Tag Archives: TCJA

Tax Cuts and Jobs Act – State and Local Taxes Update

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7 Companies Making Use of a Stock Option Tax Loophole

Summary

The Tax Cuts and Jobs Acts (TCJA) limited the individual tax deduction of state and local taxes (SALT) to $10,000 for married filing joint and $5,000 for married fling separate, or single. We feel this limitation was done to offset tax reductions done to spur the US economy. This limitation hurt and increased income taxes for taxpayers that are residents in states with high taxes. Taxpayers and states have been looking for a method of getting around this tax deduction limitation. Various ideas have failed, but the IRS recently issued IRS Notice 2020-75 which provides some hope. In the notice the IRS is explaining that if a state makes a flow through entity (an S Corporation or Partnership) liable for the income tax, rather than the shareholders or partners, and the entity pays it, then that state tax is not limited. Many states have been looking for a way to help their residence, and the IRS has explained a way, but why hasn’t more states implemented this change if they really want to help their residence? Currently only seven (7) states have made this change.

 

Scope

The purpose of this memo is to discuss Notice 2020-75 issued by Internal Revenue Service (IRS) on November 9, 2020, which allows state and local income taxes imposed on and paid by partnerships or S Corporations in computing its non-separately stated taxable income or loss for the taxable year of payment and are not subject to SALT limitation.

 

Background

Tax Cuts and Job Acts (TCJA) limits the individual deduction of SALT to $10,000 (or $5,000 for married filing separately) for tax years 2018-2025. Due to this limitation, the notice cited that certain jurisdictions have enacted or contemplating to enact tax laws that impose either a mandatory or elective entity-level income tax on partnerships and S Corporations that do business in the jurisdiction or have income derived from or connected with sources within the jurisdiction. The notice pointed out that “certain jurisdictions provide a corresponding offsetting, owner-level tax benefit, such as full or partial credit, deduction, or exclusion” for taxes deducted at the Pass-Through Entity (PTE) level and that Treasury and IRS are “aware of the uncertainty as to whether entity level-payments made under these laws to jurisdictions described in §164(b)(2) other than U.S. territories must be taken into account in applying the SALT deduction limitation at the owner level”.

 

The notice also announced the IRS’s intention to issue a proposed regulation to provide clarity to individual owners of partnerships and S Corporations in calculating their SALT deduction limitations and clarify the Specified Income Tax Payments which are deductible by partnerships and S Corporations in computing their non-separately stated income or loss.

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Discussion/Analysis

  1. Reporting of Deduction in the Partnership or S Corporation Tax Return
    1. Based on the notice, SALT does not need to be separately stated. Thus, it would be expected that the deduction will be reported under “Taxes and Licenses” on Form 1065 or 1120S and will flow-through to partners/shareholders as part of Box 1 “ordinary income or loss” on Schedule K-1.

 

  1. Deductibility of the SALT
    1. As mentioned in the notice, there are “certain jurisdictions” that shifted the individual tax to entity-level tax to “workaround” from the SALT limitation under TCJA and below are the states that imposes entity-level income tax which is referred to as a “Specified Income Tax Payment”:
    2. Connecticut – effective January 1, 2018
    3. Louisiana – election to be made
    4. Maryland – imposed to the distributive shares or pro rata shares of resident members of the PTE
    5. New Jersey – effective January 1, 2020, election to be made
    6. Oklahoma – effective January 1, 2019, needs annual election
    7. Rhode Island – effective January 1, 2019, election to be made
    8. Wisconsin – effective January 1, 2019 for person or persons holding more than 50% of capital and profits of a partnership
  2. According to the notice, if a partnership or an S Corporation makes a Specified Income Tax Payment during the taxable year, the partnership or S Corporation is allowed a deduction for the Specified Income Tax Payment in computing its taxable income for the taxable year in which the payment is made.
  3. The impending proposed regulations defined “Specified Income Tax Payments” as any amount paid by a partnership or an S Corporation to a State, a political subdivision of a State or the District of Columbia (Domestic Jurisdiction) to satisfy its liability for income taxes imposed by the Domestic Jurisdiction on the partnership or S Corporation, meaning, it will solely include the state and local taxes paid under Sec. 164(b)(2) but excluding taxes paid or accrued to foreign countries and U.S. territories under Sec. 703(a)(2)(B) and Sec. 1363(b)(2).

 

  1. Effectivity Date of the Deduction

Based on the notice, the forthcoming Proposed Regulations will apply to payments on or after November 9, 2020, but taxpayers are also permitted to apply the rules to payments made in a partnership or S Corporation tax year ending after December 31, 2017 and before November 9, 2020.

Notes/Comments

  1. This is a taxpayer friendly decision made by IRS. It is expected that other states, particularly those that impose high personal income tax rates on residents that are disproportionately affected by the $10,000 SALT deduction cap may enact similar laws in response to IRS guidance.
  2. Currently, California and many other high tax states have not made this beneficial change. If you live in a state with high income taxes, I suggest you contact them.
  3. Individual states and every individual have unique tax calculations and applications of tax laws, so please contact us if you have questions.

