Michael Kitces is a partner and the director of wealth management for Pinnacle Advisory Group, co-founder of the XY Planning Network, and publisher of the continuing education blog for financial planners, Nerd's Eye View. You can follow him on Twitter at @MichaelKitces.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The recently enacted tax legislation makes it much less likely that many taxpayers will itemize their deductions. Joining me to discuss what's going on with deductions as well as some strategies for taxpayers to consider is Michael Kitces; he's joining me via Skype.
Michael, thank you so much for being here.
Michael Kitces: My pleasure. Thanks for having me.
Benz: One of the big headlines of the recently enacted tax package was this heightened standard deduction. I'd like to start there. What's changing with standard deductions?
Kitces: The big change around standard deduction is that, simply put, they are getting larger, much larger--going to $12,000 for individuals and $24,000 for married couples. Now it's actually a roll-up both what used to be a standard deduction and what we call personal exemption. Each person in the family got a $4,050 personal exemption. But what it means even when we roll them all together is that the new standard deduction for an individual is higher than the old standard deduction and an exemption, and the new standard deduction for married couples is higher than what a married couple plus their standard deduction would have had in the past.
The whole line for claiming itemized deductions gets higher with the caveat that if you can't itemize it simply means, you get more deductions as a standard deduction, at least for individuals and couples; families that lose personal exemptions may end up slightly behind offset with the child tax credit. But the core of it is just we get this bigger flat standard deduction that everybody gets so fewer people will need to itemize at all.
Benz: In addition, there have been some changes to itemized deductions, some of the specifics related to itemized deductions. One of the biggies, people who have been watching the news have been certainly hearing a lot about this has been the cap on state and local taxes as well as property taxes that are deductible--it will be $10,000. Let's talk about that.
Kitces: The part of the change that we're seeing, the original proposal actually from the House GOP was to completely eliminate itemized deductions all together. We might have kept charitable deductions and maybe a partial mortgage deduction and then everything else was going to go away. What we got was kind of a compromise that said we're still going to keep standard deductions and itemized deductions, but the itemized deductions are going to be fewer and more limited. Then we get this series of changes that limits them.
One of the biggest ones you noted is this cap on what are called state and local tax, or SALT for short, and they are SALT deductions--the state and local tax deductions. That's anything I pay to my state and local jurisdiction, which is most commonly my state and local income taxes, my state and local property taxes. What the new rule says is you can still deduct them, but only up to a total cap all mixed together of $10,000, and it's the same $10,000 cap whether you are an individual or a married couple. Any state income taxes above that, not deductible; any property taxes above that threshold, not deductible. We just all cap out at $10,000.
Benz: This is one of the factors that may make for many households, many taxpayers it may make the standard deduction larger than their itemized deduction. Let's also talk about the homeowner related expenses or the deductions. The changes to the mortgage interest rate deduction as well as home equity loan deductions.
Kitces: This was another curtailment that we had. Under the old rules we could deduct interest on mortgage debt for the first $1 million of debt principal. That threshold now has reduced to only the interest on the first $750,000 of debt principal. You've got an existing mortgage under the old rules, it's still grandfathered and you can deduct all the interest, but any new mortgages going forward, you only get to deduct the interest on the first $750,000 of the debt principal.
On top of that we used to have rules that said if you had any home equity indebtedness--money you borrow that you didn’t use to actually buy or improve the house, you used it for some other purpose--you could deduct the interest on that home equity debt for the first $100,000 of debt principal. That's gone entirely not even grandfather. If you got existing home equity indebtedness it's simply no longer deductible in 2018 going forward.
We get a lower cap on SALT deductions. We get a lower cap on mortgage deductions, all of which make it more and more difficult for people to itemize it all and more preferable to simply claim the standard deduction now that it's bigger.