Business Taxes, Part II of III on year-end tax planning

This is Part II of three parts on year-end tax planning under the Tax Cut and Jobs Act. In our first part, we discussed the impact of the new law on personal taxes. In this part, we focus on small businesses.

Choice of Entity for Small Businesses

One of the biggest changes from the new tax law is the massive reduction in the tax rate for regular or “C” corporations. That may sound very appealing, but does this mean you should convert your S Corp. or LLC into a C Corp.? It could, if you expect to keep net income in your business.

If that is not your plan, i.e., if you want to take out money for yourself and other members, then use a pass-through entity instead of a C Corp. While a C Corp. may only pay taxes of 21% on its income, the amount the C Corp. distributes, via dividends or otherwise, will be taxed again to shareholders. If the shareholders are in the highest bracket, then income that started in the corporation had to pay over 52% in total taxes before getting into shareholders pockets. If you are a pass-through such as an LLC or partnership, then no tax is imposed at the entity level and entity members may qualify for the QBID on their personal returns – see below.

Be clear on your goals: do you want to leave net income in to grow the business for sale or an IPO? Or do you want to distribute net income to business members?  Deciding makes the choice clear.

Section 199A QBID

In our first part, we discussed the qualified business income deduction of 20% for certain pass-entities.. The deduction is complicated and subject to limitation. One such limitation is the total income of the taxpayer reported on her individual or joint tax return. The deduction phases out for high income taxpayers, starting at $157,500 of income for single taxpayers and $315,000 for married taxpayers, and phasing out when income exceeds $207,500 for single taxpayers and $415,000 for married taxpayers. There are wage and capital limits that can bring back a deduction when the phase out is exceeded, but that does not help service businesses as discussed below.

The deduction is “below the line,” so it does not reduce self-employment taxes or any items that are keyed to adjusted gross income (“AGI”). It also does not affect net operating losses.

Another limit is on income from a service business. This is defined as income from the following:

Health, law, accounting, consulting, financial services, performing arts, actuarial science, athletics, brokerage services, investing or trading in securities, or any business where the principal asset is the reputation or skill of its employees (there are now regulations on this last type, but those do not answer all questions).

Architects and engineers were excluded from the list in the final bill.

For those within the definition of service business, QBID drops to zero when the phase out is exceeded.

If you are bumping up against any limits for 2018, you will want to review ways to defer income to 2019 or reduce taxable income in 2018 by increasing your deductions.

Businesses use of Home

The new tax law imposes limits on Schedule A deductions, including state and local income and real estate taxes. If some of your real estate taxes otherwise subject this limit are for a home office or other business use, then the business portion is not limited and can be used to shelter business income.

New Rules on Entity-level Audits

Under the new tax law, LLCs and partnerships face substantial changes for the IRS audit procedures:

  1. Beginning in 2018, the IRS can audit such entities at the partnership or LLC level under the Centralized Partnership Audit Rules or “CPAR.” This gives the IRS new powers, one of which is the ability to impose a tax at the entity level and let the partners sort it all out, rather than the pre-2018 requirement to audit each partner; and
  2. The IRS would contact the Partnership Representative for the entity. If no PR has been designated, then the entity loses by default.

This means (a) updating your operating agreement to designate the PR in place of the tax matters partner and (b) electing out of the CPAR rules on your 2018 tax filing to avoid application of these unfavorable rules.

What is a WISP?

You have probably received e-mails and other notices asking you to review updated privacy policies from various vendors. Many of these were generated in response to adoption of the GDPR (General Data Protection Regulation) by the European Union in May of 2018.

What too few companies know is that there are laws in the US that require implementation of privacy safeguarding. One affecting companies doing business in Massachusetts is the Standards for the Protection of Personal Information of Residents of the Commonwealth in force since 2010.

If you are affected and have not either established or reviewed your company’s WISP (written information security program), please act right away to avoid liability for any potential breach.  Also, check the laws of any other state in which your do business to see what laws apply to your use of personal information.

Conclusion

If any of this raises questions for your year-end planning, let me know. I will be glad to see if can help.

Impact of New Tax Law, Part I of III on year-end tax planning

New Tax Law

The Tax Cut and Jobs Act made substantial changes to tax rates, deductions and credits for individuals, corporations and other entities. It also affected changes to estate taxes. For a summary of all changes, please see our post from December in 2017 year-end tax planning – a year of uncertainty.

The purpose of this post is to get you started on year-end planning to take advantage of those changes.

What is the Impact of New Tax Law?

We have been reviewing the impact of the new law with projections in our CCH ProSystem Fx tax software. While many individuals lose deductions in 2018 that they were previously allowed, that does not mean that their taxes increase as much they feared. Here are some reasons why:

  • They probably do not owe the AMT as they have in the past.
  • The change in rates lowers total taxes for many.
  • The passthrough deduction discussed below can make a big change.

If you want us to review the impact on your taxes, please let me know.

Clarifications on New Tax Law

Mortgage interest remains deductible even on an equity line of credit (ELOC), provided proceeds from the ELOC were used to purchase or substantially improve your home. However, if the proceeds were used for consumption, then the interest is not deductible.