Congress gives a holiday gift in the form of favorable tax provisions

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A good news for all of those who are planning their Tax Return preparation, as part of a year-end budget bill, Congress just passed a package of tax provisions that will provide savings for some taxpayers. The White House has announced that President Trump will sign the Further Consolidated Appropriations Act of 2020 into law. It also includes a retirement-related law titled the Setting Every Community Up for Retirement Enhancement (SECURE) Act.

Here’s a rundown of some provisions in the two laws.

The age limit for making IRA contributions and taking withdrawals is going up. Currently, an individual can’t make regular contributions to a traditional IRA in the year he or she reaches age 70½ and older. (However, contributions to a Roth IRA and rollover contributions to a Roth or traditional IRA can be made regardless of age.)

Under the new rules, the age limit for IRA contributions is raised from age 70½ to 72.

The IRA contribution limit for 2020 is $6,000, or $7,000 if you’re age 50 or older (the same as 2019 limit).

In addition to the contribution age going up, the age to take required minimum distributions (RMDs) is going up from 70½ to 72.

It will be easier for some taxpayers to get a medical expense deduction. For 2019, under the Tax Cuts and Jobs Act (TCJA), you could deduct only the part of your medical and dental expenses that is more than 10% of your adjusted gross income (AGI). This floor makes it difficult to claim a write-off unless you have very high medical bills or a low income (or both). In tax years 2017 and 2018, this “floor” for claiming a deduction was 7.5%. Under the new law, the lower 7.5% floor returns through 2020.

If you’re paying college tuition, you may (once again) get a valuable tax break. Before the TCJA, the qualified tuition and related expenses deduction allowed taxpayers to claim a deduction for qualified education expenses without having to itemize their deductions. The TCJA eliminated the deduction for 2019 but now it returns through 2020. The deduction is capped at $4,000 for an individual whose AGI doesn’t exceed $65,000 or $2,000 for a taxpayer whose AGI doesn’t exceed $80,000. (There are other education tax breaks, which weren’t touched by the new law, that may be more valuable for you, depending on your situation.)

Some people will be able to save more for retirement. The retirement bill includes an expansion of the automatic contribution to savings plans to 15% of employee pay and allows some part-time employees to participate in 401(k) plans.

Also included in the retirement package are provisions aimed at Gold Star families, eliminating an unintended tax on children and spouses of deceased military family members.

Stay tuned

These are only some of the provisions in the new laws. We’ll be writing more about them in the near future. In the meantime, contact us with any questions.

© 2019

Business year-end tax planning in a TCJA world

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The first tax-filing season under the Tax Cuts and Jobs Act (TCJA) was a time of uncertainty for many businesses as they struggled with the implications of the law’s sweeping changes for their bottom lines. With the next filing season on the horizon, you can incorporate the lessons learned into your Tax return preparation. Several areas in particular are ripe with opportunities to reduce your 2019 federal tax liability.

Entity choice

The creation of the qualified business income (QBI) deduction for pass-through entities, paired with the reduction of the corporate tax rate to a flat 21% rate from a top rate of 35%, make it worthwhile to re-evaluate whether your current entity type is the most tax-favorable.

Pass-through entities, including sole proprietorships, partnerships and S corporations, traditionally have been seen as a way to avoid the double taxation C corporations are subject to at the entity and dividend levels. Pass-through entities are taxed only once, at an individual tax rate, but that rate can be as high as 37%. If they qualify for the full 20% QBI deduction — not always a sure thing (see below) — their effective tax rate is about 30%.

The deduction for state and local taxes also plays a role in the entity choice. The TCJA limits the amount of the deduction for individual pass-through entity owners, but not for corporations.

Bear in mind, too, that the reduced corporate tax rate is permanent (or as permanent as any tax cut can be), while the QBI deduction is slated to end after 2025. Ultimately, your business’s individual circumstances will determine the optimal structure.

The QBI deduction

Pass-through entities can take several steps before December 31 to maximize their QBI deduction. The deduction is subject to phased-in limitations based on W-2 wages paid (including many employee benefits), the unadjusted basis of qualified property and taxable income. You could boost your deduction, therefore, by increasing wages (for example, by hiring new employees, giving raises or making independent contractors employees). To increase your adjusted basis, you can invest in qualified property by year end.

If the W-2 wages limitation doesn’t limit the QBI deduction, S corporation owners can increase their QBI deductions by reducing the amount of wages the business pays them. (This tactic won’t work for sole proprietorships or partnerships, because they don’t pay their owners salaries.) On the other hand, if the W-2 wages limitation limits the deduction, they might be able to take a greater deduction by increasing their wages.

Tax credits

Some of the most popular tax credits for businesses survived the tax overhaul, including the Work Opportunity Tax Credit (WOTC), the Small Business Health Care tax credit, the New Markets Tax Credit (NMTC) and the research credit (also referred to as the “research and development,” “R&D” or “research and experimentation” credit). Smaller businesses may qualify for a credit for starting new retirement plans.

The WOTC, generally worth a maximum of $2,400 per employee (although for certain employees that can increase to $9,600), is currently scheduled to expire on December 31, so make those qualified hires before year end. The NMTC — 39% over seven years — also is set to expire at year end.

