To Itemize or Standard Deduct? That is the Question.

Many have been confused with the new Tax Cut & Job Act reform being implemented for 2018.  Previously, I recapped the major changes in my blog “what does the new tax plan mean to me.”  But, a looming question remains: “Do I itemize or standard deduct moving forward?”

With the tax deadline approaching, I thought what an ideal time to clarify some of the tax changes on deductions.

The gist is this:

The new tax plan is attempting to simplify the tax code, although I’m not so sure they’ve succeeded.  In simplifying, they are going to drastically reduce the number of people who itemize deduct.  The Joint Committee on taxation estimates a change from 70% of filers standard deducting, to a whopping 94%!

What is happening to the standard deduction?

Now, many more of us are going to be standard deducting; that doesn’t necessarily mean it’s a bad thing.  The standard deduction a person receives in 2018 is $12,000 for individual filers ($24,000 for married filing jointly).  This is a substantial increase from 2017 figures of $6,350 for single and $12,700 for couples married filing jointly.

Therefore in prior years, if you didn’t have many itemized deductions, you’ll likely benefit from the new tax code.  Not only will your tax rates come down, but you’ll also benefit from standard deducting a greater amount of your income.

As a refresh, I’ll review a standard deduction.  Basically, you earn taxable income each year, which is typically after any pre-tax withholdings from your pay check.  For example, let’s say your taxable income this year is $100,000.  For simplistic purposes, we’ll also assume you pay a flat tax of 20% (which is not the case, as we have a gradual tax bracket in our country click here to see the rates). This means at the Federal level you will pay $20,000 in taxes.

Standard deduction lowers that $100,000 by your appropriate deduction.  If married filing jointly, it means you take the $100,000-$24,000= $76,000 of taxable income.  You then multiply that by the same 20% (for our example), which leaves you with a $15,200 Federal tax bill (vs. the $20,000 you would have had if you didn’t have the standard deduction).  That’s a nice little $4,800 savings, wouldn’t ya say?

This is great for those who didn’t have a lot of itemized deductions in the past.

What is happening to the itemized deduction?

 For those of us who benefited from large amounts of itemized deductions, things have drastically changed.

For starters, you are losing a bunch of things you could have previously deducted (such as miscellaneous itemized deductions, which are subject to the 2% floor).  Also, mortgage interest for new home buyers can only deduct the first $750,000 of loan interest (down from $1,000,000).  As you can see, these will greatly impact itemize deducting.

The big change; however, is on state, local, and property tax.  If you were a high earner previously and lived in a high local/state/property tax state, you could at least deduct those tax payments against your Federal return.  However, now you are limited to $10,000 for all three combined!

If in 2017, you made $300,000, paid 1% local tax, 6% state tax, and had property tax of $10,000/year, you had a total of $31,000 of taxes there alone.  These dollars would then be added to any charity to which you donated (let’s say $5,000), other miscellaneous itemized deductions (let’s say another $5,000), and mortgage interest (let’s call it another $10,000).  This would have given you a total of $51,000 to itemize deduct against your $300,000 (leaving you with a total taxable income of $249,000).  Compare taking $51,000 of itemized deductions in 2017 vs the $12,700 you would have taken if you simply standard deducted.

Moving forward (and using the same example above), you would lose the $5,000 of miscellaneous deductions.  You’d also be capped on the $31,000 of state/local/property tax to $10,000.  So, instead of the $51,000 of itemized deductions, you are now left with $10,000 for taxes + $10,000 for mortgage interest + $5,000 for charity.  A total of $25,000.  It’s only $1,000 overtaking the simple, standard deduction of $24,000.  (See illustration below)

Basically, itemized deduction works exactly like standard deducting. They both subtract against your taxable income.  From there you determine your net taxable income and multiply it against your tax rate.  The differences are the amount which then leads to how one gets their itemized deduction figure (vs. their standard deduction figure).  Then you select the higher of the two and use that to reduce your tax liability at year’s end.

The good, the bad, the ugly.

For this blog I’m simply focusing on the sheer difference and recent changes in standard vs. itemized deduction.  I recognize this is one of the more confusing of the major changes.  Hence, why I thought it important to isolate what’s happening with these deductions.  Hopefully, this will allow you to properly plan moving forward.

There are many things to consider when figuring out this new tax plan’s benefits for you. More relevant than ever, there are many strategies to help combat these changes. Get in touch with a professional early to see how you are affected by the changes.  This way they can help maximize the benefits coming to you.