Trump Tax Law Post Tax Season Thoughts

If you bought my book on the subject, this post will expand upon some lessons learned following the first full season of implementation. The book was accurate, but there were definitely some lessons learned. I will write this post as best I can such that anyone can use it, even if they didn't buy the book (which is pictured in the upper right corner of this blog and a click there will get you a copy...hint...hint). I'm going to reluctantly start with some politics, just because I'm baffled by the big mistake made in implementation. It will be directed at Trump and the GOP, but you shouldn't take any partisan bent away from it, it is just about the law and political advantage, not a critique of any political philosophy.

Politics: Adjusting the withholding tables for the new tax rates AND doing a bad job of it was a HUGE political mistake. The tax cut was pretty nice for most people, but spread out over 20 plus paychecks it had almost zero perceivable impact. If they had left the tables alone, the narrative right now would be about bigger refunds, not smaller ones, and that would temper some of the negatives going on right now (Mueller Report). Instead, people are pissed off about their refund AND dirty politics (as if there is any other kind). Okay...enough politics.

Now onto what I learned or want to emphasize from doing a few hundred tax returns under the new law:

1. There is still a bit of adjustment being accounted for in the new new tax tables, so if your refund dropped in 2018, it will drop a tiny bit more for 2019 - assuming all things being equal year over year. I still highly recommend using the irs.gov withholding calculator to ensure you get results in the area you want.

2. The new tax rates were a big deal, especially at the higher rates. This plus the higher limit for the Child Tax Credit were the largest impact on families in the solid middle class ($100k plus income).

3. The loss of the personal exemption for everyone in the family had some unique impacts. Even though many people had lower taxes, their actual taxable income was higher (made up later by higher credits for children). People who had good itemized deductions were hurt the most, due to not feeling the effect of the new standard deduction. I think the biggest impact of the higher taxable income was in how it affected the taxability of long term capital gains and qualified dividends. While the new tax law technically decoupled the lower capital gains rates from tax bracket, it is still closely tied with taxable income. This means that more capital gains will be taxed at rates higher than zero and more near the maximum rates. It also had impacts on Foreign Earned Income Exclusion tax rates and the 20% "pass-through" deduction for businesses.

4. Speaking of the 20% pass through deduction...what seemed like a very simple deduction (as long as you were below the taxable income limit at which restrictions applied) turned out to be much harder. Hard enough that it seems to have baffled some software programmers. If you filed very early, you might want to double check that your software did it correct. I'm not going to hit the details, but just be aware that "20%" didn't turn out to be 20%. I had one client who hit the income limit where restrictions came into play and it was a big deal. The convolutions that came into play at that point caused me to recommend that he seek additional help from a CPA experienced in partnerships and S-corporations so that he could explore changes in business structure and methods of sub-contractor payments to maximize the deduction. If you are near the income limits ($315,000 for MFJ and $157,500 for others) and this limit applies to you, seek experienced professional help NOW!

5. Many fewer people took the standard deduction, but this doesn't mean you can ignore it. If you are a regular contributor to charities, paying attention to how close you are to exceeding the standard deduction, and then grouping donations for maximum affect in a single year can be very rewarding in the year you itemize, as opposed to just donating willy-nilly without concern for taxes.

6. If you have a child in private school, you should explore your states laws regarding 529 plan contribution and withdrawal timing, as well as if you get a deduction for contributing. It is possible to route money you were already going to spend on school through a 529 plan and get a tax deduction for something you were already doing.

7. You don't have to have health insurance now to avoid a penalty.

8. If you had significant employment deductions, you already know you took a big hit. For others, you get NO deductions for work expenses as an employee. You can stop asking about clothes, uniforms, tools etc.

9. The above said, many people confused expenses for BUSINESSES with expenses for EMPLOYMENT. As an employee, you get no work expense deduction. If you are a business (paid on a 1099MISC or tracking your own income) your deductions were not significantly changed. The mileage deduction didn't go away, it was just eliminated for employees.

10. Starting with divorces completed in 2019, alimony is no longer deductible to the payer or added as income to the payee. Make sure you take this into account during divorce proceedings. Lawyers and judges will be slow to recognize the significance of this change.

Military Spouses Residency Relief Act Change

A lot of people seemed to have missed this, but there is a MAJOR change to the Military Spouses Residency Relief Act!

In the past, the spouse of a service member had to have established residency in the military member's state of residency in order to claim that state for residency.

Now, to summarize, the spouse of a service member may claim one of two states as their state of residency: the state they live in, or the service member's state of residency.

