By Brittney Cooper and Jonathan River
According to the most recent data provided by the IRS, 31% of individuals itemize their deductions1. However, with the enactment of the Tax Cuts and Jobs Act (the Act), it is possible that the number of individuals who will benefit from itemizing deductions will decrease significantly.
Along with changing the effective tax rates, the Act eliminated or limited certain itemized deductions while enhancing others. Individual taxpayers need to become familiar with these changes in order to understand how to maximize the benefits they receive from itemized deductions and ultimately minimize their tax liabilities.
Under the prior law, medical expenses exceeding 10% of adjusted gross income (AGI) were deductible. The Act reduced that threshold to 7.5% of AGI. In addition, this change was retroactively enacted to Jan. 1, 2017, so this change is in effect for the 2017 taxable year going forward.
State & Local Taxes
Historically, the amounts paid for state and local income tax, sales tax, and property tax comprised the largest itemized deduction category, making up 42.4% of all itemized deductions. However, the Act made significant changes limiting the ability to deduct taxes on schedule A. Under the new law, only $10,000 of combined income, sales, and property taxes are deductible.
The interest paid deduction was the second largest itemized deduction, accounting for 23.3% of all itemized deductions. Interest paid includes both investment interest (after applicable limitations) and mortgage interest. While no changes were made to the deductibility of investment interest, significant changes were made to that of mortgage interest.
Under the Act, interest deductions are allowed on acquisition debt (debt incurred during the construction, improvement, or purchase of a primary or secondary residence) up to $750,000 for married filing joint (MFJ) taxpayers, as opposed to the $1M before the law change. Grandfathering rules allow the old $1M threshold to apply to debt related to the following scenarios:
- a written contract in place by Dec. 15, 2017, where the purchase was finalized by April 1, 2018, or
- home acquisition debt taken out before Dec. 16, 2017, and then refinanced later (as long as the new loan does not exceed the principal balance on the old loan at the time of refinancing).
Interest on secondary homes may also still be deductible. Taxpayers are able to deduct acquisition debt interest on a secondary residence, up to the applicable threshold amount, if their primary residence debt has not yet reached that limit.
Mortgage interest on home equity debt often referred to as HELOC interest, is now only deductible if the home equity debt was used to buy, build, or substantially improve the taxpayer’s home that secures the loan. Interest on loans used for any other purpose, such as to pay off personal debt, is no longer deductible. Interest on home equity debt that was taken out prior to Dec. 16, 2017, and used for disallowed purposes is not grandfathered and therefore not deductible. However, existing HELOC loans used for qualified expenditures prior to that date can still be considered additional home acquisition debt up to the old $1M threshold.
Charitable contributions were the third largest itemized deduction in prior years, but charitable contributions may soon take the lead through enhanced planning techniques to maximize their benefit under the new law changes. Charitable contributions are one of the few deductions enhanced under the Act, which increased the AGI limitation on cash contributions from 50% to 60%. The 30% limitation on contributions of appreciated assets still applies.
The Act limited one specific type of charitable contribution. Under the new law change, payments or gifts in exchange for the right to purchase college athletics tickets are now non-deductible.
Under the new law, casualty losses are only deductible when sustained from a presidentially-declared disaster.
One of the changes to itemized deductions under the Act that has created a lot of discussions is the suspension of miscellaneous deductions, otherwise known as 2% deductions. These deductions include tax prep fees, investment management fees, unreimbursed employee expenses, dues and subscriptions, job search expenses, etc. However, this does not affect the ability to claim business expenses on Schedule C.
Gambling Losses & Expenses
Historically, gambling losses could only be claimed to the extent of gambling winnings, but what happens if you strike it big in Vegas one weekend? Under the new tax law, expenses incurred in gambling, not just gambling losses, are also deductible to the extent of winnings.
Itemized Deduction Limitation
The Act suspended a limitation dating back to 1991 – the Pease limitation. The Pease limitation is a limitation on itemized deductions that effectively reduced the overall itemized deduction that could be claimed on Schedule A for high-income individual taxpayers. Once an individual taxpayer reached a certain AGI threshold, the overall amount of deductible itemized deductions was reduced. This limitation has been suspended, and no overall limitation exists under the new law.
If you have any additional questions or want to learn how to effectively plan for these changes in itemized deductions under the new tax laws, reach out to a tax professional at LBMC, and let us help you navigate the maze of tax reform.
|Prior Law||As Passed|
|Medical Expenses||Amount in excess of 10% of AGI is deductible|
For both 2017 and 2018, amount in excess of 7.5% of AGI is deductible
|State and Local Taxes||Fully deductible||Up to $10,000 in combined income, sales and property tax is deductible|
|Mortgage Interest Deduction|
|Interest is deductible up to $1M of acquisition debt||Debt capped at $750k ($1M for debt incurred prior to 12/15/17)|
Home Equity Debt
|Interest is deductible up to $100k of debt − limited to combined overall $1M||Interest is deductible up to $100k of debt if used to buy, build, or substantially improve your home − subject to overall threshold limitations|
AGI Limit on Cash Contributions
|Uninsured losses are deductible (fire, storm, shipwreck, or theft)||Limited to losses sustained from presidentially-declared disasters|
|Miscellaneous Deductions||Deductible in excess of 2% of AGI||Suspended|
|Gambling Expenses||Not deductible||All expenses incurred in gambling, not just losses, are deductible to the extent of winnings|
|Limit on itemized deductions overall|
Reduces the itemized deductions allowed by the lessor of:
1 IRS, Statistics of Income Division, Publication 1304, September 2017.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.