The recently enacted tax reform law made some significant changes to the system of income tax deductions used by consumers. Here are highlights of the changes.
The standard deduction is increased.
For the 2018 tax year, the standard deduction has grown to as much as $24,000. Because of the significant increases, many taxpayers who formerly itemized their deductions may now benefit from the standard deduction instead.
Changes in Standard Deductions
Married filing jointly
Head of household
Married filing separately
These 2018 standard deduction amounts will be indexed for inflation after 2018. The additional standard deduction for the elderly and the blind is unchanged.
The deduction for state and local taxes is reduced.
For those who itemize their deductions, the maximum amount permitted for all state and local taxes (SALT) combined is $10,000 per year ($5,000 for married individuals filing separately). How the new limit affects you will depend on your specific situation. If you live in a high-tax state, you may see much of your SALT deduction reduced, and that could mean that itemizing deductions is no longer the better option.
The mortgage interest deduction has a lower cap.
For mortgage debt incurred after December 15, 2017, you may only deduct interest on debt value up to $750,000 ($375,000 for married individuals filing separately). Previously, the limit was $1 million. For home equity debt, the deduction for interest is suspended through 2025, unless the proceeds are used to buy, build, or substantially improve the home that secures the loan.
Casualty and theft losses are not now generally deductible.
Beginning this year, only losses that occur as the result of a federally-declared disaster may be deducted. Formerly, casualty and theft losses had generally been deductible to the extent they exceeded 10% of adjusted gross income (AGI).
Miscellaneous itemized deductions are suspended.
Various miscellaneous expenses, such as unreimbursed employee business expenses and tax preparation expenses, were formerly deductible as an itemized deduction to the extent they totaled more than 2% of the taxpayer’s AGI. The new law suspends the deduction for these expenses.
Charitable contributions are still deductible if you itemize.
Cash contributions will now be allowed up to 60% of the taxpayer’s “contribution base,” up from 50%. A taxpayer’s contribution base is generally equal to AGI exclusive of any net operating loss carryback for the year. This change will affect only those taxpayers who contribute a significant proportion of their income to charity.
Medical expense rules become more generous.
Taxpayers with substantial medical expenses who also itemize can now deduct unreimbursed medical expenses in excess of 7.5% of their AGI, down from the deductibility threshold of 10% previously. Note that the reduced threshold was made retroactive to January 1, 2017, but will apply only for 2017 and 2018.
Moving expenses lose their tax advantage.
The deduction for qualified moving expenses, which can be claimed even if a taxpayer doesn’t itemize, has been suspended, except for members of the Armed Forces on active duty (provided certain conditions are met).
The alimony deduction for payers is eliminated.
The tax treatment of alimony payments will change significantly under the new law. Such payments will no longer deductible by the payer (and the recipient will no longer be required to include the alimony in income). The change applies to alimony paid under any divorce or separation agreement executed after December 31, 2018.
Note that some of these provisions are scheduled to sunset in 2019 or 2026 unless Congress acts to extend them. Talk to your tax advisor to see how the law may ultimately impact your situation.
This communication is not intended to be tax advice and should not be treated as such. Each individual’s tax circumstances are different. You should contact your tax professional to discuss your personal situation.
The State of Michigan recently issued guidance in response to the Wayfair decision. In this decision, the Supreme Court held that a business’ physical presence in a state is no longer required before a state can impose a sales or use tax collection requirement on that business. Even though a physical presence is no longer required, states must meet the Constitution’s Commerce Clause requirements before imposing a tax collection requirement on the business.
The Commerce Clause requires that a tax:
- is applied to an activity with substantial nexus with the taxing state. (prior to Wayfair, the Supreme Court held that a physical presence was required to establish nexus.)
- is fairly apportioned in and out of the state
- does not discriminate against interstate commerce
- is fairly related to services provided by the state
In Wayfair, the Supreme Court held that a seller has substantial nexus in a state if it “avails itself of the substantial privilege of carrying on a business in that [state].” In the Wayfair case, South Dakota required remote sellers to remit sales tax for sales sourced to South Dakota if the seller’s sales exceeded $100,000 or the seller had 200 or more separate transactions with customers in the state.
