My firm and I have been on the very front edge talking about tax reform, keeping you updated on the progress and content of the bill as it made its way through Congress, and then, after its passage, helping you understand how the reform will affect your wallet.
It’s important to give credit where credit is due. Remember, I’m a Certified Financial Planner. I’m not a CPA or tax policy expert. In compiling information for this article and my other pieces on tax reform, I employed several CPA firms to walk me through the changes.
But I am so fascinated by this tax reform that I’ve also spent hours upon hours over the past several months seeking to understand what the changes will mean for Americans and the American economy. Overall, I am a proponent of the reform, as I believe it will result in reduced taxes for the vast majority of Americans.
During my research, however, I discovered a small yet impactful tax change that could adversely affect hundreds of thousands if not millions of taxpayers – the issue of state standard deductions.
Let me explain. About 30% of American taxpayers itemize deductions when they do their taxes. This percentage will likely decrease under the new GOP tax plan since the federal standard deduction has nearly doubled to $12,000 for single filers and $24,000 for joint filers.
But what about state tax itemized deductions? Here’s where a “donut hole” may prove costly for some taxpayers.
In most states (Georgia included) tax rules state that whichever deduction – standard or itemized – is used for the taxpayer’s federal return must also be used for the state return. For residents of states with high standard deductions, say around $10,000 or so, this rule may not make a big difference to your overall tax bill.
But for folks in states with very low standard deductions, like Georgia and Kentucky, itemizers lose the ability to take itemized deductions on their state income tax return if they choose to switch to the new higher federal standard deduction. The bottom line is that folks in these states or states like them may see a state tax increase if they choose to take the new, higher GOP standard deduction.
To illustrate this point, remember that the federal standard deduction is now $24,000 for joint filers. But in Georgia, the standard deduction for joint filers is only $3,000. So, many taxpayers who could deduct between $12,000 and $24,000 (for things like mortgage interest, charitable gifts, property taxes, state and local taxes, et cetera) need be careful which option they choose – to itemize or to use the standard deduction.
Based on my conversations with CPAs, in most cases, itemizers with deductions between $12,000 and about $19,000 will still fare better on their combined federal and state tax bill if they use the new higher standard deduction. But they shouldn’t be surprised by a slight increase in their state tax bill.
“Borderline itemizers,” who are very close to reaching the new federal standard deduction amount, may be better off sticking with their itemized deductions for both federal and state purposes. The result here is that these taxpayers would see a slight increase in their federal tax bill, but would pay far less in state taxes. Members of this group likely include families who are deducting between $19,000 and $24,000.
Here’s a quick example of the math behind opting out of the standard deduction so you can make the most of an itemized state return. Consider a couple, married filing jointly, with $23,000 of itemized deductions. They decide to forego the $24,000 standard deduction and itemize so that they may itemize for their Georgia return. Remember, if they took the federal standard deduction, they would have to take the Georgia standard deduction of just $3,000.
By choosing to itemize, they could potentially save $1,200 in Georgia state taxes and only lose $220 in the foregone federal deductions. The math works like this:
State: $23,000 – $3,000 = $20,000 (their itemized amount over the standard deduction)
$20,000 x 6% (their estimated tax rate) = $1,200 saved
Federal: $24,000 – $23,000 = $1,000 (the amount they lose by itemizing instead of taking the standard deduction)
$1,000 x 22% (their estimated tax rate) = $220 lost
When combining both federal and state, this couple may save $980 in overall taxes by choosing not to switch to the GOP’s new higher federal deduction.
In general, in certain states, we see slightly higher state taxes for the “donut hole” mentioned above. These “borderline itemizers” have between $12,000 and $19,000 in itemized deductions. “Very high borderline itemizers” ($19,000 to $23,000 in deductions) should exercise caution before using the new, higher federal standard deduction. My advice is to always consult with a tax professional to determine which filing method is best for you.
Let’s look at the three categories of “borderline itemizers,” as based on the amount of itemized deductions each group has:
- Above $24,000 – These taxpayers would likely continue to itemize on both federal and state and would no longer be considered “borderline itemizers.”
- Between $19,000 and $24,000 – This group can be referred to as “very high borderline itemizers,” as they need to be careful before choosing the new higher federal standard deduction.
- Below about $19,000 – Here, it is still likely better to switch to the new federal standard deduction. But, the $12,000 to $19,000 group of itemizers who are married, filing jointly, and the $10,000 to $12,000 group of single filers could see a slight increase in their Georgia taxes.
With all of this said, it is still difficult to find a realistic scenario where the overall tax liability between federal and state is moving higher under the new GOP tax plan. Overall, it appears that the tax reform lowers taxes for the vast majority of Americans. This new “donut hole” is an area where some folks may find themselves saving big on federal taxes, but paying a little more in state taxes.
Let’s look at a few more examples for married couples filing jointly:
A couple with $100,000 in income living in Georgia paid $2,000 in property taxes and $13,000 in other itemized deductions, for a total of $15,000. These taxpayers would save about $1,250* on their federal tax bill by switching to the standard deduction. Taking the Georgia standard deduction could cost the couple around $720 in state tax. This leaves a net tax reduction of $530.
A couple with $150,000 in income living in Georgia paid $2,000 in property taxes and $13,000 in other itemized deductions, for a total of $15,000 in deductions – the same as above, just with a higher income level. These taxpayers would save about $1,700* on their federal tax bill with the new standard deduction. Taking the Georgia standard deduction could cost around $720 in extra state tax. This leaves a net tax reduction of $980.
A couple $150,000 in income living in Georgia paid $4,000 in property taxes and $21,000 in other itemized deductions, for a total of $25,000. These taxpayers would save approximately $900* under the new GOP tax plan. This would potentially cost nothing extra in Georgia state taxes, as their itemizations would continue. In this scenario, the couple is left with a net tax reduction of $900.
Want to estimate your unique tax scenarios with the same tool that we used for the above examples? Try this tax estimation calculator for federal taxes under the new GOP tax plan: http://taxplancalculator.com/. See website for details.
Passage of the Trump/GOP tax reform shows that while Congress is capable of lowering taxes, it seems unable to simplify the tax preparation process. The state deduction issue means more work for taxpayers (or their tax preparers). Who knows? Perhaps one day state lawmakers will act to bring their standard deductions more in line with federal policy. Until then, do the math.
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