Ep.74- Why You Owe More Taxes When Filing Itemized This Year. Explained (Part 2/2)
Read Time: 5 Minutes.
There are two types of tax filers in the U.S: those who file standard deduction and those who file itemized deductions. This blog post, Part 2, explains why you owe more taxes this year if you are filing itemized deductions.. If you are filing standard deduction, read episode 73 instead.
If you are filing itemized deductions, you first need to be able to itemize more than $12,000 as an individual or $24,000 as a married couple. A White House Study shows that only 8% will itemize in 2018.
In reality, the most common scenario to itemize is when you own a house with a large enough mortgage. As a result, all property related deductions play a big role in your taxes this year.
If you are owing more taxes than anticipated, it’s most likely because of one of four reasons.
SALT (State & Local Property Taxes)
Mortgage Interest Deduction
SALT (State & Local Property Taxes) CAPPED AT $10,000
MOST LIKELY YOUR BIGGEST LOSS
SALT (State and Local Property Taxes) was previously uncapped. The new rule sets the max deduction limit at $10,000. It significantly impact states (such as California, New York, New Jersey and Connecticut ) with high housing prices, because you won’t be able to fully deduct your entire property taxes.
SALT has two components, state income tax deduction and property tax deduction. They are correlated in high property prices states, because in order to buy an expensive property, you definitely need a high enough income.
Let’s use the median L.A. property price of $615,000 to illustrate this point. In order to afford this, using the rule of thumb of 1:5, an individual needs to make at least $123,000/ yr. With the typical rate of 1.25% property tax in Los Angeles, the annual property tax is about $7,072, and as an individual, he/shel pays $8,692 in state taxes. Together, that a total deduction of $15,764. Before 2018, he/she could deduct the entire amount, but now he/she can only deduct $10,000, a loss of $5,764 in potential deduction.
PERSONAL EXEMPTION IS COMPLETELY GONE
YOUR TAXABLE INCOME IS HIGHER BY EITHER $4,050 OR $8,100 THIS YEAR
Think about personal exemptions the bonus deduction you get for showing up and filing taxes.
Before 2018, personal exemption can be claimed by pretty much everyone, and this amount goes on top of itemized deductions. That amount was $4,050 for an individual and $8,100 for a couple. But in and after 2018, this amount is completely gone, thus lowering the total amount deducted by either $4,050 or $8,100. In other words, if you itemize, with all others being the same, you will have to pay more taxes because personal exemptions are gone.
MORTGAGE INTEREST DEDUCTION CAPPED FOR EXPENSIVE HOMES
MATTERS IF YOUR MORTGAGE IS MORE THAN $750,000
It really matters only to high property states with high income earners, as you won’t be able to deduct anything over $750,000.
For example, if you have a mortgage of $1,000,000 with 4% interest rate. You are paying $39,679 in mortgage interest for the first year. It’s a substantial amount of tax deduction. However, with the new rule, you are only allowed to deduct $750,000 of the $1,000,000 at 4%, which translates into $29,760, about $10,000 less.
POORLY EDUCATED HR
YOUR HR TEAM SHOULD’VE ASKED YOU TO LOWER YOUR TAX WITHHOLDING TO 0 … BUT THEY DIDN’T
This part is true whether you file standard deduction or itemized deductions. Your tax allowance is one big reason you owe taxes this year. Let me explain.
You probably claimed at least 1, or maybe even 2 on your W-4 form, which is the form that helps calculate personal allowances.
This is how it used to work: each point you claim is worth the same amount as the personal exemption, which was $4,050 in 2017. It is subtracted from your gross income and not taxed during your regular paycheck. For example, if you make $50,000 a year, and claimed 1 as your tax allowance, your company would’ve withheld enough taxes for $45,950 ($50,000 - $4,050). It would’ve been the correct amount in 2017, because everyone could claim the personal exemption.
Wait a minute, the government eliminated personal exemption in 2018… What does that mean? It means, if we did not revised tax allowances from 1 or 2 down to 0, we have been paying too little taxes. In other words, the more you claimed during the year, the more you need to make up during tax return season.
For example, if you are an individual who claimed 1, you did not pay taxes on $4,050 during your regular pay periods. Now you need to pay for that. If you are a married couple that claimed 2, you will need to pay taxes on an income of $8,100 ($4,050 x 2). It goes on and on. The only way to avoid this, if you went to your HR to actively revise your tax allowances to 0.
Well… I did not. I don’t expect you did. It is really the company HR’s responsibility to active reset every employee’s tax allowances to 0. I doubt most companies truly understood the implication of the tax reform when it came out… Now we are all screwed.
The White House only expect 8% of all tax filers to itemize in 2018, much lower than the 30% in the past. If you are one of these 8%, your tax bills are going up for one of the following 4 reasons.
SALT capped at $10,000
Personal Exemption is gone ($4k or $8k depending on your filing status)
Mortgage Interest Deduction capped at $750k
HR did not tell you to reset personal allowance to 0