On initial reading of the law I can see very little restriction on the spouse changing this as needed, especially after a PCS move. The states may feel differently.

The law took affect for 2018 tax year and later.

More Emergency Fund Advice

First things first: YOU NEED AN EMERGENCY FUND!!!

Now that we got that out of the way, let's talk about what an emergency fund is and is not.

When people suggest an amount for an emergency fund, it is often couched in terms of 3 to 6 months of expenses. This leads to the idea that its primary purpose is for loss of income. This could not be further from the truth. While job loss is the worst case emergency for which your fund could be used, it is not the most likely, especially for a someone with a solid job. Your emergency fund is most likely to be used for an unexpected repair or an emergency trip. I recently had a slew of emergencies (hence the impetus for this post) and they included AC repair (which looked like it might be a replacement) a broken dishwasher and a near dead dryer. I also either need a new car, or have some impending repairs due on the old one.

All of the above is no sweat because I have an emergency fund. Not only that, I have a budget line item that feeds into the emergency fund so I don't have to refigure my budget to refill the fund for the money I just took out.

Knowing how much you need, and how to get the money in there is hard. That's why people simplify with the 3 to 6 months expenses trope. It will generally overfund it, as well as covering the worst case, which is often an extended job loss (it's just not the likely one). What follows is a mix of what I do, and advice for people just starting out.

I set my emergency fund at six months of MANDATORY expenses: rent/mortgage, basic (or locked in by contract) utilities, basic food, and miscellaneous NEEDS (no BS wants disguised as needs). This was easy since I have a budget (you do have a budget, right?) I then set a budget line item that filled the budget in 12 months (this is overkill - 24 months is plenty - 30 months the longest you should go). If my emergency fund gets over-filled, I buy myself something I want, but wouldn't ordinarily be willing to budget for (like a trip or fancy electronics). Make sure this amount will cover a major car repair or a trip to your furthest relative's home.

Doing it this way ensures you will eventually be prepared for almost every emergency likely to occur. But what happens if an emergency happens while filling the fund? The honest answer is you might be screwed. To avoid that, use a tax refund, other savings, or a bonus to fill the fund up as quickly as possible.

Bottom line, you need an emergency fund. The added bonus of having one is that our old buddy Murphy tends to cause emergencies for people who aren't prepared. Having an emergency fund is, paradoxically, one of the best ways to avoid needing one.

What the New Tax Law Didn't Change

Excerpt from The Short Cheap Tax Book for the Trump/GOP Tax Law:

What Didn’t Change

There was a lot of talk, and two passed bills, that went into the conference committee where the final bill language was decided.  Here’s a list of things they talked about, but didn’t change:

Capital Gains tax rates stayed the same

Identification of sold securities unchanged (no forced FIFO)*

No change to education credits

Student loan interest is still deductible

Savings bond interest used for education is still tax-free

Colleges can still provide tax-free education to their employees

Electric vehicle credit wasn’t changed

Employer education expense exclusion is unchanged

No change to MSA deductibility

No change to educator expense deduction**

No change to the sale of personal residence exclusion***

No change to Dependent Care Benefits exclusion

No change to adoption rules

No change to the solar credit

No change to the Credit for Elderly and Disabled

No change to Mortgage Credit Certificates****

No change to Earned Income Credit

No change to employer-provided housing rules

No change to exempt organizations rules on “politicking”
529 plan money still not usable for homeschool

*There was a proposal to force partial sales of batches of stocks or other assets to be determined based on “First In, First Out” rules, rather than allowing the person selling to specify what shares of stock among a batch were the ones sold.  This was not adopted.

**As will be discussed later, a whole bunch of itemized deductions were eliminated including the employee business expense deduction that teachers often use to deduct expenses above the $250 educator expense deduction.

***I am actually going to briefly cover the rules in a later chapter since people still think they have to buy a new home to make this work – something that was changed over 20 years ago.

****Links to my blog post on the subject for South Carolina

The Trump Tax Plan and You

The Short Cheap Tax Book for the Trump/GOP Tax Law is available now on Kindle.  Just $1.49.  If you don't have a Kindle, you can use a free cloud reader or phone app from Amazon.  Tons of great information and details on the new law.  All the major changes that are likely to impact most people are covered.

Here is a summary of the tax changes in the final bill that is expected to pass.  Unless otherwise noted, they apply to 2018 taxes:

Tax tables are generally better, and the tax brackets went from 10, 15, 25, 28, 33, 35, and 39.6 percent to 10, 12, 22, 24, 32, 35, and 37 percent.

