Analysis: 2018 Income Tax Rule Changes Are Creating Lots of Myths and Misconceptions

Russ Wiles

Though tax talk has died down now that the annual return – filing season is mostly concluded, new provisions as part of income tax reform already have filers thinking about next year.

But many Americans apparently are confused about various rules under the new law. Here are some of those reform-related myths and misconceptions cited by tax experts:

Tax reform will make it easier to file returns

Simplification was a major goal of tax reformers, and the new rules will make things easier for some filers. In particular, an estimated one in five taxpayers will switch from itemizing to taking the standard deduction. These people no longer will need to hang onto charitable-donation receipts and other paperwork.

However, not everyone will find tax-return filing to be any simpler, especially those who continue to itemize.

“Overall, the legislation was not simplifying,” said Mark Luscombe, a tax analyst with Wolters Kluwer Tax & Accounting. “The only thing you can point to is the increased standard deduction.”

In addition, there are some new provisions taxpayers will need to learn. Among them is a new 20% deduction, a tax-shaving break for people who own “pass-through businesses.” This provision “will require complex calculations that have never existed in the past,” said LBMC, a Tennessee company that provides accounting and other services.

In addition, the reform law didn’t simplify other potentially complex areas, such as sorting through capital gains or losses or assessing eligibility to make deductible contributions to Individual Retirement Accounts.

Reform means mortgage interest no longer is widely deductible

Actually, mortgage interest will remain deductible for the majority of homeowners.

The new law did change the rules so that mortgage interest now only can be deducted on up to $750,000 in debt on your primary home and one additional dwelling. But that’s still enough to cover loans on most U.S. homes, where the median price is near $246,000, according to the National Association of Realtors Besides, many buyers make substantial down payments of 20% or more, thus taking out smaller loans.

At any rate, this restriction applies only to newer loans taken after Dec. 14, 2017, noted Tim Steffen, director of advanced financial planning for Baird Private Wealth Management. “Any loans in place prior to then are still subject to the previous $1 million debt limit,” he said. “So if the interest on a loan was deductible in 2017, it will likely still be deductible in 2018.”

Borrowers no longer can deduct interest on home equity loans

For many people with home-equity loans, the interest deduction has been eliminated. But some borrowers still will be able to make use of this tax break. It really boils down to how loan proceeds are used.

As long as the borrowed amount is used to buy, build or substantially improve a home, the interest remains deductible, Steffen said.

But if the proceeds are used to buy a vehicle, pay off credit-card balances or other debts or for other, non-housing purposes, then the interest no longer is deductible. “This means that borrowers will need to carefully track the use of their home-equity loan proceeds in order to maintain the tax deduction,” he said.

Reform means parents no longer will receive tax breaks for their kids

The personal exemption was repealed, which means there no longer is a $4,050 deduction for a spouse and each dependent, Steffen noted. However, the newly expanded child tax credit will help to offset that.

The tax credit for children under age 17 has doubled to $2,000, plus there’s a new $500 credit for other dependents. “So older kids or even your parents who are dependents can qualify for a new credit,” Steffen said.

Also, income levels for eligibility have risen dramatically, meaning many additional families will benefit. For many households, “The new credits will more than offset the loss of the deduction,” Steffen said.

Federal tax reform doesn’t affect state income taxes

Not quite. Most states base their own income-tax systems on the federal tax code pretty much entirely or use it as a starting point. So the drastic changes at the federal level could affect some of these states and the taxes their residents pay.

Reform will broaden the federal tax base, subjecting more personal income to taxation by eliminating various deductions and exemptions. Congress largely offset this by cutting federal tax rates.

But so far, most states haven’t yet cut their own rates or made other adjustments. Unless they do, “most states will experience a revenue increase,” and residents of those states will pay more, the Tax Foundation predicted. “The vast majority of filers will receive a tax cut at the federal level, but they could easily see a state-tax increase unless states act to prevent one,” the group said.

In particular, federal tax reform eliminated the personal exemption but increased the standard deduction. Yet “eliminating the personal exemption broadens the tax base considerably more than raising the standard deduction narrows it,” subjecting more income to taxes, the Tax Foundation said.

It thus will be important for people to monitor what actions, if any, their state legislatures take.