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House Tax Cuts & Job Act – Summary & Discussion

Summary:

The House Committee on Ways and Means has approved a bill named the Tax Cuts and Job Act, dated November 6, 2017. It then passed in the House on November 16, 2017. Our opinion is that Congress can do a much better job and shouldn’t rush this bill. So, read below and you can be the judge of our thoughts.

Congress appears eager to enact a major tax reform law that could potentially make fundamental changes in the way individuals and families calculate their federal income tax bill and the amount of federal tax that will be paid. However, will it pass the Senate, which has a different version, and be signed by President Trump? Based on Congress’ recent track record, the passing of the bill isn’t assured. This memorandum was written by Peter DeGregori, CPA, CGMA, and MST, based on his interpretation and summary of the section that effects business owners and individuals. This memo does not discuss the entire bill, nor does it provide summary or opinion on all sections.

As you have read, there are some substantial tax changes and depending on where you live and how you earn your income, the proposed changes can either be advantageous or provide negative consequences. One should consider the proposed changes for possible change to your income tax strategy. Keep in mind, however, that while most experts expect a major tax law to be enacted this year, it’s by no means a sure bet. So, keep a close eye on the news and don’t act prematurely until the ink is dry on the President’s signature on the tax reform bill. For example, there are still multiple discussions of not passing a tax cut for the wealthy (they need to define wealthy) and the possible change of not allowing state and local taxes (SALT) to be deducted. The removal of the SALT deduction is a BIG issue for Congress and the Senate to discuss, which negatively effects taxpayers in states with high income taxes like California, New Jersey, Illinois, and New York. Some tax experts and economists, can argue that the deductions of state taxes are a way to adjust for the cost of living differences throughout the United States. Also, one must understand that one of the basic principles of tax law is to not double tax income, so one could argue taking away the SALT deduction goes against the basic principal of double taxation. Never-the-less, the proposal for the removal of SALT deduction is causing a BIG discussion.

Most of the proposed changes below begin after 12/31/2017, which would mean the 2018 tax returns would be affected, but one must look at each specific provision of the final bill signed by the President to determine the effective date.

Lower tax rates coming. Both the tax bill passed by the House of Representatives and the one before the Senate would reduce tax rates for many taxpayers, effective for the 2018 tax year. (Thus, the tax rates currently wouldn’t reduce the 2017 taxes.) Additionally, businesses may see their tax bills cut, although the final form of the relief isn’t clear right now. However, depending on how you earn your income and which state you reside in, you might not be receiving a tax deduction. Hence the reason for more continued debate.

If you feel confident that a tax bill will eventually be passed and there will be reduced tax rates, then the general plan of action to take advantage of lower tax rates next year would be to defer income into next year. Some possibilities follow:

  • If you are an employee who believes a bonus is coming your way before year end, consider asking your employer to delay payment of the bonus until next year.
  • If you are thinking of converting a regular IRA to a Roth IRA, postpone your conversion until next year. That way you’ll defer income from the conversion until next year and hopefully have it taxed at lower rates.
  • If you run a business that renders services and operates on the cash basis, the income you earn isn’t taxed until your clients or patients pay. So, if possible, hold off on billings until next year—or until so late in the year that no payment can be received in 2017. However, you need to consider the cash flow of your business. Remember cash is still King in a business.
  • If your business is on the accrual basis, deferral of income till next year is difficult but not impossible. For example, you might, with due regard to business considerations, be able to postpone completion of a job until 2018, or defer deliveries of merchandise until next year. Taking these ideas into consideration could postpone revenue recognition. However, again, consider the effect on your financial statements and any bank covenants or EPS requirements. Accrual rules in this area are more complex and may require a tax professional’s input.
  • The reduction or cancellation of debt generally results in taxable income to the debtor. So, if you are planning to make a deal with creditors involving debt reduction, consider postponing until 2018.

Disappearing deductions, larger standard deduction: Beginning next year, both the House-passed tax reform bill and the version before the Senate would repeal or reduce many popular tax deductions in exchange for a larger standard deduction. Think about it, if Congress is going to cut tax rates, they need offsets for the tax rate reduction. Hence the argument that everyone might not be receiving a tax cut. Here’s what you can do about this right now:

The House-passed tax reform bill would eliminate the deduction for nonbusiness state and local income or sales tax, but would allow an up-to-$10,000 deduction for real estate taxes on your home. The bill before the Senate would ban all nonbusiness deductions for state and local income, sales tax, and real estate tax. If you are an employee who expects to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding on those taxes. That way, additional amounts of state and local taxes withheld before the end of the year will be deductible in 2017. Similarly, pay the last installment of estimated state and local taxes for 2017 by Dec. 31 rather than on the 2018 due date, or prepay real estate taxes on your home. Taxpayers in high tax states do not like this proposal for elimination of state and local taxes.

Neither the House-passed bill, nor the bill before the Senate, would repeal the itemized deduction for charitable contributions. But because most other itemized deductions would be eliminated in exchange for a larger standard deduction (e.g., in both bills, $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for many. If you think you will fall in this category, consider accelerating some charitable giving into 2017. We believe that this bill would hurt charities, as it is currently proposed. If people are not going to be able to itemize due to the larger standard deduction, then they might reduce the amount of charitable deductions given. This is another reason why we don’t like the elimination of the SALT deductions.

