Author Archives: Carol Coburn

Tax Savings Tips September 2019

Make the RMD from Your Traditional IRA Tax-Free

Once you turn age 70 1/2, the tax code mandates that you withdraw a tax code–defined required minimum distribution (RMD) from your traditional IRA.

But by using the RMD or other IRA distribution with a qualified charitable distribution (QCD), you can eliminate the RMD tax bite, possibly reduce your Medicare premiums, possibly reduce the income taxes on your Social Security benefits, and more.

After you reach age 70 1/2, the tax code allows you to donate directly from your IRA account up to $100,000 per year in QCDs.

  • The QCD-donated money escapes income taxes and also does not count as adjusted gross income (AGI).
  • The QCDs can satisfy all or part of your RMD requirement.
  • The QCD doesn’t bump up against the mandated ceiling—50 percent of AGI—that applies to cash donations.

You likely will want to use the QCD if you donate money to your church, a school, or some other 501(c)(3) organization, such as the Red Cross or the American Cancer Society.

Rule 1. Make your QCD donation to a qualifying 501(c)(3) organization, such as your church, a school, or the Red Cross. Your QCD cannot go to a private foundation, a donor-advised fund, or a charitable supporting organization.

Rule 2. Don’t touch the money. The trustee must make the check or transfer payable to the charity (not to you).

Double dip. You get a double-dip benefit when you don’t itemize deductions and you contribute directly from your IRA to a charity.

  • First, you get the benefit of the standard deduction.
  • Second, you get the benefit of the direct charitable contribution deduction because it cancels your RMD income, making the RMD tax-free.

To put this another way, with the IRA-to-charity contribution, you (the non-itemizing taxpayer) create a deduction where none existed before. And these days, because of the Tax Cuts and Jobs Act, you are less likely to itemize.

Save on Medicare premiums. The government bases the Medicare premiums that you pay on the AGI reported on your tax return two years ago (e.g., your 2019 payments are based on your 2017 tax return). To see how you can save, consider this:

  • If you take the IRA money directly, it adds to your AGI, which can increase your Medicare premium costs in 2019.
  • If you use the QCD method, you add nothing to your AGI.

 Pay less tax on your Social Security benefits. Before 1984, you paid no income taxes on your Social Security benefits. Today, you have to add together your AGI, your tax-exempt income, and half of your Social Security benefits, and then pay taxes at your regular tax rate on

  • 50 percent of the Social Security benefit, if the computed amount is between $25,000 and $34,000 ($32,000 and $44,000 for joint returns), and
  • 85 percent of the Social Security benefit, if the computed amount exceeds $34,000 ($44,000 for joint returns).

The taxable RMD adds to your AGI and can make more of your Social Security benefits taxable.

Solution. Avoid the RMD taxable income inclusion with the direct IRA-to-charity donation, and that, in turn, can cut the taxes you are paying on your Social Security benefits.

 Shrink the net investment income tax (NIIT). You pay the 3.8 percent NIIT on investment income when your modified AGI is greater than $200,000 ($250,000 for joint returns).

Would your required IRA RMD add to your AGI and make you subject to this tax? If so, consider making the RMD disappear with the direct IRA-to-charity strategy because this lowers your AGI.

Take Advantage of the 199A Deduction for 2019

If you operate your business as a pass-through entity, such as a proprietorship, partnership, or S corporation, the profits of that business can generate the Section 199A tax deduction.

No-Problem Businesses

You qualify for the Section 199A deduction—period, regardless of pass-through business type—when you have

  • pass-through qualified business income (QBI), and
  • 2019 Form 1040 taxable income equal to or less than $160,700 single (and head of household) or $321,400 married, filing jointly.

With Form 1040 taxable income equal to or less than the thresholds listed above, doctors, lawyers, accountants, financial planners, stockbrokers, manufacturers, retailers, consultants, and all other businesses with pass-through income qualify for the deduction.

There’s no out-of-favor specified service business problem with income below the thresholds. And the calculation is easy.

With taxable income equal to or less than the thresholds, you qualify for the Section 199A deduction. Your deduction will equal the lesser of

  • 20 percent of your Form 1040 taxable income less net capital gains and dividends, or
  • 20 percent of your QBI.

Note that qualification for the deduction starts with your Form 1040 taxable income.

Example. You are married with joint taxable income of $320,000 and QBI of $350,000. Your Section 199A deduction is $64,000.

As you can see, no issues. If your taxable income is above the thresholds, you need to consider tax planning—now. Why now? Because some strategies require that you have time on your side.

For example, if you switch from a proprietorship to an S corporation to benefit from the W-2 wage strategy, your switch does not begin until you have the S corporation in place.

If you are looking at a retirement plan strategy, you want time to consider your options and get that tax-savings plan in place.

How Corporations Reduce IRS Audits of Home-Office Deductions

If you filed your business income and expenses as a proprietor in 2017 and reported $100,000 or more in gross receipts, your chances of IRS audit were 2.4 percent (2017 returns are still open for audit, so the percentage could increase). Had you reported this income as an S corporation, your chances of audit were only 0.20 percent.

You have probably read that the home-office deduction increases your chances of IRS audit. We’ve read that, too, but we don’t believe it. Regardless, let’s assume that you’re a little paranoid about audits, and you want to claim the home-office deduction in a way that doesn’t attract the attention of the IRS.

If you operate as a corporation, your home-office deduction does not show on either your personal return or your corporate return if you have the corporation reimburse the office as an employee business expense.

With reimbursement, the corporation claims the deduction for the expenses it reimburses to you. The corporation probably puts the reimbursement into a category called “office expenses” or something similar. Thus, the home-office deduction as a name or title does not appear in the corporate return.

You receive the reimbursement from the corporation as a reimbursed employee expense. You do not report employee-expense reimbursements as taxable income on your personal return. Thus, you do not identify the home office on your personal return.

With this method, the home-office deduction does not appear under a home-office label on either the corporate or personal tax return.

Act Fast to Claim a 30 Percent Tax Credit for Residential Solar Panels

Here’s a heads-up. The 30 percent residential solar credit

  • drops to 26 percent for tax year 2020,
  • drops to 22 percent for tax year 2021, and
  • terminates in 2022.

Also, unlike the 30 percent commercial solar credit, where you can qualify for the 30 percent tax credit when you commence construction (as defined by the IRS, but easy to do), your 30 percent residential credit is granted when you place the solar property in service.

If you are thinking of the 30 percent tax credit for a solar installation on a residence you own, don’t let the time slip away, because you must have the solar property in use before December 31 to qualify for the 30 percent tax credit (dollar for dollar).

Be Aware of Tax Issues While Working Abroad

Here are three quick things to know about working abroad.

Issue 1: Section 199A

To qualify for the Section 199A deduction, your business income must be effectively connected with the conduct of a trade or business within the United States. The preamble to the proposed Section 199A regulations clarified that in almost all circumstances, this means the income has to be U.S.-source income to qualify.

Under the tax law, you source your compensation for personal services based on where you perform the services.

For example, you perform all services for U.S. citizens living in the United States from your office in Norway. The services for the U.S.-based citizens do not generate U.S.-source income; therefore, you do not qualify for the Section 199A tax deduction.

Issue 2: Income Tax

You have two ways to reduce or eliminate the U.S. income tax on your foreign-source income:

  • Foreign earned income exclusion
  • Foreign tax credit

The only way you’ll know for sure is to calculate your return using both methods and pick the one with the better outcome.

Issue 3: Self-Employment Tax

If you file a Schedule C, you already know you need to pay self-employment tax on your net Schedule C income. However, the U.S. has totalization agreements with certain countries to avoid double Social Security taxation. These agreements usually apply to self-employed individuals.

The IRS expects to see self-employment tax when there is a Schedule C on a tax return, so be sure to do the following:

  • Get a Certificate of Coverage from the country where you reside, to help prove to the IRS you are exempt from self-employment tax.
  • File Form 8275, Disclosure Statement, with your tax return to disclose the position that you are exempt from self-employment tax due to the totalization agreement.

 Warning

If you have an interest in or signature authority over foreign financial accounts or other foreign financial assets, you may have to file special forms in addition to your tax return.

If you don’t file the forms but had a filing requirement, the penalties could be severe: as high as $12,981 per form per year. or more.

Damages you Receive for Physical Injury or Physical Sickness

Damages you receive for physical injuries or physical sickness are tax free.  Amounts to compensate for emotions distress are generally taxable, the Tax Court confirms

(Doyle, TC Memo. 2019-8).

Many S Corporation Owner have a New Requirement This Year

Owners of S Corporations must include basis information with their  Form 1040.  In the past many S Corporations that had less than $250,000 in income and $250,000 in assets did not have to include a balance sheet with the filing of their Form 1120-S to the IRS, however, now that the new code Section 199-A has been added by the 2017 Tax Reform Act. Additionally, certain S firm shareholders must now check a box on line 28 of Schedule E and attach a basis computation.  This requirement applies to those who report a loss, dispose of their stock or receive a distribution or loan repayment from the company. These taxpayers can use the shareholder stock basis and debt basis worksheets in the Shareholder’s Instruction from Schedule K-1 (Form 1120S) for this purpose.

Tax Preparation Fees are No Longer Deductible on Schedule A

Thank to the Tax Reform Act of 2017 miscellaneous itemized deductions subject to the 2% limitation have been repealed at least until after 2025.  But if you have to file Schedules C, E or F you can still write off part of the cost. The portion of the tax preparer’s fee that apply to those schedules and related forms; 4797, 4562, 4952, 8594 1045 or Schedule D.

Extension of Time To File Business Returns is Over This Month

Personal Forms 1040 have until October 15th is you have an extension of time to file Form 4868.

Respectfully,

Al Whalen, EA, ATA, CFP®

e-mail:  al@whalengroup.com

Web Site: www.whalengroup.com

 

 

 

Tax-Saving Tips August 2019

THE WHALEN GROUP

Tax-Saving Tips

August 2019

How Much is One Trillion:

 There are 60 seconds in a minute, that’s 3600 seconds per hour and 24 hours in a day, that’s 86,400 seconds in a day, 365 days in a year, that’s 31,536,000 seconds in a year.  Since the birth of Christ or since we have kept the calendar we are not 2/3’s the way to a trillion in seconds.  That’s right it takes 3,170 and ½ years of seconds to get to a Trillion. Why is that important?  Many candidates and legislators either do not understand the size of the number or what the economy would have to do to produce enough income to support some of their suggestions.

