Personal Tax

Financing a college or graduate school education often requires incurring at least some student loan debt. For those who qualify for it, the tax deduction for student loan interest can help ease the financial burden.

Overview

The deduction is available for as much as $2,500 of interest annually. Taxpayers don’t have to itemize their deductions to claim it. However, the deduction is phased out if adjusted gross income (AGI) exceeds certain levels. And married taxpayers must file jointly to claim the deduction.

Qualifying loans. The debt must be incurred to pay tuition, room and board (including properly documented off-campus expenditures), and related expenses to attend a post-high school educational institution. The funds may be borrowed to cover the qualifying expenses of the taxpayer or his or her spouse or dependent. The student must be a degree candidate carrying at least half the normal full-time course load. Loans taken to attend certain postgraduate programs (e.g., a medical residency) also can qualify.

Who gets the deduction? Only the person legally obligated to make the interest payments may deduct them. So, for example, if parents make payments on their child’s student loan (essentially as a gift to the child), the parents aren’t allowed to deduct the interest. Their child could deduct the interest they paid as long as the child isn’t a dependent that year. (A dependent may not claim the deduction.)

AGI limits. For 2020, no deduction is available with an AGI of $85,000 or more ($170,000 or more for married-joint filers). The deduction is reduced with an AGI between $70,000 and $85,000 ($140,000 and $170,000 for married-joint filers).

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Working from home can potentially deliver some attractive tax advantages. If you qualify for the home office deduction, you can deduct all direct expenses and part of your indirect expenses involved in working from home. Note, however, that qualifying for such deductions became harder under the Tax Cuts and Jobs Act of 2017 (TCJA). If you previously claimed a home office as a miscellaneous deduction on your individual income tax return, the TCJA eliminated that deduction for tax years 2018-2025. You must now file a Schedule C on Form 1040 to be eligible for the home office deduction.

What Space Can Qualify?

Direct expenses are costs that apply only to your home office. The cost of painting your home office is an example of a direct expense. Indirect expenses are costs that benefit your entire home, such as rent, deductible mortgage interest, real estate taxes, and homeowner’s insurance. You can deduct only the business portion of your indirect expenses.

Your home office could be a room in your home, a portion of a room in your home, or a separate building next to your home that you use to conduct business activities. To qualify for the deduction, that part of your home must be one of the following:

Your principal place of business. This requires you to show that you use part of your home exclusively and regularly as the principal place of business for your trade or business.

A place where you meet clients, customers, or patients. Your home office may qualify if you use it exclusively and regularly to meet with clients, customers, or patients in the normal course of your trade or business.

A separate, unattached structure used in connection with your trade or business. A shed or unattached garage might qualify for the home office deduction if it is a place that you use regularly and exclusively in connection with your trade or business.

A place where you store inventory or product samples. You must use the space on a regular basis (but not necessarily exclusively) for the storage of inventory or product samples used in your trade or business of selling products at retail or wholesale.

Note: If you set aside a room in your home as your home office and you also use the room as a guest bedroom or den, then you won’t meet the “exclusive use” test.

Simplified Option

If you prefer not to keep track of your expenses, there’s a simplified method that allows qualifying taxpayers to deduct $5 for each square foot of office space, up to a maximum of 300 square feet.

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Tax Rates Are Reduced

Under the rules in effect prior to 2018, seven income tax rates apply to individuals: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The new tax law retains seven tax rates, but modifies them as follows: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. As under the prior law, rates increase with taxable income, and the income ranges for each bracket vary depending on filing status (single, married filing jointly/surviving spouse, married filing separately, or head of household).

Changes to the income tax brackets will lower the rates at many income levels. Here are a couple of general examples. A married couple filing jointly with taxable income of $85,000 in 2018 will have a marginal tax rate of 22% under the new law, compared with 25% under the prior law. A married couple filing jointly whose taxable income in 2018 is $250,000 will have a marginal tax rate of 24% under the new law, compared with 33% under the prior law.