The House-passed bill, but not the one before the Senate, would eliminate the itemized deduction for medical expenses. If this deduction is indeed chopped in the final tax bill, and you are able to claim medical expenses as an itemized deduction this year, consider accelerating “discretionary” medical expenses into this year. For example, order and pay for new glasses, arrange to take care of needed dental work, or install a stair lift for a disabled person before the end of the year. However, most taxpayers in our practice are not able to receive a deduction for medical expenses, as they must exceed 10% of their adjusted gross income (AGI), so keeping this deduction and eliminating the SALT deduction would again make it very difficult for one to deduct their out-of-pocket medical deductions. We didn’t read about a law in the House bill to allow taxpayers to deduct medical insurance, which if Congress wants us all to have health insurance, and the cost continues to go up, we think they should allow a tax deduction.

Other year-end strategies. Here are some other “last minute” moves that could wind up saving tax dollars in the event tax reform is passed:

The exercise of an incentive stock option (ISO) can result in Alternative Minimum Tax (AMT) complications. But both the Senate and House versions of the tax reform bill call for the AMT to be repealed next year So if you hold any ISOs, it may be wise to hold off exercising them until next year.

AMT Thought: One must remember that AMT was created in 1969, when Congress noticed that many wealthy taxpayers were taking so many deductions that they were paying very low-income tax or no income tax. They created AMT is a parallel taxing system which added back certain deductions and tried to keep taxpayers effected by AMT to pay tax at a 28% tax rate. So, why is Congress proposing to remove it? Maybe they feel it isn’t needed if they remove the majority of itemized deductions. However, taxpayers could still donate a large amount to charity, receive a deduction, and not be hit with AMT if the AMT tax is repealed. Thus, I’m not sure they need to remove it. However, AMT was created for the wealthy taxpayers, but they haven’t adjusted the formula so taxpayers with incomes of $120,000 for single or $150,000 for married are being negatively affected by AMT, so we think AMT should stay but increase the AMT trigger to be something closer to $500,000 or $1,000,000 but don’t eliminate it.

If you’ve got your eye on a plug-in electric vehicle, buying one before year-end could yield you an up-to-$7,500 discount in the form of a tax credit. The House-passed bill, but not the one before the Senate, would eliminate this credit after 2017. This proposed tax bill doesn’t support a cleaner technology, so we think Congress should reconsider.

If you’re in the process of selling your principal residence and you wrap up the sale before year end, up to $250,000 of your profit ($500,000 for certain joint filers) will be tax-free if you owned and used the property as your main home for at least two of the five years before the sale. However, under the House-passed bill and the bill before the Senate, the $250,000/$500,000 tax free amounts would apply to post-2017 sales only if you own and use the property as your main home for five out of the previous eight years. If you are in process of selling your primary residence and it wouldn’t be sold until next year (2018), make sure you can meet the expected tax law change of living in the primary residence 5 out of 8 years. If you can meet that requirement, then you shouldn’t have to be concerned with the proposed tax law change.

Under current rules, alimony payments generally are an above-the line deduction for the payor and included in the income of the payee. Under the House-passed tax bill but not the version before the Senate, alimony payments would not be deductible by the payor or includible in the income of the payee, generally effective for any divorce decree or separation agreement executed after 2017. So if you’re in the middle of a divorce or separation agreement, and you’ll wind up on the paying end, it would be worth your while to wrap things up before year end if the House-passed bill carries the day. On the other hand, if you’ll wind up on the receiving end, it would be worth your while to wrap things up next year.

Both the House-passed bill and the version before the Senate would repeal the deduction for moving expenses after 2017 (except for certain members of the Armed Forces), so if you’re about to embark on a job-related move, try to incur your deductible moving expenses before year-end.

Please keep in mind that we have described only some of the year-end considerations that should be considered in light of the tax reform package currently before Congress.

Now, let me provide some additional highlights which I feel would be of interest to our clients. Again, remember these are all currently in bills, proposed or being discussed, none of this is law, until President Trump signs a final bill:

  • Carried Interest: Carried interest is a share of any profits that the general partners of private equity and hedge funds receive as compensation, regardless of whether or not they contributed any initial funds. This method of compensation seeks to motivate the general partner (fund manager) to work toward improving the fund’s performance. The Senate Finance Committee (SFC) is considering changing the holding period requirements. The SFC would impose a 3-year holding period requirement for certain partnership interests received in connection with the performance of services to qualify as long-term capital gain rather than ordinary income.o Personally, we think the house and Senate could have gone father. We think they should have made all the carried interest ordinary income which would be similar to the approach utilized with financial advisors and managing partners of real estate funds. We don’t know why this area of law that benefits hedge fund managers shouldn’t be repealed. It doesn’t make sense to be to provide them a benefit against other advisors in similar industries.
  • 100% Meals Deduction: Disallowance of deduction for meals provided at convenience of employer. The SFC Amendment added an effective date for the provision described in the modified Chairman’s mark—the disallowance of deductions for meals provided at the convenience of the employer would apply to tax years beginning after Dec. 31, 2025.

Individuals:

• Individual Tax Rate Change: Consolidates the current seven tax brackets into four, with rates of 12 percent, 25 percent, 35% and 39.6%. (Table 1):

Current Law / Tax Rates: Proposed Tax Rates

Current Law / Tax Rates: Proposed Tax Rates
Under the Tax Cuts & Job Act
10% > $0.00 12% > $0.00
15% > $9,525 25% > $45,000
25% > $38,700 35% > $200,000
28% > $93,700 39.6% > $500,000
33% > $191,450
35% > $424,950
39.6% > $426,700

These proposed tax rate changes for individuals don’t seem overly exciting to us.

