2017 year-end tax planning – a year of uncertainty (updated)

(as also seen online at IRIS)

The Republican Congress is in the process of passing the Tax Cut and Jobs Act, a new tax law. President Trump is expected to sign it by Christmas.

The law was created and passed hastily and affects many aspects of the federal tax code, so many details are still not clear. Furthermore, regulations have yet to be issued. Also, while the provisions affecting corporations are permanent, most affecting individuals expire in 2026. Thus, tax planning is complicated.

How do you plan? Very carefully – you need to augment your traditional year-end planning by anticipating the impact of the many changes.

Note: many proposed changes did not make the final law, so be sure you are referring to the final version when making your planning decisions!

Planning steps

First, be practical:

  • Determine what income and deductions you can move from 2017 to 2018 or vice versa.

Second, review the impact:

  • What happens if you shift any of these amounts of income and deductions to the other year?

Finally, watch for the impact of the Alternative Minimum Tax (“AMT”):

  • The exemption for the AMT and the threshold above which that exemption gets phased out both rise next year, so some deductions lost to the AMT in 2017 could have value in 2018. Others simply vanish next year, so you need to plan carefully!

Income

The new law lowers the tax brackets, so income will be generally subject to less tax in 2018.

Conclusion: You probably want to move income to next year if you can.

Exemptions and standard deduction

The new law eliminates personal exemptions and raises standard deductions to $12,000 for single filers and to $24,000 for married couples. These amounts will be indexed for inflation. The increased standard deduction may offset deductions that you lose, as discussed below. If you have children and others who are dependents, those tax credits are increased, which may help as well.

Conclusion: You probably want to move itemized deductions to 2017.

Itemized Deductions and Credits

The deduction for property taxes and for state and local income taxes is capped at $10,000.

Mortgage interest on new home purchases is deductible only for loans of up to $750,000 used to purchase your primary residence. Interest on home equity loans will not be deductible. (It is not clear if converting any part of home equity indebtedness that was used to purchase or improve your primary residence to a mortgage would make that interest deductible, subject to the cap.)

All miscellaneous deductions are eliminated. This includes investment and tax preparation fees, safe deposit box charges and unreimbursed employee expenses.

The casualty loss deduction is also eliminated and the bike to work exclusion ends.

Moving expenses will no longer be allowed (except for military personnel in certain cases).

The deduction of alimony will be eliminated for divorces occurring after 2018.

What survived? The deduction of student loan interest and medical expenses survived. The latter is subject to a 7.5% rather than a 10% floor. And, the new law repeals the reduction applied to itemized deductions for high-income taxpayers, which may help with some deductions.

Here are several items that were considered for limitation or elimination that remain unchanged:

Dependent care accounts, adoption expenses, tuition waivers and employer paid tuition, capital gains on the sale of your personal residence, the teacher deduction, electric car credit, Archer medical accounts and designating shares of stock or mutual funds sold.

Conclusion: you will want to move any of the eliminated deductions that you can prepay into 2017.

Note: a last-minute provision added to the new law makes prepaying 2018 income taxes in 2017 non-deductible.

Pass-through businesses

If you have income from a sole proprietorship, LLC, partnership or S Corporation, you may be able to deduct 20% of that income, subject to certain rules on wages and a phaseout beginning at $157,500 for singles and $315,000 for married taxpayers. These rules are designed to avoid abuse seen when Kansas enacted a similar law.  (Watch for a post on this soon.)

Conclusion: read the fine print (e.g. rules for personal service firms) to see if there are any opportunities you can exploit.

Estate taxes

The credit before estate or gift taxes are due is doubled to $10,000,000, indexed for inflation.

Conclusion: you may want to postpone your year-end gift planning.

Summary

Carefully review any income and deductions that you can still shift to see if moving will lessen the total taxes you pay for 2017 and 2018.

Good luck and best wishes for the holidays!

If you have any questions, please contact me.

7 things to do when starting a business to avoid nasty surprises

(also seen online at IRIS.xyz)

The only thing that hurts more than paying an income tax is not having to pay an income tax. Thomas Dewar

When you decide to start a business, taxes may be the last thing you think about. However, not realizing that you owe the self-employment tax as well as income taxes can lead to a nasty surprise when you file your taxes. This post is aimed at avoiding that costly surprise.

But, before we discuss the self-employment tax, there are other important steps to take when you become self-employed. Here are the 7 things to do after you start your own business to avoid nasty surprises:

Avoid nasty surprises – set up bookkeeping, form your entity, get licensed, buy insurance, and pay taxes

Bookkeeping – set up bookkeeping using software like QuickBooks (either online or on your laptop). You don’t want to be scrambling to find receipts at tax time or not be able to tell somebody if you are making money or not.

