How Did the TCJA Impact Deductions on 2020 Taxes?

2017 was almost over when Congress approved and then-president Donald John Trump signed the TCJA, short for the Tax Cuts and Jobs Act. Both its supporters and opponents agree that there can be no two opinions about whether enacting tax reductions was Mr. Trump’s signature legislative accomplishment.

Those who praise and those who criticize also agree that the TCJA was the most comprehensive overhaul of the Internal Revenue Code since President Ronald Wilson Reagan signed the Tax Reform Act of 1986.

While the TCJA’s provisions that garnered the most attention were lower tax rates for individuals and businesses, the legislation nearly doubled the standard deduction amounts authorized for nonitemizers (line 12 of 2020’s 1040 and 1040-SR). It didn’t change long-standing rules that authorize indexing for the tax brackets and the standard deductions, meaning the IRS adjusts them annually to reflect intervening inflation.

Boosting standard deductions was just for starters. The TCJA also abolished or curtailed many long-cherished deductions claimed by itemizers on Schedule A of the 1040 form.

The restrictions include a ceiling of $10,000 ($5,000 for married couples filing separate returns) on deductions for state and local income taxes, property taxes and general sales taxes (line 5e of 2020’s Schedule A). No indexing for the $10,000 cap. Lots more on sales taxes in a couple of paragraphs.

The changes to standard deductions and itemized deductions went on the books at the start of 2018. They’re scheduled to go off the books at the end of 2025, unless Congress decides to extend them. No extension means the previous rules for 2017 and earlier years return for 2026 and later years—an event that’s unlikely to happen.

One predictable result of increases in standard deductions and decreases in itemized deductions: A sharp spike, says the Internal Revenue Service, in the number of taxpayers who decided that it pays for them to become nonitemizers—from around 70 percent for years before 2018 to about 90 percent for years after 2017.

What percent of taxpayers continues to be itemizers for 2018 and later years?  Only about ten percent, according to the IRS.

Still, it behooves accountants and other tax professionals to remember that their client rosters include die-hard “ten-percenters,” who need no reminder that a sure-fire way for them to trim their taxes is to itemize.

This column and three subsequent ones provide some reminders for accountants when they prepare returns or otherwise advise ten-percenters. Let’s start with some low-hanging fruit—what the Internal Revenue Code says itemizers can do and can’t do.

Section 164 allows itemizers to choose between deducting state and local income taxes or state and local sales taxes. They can’t write off both in the same year (line 5a of 2020’s Schedule A for itemized deductions).

It mandates that itemizers must “elect”—IRS-idiom for decide—only one for inclusion with their other deductibles on Schedule A. Which one should accountants advise clients to choose? The choice isn’t always clear-cut.

S’pose accountants advise clients to elect sales taxes for one year. Do they irrevocably commit clients to the same election in other years?

Nope, because each year stands on its own. What Section 164 does is permit itemizers to deduct sales taxes in one year and income taxes in another year—meaning, for instance, they’re able to deduct sales taxes for 2020 and income taxes for 2021 or vice versa.

Primary beneficiaries of sales-tax deductions: residents of the states that don’t impose income taxes—Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Also throw in New Hampshire and Tennessee. Both fall into a gray area; they tax dividend and interest income, but not earned income.

Let’s pivot to itemizers who live in the other forty-one states. Sales-tax deductions also benefit residents of states with low rates for income taxes. The same holds true for seniors who live in states that authorize lower rates, exemptions and other kinds of special breaks for retirement income.

Breaks for seniors include: their Social Security benefits; and their withdrawals from such tax-deferred retirement plans as traditional IRAs, 40l(k)s, 403(b)s, and those that are designed for self-employed persons. When tax time rolls around, it pays for them to deduct their state and local sales taxes instead of their state and local income taxes.

Stay tuned for subsequent columns that explain what tax-savvy seniors should do and that delve into other twists and turns in the rules for write-offs of sales taxes.