  • Increases the standard deduction from $6,350 to $12,200 for singles, from $12,700 to $24,400 for married couples filing jointly, and from $9,350 to $18,300 for heads of household. This seems to help individuals that wouldn’t have itemized deductions over the increased standard deduction, but not the taxpayers that do.
  • Mortgage Interest Deduction: The proposal modifies the home mortgage interest deduction in the following ways. First, under the proposal, only interest paid on indebtedness used to acquire, construct or substantially improve the taxpayer’s principal residence may be included in the calculation of the deduction. Thus, under the proposal a taxpayer receives no deduction for interest paid on indebtedness used to acquire a second home.o Second, under the proposal, a taxpayer may treat no more than $500,000 as principal residence acquisition indebtedness ($250,000 in the case of married taxpayers filing separately).o In the case of principal residence acquisition, indebtedness incurred before the date of introduction (November 2, 2017), this limitation is $1,000,000 ($500,000 in the case of married taxpayers filing separately).o Last, under the proposal, interest paid on home equity indebtedness is not treated as qualified residence interest, and thus is not deductible.o Again, we think this is another law that sort of allows some cost of living adjustment, in which a home in a section of the country that costs more, would allow the taxpayer a larger deduction. We think Congress should keep the law as-is.
  • Eliminates the personal exemption. Creates a $300 personal credit, along with a $300 non-child dependent personal credit, in place for five years. Most wealthy individuals can’t utilize the personal exemptions, so I don’t understand why they are proposing to eliminate this deduction.
  • Increases the child tax credit to $1,600, with $1,000 of the tax credit initially refundable. The refundable portion is indexed to inflation until the full $1,600 is refundable. The phaseout threshold for the child tax credit is also increased: for married households, it rises from $110,000 to $230,000.
  • We discussed the mortgage interest above, but as a reminder, the proposed bill retains the mortgage interest deduction, but with a cap of $500,000 of principal on newly- purchased homes. If you recall, the previous principal cap was $1,000,000. So, if you have a mortgage over $500,000 before the tax law passed, you could deduct interest on a loan of up to $1,000,000 however, the itemized deductions laws would be significantly changed.
  • Retains charitable contribution deductions.
  • Elimination of non-business state and local tax (SALT) but would allow property tax deduction up to $10,000.
  • Eliminates the individual alternative minimum tax. This one seems exciting, but people they are eliminating the state and local tax which is generally one of the largest add backs for AMT, the elimination of AMT isn’t that appealing as discussed above, but it does cut down on alternative calculations. This seems to be a benefit for the IRS more than the taxpayers on main street.
  • Alimony: The House bill, but not the Senate version, proposes to not allow a deduction against AGI and doesn’t require the recipient to include the income. This doesn’t seem fair to us. Let’s see if they change it. We have seen many divorced couples and the one paying the alimony doesn’t like it, but the pain seems to be made a little better if there is a tax deduction. Also, if the taxpayer receiving alimony isn’t it sort of like income and why shouldn’t it be taxable? We think they need to leave this one alone.
  • Plug-In Credit: The proposal repeals the credit for plug-in electric drive motor vehicles. If this passes, then the credit on plug-in automobiles would be gone. Again, this goes against the clean air and climate change that government is trying to support.
  • Student Loan Interest deduction would be repealed. Most deductions individual deductions seem to be appealed due to the larger standard deduction and reduced income tax rates. If a student has a large loan, the deduction for the interest can be helpful, but one needs to remember that if the taxpayer is wealthy, the interest might not be deductible anyway under current law.
  • Residential Solar: There seems to be no change to the residential solar tax credit. IRC Section 25D provides a personal tax credit for the purchase of qualified solar electric property and qualified solar water heating property that is used exclusively for purposes other than heating swimming pools and hot tubs. The credit is equal to 30 percent of qualifying expenditureso In the case of qualified solar electric property and solar water heating property, the credit expires for property placed in service after December 31, 2021. In addition, the credit rate for such solar property is reduced to 26 percent for property placed in service in calendar year 2020 and to 22 percent for property placed in service in calendar year 2021.

 

Business:

As we have heard President Trump discuss, his overall goal has been to reduce income taxes on US businesses to spur the US economy. So, below are the proposed changes.

  • Reduces the corporate (C Corporation) income tax rate from 35 percent to 20 percent.o Personal service corporations would be taxed at 25%.o Remember that dividends from C Corporations are taxed again, however, the Corporation pays tax first, and then the shareholder pays the income tax on dividends. The same person isn’t taxed twice. Therefore, we believe the tax rate for pass-through’s is higher as there is only tax once.o Lowering the C Corporate tax rate seems that it will increase the stock earning per share and thus could increase the stock price. We will have to see. But if that is the case, and capital gains rate is still at 20%, this seems like a benefit to taxpayers holding stocks which typically would be considered the wealthy.
  • Eliminates the corporate alternative minimum tax. Again, we think they can keep it but adjust for some fair taxable income amounts which haven’t seem to be adjusted for the real cost of living.
  • Taxes pass-through business income at a maximum rate of 25%, subject to anti-abuse rules. Just a reminder that pass-through businesses are partnerships, S Corporations, and LLC’s taxed as either partnerships or S Corporations. However, there are some other limitations with service-based companies relating to income taxed at 25% and income which would be deemed compensation to be taxed at the individual tax rates.o A portion of net income distributions from passthrough entities would be taxed at a maximum rate of 25%, instead of at ordinary individual income tax rates, effective for tax years after 2017. The bill includes provisions to prevent individuals from converting wage income into passthrough distributions. Passive activity income would always be eligible for the 25% rate.o For income from non-passive business activities (including wages), owners and shareholders generally could elect to treat 30% of the income as eligible for the 25% rate; the other 70% would be taxed at ordinary income rates. Alternatively, owners and shareholders could apply a facts-and-circumstances formula. We think that if Congress wants to spur the economy, they shouldn’t be taxing different industries differently. So, we don’t agree with the additional formula of what amount of profit is allowed the 25% tax rate.o However, for specified service activities, the applicable percentage that would be eligible for the 25% rate would be zero. These activities are those defined in Sec. 1202(e)(3)(A) (any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees), including investing, trading, or dealing in securities, partnership interests, or commodities.

    o The Senate Finance Committee desires to tax all pass-through entities the same regardless of the activity. Thus, reasonable compensation would need to be taxed as ordinary income. We think this would be a better option for this section of the law.

