Interest on Home Equity Loans Often Still Deductible Under New Law
WASHINGTON – The Internal Revenue Service today advised taxpayers that in many cases they can continue to deduct interest paid on home equity loans.
Responding to many questions received from taxpayers and tax professionals, the IRS said that despite newly-enacted restrictions on home mortgages, taxpayers can often still deduct interest on a home equity loan, home equity line of credit (HELOC) or second mortgage, regardless of how the loan is labelled. The Tax Cuts and Jobs Act of 2017, enacted Dec. 22, suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.
Under the new law, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.
New dollar limit on total qualified residence loan balance
For anyone considering taking out a mortgage, the new law imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction. Beginning in 2018, taxpayers may only deduct interest on $750,000 of qualified residence loans. The limit is $375,000 for a married taxpayer filing a separate return. These are down from the prior limits of $1 million, or $500,000 for a married taxpayer filing a separate return. The limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home.
The following examples illustrate these points.
Example 1: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible.
Example 2: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible.
Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. A percentage of the total interest paid is deductible (see Publication 936).
For more information about the new tax law, visit the Tax Reform page on IRS.gov.
You are a dual status alien when you have been both a U.S. resident alien and a nonresident alien in the same tax year. Dual status does not refer to your citizenship, only to your resident status for tax purposes in the United States. In determining your U.S. income tax liability for a dual-status tax year, different rules apply for the part of the year you are a resident of the United States and the part of the year you are a nonresident. The most common dual-status tax years are the years of arrival and departure.
For The Part of the Year You are a U.S. Resident Alien
For the part of the year you are a U.S. resident alien, you are taxed on income from all sources. Income from sources outside the United States is taxable if you receive it while you are a resident alien.
For The Part of The Year You are a Nonresident Alien
For the part of the year you are a nonresident alien, you are taxed on income from U.S. sources only.
Not Effectively Connected Income
Income from sources outside the United States that is not effectively connected with a trade or business in the United States is not taxable if you receive it while you are a nonresident alien.
Income From U.S. Sources
Income from U.S. sources is taxable whether you receive it while a nonresident alien or a resident alien unless specifically exempt under the Internal Revenue Code or a tax treaty provision. Generally, tax treaty provisions apply only to the part of the year you were a nonresident. However, an exception to this rule exists. Refer to “Students, Apprentices, Trainees, Teachers, Professors, and Researchers Who Became Resident Aliens” found in Chapter 9 of Publication 519, U.S. Tax Guide for Aliens.
When determining what income is taxed in the United States, you must consider exemptions under U.S. tax law as well as the reduced tax rates and exemptions provided by tax treaties between the United States and certain foreign countries.
Restrictions for Filing Dual-Status Tax Returns
The following restrictions apply if you are filing a tax return for a dual-status tax year:
Special rules apply for exemptions for the part of the tax year when a dual status taxpayer is a nonresident alien if the taxpayer is a resident of Canada, Mexico, The Republic of Korea (South Korea), a U.S. national, or a student or business apprentice from India. Refer to Aliens – How Many Exemptions Can Be Claimed.
Subject to the general rules for qualification, you are allowed exemptions for your spouse and dependents in figuring taxable income for the part of the year you were a resident alien.
Your total deduction for the exemptions for your spouse and allowable dependents cannot be more than your taxable income (determined without deducting personal exemptions) for the period you are a resident alien.
You cannot use the head of household Tax Table column or Tax Rate Schedule.
You cannot file a joint return (However, a dual status alien who is married to a U.S. citizen or a resident alien may elect to file a joint return with his or her spouse. Refer to Nonresident Spouse Treated as a Resident for more information).
If you are a nonresident alien and married to a U.S. citizen or resident alien for all or part of the tax year, and you do not choose to file jointly with your spouse, you must use the Tax Table column or Tax Rate Schedule for “married filing separately” to figure your tax. You cannot use the Tax Table column or Tax Rate Schedules for married filing jointly or single.
If you are a nonresident alien and married to a U.S. citizen or resident alien, you may not take the earned income credit, the credit for the elderly or disabled, or an education credit unless you elect to be taxed as a resident alien jointly with your spouse in lieu of these dual-status taxpayer rules.
Different Rules
When you figure your U.S. tax for a dual-status year, you are subject to different rules for the part of the year you are a resident and the part of the year you are a nonresident.