Capital asset investments

Purchasing equipment and other qualified capital assets has been a valuable tool for reducing taxable income for years, but the TCJA further greased the wheels by expanding bonus depreciation and Section 179 expensing (that is, deducting the entire cost in the current tax year).

For qualified property purchased after September 27, 2017, and before January 1, 2023, you can deduct the entire cost of new and used (subject to certain conditions) qualified property in the year the property is placed in service. Special rules apply to property with a longer production period.

Eligible property includes computer systems, computer software, vehicles, machinery, equipment and office furniture. Starting in 2023, the amount of the deduction will drop 20% each year going forward, disappearing altogether in 2027, absent congressional action.

Congress has thus far failed to take action to correct a drafting error in the TCJA that leaves qualified improvement property (generally interior improvements to nonresidential real property) ineligible for bonus deprecation.

Qualified improvement property is, however, eligible for Sec. 179 expensing. The TCJA makes this expensing available to several improvements to nonresidential real property, including roofs, HVAC, fire protection systems, alarm systems and security systems. It also increases the maximum deduction for qualifying property: For 2019, the limit is $1.02 million. (The maximum deduction is limited to the amount of income from business activity.) The expensing deduction begins phasing out on a dollar-for-dollar basis when qualifying property placed in service this year exceeds $2.55 million.

Deferring income / accelerating expenses

This technique has long been employed by businesses that don’t expect to be in a higher tax bracket the following year. If you use cash-basis accounting, for example, you might defer income into 2020 by sending your December invoices toward the end of the month. (Note that the TCJA now allows businesses with three-year average annual gross receipts of $25 million or less to use cash-basis accounting.) If your accounting is done on an accrual basis, you could delay delivery of goods and services until January.

Any business can accelerate deductible expenses into 2019 by putting them on a credit card in late December and paying it off in 2020 (subject to limitations). And cash-basis businesses can prepay bills due in January, as well as certain other expenses. Some caveats now apply to this approach. First, it could affect the amount of the QBI deduction for pass-through entities. It might make more sense to maximize the deduction while it’s still around — the deduction currently is scheduled to sunset after 2025 and, depending on the results of the 2020 elections, could be eliminated before then. Moreover, this tactic isn’t advisable if you’re likely to face higher tax rates in the future.

Act now

You still have time to make a significant dent in your business’s federal tax liability for 2019. We can help you chart the best course forward to minimize your tax bill and put you on solid ground for upcoming tax years.

© 2019

It’s not too late to trim your 2019 tax bill

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Fall is in the air and that means it’s time to turn your attention to year-end tax planning. While several clear strategies and tactics emerged during the first tax filing season under the Tax Cuts and Jobs Act (TCJA), 2019 and subsequent years bring potential twists that must be considered, too. Let’s take a closer look at year-end tax planning strategies that can reduce your 2019 income tax liability.

Deferring income and accelerating expenses

Deferring income into the next tax year and accelerating expenses into the current tax year is a time-tested technique for taxpayers who don’t expect to be in a higher tax bracket the following year. Independent contractors and other self-employed individuals can, for example, hold off on sending invoices until late December to push the associated income into 2020. And all taxpayers, regardless of employment status, can defer income by taking capital gains after January 1. Be careful, though, because by waiting to sell you also risk the possibility that your investment might become less valuable.

Bear in mind, also, that there may be other reasons that taking the income this year can be more beneficial. For starters, future tax rates can go up. It’s possible that income tax rates might increase substantially by 2021, especially for those with higher incomes, depending on 2020 election results. In any event, in 2026, the higher tax rates that were in place for 2017 are scheduled to return.

Moreover, taxpayers who qualify for the qualified business income (QBI) deduction for pass-through entities (that is, sole proprietors, partnerships, limited liability companies and S corporations) could end up reducing the size of that deduction if they reduce their income. It might make more sense to maximize the QBI deduction — which is scheduled to end after 2025 — while it’s available.

Timing itemized deductions

The TCJA substantially boosted the standard deduction. For 2019, it’s $24,400 for married couples and $12,200 for single filers. With many of the previously popular itemized deductions eliminated or limited, some taxpayers can find it challenging to claim more in itemized deductions than the standard deduction. Timing, or “bunching,” those deductions may make it easier.

Bunching basically means delaying or accelerating deductions into a tax year to exceed the standard deduction and claim itemized deductions. You could, for example, bunch your charitable contributions if it means you can get a tax break for one tax year. If you normally make your donations at the end of the year, you can bunch donations in alternative years — say, donate in January and December of 2020 and January and December of 2022.

If you have a donor-advised fund (DAF), you can make multiple contributions to it in a single year, accelerating the deduction. You then decide when the funds are distributed to the charity. If, for instance, your objective is to give annually in equal increments, doing so will allow your chosen charities to receive a reliable stream of yearly donations (something that’s critical to their financial stability), and you can deduct the total amount in a single tax year.

If you donate appreciated assets that you’ve held for more than one year to a DAF or a nonprofit, you’ll avoid long-term capital gains taxes that you’d have to pay if you sold the property and (subject to certain restrictions) also obtain a deduction for the assets’ fair market value. This tactic pays off even more if you’re subject to the 3.8% net investment income tax or the top long-term capital gains tax rate (20% for 2019).

