Does the new federal budget help or hurt clients?
Given today’s contentious legislative environment, it’s not often that Congress passes anything. So when a bill actually is on track for approval, various members of Congress often try to tack on a number of provisions. Such was the path of the new federal budget (H.R. 1892), passed by President Trump in February. Though it was intended primarily to avoid a government shutdown, buried within were a number of tax-related provisions — some temporary, others permanent — that have the potential to impact both high- and low-income households.
Consequently, as we’re now in tax season, it’s worth dissecting the provisions individually to better understand how they may or may not impact our clients.
Since 2006, the Medicare Modernization Act has required that certain high-income individuals pay an Income-Related Monthly Adjustment Amount, or IRMAA, as a surcharge on their Medicare Part B premiums. In 2018, the surcharge starts at an extra $53.50/month but can rise as high as an extra $294.60/month on Medicare Part B, and applies to those whose modified adjusted gross income exceeds $85,000 for individuals, or a MAGI above $170,000 for married couples.
The ultimate objective of these IRMAA surcharges is to increase the total percentage of Part B costs that are covered by premiums, from 25% — that is, the amount covered by the base $134/month Medicare Part B premium — to as high as 80% for those paying the full $134 + $294.60 = $428.60/month premium.
Kitces IRMAA Trump Budget
Under the new Bipartisan Budget Act of 2018 though, an additional tier of surcharges is being introduced for 2019 at a MAGI threshold of $500,000 for individuals, or $750,000 for married couples. Notably, the threshold for married couples is only 150% of the threshold for individuals, introducing a sort of marriage penalty for high-income couples on Medicare. The new tier is intended to lift the Part B premium coverage from 80% to 85% for those high-income earners.
It’s also important to note that the new IRMAA tier for 2019 stacks on top of the changes to IRMAA tiers that just took effect in 2018 as a part of the Medicare Access And CHIP Reauthorization Act of 2015, which had already reduced the top IRMAA tier — i.e., where the 80%-of-costs threshold kicks in — from $214,000 in 2017 to only $160,000 in 2018, with thresholds doubled for married couples.
Thus, in the span of two years, the depth of the top IRMAA tiers has been expanded rapidly, while the bottom three IRMAA tiers have become compressed — albeit still with an individual threshold of $85,000 for individuals, or $170,000 for married couples, which means it only applies to a limited number of households.
TAX BREAKS REINSTATED
For much of the past decade, a handful of individual tax incentives have been regularly subject to a series of short-term extensions, after which they would lapse until/unless they were reinstated and extended again. In practice, this happened so often that they literally became known as the Tax Extenders.
In the Protecting Americans from Tax Hikes (PATH) Act of 2015, a number of popular Tax Extenders became permanent, including Qualified Charitable Distributions from IRAs, the deduction for State and Local Sales Taxes — albeit now subject to the overall $10,000 SALT deduction cap from TCJA 2017 — and the American Opportunity Tax Credit that replaced the old Hope Scholarship Credit back in 2009.
However, a handful of popular individual tax breaks were not made permanent under the PATH Act, and instead were only extended temporarily for two years, through the end of 2016, and lapsed as of December 31 of that year. Accordingly, the Bipartisan Budget Act has reinstated those provisions retroactively for the 2017 tax year, including the above-the-line deduction for tuition and fees, the deductibility of mortgage insurance premiums, and the ability to exclude discharged primary residence mortgage debt from income.
The above-the-line education deduction for tuition and fees allows taxpayers to deduct up to $4,000 of tuition and enrollment fees for college for themselves or their dependents. Any expenses claimed for the Tuition and Fees deduction cannot have been paid from an already tax-favored 529 college savings plan, a Coverdell Education Savings Account or via tax-free interest from a savings bond.
The Tuition and Fees deduction is partially phased out from a $4,000 maximum down to only $2,000 for individuals with modified adjusted gross Income above $65,000, or $130,000 for married couples, and is completely phased out once income exceeds $80,000 for individuals, or $160,000 for married couples.
Notably, the Tuition and Fees deduction also cannot be claimed on behalf of any student who already claimed the American Opportunity Tax Credit, or Lifetime Learning Credit, in the same tax year. And since the American Opportunity Tax Credit is actually a dollar-for-dollar credit for the first $2,000 of expenses, and 25 cents on the dollar for the next $2,000, it is always better to claim the AOTC where available — generally, the first four years of college — especially since it has higher income phase-out limits anyway.
In practice, the reinstatement of the Tuition and Fees deduction will be primarily beneficial for:
- Students who are beyond their first four years of undergrad education or are in graduate school;
- Students/families with income above $56,000 when filing as individuals, or $112,000 for married couples, but under $80,000 and $160,000, respectively, where the Lifetime Learning Credit will be phasing out faster than the Tuition and Fees deduction;
- Families with multiple students beyond the first four years of college, where the Lifetime Learning Credit can only be claimed once per tax return — i.e., per family with multiple students. Meanwhile, the Tuition and Fees deduction can be claimed across multiple students as long as the family remains below the income phase-out threshold.
However, the reinstatement of the Tuition and Fees Deduction is only for the 2017 tax year, and has already implicitly re-expired at the end of 2017, which means it is not currently available for the 2018 tax year. In addition, because the Tuition and Fees Deduction was just reinstated retroactively for 2017 as of February 9, some tax reporting software may not yet be updated for the retroactive change for 2017 tax filings. Though fortunately on Form 1040 for 2017, it appears it can still be claimed on Line 34 where it was previously claimed, albeit on a line that is currently marked as “Reserved for Future Use.”
MORTGAGE INSURANCE PREMIUMS
Under IRC Section 163(h), mortgage interest is deductible as an itemized deduction, and since 2007 the tax law has also permitted those who pay mortgage insurance premiums — e.g., Private Mortgage Insurance on a mortgage that had a less-than-20% down payment — to deduct them as mortgage interest as well. The deduction began to phase out once Adjusted Gross Income exceeded $100,000 for individuals and married couples, and fully phased out by $110,000 of AGI.
This deduction for mortgage insurance premiums was one of the tax extenders that was repeatedly extended, lapsed, extended again and lapsed again over the span of a decade, having last been extended under the PATH Act through the end of 2016.
Kitces IRMAA Trump Budget
With the Bipartisan Budget Act of 2018, the mortgage insurance premium deduction is retroactively reinstated for 2017. This means that those who had already paid mortgage insurance premiums will simply find they can deduct them on the 2017 tax return as a part of their mortgage interest deduction on Line 13 of Schedule A, where a placeholder for the mortgage insurance premium deduction was retained.
Notably, the reinstatement for deducting mortgage insurance premiums has no relationship to the new rules limiting mortgage interest deductibility, including the elimination of deductions for home equity indebtedness, under the Tax Cuts and Jobs Act, as those rules only apply for the 2018 tax years and beyond, while the mortgage insurance premium deduction is only reinstated retroactively for 2017.
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