You can save time by downloading from your bank and credit card companies. If you set up things well, all income and every expense will be properly categorized for your profit and loss statement, or P&L. The P&L and balance sheet help you monitor your business to see how well you are doing and are essential for preparing your tax returns. The balance sheet will also come in handy if you need to apply for financing.

For all these steps, you may want to hire an accountant or speak to an attorney.

Entity – for many small businesses, being a sole proprietor is appropriate. You avoid paying corporate excise taxes and filing annual reports. However, if you have partners, you may want to form a partnership, corporation or LLC (details on choosing are beyond the scope of this post).

If your business involves risks that could lead to law suits, form a corporation or LLC to shelter your personal assets from liabilities of the business that insurance may not cover. Make sure that any actions you take for the business are in your capacity as an officer or manager – i.e., never sign personally.

Remember, you may want to consult with an attorney.

Get licenses, file annual reports and pay local taxes – certain businesses require a license to operate. Most entities are required to file annual reports. And, your city may impose taxes on the personal property in your business. Be sure to find out so you don’t owe penalties for failing to file and pay.

Buy health and other insurance – in addition to liability insurance, you will want to obtain health insurance if you are no longer working for another employer. You may get favorable treatment for this expense on your income taxes. You can also purchase insurance to cover damage to equipment, loss of data, identity theft and so on.

File payroll taxes – if you hire people to work for you and pay them over $600 per quarter in any year, you need to report the compensation. If they are independent contractors, you file a form 1099 with the IRS. If they are employees, you file a W-2 with the Social Security Administration. You also provide these forms to your people for the income tax filings.

You may need to withhold and remit FICA and Medicare taxes. Also, your employees may request that you withhold and remit federal and state income taxes (unless you live in a state that does not impose income taxes). Failure to withhold and pay to the IRS and state can lead to serious penalties.

Pay your income tax – one big shock for many who start a business is how much they owe in taxes. When you received a paycheck, you probably did not focus much on the fact that your employer withholds federal and state income taxes and FICA and Medicare taxes. And, you never had a chance to spend what was withheld.

However, when you run your own business, you have full access to the pre-tax income, so you must diligently allocate funds ahead of time so that you don’t come up short at text time. To avoid owing interest on the taxes due, you make estimated tax payments each quarter to the IRS and state.

Pay the self-employment tax – when you were an employee, your employer withheld FICA and Medicare taxes from your paychecks. The employer also contributed FICA and Medicare taxes on your behalf

When you become self-employed, you are responsible for both the employee and employer amounts. This tax is based on your net self-employment income

A lot to remember, right?

Maybe, but knowing and planning is far better than trying to scrape together money in April to cover taxes you did not expect.

Good luck with your new business!

In future posts, we will examine partnering with others, assessing your profitability, rules on deducting expenses, and entry into the real estate market.

Plan now to avoid surprises from the Affordable Care Act when filing 2014 taxes

2014 was the first year Americans had access to health insurance options through the Affordable Care Act (the “ACA”). With this new access to insurance came the obligation to purchase it or face new tax consequences. If you opted not to buy health insurance in 2014, you may be faced with a penalty when you file your 2014 tax returns. Even if you did buy insurance through one of the insurance marketplaces, you may have new tax forms to complete and some surprises when it comes to your refund or tax bill.

For most taxpayers, the impact on their tax filing will be minimal, requiring those who were covered to simply check a box indicating they had insurance throughout the year. Those who received subsidies to purchase insurance and who later had increases in their 2014 salary may be required to pay back some of that subsidy. Those whose salary decreased may receive a larger than expected refund.

As these provisions are new to everyone, there may be confusion for taxpayers and tax preparers alike. Unfortunately, due to recent budget cuts, the IRS expects to be able to speak with only half of the people who call in for assistance.

