Tax season has officially begun and you might be thinking about using your tax refund to vacation in South Africa. But there have been reports that some people who were used to getting refunds are now owing. And those who owed will have to pay more. This is thanks to the Tax Cuts And Jobs Act passed in late 2017.
If you are owing, the five reasons below are most likely to explain why.
1. $10,000 limit on state and local tax (SALT) deductions. This is the infamous blue state tax as these states usually have high income, state, and property taxes. As a result, high earners in these states will claim itemized deductions. Due to the many ways people itemize deductions, it is hard to say in general how people will be affected. Some may have to pay a little more tax while others will have to pay a lot.
Unfortunately, there are no practical ways to get around this unless you plan to buy a less expensive home, or move to a state with lower state and local taxes.
You may have heard about some unorthodox techniques that blue states are doing to get around this limitation. While the reasons may be noble, I wouldn’t rely on these.
For example, California tried to reclassify its taxes as charitable donations which are not subject to the SALT limitation. The IRS released a regulation prohibiting this technique. Also, I don’t know any charity that has the power to seize your assets, bank account, and garnish wages if you don’t “donate.” As Chris Rock said, “That ain’t a payment. That’s a jack.”
Also, as stated here earlier, New York, Connecticut, Maryland, and New Jersey filed suit against the federal government arguing that limiting the SALT deduction is unconstitutional. However, most tax professionals do not think this lawsuit will succeed. The Sixteenth Amendment of the Constitution does not require the deduction of state and local taxes from taxable income. Also, Article One of the Constitution gives Congress a broad power to collect and regulate taxes. Finally, the Supreme Court has acknowledged that deductions are a matter of legislative grace from Congress.
2. Employment related deduction for employees. Before the new tax law went into effect, employees were able to deduct their unreimbursed employment-related expenses as itemized deductions. For lawyers, expenses may include bar dues, cell phones, and mileage.
Now that this deduction is eliminated, attorneys have two options. The first is to get reimbursed from their employer. Make sure to follow the firm’s reimbursement policies. The other is to be reclassified as an independent contractor. This benefits employers because they don’t have to pay federal and state payroll taxes. And employees can write off business expenses with fewer limitations and their income may qualify for the 20 percent qualified business income deduction.
There are some drawbacks to this. As an independent contractor, your net profit will be subject to self-employment taxes which may end up being higher than the employee payroll tax deductions. Also, you might lose legal protections afforded to employees, such as unemployment and disability benefits and the right to sue for wrongful termination, sexual harassment, and other labor law violations.
3. Standard deduction doubling and the elimination of personal exemptions. For people who only qualified for the standard deduction, this will likely result in a small tax break. But if you have many exemptions due to claiming children and parents as dependents, this can significantly increase your tax bill.
Not much can be done about this. But self-employed attorneys should think about hiring their parents and children as employees.
4. Home equity line of credit (HELOC) interest is nondeductible. In the past, some homeowners obtained a HELOC to make improvements to their home. Others used the funds to finance a startup or to refinance their student loans. The interest paid on the HELOC used to be tax deductible although the deduction was limited to the interest paid on the lesser of $100,000 or the purchase price of the home.
Under the new tax law, HELOC interest paid is nondeductible. You may either want to refinance the HELOC if you can find a better interest rate, or just pay it off if you are relying on the tax deduction. Or you can hold out for eight years, after which the interest will hopefully be deductible again.
5. Your business does not qualify for the 20 percent qualified business income (QBI) deduction. Unfortunately, many small businesses erroneously thought that they would qualify for the 20 percent QBI deduction and withheld accordingly. Either their business was a qualified service business (which includes lawyers) which are subject to different rules, their income made them ineligible for the deduction, or they did not follow the complex rules. While the final regulations clarified some of the ambiguities, the rules are still complex and it will take time before they are fully understood and possibly litigated.
If your taxes ended up becoming higher, know that the above rules will be repealed in 2026. But it is also possible that they may be permanent. Most of the above involves changes to the itemized deduction rules. Some can be avoided through careful planning while others are impractical to avoid.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at sachimalbe@excite.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.
5 Reasons Why Your Taxes Might Be Higher Under The New Tax Law curated from Above the Law
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