  • Allows for capital investment, except for structures, to be fully and immediately deductible for five years, and increases the Section 179 expensing limit from $500,000 to $5 million, with an increased phaseout threshold.o There is a proposed increase for section 179 deduction related to passenger automobiles that are placed in service after September 27, 2017 and before January 1, 2023, in which the amount of section 179 is increased from $8,000 to $16,000. This is most likely due to the removal of bonus depreciation by 2020.• Bonus depreciation for most assets is phased out by rate reduction and ends in year 2020.
  • Unused Business Credits: This proposal repeals the deduction for certain unused business credits. Wow, we don’t like this. So, if a company had unused business tax credits, they would lose them?
  • Reduction of business interest deduction: Limits the deductibility of net interest expense on future loans to 30% of earnings before interest, taxes, depreciation, and amortization for all businesses with gross receipts of $25 million or more. Any interest not deducted, can carry forward for up to 5 years. If the business has less than $25M in earnings, then the interest deduction limitation doesn’t apply.o The limitation does not apply to a real property trade or business as defined in section 469(c)(7)(C). Any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business is not treated as a trade or business for purposes of the limitation.
  • o Most businesses need loans to run their business. Small business count on loans, as public companies can just get more capital. So, this law, although there is a $25,000,000 gross receipts test, seems to not support helping businesses in the USA.
  • Net Operating Loss: Restricts the deduction of net operating losses to 90% of net taxable income and allows net operating losses to be carried forward indefinitely, increased by a factor reflecting inflation and the real return to capital. Eliminates net operating loss carrybacks.o We don’t like the elimination of NOL carrybacks, but we are guessing this assists the government with budgeting issues. However, if you run a business and have had a NOL the ability to carry back the loss a couple of years can really help out your business and cash flow to help minimize the pain incurred from a loss year.o There is an option for NOL carryback for 1 year if it relates to a disaster area, for small business only ($5M in gross receipts)o We feel Congress should keep the 2-year NOL carryback, at least for privately held companies.
  • Eliminates the domestic production activities deduction (section 199), and other business deductions and credits. This law was created to provide an incentive for building in the USA. Removing it doesn’t make sense. However, since they are lowering the tax rates maybe there is a threshold and carry forward to be considered.
  • Creates a territorial tax system, exempting from U.S. tax 100 percent of dividends from foreign subsidiaries.
  • Cash Accounting Method: The proposal expands the universe of taxpayers that may use the cash method of accounting. Under the proposal, the cash method of accounting may be used by taxpayers, other than tax shelters, that satisfy the gross receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $25 million for the three-prior taxable-year periods (the “$25 million gross receipts test”) to use the cash method. The $25 million amount is indexed for inflation for taxable years beginning after 2018. The current law has a $5M and $10M test. This proposed change would allow more taxpayers to use the cash basis method.o The proposal expands the universe of farming C corporations (and farming partnerships with a C corporation partner) that may use the cash method to include any farming C corporation (or farming partnership with a C corporation partner) that meets the $25 million gross receipts test.o The proposal retains the exceptions from the required use of the accrual method for qualified personal service corporations and taxpayers other than C corporations. Thus, qualified personal service corporations, partnerships without C corporation partners, S corporations, and other passthrough entities are allowed to use the cash method without regard to whether they meet the $25 million gross receipts test, so long as the use of such method clearly reflects income.o Finally, the proposal expands the exception for small construction contracts from the requirement to use the percentage-of-completion method. Under the proposal, contracts within this exception are those contracts for the construction or improvement of real property if the contract: (1) is expected (at the time such contract is entered into) to be completed within two years of commencement of the contract and (2) is performed by a taxpayer that (for the taxable year in which the contract was entered into) meets the $25 million gross receipts test.o The proposals to expand the universe of taxpayers, including farming C corporations, eligible to use the cash method, exempt certain taxpayers from the requirement to keep inventories, and expand the exception from the uniform capitalization rules apply to taxable years beginning after December 31, 2017. Application of these rules is a change in the taxpayer’s method of accounting for purposes of section 481.
  • Partnership Technical Termination: A partnership is also treated as terminated if within any 12-month period, there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits. This is sometimes referred to as a technical termination. Under regulations, the technical termination gives rise to a deemed contribution of all the partnership’s assets and liabilities to a new partnership in exchange for an interest in the new partnership, followed by a deemed distribution of interests in the new partnership to the purchasing partners and the other remaining partners.o The proposed tax bill removes the technical termination rules based on the change of ownership and profits and loss interest. This can reduce preparation of tax returns; however, some partnership may decide they want to have a short period tax return for partners.
  • Employee Fringe Benefits: The proposal provides that no deduction is allowed with respect to (1) an activity generally considered to be entertainment, amusement or recreation, (2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes, (3) a de minimis fringe that is primarily personal in nature and involving property or services that are not directly related to the taxpayer’s trade or business, (4) a facility or portion thereof used in connection with any of the above items, (5) a qualified transportation fringe, including costs of operating a facility used for qualified parking, and (6) an on-premises athletic facility provided by an employer to its employees, including costs of operating such a facility. Thus, the proposal repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer’s trade or business (and the related rule applying a 50 percent limit to such deductions). The proposal also repeals the present-law exception for recreational, social, or similar activities primarily for the benefit of employees. However, taxpayers may still, generally, deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel).
  • Like Kind Exchange (IRC section 1031): The proposal modifies the provision providing for nonrecognition of gain in the case of like-kind exchanges by limiting its application to real property that is not held primarily for sale. So, if the property is held for investment, which should include rental, the 1031 exchange should still work.

