Personal exemptions and standard deduction
Prior to 2018, taxpayers could claim a personal exemption for themselves, a spouse, and each dependent. In 2017, each exemption reduced taxable income up to $4,050. Often, however, no tax savings were realized from exemptions because they phased out as income increased or when AMT was triggered.
The TCJA eliminated personal exemptions and replaced them with Family Credits (see below).
The standard deduction was increased by TCJA. In 2017 the standard deduction was $6,350 for singles, $9,350 for head of household filers, and $12,700 for married couples. The TCJA roughly doubled the standard deduction. In 2019 they were: $12,200 for singles, $18,350 for heads of households, and $24,400 for joint filers.
For some, the increased standard deduction compensated for the elimination of exemptions, and, in some cases, resulted in a tax savings. For others, especially those with many dependents or who itemized deductions, these changes resulted in a higher tax bill.
Family tax credits
Tax credits reduce income tax dollar-for-dollar rather than, like deductions, merely reducing the amount of income subject to tax. Beginning in 2018, the TCJA doubled the child credit to $2,000 per child under age 17.
Furthermore, the TCJA also made the child credit available to more families than in the past. Under the new law, the credit does not begin to phase out until adjusted gross income exceeds $400,000 for married couples or $200,000 for all other filers. Under the old law the phaseout thresholds were $110,000 and $75,000.
For all other qualifying dependents (those older than 17) the TCJA provides a $500 nonrefundable credit.
Do the family tax credits make up for the loss of the personal deduction? In 2017, each dependent reduced the tax liability by $1,102 for a filer in the 25 percent marginal tax bracket.
Above-the-line deductions are items subtracted from income regardless of whether one itemizes. Examples are deductible IRA contributions and deductible student loan interest. The TCJA eliminated some of these deductions.
1. Moving expenses. The deduction for work-related moving expenses was eliminated, except for active-duty members of the Armed Forces.
2. Alimony payments. For divorce agreements executed (or, in some cases, modified) after December 31, 2018, alimony payments are not deductible — and will be excluded from the recipient’s taxable income.
In addition to nearly doubling of the standard deduction, the TCJA reduced and eliminated many items that were previously deductible. Many taxpayers who typically itemized in the past no longer benefited from itemizing.
Here is a closer look at the TCJA changes to itemized deductions:
The AMT is a separate tax system that limits some deductions, disallows others, and treats certain income items differently. The TCJA reduced the number of taxpayers who pay AMT.
QBI, a new deduction for pass-through businesses
Under pre-TCJA law, net taxable income from pass-through business entities (such as sole proprietorships [Schedule C businesses], partnerships, and S corporations) was simply passed through to owners. It was then taxed at the owners’ rates. In other words, no special treatment applied to pass-through income.
The TCJA established a new deduction based on a noncorporate owner’s qualified business income (QBI). The deduction generally equals 20% of QBI; however, it is reduced or eliminated at higher income levels. QBI includes rental income.
The QBI deduction is a deduction from AGI. In effect, it is like an itemized deduction. Since it does not reduce AGI, it does not reduce the Illinois income tax.
The SECURE Act, with some exceptions, eliminated the “stretch” provisions of inherited IRAs for non-spouse beneficiaries. Prior to this Act, beneficiaries of inherited IRAs were able to “stretch” out distributions over their life expectancy; grandchildren were often named as beneficiaries to “stretch” out required distributions as long as possible. This strategy was especially advantageous for Roth IRAs.
Except for spouses and a few others, the stretch was replaced by the ten-year rule. Most non-spousal beneficiaries of IRAs inherited after January 1, 2020, must distribute the entire account within ten years of the account owner’s passing.
Before SECURE, persons over 70½ were barred from making traditional IRA contributions. The SECURE Act allows persons, regardless of age, with eligible earnings to make deductible IRA contributions.
Qualified Charitable Distributions (QCD) and Traditional IRA Contributions
Persons 70½ and older can direct their IRA administrator to make contributions directly to eligible charities. Charitable contributions made this way are excluded from income but count toward RMD. The QCD allows seniors who do not itemize due to the higher standard deduction realize a tax savings from their gifting. The SECURE Act requires qualified charitable contributions be reduced by deductible IRA contributions.
These laws were passed to assist businesses and individuals with the economic consequences of the coronavirus. Generally, the provisions of these acts apply only to 2020. A few of the provisions are listed here.
Your IRA Could Owe Income Taxes
In recent years, many investors have sought to include investments other than traditional stocks, bonds, and mutual funds in their IRAs. When these investments generate more than $1,000 of unrelated business income (UBI) in one year, the IRA needs to file a tax return (Form 990-T). An IRA is most likely to generate UBI when it owns an interest in a pass-through business entity such as a partnership or limited liability company. Master limited partnerships (MLPs) most often trip up IRA owners. The Wall Street Journal reported on a person with an interest in a MLP affiliated with Kinder Morgan, Inc.; he received a tax bill for $24,321 to be paid from his IRA (November 14-15, 2015, page B7).
Investments other than MLPs can also generate UBI.
Married couples often use a credit shelter trust to reduce estate taxes. This technique effectively allows couples to shelter twice the exemption amount from estate taxes ($11.58 million in 2020). Portability achieves a similar result without the credit shelter trust and should be considered in estate planning. Portability is especially advantageous when a couple has large retirement accounts or an expensive primary residence.
Portability was made permanent in 2013. To receive the benefits, an estate tax return (Form 706) must be filed in a timely fashion after the first spouse dies.
Foreign Financial Assets
The IRS has long required taxpayers to disclose information about foreign bank and investment accounts with value more than a threshold amount. Effective 2011, Congress expanded the disclosure requirements to include all foreign financial assets with value greater than a threshold amount, regardless of whether they generate taxable income.
Failure to comply with these requirements can result in very significant penalties.
Anyone with assets outside the United States should be certain they are compliant. Persons who gamble online using Internet accounts may not realize this reporting requirement impacts them.
Rollovers as Business Start-Ups (ROBS)
These are arrangements in which a business owner uses his 401(k), IRA or other retirement funds to invest in his company. Promoters claim that this is a tax- and penalty-free use of retirement funds. However, most taxpayers do not realize the difficulty of staying in compliance with the rules. Entering into a prohibited transaction can result in the termination of the retirement account. If terminated, all monies would be considered a distribution and, if owner was less than 59½, subject to a 10% penalty. Some prohibited transactions are:
Same-Sex Marriage Ruling
The same-sex marriage ruling states that same-sex couples who are legally married are considered married for federal tax purposes, regardless of whether their state of residence recognizes same-sex marriage. In 2013 and all future years, legally married same-sex couples must file their federal income tax returns as married filing jointly (MFJ) or married filing separately (MFS).
Same-sex married couples may now enjoy all of the federal tax-related benefits previously available only to opposite-sex married couples. These benefits include (but are not limited to):
Same-sex married couples are also subject to the many marriage penalties included in the tax code.