Effectively and Not Effectively Connected Income
All worldwide income for your period of residence and all income that is effectively connected with a trade or business in the United States for your period of nonresidence, after allowable deductions, is combined and taxed at the rates that apply to U.S. citizens and residents. Income that is not connected with a trade or business in the United States for your period of nonresidence is subject to the flat 30% rate or lower treaty rate. You cannot take any deductions against this not effectively connected income. Refer to Taxation of Nonresident Aliens or Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities,for more information.
Resident Alien vs. Nonresident Alien Filing Procedures
The U.S. income tax return you must file as a dual-status alien depends on whether you are a resident alien or a nonresident alien at the end of the tax year.
You must file Form 1040NR, U.S. Nonresident Alien Income Tax Return or Form 1040NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents if you are a dual-status taxpayer who gives up residence in the United States during the year and who is not a U.S. resident on the last day of the tax year. Write “Dual-Status Return” across the top of the return. Attach a statement to your return to show the income for the part of the year you are a resident. You can use Form 1040, U.S. Individual Income Tax Return as the statement, but be sure to mark “Dual-Status Statement” across the top.
Statement
Any statement must have your name, address, and taxpayer identification number on it. You do not need to sign a separate statement or schedule accompanying your return, since your signature on the return also applies to the supporting statements and schedules.
When and Where To File
If you are a resident alien on the last day of your tax year and report your income on a calendar year basis, you generally must file no later than April 15 of the year following the close of your tax year. For additional information, refer to the Instructions for Form 1040, U.S. Individual Income Tax Return.
If you are a nonresident alien on the last day of your tax year and you report your income on a calendar year basis, you generally must file no later than April 15 of the year following the close of your tax year if you receive wages subject to withholding. If you did not receive wages subject to withholding and you report your income on a calendar year basis, you must file no later than June 15 of the year following the close of your tax year. For additional information, refer to the Instructions for Form 1040NR, U.S. Nonresident Alien Income Tax Return.
The new tax law increased standard deductions but limited or eliminated many other popular deductions.
The tax bracket income limits and rates were adjusted.
Far fewer people will claim itemized deductions in the future.
The Tax Cuts and Jobs Act enacted in late 2017 was more than 500 pages long, with detailed changes affecting everything from the taxation of trusts to the treatment of life insurance policy acquisition costs. But for most taxpayers, the biggest changes have to do with the new income tax rates, a higher standard deduction, and new limits on many popular deductions.
Here is a quick overview of the changes and details on how they may affect your taxes.
Standard versus itemized deductions
A major change from tax reform was a sharp increase in the standard deduction. For tax years 2018 through 2025, the standard deduction will be $12,000 for single filers and $24,000 for married couples filing jointly. That’s close to double the levels in 2017. The law also slightly increases the higher standard deduction for the elderly, the blind, and persons with a disability. But it eliminates the $4,050 personal exemption (see table below).
2017
2018–2025
Standard deductions
Single
$6,350
$12,000
Married filing jointly (MFJ)
$12,700
$24,000
Elderly or blind (single and not a surviving spouse)
Additional $1,550
Additional $1,600
Elderly (both over age 65 and MFJ)
Additional $2,500
Additional $2,600
Exemption
Personal exemption
$4,050 per family member
Eliminated
Changes to deductions and credits
During the debate about tax reform, lots of changes were proposed. Some didn’t make the final bill and remain unchanged—including capital gains rules for the sale of a primary residence, deductions for student loan interest, treatment of tuition waivers, adoption assistance, investment interest, teachers’ out-of-pocket expenses, and the credit for electric car purchases.
A number of important retirement savings incentives were unchanged as well, including deductions for 401(k)s, traditional IRAs, and health savings accounts (HSAs).
