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Changes to Make Now to Optimize Your 2018 Tax Return

With the 2017 tax season in full swing, thinking about what to do for 2018’s taxes may seem too far away right now. But with the last-minute sweeping overhaul made to the tax code late last year, it’s definitely not too early to start making some changes to your ordinary recordkeeping habits for your taxes sooner and change some decisions you had planned. Most of the provisions will expire in eight years without further action from Congress but for now, here’s what you need to do to get off on the right foot for 2018 taxes.

Change your tax withholding if necessary.

When you have taxes taken out of your paychecks, they go by a table the IRS updates every year. When starting a new job, people file a Form W-4 to claim allowances where the more you claim, the less taxes you’ll have withheld. You can always update your withholding by giving your employer a new W-4. Now that the withholding tables have significantly changed, you might not be having enough taxes taken out and could end up with a smaller refund than expected or owing taxes. Your employer must implement the new withholding tables by February 15, 2018.1

Once your 2017 tax return is completed, if you expect 2018 to be similar in terms of income and deductions you should definitely compare your withholding and make sure enough is being taken out. Since the IRS is also updating Form W-4 for these tables, you will want to submit one once the 2018 version is available.

Don’t neglect state and local income taxes.

You also don’t want to forget about withholding at the state and local level. Washington DC, Maryland, and Virginia residents are subject to state income taxes while Philadelphia and New York City residents also pay them at the city level. If you’re starting a new job you will also need to file the state and local equivalents of Form W-4 to have taxes properly withheld.

However, major changes were made to itemized deductions where state and local income taxes now have to be combined with real estate taxes for a maximum deduction of $10,000. The state and local income tax deduction has been the largest expenditure in itemized deductions, particularly for taxpayers earning $200,000 per year or higher.2 While you need to ensure that your state income taxes are also sufficiently withheld, there is now less incentive to over-withhold at the state and local level to get a larger itemized deduction.

If you’re thinking of taking out a home equity loan, only do so if you’re going to use it for major home improvements.

There is a lot of confusion surrounding the deductibility of home equity loan and HELOC interest since it was outlined in the tax bill as a deduction being eliminated. Provided that the proceeds of the loan are being used to make a substantial improvement (like an addition) to your home, you can still deduct the interest. But you can no longer deduct home equity interest used for personal purposes.

With the state income and real estate tax deductions severely hampered for the next eight years, you’ll want to take advantage of the bigger mortgage and home equity loan interest deduction that comes in the early years of their lives when your payments are predominantly interest. However, the mortgage interest deduction is now limited to $750,000 in principal on new mortgages.4 Older mortgages have been grandfathered in under the old limit of $1,000,000 ($1,100,000 after accounting for home equity debt) but there is no grandfathering for home equity loans. Be mindful of how much you are borrowing relative to your home’s principal so your total outstanding debt is less than $750,000.

Pay extra attention to medical expenses for the year.

The tax overhaul limited the largest itemized deductions in favor of a higher standard deduction. However, the medical expense deduction rolled back to 7.5% of adjusted gross income regardless of age.5 While this provision is also retroactive for the 2017 tax year, it will revert to 10% of adjusted gross income (7.5% for taxpayers age 65 and older) in 2019.

Given that the new standard deduction is $24,000 for married couples filing jointly, $18,000 for heads of household, and $12,000 for all other taxpayers, this benefit would only apply to those who are extremely burdened by healthcare costs. Deductible medical expenses include premiums for health and dental insurance, payments to doctors and hospitals, transportation to and from healthcare facilities, and prescription drugs. If you have any doctor visits or medical bills you were putting off and you’re under 65, 2018 would be a good time to claim them since they will be harder to deduct in 2019 onward.

Make efficient use of 529 plans.

If you send your children to private school, you can now make tax-free withdrawals from 529 education savings plans. You can withdraw up to $10,000 per student (not per account) for tuition paid to an elementary or secondary school.6 In spite of this limitation, you may want to consider opening a second 529 plan separate from your children’s college savings given the shorter timeframes for the investments.

Consider making a career change to freelance or contract if you frequently have unreimbursed job-related expenses.

The tax reform eliminated the employee business expense deduction.7 Self-employed taxpayers can still deduct business expenses as usual and there is also a new 20% deduction of profits for the owners of pass-through business entities like sole proprietorships and S corporations. While transitioning from employee to self-employed entails new recordkeeping requirements and having to pay self-employment taxes (Social Security and Medicare that you now must pay both the employee and employer share of), the loss of several tax benefits for employees and the new deduction for small business owners has made switching to contract status more preferable for some taxpayers in 2018 and onward. If you have to pay for conferences, travel, continuing education and licenses, and similar expenses out of pocket that take a significant bite out of your pay then it’s definitely worth considering.

The IRS may issue further interpretations of the 2018 tax reform and Congress could also make additional updates before 2019. With the reforms that are currently in effect, making or considering these changes while it’s still early in the year can result in a lower tax bill when it’s time to file your 2018 tax return.