What if you’re looking to divest yourself of assets on which you have a loss? Rather than donate the asset, the better move from a tax perspective is more likely going to be to sell it to take advantage of the loss and then donate the proceeds.

Timing also comes into play with medical expenses. The TCJA lowered the threshold for deducting unreimbursed medical expenses to 7.5% of adjusted gross income (AGI) for 2017 and 2018, but it bounces back to 10% of AGI for 2019. Bunching qualified medical expenses into one year could make you eligible for the deduction.

You also could bunch property tax payments (assuming local law permits you to pay in advance). This approach might, however, bring your total state and local tax deduction over the $10,000 limit, which means that you’d effectively forfeit the deduction on the excess.

As with income deferral and expense acceleration, you need to consider your tax bracket status when timing deductions. Itemized deductions are worth more when you’re in a higher tax bracket. If you expect to land in a higher bracket in 2020, you’ll save more by timing your deductions for that year.

Loss harvesting against capital gains

2019 has been a turbulent year for some investments. Thus, your portfolio may be ripe for loss harvesting — that is, selling underperforming investments before year end to realize losses you can use to offset taxable gains you also realized this year, on a dollar-for-dollar basis. If your losses exceed your gains, you generally can apply up to $3,000 of the excess to offset ordinary income. Any unused losses, however, may be carried forward indefinitely throughout your lifetime, providing the opportunity for you to use the losses in a subsequent year.

Maximizing your retirement contributions

As always, individual taxpayers should consider making their maximum allowable contributions for the year to their IRAs, 401(k) plans, deferred annuities and other tax-advantaged retirement accounts. For 2019, you can contribute up to $19,000 to 401(k)s and $6,000 for IRAs. Those age 50 or older are eligible to make an additional catch-up contribution of $1,000 to an IRA and, so long as the plan allows, $6,000 for 401(k)s and other employer-sponsored plans.

Accounting for 2019 TCJA changes

Most — but not all — provisions of the TCJA took effect in 2018. The repeal of the individual mandate penalty for those without qualified health insurance, for example, isn’t effective until this year. In addition, the TCJA eliminates the deduction for alimony payments for couples divorced in 2019 or later, and alimony recipients are no longer required to include the payments in their taxable income.

Act now

The future of tax planning is uncertain — even without dramatic change in Washington, D.C., many of the most significant TCJA provisions are set to expire within six years. Contact us for help with your year-end tax planning.

© 2019

IRS updates rules for personal use of employer-provided vehicles

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The IRS recently announced the inflation-adjusted maximum value of an employer-provided vehicle under the vehicle cents-per-mile rule and the fleet-average value rule. Employers can use the rules to value an employee’s personal use of such a vehicle for income and employment tax purposes.

The new values reflect vehicle-related amendments in the Tax Cuts and Jobs Act (TCJA) and the IRS’s intent to make the rules more widely available to employers. The IRS is also temporarily loosening some of the consistency requirements for 2018 and 2019.

Valuation methods for personal use
When an employer provides an employee with a vehicle that’s available for personal use, it must include the value of the personal use in the employee’s income. Employers generally have four methods available to value an employee’s personal use of a company car:

  1. General valuation rule. This involves the fair market value (FMV), which is defined as the amount the employee would have to pay a third party to lease the same or similar vehicle on the same or comparable terms in the geographic area where the employee uses the vehicle.
  2. Commuting valuation rule. This is the amount of each one-way commute, from home to work or from work to home, multiplied by $1.50. (This method’s availability is subject to stringent requirements, including having a written policy limiting the employee’s use to commuting and “de minimis” personal use.)
  3. The cents-per-mile rule. Employers can use the business standard mileage rate (58 cents for 2019, less up to 5.5 cents if the employer doesn’t provide fuel) multiplied by the total miles the employee drives the vehicle (including cars, trucks and vans) for personal purposes.
  4. The automobile annual lease valuation rule. With this method, employers use the annual lease value of the automobile (including trucks and vans) — as specified by an IRS table that bases annual lease value on an automobile’s FMV — multiplied by the percentage of personal miles out of total miles driven by the employee. This amount also is subject to a fuel adjustment.

The fleet-average value rule allows employers operating a fleet of 20 or more qualifying automobiles to use an average annual lease value for every qualifying vehicle in the fleet when applying the automobile annual lease valuation rule.

The fleet-average value rule or the simple cents-per-mile rule isn’t available, though, if the FMV of the vehicle exceeds a certain base value, adjusted annually for inflation, on the first date the vehicle is made available to the employee for personal use. In 2017, the maximum value for the cents-per-mile rule was $15,900 for a passenger automobile and $17,800 for a truck or van. The maximum value for the fleet-average value rule that year was $21,100 for a passenger automobile and $23,300 for a truck or van.

The role of the TCJA
The base values were raised significantly earlier this year, in IRS Notice 2019-08, to reflect amendments made by the TCJA. The law changes the price inflation measure for automobiles (including trucks and vans). It also substantially increases the maximum annual dollar limitations on the depreciation deductions for passenger automobiles, basing the latter on the depreciation of a passenger automobile with a cost of $50,000 (up from $12,800), inflation adjusted annually, over a five-year recovery period.