The Court found three factors important in finding South Dakota’s law constitutional:
- the law had a safe harbor for smaller sellers (those with under $100,000 in sales or under 200 transactions per year)
- the law only applied on a prospective basis—there was no retroactive tax remittance requirement
- South Dakota is a member of the Streamlined Sales and Use Tax Agreement that standardizes its sales tax rules to reduce administrative and compliance costs. Michigan is also a member of this body.
Sales and Use Tax Nexus in Michigan
A seller has substantial nexus in Michigan (and therefore has a sales/use tax remittance obligation) under three rules:
- The seller has a physical presence in Michigan
- The seller can have representational , attributional, or “click-through” presence. See a prior post explaining these rules.
- The seller has economic nexus as described in Wayfair
After September 30, 2018, a seller that has sales (both taxable and non-taxable) into Michigan exceeding $100,000, or a seller that has 200 or more separate transactions of sales (both taxable and non-taxable) into Michigan in the previous calendar year has nexus in Michigan and is required to remit sales or use tax on all of its taxable sales into Michigan and file all required returns.
Remote sellers must review their 2017 calendar year sales (January to December) to determine if they meet either of the two economic nexus thresholds. If they meet either threshold, they must begin filing and paying sales tax in Michigan beginning October 1, 2018 forward.
Remote sellers that only have nexus due to exceeding either of the economic nexus standards are not liable for any tax, penalty, or interest for any transactions occurring before September 30, 2018.
Example: Glamazon.com has no physical or representational presence in Michigan. However, it had $150,000 of sales into Michigan between January 1, 2018 and December 31, 2018. It has economic nexus in Michigan effective after September 30, 2018. It must begin reporting and paying sales tax on all taxable sales from October 1, 2018 forward.
Once a seller has nexus due to its economic presence, it must remit tax until a calendar year passes in which it does not meet either of the economic nexus standards.
Example: Assume same facts as above example; however, between January 1, 2018 and December 31, 2018, Glamazon.com only has $80,000 of sales into Michigan and only has 150 separate transactions into Michigan. Seller no longer has economic nexus beginning January 1, 2019 and may cease remitting and reporting tax after that date (i.e., it must continue to remit and report sales tax through December 31, 2018, but may cease remitting and reporting for sales on or after January 1, 2019).
Over the past few years, there has been a $100 per day per employee penalty for employers who provided certain Health Reimbursement Accounts (HRAs) and/or Employer Payment Plans.
Under an HRA, an employer reimburses employees for the medical expenses up to a certain limit. The reimbursement is deductible by the employer and tax-free to the employee.
Under an Employer Payment Plan, the employer either reimburses employees for the cost of health insurance premiums or directly pays the insurance company for the employees’ health insurance coverage. Again, the payment is deductible by the employer and tax-free to the employee.
Under the market reform provisions of Obamacare, these plans became disfavored and subjected the employer to a $100 per day per employee (i.e., $36,500 per employee per year) penalty. The primary reason for the penalty is because the market reform provisions eliminated any annual or lifetime cap on benefits. HRAs are generally subject to an annual cap and Employer Payment Plans are deemed to be capped at the cost of the employee’s premium that is being paid.
Qualified HRAs No Longer Subject to $100 per Day per Employee Penalty
Qualified HRAs are exempt from the $100 penalty. Employer Payment Plans remain subject to the penalty.
Eligible employers that do not offer group health insurance coverage to any employees can offer a Qualified Small Employer HRA (QSEHRA). Eligible employers are employers that are not applicable large employers under Obamacare (applicable large employers have 50 or more employees).
The employer must offer a QSEHRA to each eligible employee. An eligible employee is defined broadly as any employee; however, the employer can elect to exclude the following:
- Employees who have not completed 90 days of service
- Employees under age 25
- Part-time or seasonal employees
- Employees covered by a collective bargaining agreement covering accident and health benefits
- Nonresident alien employees with no U.S. source income
A QSEHRA must be provided on the same terms to all eligible employees and funded entirely by the employer. Payments and reimbursements are limited to $4,950 per year ($10,000 for family coverage) and are prorated if the employee is not covered for the whole year. For example, if a single person starts employment on July 1, then the limit is reduced by 50%–$2,475 ($4,950 times 50%). These amounts will be adjusted for inflation.
