Good news. The Tax Cuts and Jobs Act (TCJA) did not harm the backdoor Roth strategy.
As you likely know, the Roth IRA is a terrific way to grow your wealth with a minimum tax downside because you pay the taxes up front and then, with the proper holding period, pay no taxes after that.
But if you earn too much, you’re completely barred from contributing to a Roth IRA unless you can use the backdoor Roth technique, which involves making a nondeductible contribution to a traditional IRA and then rolling that money into a Roth.
The backdoor Roth strategy has been around for a good nine years, and it has experienced no trouble that we are aware of, so we think it’s a good strategy. We also like the recent notations in the legislative history and the comments from the IRS spokesperson that show approval of the strategy.
Keep in mind that with some planning, you can avoid any taxes on the rollover. For example, if you have an existing traditional IRA, you can move those monies to your qualified plan to avoid having the backdoor strategy trigger some taxes. And if you have no traditional IRA, the nondeductible contribution to the traditional IRA and the subsequent rollover to the Roth IRA triggers no taxes.
New IRS FAQs on Section 199A
On April 11, likely after you filed your tax return, the IRS updated its Section 199A frequently asked questions (FAQs) by increasing the number of questions and answers from 12 to 33. The IRS often publishes FAQs on its website to help educate you on various tax law provisions. Section 199A is no different: the IRS has been updating its FAQ website with additional questions and answers on the new qualified business income (QBI) tax deduction.
We noted three of the FAQs that help fill in some holes in the final Section 199A regulations but will cause problems for many taxpayers. In fact, there will be taxpayers who will need to file amended tax returns because of the FAQs.
FAQ 29: QBI Subtractions for Partnerships
In this FAQ on partnerships, the IRS hints at the following:
- Unreimbursed partnership expenses and business interest expenses reduce QBI in some, if not all, circumstances.
- Traditional IRA contributions based on self-employment income don’t reduce QBI (since the IRS didn’t include them), while SEP, SIMPLE, and qualified plan deductions do reduce QBI.
FAQ 32: QBI in Final vs. Proposed Regulations
In FAQ 32, the IRS clearly states that the definition of QBI is the same in both the proposed and the final regulations. Since the definition was clarified in the final regulations, this was a surprise to many.
And what this means is that you reduce QBI by the self-employed health insurance deduction, the one-half of self-employment tax deduction, and the qualified retirement plan deductions.
FAQ 33 Has to Be Wrong
FAQ 33 states that an S corporation shareholder who owns more than 2 percent may have to reduce QBI at both the entity (S corporation) and the shareholder (1040 tax return) levels.
We don’t agree with the double subtraction indicated in IRS FAQ 33, for three reasons:
- The final regulations state that you reduce QBI “to the extent that the individual’s gross income from the trade or business is taken into account in calculating the allowable deduction.” Unlike the proprietorship, the S corporation reduces its business income by reimbursing or paying for the health insurance that it puts on the more than 2 percent shareholder’s W-2.
- Under Notice 2008-1, the self-employed health insurance deduction for the 2 percent S corporation shareholder requires that you include the insurance cost as shareholder wages. The wages reduce QBI.
- And income from the trade or business of being an employee is not QBI.
Website Is Not an Authority
If you don’t like the positions taken on the IRS’s FAQ website, then there’s one silver lining: FAQs don’t constitute an authority for tax return positions.
TCJA Allows Bonus Depreciation on Purchase of Leased Vehicle
Before the Tax Cuts and Jobs Act (TCJA), your purchase of the vehicle you were leasing did not qualify for either Section 179 expensing or bonus depreciation. But times have changed.
The TCJA made two changes that mean 100 percent bonus depreciation is available on the vehicle you lease and then purchase, regardless of whether you purchase it during the lease term or at the end of the lease. The two technical reasons you can do this are as follows:
- During the lease, you had no depreciable interest.
- Bonus depreciation is now available on used property.
Technically, the two changes work like this:
- While you were leasing the vehicle, you had no depreciable interest in the vehicle. The lessor depreciated the vehicle. You, the lessee, paid rent.