 

Other Taxes:

  • International: Elimination of U.S. tax on reinvestments in U.S. property. Under current law, a foreign subsidiary’s undistributed earnings that are reinvested in U.S. property are subject to current U.S. tax. The bill would amend Sec. 956(a) to eliminate this tax on reinvestments in the United States for tax years of foreign corporations beginning after Dec. 31, 2017. This provision would remove the disincentive from reinvesting foreign earnings in the United States.
  • Repatriation provision: The bill would amend Sec. 956 to provide that U.S. shareholders owning at least 10% of a foreign subsidiary will include in income for the subsidiary’s last tax year beginning before 2018 the shareholder’s pro rata share of the net post-1986 historical earnings and profits (E&P) of the foreign subsidiary to the extent that E&P have not been previously subject to U.S. tax, determined as of Nov. 2, 2017, or Dec. 31, 2017 (whichever is higher). The portion of E&P attributable to cash or cash equivalents would be taxed at a 12% rate; the remainder would be taxed at a 5% rate. U.S. shareholders can elect to pay the tax liability over eight years in equal annual installments of 12.5% of the total tax due.
  • Estate Tax: The proposal doubles the estate and gift tax exemption amount for decedents dying and gifts made after December 31, 2017. This is accomplished by increasing the basic exclusion amount provided in section 2010(c)(3) of the Code from $5 million to $10 million. The $10 million amount is indexed for inflation occurring after 2011.o For estates of decedents dying and generation-skipping transfers made after December 31, 2023, the proposal repeals the estate tax and the generation- skipping transfer tax. The proposal includes a transition rule for assets placed in a qualified domestic trust by a decedent who died before the effective date of the proposal. Specifically, estate tax will not be imposed on: (1) distributions before the death of a surviving spouse from the trust more than 10 years after the date of enactment; or (2) assets remaining in the qualified domestic trust upon the death of the surviving spouse. The top marginal gift tax rate is reduced to 35 percent for gifts made after December 31, 2023.o The proposal generally retains the present law rules for determining the income tax basis of assets acquired by gift and assets acquired from a decedent. As a result, property received from a donor of a lifetime gift generally will continue to take a carryover basis, and property acquired from a decedent’s estate generally will continue to take a stepped-up basis.o We think this one might be revised as the public sees it as creating a benefit for the wealthy.o Effective dates: The proposal to double the estate and gift tax exemption is effective for estates of decedents dying, generation-skipping transfers, and gifts made after December 31, 2017. The repeal of the estate and generation- skipping transfer taxes, and the reduction in the gift tax rate to 35 percent, are effective for estates of decedents dying, generation-skipping transfers, and gifts made after December 31, 2023.

Tax-Exempt Entities: The proposed changes by the house include a slight modification for UBTI.

  • Under the proposal, unrelated business taxable income includes any expenses paid or incurred by a tax-exempt organization for qualified transportation fringe benefits (as defined in section 132(f)), a parking facility used in connection with qualified parking (as defined in section 132(f)(5)(C)), or any on-premises athletic facility (as defined in section 132(j)(4)(B)), provided such amounts are not deductible under section 274.

 

Suggestions for Congress:

  • Unfortunately, this bill isn’t going to make everyone happy, but if they want to increase jobs and provide the people on main street tax benefits, we feel Congress can consider other items.
  • I think Congress can still allow the state and local tax deduction, and consider maybe a limit or cap on large taxable income. Maybe at least $1,000,000 or more. Removing the SALT deduction will hurt a lot of taxpayers in states with high tax rates and most of these states have a much larger cost of living. Congress needs to reduce deductions to offset reduce tax rates but reducing tax rates and reducing deductions is probably going to keep a lot of taxpayers in the middle class at the same amount of tax or more.
  • Consider removing the carried interest tax benefit beginning in 2018. You will read above, that we do not feel it is fair that managers of hedge funds or private equity get a reduced tax rate compared to financial advisors or managers of real estate funds.
  • Consider increasing the net investment income tax (NIIT) rate on investment income, but increase the threshold of when the NIIT is applied. We think applying the NIIT to taxpayers below $500,000 of taxable income isn’t fair.
  • Consider keeping itemized deductions and allow taxpayers to deduct health insurance costs as the government wants us to have it.
  • If you keep itemized deductions, AMT needs to stay, but increase the threshold amount. Taxpayers making less than $400,000 shouldn’t be hit with AMT.
  • Consider removing the benefit of deducting the intangible drilling costs for oil and gas. If the US is trying to move to clean and renewalable energy, then the US should consider if they need to keep a tax benefit for oil and gas investments.
  • Consider increasing the long-term capital gains rate for taxpayers with very large investment income.
  • Do not carve out professional service business from the 25% tax rate for pass throughs. Those companies create jobs also, and if the goal is to increase the jobs in America and spur the economy, then all businesses should be treated the same regardless of industry. This is what the Senate proposed, and we agree with the Senate. Also, if you compare a professional service company with a manufacturing company that is labor intensive, both companies utilize labor, but because one company charges for labor and one company sells a good, why should the tax rate be different?
  • Consider not removing the Estate tax and also consider if you really need to increase the Estate exemption from $5,000,000 to $10,000,000.
  • Consider removing not for profit status for professional sports leagues.
  • Consider examining not for profit entities much more. For example, let’s look at all the news about the Clinton Foundation. Are they really meeting the not for profit status that other charities are required to meet?
  • Cut costs. Although not part of the tax bill. Government waste’s money, and they really need to look at cutting costs. Congress needs to make difficult decisions that is for the best of the countries fiscal strength. Why does the USA have such a large deficit? Congress can and is responsible for the deficit.
  • Congress needs to abide by all laws they pass. Is there a valid reason why Congress can be exempt from the Affordable Care Act? They created it. If it was so good for the country, they should be required to live by their own laws.
  • Congress needs to consider continuing education just like doctors, lawyers, and accountants. I think they need mandatory ethic’s and receive continuing education on items that would help them do a better job. Maybe like accounting, finance, law, sexual harassment, and maybe the ability to fully understand more complex laws they have past. Professionals and businesses need to deal with it, why not Congress? If we look at their track records, the deficit, I don’t think anyone would agree they would be getting an “A”.

