely that many employees over withheld, paying more tax than required in early 2018 because their employers were relying on the 2017 tables that included the higher tax rates.
To give taxpayers a sense of how much they should have withheld from their pay, the IRS released an updated Withholding Calculator and Form W-4, which you can use to update your 2018 tax withholding. The IRS has also issued several "Information Releases" as reminders to the public to do a paycheck checkup to update their 2018 tax withholding.
Taxpayers who are self-employed, retired, or receive most of their income from investments should also revise their estimated tax payments to ensure their payments are accurate, in order to avoid underpayment penalties.
The limit on the deduction for state and local taxes – commonly referred to as the SALT deduction -- is also hitting a lot of taxpayers.
The TJCA imposed an annual limit of $10,000 on this deduction beginning in the 2018 tax year. The new law was clear to restrict the prepayment of 2018 state income tax in 2017, but the prepayment of property taxes wasn't as clear cut.
Many individuals prepaid their 2018 property taxes before the close of 2017. Not only did this give them a higher deduction for 2017, it will also help them avoid hitting the new limit on SALT deductions in 2018. But it was unclear if claiming a deduction for doing this would be allowed by the IRS.
To clarify this issue, the IRS said 2018 property taxes could only be prepaid in 2017 and deducted if the tax had been assessed by the taxpayer's local jurisdiction in 2017. Some tax advisors are questioning the IRS' position on this issue, which the tax law didn't address.
Several states have proposed alternatives they believe would preserve the federal deduction for property taxes by arranging transactions that recharacterize the payment of property taxes as charitable contributions to state-sponsored charities. However, the IRS has indicated the agency and the Treasury plan to issue regulations this year that will most likely restrict and limit these deductions.
Home equity loans
Another popular tax planning strategy that's creating some confusion is the deduction for interest on home equity loans.
That's because while the TCJA disallowed the deduction on home equity loans after January 1st, 2018, there is some wiggle room. The IRS clarified that taxpayers may still deduct the interest paid on borrowed amounts as long as the funds are used to buy, construct or improve the taxpayer's residence.
This deduction is also subject to the overall limit on deductible home loan interest on up to total loans of $750,000. The interest on new mortgages and home equity loans in excess of the limit is no longer deductible.