So the Tax Cuts and Jobs Act (TCJA) is now the law of the land. While I'm still digesting the law and many things won't be known for sure until the first court case, here are some thoughts on how it will change the transition from uniformed service to the civilian sector.
What Changes Affect Military Retirement?
- Miscellaneous Itemized Deductions Eliminated. The miscellaneous itemized deductions subject to a 2% floor are eliminated. Completely. That means your job hunting expenses are no longer deductible. It also means my fees (or any other investment advisor or tax professional) are no longer deductible.
- State and Local Tax (SALT) Deduction Limitation. A lot of military retirees, especially retired senior officers, pay a lot in state income tax and property taxes. Under the TCJA, you'll only be able to deduct a maximum of $10,000 in SALT.
- Moving Expense Changes. Moving expenses are no longer deductible. Additionally, any moving expenses paid for by your employer are taxable. Now there is a carve out for Active Duty Military members. I'm not 100% sure yet how that will apply to a retirement move. The law says the move must be "incident to a permanent change of station." What is certain, is that if your new employer pays for your moving expenses, you'll pay taxes on the value of the expenses that are paid for by the employer.
- Capital Gains, Kind Of. Capital gains still receive favorable tax treatment. But, the thresholds for that treatment are no longer tied to tax brackets, but rather to a dollar amount.
- Itemized Deduction and Exemption Phase Outs. Many of you have or would have had your itemized deductions and exemptions reduced due to the amount of your income. That is no longer the case. On the other hand, there isn't that much left to deduct and there are no longer any exemptions.
- The AMT. When I first looked at the proposed legislation, I said to myself, "They're changing the income tax to the Alternative Minimum Tax." One of the most of the substantive changes to the Code were making the income tax rules virtually the same as the AMT (SALT Deductions, Exemptions, Miscellaneous Itemized Deductions). Additionally, the exemption for the AMT was increased significantly, so I suspect that many of you who paid the AMT, will no longer have to pay it.
What Has Stayed the Same for Military Retirees?
- You'll Need to Watch Withholding. There will still be issues with withholding when you start your first job if you don't put some thought into it. Remember, your employer and DFAS (unless you tell them otherwise) will, at a minimum, treat your first $24,000 as tax free income (assuming you file Married Filing Jointly) when calculating your withholding. In reality, one of them should treat the $24,000 as taxable income, most likely taxable at a rate of 22% or higher. At 22%, you'll under-withhold by $5,280 and get to write a big check to the IRS when you file. Now this does assume we're talking the first full year of retirement.
- You'll miss a lot of things. Many credits and deductions will go away. Here are some...
- Rental Losses. The ability to deduct a real estate rental loss phases out between $100,000 and $150,000 Adjusted Gross Income (AGI).
- American Opportunity Credit (AOC). The ability to take the AOC (for college expenses), phases out between $160,000 - $180,000.
- No Roth IRA. I see this one a lot from retired senior officres. Many of you will lose the ability to contribute to a Roth IRA directly. The phase out for 2018 is $189,000 - $199,00 for Married Couples and $120,000 - $135,000 for Single taxpayers.
- ObamaCare Surtaxes. The Medicare surtaxes added as a part of ObamaCare are still in effect. They are a 0.9% taxes on wages above $250,000 for married taxpayers and $200,000 for single taxpayers. As a reminder, military retirement pension is not considered wages. Additionally, if your AGI exceeds $250,000 married or $200,000 single AND you have investment income, that investment income will be subject to a 3.8% surtax.
This is just the beginning. As people in the financial and tax fields peel this back and the IRS writes regulations, things will continue to evolve. And remember, most of the changes are scheduled to sunset in 2025. Tax arbitrage anyone?