FACTS:

 A GOVERNMENT DEFICIT– The Social Security Trust Fund paid out $853.5 billion in 2018, more than the $831.0 billion the fund produced in total income. The 2018 deficit breaks a streak of 34 consecutive years (1984-2017) of “income exceeding cost.”  As recently as 2009, the annual surplus was $134 billion (source: OASI Trust Fund).

  1. Social Security Issue. The estimated Social Security shortfall today (i.e., a present value number) between the future taxes anticipated being collected and the future benefits expected to be paid out over the next 75 years is 13.9 trillion.  The entire $13.9 trillion deficit could be eliminated by an immediate 2.7 percentage point increase in combined Social Security payroll tax rate (from 12.4% to 15.1%) or an immediate 17% reduction in benefits that are paid out to current and future beneficiaries (source: Social Security Trustees).
  2. Medicare Issue. Per a 4/22/19 report, the trust fund supporting Medicare Part A (hospital insurance) is projected to be depleted by 2026.  The long-term (75 year) present value shortfall in the trust fund could be corrected by an immediate 0.91 percentage point increase in combined Medicare payroll taxes (from its current 2.9% to 3.81%) or an immediate 19% reduction in Medicare expenditures (source: Medicare Trustees 2019 Report).

 

Roth IRA versus Traditional IRA: Which Is Better for You?

Roth IRAs tend to get a lot of hype, and for good reason: because you pay the taxes up front, your eventual withdrawals (assuming you meet the age and holding-period requirements—more on these below) are completely tax-free.

While we like “tax-free” as much as the next person, there are times when a traditional IRA will put more money in your pocket than a Roth would.

Making the Decision on What’s Best

Example. Say that your tax rate is 32 percent and that you will invest $5,000 a year in an IRA and earn 6 percent interest. Should you put the $5,000 a year into a Roth or a traditional IRA?

Say further that neither you nor your spouse is covered by a workplace retirement plan, so you can contribute the $5,000 a year without worry because it’s under the contribution limits. If your income is too high for the Roth IRA, you make the $5,000 contribution via the backdoor.

Traditional IRA

If you invest the $5,000 in a traditional IRA, you create a side fund of $1,600 ($5,000 x 32 percent). On the side fund, you pay taxes each year at 32 percent, making your side fund grow at 4.08 percent (68 percent of 6 percent).

Roth IRA

Roth contributions are not deductible; this means no side fund, so your annual investment remains at $5,000.

Cashing Out

For the Roth, your marginal tax rate at the time of your payout doesn’t matter because you paid your taxes before the money went into the account. The whole amount is now yours, with no additional taxes due.

But for the traditional IRA, your current tax bracket matters a great deal. You have taken care of the taxes on the side fund annually along the way, but the traditional IRA (both growth and contributions) is taxed at your current marginal tax rate at the time you cash out.

The table below shows you how this looks with tax rates of 22 percent, 32 percent, and 37 percent at the time you cash out (winners are in bold):

 

Marginal tax rate at cash-out 10 years @ 6% 20 years @ 6% 30 years @ 6% 40 years @ 6%
22% Trad: $74,557

Roth: $69,858

Trad: $202,074

Roth: $194,964

Trad: $421,482

Roth: $419,008

Trad: $801,048

Roth: $820,238

32% Trad: $67,571

Roth: $69,858

Trad: $182,578

Roth: $194,964

Trad: $379,581

Roth: $419,008

Trad: $719,024

Roth: $820,238

37% Trad: $64,079

Roth: $69,858

Trad: $172,830

Roth: $194,964

Trad: $358,630

Roth: $419,008

Trad: $678,012

Roth: $820,238

 

You can see that the traditional IRA needs a low tax rate at the time of cash-out to win. But even in the 22 percent cash-out tax rate, the Roth wins at the 40-year mark.

Rate of Growth

What about your rate of growth? Do variances here change things any? Let’s take a look.

Here, we’ll look at different rates of growth for a fixed period (30 years) before you withdraw your money. Once again, we’ll consider three different marginal tax rates at the time you cash out—22 percent, 32 percent, and 37 percent.

 

Marginal tax rate at cash-out 3% for 30 years 6% for 30 years 9% for 30 years 12% for 30 years
22% Trad: $257,760

Roth: $245,013

Trad: $421,482

Roth: $419,008

Trad: $716,547

Roth: $742,876

Trad: $1,256,032

Roth: $1,351,463

32% Trad: $233,259

Roth: $245,013

Trad: $379,581

Roth: $419,008

Trad: $642,260

Roth: $742,876

Trad: $1,120,886

Roth: $1,351,463

37% Trad: $221,008

Roth: $245,013

Trad: $358,630

Roth: $419,008

Trad: $605,116

Roth: $742,876

Trad: $1,053,312

Roth: $1,351,463

In the scenarios above, the traditional IRA/side fund combo wins only when your marginal tax rate is lower at the time of withdrawal and only at the lower growth rates.

At higher rates of return—9 percent and 12 percent, in our examples above—the Roth still wins, even if you’re in a higher tax bracket when you withdraw your money.

Tax Factor

What’s going on here? For starters, the side fund is not tax-favored in any way. Plus, taxes hobble your cash-out on the traditional IRA:

  • You pay taxes as you earn the money in the side fund.
  • You pay taxes on the accumulated growth inside the traditional IRA when you withdraw the money.

Creating More Business Meal Tax Deductions After the TCJA

Here’s good news for business meals: the Tax Cuts and Jobs Act (TCJA) removed the “directly related and associated with” requirements from business meals.

The net effect of this change is to subject business meals once again to the pre-1963 “ordinary and necessary” business expense rules.

You are going to like these rules.

Restaurants and Bars

Question 1. If, for business reasons, you take a customer to breakfast, lunch, or dinner at a restaurant or hotel, or to a bar for a few drinks, but you do not discuss business, can you deduct the costs of the meals and drinks?

Answer 1. Yes. Even though you did not discuss business, the law provides that if the circumstances are of a type generally considered conducive to a business discussion, you may deduct the expenses for meals and beverages to the extent they are ordinary and necessary expenses. Consider this “no discussion” meal a “quiet business meal.”

Question 2. What are circumstances conducive to a business discussion?

Answer 2. This depends on the facts, taking into account the surroundings in which the meals or beverages are furnished, your business, and your relationship to the person entertained. The surroundings should be such that there are no substantial distractions to the discussion.

Generally, a restaurant, a hotel dining room, or a similar place that does not involve distracting influences, such as a floor show, is considered conducive to a business discussion. On the other hand, business meals at nightclubs, sporting events, large cocktail parties, and sizable social gatherings would not generally be conducive to a business discussion.

Meals Served in Your Home

Question 3. Does a business meal served in your home disqualify the deduction?

Answer 3. No, as long as you serve the food and beverages under circumstances conducive to a business discussion. But because you are in your home, the IRS adds that you must clearly show that the expenditure was commercially rather than socially motivated.

Goodwill Meals

Question 4. If, for goodwill purposes, you take a customer and his or her spouse to lunch and don’t discuss business, will the cost of the lunch become non-deductible?

Answer 4. Not if, in light of all facts and circumstances, the surroundings are considered conducive to a business discussion, and the expenses are ordinary and necessary expenses of carrying on the business rather than socially motivated expenses.

Question 5. Is the situation the same if the taxpayer’s spouse accompanies the taxpayer at a dinner for business goodwill reasons?

Answer 5. Yes, the meal is deductible. This is true whether or not the customer’s spouse is present. Again, the meal must meet the ordinary and necessary business expense standards.

Document the Meal Deductions

You need to keep records that prove your business meals are ordinary and necessary business expenses. You can accomplish this by keeping the following:

  1. Receipts that show the purchases (food and drinks consumed)
  2. Proof of payment (credit card receipt/statement or canceled check)
  3. Note of the name of the person or persons with whom you had the meals
  4. Record of the business reason for the meal (a short note—say, seven words or fewer)

The costs of your business meals continue to be 50 percent deductible (as they were before the TCJA).

Beware: IRS Error in Rental Property Deduction Publication

Here’s a heads-up on mortgage insurance.

Personal Residence Mortgage Insurance

The deduction for mortgage insurance on a qualified residence ended on December 31, 2017. But don’t give up on the deduction.

The personal residence mortgage insurance deduction is part of what is called “tax extenders,” and it’s highly possible that lawmakers will reinstate the deduction retroactively for all of 2018 and 2019. That’s the good news. The bad news is that to claim the retroactive deduction we will need to amend your 2018 tax return.

Rental Property Mortgage Insurance—IRS Mistake

Online at the IRS frequently asked rental property questions, you will find the following question and incorrect answer:

Question: Can you deduct private mortgage insurance (PMI) premiums on rental property? If so, which line item on Schedule E?

Answer: No, you can’t claim a deduction for private mortgage insurance premiums.

This is wrong.

The cause for the error comes from IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes), where on page 1 in the “What’s New” section, the IRS states that the deduction for mortgage insurance premiums expired and you can’t claim that deduction for premiums after 2017 unless lawmakers extend the break.

The mistake that the IRS makes in its publication and FAQ is that the expiration of the mortgage insurance deduction applies to your qualified personal residence, not your rental property.

Rules for Rental Property Mortgage Insurance

You generally treat mortgage insurance on rental property loans and mortgages as an ordinary and necessary business rental expense that you deduct on Schedule E against the income from that rental property. Depending on the type of loan, you could pay the mortgage insurance either in a lump sum or annually as you make your mortgage payments.

How you treat the mortgage insurance premiums depends on how the proceeds of the loan are used, rather than on the character of the property that you mortgage. For example, you could take a mortgage on your personal residence and use the proceeds from the loan for a rental property, an investment, or personal purposes.