Payments/Reimbursements are Taxable If Employee Does Not Have Minimum Essential Coverage
Unlike a regular HRA, premiums for individual health insurance policies, as well as other medical expenses such as deductibles and copays, can be paid or reimbursed by a QSEHRA. However, any payments or reimbursements from a QSEHRA for medical care (including insurance premiums) that are provided when an individual does not have minimum essential coverage are included in the employee’s income. Generally, an individual health insurance policy qualifies as minimum essential coverage, but the employer must verify that the employee has minimum essential coverage. Payments under a QSEHRA will affect the employee’s amount and qualification for the premium tax credit.
Employer Must Provide Notice to Employees
An employer funding a QSEHRA must provide written notice to each eligible employee no later than 90 days before the beginning of the year (or the date the employee first becomes eligible to participate). The notice must state the amount that will be available for reimbursement or payment for the year. Additionally, the notice must remind the employee that any benefits available under a QSEHRA must be disclosed to the health insurance marketplace if the employee applies for coverage through the marketplace and requests advance payment of the premium tax credit. The notice must also include a statement that if the employee does not have minimum essential coverage for any month, he may be subject to a penalty for the month and that payments and reimbursements under the QSEHRA may be included in income.
Employers that do not provide proper notice to employees are subject to a penalty of $50 per employee. The total penalty that can be assessed for one year cannot exceed $2,500.
Finally, amounts paid under a QSEHRA must be reported on the employee’s W2 (even though the payments are generally tax-free).
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Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
College costs continue to grow rapidly each year. Section 529 plans allow taxpayers to save for college and receive tax benefits. There are two types of Section 529 plans.
The Prepaid Tuition Program
This program allows taxpayers to lock in today’s tuition rates and make lump-sum or monthly payments so when the account beneficiary is ready for college, a decent portion of the costs are already paid. The prepaid tuition program locks in current tuition rates so when the beneficiary is ready for college, she won’t be subject to the increased tuition rates applicable when she enters college. Basically, the rate of return on the prepaid tuition program is equal to the inflation rate of tuition.
The Education Savings Account
This program is a tax-advantaged savings account that is used to pay for college expenses. Taxpayers contribute to this account, and the earnings can be withdrawn tax-free if they are used for qualifying education expenses. There is no guarantee that the amount in the savings account will fully fund educational expenses.
Federal Tax Treatment of Both Types of Section 529 Plans
Amounts contributed to Section 529 plans are NOT deductible at the federal level. The tax advantage lies in the fact that the earnings are not taxed if they are used for qualifying educational expenses. Qualifying educational expenses include tuition, fees, supplies and equipment, and room and board.
If earnings are withdrawn and not used for educational purposes, the earnings are subject to income tax and a 10% penalty.
Generally, amounts can be rolled over from one qualified tuition program to another for the benefit of the same beneficiary, or another beneficiary who is a member of the same family, without tax consequences.
Contributions to Section 529 plans are considered gifts which are subject to gift tax. The annual gift tax exclusion for 2018 is $15,000. Taxpayers can elect to treat contributions to Section 529 plans as if they were made evenly over 5 years. Taxpayers can therefore contribute up to 5 times the annual gift tax exclusion amount of $15,000 (which is $75,000), elect to treat the gift as occurring evenly over 5 years, and not be subject to gift tax.
Example: Joan contributes $60,000 to her child’s Section 529 plan. She can elect to treat the gift as occurring $15,000 per year for five years. Since the annual gift each year is under $15,000, the gift is not subject to gift tax.
Married couples can contribute $30,000 per year without incurring gift tax through gift splitting. They can contribute $150,000 per beneficiary and elect to treat the gift as being made $30,000 per year for five years.