The IRS announced in the guidance that it intended to amend the tax regulations to incorporate a base value of $50,000 for both the cents-per-mile and the fleet-average value rules, effective for the 2018 calendar year. It also intended to amend the regulations to provide that the base value will be adjusted annually for 2019 and future years using the new price inflation measure.

The latest news
Now, in Notice 2019-34, the IRS has announced the adjusted values for 2019. For vehicles and automobiles first made available to employees for personal use in calendar year 2019, the maximum value under both rules is $50,400. Under planned amendments to the applicable regulations, these maximum values will be the same as the maximum standard automobile cost that determines eligibility to set reimbursement allowances under a fixed and variable rate (FAVR) plan — an alternative to the business standard mileage rate.

The IRS also shared its intention to amend the tax regulations to provide relief to employers that previously didn’t qualify for the cents-per-mile rule because, under the earlier rules, the vehicle’s FMV exceeded the permissible maximum value. Under amended regulations, the employer may first adopt the cents-per-mile valuation rule for 2018 or 2019 based on the maximum value of a vehicle for 2018 or 2019.

Note, though, that employers that adopt the cents-per-mile rule generally must continue to use it for all subsequent years in which the vehicle qualifies for it. An employer can, however, use the commuting valuation rule for any year the vehicle qualifies.

Similarly, employers that didn’t qualify for the fleet-average value rule before 2019 because of the pre-2018 maximum value limit can adopt the rule for 2018 or 2019 if it falls under the applicable maximum value.

The new notice confirms that employers can use the flexible guidelines in Announcement 85-113 to determine the timing for when personal use income is deemed paid. That means employers may use the rules in that guidance, the adjustment process, or the refund claim process to correct any over-payment of federal employment taxes resulting from application of the notice’s transition relief.

Additional requirements
Satisfying the maximum value limit isn’t enough for an employer to use the cents-per-mile rule or the fleet-average value rule to value an employee’s personal use of a vehicle. Both rules come with other requirements that can prove difficult to meet. For example, the cents-per-mile rule generally is available only if the employer reasonably expects the vehicle to be regularly used in its trade or business throughout the calendar year or the vehicle meets the mileage test. We can help you determine the appropriate valuation method for your circumstances.
© 2019

It’s a good time to check your withholding and make changes, if necessary

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Due to the massive changes in the Tax Cuts and Jobs Act (TCJA), the 2019 filing season resulted in surprises. Some filers who have gotten a refund in past years wound up owing money. The IRS reports that the number of refunds paid this year is down from last year — and the average refund is lower. As of May 10, 2019, the IRS paid out 101,590,000 refunds averaging $2,868. This compares with 102,582,000 refunds paid out in 2018 with an average amount of $2,940.

Of course, receiving a tax refund shouldn’t necessarily be your goal. It essentially means you’re giving the government an interest-free loan.

Law changes and withholding
Last year, the IRS updated the withholding tables that indicate how much employers should hold back from their employees’ paychecks. In general, the amount withheld was reduced. This was done to reflect changes under the TCJA — including the increase in the standard deduction, suspension of personal exemptions and changes in tax rates.

The new tables may have provided the correct amount of tax withholding for some individuals, but they might have caused other taxpayers to not have enough money withheld to pay their ultimate tax liabilities.

Conduct a “paycheck checkup”
The IRS is cautioning taxpayers to review their tax situations for this year and adjust withholding, if appropriate.

The tax agency has a withholding calculator to assist you in conducting a paycheck checkup. The calculator reflects tax law changes in areas such as available itemized deductions, the increased child credit, the new dependent credit and the repeal of dependent exemptions. You can access the IRS calculator at https://bit.ly/2aLxK0A.

Situations where changes are needed
There are a number of situations when you should check your withholding. In addition to tax law changes, the IRS recommends that you perform a checkup if you:

  • Adjusted your withholding in 2018, especially in the middle or later part of the year,
  • Owed additional tax when you filed your 2018 return,
  • Received a refund that was smaller or larger than expected,
  • Got married or divorced, had a child or adopted one,
  • Purchased a home, or
  • Had changes in income.

You can modify your withholding at any time during the year, or even multiple times within a year. To do so, you simply submit a new Form W-4 to your employer. Changes typically go into effect several weeks after a new Form W-4 is submitted. (For estimated tax payments, you can make adjustments each time quarterly estimated payments are due. The next payment is due on Monday, June 17.)

We can help
Contact us to discuss your specific situation and what you can do to remedy any shortfalls to minimize taxes due, as well as any penalties and interest. We can help you sort through whether or not you need to adjust your withholding.

© 2019

Stretch your college student’s spending money with the dependent tax credit

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If you’re the parent of a child who is age 17 to 23, and you pay all (or most) of his or her expenses, you may be surprised to learn you’re not eligible for the child tax credit. But there’s a dependent tax credit that may be available to you. It’s not as valuable as the child tax credit, but when you’re saving for college or paying tuition, every dollar counts!

