The Tax Cuts and Jobs Act enacted late last year opened a variety of opportunities for average people to reduce their tax burden. The biggest advantage of the tax cuts for individuals is the reduced tax rates and extension of income in the lower brackets. Itemized deductions also pay a serious role in how the changes in the code will affect your final results next spring.
Gaming the standard deduction was less of an issue in the past. Now, with the standard deduction at $24,000 for joint returns ($12,000 for single filers and $18,000 for head of household) there is ample opportunity to reduce your tax bill. Exemptions are gone so many will face higher taxes in this area. State and local taxes (SALT) are limited to $10,000 in 2018 – 2025. With the standard deduction so high and SALT limited to such a low level, most people will no longer need to itemize.
For every problem there is a solution. Today we will cover each deduction on Schedule A and look for alternatives. Pulling deductions from Schedule A (even if you don’t itemize) and deducting them elsewhere on the return is akin to legally double dipping. That is our mission. We want to have our cake and eat it too. If we play this right you should manage a big juicy standard deduction while deducting a large portion of each expense as well.
Medical and Dental Expenses
Medical expenses were always a high hurdle to overcome with the 7 ½% (10% in some cases in the past) of AGI reduction of qualified medical expenses. There are several ways to remove numbers from this section and deduct them elsewhere.
If you have a qualified medical plan you can contribute to a health savings account (HSA).
Your employer may offer a Health Reimbursement Arrangement (HRA). The employer sets the amount available to employees. Unused portions can be rolled into the following year if the employer allows. If unused funds are not allowed to roll to the next year it becomes a “use it or lose it” plan.
Certain restrictions exist for self-employed persons. People with a side gig/side hustle or small business can use a Qualified Small Employer Health Reimbursement Arrangement (QSEHRA). QSEHRAs require administration. The cost is minimal, but the rules complex enough that you will want professional help. My office recommends Take Command Health for administration. The tax savings are well worth it.
Employers may cover annual physicals and other medical expenses as an employment requirement. The cost is born by the employer and the employer also gets the deduction.
Investment property owners and those with self-employment income can also shift some medical expenses from Schedule A. Small business owners can deduct most medical insurance premiums on the front page of Form 1040 as an adjustment to income. A landlord who is hurt while working on an investment property will have a medical expenses related to the investment property and are therefore deductible against the rental income. A self-employed semi driver can shift medical expenses required to drive a commercial vehicle from Schedule A to the business part of the tax return.
State and Local Taxes (SALT)
This is the issue that started all the problems. There is a cap on SALT deductions of $10,000 from 2018 – 2025 unless Congress changes the code. Several high tax states have devised plans to work around the issue, shifting the expense to the charitable contributions line of Schedule A. The IRS nixed the idea and at least two states have sued. Because the IRS allowed similar schemes in the past when it involves college funding the court will have a serious consideration on its hands. When the issue clears up I’ll let you know.
The problem affects all states. The higher your income, the more likely this becomes an issue. Texas, a state with a reputation for low taxes is really a high tax state. The sales tax and property taxes more than offset the income tax free part of the Texas tax code.
We don’t have to wait for the courts to decide the outcome before we skin this cat. (My apologies to all the cat lovers of the world. For the record, my cat, Pinky, just clawed me in protest as I wrote this.) Property taxes can be partially shifted to an office in the home if you have a business or investment properties. The office in the home must be “regular and exclusive” and it is worth the effort to meet the tax code requirements.
Be sure to report personal property taxes related to a business or investment property on the appropriate form and not on Schedule A where it has limited value.
Interest You Paid
There is more incentive than ever to pay off the mortgage early. You can shift some of the mortgage interest to an office in the home as proffered above.
Investment interest has significantly reduced value under the new tax rules. Margin accounts should be avoided. They’re a bad idea to start with (buying investments with borrowed funds) and the deductibility of the expense is now also limited.
Gifts to Charity
There is some minor good news on charitable deductions. Cash donations were limited to 50% of AGI in the past with the remainder carried forward for up to five years. The deduction limit for cash is now increased to 60% of AGI.
Still, the goal is to reduce Schedule A to a nonevent on your tax return. If we reduce deductions to less than the new higher standard deduction we can, in effect, double dip.