Contributions to Section 529 plans remove the assets from the contributor’s estate for estate tax purposes. Section 529 plans are unique in that they reduce the contributor’s taxable estate even though the contributor still has control of the Section 529 account. A danger exists when 5 year averaging is elected and the contributor dies before the 5 years expires. Here, any contributions treated as gifts after the taxpayer dies will be brought back into the contributor’s estate. However, under the Tax Cuts & Jobs Act passed last year, the unified gift and estate exclusion amount is roughly $11 million ($22 million for a married couple electing portability). The drastic increase in the gift and estate tax exclusion amount virtually eliminates gift and estate taxes for the vast majority of people.
Michigan Tax Treatment of Michigan Section 529 Plans
The State of Michigan treats prepaid tuition programs and educational savings accounts differently.
Prepaid Tuition Programs
Michigan allows a state income tax deduction for the total amount paid each year for prepaid tuition programs. There is no limit to the deduction. However, the gift tax consequences may limit how much is contributed each year. Earnings are tax free to the extent they are used for qualified education expenses.
Educational Savings Accounts
Michigan allows a deduction of $5,000 ($10,000 for married filing jointly) per year for the amount contributed to educational savings accounts. The maximum account balance of a single beneficiary is $500,000. Earnings are tax free to the extent they are used for qualified education expenses.
PATH Act of 2015 Avoids Taxation of Refunded Tuition When Recontributed to Section 529 Plan
The Protecting Americans from Tax Hikes Act of 2015 addressed situations where a beneficiary receives a distribution from a Section 529 plan, uses the distribution to pay for qualified education expenses, then receives a refund of those expenses (e.g., a beneficiary drops a class mid-semester and receives a tuition refund). Prior to the law change, the beneficiary would have to pay tax on the earnings portion of the Section 529 plan distribution that was refunded.
Under the law changes in 2015, the portion of such distribution refunded to a student is not subject to income tax to the extent the refund is recontributed to that student’s Section 529 plan within 60 days of the receipt of the refund.
TCJA Allows Rollover of Section 529 Funds into ABLE Accounts
An ABLE (Achieving a Better Life Experience) account allows contributions to be made for a beneficiary to cover expenses related to living with a disability. The contributions are not tax deductible, but distributions (including earnings) can be withdrawn tax free to cover expenses such as: education, assistive technology, hiring personal care attendants, accessible housing, healthcare costs, transportation, and much more.
Under the Tax Cuts & Jobs Act of 2017, a distribution from a Section 529 plan is not subject to tax if it is transferred to an ABLE account within 60 days of distribution. Tax-free rollover treatment is available between 2018 and 2025. The rollover distribution is limited to the annual gift tax exclusion ($15,000 for 2018).
TCJA Expands Definition of Qualified Higher Education Expenses
Qualified higher education expenses have been expanded to include the beneficiary’s tuition costs at an elementary or secondary public, private, or religious school up to $10,000 per year.
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Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
In many cases, shopping online comes with a major perk—online purchases are not subject to sales tax. While online purchases are not subject to sales tax, they are generally subject to use tax. Use tax is not charged by the online seller, but shoppers in many states are required to report purchases subject to use tax on their personal tax returns and pay the use tax liability along with filing their state tax returns. As you can guess, compliance with this requirement is very low.
States are obviously not happy because they are not able to collect sales tax from online retailers and because online buyers are not reporting their purchases that are subject to use tax. It’s estimated that online sales surpassed $409 billion last year and according to the U.S. Government Accountability Office, states lose between $8 billion and $33 billion every year.
The reason states are not able to collect sales tax from many online retailers is because a retailer must have a physical presence in the state before the retailer is subject to the sales tax collection requirement. The Supreme Court in two older cases held that the Constitution requires a physical presence before a business can be subject to a state’s sales tax jurisdiction. Physical presence could include a retail location, warehouse, employees, or delivery vans in a state.
In-state retailers are also not happy because online retailers are effectively able to sell their products at a discount because no sales tax is imposed.
