When Congress passed the Tax Cuts and Jobs Act late in 2017 it was widely covered in the media that high income taxpayers in higher tax states could actually face a tax increase as a result of the bill. The reason for this is the $10k limitation placed by the bill on the deductibility of state income taxes. Prior to the passage of this bill, if you itemized deductions on your Federal return, you were able to take the full amount of the state income and property taxes you paid during the year as a deduction. For a high income taxpayer in a state with high income taxes, this often resulted in a big deduction at the Federal level.
There was a lesser reported potential tax increase for many of the same taxpayers in high tax states like Maryland. On your Maryland income tax return, you are only allowed to itemize your deductions if you also itemize your deductions on your federal return. The new higher standard Federal deduction and limitations on various deductions means that more taxpayers will wind up taking the standard deduction on their Federal returns going forward. Why is this a problem?
The standard deduction on your Maryland return is MUCH lower than the standard deduction on your federal return. Instead of the new $12,000 single/$24,000 married standard deductions on your federal return, the Maryland standard deductions in 2017 were $2,000 and $4,000, respectively. While any state income taxes deducted at the federal level were never allowed to be deducted for state purposes, all other federal deductions were allowed.
So let's say in 2017 you had $8k of real estate taxes, $10k of charitable contributions and $3k of deductible medical expenses last year and filed as a married couple. You would have itemized your deductions and taken a $21k deduction on both your federal and state tax returns. Fast forward to 2018 and you would no longer itemize your deductions for federal purposes because you could take the higher $24k standard deduction. This means you must take the standard deduction on your MD return as well, which stood at $4k until recently. You just lost $17k in deductions on your MD return, which at a rough 7% rate is $1,190!
There were various proposals put forward for the state legislature to consider. Among them was one that would have allowed you to itemize your deductions on your Maryland return even if you didn't itemize on your Federal return. Unfortunately for Maryland taxpayers, the bill that was passed offered a small increase of $500 to the standard deduction, something that won't go very far to mitigate the impact of the federal tax reform bill for many Maryland taxpayers.
Then there is the Maryland Estate tax. Since 2004 the Maryland estate tax exemption has been "decoupled" from the Federal estate tax exemption. In 2014 Maryland passed legislation that gradually increased the state estate tax exemption each year from $1 million up to the Federal exemption amount by 2019. Under the tax law prior to the 2017 tax reform bill, that would have meant the Maryland estate tax exemption would have been about $4 million in 2018 and about $5.7 million in 2019.
When the Tax reform bill changed the Federal estate tax exemption to $11.2 million in 2019, it meant the Maryland estate tax exemption would go from $4 million in 2018 to $11.2 million in 2019. The state legislature wasn't too fond of this development so they recently enacted a bill that will cap the Maryland estate tax exemption at $5 million, an amount that will not be indexed for inflation. The bill does allow for the portability of the estate tax exemption however, a feature allowed under Federal law for several years now that was previously not available for Maryland estate tax purposes. Portability allows spouses to pass their exemption amount to each other on death, which essentially gives them a "joint" exemption of $10 million.
So what does all this mean for you? On the income tax side, the best planning opportunities will be similar to what you can do from a tax planning standpoint for your federal returns - such as bunching your deductions so every other year you can benefit from the itemized deduction on the federal and state returns. On the estate tax side, you should review your estate tax documents to be sure they still make sense under the new rules. We'd be happy to help you with any of this so feel free to reach out to us.
-Chris Benson, CPA
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