Standard deductions were changed to $12,000 for Single and MFS, $18,000 for Head of Household (HH) and $24,000 for Married Filing Jointly (MFJ) and Qualifying Widower (QW).  This sounds awesome, but they eliminated the personal exemption of $4050 for everyone on the return.  For kids, this was offset by doubling the Child Tax Credit (discussed below).  Effectively, your standard deduction plus exemptions for Single/MFS went from about $10,500 to $12,000.  For MFJ it went from about $21,000 to $24,000 and for HH it went from about $13,500 to $18,000.

Claiming Head of Household has been subjected to preparer due diligence rules, so be prepared for more scrutiny from your tax guy and the IRS (starting in 2019 with 2018 tax returns - this year you are okay).

The Child Tax Credit went from $1000 to $2000, with up to $1400 refundable (able to reduce your taxes below zero.)  Other dependents get $500 (dependents who are not qualifying children age 16 and below).  The income numbers where the credit phased out were dramatically increased to $200,000 for Single and $400,000 for MFJ (up from $110,000 for MFJ).  If you are in the 25% tax bracket, you almost break even with these changes and the elimination of the exemption.  In the lower brackets, you come out well ahead.

You can deduct no more than $10,000 of state and local income and property taxes on your tax return.  You cannot prepay 2018 INCOME taxes in order to deduct them in 2017 before this change happens (You can prepay property taxes if assessed).

NEW home loans in 2018 and later can deduct interest on up to $750,000 of loans (down from 1,000,000).  Home equity debt interest is no longer deductible (new loans only).

ALL miscellaneous itemized deductions subject to the 2% of income limitation are eliminated: tax prep fees, employee business expense, investment expense and a TON more.

Casualty and theft losses are only deductible for President declared disasters.  There is also a special provision for losses due to disasters that occured in 2016.

You can deduct up to 60% of your income in "normal" charitable contributions.  Up from 50%.  (Some contributions have more restrictive limits such as stock that's worth more than when you bought it).

For 2017 and 2018 ONLY, you can deduct medical expenses that exceed 7.5% of your Adjusted Gross Income (Obamacare was phasing in a 10% threshold which will apply to everyone in 2019 and later years).

The high-income phaseout of itemized deductions was repealed.

There's a chance they won't change the withholding tables for 2018, so all these changes may show up on your tax return and not on your paycheck.  Most people will get bigger refunds, so this isn't a disaster.  UPDATE: The IRS will not be changing the W-4 form where you tell them your marital status and number of exemptions (at least not in 2018), but they do expect to have withholding tables updated by the end of January.

The Kiddie Tax was simplified dramatically (when your child has more than $2000 ish of investment income).  Children subject to the Kiddie Tax pay taxes at the rate of Estates and Trusts (higher than they normally would).

You can use up to $10,000 of 529 college savings plan money, per child, per year, on elementary and secondary tuition and other expenses without paying tax on it.

Moving expenses are no longer deductible and employer reimbursement for moving expenses is taxable except for military PCS moves.

Starting in 2019, any NEW divorce agreements will have alimony non-taxable to the recipient and non-deductible by the payer.

The estate tax exemption was raised from 5 million to 10 million.

Starting in 2019, there is no penalty for not having health insurance.

The Alternative Minimum Tax exemption and income at which it phases out were significantly increased and indexed for inflation.

Student loans cancelled due to death or total and permanent disability are no longer included as income.

They made some changes affecting the ability to undo conversions between Roth and traditional IRA during year due to value changes - too wonky to go into here.

*The following things that were talked about or included in either the House or Senate bill did not end up changing in the final bill:

Capital Gains rates are unchanged.

No change to education credits, student loan interest deductibility, plug-in vehicle credits.

Savings bond interest used for education is still not taxable.

Education provided by colleges to their employees is still tax-free in the same way as it was before.

The exclusion of employer-provided education assistance is unchanged.

Educators can still deduct $250 of in-class supplies they provide in the same manner as before, but anything above this amount that used to be deductible was eliminated with the elimination of the 2% floor itemized deductions.

No change to the exclusion of gain from the sale of personal residence (to be clear - you DO NOT have to buy a new home within 2 years to exclude it, that law was changed 20 years ago).

No change to MSA deductions or employer-provided Dependent Care Benefits rules.

No change to adoption credit or exclusion of employer-provided assistance.

No change to the solar credit (it still starts phasing out in 2020.

**Need to research more:

There's a 20% deduction for income from pass-through entities like partnerships or LLC's - Buy my Book

There are some weird changes to deducting business losses off of your ordinary income

The deduction for entertainment expenses might have been eliminated