While gearing up for the 2014 tax season, it’s helpful to understand some the most important provisions of the ACA:

  • 1. Exemptions: The ACA provided some exemptions that allow taxpayers to opt out of purchasing insurance without any penalties, including hardship, affordability and religion. There are different methods for applying for an exemption depending on the type of exemption you are requesting. To learn more, go to: https://www.healthcare.gov/fees-exemptions/apply-for-exemption/
  • 2. Penalties: Those who do not qualify for an exemption, were insured for only part of the year, or remain uninsured will be required to pay a penalty called “The Individual Shared Responsibility Payment.” The penalty is set to increase over the coming years, so compare not to see if it is more beneficial for you to pay the penalty or buy insurance. The Tax Policy Center has designed a calculator to help you determine your penalty is you opt to remain uninsured: http://taxpolicycenter.org/taxfacts/acacalculator.cfm.
  • 3. Reconciling: Those who purchased subsidized insurance on the exchanges received an advance on a tax credit. At the time of requesting the subsidy for insurance in 2014, the amount of the subsidy was calculated based on the taxpayer’s 2012 income. The amount of the subsidy granted will be reconciled in the taxpayer’s 2014 filing using the taxpayer’s actual 2014 income and that will affect the taxpayer’s refund or bill. Changes in an individual’s personal circumstances, such as divorce, marriage or a new child can also impact those numbers.
  • There’s still time to plan. Taxpayers facing a loss in premium subsidies because of an increase in income can reduce their income to qualify for the credits. For example, they can contribute to an IRA by April 15, 2015, for the 2014 tax year.

    Year-end tax planning – how to minimize the total tax paid in 2014 and 2015

    This year, when projecting your potential taxes, you have to factor in the changes from 2013 that affect 2014 and 2015, which can be daunting. That is:

    • You have the standard plan: “defer income/accelerate deductions unless you are in the alternative minimum tax (“AMT”)” (see below).
    • But then you also have the new 3.8% surtax, with rules that do not play well with the others!
    • Finally, the tax rates changed again for 2014 (see the table below).

    If any of this is not clear, please ask questions.

    Can you act?
    To make your review of 2014 planning less daunting, take these separate steps: (1) ask “can you act?” – determine what you can do reviewing the “what can you act on” list below; then (2), if you can act on any of the items in 2014 or 2015 – moving from one year to the other, or delaying further – then ask “what impact does your acting have?” ; and finally, ask “what happens if I take all of these actions?” – determine the impact of all possible moves in concert, especially vis a vis the AMT. Preparing tax projections for both years is the best way to find out how to act most effectively to reduce taxes. It permits you to see which moves have the best results in which years, so that the total tax paid in the two years is minimized.

    What can you act on?
    Wages – Can you defer or accelerate between years or even convert income into deferred income, such as stock options, or income to be received at retirement? Can you convert compensation into tax-free fringes?

    AMT – the AMT is the 28% flat rate calculated differently than the marginal rate of up to 39.6%. If your deductions bring the regular tax down too low, the AMT kicks in, so that the deductions are wasted and need to be moved to another year, if possible. Otherwise, you will want to increase income for that year to “pull yourself out of the AMT.” The AMT exemptions amounts for 2014 are $52,800 for individuals and $82,100 for married couples filing jointly.

    The 3.8% Medicare surtax – This affects all income for 2014 and beyond, but only to the extent of the lesser of (a) net investment income or (b) the excess of modified adjusted gross income (“AGI”) over the threshold, which is $250,000 ($200,000 for single taxpayers). Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income but excludes pensions and IRA distributions. The 3.8% surtax must be covered with your withholdings and estimated payments to avoid penalties and interest. See our post at Update on the impact of the 3.8% Medicare surtax .

    Standard Deduction – up in 2014 to $6,200 for single taxpayers and married taxpayers filing separately, $12,400 for married couples filing jointly, and $9,100 for heads of household.

    Schedule A itemized deductions – can you shift income and deductions for the maximum benefit, given the income-based deduction thresholds?

    • //Miscellaneous// – only the amount above 2% is allowed on Schedule A. Miscellaneous expenses include items such as unreimbursed employee expenses, tax preparation fees and investment-related expenses.
    • //Other Deductions// – certain itemized deductions are phased out once your AGI exceeds $305,050 for married filing jointly ($254,200 for singles), so that your itemized deductions are reduced by 3%, on up to 80% of the deduction, for the excess of your AGI above $305,050 ($254,200 for single filers).

    N.B. – (a) many of the deductions affected by the phase-out are the ones not allowed in the AMT calculation and (b) investment interest is not subject to reduction on Schedule A.

    Schedule C income and expenses – can you defer or accelerate between years so that the net income falls in the best year?

    Investment income – can you shift interest, dividends, and capital gains? The tax rate on capital gains was as low as 0% in 2013, with a cap at 15%. However, that cap went up to 20% in 2014 for AGI over $457,600, for married filing jointly ($406,750 for single; $12,150 for trusts and estates). You net losses against gains, with up to $3,000 of an excess loss over gains being allowed to shelter other income and losses you do not use carry to the next year.

