As we all know since it’s been all over the news, there have been some pretty significant tax changes passed recently. While the tax deduction being capped at $10,000 made the most waves and caused many to question whether they should prepay their 2018 property taxes. While there isn’t enough time to touch on all 1,000+ pages of the “Tax Cuts and Jobs Act”, I hope to touch on many of the major and most impactful ones below over the next few weeks.
As I mentioned above, the change that’s flooded the news has been the $10,000 cap on the state and local tax deduction for 2018. As I mentioned to many of our clients when they inquired, it’s not a “one answer fits all” question. To understand whether a taxpayer will be effected, we first need to understand all of the ramifications associated with this particular deduction.
The tax portion of Itemized deductions includes 1) state income or sales taxes w/ sales tax being the actual amount paid throughout the year or an amount designated by the IRS based on other factors (income and dependents); 2) Real Estate taxes; 3) Personal property taxes; and 4) Other taxes. This deduction used to be unlimited BUT was subject to phase out for high income taxpayers. It is also an “add-back” when determining Alternative Minimum Tax (“AMT”) which is a 2nd tax calculation that runs simultaneously with your “regular” tax.
AMT starts with taxable income and adds back certain items – personal exemptions, taxes (Sch A, Line 9), Miscellaneous Itemized deductions, Medical expenses in excess of 7.5% of AGI as well as others. This determines the taxpayer’s Alternative Minimum Taxable Income (“AMTI”). From that you are entitled to an exemption. However, that exemption starts to phase out once your income reaches $119,700 if single ($159,700 if married filing jointly (MFJ)). Once you factor in the exemption (if applicable), all AMTI $186,300 and less is multiplied by 26%; greater than $186,300 by 28% to come up with your Tentative Minimum Tax. This is then compared to your “regular” tax. If your Tentative Minimum Tax is greater, the difference is referred to you as your AMT; if your “regular” tax is higher, there is no AMT.
Why do I explain AMT when talking about your tax deduction and whether you should prepay your 2018 property taxes? Because if you are already subject to AMT, prepaying your property taxes to get the “benefit” of the deduction and reduce your “regular” tax will only increase the add-back when determining your AMTI, thus your AMT. The amount you pay is the same.