Planning note. You deduct the mortgage insurance on the rental properties over the period of benefit. For example, if you make a one-time payment, you amortize the mortgage insurance over the life of the loan.

If you make annual payments because of, say, a mortgagor requirement of a loan-to-equity ratio or other formula, you deduct the mortgage insurance premiums as you pay them.

Record Keeping Requirements and Retention:

Note: Keep copies of your filed tax returns. They help in preparing future tax returns and making computations if you file an amended return.

Period of Limitations that apply to income tax returns

  1. Keep records for 3 years if situations (4), (5), and (6) below do not apply to you.
  2. Keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return.
  3. Keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction.
  4. Keep records for 6 years if you do not report income that you should report, and it is more than 25% of the gross income shown on your return.
  5. Keep records indefinitely if you do not file a return.
  6. Keep records indefinitely if you file a fraudulent return.
  7. Keep employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later. I am currently advising my clients to use their employment tax records to verify with Social Security.

The following questions should be applied to each record as you decide whether to keep a document or throw it away.

Are the records connected to property?

Generally, keep records relating to property until the period of limitations expires for the year in which you dispose of the property. You must keep these records to figure any depreciation, amortization, or depletion deduction and to figure the gain or loss when you sell or otherwise dispose of the property.

If you received property in a nontaxable exchange, your basis in that property is the same as the basis of the property you gave up, increased by any money you paid. You must keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which you dispose of the new property.

What should I do with my records for nontax purposes?

When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes. For example, your insurance company or creditors may require you to keep them longer than the IRS does.

As a tax professional, I am required to keep a copy of your return or a listing of returns I prepare for only three years.  This I will do, along with the source documents applicable to your filing. I currently keep copies longer than the required three years.

If records are lost or otherwise destroyed, the Internal Revenue Service, for a fee, will provide a copy of the return, but they have no source documents.

This letter also serves as a reminder to keep your records in a safe and secure environment.

Respectfully,

Al Whalen, EA, ATA, CFP®

Email: al@whalengroup.com

Web Site: www.whalengroup.com

 

Tax-Saving Tips July 2019

THE WHALEN GROUP

July 2019

Proven Tax Reduction Strategies for Sole Proprietors

If you operate your business as a sole proprietorship, there are many strategies to reduce your taxes.

Let’s start with the following 10:

  1. Use the Section 105 plan to make your health insurance a tax-favored business deduction on your Schedule C.
  2. Employ your under-age-18 child to make taxable income disappear.
  3. Employ your spouse without paying him or her a W-2 wage.
  4. Rent your office, even your home office, from your spouse to save self-employment taxes.
  5. Establish that an office in your home is your principal office to increase (yes, increase!) your vehicle deductions and also turn personal home expenses into business expenses.
  6. Give yourself flowers, fruit, and books as tax-deductible fringe benefits.
  7. Combine the home office and a heavy SUV, crossover vehicle, or pickup truck to grab big deductions this year.
  8. Design a business trip that includes some personal days—days you treat as 100 percent business even though you don’t work on those days.
  9. Use the seven-day tax deduction travel rule to create a business trip that is 87 percent personal vacation.
  10. Deduct your smartphone and provide smartphones to your employees as tax-free fringe benefits.

If one or more of these look good to you, let’s talk about how to make them work.

Incorporation Is Not for Everyone

If you’re not good at paperwork, the corporate form of business is probably not for you.

Let me tell you about a tax court case involving William H. Bruecher III. He learned a lesson by paying more than $27,000 in taxes on monies his corporation supposedly loaned to him. Mr. Bruecher’s corporation did not pay him a salary; rather, the corporation paid his personal expenses, classifying the payments as advances.

Advance Account on Corporate Books

Advances handled properly do not create a tax problem. The IRS in an audit, or the court in a decision, first looks to see whether the advances are loans or dividends. If repayment by the owner and collection by the corporation seem assured, or actually take place in a later year, the advance is a loan.

Intent to Repay

To decide whether there is intent to repay, the court looks at factors such as the following:

  • Promissory notes or other written promises to repay the advance
  • Interest charges on the advance
  • Collateral to ensure repayment
  • Past history of repayment

Neither Mr. Bruecher nor his corporation could produce any of these. Further, the very personal nature of some of the advances (such as divorce settlement payments, child support payments, and payments to the grocery store) got the court’s attention.

In court, Mr. Bruecher delivered his self-serving testimony and presented as evidence the corporate tax return, on which the advances were classified as loans. Not good enough, ruled the court, as it made the advances taxable dividends to Mr. Bruecher.

Takeaways

When you operate as a corporation, the corporation is a separate legal entity, and you should have a corporate paper trail that clearly reflects intent and action.

  • C corporation. Clear out the advance account and make the advances interest-bearing loans, with specific repayment dates.
  • S corporation. Either offset the advances with the distribution account or evidence the advances as interest-bearing loans.

 “It is a good thing that we do get as much government as we pay for” – Will Rogers

 How to Deduct Cruise Ship Conventions, Seminars, and Meetings

If you want to attend a convention, seminar, or similar meeting onboard a cruise ship and deduct all your costs, you face some very special rules. But it can be done.

When you know the tax code rules, you will find an enlightened workaround that removes almost all the hassle and gives you what you want. The IRS considers all ships that sail cruise ships.

In 1982, your lawmakers were attempting to give the U.S. cruise ship industry a leg up by outlawing all cruise ship conventions, seminars, and similar meetings other than those

  • that take place on a vessel registered in the United States, and
  • for which all ports of call of such vessel are located in the United States or in possessions of the United States.

The 1982 law remains on the books. Lawmakers have not updated the limits for inflation. Here’s the cruise ship convention tax code rule as it existed in 1982 and as it exists today:

With respect to cruises beginning in any calendar year, not more than $2,000 of the expenses attributable to an individual attending one or more meetings may be taken into account under Section 162 . . .”

Had the $2,000 been indexed for inflation, the 2019 amount would be a reasonable $5,431, and that would likely encourage more 2019 U.S. cruise ship convention-type travel.

The $2,000 is pretty skimpy when you consider that the expenses include

  • the cost of air or other travel to get to and from the cruise ship port;
  • the cost of the cruise; and
  • the cost of the convention, seminar, or similar meeting.

Bigger, Better Deductions with Less Hassle

This is a way you can avoid the $2,000 limit, take the cruise you want, and likely deduct all your costs. And this does not have to involve a U.S. ship. Any ship from any country works.

Here’s the strategy. You take the cruise ship to a convention, seminar, or meeting that’s held

  • on land, say at a hotel, and
  • in the tax-law-defined North American area.

When you meet the two easy requirements above, you deduct (a) the full cost of getting to and from the location; (b) the full cost of the convention, seminar, or similar meeting; and (c) likely the full cost of the cruise if your onboard ship expenses are less than the 2019 daily luxury water limits.

Using the 2019 luxury water limits, if your average daily cost of the cruise is $692 or less, you can use this strategy to deduct all cruise ship costs to travel to and from the seminar.

Impact of Death, Retirement, and Disability on the 179 Deduction

What tax effect would death, retirement, or disability have on you or your business? Here’s an easy example to illustrate.

Let’s say that in 2017, you purchased for business use a pickup truck with a gross vehicle weight rating greater than 6,000 pounds. Asserting that you use the pickup 100 percent for business, you expensed the entire $55,000 cost.

What happens to that $55,000 expensed amount if you die, retire, or become disabled before the end of the vehicle’s five-year depreciation period?

Death

If your heirs are not going to pay estate taxes, your death is about as good as it gets. Here’s why: You get to keep your Section 179 deduction. (It goes to the grave with you.)

Your pickup truck gets marked up to fair market value. (Remember, you expensed it to zero, but now at your death, the fair market value is the new basis to your heir or heirs.)

Example. Using Section 179, you expensed the entire cost of your $55,000 pickup truck. You die. Your daughter inherits the pickup at its fair market value, which is now $31,000, and sells it immediately for $31,000. Here are the results:

  • You get to keep your Section 179 deduction—no recapture applies.
  • Your daughter pays zero tax on her sale of the pickup truck.
  • Your estate includes the $31,000 fair market value of the pickup, and if your estate is less than $11.4 million, your estate pays no estate taxes.

Disability

This is ugly. If you become disabled and you allow your business use of the pickup to fall to 50 percent or below during its five-year depreciable life, you must recapture and pay taxes on the excess deductions generated by the Section 179 deduction.

To make matters worse, you must use straight-line depreciation in making the excess-deduction calculation.

Retirement

With retirement, you have exactly the same problem as you would have if you were to become disabled. In fact, with retirement, you disable your business involvement, and that makes your pickup truck fail the more-than-50-percent-business-use test, resulting in recapture of the excess benefit over straight-line depreciation.

“I am proud to be paying taxes in the United States.  The only thing is I could be just as proud for half the money” – Arthur Godfrey

IRS Scan Notices:

 Two new IRS impersonation telephone scams are on the agency’s radar.  In one, thieves posing as IRS employees tell victims they owe back taxes and must pay up fast or their Social Security numbers will be suspended or cancelled.  The second involves the mailing of letters threatening liens or levies for unpaid taxes.  The letters reference the “Bureau of Tax Enforcement,” which does not exist.

 What To Do If You Receive a CP2000 Notice From The IRS

These letters let you know the agency computers found a discrepancy between income and deductions you reported on your tax return, remember know human eye has seen this until you open the letter.  The IRS computer receives data for employer form W-2, Form 1099, Form 1098 and others, the data is electronically compare to what you reported on your tax return, when there is a difference not in your favor out pops the CP2000 letter. What you should do: First, check your records.  If you agree with the proposed changes, return the form with your payment, if you do not have the money now explain when it can be paid or arrange for an installment payment plan. Second is you do not agree then send the document back to the IRS with a explanation of why you disagree. Third, always respond time, within 30 days of the date on the form, you can call the IRS if you need more time, but do not ignore the CP2000.  Remember you can call our office a get help  NO Charge weather a client or not.

Estate Tax Issues.

