The tax reform legislation that became law at the end of last year will affect Americans’ finances in many different ways. For example, lower tax brackets will result in higher take-home pay for many people, while an expanded child tax credit will make more people eligible for this benefit.
One of the biggest impacts on your finances could be the significant increase in the standard deduction. This is the deduction you can claim without having to track and organize all of your deductible expenses for things like mortgage interest, state and local taxes and charitable contributions.
Who Itemizes Deductions?
Only about 30 percent of Americans itemize deductions, according to the Tax Policy Center. High-income households are more likely to itemize: About nine out of 10 households (92 percent) with adjusted gross income (AGI) in excess of $500,000 a year itemize deductions, while fewer than one out of ten (just seven percent) households with AGI under $30,000 a year itemize.
Due to tax reform, the percentage of Americans who itemize deductions could fall even farther. This is because the standard deduction has been almost doubled for tax year 2018:
|Filing status||Before Tax Reform||After Tax Reform|
|Heads of Household||$9,550||$18,000|
|Married Couples Filing Jointly||$13,000||$24,000|
If you have typically itemized deductions in the past, it might be smart to reconsider whether or not itemizing is still a smart decision. Why? The new higher standard deduction could be more than the total amount of your itemized deductions once the higher standard deduction kicks in this year.
Meet Jim and Jane
Let’s consider a hypothetical example to see how this might look. Jim and Jane, a married couple who file a joint tax return, had $200,000 in AGI in 2016 and $20,000 in itemized deductions. They recently crunched the numbers for last year in preparation for filing their 2017 tax return and their AGI and itemized deductions are about the same.
Since the new higher standard deduction doesn’t become effective until tax year 2018, Jim and Jane should probably itemize deductions again on their 2017 return. Their total itemized deductions for 2017 of $20,000 are once again higher than the standard deduction of $13,000, so they could realize tax savings by itemizing.
Now let’s fast forward one year to early 2019. Jim and Jane’s income rose slightly in 2018 to $210,000 and their itemized deductions also rose to $21,000. However, this is below the new higher standard deduction of $24,000, so it probably wouldn’t be wise for them to itemize this time around.
But what if Jim and Jane enjoy a significant income boost in 2018 — let’s say to $300,000 — and their itemized deductions also increase proportionally to $30,000? Now it probably makes sense for them to itemize — because their itemized deductions would be $6,000 higher than the standard deduction.
Other Factors to Consider
Keep in mind that itemizing deductions requires additional recordkeeping in order to substantiate deductible expenses. There are also additional filing requirements — specifically, you must file Schedule A with your 1040 form. If you hire a CPA to prepare and file your tax return, you may be charged extra for Schedule A filing. Be sure to factor this cost into your itemizing decision.
Another tax reform provision could also affect your decision about whether or not to itemize deductions: the new limitation on deductions for state and local taxes (SALT). Starting this year, you can only deduct up to $10,000 annually in SALT. If you have traditionally claimed SALT deductions that are much higher than this, your deductible expenses could be significantly lower going forward.
Start Planning Now
It’s not too early to start thinking about whether or not you will itemize deductions this time next year when you’re preparing your 2018 tax return. Be sure to consult with a tax professional for more detailed guidance given your specific situation.