Year-end Tax Planning for Young Professionals Under the New Tax Law
Year-end tax planning for young professionals can be challenging given the pace at which life changes with new kids, job changes, and the purchase of a new home. Add in the most sweeping tax reform since (most of) those reading this were in diapers and this year’s tax planning just got more complicated. What follows is an important breakdown of the most relevant tax law changes for young professionals that will be taking effect in 2018 and what actionable items readers can take heading into the last week of the year.
The Most Relevant Tax Law Changes for Young Professionals
Tax reform inevitably has winners and losers, and the Tax Cuts and Jobs Act of 2017 (TCJA), is no different. Here are the eight most impactful tax law changes for young professionals to be aware of heading into 2018:
- Tax Bracket Rate Cuts: The number of tax brackets didn’t change (get any simpler) but the good news is that married young professionals should see their tax brackets go down 1-4%, while some high earning individuals may see their brackets go up slightly.
- Increased Standard Deduction: Under TCJA the standard deduction nearly doubles for singles to $12,000 and for married couples to $24,000, compared to $6,350 and $12,700 previously. This will likely lead to many more young professionals simply claiming the standard deduction and not itemizing (see more below).
- Bye-Bye Personal Exemptions: Young professionals with kids will no longer be able to claim personal exemptions on their kids, as the increased standard deduction essentially merges personal exemptions and the standard deduction into one.
- Child Tax Credit: The good news for those young professionals with kids, is that the child tax credit is doubled from $1,000 per qualifying child to $2,000 and the phaseout is increased to $200,000 for singles and $400,000 for married couples. The expanded child tax credit should help offset the elimination of the personal exemption for big families—except for those earning above the phaseout.
- Limiting of the State and Real Estate Taxes: One of the biggest changes to the young professional’s taxes moving forward will be the limited deductibility of state and real estate taxes to $10,000. This has broad implications, but the biggest is simply that most young professionals will likely not itemize their deductions moving forward, given that in many cases their itemized deductions might not exceed the standard deduction.
- 529 Plans Expanded: Parents can now use 529 plans to pay for private elementary and secondary school expenses (in addition to continuing to be able to use to pay for college). This expansion is limited to $10,000 per student per year in distributions.
- Mortgage Interest Deduction—Limited: TCJA limits the amount of mortgage interest that can be deducted to the first $750,000 of principal debt (aka your mortgage), compared to the previous limit of $1 million. The limitation is not retroactive, however, and only applies to new mortgages taken out after December 15th, 2017. In addition, TCJA eliminates the deductibility of home equity indebtedness (i.e. Home equity loans, HELOCs), which was previously deductible up to $100,000. Also notable, is that this change is not grandfathered in, meaning after 2017 young professionals will no longer be able to deduct any interest on home equity debt.
- Student Loan Interest—Unchanged: Thankfully for young professionals, one thing that did not find its way into the final bill was the repeal of the student loan interest deduction. Although its use is somewhat limited by the income phaseout, those with student loans can still deduct the interest if they fall below the $80,000 and $160,000 phaseout for singles and married couples respectively.
Year-End Tax Planning for Young Professionals Under the TCJA
Each young professional’s tax situation will be impacted uniquely by the new law, however, there are some general themes that can help guide last-minute tax decisions in 2017. With tax brackets set to go down in 2018, it’s likely advantageous to defer income (where possible) to 2018, where you’ll be able to pay taxes at a lower rate. On the flip side, lower tax rates, drive down the relative value of deductions, meaning it will be advantageous to expedite deductions into this year where tax brackets are lower. This is in addition to the doubling of the standard deduction and the limiting of the deductibility of state and property taxes which will likely mean fewer and fewer young professionals itemizing their deductions in the first place, as they are likely not to exceed the standard deduction.
In light of the two general themes—push income out to 2018 and pull deductions into 2017—there are two primary strategies you should consider before year-end.
First, with state and local taxes being limited to $10,000 starting next year, young professionals should consider pre-paying their property taxes this year to ensure they get to take the full deduction this year, when they likely not be able to next year. For those Minnesota residents, a number of counties are extending their county government center hours due to the influx of residents pre-paying. Also, be sure to check with your lender if you’re paying your property taxes via escrow as you’ll want to avoid paying twice!
Lastly, for those charitably inclined young professionals, it may make sense to make your next few years’ worth of tax payments this year, instead of making equal and consistent donations over the next few years. The doubling of the standard deduction effectively establishes a high deduction hurdle rate that young professionals will need to surpass before it makes sense not to simply take the standard deduction. In short, the idea of “lumping” contributions together every few years in order to get over the standard deduction hurdle rate will likely make sense, from a pure tax savings standpoint.
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