The Tax Cuts and Jobs Act enacted late last year opened a variety of opportunities for average people to reduce their tax burden. The biggest advantage of the tax cuts for individuals is the reduced tax rates and extension of income in the lower brackets. Itemized deductions also pay a serious role in how the changes in the code will affect your final results next spring.
Gaming the standard deduction was less of an issue in the past. Now, with the standard deduction at $24,000 for joint returns ($12,000 for single filers and $18,000 for head of household) there is ample opportunity to reduce your tax bill. Exemptions are gone so many will face higher taxes in this area. State and local taxes (SALT) are limited to $10,000 in 2018 – 2025. With the standard deduction so high and SALT limited to such a low level, most people will no longer need to itemize.
For every problem there is a solution. Today we will cover each deduction on Schedule A and look for alternatives. Pulling deductions from Schedule A (even if you don’t itemize) and deducting them elsewhere on the return is akin to legally double dipping. That is our mission. We want to have our cake and eat it too. If we play this right you should manage a big juicy standard deduction while deducting a large portion of each expense as well.
Medical and Dental Expenses
Medical expenses were always a high hurdle to overcome with the 7 ½% (10% in some cases in the past) of AGI reduction of qualified medical expenses. There are several ways to remove numbers from this section and deduct them elsewhere.
If you have a qualified medical plan you can contribute to a health savings account (HSA).
Your employer may offer a Health Reimbursement Arrangement (HRA). The employer sets the amount available to employees. Unused portions can be rolled into the following year if the employer allows. If unused funds are not allowed to roll to the next year it becomes a “use it or lose it” plan.
Certain restrictions exist for self-employed persons. People with a side gig/side hustle or small business can use a Qualified Small Employer Health Reimbursement Arrangement (QSEHRA). QSEHRAs require administration. The cost is minimal, but the rules complex enough that you will want professional help. My office recommends Take Command Health for administration. The tax savings are well worth it.
Employers may cover annual physicals and other medical expenses as an employment requirement. The cost is born by the employer and the employer also gets the deduction.
Investment property owners and those with self-employment income can also shift some medical expenses from Schedule A. Small business owners can deduct most medical insurance premiums on the front page of Form 1040 as an adjustment to income. A landlord who is hurt while working on an investment property will have a medical expenses related to the investment property and are therefore deductible against the rental income. A self-employed semi driver can shift medical expenses required to drive a commercial vehicle from Schedule A to the business part of the tax return.
State and Local Taxes (SALT)
This is the issue that started all the problems. There is a cap on SALT deductions of $10,000 from 2018 – 2025 unless Congress changes the code. Several high tax states have devised plans to work around the issue, shifting the expense to the charitable contributions line of Schedule A. The IRS nixed the idea and at least two states have sued. Because the IRS allowed similar schemes in the past when it involves college funding the court will have a serious consideration on its hands. When the issue clears up I’ll let you know.
The problem affects all states. The higher your income, the more likely this becomes an issue. Texas, a state with a reputation for low taxes is really a high tax state. The sales tax and property taxes more than offset the income tax free part of the Texas tax code.
We don’t have to wait for the courts to decide the outcome before we skin this cat. (My apologies to all the cat lovers of the world. For the record, my cat, Pinky, just clawed me in protest as I wrote this.) Property taxes can be partially shifted to an office in the home if you have a business or investment properties. The office in the home must be “regular and exclusive” and it is worth the effort to meet the tax code requirements.
Be sure to report personal property taxes related to a business or investment property on the appropriate form and not on Schedule A where it has limited value.
Interest You Paid
There is more incentive than ever to pay off the mortgage early. You can shift some of the mortgage interest to an office in the home as proffered above.
Investment interest has significantly reduced value under the new tax rules. Margin accounts should be avoided. They’re a bad idea to start with (buying investments with borrowed funds) and the deductibility of the expense is now also limited.
Gifts to Charity
There is some minor good news on charitable deductions. Cash donations were limited to 50% of AGI in the past with the remainder carried forward for up to five years. The deduction limit for cash is now increased to 60% of AGI.
Still, the goal is to reduce Schedule A to a nonevent on your tax return. If we reduce deductions to less than the new higher standard deduction we can, in effect, double dip.
I’ve published on this strategy in the past. The strategy is more powerful than ever under the new rules. Taxpayers with business income or investment properties can shift normal contributions to charity into promotional/advertizing expenses for the business.
It works like this. Instead of donating to the charity of your choice, ask the charity about any upcoming events and sponsor said events. Your business or rental properties get a nice plug in the brochures handed out at the event and probably a prominent display of your company logo and contact information. While this may not be the best way to grow a business, it is a powerful way to build community goodwill for your company! It’s also a business deduction. You can support your favorite charities and get a deduction, too.
