Trump supporters welcomed the Republican-backed tax reform package that took effect just over a year ago—and expected that they would see reduced tax liability as a result. Now that the first tax filing season under the new tax changes is well underway, many taxpayers—especially those in higher income tax brackets living in high tax states—are shocked to find that the Trump tax “cuts” actually left them shouldering a higher tax burden for the 2018 tax year.
Many advisors now find themselves facing clients who are angry and wondering why their overall tax burden has increased—and now have the opportunity to add value by explaining the new rules and proposing possible solutions.
Post-Reform State of Deductions
The 2017 Tax Act limited the ability of taxpayers to deduct state and local taxes (including sales, income and property taxes, which were previously deductible from federal income taxes without limit). The new law now imposes a cap of $10,000 ($5,000 for married taxpayers filing separate returns) on this deduction. Foreign real property taxes can no longer be deducted. These rules apply for tax years beginning after December 31, 2017 and before January 1, 2026.
For high-income clients who live in high tax states (notably, most traditionally “blue” states, such as New York and California, have the highest state-level taxes), placing a $10,000 cap on the deductibility of state and local taxes can represent a significant tax increase. Additionally, many higher income clients who have bought a new home recently will find that their mortgage interest deduction is also limited—only interest on the first $750,000 of mortgage debt can be deducted post-reform. This $750,000 cap may seem generous, but higher income clients who live in high tax states often find themselves facing a real estate market where homes are significantly more expensive than in no or low-tax states.
Although the highest ordinary income tax rate was reduced from 39.6 percent to 37 percent, the standard deduction was doubled and the child tax credit was significantly expanded so that more high-income clients can now benefit, higher income clients are still learning that they will pay more in taxes in 2018 than they did under the old pre-2018 law.
Potential Planning Opportunities