Again, I think Congress can do a much better job. Well, we will have to wait and see what Congress and President Trump decides. If you would like more details about any aspect of how the proposed legislation may affect you, please contact Peter DeGregori, CPA at 949-756-8080. Or find us at www.verticaladvisors.com.

To ensure compliance with requirements imposed by the IRS, we inform you that any US federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and it cannot be used for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. If you are not the original addressee of this communication, you should seek advice based on your particular circumstances from an independent advisor.

Tax and Business Newsletter – Fall 2016

This is one of our quarterly newsletters, which are meant to help keep our clients up to date with various tax and business laws as well as tax planning opportunities. 

 Please take a moment to scan through the newsletter and contact us if you have any questions. Please click here to view.

As a friendly reminder, the following deadlines are approaching:

September 15th is the due date for individuals to pay the third quarter installment of 2016 tax and it is also the deadline for filing extended 2015 tax returns for calendar-year corporations, partnership and limited liability returns.

 October 17th is the filing deadline for extended 2015 individual tax returns.

We appreciate the opportunity to be of service to you.

The California Competes Tax Credit

To Clients and Friends of Vertical Advisors, LLP:

 The California Competes Tax Credit is an income tax credit available to businesses that want to come to California or stay and grow in California.  Tax credit agreements will be negotiated by Go-Biz and approved by a statutorily created “California Competes Tax Credit committee”.    Business owners can apply now on their own at http://www.business.ca.gov/Programs/CaliforniaCompetesTaxCredit.aspx

 Alternatively, if you need assistance in completing the application, contact us for options.  The State of California has budgeted specific amounts for specific periods, so once the budget amount is allocated, there is no more money.  I have attached a Q&A publication.

 Please contact our office if we can be of assistance for the California credit or if you would like us to research credits for other states.

Download PDF here.

Vertical Advisors Tax and Business Summer 2016

This is one of our quarterly newsletters which are meant to help keep our clients up to date with various tax and business laws as well as tax planning opportunities.

Inside this issue
Learn how to manage your retirement accounts
Be familiar with these retirement plan definitions
Organize your business records to save time and money
Are you in the crosshairs of the IRS?

Read article here

NEXT GENERATION ACCOUNTING FIRM OF THE YEAR, VERTICAL ADVISORS LLP

Business owners need more than the traditional accounting firm. So, what do they need?

They need a Next Generation Accounting Firm. What is a Next Generation Accounting Firm (NGAF)? A next generation accounting firm isn’t your traditional accounting firm that is generally reactive. A NGAF focuses on being proactive, focuses on strategy and takes more of a consulting approach in which the client should see a financial benefit rather than just a product (tax returns or financial statements).

Vertical Advisors LLP (VA) is a NGAF which services clients throughout the United State of America, and has seen a large shift in what business owners are demanding from their accounting firm. VA provides services exclusively to privately held companies and their owners. Business owners want their accounting firm to provide a proactive, strategic and consulting service. They need more than just tax returns and financial statements. They are looking for items such like, Federal and state income tax strategies, KPI and ratio analysis, cash flow management advice, retirement planning, estate planning, etal. And most of all a comprehensive approach to connect all of these items together.

Privately held business owners are demanding more assistance with their business. They generally need a firm that can provide a wide range of services from the traditional services of bookkeeping / accounting clean up, virtual controller / CFO to high end tax strategies and critical business and financial consulting. They need federal and state tax strategies as they are expanding. They need international tax planning, they need insight about what other business owners are doing. They need leverage from a trusted business
advisor.

Vertical Advisors LLP is a NGAF and has been providing these services for over 20 years.

Tax Planning in the US

Is it fair to say that most HNWIs and SMEs pay more tax than is necessary? How would individuals and companies be alerted to this scenario?
In our experience, we see individuals and privately held companies paying too much income tax and not having a good understanding of the strategies and options that are available. If a taxpayer files a tax return and feels they are paying too much income tax, they should stop and get a second opinion. In our experience most tax preparers are not tax strategists.

Are there particular state or federal taxes that could easily be reduced with timely professional advice?
Each business is slightly different but there are a lot of similar strategies that privately held businesses can utilize. Surprisingly, we are seeing that tax returns are not prepared correctly and just that error creates an audit risk, which can consume time and money. We also see that businesses are not utilizing Research and Development Credit, the Domestic Production Activity Deduction and many other tax strategies that are available.

In your experience, what are the typical problems that small businesses have regarding their accounting and income tax?
When we meet with a new client, we first focus on their accounting and financial reporting. In our experience, this is the most critical piece of their business. This data provides the company with information to help them run their business, and make better business decisions. Too often we find that the accounting function isn’t running properly and we must fix that first. Good accounting is not only needed for management to run the business but it can be an integral component for tax planning, employee compensation, banking, government examination, and potential sale or IPO.

Offshore trusts that are used for the purposes of tax mitigation have received bad press in recent years – what is your view on trusts used as a vehicle to offer lower taxes?
It is a tool that can be part of a strategy if it makes sense for the taxpayer. Too often we see a professional suggesting an offshore trust or a complex strategy when we don’t feel it is necessary.

