The end of 2017 brought about a major overhaul to the United States tax system called the Tax Cuts and Jobs Act (TCJA). Last year, we spoke with Russell Barnett, EA, CTC to get a sense of how the new code might impact taxpayers. One year after the overhaul, we turned to Mr. Barnett again to learn what insights he’s gained after working with the new regulations. Here’s our conversation:
Diamond Certified Resource: The TCJA affected businesses the most. Over the past year, have you noticed any trends? Are businesses choosing to reincorporate in certain ways?
Russell Barnett: Business owners need to consider many factors to ensure optimal tax savings. The big new one is the 199(A) deduction (also called the qualified business income deduction) that many businesses now qualify for, including sole proprietorships, partnerships, LLCs, most rental real estate activities and even some trusts. The rules are extremely complex, and the choice of what type of entity a business operates as can play a key role in ensuring maximum benefits from this new deduction.
DCR: The TCJA changed what deductions could be itemized. Are you finding that people who used to itemize their tax returns are now taking the standard deduction?
RB: Yes, but it’s a little more complicated in California. Starting last year, the TCJA increased the federal standard deduction for a married couple from $12,700 to $24,000. This jump would compel more people to now take the standard deduction for their federal filings. However, California didn’t change their laws to conform with the TCJA, and the state’s standard deduction for a married couple is $8,472. This means most taxpayers who previously itemized deductions will continue to do so for state tax purposes, even if they no longer itemize for federal purposes.
DCR: The TCJA changed mortgage interest deductions for homes sold after December 15, 2017. But as of 2018, the IRS hadn’t decided if the same limits would apply to refinanced mortgages. Have they since made a decision?
RB: Mortgages that existed prior to December 15, 2017 were grandfathered in at the previous $1 million limit for loans used to build, buy or improve a taxpayer’s primary and secondary (if applicable) residence, rather than being subject to the new limit of $750,000.
The IRS will allow these grandfathered limits to continue to apply to refinanced loans, but only up to the balance of the grandfathered loan. In other words, if you have a grandfathered loan of $800,000 and refinance it with a $900,000 loan, only the $800,000 is grandfathered, and the interest on the additional $100,000 won’t be deductible for federal tax purposes. Also, interest on mortgage debt not used to build, buy or improve the residence is no longer deductible starting on the 2017 tax return. Previously, interest on up to $100,000 of such loans was deductible.
It’s important to note that California hasn’t changed any of their laws regarding mortgage interest deductibility, so the old rules still apply for state tax purposes. Interest on loans of up to $1.1 million, of which up to $100,000 can be non-acquisition debt, is deductible.
DCR: Have there been any new revisions to the TCJA that people should know about?
RB: The major provisions of the TCJA remain unchanged, but there have been some updates that help clarify the rules in certain key areas. Here are a few examples:
- As I mentioned before, the IRS released its final regulations regarding the 199(A) deduction. Congress had left many parts of that provision open for IRS interpretation, so there was a lot of uncertainty about who would qualify. The regulations also introduce several limitations meant to prevent the abuse of this provision, which were not specifically written into the original text of the TCJA.
- Some states were also looking for ways to help their residents get around the new $10,000 deductible limit on state and local taxes (SALT). But the IRS released regulations making it clear that such workarounds are not permitted.
- The TCJA eliminated the business deduction for most entertainment expenses, leaving a lot of uncertainty about whether business meals with customers or prospects would be considered “entertainment” and disallowed. The IRS recently clarified its rules and declared that most business meals remain deductible as before, and they also explained circumstances in which entertainment expenses can still be deducted.
DCR: This year’s protracted government shutdown had a big effect on the IRS. How did you and your clients feel the impact? Are there any lingering effects?
RB: The IRS worked hard to make sure the shutdown didn’t delay the start of tax filing season. However, during that period it was impossible to reach the IRS by phone for routine or even urgent matters, which caused a lot of frustration for taxpayers and tax professionals alike. The agency is now working through a huge backlog of mail that couldn’t be processed during the shutdown. The IRS estimates that it could be a year before processing times are back to normal.
DCR: Did you learn any interesting or unexpected things about the revamped tax code over the past year?
RB: I learned that the resulting tax code is anything but simple. Many taxpayers will find that it takes longer to complete their taxes than before, unfortunately. Another thing people should keep in mind is that many of the TCJA’s provisions will expire in a few years, leaving the tax code mostly as it was before the overhaul was passed.
DCR: Anything else you think would be useful for folks to know for this tax season?
RB: For taxpayers who want to legally reduce their payments, the TCJA has highlighted the importance of doing proactive tax planning. If you wait until filing your return to think about tax reduction, it’s too late in most cases.
Whether you prepare your taxes yourself or hire a professional, it’s crucial to carefully review your tax return. I believe everyone should make an effort to understand how the new laws impact their returns.
Lastly, there are many anecdotes and news stories in which people complain that their tax refunds are smaller this year. But very few of these stories explain that the smaller refunds are likely the result of less taxes being withheld from individuals’ paychecks. Most taxpayers will owe a little less in federal taxes than they did before the TCJA was passed.