Category: Tax Services

Posted on Nov 15, 2018

Today, approximately 38 million private-sector employees in the United States lack access to a retirement savings plan through their employers. However, momentum is building in Washington, D.C., to remedy this situation by helping small employers take advantage of multiple employer defined contribution plans (MEPs).

Could a MEP work for you and your workers? If the federal government expands these retirement savings programs, small employers will need to carefully consider the pros and cons before jumping at the MEP opportunity.

Wheels of Change

In September, President Trump issued an executive order, asking the U.S. Department of Labor (DOL) to investigate ways to help employers expand access to MEPs and other retirement plan options for their workers. The order also aims to improve the effectiveness and reduce the cost of employee benefit plan notices and disclosures.

The DOL followed up by publishing proposed regulations that would expand eligibility for MEP participation. Those regulations are expected to be finalized in early 2019.

A MEP essentially acts as the sponsor of a defined contribution (DC) plan, on behalf of a group of employers under its administrative umbrella. “The employers would not be viewed as sponsoring their own plans under ERISA. Rather, the [MEP] would be treated as a single employee benefit plan for purposes of ERISA,” says the Society for Human Resource Management. The MEP’s sponsor “would generally be responsible, as plan administrator, for complying with ERISA’s reporting, disclosure and fiduciary obligations.”

In principle, the administrative efficiencies of participating in a MEP would lower the costs of providing employees with retirement savings plans. But there are additional factors to take into consideration in evaluating MEPs.

Current rules only provide for “closed” MEPs that are sponsored by an association whose principal purpose is something other than sponsoring the MEP, and whose members must also have a “commonality of interest.”

Under the DOL’s more relaxed proposal, membership in a MEP would open up to companies in the same geographic area or in the same trade, profession or industry. Also, sponsoring the MEP could be the association’s primary purpose, so long as it had at least one secondary “substantial business purpose.”

Several additional requirements for associations that sponsor MEPs were listed in the proposed regulations. Among them, the association must:

  • Have a formal organizational structure with a governing body and bylaws,
  • Be controlled by its employer members,
  • Limit participation in the MEP to employees or former employees of MEP members, and
  • Not be a financial institution, insurance company, broker-dealer, third party administrator or recordkeeper.

The regulations would allow PEOs (professional employer organizations) to sponsor MEPs, if the PEOs meet certain requirements, including to perform “substantial employment functions” on behalf of their employer clients. Also, self-employed individuals and sole proprietors would be eligible to participate in a MEP.

Legislative Improvements

Even though the proposed DOL regs would ease current restrictions on MEPs, enough constraints would remain that could limit their expansion. A major issue that the proposed regulations fail to resolve is the so-called “bad apple” rule. That is, if one employer in a MEP fails to fulfill its administrative requirements, that failure, depending on its severity, could cause the entire MEP to be disqualified under the DOL proposal.

Fortunately, the House of Representatives has already passed a bill (the Family Savings Act) that addresses the bad apple issue. A similar measure (the Retirement Enhancement and Savings Act) is now pending in the Senate. The proposed legislation would clarify that the plans would separate noncompliant employers from other employers — or in essence “quarantine” the bad apples.

The bill also clarifies that employers’ fiduciary liability for the operation of the MEP is limited. But employers can’t avoid fiduciary liability altogether. That’s because they remain responsible for:

  1. Selecting a MEP and its investment lineup, and
  2. Ensuring that the MEP and the association that sponsors it adhere to the quality criteria the employer used when deciding to join the MEP.

The Senate version of the legislation would create a type of MEP known as a “pooled employer plan” (or PEP). PEP participants would interact with the plan electronically to help keep the plan’s administrative costs as low as possible.

Boom or Bust?

It’s unclear whether the new-and-improved MEPs will have a significant cost advantage — or whether that’s even a primary objective of employers that decide to join a MEP. Inexpensive Web-based 401(k) plan sponsorship platforms have emerged in recent years that help to address the cost issue.

Plus, there’s concern that some MEPs will lower costs by transferring fiduciary responsibilities to employers. But many employers may look beyond cost when deciding on a retirement plan. They may also value the simplicity of outsourcing plan administration and sharing fiduciary responsibilities with the plan sponsor.

Need more information about your situation? Your benefits advisor can help you select the retirement savings plan options that make the most sense for you and your employees.