The Times Are a Changin’
In 2016, South Dakota declared a fiscal emergency based on its inability to collect sales tax from remote sellers. To combat this, South Dakota passed a law that requires out-of-state sellers to collect and remit sales tax as if they had a physical presence in the state. The statute applies to retailers that (1) deliver more than $100,000 of goods or services (yes, South Dakota imposes a sales tax on services) into the state or (2) engage in 200 or more transactions for delivery of goods or services into the state.
South Dakota was challenging the physical presence requirement for sales tax. The case was recently decided in the Supreme Court of the U.S. In South Dakota vs. Wayfair, Inc. the Supreme Court sided with South Dakota, ruling that the physical presence requirement is outdated. Given advances in technology, a business may be present in a state in a meaningful way without being physically present in that state.
Example: Before Amazon.com opened a warehouse in Michigan it was not subject to sales tax in Michigan because it had no physical presence. Regardless of how powerful a presence it had in Michigan through its website it was not subject to sales tax liability in Michigan. However, a small retail shop located in Michigan would be subject to sales tax liability. Should a small retail shop be subject to sales tax even though Amazon.com has a much stronger presence in the state (albeit not a physical presence).
In the wake of Wayfair, the following items have to be kept in mind:
- States will likely change their sales tax laws to remove the physical presence requirement. Business owners selling into states where they do not have a physical presence should determine what the sales tax requirements are in those states to determine if they have a filing requirement. As states will update their laws in the coming months and years, regular reviews of state filing requirements should be conducted.
- States still are not free to do whatever they want. The Court in Wayfair pointed out that South Dakota’s statute has several features that pass muster under the Constitution. First, the law does not apply to businesses that do not meet the $100,000 sales threshold or the 200 transaction threshold. Also, South Dakota is a member of the Streamlined Sales and Use Tax Agreement, which reduces administrative costs by providing state-funded sales tax software. States that impose laws that do not have similar safeguards may find their laws invalid.
It isn’t easy deciding whether a worker should be treated as an employee or an independent contractor. But the IRS looks at the distinction closely.
For an employee, a business generally must withhold income and FICA (Social Security and Medicare) taxes from the employee’s pay and remit those taxes to the government. Additionally, the employer must pay FICA taxes for the employee (currently 7.65% of earnings up to $128,400 and 1.45% of earnings exceeding that amount).1
The business must also pay unemployment taxes for the worker. In contrast, for an independent contractor, a business is not required to withhold income or FICA taxes. The contractor is fully liable for his or her own self-employment taxes, and FICA and federal unemployment taxes do not apply.
Employees Versus Independent Contractors
To determine whether a worker is an independent contractor or employee, the IRS examines factors in three categories:
- Behavioral control — the extent to which the business controls how the work is done, whether through instructions, training, or otherwise.
- Financial control — the extent to which the worker has the ability to control the economic aspects of the job. Factors considered include the worker’s investment and whether he or she may realize a profit or loss.
- Type of relationship — whether the worker’s services are essential to the business, the expected length of the relationship, and whether the business provides the worker with employee-type benefits, such as insurance, vacation pay, or sick pay, etc.
In certain cases where a taxpayer has a reasonable basis for treating an individual as a non-employee (such as a prior IRS ruling), non-employee treatment may be allowed regardless of the three-prong test.
If the proper classification is unclear, the business or the worker may obtain an official IRS determination by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Generally, if a business has made payments of $600 or more to an independent contractor, it must file an information return (Form 1099-MISC) with the IRS and send a corresponding statement to the independent contractor.
Consequences of Misclassification
Where the employer misclassifies the employee as an independent contractor, the IRS may impose penalties for failure to deduct and withhold the employee’s income and/or FICA taxes. Penalties may be doubled if the employer also failed to file a Form 1099-MISC, though the lower penalty will apply if the failure was due to reasonable cause and not willful neglect.
Employers with misclassified workers may be able to correct their mistakes through the IRS’s Voluntary Classification Settlement Program (VCSP). For employers that meet the program’s eligibility requirements, the VCSP provides the following benefits:
- Workers improperly classified as independent contractors are treated as employees going forward.
- The employer pays 10% of the most recent tax year’s employment tax liability for the identified workers, determined under reduced rates (but no interest or penalties).
