Tax Law change under the new Trump Administration? Maybe, but too soon for planning

Enacting Major Changes Will Take Time

President Trump made tax reform a key issue in his campaign. He is now president and Republicans are in charge of the House and Senate, so the likelihood of overhauling the federal tax system is better than they have been for decades.

However, President Trump and Congress are trying to enact changes to the Affordable Care Act as well as addressing budget issues and foreign relations. Also, dealing with all the recent hearings involving the FBI have diverted attention. Finally, there are many details that need to be worked out, making it unlikely that major changes will happen until 2018.

Change in IRS Regulations

President Trump has already made changes in IRS regulations. On his first day in office, he temporarily froze tax regulations and then shortly thereafter, ordered that two existing regulations had to be removed for each one that was added. What is the impact?

  • The Trump administration has stated that the two-for-one exchange rule only applies to significant regulatory actions. The rule may not affect the many IRS regulations that are procedural in nature or are needed by taxpayers.
  • One new regulation that has been threatened is the Department of Labor’s new fiduciary rules for retirement advisers. This updated regulation requires retirement advisers to act in their clients’ best interests, which is a stricter standard than was previously required.
  • Also affected are the new partnership audit procedure. A 2015 law streamlined the exam process of large partnerships. The IRS released proposed regulations which implemented the regime on January 18. However, it later pulled the regulations in response to the freeze.

Possible Tax Law Changes – Lower Corporate Tax Rate

Currently, the corporate tax rate tops out at 35%. House Republicans want to lower it to 20% with 25% for businesses that pass income through their owners and for those that are self-employed. President Trump is calling for a 15% corporate tax. In 2014, nearly 25 million Americans filed taxes as sole proprietors (Schedule C), so the change affects many taxpayers.

Tax strategy: Under this change, individuals who are high-earning could become independent contractors or set up LLCs to shift income and advantage of the lower corporate tax rate. Additionally, those who own pass-through businesses could reduce their salaries and take higher profits.

This is how residents of Kansas responded to a similar state law. The state is now working to repeal a law passed in 2012 that exempted pass-through firms from state income tax. The result was that many individuals and businesses in the state restructured their business as pass-through entities or created new businesses to take advantage of the tax break. In just a few years, the number of pass-throughs in the state almost doubled. The state is now facing a large budget deficit as a result because the pass-through exemption is estimated to have cost the state $472 million in 2014 alone. The cost for 2015 was even higher.

The impact of this tax strategy on the 15% tax at the federal level would be expensive. It is estimated to cost up to $1.95 trillion in lost tax revenues over the next ten years. The Trump administration is considering ways to prevent abuse of this low tax rate but any attempt to prevent gaming the system will likely add more complexity to the tax code. Tax-savvy practitioners will likely still be able to find loopholes.

Tax only on Income Earned inside the US

Worldwide income is taxed presently, with credits for foreign taxes paid. The proposed law would generally tax only income that is earned within U.S.

Multinational Tax: A new, low tax on multinationals is part of the proposed tax, added to raise revenue to fund other rate reductions.

Estate Tax Repeal

Republicans would like to repeal the estate tax. President Trump would impose a tax on pre-death appreciation of assets, with a $10 million per couple exemption. There would be no step up in basis at death. And it is likely that gift tax rules would be retained.

Even if the federal estate tax law is repealed, many states will continue to impost a tax. Massachusetts only exempts $1 million of assets passing to someone other than a spouse, such as a trust. New York and other states have higher exemptions. Thus, planning is still important for most people.

Planning Opportunities

With the uncertainty of any change being enacted, this is not an easy year for planning. For example, this may not be the year for a Roth conversion, if tax rates will go down next year. It may not be the time for complex estate planning techniques involving irrevocable transfers, if the estate tax is eliminated in 2018.

We will keep monitoring this to assess any moves that do make sense and update this post when the likelihood of real changes becomes clear.

Scam alert: your secrets are not safe with the IRS

The IRS recently announced that the tax information of 104,000 filers was stolen by hackers and used to file false returns. The same thieves attempted to steal tax data from an additional 100,000 filers, but were unsuccessful.

The unauthorized access of records occurred between February and May of 2015, when hackers used the IRS’s “Get a Transcript” web tool to access filers’ tax return transcripts. The hackers had previously obtained social security numbers of these 200,000 filers from other sources. The IRS pointed out that their servers were not hacked, but their online service allowed resourceful thieves to access filers’ information.