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Posted on Jul 3, 2018


The Supreme Court often agrees to rule on questions upon which individual appeals courts have reached different conclusions, to create a uniform national legal standard.

And that’s what the court did with a 5-4 decision in a case called Epic Systems Corp. v. Lewis. The basic question was whether the Federal Arbitration Act has greater authority over arbitration agreements between employers and employees than the National Labor Relations Act (NLRA).

The court consolidated three similar cases in its ruling. In each case, employees had entered into agreements with their employers to resolve any labor disputes that might arise by arbitration, instead of taking the employers to court.

Which Law Governs?

Despite having signed those agreements, once disputes arose affecting the individuals and their coworkers, the employees argued that the agreements weren’t valid.

Why? Because, the employees alleged, those agreements prevented them from participating in a class action lawsuit, which they argue is a “protected activity” safeguarded by the NLRA. For the last six years, the National Labor Relations Board (which plays a key role in enforcing the NLRA) has taken the position that employees’ ability to pursue a class action case is a “protected activity” and supersedes the Federal Arbitration Act.

The majority Supreme Court opinion written by Justice Neil Gorsuch essentially concluded that the basic goal of Congress when it adopted the NLRA was to enable employees to form labor unions. On that basis, the protected activity that is sheltered by the NLRA is about union building and is unrelated to arbitration agreements.

This ruling doesn’t give employers a blank check, however, in how they introduce arbitration agreements into their employer-employee dispute resolution programs. Rather, it declares that arbitration agreements that preempt class action litigation aren’t intrinsically illegal. How you put them in place matters a great deal as to whether they will hold up in court, if challenged.

Why Arbitration?

Why would you want to have employees accept mandatory arbitration in the first place? Arbitration enables a dispute to be resolved more quickly and inexpensively than it generally would be in the court system. When sued and taken to court by a disgruntled employee, even with a dubious claim, many employers decide to settle the case just to make it go away and save money. But with arbitration, that isn’t necessary. Because the process is relatively inexpensive, it’s easier to stick to your guns and defeat claims that are found to be bogus.

To be clear, arbitration doesn’t guarantee an employer will come out on top in a dispute. Chances are if you would lose in court, you’d probably lose in arbitration. But at least the process would typically be much faster and less costly.

Implementing an Arbitration Policy

To make arbitration agreements hold up to a potential legal challenge, attorneys recommend that you take several precautions. One is to make it a stand-alone agreement that the employee signs, versus having it just be one of many pieces of a longer employment agreement. This way it would be tough for an employee to claim he or she wasn’t aware of having agreed to arbitration.

It must be clearly stated that the agreement is mutual — that is, it applies equally to the employer and the employee. It’s also important that the agreement provide general guidance on the categories of disputes that it covers. For example, arbitration might not be the best way to deal with a dispute involving theft of company property.

Here are a few additional provisions to consider when you work with an attorney to draft an arbitration agreement:

  • Payment of arbitration fees. You might agree to cover all the fees associated with an arbitration unless the dispute involves a highly paid executive. Courts have occasionally raised concerns about requiring employees to split these fees on the basis that this might make the use of arbitration unworkable to an employee (except where the plaintiff’s attorney would work on a contingency basis).
  • “Severability” clause. Such a clause says that if one part of the agreement is deemed invalid, that part can be thrown out without shooting down the entire agreement.
  • Limits on statutory remedies. In cases where employees prevail but the agreement includes caps on the awards to employees, courts have at times rejected such agreements if using the judicial system would’ve resulted in higher awards.

Final Thoughts

Whatever provisions you incorporate into an arbitration agreement, the goal is to avoid problems if an employee challenges its validity in court. Standards will vary by jurisdiction and according to the level of risk you’re willing to assume. A qualified labor attorney can walk you through the entire process, from considering whether you want an arbitration agreement to drafting the agreement itself if you opt to use one.

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Posted on Jun 30, 2018

Summer jobs can be an effective way to teach children about financial responsibility, encourage them to save for college or retirement, and provide them with spending money during the school year. If you own a business, consider hiring your child (or grandchild) as a legitimate employee. It can be a smart tax-saving strategy for employee and employer alike, especially under the Tax Cuts and Jobs Act (TCJA).

Tax Advantages

When you hire your child, you get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable).