- The government agrees not to raise the issue of the workers’ classification for prior years in an employment-tax audit.
Your tax advisor can help you sort through the IRS rules and fulfill your tax reporting obligations.
1Internal Revenue Service. For 2018, the Social Security tax rate is 6.2% and is applied to earnings up to $128,400. The Medicare tax rate of 1.45% is applied to all earnings.
Any employer reimbursing its employees for business-related expenses should consider whether the reimbursement arrangement meets the IRS’s requirements for an accountable plan. Having an accountable plan that meets tax law requirements can provide tax advantages.
Each expense reimbursed under an accountable plan must have a business connection. This means that the expense must be allowable as a deduction and paid or incurred by the employee while performing services as an employee.
Employees must adequately account for their expenses and return any excess reimbursements or allowances within a reasonable period of time. The meaning of reasonable period of time depends on the facts and circumstances, but the IRS has provided several safe harbors.
Substantiation of an expense within 60 days after it is paid or incurred will be deemed reasonable, as will the return of an advance within 120 days. Alternatively, an employer may provide its employees with periodic statements (at least quarterly) that require them to either account for or return any advances within 120 days of the statement.
Expense reimbursements made under an accountable plan that meets the requirements are not included in an employee’s wages and are not subject to federal income or employment taxes. This can be a tax saver for both the employer and the employee.
If no accountable plan is in place, amounts paid to the employee count as taxable wages. In the past, the employee could potentially deduct the expenses, but only if the employee itemizes deductions rather than claims the standard deduction. Under the new tax law, this deduction is no longer available–so the employee will include the reimbursement in income, but would not be entitled to a deduction.
Your small business does many things. It supports the community by providing goods and services. It supports the local government by paying taxes and fees. And it supports your employees by providing their livelihoods.
Your business provides for you, too. But don’t count on this to continue. You need a plan for using your business to create personal wealth.
Fund a Retirement Plan
Contributing to a retirement plan is generally a great way to convert money from your business into a personal benefit. Over time, you may be able to accumulate a substantial amount, especially if you contribute the maximum amount. If you don’t have a retirement plan, your financial professional can give you information about the options best suited for small businesses.
Fund Your Exit Strategy
A potentially more lucrative way to convert business wealth into personal wealth is to sell your company. This is a big step and it could take longer than you think, so allow plenty of time. Make sure you have a business valuation done early in the process. That way, if the value isn’t as high as you want (need) it to be, you have time to make necessary changes.
If you don’t have a formal succession plan, create one. If you do have one, make sure it’s kept up to date. A succession plan shows potential buyers that you are committed to having the business survive without you. A buy-sell agreement is a popular way to provide for the transfer of a business. Such agreements are legal contracts that establish who can buy an interest in a company and under what conditions they may do so.
Fund Your Buy-Sell Agreement
Life insurance is a popular way to fund buy-sell agreements. If you’d like to learn more about the role insurance can play in your — and your company’s — future, call your financial professional. Don’t have one? We have recommendations.
The Tax Cuts and Jobs Act (TCJA) has made changes to the tax treatment of alimony that you will be interested in. These changes take effect for divorces and legal separations after 2018.
Current rules. Under the current rules, an individual who pays alimony may deduct an amount equal to the alimony or separate maintenance payments paid during the year as an “above-the-line” deduction. (An “above-the-line” deduction, i.e., a deduction that a taxpayer need not itemize deductions to claim, is more valuable for the taxpayer than an itemized deduction.)
And, under current rules, alimony and separate maintenance payments are taxable to the recipient spouse (includible in that spouse’s gross income).
Please note that the tax rules for child support—i.e., that payers of child support don’t get a deduction, and recipients of child support don’t have to pay tax on those amounts—is unchanged.
TCJA rules. Under the TCJA rules, there is no deduction for alimony for the payer. Furthermore, alimony is not gross income to the recipient. So for divorces and legal separations that are executed (i.e., that come into legal existence due to a court order) after 2018, the alimony-paying spouse won’t be able to deduct the payments, and the alimony-receiving spouse doesn’t include them in gross income or pay federal income tax on them.