On the other hand, there were a wide range of other deductions and credits that were changed, added, or eliminated, including:
2017
2018–2025
Dependent credit (other than child)
N/A
$500 credit per qualifying dependent
Child/dependent tax credit
$1,000 credit per qualifying child < age 17 (modified adjusted gross income [MAGI] limit $110,000 MFJ/$75,000 single)
$2,000 credit per qualifying child < age 17 (MAGI limit $400,000 MFJ/$200,000 single)
Moving expenses
Deductible (move >50 miles for a new job)
Eliminated
State and local taxes
Deductible (property and sales or income tax)
Capped at $10,000 of expenses (property and sales or income tax, regardless of filing status)
Mortgage interest
Limited to interest on $1,000,000 of debt on primary or secondary home
Limited to interest on $750,000 of debt on primary or secondary home (no change for existing mortgages)
Home equity loan interest deduction
Limited to interest on $100,000 of debt
Eliminated (does not apply to home equity loans for substantial home improvements that comply with debt limit)
Medical expense deduction
Deductible if >7.5% of AGI
No change for 2018
>10% of AGI 2019–2025
Casualty and theft
Deductible if >10% of AGI
Eliminated (except in the case of federally recognized natural disaster)
Alimony
Deductible by the payer;
taxable to the payee
The deduction for the payer is eliminated;
the recipient is no longer taxed
Investment interest expense
Deductible up to the amount of net investment income
Unchanged
Miscellaneous expenses, including:
Tax prep fees
Investment advisory fees
Unreimbursed work expenses (travel, parking, meals, and entertaining)
Depreciation on phone or computer required for work
Investment expenses
Job search expenses
Deductible in excess of 2% of AGI
Eliminated
Charitable gifts of cash
Limited to 50% of AGI
Raised to 60% of AGI
Other major changes
The tax reform law included a number of other major changes for individual taxpayers. For one, the new law eliminates the Pease phaseout on itemized deductions for taxpayers with high AGIs from 2018 to 2025. In addition, the law made changes to the alternative minimum tax (AMT) and was designed to reduce the number of taxpayers forced to pay using that system.
The law also created a new opportunity for education funding, allowing taxpayers to use 529 accounts to fund up to $10,000 of K–12 qualified tuition expenses per student each year, in addition to the existing uses for higher education.
2017
2018–2025
AMT exemption, single
$54,300 exemption
$70,300 exemption
AMT exemption, MFJ
$84,500 exemption
$109,400 exemption
Pease itemized deduction phaseout, single
Started at $261,500
Eliminated
Pease itemized deduction phaseout, MFJ
Started at $313,800
Eliminated
529 education savings
Qualified higher education expenses
Expanded to include up to $10,000 in K–12 tuition per beneficiary per year
New tax rates
Tax reform also reset the tax brackets, setting new income thresholds and tax rates, while retaining the total number of 7 brackets. It’s worth remembering that the tax code is progressive, so your marginal tax rate is the top tax rate you pay—the rate you would pay on an additional dollar of income. But you will generally pay taxes at a variety of rates, depending on your taxable income. So looking at the chart below, a single filer with $85,000 in income would pay taxes at the 10% rate on the first $9,525, pay 12% on the income from $9,526 to $38,700, pay 22% on additional income up to $82,500, and have a marginal tax rate of 24%.
How these changes play out
Taken together, these changes will dramatically change the tax-filing experience for many Americans. For some, it will simplify the process. Because the higher standard deduction will exceed the value of itemized deductions for many taxpayers, the Tax Policy Center estimates that more than 25 million families will stop itemizing in 2018—that’s more than half the number of people who have itemized in recent years.
How do you know whether it will still make sense to itemize? A general rule of thumb is to start with your tax returns for 2016 or 2017. If your situation is similar in 2018, and your itemized deductions fall below the new standard deduction ($12,000 individual/$24,000 MFJ), you will likely not itemize. If your total deductions exceeded the new standard deduction, you need to consider the new rules for deductions.
However, the total impact of the changes to rates and deductions will vary dramatically from one taxpayer to another. Here are a few simplified case studies that show how some of these changes could play out. These are hypothetical, and to get an accurate sense of what the tax law means for you, consult a tax professional.
Case 1: A higher standard deduction
Let’s look at Julie and Frank, retirees who live in a state with no income tax, have paid off their home, and have limited deductions. They pay taxes as married filing jointly and have been taking the standard deduction for a few years. Let’s say that in both 2017 and 2018 they have income of $90,000 from pensions, a 401(k), and the taxable portion of Social Security. Their local property tax is $4,800, and state sales taxes were $3,200. They made charitable gifts worth $2,000.
In 2017, their total itemized deductions would have been $10,000. So they would have opted for the standard deduction of $12,700. They would also have been entitled to personal exemptions of $8,100, leaving them with taxable income of $69,200. Their 2017 federal tax bill: about $9,400.