How can tax saving initiatives be kept up to date, especially in light of changing legislation? What happens if a current tax plan is no longer viable because of legislative changes?
Unfortunately, tax laws change often. Most tax strategists keep up on the tax law changes so they can perform their job well. We review our client’s tax strategy at a minimum annually. If there is a big tax change, then we review with each affected client.

Many companies and individuals may wish to minimize tax liabilities, but are put off by potentially being challenged by the IRS? In reality is this the case? Is there increased risk by undertaking a tax mitigation plan?
Certain tax treatments can increase the change of an examination. However, if the tax strategy is done correctly, then we suggest it as it is the law and we build each client file to be prepare for a government examination.

Is tax mitigation more possible in the context of federal taxes?
Yes, depending on the state(s) you reside or have business activity in, income taxes can cost up to 50% of profits. We feel this is very high, and we are passionate about creating customized tax strategies to help our clients legally mitigate income tax.

Are there certain industry sectors that benefit from tax breaks in the US?
There are typically tax strategies that any industry can use. However, some of the more typical strategies that can be used are for US manufacturers, real estate, farming, and any business that spends a good amount of money in R&D. However, there are tax strategies which are not dependent on the type of industry.

Identity Theft with the IRS

ID-THEFT.001Over the last 5 to 7 years, our office has unfortunately seen a steady increase in identity theft relating to US taxpayers accounts with the Internal Revenue Service (IRS). This causes issues with filing tax returns and receiving refunds. One of our clients that is in the IT industry sent us this article about how bad identity theft is with the IRS. We were familiar with some of these issues discussed in the article, but the issues seem to be greater. Thus we recommend you read the article at http://bit.ly/1DBadb5. This article is written by KrebsonSecurity (www.krebsonsecurity.com) which we have been informed is an authority on computer security.

In addition to this article, we recommend the following steps. If a taxpayer has any identity theft they should complete IRS form 14039 which can be found at the IRS website at www.irs.gov. This form is a method for the IRS to increase security on your account. Recent identity theft occurrences should prompt a taxpayer to file this IRS form, even if they haven’t had identity theft with the IRS. For example, if you were informed by a large retailer that your information may have been hacked or was hacked and even if you haven’t seen any identity theft issues, you should file IRS form 14039, now!

Another way of being alerted that your identity has been compromised with the IRS is when you electronically file your tax return and the IRS computers state the return won’t be accepted because it has already been filed. At this point, we strongly recommend you complete and remit IRS form 14039 quickly. You can speak with your tax preparer for more details, but filing this IRS form creates additional steps for protecting your identity with the IRS.

Paying income taxes isn’t fun, and now we may have to deal with identity theft with the IRS.  Please contact us if you have any additional questions.

Tax Planning In The US

Peter DeGregori, Managing Partner of Vertical Advisors LLP, talks to Finance Monthly about the variations in federal tax, the use of offshore trusts for tax mitigation and keeping up to date with new legislation.

Is it fair to say that most HNWIs and SMEs pay more tax than is necessary? How would individuals and companies be alerted to this scenario?
In our experience, we see individuals and privately held companies paying too much income tax and not having a good understanding of the strategies and options that are available. If a taxpayer files a tax return and feels they are paying too much income tax, they should stop and get a second opinion. In our experience most tax preparers are not tax strategists.

Are there particular state or federal taxes that could easily be reduced with timely professional advice?
Each business is slightly different but there are a lot of similar strategies that privately held businesses can utilize. Surprisingly, we are seeing that tax returns are not prepared correctly and just that error creates an audit risk, which can consume time and money. We also see that businesses are not utilizing Research and Development Credit, the Domestic Production Activity Deduction and many other tax strategies that are available.

In your experience, what are the typical problems that small businesses have regarding their accounting and income tax?
When we meet with a new client, we first focus on their accounting and financial reporting. In our experience, this is the most critical piece of their business. This data provides the company with information to help them run their business, and make better business decisions. Too often we find that the accounting function isn’t running properly and we must fix that first. Good accounting is not only needed for management to run the business but it can be an integral component for tax planning, employee compensation, banking, government examination, and potential sale or IPO.

Offshore trusts that are used for the purposes of tax mitigation have received bad press in recent years – what is your view on trusts used as a vehicle to offer lower taxes?
It is a tool that can be part of a strategy if it makes sense for the taxpayer. Too often we see a professional suggesting an offshore trust or a complex strategy when we don’t feel it is necessary.

How can tax saving initiatives be kept up to date, especially in light of changing legislation? What happens if a current tax plan is no longer viable because of legislative changes?
Unfortunately, tax laws change often. Most tax strategists keep up on the tax law changes so they can perform their job well. We review our client’s tax strategy at a minimum annually. If there is a big tax change, then we review with each affected client.

Many companies and individuals may wish to minimize tax liabilities, but are put off by potentially being challenged by the IRS? In reality is this the case? Is there increased risk by undertaking a tax mitigation plan?
Certain tax treatments can increase the change of an examination. However, if the tax strategy is done correctly, then we suggest it as it is the law and we build each client file to be prepare for a government examination.

Is tax mitigation more possible in the context of federal taxes?
Yes, depending on the state(s) you reside or have business activity in, income taxes can cost up to 50% of profits. We feel this is very high, and we are passionate about creating customized tax strategies to help our clients legally mitigate income tax.

Are there certain industry sectors that benefit from tax breaks in the US?
There are typically tax strategies that any industry can use. However, some of the more typical strategies that can be used are for US manufacturers, real estate, farming, and any business that spends a good amount of money in R&D. However, there are tax strategies which are not dependent on the type of industry.