 D.C. and 12 states currently levy their own estate taxes on some decedents. Conn., Hawaii, ILL., Maine, MD., Mass., Minn., N.Y., Ore., R.I., Vt. And Wash.  The estate tax exemption amounts in the 13 locales vary widely from state to state.  However, no state has raised its exemption amount to match the current federal level: $11,400,000 per person $22,800,000 for couples if portability is timely elected on form 706 for the first to die spouse.  Iowa, Ky., Md., N.J. and Pa. have inheritance taxes.

Willfully Failing to Report Foreign Accounts Can Lead to a Stiff Penalty.

 Under the statute, the fine is the greater of $100,000 or 50% of the highest balance in the accounts. But courts are split on whether the fine is capped.  The regulations state that the penalty shall be no greater than $100,000.

Eight district courts have addressed the conflict between the regs and the statute.  Two say the Service is bound by the $100,000 cap set forth in the regulations, and six agree that the statute controls.  The IRS slapped a $614,000 penalty on a man for willful failure to disclose his accounts.  The court reviewed the state of law and upheld the fine (Schoenfeld, D.C., Fla.).  Source Kiplinger The conclusion here should be, always report foreign bank and investment accounts if at any time during the years the aggregate value exceeds $10,000.  There is no penalty for having a foreign investment or bank accounts only for not reporting them.

‘Alexander Hamilton started the U.S. Treasury with nothing and that was the closest our country has ever been to being even.” – Will Rogers

 Inheriting an IRA Poses Hazard for Some Heirs.

 Arranging our estate to avoid or limit taxation is important with IRAs you can have named beneficiaries which avoid probate at death.  A spouse beneficiary can have the account transferred to their IRA, a non-spouse beneficiary can receive it as an inherited IRA and take distributions over their lifetime or lump-sum distributions at their leisure after making it an inherited IRA.  An inherited IRA title is different, meaning if John Doe died naming a son as beneficiary (William Doe) the title should read “John Doe (deceased April 1, 2019) IRA for the benefit of William Doe.”

Depending on the IRA being age 70 ½  or older makes a difference with the options you may have as beneficiary.  If you are a spouse and RMDs have not started then you have 4 options:

  1. Treat as your own IRA by transferring to an existing IRA account or starting a new one.
  2. Five-Year Rule (decedent had not begun RMDs) The spouse beneficiary must withdraw the entire balance by December 31 of the fifth year after the IRA owner’s death.
  3. Life Expectancy Payments (available if deceased had or had not begun RMDs) The spouse beneficiary can take distributions over life expectancy using the recalculation or nonrecalculation   These distributions must begin by December 31 of the year after the IRA owner’s death.
  4. Take the entire IRA amount in Lum-sum fully taxable.

The non-spouse beneficiary have 3 options:

  1. Take the beneficiary portion in limp sum, fully taxable (no premature penalty).
  2. Use the Five-Year Rule as in 2 above.
  3. Life Expectancy Payments as in 3 above.

The worst situation is to not have a beneficiary elected, then the IRA is subject to probate and must be Lump-sum distribution fully taxable.  Remember reviewing the beneficiary election you have chosen is important for instance assume the beneficiary you have named as passed away then the IRA must be probated  and distributed fully taxable as if you had not named a beneficiary. Remember that if the distribution is not in the final year of the Estate Return then it will be taxed at the Estate & Trust Tax Rates:

Taxable Income                                                                  2019 Tax

Not over $2,600                                                                   10% of the taxable income

Over $2.600 but not over $9,300                                                 $260 plus 24% of excess over $2600

Over $9,300 but not over $12,750                                               $1,868 plus 35% of the excess over $9,300

Over $12,750                                                                               $3,075.50 plus 37% of the excess over $12,750

At the Whalen Group we do estate planning and will review your wills, trust, Durable Powers of Attorney for Healthcare and Finance, beneficiaries and other important estate documents at NO CHARGE just make an appointment.

REMEMBER to refer a friend to the Web Site or to be added to the e-mail list for the newsletters.

 Respectfully,
Al Whalen, EA, ATA, CFP®

10501 W Gowan Rd Ste 100

Las Vegas, NV 89129

Phone:  (702) 878-3900

al@whalengroup.com

Web Site: www.whalengroup.com

 

 

 

Tax Savings Tips

April 2019

Good News: Most Rentals Likely Qualify as Section 199A Businesses

The Tax Cuts and Jobs Act tax reform added new tax code Section 199A, which created a 20 percent tax deduction possibility for you if your rental property (a) has profits and (b) can qualify as a trade or business.

As the law now stands, with rentals that achieve trade or business status, you win. Your business-status rental property creates the following five possible tax benefits for you:

  1. Your rental property can create a Section 199A tax deduction of up to 20 percent of the rental property’s qualified business income.
  2. Your rental property receives tax-favored Section 1231 treatment, which (upon sale) delivers with a tax loss—an ordinary loss (the best kind of loss)—and with a tax-favored capital gain (the best kind of gain).
  3. Your rental property can create the home-office deduction if you meet the other home-office requirements of exclusive and regular use.
  4. Your rental-business status creates rental property deductions for the cost of your attendance at rental property meetings, seminars, and conventions.
  5. Your rental-business status enables Section 179 expensing for certain assets used in the business (special rules apply to the real property).

To obtain the benefits listed above, you must have a rental property that qualifies as a trade or business.
How to Reimburse Medicare When You Have Fewer Than 20 Employees

The Affordable Care Act’s $100-a-day penalty for improper medical reimbursements likely has your attention. And it should. But you can find many reimbursements that are allowed without penalty, including the ability to reimburse Medicare when you have fewer than 20 employees.

Some group insurance plans do not cover Medicare-eligible employees if the group plan covers fewer than 20 employees because:

  • With fewer than 20 employees, the insurance company is the primary payer and Medicare is secondary.
  • With 20 or more employees, Medicare is the primary payer and the insurance company is secondary.

If you (a) offer group insurance coverage to your fewer-than-20-employee workforce and (b) have one or more of the fewer than 20 employees on Medicare, you may use a health reimbursement account (HRA) or other account-based plan to reimburse Medicare parts B and/or D and Medigap insurance, if you satisfy the following requirements:

  1. You offer a group health plan to employees who are not eligible for Medicare.
  2. The employee receiving the HRA or other account-based Medicare reimbursement plan is actually enrolled in Medicare Part B or D.
  3. You make the HRA or other account-based Medicare reimbursement plan available only to employees who are enrolled in Medicare Part B or D.
  4. You permit the Medicare employee to permanently opt out of and waive future reimbursements from the HRA or other account-based plan at least annually and upon termination of employment.

What Can I Do If My K-1 Omits 199A Information?

Tax reform’s Section 199A deduction often confuses small-business owners and tax professionals alike. It’s quite possible you’ll get a Schedule K-1 from a business that omits the information you need to calculate your deduction.

What do you do?

You have a big problem. Without a properly completed Schedule K-1, your Section 199A deduction is a big fat $0.

Best option: fix the K-1. You should request a corrected Schedule K-1 from the entity giving you the Schedule K-1 so you have the information you need to calculate your Section 199A deduction.

Not-so-great options. If you can’t get a corrected Schedule K-1, you have two options:

  1. Take no Section 199A deduction.
  2. File Form 8082 with your tax return and claim the Section 199A deduction.

You file Form 8082 with your tax return when you take a position on your tax return that is inconsistent with the Schedule K-1 you received.

Since the final regulations presume the Section 199A amounts are $0 when omitted, it is possible Form 8082 can rebut that presumption. The truth is, we do not know for sure.

You can determine qualified business income, but not W-2 wages or unadjusted basis immediately after acquisition of qualified property, from the other information on the Schedule K-1. Therefore, the Form 8082 option is likely available only if you are under the Section 199A taxable income threshold ($315,000 on a joint return or $157,500 for all other filing statuses).

You also might use Form 8082 if your Schedule K-1 has wrong Section 199A information—for example, if the K-1 indicates the business is a specified service trade or business, but it is not.

Amended return. If you did not take a Section 199A deduction and you eventually get a corrected Schedule K-1, you can claim the deduction on an amended return and obtain a refund.
Terminating Your S Corporation Election

Tax reform may have you thinking of changing your S corporation to a C corporation, partnership, or sole proprietorship.

With such a switch, you need to consider:

  • How do I terminate the S corporation election correctly?
  • What are the tax consequences to me?

If you want to turn your S corporation into a C corporation, you file an S corporation election revocation statement with the IRS. Your corporation is then a C corporation for federal tax purposes.

If you don’t want your business to be either an S or a C corporation, you liquidate the S corporation and contribute the assets to a new business entity.

If you chose S corporation taxation for your limited liability company (LLC), changing that election is a little more complicated.

First, you must file the S corporation election revocation statement with the IRS. The tax law then treats your LLC as a C corporation for federal tax purposes.

If that’s what you want, stop there.

If you want a disregarded entity (single-member LLC) or a partnership (multi-member LLC), you also need to file Form 8832, Entity Classification Election, to revoke the C corporation election.
Improvement Property Update

Qualified improvement property is any improvement to the interior portion of a building that is nonresidential real property (think office buildings and shopping centers) if you place the improvement in service after the date you place the building in service.

Lawmakers intended qualified improvement property to be 15-year property and eligible for 100 percent bonus depreciation. Not so.

Due to a drafting error in the Tax Cuts and Jobs Act (TCJA), qualified improvement property is currently 39-year property and ineligible for bonus depreciation.

One possible workaround for some taxpayers: qualified improvement property is Section 179 property, so you can elect to expense it using Section 179. But as you probably know, Section 179 is not available to everyone and has its limitations, which can affect your ability to claim it.

Congress has several bills that contain the fix. For example, the Tax Technical and Clerical Corrections Act, introduced in the House of Representatives, would fix the qualified improvement property issue retroactively, along with many other TCJA issues.

 

The best solution is to wait. If you can, hold off filing your tax return until after lawmakers fix the problem retroactively. Then you can claim bonus depreciation on your 2018 qualified improvement property on your extended 2018 tax return.

