Tax Planning Hacks for your Itemized Deductions and more

The Tax Cut and Jobs Act brought the most significant changes to our income taxes in the last thirty years.  We continue to assess its impact in this post, which provides updates and some strategies for items discussed at the end of 2018 in these three posts:

As a quick summary of the posts, in the first post, we discussed the impact of the new law on personal taxes; in the second post, we discussed planning for small businesses; and in our third post, we provided a practical guide for year-end action.   

Itemized deduction strategies

As we noted in these tax planning posts, far fewer US Taxpayers will itemize because of the increased $24,000 standard deduction for married couples ($12,000 for individuals).  One estimate is that the number will be about 6% of all taxpayers for 2018, down from over 30% in prior years. 

Bunching your itemized deductions into a single year is one way to push your total above the standard deduction amount, and thus restore the tax deduction benefit for such items as charitable donations.  We discussed bunching and giving to donor advised funds in our third post.  As we noted then, charitable donations are the easiest Schedule A items to which to apply bunching.

Miscellaneous deductions are gone;
Or are they? 

Now that the miscellaneous itemized deductions are gone, can you do anything with tax prep and investment fees? 

Take tax prep fees on other schedules

For the tax preparation fees, you can deduct those amounts on Schedule C, Schedule E (page 1), or Schedule F.  And, if you have K-1s, input the fees as unreimbursed expenses so that the fees flow to Schedule E (page 2).

Capitalize investment fees

As for investment fees, there is support for capitalizing these costs, but the support is not dispositive.  This interpretation of the Treasury regulations is that you can capitalize the cost of evaluating the value of stocks purchased and sold.  You would need to elect to capitalize the related fee for each transaction, so this could be a great deal of work, depending on the amount of fees and number of stocks purchased or sold in a given year.  Taking this approach seems fair, as the treatment parallels treatment of fees in mutual fund, where the advisory fees are netted out before capital gain and dividend distributions to shareholders. 

Kiddie tax

The first $1,050 of unearned income for children who are dependents is not taxed in 2018.  Amounts above that level are taxed at the same rate as trusts and estates.  Those brackets are quite compressed compared to individual brackets.  Nonetheless, a child of a parent in the 37% tax bracket can still have $12,500 of income taxed at a lower rate.  That could save taxes on college funds (but compare to sheltering in a 529 plan).

Child tax credit

The $2,000 child credit phases out at much higher adjusted income levels for 2018:  over $400,000 for married couples, $200,000 for single taxpayers.  If your child is age 17 or over, you lose the $2,000 credit, but you may qualify for the $500 dependent credit.   This credit could not only applies to college students, it covers disabled children, elderly parents and other family that are your dependents.      

QBID for rental real estate

The IRS regulations provide a safe harbor for people who spend 250 or more hours a year on activities related to their rental properties.  You will need to keep records of your time and maintain separate bank accounts for the activities. 

Enterprise Zone rollovers  

You can roll over gain from stock or other capital assets to investments in an enterprise zone, delaying tax on the gain, and even eliminating tax on a portion.  We will post more on this at a future date.

Estate taxes

With the doubling of the federal gift and estate tax credit, few estates will be subject to federal estate tax.  This means that gifting is not nearly as important as retaining low basis assets for the step at death.  By this we mean that keeping assets in your name results in those assets are treated as having basis equal to the fair market value at death, so your heirs only pay tax on any gain that occurs after your death. 

Conclusion

There have been many changes to our tax law, so if you are not sure how you are affected, contact me for some planning. Maybe we can help you save on taxes!

Steven

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.