Your child’s wages are also exempt from Social Security, Medicare, and FUTA taxes, if the following conditions are met:

  • Your business operates as a sole proprietorship, a single-member limited liability company (LLC) that’s treated as a sole proprietorship for tax purposes, a husband-wife partnership or an LLC that is treated as a husband-wife partnership.
  • Your child is under age 18 (or under age 21 in the case of the FUTA tax exemption).
  • Your child is a legitimate part-time or full-time employee of the business.

Unfortunately, corporations aren’t eligible for this break. (See “Corporate Employers Don’t Get Payroll Tax Break” at right.)

Thanks to the TCJA, your employee-child can use his or her standard deduction to shelter up to $12,000 of 2018 wages paid by your business from the federal income tax. For 2017, the standard deduction was only $6,350. But the TCJA nearly doubled it for 2018 through 2025. That makes the hiring-your-kid strategy better than before.

Important note: For an unmarried dependent child with earned income, the 2018 standard deduction is the greater of 1) $1,050 or 2) earned income + $350 but no more than $12,000.

In other words, for 2018, your child will owe nothing in federal taxes on the first $12,000 of wages, unless he or she has income from other sources. Your child can save some of the wages — and possibly even contribute money to a Roth IRA or put it into a college fund.

The Roth Angle

The only tax-law requirement for your child to make annual Roth IRA contributions is having earned income for the year that at least equals what’s contributed for that year. Age is completely irrelevant. So, if your child earns some cash from a summer job or part-time work after school, he or she is entitled to make a Roth contribution for that year.

For the 2018 tax year, a working child can contribute the lesser of:

  • His or her earned income, or
  • $5,500.

While the same $5,500 contribution limit applies equally to Roth IRAs and traditional deductible IRAs, the Roth option usually makes more sense for young people. Why? Your child can withdraw all or part of the annual Roth contributions — without any federal income tax or penalty — to pay for college or for any other reason. However, Roth earnings generally can’t be withdrawn tax-free before age 59½.

In contrast, if your child makes deductible contributions to a traditional IRA, any subsequent withdrawals must be included in gross income. Even worse, traditional IRA withdrawals taken before age 59½ will be hit with a 10% early withdrawal penalty tax unless an exception applies. (One exception is to pay for qualified higher-education expenses.)

Important note: Even though your child can withdraw Roth contributions without any adverse federal income tax consequences, the best strategy is to leave as much of the Roth account balance as possible untouched until retirement (or later) in order to accumulate a larger federal-income-tax-free sum.

Modest Contributions Can Add Up

By making Roth contributions for just a few teenage years, your child can potentially accumulate a significant nest egg by retirement age. Realistically, however, most kids won’t be willing to contribute the $5,500 annual maximum even when they have enough earnings to do so.

If you can talk your teenager into contributing a meaningful amount toward retirement — rather than buying clothes at the mall, concert tickets or V-Bucks to spend on Fortnite (the latest video game fad) — here’s what could happen.

Tommy the Teenager contributes $1,000 to a Roth IRA at the end of each year for four years (ages 15 through 18). Assuming a 5% annual rate of return, the Roth account would be worth about $33,000 in 45 years when the “kid” is 60 years old. If you assume a more-optimistic 8% return, the account would be worth about $114,000 in 45 years.

If Tommy’s parent could talk him into contributing $2,500 each year, his Roth account would be worth a whopping $285,000, assuming an 8% rate of return.

Tax Deductions for Traditional IRA Contributions

Aren’t the tax deductions for traditional IRA contributions an advantage compared to contributing to Roth IRAs? While it’s true that there are no write-offs for Roth contributions, your child probably won’t get any meaningful tax breaks from contributing to a traditional IRA either. That’s because an unmarried dependent child’s standard deduction will automatically shelter up to $12,000 of 2018 earned income from federal income tax. Plus, any additional income will almost certainly be taxed at very low rates.

So, unless the child has enough taxable income to owe a significant amount of tax, the theoretical advantage of being able to deduct traditional IRA contributions is mostly or entirely worthless. Since that’s the only advantage a traditional IRA has over a Roth account, the Roth option almost always comes out on top.

Tax-Savvy Parents Raise Tax-Savvy Kids

Hiring your child can be a tax-smart idea. Remember, however, that the child’s wages must be reasonable for the work performed. So, this strategy works best with teenage children whom you can assign meaningful tasks to. Keep the same records as for any other employee to substantiate hours worked and duties performed (such as timesheets and job descriptions), and issue your child a Form W-2, as you would for any other employee.

