As if federal employees are not busy enough making decisions during the current OPM-sponsored benefits open season that concludes Dec. 11, 2017, employees have little time to plan for the possible federal tax overhaul currently being debated in Congress and, if passed, may be enacted by year’s end.
Among the major changes, the tax overhaul could result in fewer tax breaks for homeowners. There would be no deductions for state and local income and sales taxes, a higher threshold for charitable contributions, and no personal exemptions. This column presents some year-end planning suggestions for employees to perform, given what may happen starting Jan. 1, 2018.
At this time, Republican leaders in the House and the Senate have proposed different bills to overhaul the tax code. Both the House and the Senate bills take away or limit many individual tax breaks. The ultimate purpose of the tax bills is to simplify the current tax system and to spur economic growth. The bills would greatly increase the standard deduction, resulting in perhaps 30 million filers using the standard deduction and not having to file Schedule A (“itemized deductions”), thus avoiding to list itemized deductions including mortgage interest, property taxes and charitable contributions.
List of the major changes — with some recommended tax moves before year end
Standard deduction and personal exemption
Both the House bill and the Senate bill would almost double the standard deduction for single and married individuals. For 2018, the House bill raises the standard deduction for married couples to $24,400 while the Senate raises the standard deduction for married couples to $24,000. The standard deduction for single individuals would be half of the standard deduction for married individuals. Both the House bill and the Senate bill would repeal the personal exemption for each family member, which is scheduled to be $4,150 for 2018.
Mortgage interest deduction
The Senate bill preserves the current law allowing the mortgage interest deduction on up to a total of $1 million of mortgage debt on as many as two homes, including a primary residence and a vacation home.
The House bill allows home buyers taking out mortgages after Nov. 2, 2017 to deduct interest on mortgages not exceeding $500,000, and only on one home. This means no more mortgage interest deduction on second or vacation homes.
Both the Senate and the House bills end the interest deduction for home equity loans.
Primary residence sale capital gain exclusion
Under Internal Revenue Code Section 121, individuals can sell their principal residences and exclude from capital gains tax the first $500,000 of profit if the individual home owner is married filing jointly and $250,000 if the homeowner is single or files as head of household. The current law, which has been around since August 1997, requires that the homeowners live in the home for at least two out of the five years preceding the sale. Both the House and the Senates bills would require homeowners to live in a home for five of the prior eight years to take advantage of the capital gain exclusion. The House bill reduces the exemption dollar for dollar for sellers whose incomes exceed $500,000 ($250,000 for singles). Those homeowners whose homes are on the market to be sold, or whose homes were recently sold and who may be affected by the new rules, are encouraged to go to settlement before Dec. 31, 2017.
The House bill repeals the deduction for state and local income and sales taxes
The House bill eliminates the deduction for state and local income and sales taxes and also limits the property (real estate) tax deduction to $10,000. The Senate bill repeals the entire property tax deduction in addition to state and local income taxes and sales taxes.
Those federal employees who will not owe alternative minimum taxes (AMT) for 2017 may want to prepay in December 2017 state and local income taxes that could be disallowed in 2018. Employees who live in the seven states that have no income taxes and who are considering a major purchase such as a car or a truck may want to make their purchases before Jan. 1, 2018 in order to be able to deduct the sales tax on their 2017 tax returns.
Under both the House and Senate bills, the standard deduction will greatly increase. Currently 30 percent of filers who itemize list charitable contributions. If the law changes, then only 10 percent of filers will have to list their charitable contributions. Employees who donate a small percentage of their income may therefore want to accelerate donations into 2017 in order to get a deduction on their 2017 taxes.
Plug-in cars The House bill repeals a tax credit of as much as $7,500 for plug-in cars including the Tesla and Chevy Bolt. Any individual thinking about buying a plug-in car should do so before Dec. 31, 2017.
Medical expense deductions
The House bill repeals the deduction for medical expenses. The medical expense deduction is especially important for individuals paying large bills for home health aides and nursing home care. The Senate bill retains the medical expense deduction.
There are numerous employees who have parents with many medical expenses and may lose the deduction if the House bill becomes law. These parents may also have taxable income from pensions or individual retirement accounts that they use for nursing home or for in-home care. Without the deduction for those expenses, they could face a much higher tax bill, run out of money sooner and end up on Medicaid faster, thus costing the federal government more money in the end because of more Medicaid spending for needy citizens.
For federal employees and annuitants who are and/or will soon be priced out of the Federal Long Term Care Insurance Program (FLTCIP), the possible end to the medical expense deduction is another dose of bad news for paying for their future long term care needs. The FLTCIP premiums have skyrocketed in recent years and will most likely increase in future years to the point that many federal annuitants will no longer be able to afford to pay the premiums. They will likely have to withdraw more than they want to from their traditional Thrift Savings Plan (TSP), paying federal and state income taxes and perhaps depleting their TSP account earlier in their retirement.
In the House bill, alimony ceases to be deductible by the payer effective with agreements signed after Dec. 31, 2017. That means individuals in the midst of a divorce or a separation and who will pay alimony should sign divorce or separation agreements before Jan. 1, 2018.
Both the House bill and the Senate bill repeal a deduction for certain moving expenses and another tax break for moving expenses that are reimbursed by employers. There is an exception for Uniformed Forces members on active duty.