I’ve published on this strategy in the past. The strategy is more powerful than ever under the new rules. Taxpayers with business income or investment properties can shift normal contributions to charity into promotional/advertizing expenses for the business.
It works like this. Instead of donating to the charity of your choice, ask the charity about any upcoming events and sponsor said events. Your business or rental properties get a nice plug in the brochures handed out at the event and probably a prominent display of your company logo and contact information. While this may not be the best way to grow a business, it is a powerful way to build community goodwill for your company! It’s also a business deduction. You can support your favorite charities and get a deduction, too.
Landlords need caution when applying this strategy. Deducting a $20,000 sponsorship when you only have one small duplex in the low rent side of town is unlikely to pass the sniff test! On the other hand, if you have five duplexes around town and you sponsor an event for $1,000, it probably falls within acceptable parameters. Landlords should have a business name: ABC Rental, LLC, for example. By having all your properties under one umbrella it allows the sponsorship to promote all your properties.
Casualty and Theft Losses
The Tax Cuts and Jobs Act eliminated casualty and theft loss deductions except for casualty losses in federally declared disaster areas. Even if you are in a federally declared disaster area, the first $100, plus 10% of AGI, doesn’t count. Example: If your AGI is $100,000, the first $10,100 of casualty losses in federally declared disaster areas doesn’t count.
There are few options if you suffer one of these losses. Business owners can deduct the loss as a business expense.
The loss/theft might qualify as a capital loss. This is a stretch for most situations, but you should be aware of the possibility in case it happens. Capital losses are reported on Schedule D where there are no restrictions like Schedule A. Schedule D losses are limited to $3,000 per year, plus all capital gains.
Casualty and theft losses are reduced by insurance coverage. If all or most of the loss is covered by insurance there is little or no opportunity to deduct expenses. More than ever, adequate insurance of assets is indicated.
Miscellaneous Expenses, Subject to 2%
Miscellaneous expenses, subject to 2% of AGI are eliminated for 2018 – 2025 under the current code. There are still a few planning opportunities for those who plan.
Unreimbursed employee expenses is the biggest issue in this section. It is important to have a serious discussion with your employer on your out-of-pocket work expenses. Your employer gets a full deduction on most of these expenses while you get nothing if they are not reimbursed! It might be worth a salary adjustment to make room for reimbursed expenses. Example: If you typically have $5,000 per year of work expenses, any salary reduction less than $5,000 with full reimbursement of work related expenses is a win for you and a nice tax deduction for the employer. Employers: this can be a valuable employee perk that pays both you and the employee. A true win/win.
Tax preparation fees are only deductible as they apply to the business or rental property portion of the return. A lot of accountants miss this. If your tax preparation fee is $500, a portion is for the personal part of your return (no longer deductible) and a portion is for the business (Schedule C and other related business forms) and rental property part of the return (Schedule E). Ask your accountant to break out the prep fee (required by the IRS to deduct). Your accountant can list $250, for example, as the portion of the prep fee attributed to the business portion of your personal tax return. This $250 can be deducted on the appropriate forms (Schedule C for small business, Schedule F for farms and Schedule E for income properties).
A safe deposit box used for business or income properties is deducted on their respective area of the return instead of Schedule A.
This section of Schedule A catches a lot of minor deductions. Think the deduction through before writing it off (pun intended). On Schedule A it is now worthless. But, if it is an expense related to a business or rental property . . .
Union dues are the remaining big item. I wish I had an answer. If any of you kind readers have a suggestion, let me know. Union dues are no longer deductible until the tax code changes or I figure out a work around. Don’t hold your breath.
Other Miscellaneous Deductions
This is the last section of deductions on Schedule A. These deductions are not reduced by 2% of AGI.
We will focus on the two most common items reported in this section: gambling losses and claim repayments.
Gambling losses are reportable on Schedule A up to gambling winnings. The best way to avoid tax problems is to stop gambling! The odds are against you. As budding accountants you know better. There, I said it. Now on with the show.
If you insist on gambling, at least keep a daily log of your results/sessions. You can use gambling sessions to remove losses attributable to gains in the same session on the front page of Form 1040. Most states follow federal on gambling sessions so the tax advantage stretches to the state return for most taxpayers.