Bitcoin – The IRS stated it is taxable. Now what?

BitcoinOn March 25, 2014, the Internal Revenue Service (IRS) released Notice 2014-21 stating that virtual currency is treated as property. In English, this means that virtual currency like Bitcoin will be subject to income tax just like it is treated as cash or property.  The taxability will depend on the type of transaction and how it is received.  The type of tax treatment will be similar based on current transactions dealing with cash and existing tax laws.  Let’s look at three common examples:

Employment & Independent Contractor Relationship:  We all know, that if you work for someone as either a employee or independent contractor and you are paid in cash, that the cash amount is taxable as compensation or income.  Thus if you work for someone and they pay you in Bitcoin or another virtual currency, the IRS is now stating that transaction is taxable based on the fair market value (FMV) on the day of receipt (assuming the taxpayer is using the cash basis of accounting).  If a taxpayer is using the accrual method of accounting, income would be triggered differently.  Thus the employee or contractor would be taxed just like they received cash.  Some items to consider are:  (1) Will you receive a W-2 or 1099-k?, (2) The income most likely would be subject to self-employment tax, or Federal and state withholding, payroll tax and don’t forget additional Medicare tax (AKA Obamacare), (3) Tracking the income at the date of receipt will provide a tax basis / cost, (4) Tracking a gain or loss on the date of conversion from Bitcoin to cash or property.  Thus, there are many things to consider.  The fact that virtual currency will eventually be converted into cash or property creates an additional step not generally created if paid in cash.

Mining Operation: If you own or are a partner in a mining operation then the mining operation will generate income when a Bitcoin or virtual currency is mined.  Depending on the entity structure type  (i.e. sole-proprietorship,  C Corporation, S -Corporation, Partnership, LLC) the taxability of the income will be treated differently.  When a business is in the business to generate a profit, then expenses to run the business can be deductible against the income.  Side note, there are exceptions if the business is deemed illegal.  Anyway, thus in a virtual mining operation, the hardware, software, utilities and other operating expense can be used to reduce the taxable income.  Then depending on the entity structure, the income will be taxed differently.  The mining operation taxability is similar to any other for profit business, but again, another step is created due to a virtual currency being used.  Since virtual currency mining isn’t like normal manual labor mining, the tax issue of this business being active or passive is more relevant.  This again, can change the tax results.  For example, will Net Investment Income Tax (NIIT) / (AKA: Obamatax) be due?

When the virtual currency is mined, the FMV of that currency will generate income.  That currency value on that date should be tracked as it will generate income and also create a tax basis for the currency.  If the virtual currency is exchanged into US dollar, then the transaction has ended and income is generated.  However, if the virtual currency is held for a period of time, then the business should keep track of the FMV on the date it was mined and generated income.  Later when the virtual currency is exchanged into US currency, that transaction will create another taxable transaction based on currency exchange tax laws.  Thus tracking the virtual currency from mined date to exchange date is very important.  As with any business it is also important to make sure the business is properly tracking and supporting expenses and chooses the entity structure wisely.  For example, an S Corporation structure can generate less tax than a sole proprietorship or partnership / LLC.  Entity structures need to be throughly reviewed  based on the business operation and consideration of the partners / shareholders.

Let’s discuss an example.  A mining operation generates three (3) bitcoins.  The value of those bitcoins on the day they are mined is $700 a coin, so income under the new IRS ruling would be  $2,100 for that week. If the bitcoin is exchanged into cash on the mining date, then the income step is over. However, if the bitcoin isn’t exchanged into dollars on the mining date then the company needs to track the bitcoin and later when it is exchanged into cash at $800 a coin, there would be $300 of additional income.  However, if the exchange rate  is $600 a coin, there would trigger a $300 loss.  The mining income and exchange income should be tracked separately due to various tax laws.

If you are part of a pool mining operation, then the above still needs to be considered and then other tax items like, passive versus non-passive come up slightly differently.  Also, the pooling operating agreement should have an operating agreement, explanation about tax ramifications and who is the tax matters partner.  All these items discussed come up with any business.

Investing in Virtual Currency:  If an individual invests in virtual currency, then the transaction should be treated just like any other investment.  For example, buying a stock.  The opportunity to be taxed at the lower long term capital gains rate is possible.  The long term capital gains tax rates are generally either 15% or 20%, and then one must not forget the Net Investment Income Tax (NIIT) / (AKA Obamatax).  The individual will need to track their cost basis / tax basis, the date of purchase, the date of sale and the sales price.  The holding period will determine if the transaction will qualify for the reduced long term capital gains rate or not.

In summary, now that the IRS has taken the position that they will treat virtual currency like property from a tax law perspective, income tax now becomes an issue that virtual currency holders didn’t really have to worry about in the past.  It will be interesting to see any debate about the IRS notice and to see how the community will deal with the IRS notice.  Will the community provide the IRS with W-2’s, and 1099’s, or not?  Will the community report virtual currency holdings or not?  It is hard for the IRS to track transactions if they are not reported, but this IRS notice is telling the taxpayer, the law, and the taxpayer would need to comply.

If we look at how aggressive the IRS has been over the last five years regarding offshore bank accounts then one could argue that this taxation on virtual currency is here to stay. The community and network of virtual currency has also provided support that the currency is valuable and easily converted into good and world currencies.  So, if you are involved with virtual currencies, now is the time to speak with your tax advisor and create a plan on how to deal with the taxation and create a strategy just like any other successful business.

The IRS notice can be found at http://goo.gl/ONYs4y as of today.  However, if the link doesn’t work, go to www.irs.gov and search the website for Notice 2014-21.  Please feel free to ask questions and comments.  Please contact us if we can be of assistance.