Landlords need caution when applying this strategy. Deducting a $20,000 sponsorship when you only have one small duplex in the low rent side of town is unlikely to pass the sniff test! On the other hand, if you have five duplexes around town and you sponsor an event for $1,000, it probably falls within acceptable parameters. Landlords should have a business name: ABC Rental, LLC, for example. By having all your properties under one umbrella it allows the sponsorship to promote all your properties.
Casualty and Theft Losses
The Tax Cuts and Jobs Act eliminated casualty and theft loss deductions except for casualty losses in federally declared disaster areas. Even if you are in a federally declared disaster area, the first $100, plus 10% of AGI, doesn’t count. Example: If your AGI is $100,000, the first $10,100 of casualty losses in federally declared disaster areas doesn’t count.
There are few options if you suffer one of these losses. Business owners can deduct the loss as a business expense.
The loss/theft might qualify as a capital loss. This is a stretch for most situations, but you should be aware of the possibility in case it happens. Capital losses are reported on Schedule D where there are no restrictions like Schedule A. Schedule D losses are limited to $3,000 per year, plus all capital gains.
Casualty and theft losses are reduced by insurance coverage. If all or most of the loss is covered by insurance there is little or no opportunity to deduct expenses. More than ever, adequate insurance of assets is indicated.
Miscellaneous Expenses, Subject to 2%
Miscellaneous expenses, subject to 2% of AGI are eliminated for 2018 – 2025 under the current code. There are still a few planning opportunities for those who plan.
Unreimbursed employee expenses is the biggest issue in this section. It is important to have a serious discussion with your employer on your out-of-pocket work expenses. Your employer gets a full deduction on most of these expenses while you get nothing if they are not reimbursed! It might be worth a salary adjustment to make room for reimbursed expenses. Example: If you typically have $5,000 per year of work expenses, any salary reduction less than $5,000 with full reimbursement of work related expenses is a win for you and a nice tax deduction for the employer. Employers: this can be a valuable employee perk that pays both you and the employee. A true win/win.
Tax preparation fees are only deductible as they apply to the business or rental property portion of the return. A lot of accountants miss this. If your tax preparation fee is $500, a portion is for the personal part of your return (no longer deductible) and a portion is for the business (Schedule C and other related business forms) and rental property part of the return (Schedule E). Ask your accountant to break out the prep fee (required by the IRS to deduct). Your accountant can list $250, for example, as the portion of the prep fee attributed to the business portion of your personal tax return. This $250 can be deducted on the appropriate forms (Schedule C for small business, Schedule F for farms and Schedule E for income properties).
A safe deposit box used for business or income properties is deducted on their respective area of the return instead of Schedule A.
This section of Schedule A catches a lot of minor deductions. Think the deduction through before writing it off (pun intended). On Schedule A it is now worthless. But, if it is an expense related to a business or rental property . . .
Union dues are the remaining big item. I wish I had an answer. If any of you kind readers have a suggestion, let me know. Union dues are no longer deductible until the tax code changes or I figure out a work around. Don’t hold your breath.
Other Miscellaneous Deductions
This is the last section of deductions on Schedule A. These deductions are not reduced by 2% of AGI.
We will focus on the two most common items reported in this section: gambling losses and claim repayments.
Gambling losses are reportable on Schedule A up to gambling winnings. The best way to avoid tax problems is to stop gambling! The odds are against you. As budding accountants you know better. There, I said it. Now on with the show.
If you insist on gambling, at least keep a daily log of your results/sessions. You can use gambling sessions to remove losses attributable to gains in the same session on the front page of Form 1040. Most states follow federal on gambling sessions so the tax advantage stretches to the state return for most taxpayers.
Gambling sessions don’t remove all the losses from Schedule A, but it should shift a serious portion of the losses from Schedule A to the front page of 1040 where they have value. You can read more about gambling sessions here.
The other big item in this section of Schedule A is claim repayments. We are not talking about business or investment property repayment issues. Those are reported on their respective forms.
A common repayment is unemployment benefits. The claim repayments reported on this section of Schedule A are taxable items of income on a previous tax return. Repayments of items not reported as income on a prior return are not deductible.
We’ll use unemployment benefits as our example. Repayments made in the year the income was received is adjusted where the income is reported. Example: You receive $2,800 of unemployment benefits and are later required to repay $200 of the benefits. You repaid in the same year you received benefits. You adjust the reported $2,800 to $2,600. No itemizing required.
All claim repayments reported as income in a prior year under $3,000 must be reported on Schedule A. Repayments over $3,000 can also be reported on Schedule A, but you want to use an alternative method. There is a planning opportunity here.
For repayments over $3,000 you can calculate a credit for the repayment, reporting the credit on page 2 of Form 1040 (line 73 on the 2017 return). In the margin write 1341, to inform the IRS of the code section you are using for your right of claim.