TCJA rules don’t apply to existing divorces and separations. It’s important to emphasize that the current rules continue to apply to already-existing divorces and separations, as well as divorces and separations that are executed before 2019.
Some taxpayers may want the TCJA rules to apply to their existing divorce or separation. Under a special rule, if taxpayers have an existing (pre-2019) divorce or separation decree, and they have that agreement legally modified, then the new rules don’t apply to that modified decree, unless the modification expressly provides that the TCJA rules are to apply. There may be situations where applying the TCJA rules voluntarily is beneficial for the taxpayers, such as a change in the income levels of the alimony payer or the alimony recipient.
If you wish to discuss the impact of these rules on your particular situation, please give me a call.
I am writing to let you know about changes that the Tax Cuts and Jobs Act (TCJA) made in the rules for deducting home mortgage interest.
Deductibility of interest on “acquisition debt.” Taxpayers may deduct interest on mortgage debt that is “acquisition debt.” Acquisition debt means debt that is: (1) secured by the taxpayer’s principal home and/or a second home, and (2) incurred in acquiring, constructing, or substantially improving the home. This rule isn’t changed by the TCJA.
Pre-TCJA maximum for acquisition debt. Under the pre-TCJA rules, the maximum amount that was treated as acquisition debt for the purpose of deducting interest was $1 million ($500,000 for marrieds filing separately). This meant that a taxpayer could deduct interest on no more than $1 million of acquisition debt.
Pre-TCJA deduction for “home equity” debt; maximum. Under pre-TCJA rules, taxpayers could also deduct interest on “home equity debt.” “Home equity debt,” as specially defined for purposes of the mortgage interest deduction, meant debt that: (1) was secured by the taxpayer’s home, and (2) wasn’t “acquisition indebtedness” (that is, wasn’t incurred to acquire, construct, or substantially improve the home). Thus, the rule allowing deduction of interest on home equity debt enabled taxpayers to deduct interest on debt that was not incurred to acquire, construct, or substantially improve a home—on debt that could be used for any purpose. As with acquisition debt, pre-TCJA rules limited the maximum amount of “home equity debt” on which interest could be deducted to the lesser of $100,000 ($50,000 for a married taxpayer filing separately), or the taxpayer’s equity in the home.
TCJA decreases maximum acquisition debt. Under the TCJA, starting in 2018, the limit on acquisition debt is reduced to $750,000 ($375,000 for a married taxpayer filing separately). The $1 million, pre-TCJA limit applies to acquisition debt incurred before Dec. 15, 2017, and to debt arising from refinancing pre-Dec. 15, 2017 acquisition debt, to the extent the debt resulting from the refinancing does not exceed the original debt amount. Thus, taxpayers can refinance up to $1 million of pre-Dec. 15, 2017 acquisition debt, and that refinanced debt amount won’t be subject to the reduced limitation.
TCJA eliminates deduction for “home equity” debt. Also, starting in 2018, there is no longer a deduction for interest on “home equity debt.” The elimination of the deduction for interest on home equity debt applies regardless of when the home equity debt was incurred.
Taking the TCJA changes into account. Taxpayers considering taking out a home equity loan—i.e., a loan that’s not incurred to acquire, construct, or substantially improve the home—should take into consideration the fact that interest on the loan won’t be deductible. Further, taxpayers with outstanding home equity debt—again, meaning debt that’s not incurred to acquire, construct, or substantially improve the home—will lose the prior-law interest deduction for interest on that debt, starting in 2018. (Interest on home equity debt is deductible for the 2017 tax year, the return for which is filed in early 2018.)
TCJA changes will last through 2025. Finally, it’s important to note that both of these changes—the lowered maximum for acquisition debt, and the elimination of the deduction for home equity debt—last for eight years, through 2025. In the absence of intervening legislation, the pre-TCJA rules will come back into effect in 2026. So beginning in 2026, interest on “home equity” loans will be deductible again, and the limit on qualifying acquisition debt will be raised back to $1 million ($500,000 for married separate filers).
If you would like to discuss how these changes affect your particular situation, and any planning moves you should consider in light of them, please give me a call.