    Notes

    • (a) capital gains include the sale of a primary residence (above the $250,000 per owner shelter);
    • (b) if you sell to recognize a loss, and want to hold the stock again, be aware of the wash sale rule which bars recognition of the loss if you re-purchase substantially the same security within 30 days, even if it is in different accounts you own, including repurchasing in your IRA;
    • (c) an installment sale that spreads gain over several years; a like-kind exchanges involve investment property, which means you can swap, rent and later convert to residential; and
    • (d) purchasing mutual funds late in the year can lead to dividend and capital gains distributions where the mutual fund price changes but your investment does not, such that you have no economic gain for the distribution on which you pay taxes – you are effectively pre-paying taxes because you did not purchase after the declared distribution date.

    Investment income also includes passive income and losses (rental property, limited partnerships and LLCs). If you can re-characterize any activities as material participation rather than passive by grouping together to meet the material participation rules, you have a one-time election to regroup (see final regulations on when and how you elect issued early in 2014).

    Roth conversions – can you convert an IRA to a Roth IRA, so that future distributions are not subject to tax? Be sure to pay the tax with funds outside of the IRA so that the conversion has maximum benefit.

    Stock options – can you exercise a non-qualified option (“NQ”), which is treated as ordinary income, or instead exercise ISOs, which can be investment income (but create an AMT)? Disqualifying an ISO converts it into a NQ, so that you have control over the type and timing of the income.

    Required minimum distributions (“RMD”) – If you turned age 70½ in 2014, you can take a distribution in 2014 instead of next year to decrease your 2015 income – but the IRA distribution is not subject to the surtax so this would be done for the Schedule A phase outs (see below).
    A direct distribution from an IRA to a charity allows you to give up to $100,000 (per person) of your RMD and lower your AGI for purposes of determining taxes.

    Estate taxes – Federal Estate Tax Exemption for estates of decedents who die in 2014 is $5,340,000, up from $5,250,000 for 2013.

    Gifting – can you shift assets by gifting within the $14,000 per year/per person annual gift tax exclusion, or even by filing a gift tax return to use some of your unified credit now, so that income is in the lower tax bracket of new owner? You may want to combine this estate tax savings strategy with income tax savings ideas so that you shift an income-producing asset to someone in a lower tax bracket.

    Inherited IRA – be sure to divide an inherited IRA among beneficiaries to get the maximum life expectancy for RMD calculations for each.

    If you made it this far, I hope you have a good idea of your 2014-2015 tax plan, or else a set of questions to ask so we can help devise one for you! //Please contact us//.

    Federal Tax Rates for 2014:
    [[image:2014-federal-tax-rates.jpg|large|link=source]][[file:2014-federal-tax-rates.pdf]]