In 2018, they would again opt for the standard deduction, because $24,000 would be greater than the $10,000 of itemized deductions. But in 2018, there would be no personal exemptions. Still, they would be better off, with taxable income of just $66,000. Their federal 2018 tax bill: about $7,500.
Case 2: No longer itemizing
Let’s look at Pete and Susan, another couple living in a state without income tax. We will assume that their financial situation is the same in 2017 and 2018: They are married and file jointly, have $150,000 in income from their jobs, and paid $9,000 in mortgage interest on a $350,000 loan, $4,500 in local taxes, and about $9,000 in state sales tax.
In 2017, their total itemized deductions exceeded the value of the standard deduction—$22,500 versus $12,700—so they itemized. They deducted the $22,500 from their income, along with the $8,100 personal exemption, leaving them with $119,400 in taxable income. Their 2017 tax bill: about $21,300.
In 2018, their state and local tax deduction would be limited to $10,000, so their total itemized deductions would consist of the $9,000 in mortgage interest and the maximum of $10,000 in state and local taxes, a total of $19,000. At the same time, the standard deduction rose to $24,000. So in 2018, Pete and Susan choose to take the standard deduction, reducing their taxable income to $126,000. Their 2018 tax bill: about $19,600.
Case 3: Still itemizing
Let’s take another hypothetical couple, Lily and Joe. In this case, we will again assume identical financial situations for 2017 and 2018 and no state income taxes. The couple is married filing jointly, with income of $200,000 from jobs and investment interest, $10,000 a year in mortgage interest payments for their $500,000 home mortgage, $7,000 in property taxes, and another $5,000 in local income taxes. The couple also gives significantly to their local church, $8,000 per year, and a local hospital, $2,000 per year.
In 2017, the couple’s $32,000 in itemized deductions was greater than the standard deduction. After itemizing, they had taxable income of $168,000 and a tax bill of about $34,000.
The couple’s itemized deductions will still exceed the standard deduction in 2018, even after the limit on state and local taxes reduces their total itemized deductions to $30,000 ($10,000 mortgage interest + $10,000 state and local taxes + $10,000 charitable gift deduction). After deducting $30,000, the couple has taxable income of $170,000, higher than 2017, but new tax rates still lower their tax bill to about $29,379.
The bottom line—run the numbers
One of the goals of tax reform was simplicity through standard deductions and higher exclusions for the AMT. For some, it will still make sense to itemize, but many deductions have changed. So if you’ve considered the tax implications of a charitable giving program, property taxes, mortgage debt, or home equity debt, you’ll need to carefully examine how things will change starting in 2018.
If you have questions, it makes sense to work with a professional to see how the law may affect you, and whether there are strategies you should consider to help manage your tax situation going forward.
Taxpayers with an expired Individual Taxpayer Identification Number should renew it as soon as possible if they need to file a 2017 tax return. They can renew it by submitting a Form W-7. Tax returns with expired ITINs will face delays. Affected taxpayers may also lose out on key tax benefits until they renew their ITINs. It can take the IRS up to 11 weeks to complete an ITIN renewal during tax season.
Expired ITINs
ITINs that expired at the end of 2017 include those:
Not used on a tax return at least once in the past three years.
With middle digits of 70, 71, 72 or 80.
ITINs that have middle digits of 78 or 79 expired on December 31, 2016, but taxpayers can still renew them.
Renewing an ITIN
After filling out the Form W-7 and gathering all required documentation, taxpayers have three ways to submit the package:
Mail it to the IRS address on the Form W-7 instructions.
Taxpayers who are eligible for, or who have, a Social Security number shouldn’t renew their ITIN; instead, they should notify the IRS of their SSN and previous ITIN so the IRS can merge their accounts.
Taxpayers who have filing or payment obligations under U.S. tax law and don’t have or aren’t eligible for an SSN must file with an ITIN. This number is nine digits and formatted like an SSN. An ITIN page on IRS.gov provides links to FAQs and other resources.
Share this tip on social media — #IRSTaxTip: Taxpayers with Expired ITINs Should Renew Them Now to File Their 2017 Taxes. https://go.usa.gov/xnAFF
WASHINGTON –The #Internal_Revenue_Service today announced steep declines in #tax-related #identity #theft in 2017, attributing the success to the Security Summit initiatives that help safeguard the nation’s taxpayers.
