Misconceptions you may have about your 2018 tax return

February, 07 2019 by Jean Lee Scherkey, EA

When I was a kid, time seemed to creep and crawl like the moss that grows on an unsuspecting sloth. During those wonder years, my dad would tell me that time flies. When he said this, I couldn’t help but return his reverb with a glance that confirmed my suspicion that he was not from this galaxy. Could it be that my dad was right about time all along? It seems like it was just the other day when the Tax Cuts and Jobs Act of 2017 (or TCJA) was signed into law. Surely there would have been enough time to interpret all of the twists and turns of this historic legislation. However, even though it has been a little over a year since TCJA was signed into law, rumors about its impact are flying off the pages of print and virtual publications and the lips of people from coast to coast. There is a plethora of information (and more pointedly, misinformation) out there about TCJA that taxpayers are taking as gospel and applying to their 2018 tax situation. One of these misconceptions is that alimony is no longer deductible for anyone. Many taxpayers who normally take an income adjustment for alimony paid may be pacing the floor at night, bracing for a higher tax bill that may never come. Others may have lulled themselves into a false sense of security, believing that, with the reduced tax rates and increased standard deduction, a large 2018 refund is in their future, and as such, they do not need to make their fourth quarter estimated tax payment or adjust their withholding. The best way to quash rumors and misinformation is by arming yourself with the facts.

Below is a list of misconceptions and examples of misinformation taxpayers may encounter during the upcoming tax season. Hopefully, the information below will help you not only bank some extra time in the preparation of your return, but also save you some dollars by not making costly mistakes.

The tax changes in TCJA are permanent. Many may assume that the tax changes within TCJA are permanent. Some of the business provisions are permanent. However, for the majority of the individual provisions, the changes became effective after January 1, 2018, and are set to expire after December 31, 2025. Although shopping frenzies on Black Friday are certain, the permanence of the tax code is never certain, as it can be changed by Congress. The “lame duck” Congress has introduced potential tax legislation for some items but making the individual changes permanent is not included in these bills.

States automatically conform to the new Federal tax laws. Upon hearing that the standard deduction has doubled and that many itemized deductions have been eliminated, it is easy to assume there is no longer a need to keep track of certain deductions, and therefore, it is okay to shred or throw away receipts that would normally be kept. This may be the most concerning misconception. Some states have fully conformed to the new federal laws, while others have partially conformed. Meanwhile, some states decided not to conform to any of the new provisions. For example, in California taxpayers will still be able to deduct unreimbursed employee business expenses that are over 2% of their federal adjusted gross income. It will be crucial for every taxpayer to continue to retain documentation on certain deductions that may have been eliminated at the federal level but still apply at the state level. Retaining this documentation may result in lower state taxes, thereby easing the sting of losing the deductions on the federal return.

Alimony paid is no longer deductible and alimony received is no longer included in income. Many taxpayers may assume that alimony received is no longer includable in income and alimony paid is no longer deductible from total income. However, according to the provisions in TCJA, this is only true for divorce or separation instruments executed on or after January 1, 2019”. Alimony that is paid under a divorce or separation agreement executed before January 1, 2019, will still adhere to the alimony rules in place before TCJA. Divorce or separation agreements that were in place before January 1, 2019, and are modified after December 31, 2018, will still follow the old alimony rules unless the modified agreement specifically states it now follows the new rules.

I am no longer subject to the ACA individual shared responsibility payment. Although TCJA reduced the individual shared responsibility payment to $0, it does not take effect until January 1, 2019. This means that those without health insurance during 2018 will still incur this payment unless they qualify for an exception. And TCJA did not repeal the requirement for people to pay back any excess Premium Tax Credit received during the year, so folks who received an insurance subsidy through the Marketplace may still be facing a payback amount if their income increased.

Personal casualty, theft, and Ponzi scheme losses are still deductible. With the exception of presidentially declared disaster areas, personal casualty losses are no longer deductible on the federal return. Remember, theft losses have never received a presidential declaration, so these will no longer be deductible. This will be a considerable blow to those who suffer losses that are not connected to a federally declared disaster to their home or other property. Examples may include house fires caused by electrical faults, or isolated flood circumstances (even floods caused by broken pipes). Casualty, theft, and Ponzi scheme losses in connection with a business are still deductible on the federal return on the applicable business schedule.

Hobby losses are still deductible. Whether it's driving for Uber, renting an extra bedroom on Airbnb or making jewelry to sell to co-workers and friends, many people have a “side gig.” If the side gig does not rise to the level of a trade or business, the hobby loss rules will apply. All hobby expenses are no longer deductible, as they were treated as miscellaneous itemized deductions which have been eliminated. Expenses such as mortgage interest and property taxes are deductible up to the amount allowable whether or not a taxpayer has an activity that is not engaged in for profit. Casualty and theft losses surrounding a hobby are not deductible. However, hobby expenses may still be allowed as a deduction on your state return, as mentioned earlier.

Home mortgage interest deduction is deductible on only $750,000 of indebtedness. For taxpayers who live in states where the cost of homes is high, the thought of not being able to deduct all the mortgage interest they were able to previously is a rough blow. However, there is a ray of light. Any acquisition indebtedness that originated before December 16, 2017, is grandfathered into the $1,000,000 acquisition indebtedness limitation ($500,000 for those who use the Married Filing Separate filing status) and not the $750,000 limitation under TCJA. Furthermore, if loans that were established before December 16, 2017, are refinanced after December 15, 2017, the $1,000,000 limit remains, as long as the additional debt was not added to the refinanced loan. If you decide to refinance a grandfathered debt (mortgage) after December 15, 2017, and borrow an additional amount of money, even if it is for home improvements, the loan is no longer considered grandfathered in and is subject to the $750,000 limitation.

Home equity mortgage interest is still deductible on loans that were taken out prior to the tax reform act. Many taxpayers will be in for a shock when they learn that the mortgage interest paid on their home equity loan may no longer be deductible. Before TCJA, taxpayers were able to deduct up to $100,000 of equity debt, even if the loan proceeds were not used to substantially improve the home. With the passage of TCJA, proceeds from a home equity loan that are not used to substantially improve, buy, or build the home are not deductible, even if the amount of equity debt used was $100,000 or less. In other words, mortgage funds that are used for non-home improvement purposes, such as to pay down debt, to purchase a car, pay for college, or take a vacation, are no longer deductible. The interest paid on a home equity loan may still be deductible if the proceeds were used to substantially improve the home and the total combined home acquisition and equity debt balances are not over $1,000,000 for loans that originated before December 16, 2017, and $750,000 for loans that originated after December 15, 2017.
 
Switching business entities to take advantage of the 20% qualified business deduction. Many small business taxpayers are anticipating a big tax break this year due to the new 20% qualified business income deduction. You may have been considering switching your small business that is organized as a C Corporation into a sole proprietorship or S Corporation to take advantage of the deduction. Although this may sound enticing, you may want to take a step back and look at the bigger picture. There are many limitations and complexities to this deduction, and there may have been very important reasons why you formed your business as a C Corporation that goes  beyond taxes. By switching entities, these reasons may fall by the wayside. When considering a change of entity, it may be good to invest in some good tax advice beforehand.

One thing is for certain - even if the 2018 tax filing season flies by, the preparation of our returns will not. Taxpayers may even want to consider filing an extension on their 2018 tax returns. It will not be surprising if there are corrected Forms 1098, 1099 and Schedule K-1s issued after April 15, as payment agencies work to comply with the new reporting rules. Taking the extra time and care may just keep the ghost of tax seasons past from haunting us in the future. Until the next time, may your days be filled with joy and your tax burdens be light.