The deduction for state and local income taxes (SALT) and property taxes is capped at $10,000. However, property taxes for rental properties are still fully deductible against rental income on Schedule E. And farmers and self-employed taxpayers can still deduct the business portion of the taxes on Schedules F and C. Finally, you may be able to use a trust to share ownership of a property with beneficiaries so that they can deduct a portion of the property taxes.

Change for Small Businesses

One of the biggest changes is the qualified business income deduction (“QBID”) under section 199A, also know as the pass-through deduction. This deduction reduces taxable income from qualifying businesses by 20% for taxpayers under the income limitations. This is, net profits form the business after any W-2 salary paid to the owners is reduced.

Pass through businesses include sole proprietors, S corporations, LLCs and partnerships. They also include real estate investment trusts (“REITs”) and certain publicly traded partnerships (“PTP”). But there are income limits and thresholds that eliminate the QBID service companies. Here is a good chart on that may help you see if you qualify for the 20% deduction. Also, watch for more in our next post.

Planning under 199A for QBID

If you have a pass-through business and your year-end planning shows that you may hit the income limits that reduce or eliminate the deduction, you can move income and deductions for Schedule A to change that. Push income into next year and bring any deductions from next year into this year. If you succeed in getting back under the income the limitation, you get a 120% benefit for the right offs – that is, 100% deduction value on Schedule A and 20% QBID value.

The income limits are toughest on service companies. If your small business is a service company, you may want to break out any non-service business to get the benefit of QBID. A professional office that does billing, debt collection or operates a professional building may be able to put those activities in separate entities that qualify for QBID. Furthermore, if your small business is considering buying an office, keep that in a separate entity from the business.

Conclusion

Watch for Part II coming soon. In the meantime, please contact us if you have any questions.

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.

Scam update for more on Cyber-Attackers, Cloud Computing – be Vigilant!

We wrote before about the need for vigilance to protect you from cybercriminals. We drew on input from Norton Antivirus about social media scams. In this post, we draw upon the Kiplinger’s Tax Letter and SingleHop.com site.

IRS e-mails – You might not think that tax preparers would fall for e-mail scams, but some do. The 2-27-15 Kiplinger’s Tax Letter describes use of bogus e-mails asking professionals to “update their IRS e-services accounts and their electronic filing ID numbers plus provide personal data.” As we have said in prior posts, the IRS categorically states that they do not send out e-mails.

Cloud Computing – SingleHop is a company endeavoring to be private cloud experts. They champion users holding cloud servers accountable for maintaining high level, monitored and updated security for all client files. Their recent newsletter notes that over 250,000 complaints were filed with the FBI’s Internet Crime Complaint Center (ic3.gov) in 2013 alone, of which over 20% were under age 30. (For more on how “private cloud” computing fits in the internet infrastructure, here is a helpful SingleHop page: [[https://www.singlehop.com/private-cloud-hosting/|SingleHop site]])

They caution you not to rely on links from e-mails to the websites you frequent. Instead, they encourage you to create bookmarks for these websites to ensure that you are logging onto the site you intend. They also favor sites that use two levels to authenticate you before granting access to personal information. “With such methods, after logging in with your password, the site will text or email you a single-use code that must be entered. Only the registered phone number or email address will receive the code, making it that much harder for hackers to gain unauthorized access to your accounts.”

Scam Update – With the cautions from both sources in mind, we updated our post, to help you remain vigilant:

//Hidden URLs// – Those shortened URLs are convenient, but they may be links to websites you don’t want to visit, or worse, they could install malware on your computer. SingleHop admonishes, “Especially look out for slightly misspelled words or words that use unexpected characters, such as substituting a “0” (number) for a “0” (letter) — for example, HOME DEPOT. If something looks even a little bit fishy, delete the email or close the site immediately.”

//Phishing Requests// – When you get an invitation to click on any link, think twice. When you click, you may be taken to a fake Twitter or Facebook or to a bank, credit card issuer, or another financial institution login page. SingleHop says “Phishers will design their sites to look exactly like the website of your” institutions. If you fall for the fake website, and enter you username and password, the cybercriminals can use your information on the real website to gain complete control of your account.

//Hidden Charges// – Be wary of those online quizzes that offer to tell you interesting information about yourself like which 1960s sitcom star you resemble. If the quiz asks you for personal information, such as your phone number, stop. If you continue, you many end up subscribing to some service that charges a recurring monthly fee.

//Cash Grabs// – It’s great to make new friends, but maybe not by “friending” strangers on Facebook. That person you just friended on Facebook may soon be asking you for money. You can avoid this situation by limiting your social media connections to people you know personally. Ignore friend requests when you do not know the person and have no friends in common.

//Chain Letters// – Sure, you want to be sure that Microsoft will donate the millions it promised to some worthy charity if you keep the online chain letter going. However, such “chain letter” e-mails are a way for spammers to access your friends to connect with them later. Also, you never know to whom your friends will forward the letter.

Sites that are popular with users are popular with criminals, so remain vigilant when you are on line, and, of course, keep your antivirus and anti-malware software up to date. Be wary and think twice before clicking on a suspicious link!