You calculate the credit by going back to the return the income was reported on. Calculate the prior return without the income repaid in the current year. The reduction in tax is the credit.
I covered what I feel will be over 90% of the issues surrounding Schedule A and the available solutions for moving the deduction to another area of the return. This, in effect, allows a bit of double dipping. You still get the new, outsized standard deduction while still claiming a serious portion of the actual expenses.
Unfortunately, not everyone will benefit from these strategies. However, with the volume of options provided there should be at a least a few options available to most readers.
If you have any creative ideas to divert deductions from Schedule A to areas of the tax return where they have value I’d be happy to hear them.
Remember, an expense is worthless until you get a write-off.
Wealth Building Resources
Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?
Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.
QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. Quickbooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.
A cost segregation study can save $100,000 for income property owners. Here is my review of how cost segregations studies work and how to get one yourself.
There is an old Looney Tunes cartoon where Daffy Duck is portraying Sherlock Holmes. Daffy is seated at a desk stacked with papers vigorously working the calculator. Porky Pig, portraying Watson, walks in and asks, “Whatever are you doing, Holmes.” “Deducting, my dear Watson. Deducting,” came the frantic reply.
Deductions come in a variety of flavors. We are all familiar with deductions matched with an expense. Donations to charity are deductible on Schedule A. Business owners deduct marketing expenses dollar for dollar.
There is another elusive deduction taxpayers only dream about: the non-cash deduction. The appeal of the non-cash deduction is the large write-off without a matching real world expense. Capitalizing on non-cash deductions can supercharge your retirement or debt reduction plans. The list of non-cash deductions is long. We will explore several ways you can reduce your taxes without spending a penny or taking a deduction significantly higher than the actual expense and stay out of jail in the process.
It’s All Legal
Accountants mentioning non-cash deductions frequently mean things like depreciation. We are not. Depreciation is a non-cash deduction, but it required the full cash investment at some time in the past to achieve the deduction. What we mean here by non-cash deductions are those expenses claimed on a tax return where the deduction allowed is greater than the cash outlay.
The weak of heart sometimes get nervous about these deductions, worried they might not be legal. I assure you they are. The IRS has even codified many of these strategies.
Most non-cash deductions affect business owners and folks with a side gig. Individuals sometimes think they are getting a special deduction when they have non-cash charitable deductions, but once again, there is a greater cash outlay at some time in the past to get the deduction. The exception is donations of highly appreciated assets. Individuals get special tax treatment when they donate artwork, property, stocks, et cetera, to a qualified nonprofit organization. If the asset has increased in value, the non-cash donation fits our description of non-cash deduction for this post. Therefore, your friendly accountant likes it.
Taking Care of Business
Business owners and those with a side gig have ample opportunity to deduct things they never spent money on. A required receipt is not the deciding factor. For example: A receipt is not needed for a meal expense if the expense is under $75. You still need a record of the expense and that makes it deductible, but an actual receipt is unnecessary. That said, you still only deduct the actual cost of the meal unless you are cheating. And there is no reason to be here if you are cheating. We only use legal methods around these parts to lower our tax liability.
Miles: Talking about receipts, mileage is a non-cash deduction worth more than the actual expense unless you are driving a big-ass, gas-guzzling SUV. The 2017 mileage rates for deductions are as follows:
53.5 cents per mile for business miles driven;
17 cents for medical or moving miles; and,
14 cents a mile driven for nonprofit organizations.
A few qualifiers are required. Business miles are straight forward. If you drive for business (or for your employer) you can deduct 53.5 cents per mile. Sole proprietors deduct on Schedule C, landlords on Schedule E and farmers on Schedule F. Employees claim non-reimbursed business miles for an employer on Form 2106 which flows to Schedule A. There are additional limitations on the deduction for individuals.
Business miles can be paid to the employee by the employer even if it is your own company. The employer takes the deduction and the employee does NOT claim the reimbursement.
Medical miles are claimed on Schedule A, but are also allowed for Health Savings Accounts. Schedule A has serious medical deduction limitations. But your employers Health Reimbursement Arrangement might allow the expense, putting additional tax-free cash in your pocket. Medical travel is an allowed distribution from Health Savings Accounts.
Moving miles only apply to those claimed on Form 3903. This means the move must be work related and of a greater distance. A move down the street does not count; a move across country probably does if it is for a new job.
The mileage rate for nonprofit driven miles is smaller, but does add up if you enjoy helping out. Miles driven to church do NOT count, even if you are a Sunday School teacher or an usher. Similar, miles to council meetings are not deductible. What miles ARE deductible? If you drive to church to do maintenance work or repairs. Miles driven to a work site for Habitat for Humanity. Miles driven to a national conference for your church would also count. Only the routine miles probably driven anyway do not count.