Key indicators of identity theft dropped for the second year in a row in 2017. This includes a 40 percent decline in taxpayers reporting they are #victims of identity theft in 2016. Since 2015, the number of tax-related identity theft victims has fallen by almost two-thirds and billions of dollars of taxpayer refunds have been protected.
“These dramatic declines reflect the continuing success of the Security Summit effort,” said Acting #IRS Commissioner David Kautter. “This partnership between the IRS, states and the tax community is helping protect taxpayers against identity theft. More work remains in this effort, and we look forward to continuing this collaborative effort to fight identity theft and refund fraud.”
The Internal Revenue Service, state tax agencies and the tax industry have started their third filing season working as the Security Summit, a private-public sector partnership formed in 2015 to combat identity theft. Summit partners have put in place multiple behind-the-scenes safeguards that are helping protect the nation’s taxpayers.
Because the IRS and Summit partners have stepped up efforts to stop suspected fraudulent returns from entering tax processing systems, there continues to be a substantial decline in the number of taxpayers reporting that they are victims of identity theft.
Here are key calendar-year 2017 indicators:
The number of taxpayers reporting to the IRS that they are victims of identity theft continued its major decline. In 2017, the IRS received 242,000 reports from taxpayers compared to 401,000 in 2016 – a 40 percent decline. This was the second year in a row this number fell, dropping from the 677,000 victim reports in 2015. Overall, the number of identity theft victims has fallen nearly 65 percent between 2015 and 2017.
The number of tax returns with confirmed identity theft declined to 597,000 in 2017, compared to 883,000 in 2016 – a 32 percent decline. The amount of refunds protected from those fraudulent returns was $6 billion in 2017, compared to $6.4 billion in 2016. In 2015, there were 1.4 million confirmed identity theft returns totaling $8.7 billion in refunds protected. Overall during the 2015-2017 period, the number of confirmed identity theft tax returns fell by 57 percent with more than $20 billion in taxpayer refunds being protected.
The financial industry is a key partner in fighting identity theft, helping the IRS recover fraudulent refunds that may have been issued. In 2017, banks recovered 144,000 refunds compared to 124,000 in 2016 – a 16 percent increase. The amount of refunds recovered was $204 million in 2017, compared to $281 million in 2016. In 2015, the financial industry recovered 249,000 refunds totaling $852 million.
In addition to these steep declines, the IRS also is continues reducing the year-over-year inventory backlog of taxpayers who file identity theft reports. For fiscal year 2017, the beginning inventory of identity theft reports submitted by taxpayers was approximately 34,000, under 10 percent of the fiscal year 2013 beginning inventory of 372,000 taxpayer identity theft cases.
These declines follow extensive Summit education efforts in 2017. The Summit partnership conducted awareness campaigns for tax professionals – Don’t Take the Bait – and for taxpayers – National Tax Security Awareness Week – because everyone has a role in fighting against identity theft.
Cybercriminals Looking for New Lines of Attack
Last year, multiple data breaches from outside the tax system means cybercriminals have basic information on millions of Americans, such as names, Social Security numbers and addresses. The steps taken by the Summit partners since 2015 help protect against fraudulent tax filings that use this basic data. As the IRS and Summit partners have strengthened their defenses, identity thieves are looking to steal more detailed financial information to help provide a more detailed, realistic tax return to better impersonate legitimate taxpayers. Because they need more personal data, cyberthieves increasingly are targeting tax professionals, human resource departments, businesses and other places that have large amounts of sensitive financial information. The IRS continues to see a number of these schemes in attempts to get taxpayer W-2 information from tax professionals and employers.
Everyone must be vigilant and alert. Both taxpayers and tax professionals are encouraged to:
Use Security Software. Always use security software with firewall and anti-virus protections. Make sure the security software is always turned on and can automatically update. Encrypt sensitive files, such as tax records, stored on computers. Use strong, unique passwords for each account.
Watch out for scams. Learn to recognize and avoid phishing emails, threatening calls and texts from thieves posing as legitimate organizations such as banks, credit card companies and even the IRS or a tax software firm. Do not click on links or download attachments from unknown or suspicious emails.
Protect personal data. Don’t routinely carry Social Security cards and make sure tax records are secure. Shop at reputable online retailers. Treat personal information like cash; don’t leave it lying around.
Tax Reform page on IRS.gov.
ROGER S KIM CPA PLLC -NY,NJ Licensed (Member AICPA, CFA Society.) MBE Certified 