Gambling sessions don’t remove all the losses from Schedule A, but it should shift a serious portion of the losses from Schedule A to the front page of 1040 where they have value. You can read more about gambling sessions here.
The other big item in this section of Schedule A is claim repayments. We are not talking about business or investment property repayment issues. Those are reported on their respective forms.
A common repayment is unemployment benefits. The claim repayments reported on this section of Schedule A are taxable items of income on a previous tax return. Repayments of items not reported as income on a prior return are not deductible.
We’ll use unemployment benefits as our example. Repayments made in the year the income was received is adjusted where the income is reported. Example: You receive $2,800 of unemployment benefits and are later required to repay $200 of the benefits. You repaid in the same year you received benefits. You adjust the reported $2,800 to $2,600. No itemizing required.
All claim repayments reported as income in a prior year under $3,000 must be reported on Schedule A. Repayments over $3,000 can also be reported on Schedule A, but you want to use an alternative method. There is a planning opportunity here.
For repayments over $3,000 you can calculate a credit for the repayment, reporting the credit on page 2 of Form 1040 (line 73 on the 2017 return). In the margin write 1341, to inform the IRS of the code section you are using for your right of claim.
You calculate the credit by going back to the return the income was reported on. Calculate the prior return without the income repaid in the current year. The reduction in tax is the credit.
I covered what I feel will be over 90% of the issues surrounding Schedule A and the available solutions for moving the deduction to another area of the return. This, in effect, allows a bit of double dipping. You still get the new, outsized standard deduction while still claiming a serious portion of the actual expenses.
Unfortunately, not everyone will benefit from these strategies. However, with the volume of options provided there should be at a least a few options available to most readers.
If you have any creative ideas to divert deductions from Schedule A to areas of the tax return where they have value I’d be happy to hear them.
Remember, an expense is worthless until you get a write-off.
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Mike L Weber
Friday 27th of July 2018
I don’t understand your comments about margin interest. My understanding is that individual investment interests is still deductible as before (no changes) assuming you still itemize and up to your amount of taxable investment (same as in 2017 and prior years.)
Wednesday 4th of July 2018
I tithe 10% to my church plus and additional 2% in charity. It came out to $34k last year. I will also have the $10k in SALT. My home is paid off, so no mortgage interest.
My plan this year, in addition to the approx. $34k for this years charitable giving is to pre-pay next year's charity in late December. This will result in a $78k deduction this year ($34k + $34k + $10k) and next year I will just claim the standard deduction of $24k.
This way, instead of $88k in itemized deductions for two years, I will receive $102k in deductions. Calculating all my taxes, both state & federal, it should save me $2400 in taxes. Then I will just rinse and repeat on that two year cycle moving forward.
What I haven't calculated is the opportunity cost of the investment income I could have received by spreading the $34k over the course of a year instead of paying it all up front. There is also a bit more risk associated because I will be dipping in to my emergency cash to fund the pre-pay. I would rather do this than sell stock in my post-tax brokerage accounts...especially since nearly everything I sell will expose me to capital gains.
Any thoughts on this strategy?
Wednesday 4th of July 2018
Allen, you are thinking on the right track. I advise similar strategies under the current tax environment.
Another consideration: Giving extra money to a charity one year and skipping or reducing the next year can increase tax deductions for you, but the charity needs stable cash flow to operate. Consider a donor advised fund at Vanguard. You can donate to the fund and get the deduction currently while spreading out your contributions to the charity evenly.
Thursday 21st of June 2018
Only slightly off-topic question: with the home office/room rent, how does depreciation recapture work when the house gets sold? Is it considered an ordinary income on respective schedules (C, E)?
We're renting a room out and considering establishing a home office, but a tax person I spoke to kinda insinuated that it's not a good idea because when we sell (not planning any time soon), depreciation recapture will hit us hard.
Please enlighten :)
Sunday 24th of June 2018
The tax guy you spoke with may have been referring to the Section 121 exclusion on a primary residence because SL depreciation isn't taxed at the special 25% rate (only accelerated depreciation over SL if sold in the first 5 years is punished). The neat thing about the office in the home is that depreciation isn't required, avoiding recapture issues.