If Congress retroactively fixes the qualified improvement property issue after you file your 2018 tax return, you’ll have to amend your tax return in order to get the benefits of qualified improvement property being 15-year property.

The Affordable Care Act (ACA) tax penalty is over starting in 2019. For tax years after 2018 the penalty for not having qualifying health care coverage is gone.

Higher Income Earners may have experienced larger tax bills even though the highest tax rate has been lowered.  The three most lightly issues are the two surtaxes on upper income earners and the SALT tax.

There is a .09% tax on earned income in excess of $200,000 for single filers and $250,000 for joint filers. There is a 3.8% tax on net investment income for single and head of household filer when modified adjusted gross income exceeds $200,000 and $250,000 for married couples.  Many filers are learning that the tax deductible portion of their Taxes paid on itemized deduction for state and local tax was limited to $10,000 this year. This naturally affects individuals with state income, however, high income earners generally pay higher sales tax and have lager purchase item, such as, purchases of automobiles, boats and other large items.

PLANNING NOTE:  If you receive a state income tax refund this year you must take care to allocate the correct amount as income on your 2019 tax return. IRS has issue a Revenue Ruling 2019-11 for examples on figuring how much of your state refund is taxable on your 2019 tax return.  We will discuss the examples in future letters.

REMEMBER YOU CAN REVIEW THIS AND OTHER LETTERS ON MY WEB SITE; www.whalengroup.com

 Respectfully,
Al Whalen, EA,ATA, CFP®

Tax-Saving Tips

 

THE WHALEN GROUP

Tax-Saving Tips

February 2019

IRS Issues Final Section 199A Regulations and Defines QBI

Your ownership of a pass-through trade or business can generate a Section 199A tax deduction of up to 20 percent of your qualified business income (QBI). The C corporation does not generate this deduction, but the proprietorship, partnership, S corporation, and certain trusts, estates, and rental properties do.

The tax code says QBI includes the net dollar amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.

Sole Proprietorship QBI

The QBI for the sole proprietor begins with your net business profit as shown on your Schedule C. You then adjust that profit as follows:

  • Subtract the deduction for self-employed health insurance.
  • Subtract the deduction for one-half of the self-employment tax.
  • Subtract qualified retirement plan deductions.
  • Subtract Section 1231 net losses (ignore gains).

Example. You have $120,000 of net income on Schedule C. You deducted $10,000 for self-employed health insurance, $8,478 for one-half of your self-employment taxes, and $10,000 for a SEP-IRA contribution. Your QBI is $91,522 ($120,000 – $10,000 – $8,478 – $10,000).

Rental Property QBI

If you own rental property as an individual or through a single-member LLC for which you did not elect corporate taxation, you report your rental activity on Schedule E of your Form 1040. If you can claim the property is a trade or business, your QBI begins with the net income from your Schedule E.

Partner’s QBI from the Partnership

A partner may obtain income from the partnership in two ways: (1) as a payout of profits and/or (2) as a Section 707 payment (generally referred to as a “guaranteed payment”). The profits qualify as QBI, and the partnership profits are adjusted for the same items as with the sole proprietorship. The Section 707 payments reduce the net income of the partnership. They do not count as QBI.

S Corporation Shareholder QBI

The more than 2 percent shareholder in an S corporation ends with QBI calculated in the same manner as for the sole proprietor. For example, the S corporation treats the health insurance as wages to the shareholder which reduces the profits of the S corporation and that reduces the shareholder’s QBI.

Wages paid to the shareholder-employee reduce the net income of the S corporation but do not count as QBI.

Trusts and Estates

The rules above apply to trusts and estates. The tricky part is where to apply the rules—to the trust, to the estate, or to the beneficiary?

IRS Clarifies Net Capital Gains in Final 199A Regulations

New tax code Section 199A can give you a tax deduction of up to 20 percent of your taxable income reduced by net capital gains. In new final regulations, the IRS has provided clarity on the capital gains component of the Section 199A tax deduction.

The Section 199A tax deduction applies to your trade or business income from a pass-through entity such as a proprietorship, a rental property, a trust, an estate, a partnership, or an S corporation. When taxable income is equal to or less than the threshold of $315,000 (married, filing jointly) or $157,500 (filing as single or head of household), you apply the 20 percent to the lesser of your

  • taxable income reduced by net capital gains, or

For the Section 199A calculation, your net capital gains are

  • all net capital gains taxed at a preferred tax rate, plus
  • dividends that are taxed at preferred capital gains rates.

Example. You have $200,000 of taxable income, $12,000 of unrecaptured Section 1250 capital gain from the sale of a rental property, and $13,000 of long-term capital gain from the sale of that rental. For Section 199A purposes, you apply the 20 percent deduction to a taxable income ceiling of $175,000 ($200,000 – $12,000 – $13,000).

IRS Creates a New “Safe Harbor” for Section 199A Rental Properties

The Section 199A 20 percent tax deduction is a gift from lawmakers—literally. You don’t earn this deduction; it’s simply there for you if you qualify.

Under the trade or business rule, your rental property profits can create the deduction. And now, under an alternative rule, you can use the newly created IRS safe harbor to make your rentals qualify for the deduction.

When you meet the new safe-harbor rules, the IRS deems your rental a trade or business with net rental profits that are QBI for the Section 199A tax deduction. But you may not want to use the safe-harbor rules, because they contain some onerous provisions. Also, you may not qualify to use the safe harbor. No problem. You can simply use the second method and win your 199A tax deduction using the existing trade or business tax law rules.

Under the new Section 199A rental real estate safe harbor (and only for this Section 199A safe harbor), each of your rental real estate properties individually or as a group (if you so choose) falls into one of the following categories:

  1. Residential real estate enterprise
  2. Commercial real estate enterprise
  3. Triple net lease real estate

Grouping rule. You (or your pass-through entity) must either

  • treat each rental property as a separate enterprise, or
  • treat all similar properties as a single enterprise.

Example. You have 10 rentals; eight are residential, and two are commercial. None are triple net lease. With grouping, you have two enterprises: one residential and one commercial.

With grouping of the residential and no grouping of the commercial, you have three enterprises: residential, commercial 1, and commercial 2. (Reminder: You don’t have to use the safe-harbor rules for your rental properties. You can use the historical trade or business rules.)

Safe-Harbor Requirements

Solely for Section 199A purposes, the IRS will treat your rental real estate enterprise as a trade or business if you (or your pass-through entity) can satisfy the following requirements:

  1. You maintain separate books and records that reflect the income and expenses of each rental real estate enterprise.
  2. You perform 250 or more hours of “rental services” during the tax year.
  3. You maintain contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed, (ii) description of all services performed, (iii) dates on which such services were performed, and (iv) who performed the services. (Note: The contemporaneous records rule does not apply to tax years beginning before January 1, 2019—but don’t let this give you false hope; you still need proof.)

Rental Services

Qualifying defined “rental services” can be done by you, your employees, your agents, and/or your independent contractors. Such services include

  1. advertising to rent or lease the real estate;
  2. negotiating and executing leases;
  3. verifying information contained in prospective tenant applications;
  4. collecting rent;
  5. operating, maintaining, and repairing the property;
  6. managing the real estate;
  7. purchasing materials; and
  8. supervising employees and independent contractors.

Rental services that do not qualify for the safe harbor include

  • financial or investment management activities, such as arranging financing, procuring property, or studying and reviewing financial statements or reports on operations;
  • planning, managing, or constructing long-term capital improvements; and
  • hours spent traveling to and from the real estate.

Reminder. The safe-harbor rules above are solely for Section 199A purposes.

Beware. The passive-activity rules for material participation and status as a real estate professional contain many differences from what you see for the Section 199A tax deduction.

Time log. Your number-one important record for obtaining hassle-free tax deductions on your rental real estate is an accurate and provable time log. If you are using the new Section 199A safe harbor, you now have one additional reason to track time spent.

Nonqualifying Real Estate

Triple net lease property does not qualify for the safe harbor. Remember, the safe harbor is not the only method you can use to qualify your rental real estate for the Section 199A tax deduction.

Also, you may not use the safe harbor on real estate that you use as a residence. If you have a vacation home, Section 280A makes that vacation home either a rental property or a residence.

Safe Harbor—No 1099 Issues

If you use the safe harbor, your rental is a business regardless of whether you send 1099s to service providers. In its preamble to the final Section 199A regulations, the IRS notes that the law requires a trade or business to send 1099s to certain service providers.

Final Thoughts

You may not find it easy getting to the safe harbor. But remember, once you are inside the safe harbor, you have the comfort of knowing that your rental properties are business properties for the possible 20 percent tax deduction under Section 199A. Now, because of the safe harbor, you have a choice:

  • use the safe harbor, or
  • use the existing tax code trade or business rules to prove that your rental is a trade or business.

And remember, once you are inside the safe harbor, the fact that you did or did not issue 1099s to your service providers is moot for purposes of the Section 199A tax deduction.

IRS Section 199A Final Regs Shed New Light on Service Businesses

Remember, new tax code Section 199A offers you a 20 percent tax deduction gift if you have

  • pass-through business income (such as from a proprietorship, a partnership, or an S corporation), and
  • 2018 taxable income of $315,000 or less (married, filing jointly) or $157,500 or less (filing as single or head of household).

But once your taxable income is greater than the relevant amount listed above (which Section 199A calls a “threshold”), your Section 199A tax deduction becomes more complicated. Under the rules that apply to this new Section 199A tax deduction, the tax code creates two types of businesses:

  1. Business that are in favor and can realize the new deduction regardless of taxable income.
  2. Business that are out of favor. The tax code calls the out-of-favor business a “specified service trade or business.”

If you own an out-of-favor specified service trade or business, you suffer a zero Section 199A tax deduction on that business’s out-of-favor income when you have 1040 taxable income greater than $415,000 (married, filing jointly) or $207,500 (filing as single or head of household).

With taxable income greater than the $315,000/$157,500 threshold and less than the $415,000/$207,500 upper limit, Section 199A reduces the tax deduction available to your out-of-favor specified service trade or business.