Background of the credits
The Tax Cuts and Jobs Act (TCJA) increased the child credit to $2,000 per qualifying child under the age of 17. The law also substantially increased the phaseout income thresholds for the credit so more people qualify for it. Unfortunately, the TCJA eliminated dependency exemptions for older children for 2018 through 2025. But the TCJA established a new $500 tax credit for dependents who aren’t under-age-17 children who qualify for the child tax credit. However, these individuals must pass certain tests to be classified as dependents.

A qualifying dependent for purposes of the $500 credit includes:

1.    A dependent child who lives with you for over half the year and is over age 16 and up to age 23 if he or she is a student, and
2.    Other non-child dependent relatives (such as a grandchild, sibling, father, mother, grandfather, grandmother and other relatives).

To be eligible for the $500 credit, you must provide over half of the person’s support for the year and he or she must be a U.S. citizen, U.S. national or U.S. resident.

Both the child tax credit and the dependent credit begin to phase out at $200,000 of modified adjusted gross income ($400,000 for married joint filers).

The child’s income
After the TCJA passed, it was unclear if your child would qualify you for the $500 credit if he or she had any gross income for the year. Fortunately, IRS Notice 2018-70 favorably resolved the income question. According to the guidance, a dependent will pass the income test for the 2018 tax year if he or she has gross income of $4,150 or less. (The $4,150 amount will be adjusted for inflation in future years.)

More spending money
Although $500 per child doesn’t cover much for today’s college student, it can help with books, clothing, software and other needs. Contact us with questions about whether you qualify for either the child or the dependent tax credits.

© 2019

Vehicle-expense deduction ins and outs for individual taxpayers

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It’s not just businesses that can deduct vehicle-related expenses. Individuals also can deduct them in certain circumstances. Unfortunately, the Tax Cuts and Jobs Act (TCJA) might reduce your deduction compared to what you claimed on your 2017 return.

For 2017, miles driven for business, moving, medical and charitable purposes were potentially deductible. For 2018 through 2025, business and moving miles are deductible only in much more limited circumstances. TCJA changes could also affect your tax benefit from medical and charitable miles.

Current limits vs. 2017

Before 2018, if you were an employee, you potentially could deduct business mileage not reimbursed by your employer as a miscellaneous itemized deduction. But the deduction was subject to a 2% of adjusted gross income (AGI) floor, which meant that mileage was deductible only to the extent that your total miscellaneous itemized deductions for the year exceeded 2% of your AGI. For 2018 through 2025, you can’t deduct the mileage regardless of your AGI. Why? The TCJA suspends miscellaneous itemized deductions subject to the 2% floor.

If you’re self-employed, business mileage is deducted from self-employment income. Therefore, it’s not subject to the 2% floor and is still deductible for 2018 through 2025, as long as it otherwise qualifies.

Miles driven for a work-related move in 2017 were generally deductible “above the line” (that is, itemizing isn’t required to claim the deduction). But for 2018 through 2025, under the TCJA, moving expenses are deductible only for certain military families.

Miles driven for health-care-related purposes are deductible as part of the medical expense itemized deduction. Under the TCJA, for 2017 and 2018, medical expenses are deductible to the extent they exceed 7.5% of your AGI. For 2019, the floor returns to 10%, unless Congress extends the 7.5% floor.

The limits for deducting expenses for charitable miles driven haven’t changed, but keep in mind that it’s an itemized deduction. So, you can claim the deduction only if you itemize. For 2018 through 2025, the standard deduction has been nearly doubled. Depending on your total itemized deductions, you might be better off claiming the standard deduction, in which case you’ll get no tax benefit from your charitable miles (or from your medical miles, even if you exceed the AGI floor).

Differing mileage rates

Rather than keeping track of your actual vehicle expenses, you can use a standard mileage rate to compute your deductions. The rates vary depending on the purpose and the year:

  • Business: 54.5 cents (2018), 58 cents (2019)
  • Medical: 18 cents (2018), 20 cents (2019)
  • Moving: 18 cents (2018), 20 cents (2019)
  • Charitable: 14 cents (2018 and 2019)

In addition to deductions based on the standard mileage rate, you may deduct related parking fees and tolls. There are also substantiation requirements, which include tracking miles driven.

Get help

Do you have questions about deducting vehicle-related expenses? Contact us. We can help you with your 2018 return and 2019 tax planning.

© 2019

IRS provides QBI deduction guidance in the nick of time

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When President Trump signed into law the Tax Cuts and Jobs Act (TCJA) in December 2017, much was made of the dramatic cut in corporate tax rates. But the TCJA also includes a generous deduction for smaller businesses that operate as pass-through entities, with income that is “passed through” to owners and taxed as individual income.

The IRS issued proposed regulations for the qualified business income (QBI), or Section 199A, deduction in August 2018. Now, it has released final regulations and additional guidance, just before the first tax season in which taxpayers can claim the deduction. Among other things, the guidance provides clarity on who qualifies for the QBI deduction and how to calculate the deduction amount.