    Planning ideas for the impact of tax law changes in 2013

    The only way that the American Taxpayer Relief Act of 2012 provides relief to high income taxpayers is by ending uncertainty. The wait is over and we now know what we can for tax planning; guessing based on the last news from Washington is over.
    So, what planning can you do? Start with reviewing all the changes below. Then consider how they apply to you and what you can affect to bear less of a tax burden in this or future years – see the “action” items below in each section.
    **Payroll**
    **Social Security:** The payroll tax holiday ended so that the Social Security tax rates have returned to 6.2% (up from 4.2%) for 2013 wages up to the taxable wage limit of $113,700.
    **Action:** //not much to do on this one, because it ends a set maximum each year, unlike the Medicare tax below.//
    **Health insurance funding via additional Medicare tax:** The Patient Protection and Affordable Care Act adds a .9% tax applies to single individuals earning over $200,000 and married couples who earn over $250,000 and file jointly. This raises the rate from 1.45%, will rise to 2.35%. However, employers must withhold the Additional Medicare Tax from **all** workers, regardless of marital status, from wages exceeding $200,000.
    Action: bunch income in one year (defer/accelerate if you can get below the range – see rates below).
    **New Ordinary Income Tax Rate:**
    For most individuals, the federal income tax rates for 2013 will be the same as last year: 10%, 15%, 25%, 28%, 33%, and 35%. However, the maximum rate for higher-income folks increases to 39.6% (up from 35%). This change only affects singles with adjusted gross income (AGI) above $400,000, married joint-filing couples with income above $450,000, heads of households with income above $425,000, and married individuals who file separate returns with income above $225,000.
    **Action:** //bunch income into one year (defer/accelerate if you can get below the range – especially if you coordinate earned income with net realized gains). The goal is to shift income (and deductions, as discussed below) from one year to another so that the total tax for both years is less. This is easier for self-employed or owners of private companies, as they can shift income within reasonable limits. Also, with large portfolios, there is some ability to put net gains in one year rather than another. As stated below, you can move all dividend and taxable interest paying investments into qualified plans, keeping your asset allocation but lessening the tax burden.//
    **New Long-Term Gains and Dividends Tax Rate:**
    The tax rates on long-term capital gains and dividends are the same as last year for most taxpayers. However, the rate goes to 20% (up from 15%) for singles with AGI above $400,000, married joint-filing couples with income above $450,000, heads of households with AGI above $425,000, and married individuals who file separate returns with AGI above $225,000. When you add in the new 3.8% Medicare surtax, you get a combined rate of 23.8% on long-term gains and dividends.
    **Action:** //Once again, shift net gains into one year and put dividend paying investments in qualified plans.//
    **Stealth rate increases:**
    **Personal and Dependent Exemption Deduction Phase-Out:** The 2009 phase-out rule for personal and dependent exemption deductions has been restored, so your personal and dependent exemption write-offs are reduced if not even completely eliminated. This phase-out starts at the following AGI thresholds: $250,000 for single filers, $300,000 for married joint-filing couples, $275,000 for heads of households, and $150,000 for married individuals who file separate returns.
    **Itemized Deduction Phase-Out:** As above, the 2009 phase-out rule for itemized deductions has been restored, so you can potentially lose up to 80% of your write-offs for mortgage interest, state and local income and property taxes, and charitable contributions if your AGI exceeds the applicable threshold: $250,000 for single filers, $300,000 for married joint-filing couples, $275,000 for heads of households, or $150,000 for married individuals who file separate returns. The itemized deductions are reduced by 3% of the amount by which your AGI exceeds the threshold, up to a maximum of 80% of the total affected deductions.
    **Medical Expenses:** The floor above which medical expenses can be deducted goes from 7.5% to 10%.
    **Action:** //for each of these, try to move deductions into one year, and bunch income to another, so that the total tax for both years is less.//
    **Alternative Minimum Tax Help**
    The AMT “patch”, which prevented millions having this add-on tax, has higher exemptions and allows various personal tax credits. The new law makes the patch permanent, starting with 2012. The change will keep about 30 million households out of the AMT.
    **Action:** you can identify which AMT items affect you and bunch them into one year, to save taxes on another.

    //**Gift and Estate Tax Rules Made Permanent**//
    For 2013 and beyond, the new law permanently installs a unified federal estate and gift tax exemption of $5 million (adjusted annually for inflation, making it $5,250,000 for 2013) and a 40% maximum tax rate (up from last year’s 35% rate). Also, you can still leave your unused estate and gift tax exemption to your surviving spouse (the “portable exemption”).
    **Action:** //review your assets to see if you can gift any now, even if in a trust for future ownership change, and also check to see if any such gifts help on state estate taxes. You may want to consider a second-to-die policy in an irrevocable trust, if your assets will exceed the credits after gifts.//

    **Other changes**
    **Action:** //see if any apply, then shift income and deductions so you benefit from them.//
    **American Opportunity Higher Education Tax Credit Extended:** The American Opportunity credit, providing up to $2,500 for up to four years of undergraduate education, was extended through 2017.
    **Higher Education Tuition Deduction Extended:** While this deduction was set to expire at the end of 2011, the new law restores it for 2012 and 2013, allowing for as much as $4,000 or $2,000 for higher-income folks.
    Option to Deduct State and Local Sales Taxes Extended*: This option also expired in 2011 but is restored for 2012 and 2013, giving taxpayers with little or no state income taxes the option to claim an itemized deduction for state and local sales taxes.
    **Charitable Donations from IRAs Extended:** This option also expired in 2011 but is restored for 2012 and 2013, allowing IRA owners who had reach age 70½ to make charitable donations of up to $100,000 directly out of their IRAs. The donations count as IRA required minimum distributions.
    For 2012, you can still act if you do so this month – it will be treated as a December 2012 transaction.
    **$250 Deduction for K-12 Educators’ Expenses Extended:** Yet another deduction that expired in 2011 is restored for 2012 and 2013, allowing teachers and other K-12 educators a $250 “above the line deduction” for school-related expenses that they paid.
    **$500 Energy-Efficient Home Improvement Credit Extended:** Finally, another credit that expired in 2011 is restored for 2012 and 2013, allowing taxpayers could claim a tax credit of up to $500 for certain energy-saving improvements to a principal residence.