How to Prepare for Changes this Tax Season

Because of comprehensive tax reform passed in late 2017, many of us will see changes when filing our 2018 tax returns. While these changes from the Tax Cuts and Jobs Act (TCJA) include a higher standard deduction and estate tax exemptions, other popular deductions have been reduced or eliminated.

Here is an overview of some of the key provisions affecting individuals.

• Standard deduction increased. Previously, the standard deduction was $6,350 for individuals and $12,700 for married couples filing jointly. The new tax law nearly doubles this amount to $12,000 and $24,000, respectively, for tax year 2018.
• Personal exemptions suspended. The new tax law eliminates personal exemptions. Previously, taxpayers received a personal exemption of $4,050 for each family member, subject to certain limitations (in 2017, the phase-out began at $313,800).
• Estate and gift tax exemption increased. The estate and gift tax exemption for tax year 2018 is now $11.18 million for individuals and $22.36 million for married couples, up from $5.49 million and $10.98 million, respectively.

• Individual and trust income tax rates modified. The new law lowered the individual and trust tax rates and adjusted the thresholds for the tax brackets. 
• Kiddie Tax adjusted. The net unearned income (above $2,100) of a child is now subject to trust and estate tax rates. Previously, these earnings were taxed at the parent’s tax rate.

• State and local income, sales and property tax deductions (SALT) reduced. The taxpayer’s deduction for state and local income, sales and property taxes is limited to a combined, total deduction of $10,000 ($5,000 if married filing separately). Any state and local taxes paid above this amount cannot be deducted. Previously the deduction amount was unlimited.
• Mortgage interest deduction limited. Individuals can only deduct interest paid on the first $750,000 of a mortgage, down from $1 million. The change affects mortgages taken out after December 15, 2017. Any mortgages taken out on or prior to this date are “grandfathered” and the mortgage holders can still deduct the interest on a mortgage of up to $1 million.
• Charitable deductions revised. Cash gifts to charity were previously deductible up to 50% of adjusted gross income (AGI); that limit is now 60% of AGI.
• Medical expense deduction amended. Qualified medical expenses are deductible only to the extent they exceed the applicable AGI threshold. For tax year 2018, the threshold for the medical expense deduction is 7.5% of AGI.
• Casualty and theft loss deduction adjusted. Tax reform repealed the deduction for casualty and theft losses, except for losses incurred in presidentially declared disaster areas.
• Miscellaneous itemized deductions suspended. Previously, certain expenses were deductible to the extent that they exceeded 2% of AGI. These included investment expenses, tax preparation fees, unreimbursed employee expenses, and others. These expenses are no longer deductible.

• “Pease Limitation” eliminated. Previously, the Pease Limitation reduced itemized deductions once a taxpayer’s adjusted gross income exceeded certain thresholds (in 2017, $261,500 for single taxpayers and $313,800 for married couples filing jointly).
• Alternative Minimum Tax (AMT) reformed. The TCJA temporarily reduces the number of taxpayers who’ll have to pay the AMT by increasing both the AMT exemption amount (to $70,300 for individuals filing single and head of household, $109,400 for married filing jointly) and the AMT exemption phase-out thresholds (to $500,000 for individual taxpayers other than estates and trusts and $1 million for married couples).
• Pass-through deduction expanded. There is a new 20% deduction for qualified business income from a partnership, S corporation, or sole proprietorship.
• Alimony payment deductions modified. For divorce agreements executed (or, in some cases, modified) after December 31, 2018, alimony payments won’t be deductible for the spouse who makes alimony payments and they won’t be included in the income of the receiving spouse. This change is permanent.
• 529 Savings Plans. Effective January 1, 2018, for the purposes of 529 savings plans, the definition of "qualified higher education expense" has been expanded to include tuition at elementary or secondary schools.  For more information on 529 plans, click here.
• Child and family tax credit increased. For 2018, the maximum credit increases to $2,000 per qualifying child, up from $1,000. In addition, the income threshold at which the child tax credit begins to phase out increased to $200,000 for single taxpayers or $400,000 if married filing jointly (previously $75,000 and $110,000 respectively). 
• Roth conversions recharacterized. Taxpayers can no longer recharacterize a conversion from a traditional IRA, SEP or SIMPLE to a Roth IRA. The new law also prohibits recharacterizing amounts rolled over to a Roth IRA from other retirement plans, such as 401(k) or 403(b) plans.

Note that all changes not described as permanent may revert back to pre-tax reform status in 2026. A full listing of tax reform changes that affect individuals is available at IRS.gov. 

Talk to your tax advisor about what these tax changes may mean for you and contact your Morgan Stanley Financial Advisor about your investments.