This breach is especially alarming because IRS Transcripts contain sensitive information about filers. Specifically, they include much of the information reported to the IRS on 1040 and the supporting forms, such as W-2s. The stolen information was then used to file 36,500 fraudulent tax returns seeking refunds. As many as 13,000 of those phony returns were accepted by the IRS, for a total of $39 million in refunds paid.

The IRS acted after discovering the breach by closing down the “Get a Transcript” tool for individual filers. Filers may still request their transcripts, but must do so by mailing in a completed form 4506. The IRS has not indicated when it will provide the online service again.

Their next step was to notify all 200,000 victims, informing them that their social security numbers and possibly other personal data was stolen. For those 104,000 whose tax information was stolen, the IRS is offering credit monitoring services. These victims will receive instructions to sign up for the credit monitoring note: these outreach letters will not request any personal identification information from taxpayers). In addition, the IRS will continue to monitor those tax accounts.

As always, victims may apply for identity protection numbers to prevent the filing of future returns using their information. Additionally, the IRS plans to strengthen its authentication procedures.

The hackers were able to answer many of the “out of wallet” security questions by using information that can be easily found on credit reports and social media sites like Facebook. As a result, the IRS will use questions that are more difficult to answer.

The IRS plans to employ a more proactive approach to prevent future breaches by partnering with private tax software companies, payroll companies and state agencies to share data on uncovered scams. Congress may act as well and may move up the date that W-2 forms must be filed with the government to January 31. This change would make it more difficult for scammers to e-file fake 1040s.

If you were affected by this breach, you will receive a notice in the mail from the IRS. If you do not receive a notice, we still recommend you access your free credit reports annually and stay vigilant about keeping your sensitive data protected.

Some interesting statistics on risk of an IRS audit, from The Kiplinger Tax Letter, 1-17-14

“IRS is struggling on the enforcement front. 2013’s individual audit rate fell to 0.96%… one out of every 104 filed returns. It’s the first time in seven years that this key statistic dipped below 1%. And we expect this figure to sink even lower for 2014 as the agency’s resources continue to shrink. The number of enforcement personnel has decreased to its lowest level in years, partly due to budget cuts and reassigning agents to work identity theft cases.”

The Tax Letter breaks down to .88% for below $200,000 of income, 2.7% for above that level but below $1 million, and 10.85% for over $1 million of income (down from 12.14%)

The Tax Letter indicates certain red flags (some text omitted)
“Claiming 100% business use of a vehicle. They know that it’s extremely rare for an individual to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.
“Deducting business meals, travel and entertainment on Schedule C.
Big deductions here are always ripe for audit. A large write-off will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don’t satisfy the strict substantiation requirements.
“Writing off a hobby loss. Chances of losing the audit lottery increase if you have wage income and file a Schedule C with large losses. And if the activity sounds like a hobby…dog breeding, car racing and such…IRS’ antennas go up higher.
“Failing to report a foreign bank account. The agency is intensely interested in people with offshore accounts, especially those in tax havens, and tax authorities have had success in getting foreign banks to disclose account owner information. This is a top IRS priority. Keeping mum about the accounts can lead to harsh fines.
“Taking higher-than-average deductions. IRS may pull a return for review if the deductions shown are disproportionately large compared with reported income. But folks who have proper documentation shouldn’t be afraid to claim the write-offs.”

The last phrase is the key: if you have a proper reporting position with full documentation, then the risk of any adverse determination is drastically reduced (but you have the time lost responding if the IRS does raise a question).

Let me know if this raises questions for you.

Same-sex marriages filing jointly with the IRS…

Kiplinger’s Tax Newsletter reports:

Same-sex couples are one step closer to joint filing of their federal returns. An Appeals Court scrapped a law barring them from being treated as married for purposes of federal law, even though they are legally married under state law. This part of the Defense of Marriage Act is unconstitutional (Gill v. OPM, 1st Cir.).
This decision will almost certainly be appealed to the Supreme Court, delaying any final resolution until next year. So until the High Court gives the nod, all same-sex couples remain barred from filing joint income tax returns with IRS.
In the interim, married same-sex couples should file protective refund claims with IRS on Form 1040-X if joint return status would save them tax. The Service will hold the protective claims in abeyance until there’s a final decision in the case.

Same-sex couples also can enroll in long-term-care insurance programs that states offer to their employees. A federal district court struck down a U.S. law
that disqualifies state-maintained long-term-care plans if married same-sex couples or domestic partners are covered (Dragovich v. Treasury Department, D.C. Calif.).

We will continue to track this…..