For better or for worse, major tax changes tax have been pushed over the finish line. Here are the eight major impact areas for the Foreign Service:
1. The standard deduction has been doubled to $24,000 for Married Filing Jointly (MFJ) and $12,000 for Singles; however, personal exemptions ($4,050 per person) have been eliminated in 2018. If you are 65 or over, you can add an additional $1,300 per person to the standard deduction ($26,600 total for a married couple.) The expanded child tax credit (children under 17) is a significant area of new savings. For families, the child credit has doubled from $1,000 to $2,000 and the income phase-out has dramatically increased—MFJ has gone up from $110,000 to $400,000 and for Singles from $75,000 to $200,000. There is even a new $500 credit for dependents who are not “qualifying” children (i.e., dependents under age 17). This may include older (e.g., college-aged) children who are still claimed as dependents, and even dependent parents who are cared for in the home.
Impact: The majority of Foreign Service filers will claim the standard deduction going forward which means there is no tax deduction for mortgage interest. We have always wanted our clients to enter retirement with their principal residence paid off—this only makes the argument even stronger. The same goes for home equity loans that were used to pay off personal debts. There is no tax deduction for this type of interest and the elimination of this debt should be prioritized. The expanded child tax credit should offset the loss of the personal exemptions for most families.
2. There remains seven tax brackets (10%, 12%, 22%, 24%, 32%, 35%), and a top rate of 37%); most of the previous brackets have been trimmed by 1—4%.
Impact: Based on the trajectory of federal debt and entitlement spending, these may be the lowest federal tax rates you will ever see. Many employees should consider directing some of their contributions to the Roth TSP and paying federal taxes now.
3. If you itemize, the state and local income taxes (SALT) and property tax deductions are now capped at $10,000 (for both married and single.) Mortgage interest remains deductible but the maximum deductibility for new mortgages is $750,000. Home equity loans that were used for personal spending, refinancing credit cards, paying for college, buying a car, etc. are no longer deductible and are not grandfathered. Rental properties that are reported on Schedule E are not affected by these changes.
Impact: Double-check your numbers when deciding to rent or buy real estate. Picking the right state for retirement is more important than ever.
4. Capital gains rates remain the same (0%, 15%, 20%, 23.8%) and just to make things even more complicated, are based off the old 2017 income brackets, not the new ones.
Impact: Tax diversification—having money in pre-tax, Roth, HSAs and taxable accounts is still important in order to control your adjusted income and effective tax rate in retirement.
5. You can write off your medical expenses if they exceed 7.5% of your Adjusted Gross Income (AGI) in 2017 & 2018. After 2018, the threshold will revert back to 10% of AGI.
Impact: Keep track of your medical spending and take care of any issues in 2018 if you are near the threshold.
6. All miscellaneous itemized deductions subject to the 2%-of-AGI floor were repealed. This includes all tax preparation expenses, various unreimbursed employee business expenses (including the home office deduction for employees), safety deposit box fees, depreciation of home computers used for investment, and the deduction for investment advisory fees.
Impact: No more moving expense deductions. We are not aware of any provisions that would permit the deduction of home leave expenses going forward since miscellaneous itemized deductions were eliminated.
7. 529 plan distributions can now be used tax-free for K-12 tuition up to $10,000 in distributions per student per year.
Impact: 529s have gotten better and more flexible. Families that expect to choose private K-12 schools (such as boarding school) should consider super-funding these accounts early in their child’s life.
8. The Alternative Minimum Tax (AMT) has been greatly reduced. The majority of taxpayers will not reach the income threshold for the AMT.
Impact: Most senior tandems should not be tripped up by the AMT going forward.
Bonus—The Section 121 capital gain exclusion for the sale of a primary residence remains two out of five years with a 10-year extension for the military and Foreign Service. It was originally slated to change to five out of eight years, but the real estate lobby prevailed in committee and kept the existing law intact.
This article is based on our understanding of the TCJA of 2017. Good luck as you evaluate your own personal situation!
For questions or comments, please contact me on our website or LinkedIn.
Logbook Financial Planning, LLC
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