QBI deduction in action
The QBI deduction generally allows partnerships, limited liability companies, S corporations and sole proprietorships to deduct up to 20% of QBI received. QBI is the net amount of income, gains, deductions and losses (excluding reasonable compensation, certain investment items and payments to partners) for services rendered. The calculation is performed for each qualified business and aggregated. (If the net amount is below zero, it’s treated as a loss for the following year, reducing that year’s QBI deduction.)

If a taxpayer’s taxable income exceeds $157,500 for single filers or $315,000 for joint filers, a wage limit begins phasing in. Under the limit, the deduction can’t exceed the greater of 1) 50% of the business’s W-2 wages or 2) 25% of the W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified business property (QBP).

For a partnership or S corporation, each partner or shareholder is treated as having paid W-2 wages for the tax year in an amount equal to his or her allocable share of the W-2 wages paid by the entity for the tax year. The UBIA of qualified property generally is the purchase price of tangible depreciable property held at the end of the tax year.

The application of the limit is phased in for individuals with taxable income exceeding the threshold amount, over the next $100,000 of taxable income for married individuals filing jointly or the next $50,000 for single filers. The limit phases in completely when taxable income exceeds $415,000 for joint filers and $207,500 for single filers.

The amount of the deduction generally can’t exceed 20% of the taxable income less any net capital gains. So, for example, let’s say a married couple owns a business. If their QBI with no net capital gains is $400,000 and their taxable income is $300,000, the deduction is limited to 20% of $300,000, or $60,000.

The QBI deduction is further limited for specified service trades or businesses (SSTBs). SSTBs include, among others, businesses involving law, financial, health, brokerage and consulting services, as well as any business (other than engineering and architecture) where the principal asset is the reputation or skill of an employee or owner. The QBI deduction for SSTBs begins to phase out at $315,000 in taxable income for married taxpayers filing jointly and $157,500 for single filers, and phase out completely at $415,000 and $207,500, respectively (the same thresholds at which the wage limit phases in).

The QBI deduction applies to taxable income and doesn’t come into play when computing adjusted gross income (AGI). It’s available to taxpayers who itemize deductions, as well as those who don’t itemize, and to those paying the alternative minimum tax.

Rental real estate owners
One of the lingering questions related to the QBI deduction was whether it was available for owners of rental real estate. The latest guidance (found in IRS Notice 2019-07) includes a proposed safe harbor that allows certain real estate enterprises to qualify as a business for purposes of the deduction. Taxpayers can rely on the safe harbor until a final rule is issued.

Generally, individuals and entities that own rental real estate directly or through disregarded entities (entities that aren’t considered separate from their owners for income tax purposes, such as single-member LLCs) can claim the deduction if:

  • Separate books and records are kept for each rental real estate enterprise,
  • For taxable years through 2022, at least 250 hours of services are performed each year for the enterprise, and
  • For tax years after 2018, the taxpayer maintains contemporaneous records showing the hours of all services performed, the services performed, the dates they were performed and who performed them.

The 250 hours of services may be performed by owners, employees or contractors. Time spent on maintenance, repairs, rent collection, expense payment, provision of services to tenants and rental efforts counts toward the 250 hours. Investment-related activities, such as arranging financing, procuring property and reviewing financial statements, do not.

Be aware that rental real estate used by a taxpayer as a residence for any part of the year isn’t eligible for the safe harbor.

This safe harbor also isn’t available for property leased under a triple net lease that requires the tenant to pay all or some of the real estate taxes, maintenance, and building insurance and fees, or for property used by the taxpayer as a residence for any part of the year.

Aggregation of multiple businesses
It’s not unusual for small business owners to operate more than one business. The proposed regs include rules allowing an individual to aggregate multiple businesses that are owned and operated as part of a larger, integrated business for purposes of the W-2 wages and UBIA of qualified property limitations, thereby maximizing the deduction. The final regs retain these rules with some modifications.

For example, the proposed rules allow a taxpayer to aggregate trades or businesses based on a 50% ownership test, which must be maintained for a majority of the taxable year. The final regulations clarify that the majority of the taxable year must include the last day of the taxable year.

The final regs also allow a “relevant pass-through entity” — such as a partnership or S corporation — to aggregate businesses it operates directly or through lower-tier pass-through entities to calculate its QBI deduction, assuming it meets the ownership test and other tests. (The proposed regs allow these entities to aggregate only at the individual-owner level.) Where aggregation is chosen, the entity and its owners must report the combined QBI, wages and UBIA of qualified property figures.

A taxpayer who doesn’t aggregate in one year can still choose to do so in a future year. Once aggregation is chosen, though, the taxpayer must continue to aggregate in future years unless there’s a significant change in circumstances.

The final regs generally don’t allow an initial aggregation of businesses to be done on an amended return, but the IRS recognizes that many taxpayers may be unaware of the aggregation rules when filing their 2018 tax returns. Therefore, it will permit taxpayers to make initial aggregations on amended returns for 2018.

UBIA in qualified property
The final regs also make some changes regarding the determination of UBIA in qualified property. The proposed regs adjust UBIA for nonrecognition transactions (where the entity doesn’t recognize a gain or loss on a contribution in exchange for an interest or share), like-kind exchanges and involuntary conversions.