This brings us to the question: What if your taxable income is above the limit, but your pass-through business has one part that’s out of favor and another part that’s in favor? You will like what the rules have done for you if you are in this situation. The new regulations make it clear that it is possible for you to benefit from the de minimis rule.

The rule. If the trade or business has annual gross receipts of $25 million or less, it is an in-favor business if it gets less than 10 percent of its gross receipts from an out-of-favor specified service trade or business, such as (among others) law, consulting, accounting, and health care. If gross receipts are greater than $25 million, substitute 5 percent for the 10 percent.

De Minimis Example 1

Green Lawn LLC sells lawn care and landscaping equipment and also provides advice and counsel on landscape design for large office parks and residential buildings.

The landscape design services include advice on the selection and placement of trees, shrubs, and flowers and are considered under Section 199A an out-of-favor consulting business.

Green Lawn LLC separately invoices for its landscape design services and does not sell the trees, shrubs, or flowers it recommends for use in the landscape design. Green Lawn LLC maintains one set of books and records and treats the equipment sales and design services as a single trade or business.

Green Lawn LLC has gross receipts of $2 million, of which $250,000 is attributable to the landscape design services, a consulting business. Because consulting services are 10 percent or more of total gross receipts, the entirety of Green Lawn LLC’s trade or business is an out-of-favor specified service trade or business.

De Minimis Example 2

Veterinarian LLC provides veterinarian services performed by licensed staff and also develops and sells its own line of organic dog food at its veterinarian clinic and online. The veterinarian services are in the out-of-favor specified service trade or business of health care.

Veterinarian LLC separately invoices for its veterinarian services and the sale of its organic dog food. It maintains separate books and records for its veterinarian clinic and its development and sale of dog food. Veterinarian LLC also has separate employees who are unaffiliated with the veterinary clinic and work only on the formulation, marketing, sales, and distribution of the organic dog food products.

Veterinarian LLC treats its veterinary practice and the dog food development and sales as separate trades or businesses for purposes of Sections 162 and 199A. It has gross receipts of $3 million. Of the gross receipts, $1 million is attributable to the out-of-favor veterinary services.

Although the gross receipts from the services in the field of health care exceed 10 percent of Veterinarian LLC’s total gross receipts, the dog food business is a separate, in-favor business.

Note that Animal Care wins because it has two trades or businesses, which it proves with its financial books and its separation of its employees.

Green Lawn LLC, in the previous example, failed because it had one business only, which it also proved by the way it kept its books.

IRS Updates Defined Wages for New Section 199A Tax Deductions

Your Section 199A tax deduction will benefit from your business’s W-2 wages paid to you and your employees if you

  • are married and filing jointly and your taxable income is over $315,000 and less than $415,000;
  • are filing as single or head of household and your taxable income is over $157,500 and less than $207,500; or
  • have an in-favor business and your taxable income is greater than $415,000 (married, filing jointly) or $207,500 (filing as single or head of household).

If you are above the $415,000/$207,500 threshold with no wages and no property, your Section 199A tax deduction is zero regardless of your type of business.

Example 1. You have an in-favor business with $400,000 of QBI with no wages or property. Your Form 1040 shows $500,000 of taxable income. Your Section 199A tax deduction is zero.

Note. Your $500,000 in taxable income is above the threshold. Without wages or property, the deduction is zero regardless of the type of business.

Example 2. Your in-favor business has $400,000 of QBI after wages of $300,000. Your Form 1040 shows $500,000 of taxable income. Your Section 199A tax deduction is $80,000. For Section 199A purposes, W-2 wages include

  • cash wages and benefits,
  • elective deferrals,
  • deferred compensation, and
  • designated Roth contributions.

For Section 199A purposes, you must use one of the three following IRS-created methods to find your Section 199A wages:

  1. Unmodified box method. Under this effortless method, your W-2 wages are the lesser of Box 1 or Box 5.
  2. Modified Box 1 method. Under this more accurate method, your W-2 wages are the total of Box 1 plus amounts in Box 12 that are coded D, E, F, G, and S minus amounts in Box 1 that are not wages for federal income tax withholding purposes.
  3. Tracking wages method. Under this most accurate method, you track the W-2 wages subject to federal income tax withholding and add the amounts in Box 12 that are coded D, E, F, G, and S.

If you operate as an S corporation, you should use the modified Box 1 method (method 2) or the tracking wages method (method 3) to ensure your S corporation includes your elected deferrals and health insurance in its W-2 wage calculation.

NOTE WORTHY:  Remember you can get up to date information on my Web Site www.whalengroup.com  and if you have tax questions contact me at al@whalengroup.com

Respectfully,

Al Whalen, EA, ATA, CFP®

 

 

 

 

 

THE WHALEN GROUP Tax-Saving Tips

January 2019

TCJA Tax Reform Sticks It to Business Start-Ups That Lose Money

The Tax Cuts and Jobs Act (TCJA) tax reform added an amazing limit on larger business losses that can attack you where it hurts—right in your cash flow.

And this new law works in some unusual ways that can tax you even when you have no real income for the year. When you know how this ugly new rule works, you have some planning opportunities to dodge the problem.

Over the years, lawmakers have implemented rules that limit your ability to use your business or rental losses against other income sources. The big three are:

  1. The “at risk” limitation, which limits your losses to amounts that you have at risk in the activity
  2. The partnership and S corporation basis limitations, which limit your losses to the extent of your basis in your partnership interest or S corporation stock
  3. The passive loss limitation, which limits your passive losses to the extent of your passive income unless an exception applies

 The TCJA tax reform added Section 461(l) to the tax code, and it applies to individuals (not corporations) for tax years 2018 through 2025.

The big picture under this new provision: You can’t use the portion of your business losses deemed by the new law to be an “excess business loss” in the current year. Instead, you’ll treat the excess business loss as if it were a net operating loss (NOL) carryover to the next taxable year.

To determine your excess business loss, follow these three steps:

  1. Add the net income or loss from all your trade or business activities.
  2. If step 1 is an overall loss, then compare it to the maximum allowed loss amount: $250,000 (or $500,000 on a joint return).
  3. The amount by which your overall loss exceeds the maximum allowed loss amount is your new tax law–defined “excess business loss.”

Example. Paul invested $850,000 in a start-up business in 2018, and the business passed through a $750,000 loss to Paul. He has sufficient basis to use the entire loss, and it is not a passive activity. Paul’s wife had 2018 wages of $50,000, and they had other 2018 non-business income of $600,000.

Under prior law, Paul’s loss would offset all other income on the tax return and they’d owe no federal income tax. Under the TCJA tax reform that applies to years 2018 through 2025 (assuming the wages are trade or business income):

  • Their overall business loss is $700,000 ($750,000 – $50,000).
  • The excess business loss is $200,000 ($700,000 overall loss less $500,000).
  • $150,000 of income ($600,000 + $50,000 – $500,000) flows through the rest of their tax return.
  • They’ll have a $200,000 NOL to carry forward to 2019.

To avoid this ugly rule, you’ll need to keep your overall business loss to no more than $250,000 (or $500,000 joint). Your two big-picture strategies to make this happen are

  • accelerating business income, and
  • delaying business deductions.

Answers to Common Section 199A Questions

For most small businesses and the self-employed, the 20 percent tax deduction from new tax code Section 199A is the most valuable deduction to come out of the Tax Cuts and Jobs Act.

The Section 199A tax deduction is complicated, and many questions remain unanswered even after the IRS issued its proposed regulations on the provision. And to further complicate matters, there’s also a lot of misinformation out there about Section 199A.

Below are answers to six common questions about this new 199A tax deduction.

Question 1. Are real estate agents and brokers in an out-of-favor specified service trade or business for purposes of Section 199A?

Answer 1. No.

Question 2. Do my S corporation shareholder wages count as wages paid by the S corporation for purposes of the 50 percent Section 199A wage limitation?

Answer 2. Yes.

Question 3. Will my allowable SEP/SIMPLE/401(k) contribution as a Schedule C taxpayer be based only on Schedule C net earnings, or do I first subtract the Section 199A deduction?

Answer 3. You’ll continue to use Schedule C net earnings with no adjustment for Section 199A.

Question 4. Is my qualified business income for the Section 199A deduction reduced by either bonus depreciation or Section 179 expensing?

Answer 4. Yes, to both.

Question 5. I took out a loan to buy S corporation stock. The interest is deductible on my Schedule E. Does the interest reduce my Section 199A qualified business income?

Answer 5. Yes, in most circumstances.

Question 6. The out-of-favor specified service trade or business does not qualify for the Section 199A deduction, correct?

Answer 6. Incorrect.

Looking at your taxable income is the first step to see whether you qualify for the Section 199A tax deduction. If your taxable income on IRS Form 1040 is $157,500 or less (single) or $315,000 or less (married, filing jointly) and you have a pass-through business such as a proprietorship, partnership, or S corporation, you qualify for the Section 199A deduction.

With taxable income equal to or below the thresholds above, your type of pass-through business makes no difference. Retail store owners and medical doctors with income equal to or below the thresholds qualify in the same exact manner.

Avoid the 1099 Prepaid-Rent Mismatch

Two questions:

  • Did you prepay your 2019 rent so that you have a big 2018 tax deduction?
  • How do you identify in your accounting records the monies you put on your IRS Form 1099-MISC for the business rent payments to your landlord?

For the 1099-MISC, do you simply look at your checkbook or payment ledgers to identify the amounts you are going to report? If so, you will create an incorrect 1099 for your landlord that’s going to cause your landlord a tax problem.

One golden rule when it comes to your landlord is “do not cause your landlord tax trouble.”

Let’s say you wrote a $55,000 check to your landlord on December 31 and mailed it that day. Your landlord received the check on January 3. Here’s how your Form 1099-MISC can create a tax problem for your landlord:

  • Your Form 1099-MISC to the landlord shows rent paid of $105,000 ($50,000 paid during the year and then the $55,000 prepayment on December 31).
  • The landlord’s 2018 federal income tax return shows $50,000 in rent received (he received the $55,000 in 2019).
  • IRS computers note the difference and start an inquiry.