Office in the Home: The office in the home for your business, side gig, or even your employer can turn into a nice non-cash deduction. The home office must be regular and exclusive for the business/side gig. That means a spare bedroom used as the office and for nothing else counts; a corner of the living room does not. The home office for an employer must be for the convenience of the employer in addition to the regular and exclusive rule.
I consider the home office a non-cash deduction because you get to deduct something you were spending on anyway. And there is a way for certain taxpayers to get a real non-cash deduction above actual expense too!
For easy figuring we will assume a 1,000 square foot home with a 100 square foot qualified office. In this scenario 10% of the home is office. You use Form 8829 to claim home office expenses. Ten percent of mortgage interest, property taxes, utilities, homeowners insurance, et cetera count toward the home office expense. Additional deductions are allowed for expensed directly related to the home office. Office furniture and office remodeling are fully included in the amount allowed for the home office expense.
A few years ago the IRS offered a simple way to claim the home office by providing a safe harbor or $5 per square foot up to 300 square feet, a $1,500 maximum home office deduction. Your personal circumstances will determine if the safe harbor is a better deal than actual expenses.
The home office is complicated. Daycares, for example have significant additional rules. A short blog post only provides the concept. I have added links where I feel additional reading is required. The links allow this post to remain modest in size while retaining flow. You can research deeper into subjects affecting you.
Meals & Incidental Expenses: Meals and incidental expenses are deductions for businesses and for employees in limited circumstances.
Normally you claim the actual meal expense. But when you are traveling the rules change and for the better in most cases. Rather than keep loads of receipts while traveling, you can use a per diem instead. The per diem is allowed if your travel includes an overnight stay.
There are two methods available when using the per diem instead of actual expenses: High-Low and CONUS/OCONUS rates. The high-low method is easiest. Except for a few high costs areas of the U.S., the meal per diem is $52 with an additional $5 added for incidentals, for a $57 per diem.
If you love keeping perfect records you can use the CONUS (continental U.S.) table for U.S. travel and the OCONUS (outside continental U.S.) rates set by the Department of Defense based on each city traveled to. You can use only one method on your tax return. No cherry picking between methods. You can change the method from a prior year if desired. I included several links so you fully understand this non-cash deduction, including calculators for finding your per diem rate.
This is not a full non-cash deduction, but for people reading blogs like The Wealthy Accountant it is a way to receive a larger deduction than the actual expense. Frugality pays when the IRS has a per diem.
Renting Your Home to Your Business: There was a time I thought I was the only guy doing this. Then reality set in. I was in a continuing education class a few years back when the presenter talked about this. Now I will share it with you.
There is a little section of the Internal Revenue Code which says you don’t claim rental income if you rented the property less than 15 days in the year and you used the property personally at least 15 days per year (IRC Sec. 280A(g).) There is a planning tip in there.
A vacation home can be a powerful tax-free cash generator in these instances. I’ll let you research that subject with the links. What we are talking about today is non-cash deductions and I have a whopper for you.
Business owners frequently have a summer picnic for clients or employees, Christmas parties, et cetera. You can always have the event at the workplace, but it still feels like going to work when it should be a time to unwind from work. You can also rent a banquet hall. Or, better still, have the event at your home!
As an example, assume you decide to have the Christmas party this year at your home rather than at a local hotel or banquet hall. You can do a quick search of rates around town of what it would cost if you did use the outside venue. Now you decide to have the event at your home. Here is what happens:
The cost of the event is still a business expense. Let’s say a reasonable fee for such an event is $1,500 in your area. Your business writes you a check for $1,500 and takes the deduction along with the cost of the food and any other related expense. YOU DO NOT CLAIM THE $1,500 AS INCOME! Since you rented your home less than 15 days during the year you do not claim the rent income, but the business does deduct the expense.
Before you salivate too much, let me remind you reasonable rent is required. You can’t say rent for one day is $20,000 unless you have a mansion and a large enough company to justify such a rent rate. In my business I make a few calls to get an idea of rates around town and use that as my guide. I keep a record in case the IRS comes a knockin’. I want to keep my tax-free income and deduction!
As we finish up I want to make one more point. When I write tax posts I usually get plenty of email telling me I am wrong. I know I am wrong! I can’t possibly include all possibilities so I provide concepts here with plenty of links for deeper research. It also keeps tax posts moving forward at a reasonable clip. (Of course, you are more than welcome to expand on these topics in the comments section below.)
There are plenty a juicy non-cash deductions out there. The ones I included here should give a majority of readers at least one way to line their pocket at IRS expense. Use this as a starting point. Don’t stretch the rules; it isn’t necessary. Follow the rules and you will enjoy the fruits of non-cash tax deduction loopholes.