The Tax Cuts and Jobs Act of 2017 went into effect on January 1, 2018 and started the year off with a bang. Most notably, the tax reform act imposed a new cap on state and local tax deductions at $10,000 for married filing jointly couples and $5,000 for single filers. In other words, if you’re single and the sum of your property, state and local taxes exceeded $5,000 during the year (which is easily achievable in California due to high property values), too bad – you don’t get to deduct all the expenses you paid! Corporations received a huge tax break due to the lowering of the top tax bracket from 35% down to 21%, mostly on the backs of the Middle Class. The threshold for itemizing taxes went up, and many expenses that qualified for a tax deduction in prior years were eliminated or phased-out, making taxes “simpler” but also resulting in a larger expense, for many.
However, one positive outcome of the Tax Cuts and Jobs Act (TCJA) is new flexibility created around 529 College Savings Plans. A 529 plan is an education savings vehicle that functions much like a Roth IRA. You put after-tax money into the account, and the growth on the investment is tax-free if the money is utilized for qualified education expenses. Qualified expenses include tuition, room and board, books and supplies, to name a few.
Previously, the earmarked 529 savings was meant for higher education costs such as university or trade school expenses. Under the new law, you can now draw annually up to $10,000 per child, tax-free, to pay kindergarten through 12th grade tuition at a public, private or religious school[i]. Given the new benefit, many parents and grandparents are interested in starting the tax-free savings plans as soon as a child is born rather than waiting until traditional college planning has begun.
The Tax Cuts and Jobs Act is a federal law, but not all states and educational institutions sponsoring 529s have been able to adopt the new flexibility standards allowing distributions for K-12 education. In California, legislative change is still pending, therefore, it is important to check with your CPA and 529 sponsor prior to making any withdrawals, so as not to trigger a 10% early withdrawal penalty unexpectedly.
Like many other tax benefits that disappeared, the TCJA rules eliminated tax deductions for interest paid on home equity loans or home equity lines of credit. For those in a pinch to put their kids through college, the equity loans were an appealing option because the interest paid was tax deductible. With the removal of any benefits to carry equity loans, many parents are turning towards saving early to stretch hard-earned dollars.
Student Loan Interest Deduction Saved
The new law leaves the student loan interest deduction unchanged at $2,500. However, as mentioned, the threshold to qualify for itemization is higher. Also, when student loans are cancelled due to death or disability, they are now tax-exempt[ii].
Alimony Taxation Changes
New divorcees (divorced post-2018) are also affected significantly under the new TCJA rules. Under the new laws, alimony is no longer considered taxable income to the recipient[iii], essentially lowering their taxable income and possibly making it easier for the family to qualify for needs-based financial aid.
While the new tax laws were supposed to make taxes simpler, change always seems complicated. The finance industry is scrambling to learn and be complaint with the new rules before the 2018 tax filing season rolls around. There is still time to initiate planning this year that could reap tax benefits or avoid tax pitfalls. Consult your CPA or Certified Financial Planner™ before the year is over to make sure you’re on track and taking advantage of available options.
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