An incorrect 1099 that overstates the landlord’s income is a problem that can lead to a tax audit.

IRS Reg. Section 1.6041-1(f) says:

The amount to be reported as paid to a payee is the amount includible in the gross income of the payee . . .

Note. As you will see below, this amount does not necessarily equal the tax deduction claimed by the payor.

Reg. Section 1.6041-1(h) says:

For purposes of a return of information, an amount is deemed to have been paid when it is credited or set apart to a person without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and is made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition.

The 1099-MISC is a “return of information.”

The landlord did not have control of the money until he or she had possession of the check in 2019.

In Cheryl Mayfield Therapy Center, the court stated:

A “payment” is made for purposes of section 6041 information returns when an amount is made available to a person “so that it may be drawn at any time, and its receipt brought within his own control and disposition.”

Surprisingly, the 1099 could contain a taxable amount to the payee that is different from the deduction amount of the payor.

For example, in this case, the correct 1099-MISC amount is $50,000. That’s the amount you should put on the 1099-MISC you send to the landlord for 2018 even though you are going to deduct $105,000 as a cash-basis taxpayer.

Avoiding the Kiddie Tax after Tax Reform

If your family has trouble with the kiddie tax, you face some new wrinkles for tax years 2018 through 2025 thanks to the Tax Cuts and Jobs Act (TCJA) tax reform. This is one of the many areas where tax planning can pay off.

For 2018–2025, the TCJA tax reform changes the kiddie tax rules to tax a portion of an affected child’s or young adult’s unearned income at the federal income tax rates paid by trusts and estates. Trust tax rates can be as high as 37 percent or, for long-term capital gains and qualified dividends, as high as 20 percent.

Unearned income means income other than wages, salaries, professional fees, and other amounts received as compensation for personal services. So, among other things, unearned income includes capital gains, dividends, and interest. Earned income from a job or self-employment is never subject to the kiddie tax.

Your dependent child or young adult faces no kiddie tax problems if he or she does not have unearned income in excess of the kiddie tax unearned income threshold ($2,100 for 2018 and $2,200 for 2019). And when your dependent child exceeds the threshold by only a minor amount, the kiddie tax hit is minimal and nothing to get too upset about.

But if your child is getting hit hard by the kiddie tax, your tax planning should consider

  • employing your child so that he or she has earned income sufficient to eliminate the kiddie tax, or
  • changing the investment mix from income generation to capital growth.

Tax Reform’s New Qualified Opportunity Funds

Qualified opportunity funds are a new tax-planning strategy created by the Tax Cuts and Jobs Act tax reform.

The new funds have the ability to defer current-year capital gains, eliminate some of them later, and then on the new investment make capital gains tax-free. To put the benefits in place, you need to navigate some new rules and time frames.

Example: On December 1, 2018, you sell $8 million of stock with a cost basis of $3 million for a long-term capital gain of $5 million.

  1. Within 180 days, you invest the $5 million gain in a qualified opportunity fund.
  2. You make an election on your 2018 tax return to defer the $5 million in long-term capital gain income, meaning no taxes on this gain in 2018.
  3. On December 31, 2026, your qualified opportunity fund has a basis of $750,000 (15 percent of the deferred $5 million capital gain), since you held it for at least seven years.
  4. Let’s assume the fund has a fair market value of $7 million on December 31, 2026. You’ll have a deemed sale on December 31, 2026, and recognize $4.25 million in income, computed as follows:
  • $5 million, which is the lesser of the deferred gain ($5 million) or the fair market value of the fund ($7 million), less
  • $750,000, the basis in the fund.
  1. On January 1, 2027, your basis in the qualified opportunity fund is $5 million ($750,000 original basis plus $4.25 million of deferred gain recognized and taxed in 2026).
  2. If you sell the qualified opportunity zone fund in August 2028 for $10 million, then your basis in the fund is $10 million and you recognize no taxable gain on the sale, since you held it for more than 10 years.

Overall, you have a total of $10 million in gains from these transactions: $5 million from 2018 and $5 million in 2028. Using the qualified opportunity fund investment strategy, you

  • temporarily defer $4.25 million of long-term capital gain from 2018 to 2026, and
  • permanently exclude from tax $750,000 of long-term capital gain from 2018 and $5 million of gain in 2028.

For this strategy to make great financial sense, you need (a) appreciation in your qualified opportunity fund and (b) to hold the investment for at least 10 years so that the appreciation is tax-free to you when you sell your investment.

NOTE:  You can review prior news letter under Blog and newsletters at my web site www.whalengroup.com and I am always available one the web site or at the office to answer your question on ant tax issue.

Respectfully,

Al Whalen, EA, ATA, CFP®

 

 

 

 

YEAR-END TAX PLANNING 2018

THE WHALEN GROUP

INDIVIDUAL TAX ISSUES

Individuals who are 70 ½ years of age or older in this calendar year must take a Required Minimum Distribution (RMD) from their IRA by December 31st.  There is a 50% penalty tax for forgetting this provision.  The only exception to this rule is the first year you turn 70 ½ you may wait until April 15th of the following year; however, you must make two distributions in that next year if you use this delay of distribution.

PLANNING TIP:  Take advantage of a charitable break for IRA owners that’s now permanent in the law.  Individual’s 70 ½ and older can transfer as much as $100,000 annually from their IRAs directly to a qualified charity.  If married, you and your spouse can give up to $100,000 each from your separate IRAs. The benefits here are: 1) This distribution also qualifies toward your RMD requirements, 2) This distribution is not taxable to you, 3) This amount of IRA  is forever removed from future income and estate tax, and 4) The charity of your choice benefits from your generosity.  This planning is a WIN, WIN, WIN, WIN, when used properly, remember the distribution must go from the IRA directly to the charity you cannot receive the funds  and then write a check to the charity for this to work.  All IRA account custodians will have the necessary forms.  NOTE:  This provision is just for IRAs, therefore, if you have 401Ks, 403Bs 457plans, pension, profit sharing or other qualified plans you must transfer the funds to an IRA rollover account first then directly transfer to the charity.

 Higher- income earners had the top marginal rate reduced from 39.6% to 37%, however, the new Tax Cuts and Jobs Act did not eliminate the surtax of 3.8% on certain unearned income.  The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married couple filing a separate return, and $200,000 in any other case).

 PLANNING TIP:  Long-term Capital Gains  are  most likely the issue to get the surtax,  many taxpayers that normally have adjust gross income under $250,000 do not experience the surtax until they have a large long-term capital gain tax.  One way to either reduce or eliminate the surtax is to consider an installment sale.  Example:  You sell a piece of land for $110,000 with a basis of $10,000,  therefore, you have a gain of $100,000, you could spread the gain over two years by receiving half this year and the balance next year, this is especially good towards the end of the year.  Now let’s further assume your joint adjusted gross income is $200,000, by spreading the $100,000 gain over two years ($50,000 this year and $50,000 next year) you would not experience the surtax of 3.8% at all.

Individuals who must pay estimated tax and need to take RMD’s (required minimum distributions) from retirement accounts or any IRA distributions can elect to make up to 100% of the distribution go to income tax withholding, this possibly eliminates the need to pay estimated tax installments using Form 1040-ES.  This is especially effective if you take the distribution near year end as the IRS considers the withholdings as if it had been timely withheld throughout the year.

Long-term capital gain from sales of assets held over one year and qualifying dividend is taxed at 0%, 15%, or 20%, depending on the taxpayer’s taxable income.  The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, it is not more than the “maximum zero rate amount “ (e.g., $77,200 for a married couple $38,600 for single filer).  Remember to take in to account any capital loses that can reduce net long-term capital gains in the planning process. The other long-term capital gains rates are: Married Filing Joint Returns (MFJ) $0 – $77,200 no tax, $77,201-$479,000

15% tax on gain and over $479,000 capital gains are tax at 20%.  For single filers $0 – $38,600 no tax, $38,601 – $425,800 15% capital gains tax and over $425800 capital gains are taxed at 20%.

PLANNING TIP:  Zero-percentage-rate gains and dividends produces increase adjusted gross income (modified adjusted gross income) which can cause more of your social security to be subject to income tax.

Postpone income until 2019 and accelerate deductions into 2018 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2018 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest.  Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2018.  Changes in filing status, loss of child deduction and or child credits, etc., are some examples that could affect this type of planning.

PLANNING TIP:  Many employers are on a fiscal year and will allow you to take your year end bonus in December or January which allows you to take advantage of income shifting.

If your IRA investment portfolio has suffered  and you think a ROTH IRA would be better than consider converting your traditional-IRA into a ROTH IRA if eligible to do so.  NOTE, keep in mind that doing so will increase your adjusted gross income and may reduce tax breaks that geared to AGI or MAGI (modified adjusted gross income).

Itemized deductions new rules beginning in 2018 the IRS estimates that approximately 95% less taxpayers will qualify to itemize deductions, this is due in large part to the new standard deduction amounts, $24,000 for joint filers, $12,000 for single filers, $18,000 for head of household filers and $12,000 for married filing separately.  In addition no more that $10,000 of state and local taxes may be deducted (this includes real estate tax) Miscellaneous itemized deductions subject to the 2% of AGI have been eliminated, (employee business expenses, investment advisor fees, legal fees, tax preparation fees, special clothing cost, union and professional dues, etc.).  Giving cash to public charities are now deductible to the extent of 60% of AGI. We were able to use the ” bunching strategy” in the pass, however, it may become more useful now that we have the higher standard deduction.  Bunching itemized deduction examples: paying off medical expenses using a no or low interest credit card, making two years’ worth of charitable contributions (consider Donor Advised Funds) plus interest deductions on a restricted amount of qualifying residence debt, but payments of those items won’t save taxes if they don’t cumulatively exceed the new, higher standard deduction. The idea here is to bunch your itemized deductions from one year to the next, you may only get to itemize every other year if you are otherwise boarder line.

FSA and HSA Consider increasing the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.  If you become eligible in December of 2018 to make health savings account (HAS) contributions, you can make a full year’s worth of deductible HAS contributions for 2018.