- Your purchase of the vehicle that you were leasing is the purchase of a vehicle that you had NOT used under the bonus depreciation law, because you did not have a depreciable interest in it at any time.
Example. You pay $32,000 for a pickup truck that you have been leasing for business purposes. The pickup truck has a gross vehicle weight rating of 6,531 pounds, and your mileage log proves 90 percent business use. You may use bonus depreciation to deduct the $28,800 business cost of the pickup ($32,000 x 90 percent).
Note the difference: As with prior law, with Section 179 expensing, you get no additional deductions. But with bonus depreciation, you can expense your entire business cost.
How to Handle Multiple Rental Activities and the 199A Deduction
There’s a lot of confusion out there around your rental activity and Section 199A. Your Section 199A considerations multiply when you have multiple rental activities. Here’s what you need to consider:
- Are your rental activities multiple trades or businesses, or one trade or business?
- Can you aggregate the rentals for Section 199A purposes? Do you want to?
- How does the Section 199A rental safe harbor impact your Section 199A deduction if you use it?
Whether your rental activities are each a trade or business, or they constitute one trade or business, is inherently based on the facts of your particular situation. The IRS also believes that multiple trades or businesses will generally not exist within an entity unless it can use different methods of accounting for each trade or business under the Section 466 regulations. These regulations explain that you can’t consider a trade or business separate and distinct unless you keep a complete and separable set of books and records for that trade or business.
This determination is an important factor for you if any one rental activity (taken individually) doesn’t rise to the level of a trade or business, but all the rental activities (viewed collectively) do rise to the level of a trade or business. One of the factors the IRS looks to when determining whether a rental activity is a trade or business is the number of properties rented.
The Section 199A regulations allow you to aggregate multiple trades or businesses such that you treat the aggregated group as one trade or business for determining your Section 199A deduction. This is an important consideration if one or more of your rental businesses have insufficient wages or unadjusted basis in assets (UBIA) to get the maximum Section 199A deduction for that property.
The final regulations tell us you can aggregate, in most circumstances, provided that the rental activities share centralized administrative functions, such as accounting, legal, and human resources functions. The big wrinkle is the type of rental business: you generally can’t aggregate residential rental businesses and commercial rental businesses with each other because they aren’t the same type of property.
Rental Safe Harbor
Along with the final regulations, the IRS gave you an optional safe harbor to deem your rental activities as qualifying for the Section 199A deduction. The safe harbor isn’t the best strategy because most rentals qualify as a trade or business anyway.
Deduct Your Costs of Sponsoring Sports Teams
Have you wondered what it takes to deduct the costs of sponsoring a sports team? What if you play on the team? Could you pay for the team travel expenses?
Revenue Ruling 70-393 states that the monies spent to outfit and support a sports team are similar to monies spent on other methods of advertising; accordingly, you may deduct them as business expenses for federal income tax purposes.
In the Strong case, Strong Construction Co. Inc. advertised its business primarily through either word of mouth or athletic sponsorships. As part of the athletic sponsorships, the corporation paid for the uniforms, logo design, hats, T-shirts, sweatpants, coats, bags, and pants for all players on its sponsored teams (broomball, softball, wrestling, etc.). The court ruled that the expenses were ordinary and necessary business expenses and that Strong could deduct them as advertising or promotion.
In the Bower case, James Bower sponsored the Lafayette Bower Housing Hustlers basketball team, and he was both an assistant coach and a player. As the Hustlers’ sponsor, Bower paid for the team’s travel, lodging, food, promotions, AAU fees, tournament fees, gym rental, and uniforms. The court noted that Bower’s sponsorship increased his commodity brokerage commissions and generated additional clients; accordingly, the court ruled that Bower’s sponsorship expenses were deductible business expenses.
WHERE DO WE GET OUR REVENUE?
Sources of Tax Revenue in the United States, 2017
Individual Income Taxes 38.63%
Social Insurance Taxes 23.05%
Consumption Taxes 15.85%
Property Taxes 15.40%
Corporate Taxes 7.07%
Source: Tax Foundation
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).
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).