Under the final regs, UBIA of qualified property generally remains unadjusted as a result of these transactions. Property contributed to a partnership or S corporation in a nonrecognition transaction usually will retain its UBIA on the date it was first placed in service by the contributing partner or shareholder. The UBIA of property received in a like-kind exchange is generally the same as the UBIA of the relinquished property. The same rule applies for property acquired as part of an involuntary conversion.

SSTB limitations
Many of the comments the IRS received after publishing the proposed regs sought further guidance on whether specific types of businesses are SSTBs. The IRS, however, found such analysis beyond the scope of the new guidance. It pointed out that the determination of whether a particular business is an SSTB often depends on its individual facts and circumstances.

Nonetheless, the IRS did establish rules regarding certain kinds of businesses. For example, it states that veterinarians provide health services (which means that they’re subject to the SSTB limits), but real estate and insurance agents and brokers don’t provide brokerage services (so they aren’t subject to the limits).

The final regs retain the proposed rule limiting the meaning of the “reputation or skill” clause, also known as the “catch-all.” The clause applies only to cases where an individual or a relevant pass-through entity is engaged in the business of receiving income from endorsements, the licensing of an individual’s likeness or features, or appearance fees.

The IRS also uses the final regs to put a lid on the so-called “crack and pack” strategy, which has been floated as a way to minimize the negative impact of the SSTB limit. The strategy would have allowed entities to split their non-SSTB components into separate entities that charged the SSTBs fees.

The proposed regs generally treat a business that provides more than 80% of its property or services to an SSTB as an SSTB if the businesses share more than 50% common ownership. The final regs eliminate the 80% rule. As a result, when a business provides property or services to an STTB with 50% or more common ownership, the portion of that business providing property or services to the SSTB will be treated as a separate SSTB.

The final regs also remove the “incidental to an SSTB” rule. The proposed rule requires businesses with at least 50% common ownership and shared expenses with an SSTB to be considered part of the same business for purposes of the deduction if the business’s gross receipts represent 5% or less of the total combined receipts of the business and the SSTB.

Note, though, that businesses with some income that qualifies for the deduction and some that doesn’t can still separate the different activities by keeping separate books to claim the deduction on the eligible income. For example, banking activities (taking deposits, making loans) qualify for the deduction, but wealth management and similar advisory services don’t, so a financial services business could separate the bookkeeping for these functions and claim the deduction on the qualifying income.

REIT investments
The TCJA allows individuals a deduction of up to 20% of their combined qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income, including dividends and income earned through pass-through entities. The new guidance clarifies that shareholders of mutual funds with REIT investments can apply the deduction. The IRS is still considering whether PTP investments held via mutual funds qualify.

Proceed with caution
The tax code imposes a penalty for underpayments of income tax that exceed the greater of 10% of the correct amount of tax or $5,000. But the TCJA leaves less room for error by taxpayers claiming the QBI deduction: It lowers the threshold for the underpayment penalty for such taxpayers to 5%. We can help you avoid such penalties and answer all of your questions regarding the QBI deduction.

© 2019

Why you shouldn’t wait to file your 2018 income tax return

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The IRS opened the 2018 income tax return filing season on January 28. Even if you typically don’t file until much closer to the April 15 deadline, this year consider filing as soon as you can. Why? You can potentially protect yourself from tax identity theft — and reap other benefits, too.

What is tax identity theft?
In a tax identity theft scheme, a thief uses your personal information to file a fraudulent tax return early in the tax filing season and claim a bogus refund.

You discover the fraud when you file your return and are informed by the IRS that the return has been rejected because one with your Social Security number has already been filed for the same tax year. While you should ultimately be able to prove that your return is the legitimate one, tax identity theft can cause major headaches to straighten out and significantly delay your refund.

Filing early may be your best defense: If you file first, it will be the tax return filed by a would-be thief that will be rejected — not yours.

What if you haven’t received your W-2s and 1099s?
To file your tax return, you must have received all of your W-2s and 1099s. January 31 was the deadline for employers to issue 2018 Form W-2 to employees and, generally, for businesses to issue Form 1099 to recipients of any 2018 interest, dividend or reportable miscellaneous income payments.

If you haven’t received a W-2 or 1099, first contact the entity that should have issued it. If that doesn’t work, you can contact the IRS for help.

What are other benefits of filing early?
Besides protecting yourself from tax identity theft, the most obvious benefit of filing early is that, if you’re getting a refund, you’ll get that refund sooner. The IRS expects more than nine out of ten refunds to be issued within 21 days.

But even if you owe tax, filing early can be beneficial. You still won’t need to pay your tax bill until April 15, but you’ll know sooner how much you owe and can plan accordingly. Keep in mind that some taxpayers who typically have gotten refunds in the past could find themselves owing tax when they file their 2018 return due to tax law changes under the Tax Cuts and Jobs Act (TCJA) and reduced withholding from 2018 paychecks.

Need help?
If you have questions about tax identity theft or would like help filing your 2018 return early, please contact us. While the new Form 1040 essentially does fit on a postcard, many taxpayers will also have to complete multiple schedules along with the form. And the TCJA has changed many tax breaks. We can help you ensure you file an accurate return that takes advantage of all of the breaks available to you.

© 2019