Review your investment portfolio for possible tax savings adjustments.  If you are considering taking profits in your portfolio then make sure that you balance gains and losses to reduce the tax.  Now is the time to reduce underperforming, investments as an offset against the winners.  Remember losses offset gains dollar for dollar, any excess losses are deductible up to $3,000 the balance must be carried forward until used up or your death whichever comes first.

PLANNING TIP:  If you hold under performing stock positions and have an unrealized loss, you could sell the stock experiencing a capital loss and then repurchase the same stock after 31 days and avoid the WASH LOSS rules. If repurchased prior to 31 days then your stock price gets adjusted and no loss is recognized.

Gifting to avoid gift tax Consider making gifts sheltered by the annual gift tax exclusion before

the end of the year  if doing so may save gift and estate taxes. The exclusion applies gifts of up to $15,000 made in 2018 to each of an unlimited number of individuals.  There is an unlimited transfer directly to educational institutions for tuition (not considered a gift), or unlimited transfer to medical care providers (not considered a Gift). You cannot carryover unused exclusions from one year to the next. Such transfers may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.

PLANNING TIP:   Many may prefer CASH, however, consider appreciated stocks, mutual funds or other appreciated assets. Remember the transfer of these assets are transferred at FMV so keep the FMV at $15,000 or under.  The basis of the asset transfers as well, example you own a stock position that has a market value of $15,000 with a cost basis of $5,000 for a gain of $10,000, if you transfer the position to a individual that is in the ZERO capital gains bracket the $10,000 gain would not be taxable.  Remember there three capital gains brackets this year 0%, 15%, and 20% depending upon your adjusted gross income.

Energy credit still available If you install solar panels you can claim a credit of 30% of the total cost.  For solar energy systems installed in a residence, the full credit applies through 2019 and then phased out until it ends after 2021.

Divorce Tax reform changes the alimony game.  The Tax Cuts and Jobs Act (TCJA) eliminates tax deductions for alimony payments that are required under post 2018 divorce agreements.  More specifically, the TCJA’s new denial of alimony tax deductions applies to payments required by divorce or separation instruments; 1. Executed after December 31, 2018, or 2. Modified after that date, if modification specifically states that the new TCJA treatment of alimony payments now applies. When alimony payment are not deductible by the person paying then they are not taxable to the one receiving the payments.

Education Planning  There are two ways to help your kids or grandkids with their education.

  1. Contributing to a 529 plan is one option, you can shelter from gift tax as much as $75,00 is a single year per beneficiary ($150,000 if your spouse joins in). If you contribute the maximum, you’ll be treated as gifting $15,000 (or $30,000) to that beneficiary in 2018 and in each of the next four years.  Pay ins are excluded from your estate as long as you live through the fifth year.  Planning note:  now that 529 plans are not just for college, tax free distributions of up to $10,000 can now be taken each year to help pay for private parochial K-12 tuition. The $10,000 cap does not apply to 529 plan withdrawals to pay for college.
  2. Paying a person’s tuition directly to the school is tax-favored, too. The payment is not treated as a gift for purposes of the gift tax rules.

BUSINESS TAX ISSUES

 Small business new rules  For tax years after 2017, taxpayers other than C-corporations may be entitled to a deduction of up to 20% of their qualified business income.  For 2018, if taxable income does not exceeds $315,000 for a married couple filing jointly, $157,500 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health , actuarial science, consulting services, performing arts, athletics, financial services, investment management, trading services, dealing in securities, partnership interests, commodities, or any business where principal asset is the reputation or skill of one or of its employees), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. The limitations are phased out for joint filers with taxable income between $315,000 and $415,000 and for all other taxpayers with taxable income between $157,500 and $207,500.

PLANNING TIP:  Tax payers may be able to achieve significant savings by deferring income or accelerating deductions so as to come under the dollar thresholds (or be subject to a smaller phase out of the deduction) for 2018.  Depending on their business model, taxpayers also may be able to increase the new deduction by increasing W-2 wages before year-end.

Cash method of accounting More “Small Businesses” are able to use the cash method of accounting in 2018 and later years than were allowed to do so in the past.  To qualify as a “small business” a taxpayer must, among other things, satisfy a gross receipts test.  Effective for tax years beginning after December 31, 2017, the gross-receipts test is satisfied if, during a three year test period, average annual gross receipts don’t exceed $25 million (the dollar amount use to be $5 million). Cash method taxpayer may find it a lot easier to shift income, for example, by holding off billing till next year or by accelerating expenses, paying bills early or by making certain prepayments.

Bonus depreciation  Finally a deduction for business that makes sense,     businesses can claim a 100% bonus first-year depreciation for machinery and equipment – bought and place in service, new or used (with some exceptions) in 2018.  That means 100% of the cost whether paid off or not placed in service this year is fully deductible. As a result, the 100% bonus first- year write off is available even if the qualifying asset is in service for only one day in 2018.

Expensing 179 Businesses should consider making expenditures that qualify for the liberalized business property expensing option.  For tax years beginning in 2018, the expensing limit is $1,000,000 and investment ceiling limit is $2,500,000.  Expensing is generally available for most depreciable property (other than buildings), and off- the- shelf computer software. Expensing is also available for qualified improvement property (generally, any interior improvement to a building’s interior, but not enlargement of a building, elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems.  Expensing deduction is available (provided you are otherwise eligible to take it) regardless of how long the property is held during the year.  This can be a powerful planning tool, thus property placed in service even in the last day of 2018 gets the deduction if elected.

De minimis safe harbor election Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the cost of lower-cost assets and materials and supplies, assuming the cost does not have to be capitalized under Code Sec. 263A uniform capitalization (UNICAP) rules.  To qualify for the election. The cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA,s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500.  Where the UNICAP rules aren’t an issue, consider purchasing such qualified items before the end of 2018.

PLANNING TIP:  The purpose of this election is to reduce the depreciation of small asset acquisitions use in your trade or business.  This is another form of expensing, and  there is no recapture of depreciation when the asset is disposed of later.

To accelerate or defer  A corporation (other than a “large” corporation) that anticipates a small net operating loss (NOL) for 2018 (and substantial net income in 2019) may find it worthwhile to accelerate just enough of its 2019 income (or defer just enough of its 2018 deductions) to create a small  amount of net income for 2018.  This will permit the corporation to base its 2019 estimated tax installments on relatively small amount of income shown on its 2018 return, rather than having to pay estimated taxes based on 100% of its much larger 2019 taxable income.

Business owners can shift income and expenses between 2018 and 2019.

  1. Professionals can postpone their year-end billings to collect less revenue in 2018 or they can speed them up is they expect to be in a higher tax bracket next year.
  2. It may pay to postpone a bonus or to accelerate a bonus.
  3. Putting assets into service by December 31 can provide large write-offs: 100% bonus depreciation and Section 179, see above.
  4. Buying a new heavy SUV by December 31 can provide large write-offs. The SUV must have gross vehicle weight over 6,000 pounds.
  5. Purchasing a large pickup truck with gross vehicle weight over 6,000 pounds can be fully expensed or use 100% bonus depreciation as long as the cargo bed is at least six feet long and it is not accessible from the cab.
  6. Owners of regular corporations should consider taking a dividend as opposed to salary. If the corporation is in a lower tax bracket than the owner’s personal income tax bracket the owner gets a preferential tax advantage on the dividend and the corporation avoids payroll taxes.  This only works with C-Corporations.
  7. Owners of companies should consider putting retirement plans into service before December 31. They may be funded in 2019 for 2018 if started by year-end

New C-Corporation rate Starting in 2018 the maximum corporate if 21% which allows a lot of tax planning, for small companies taking less salary and more dividend may be beneficial then in the past with the lowest rate being the 21% to the highest rate of 42% with the combination of the two taxes, both corporate and individual.

OTHER TAX ISSUES

Estate Tax  The life time estate and gift tax exemption is $11,180,000 for 2018 or $23,360,000 for couples if portability is timely elected on form 706 after the death of the first-to-die spouse. Note this higher amount is set to expire after 2025 (most planners expect this law to become perinate, however, you never know what congress will do for certain). Planning here is very important, especially if the after 2015 the old laws come back excluding just over 5 million per person.

Who pays what of our income tax The IRS just released the 2016 “share of income and share of Federal Income Taxes Paid” report:

Top 1% income earners paid 37.3% of all income tax

Top 5% income earners paid 58.2%

Top 10% income earners paid 69.4%

Top 25%  income earners paid 85.9%

Top 50% income earners paid 97%

Bottom 50% income earners only paid 3%

The above is Share of Total Adjusted Gross Income to Share of Total Income Taxes Paid.  This is the actual “Internal Revenue Service Report”.  Note to be in the top 1% you had to have adjusted gross income of $480,804 or more, to be in the bottom 50% you had to have adjusted gross income below $40,078. This group earned 11.6% of total AGI, yet only paid three percent of tax.   In contrast  to the top one percent earned 19.7% of AGI but paid 37.3% of taxes. Our income tax system is progressive, unlike sales tax and other taxes, that are a flat tax for everyone (same percentage for all), the more you make the higher percentage you pay.  The question is always in our “progressive system”,  “how much should someone that makes more than me be paying for the benefits”) that we all have?  What is really fair? The percentage is relative, if the country needs more money to operate, than collect it from someone other than me is how many feel.

Social Security COLA Increase (see attached The Tax Book News ‘Social Security COLA Increase”). In 2019 social security benefits will increase by 2.8%.

This letter will be posted on the Web Site www.whalengroup.com , please share with friends, that’s the greatest compliment I can receive.

I wish all my clients, friends and family a Very Happy Thanksgiving.  We have so much to be thankful for here in America yet it is also a time to remember the less fortunate, those suffering from storms, fires and other issues.

 Respectfully,

Al Whalen, EA, ATA, CFP®

Attachment:

Social Security COLA Increase (The Tax Book)

Sources:

The Tax Cuts and Jobs Act of 2017

The Tax Book

Wolters Kluwer CCH CPELink

The Tax Foundation

Internal Revenue Service, Code and Regulations

IRS, Statistics of Income, Individual Income Rates and Tax Shares (2018)