Dollars In, Dollars Out. At the end of 2018, Medicare was covering 59.9 million Americans (18% of our population). The program was cash positive in 2018, taking in $756 billion of income (including $10 billion of interest income) while paying out $741 billion in benefits (source: Medicare)
Note: When politicians espouse “Medicare for all”, you should ask the question, How are you going to pay for it?
Politics defined, Poly from the Latin meaning “many” and “ticks” are “blood sucking parasites”
WHO PAYS WHAT BY PERCENTAGE?
Summary of the Latest Federal Tax Data, 2018 Update. The top 50 percent of all taxpayers pay 97 percent of all individual income taxes. The bottom 50 percent pay the other 3 percent. Makes you wonder about all those folks who claim the wealthy aren’t paying their fair share.
The Top 1 Percent’s Tax Rates Over Time. In the 1950s, when the top marginal income tax rate reached 92%, the top 1 percent of taxpayers paid an effective rate of only 16.9%. As top marginal rates have fallen and tax loop holes have closed, the tax burden on the “rich” has risen. In 2016 the top 1 percent of income earners (those with AGI over $481,000) paid 37.3% of all income tax.
The Progressive Tax System. Our current income tax system started in 1913 with a progressive tax on income, meaning the more you make the higher your tax bracket and the more by percentage you pay. The following is the 1913 Tax Schedule:
1 percent on amount over $20,000 and not exceeding $50,000
2 percent on amount over $50,000 and not exceeding $75,000
3 percent on amount over $75,000 and not exceeding $100,000
4 percent on amount over $100,000 an not exceeding $250,000
5 percent on amount over $250,000 and not exceeding $500,000
6 percent on amount over $500,000
$1,000,000 of taxable income then and now:
1913 single or married tax liability $50,050
2018 single tax liability $345,690
2018 married filing jointly $309,379
Inflation adjusted (3 percent average) the above minimum $20,000 before tax began would be $445,593 today. To be included in the top 1 percent of income earners your adjusted gross income had to be $481,000 or more in 2016.
Quotable: “What is the difference between a taxidermist and a tax collector? The taxidermist takes only your skin.”—Mark Twain
IRS ON ISSUES.
IRS has announced that they are extending a nationwide survey of consumer tipping practices in businesses where tipping is prevalent, such as casinos, restaurants, hotels, hair salons and taxis. The IRS first announced the project in 2015 and is now extending it. Look for audits in this area in the future.
IRS announces the backup withholding requirements for 2019 at 25%. Backup withholding is the percentage IRS requires payors to withhold when the payor does not have a valid social security or employer identification number on file.
IRS creates passenger automobile depreciation safe harbor Rev Proc 2019-13, 2019-9 IRB; IR 2019-14, 2/13/2019. Code Sec. 280F(a) imposes dollar limitations on the depreciation deduction for the year the taxpayer places the passenger automobile in service and for each succeeding year. Code Sec 168(k) for which the 100% additional first year depreciation deduction is allowable. Code Sec 168(k) (2)(F)(i) increases the first year depreciation by $8,000.
What does this mean? If you place in service a passenger automobile after September 27, 2017 you are allowed with this safe harbor rule to deduct:
$18,000 for the placed in service year;
$16,000 for the second tax year;
$9,600 for the third tax year; and
$5,760 for each succeeding year.
The Rev Proc. Gives examples on how the Safe Harbors Rule Works in the Procedure, year 2 the adjusted basis is multiplied by 32%, year 3 adjusted basis is multiplied by 19.2% and so on, the above amounts are the maximum amount that can be deducted.
Effective date. The Revenue Procedure is effective on Feb. 13, 2019.
Quotable: “This is too difficult for a mathematician, it takes a philosopher.”– Albert Einstein, on his tax return.
REMEMBER; My monthly Tax Tips Letters are available at the Web Site, www.whalengroup.com under” WG Blog” also review the quarterly News Letters under “News Letters”. Invite a friend or business to be added to the news letters e-mail list through the Web Site.
Enjoy the beginning of summer.
Al Whalen, EA, ATA, CFP®