The income levels affected by each tax rate will be adjusted annually for inflation. However, the new brackets are currently set to expire after the 2025 tax year.

Your Taxable Income Is Likely to Change

In addition to lowering the tax rates applied to your taxable income, the new law also modifies how taxable income is calculated. Here are some of the changes:

• The basic standard deduction for 2018 is $12,000 for a single individual and $24,000 for a married couple filing jointly — compared to standard deductions of $6,500 and $13,000, respectively, under the prior rules.
• The itemized deduction for mortgage interest payments is now allowable only on mortgage interest paid on underlying indebtedness of up to $750,000, as compared to $1,000,000 under prior law. Additionally, the act suspends the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build, or substantially improve the home that secures the loan.
• The total itemized deduction for all state and local property and income (or sales) taxes is capped at $10,000 ($5,000 for a married taxpayer filing a separate return).
• The personal exemption, which had been scheduled to be $4,150 under prior law, has been eliminated.

Under the new law, many more taxpayers are expected to find that claiming the standard deduction is more valuable than itemizing deductions, simplifying their filing tasks. Others may find that their itemized deductions have been substantially limited, particularly people who live in places with relatively high state and local taxes and housing costs.

The four changes listed above are set to expire after the 2025 tax year.

Future IRS Inflation Adjustments Will Be Smaller

Under the prior law, the IRS used the Consumer Price Index for “all-urban consumers” (CPI-U) to adjust various thresholds and limits each year to compensate for inflation. Under the new law, the IRS will use the so-called chained Consumer Price Index (chained CPI-U) instead.

CPI-U assumes that consumers buy the same things in the same amounts year after year and do not alter their behavior when prices change. Chained CPI-U assumes that consumers do shift their preferences to less costly alternatives. The differences between the indexes appear small from year to year, but over longer periods of time, chained CPI-U is expected to show noticeably less inflation than CPI-U. That is expected to reduce the amount of inflation indexing applied to tax brackets, deductions, and credits.

The new law makes this change permanent.

The Alternative Minimum Tax Lives On, But With Less Punch

The floor for triggering the alternative minimum tax has been raised. For married couples filing joint returns, the exemption is now $109,400 — up from the previously-scheduled exemption of $86,200. For those filing as single taxpayers, the new exemption amount is $70,300 — up from $55,400. Additionally, the income levels at which the exemption is phased out have increased.

These changes are set to expire after 2025.

Other Changes to Note

• Child credit — Starting with the 2018 tax year, taxpayers can claim a $2,000 per child tax credit, or double the prior credit amount. The refundable portion of the credit has been increased to $1,400 per qualifying child, and other restrictions on the credit have been eased.

• Charitable contributions — Generally, for those who itemize their deductions, the limit for claiming deductions for cash donations to qualified charitable organizations has increased from 50% to 60% of the taxpayer’s “contribution base” (generally, adjusted gross income exclusive of net operating loss carrybacks for the year).

• Health insurance — Beginning in 2019, consumers will no longer be subject to penalty taxes if they lack health insurance.

• Divorce and separation agreements — Generally, alimony paid pursuant to a post-2018 divorce decree or separation agreement will not be deductible by the payer and will not be included in the recipient’s gross income.

• Education savings — Distributions from 529 plans will not be included in gross income where used to pay up to $10,000 per year of qualified education expenses at elementary and secondary public, private, or religious schools. Under prior law, only distributions for qualified higher education expenses were tax free. The $10,000 limitation on qualified elementary and secondary school expenses will apply on a per-student (not per-account) basis.

• Estate and gift tax exemption — The basic exclusion amount has been increased to an estimated $11.2 million, up from $5.6 million under prior law.

Please keep in mind that this is a summary of selected highlights and should not be considered tax advice. To fully understand how the new tax laws affect your situation, please consult a qualified tax advisor.

From income tax preparation for individuals to complex corporate taxes for businesses, you’ll like working with Nitya LLC because we make filing taxes easy. Just send us your paperwork, receipts, and prior tax returns and we’ll take care of everything. Call 301-728-0808 or request a free consultation online.