Encouraging your child to make Roth IRA contributions is a great way to introduce the ideas of saving money and investing for the future. It’s also a great lesson in tax planning. It’s never too soon for children to learn about taxes and how to legally minimize or avoid them.

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Posted on Jun 23, 2018

Many state legislatures are now in session. A major issue that state lawmakers may currently face is whether to conform their state income tax systems to all the changes included in the Tax Cuts and Jobs Act (TCJA). Some states are considering or have adopted legislation to address the following key provisions of the new tax law.

Beyond SALT

The media has given a lot of attention to certain provisions in the TCJA, such as the new limit on federal income tax itemized deductions for personal state and local taxes (SALT). For 2018 through 2025, the maximum deduction for the combined total of state and local income and property taxes is $10,000, or $5,000 for married people who elect to file separately. This new federal limit has put pressure on some states to reduce residents’ state income tax burdens or find ways to work around the rules.

But the bigger issue is whether states will conform with all the other changes made by the TCJA. Many states “piggyback” their state personal and corporate income tax rules on the federal rules to simplify filing your state income taxes. But when big changes are made to the federal rules, as happened with the TCJA, state legislatures must decide whether to conform or “decouple.” (See “Traditional Approaches to State Tax Conformity” at right.)

TCJA Provisions that Could Potentially Reduce State Tax Collections

Several TCJA changes threaten to reduce state taxable income and result in lower tax collections for the state — unless the state decouples from the changes. Examples of pro-taxpayer TCJA provisions that states must decide whether to conform to (thereby reducing the state’s tax base) or decouple from (thereby maintaining the state’s tax base) include:

Bigger standard deductions. Many states base the state taxable income of individual taxpayers on federal taxable income. The TCJA almost doubled the federal standard deductions, causing federal taxable income to decrease for many taxpayers.

Elimination of itemized deduction phaseout rule. Under prior law, up to 80% of the most popular federal itemized deductions — for mortgage interest, state and local taxes, and charitable donations — could be phased out for high-income taxpayers. If state taxable income is based on federal taxable income, this phaseout rule increased state taxable income and thereby created more tax revenue for the state. For 2018 through 2015, the TCJA eliminates the itemized deduction phaseout rule.

Higher gift and estate tax exemption. For 2018 through 2025, the TCJA essentially doubles the unified federal gift and estate tax exemption. For 2018, the exemption is a whopping $11.18 million or effectively $22.36 million for a married couple. Several states and the District of Columbia tie their state death tax exemptions to the federal exemption.

Liberalized rule for Section 529 plans. The TCJA liberalizes the Sec. 529 plan rules to allow federal-income-tax-free withdrawals of up to $10,000 a year to cover tuition at a public, private, or religious elementary or secondary school. This change is permanent, for qualifying withdrawals made after December 31, 2017.

Deduction for pass-through business income. For 2018 through 2025, the TCJA allows individual taxpayers to claim a deduction for up to 20% of qualified business income (QBI) from so-called “pass-through” businesses. This includes sole proprietorships, partnerships, S corporations and limited liability companies (LLCs) treated as sole proprietorships or partnerships for tax purposes. Limitations apply at higher income levels.

First-year expensing and depreciation for business assets. Under the TCJA, for qualifying property placed in service in tax years beginning after December 31, 2017, the maximum Section 179 deduction is increased to $1 million (up from $510,000 for tax years beginning in 2017), with inflation adjustments after 2018.

Under the TCJA, 100% first-year bonus depreciation is also allowed for qualified property generally placed in service between September 28, 2017, and December 31, 2022. Bonus depreciation is now allowed for both new and used qualifying property.

TCJA Provisions that Could Potentially Boost State Tax Collections

Not all TCJA provisions are taxpayer friendly. Some changes will generate additional federal taxable income and, for states that conform to the changes, additional state income tax revenue. Examples include:

Elimination of personal and dependent exemption deductions. For 2018 through 2025, the TCJA eliminates exemption deductions. Quite a few states are affected by this change, because the number of exemptions they allow a taxpayer to claim for state income tax purposes is tied to the number of exemptions claimed on the federal return.

New limits on business interest deductions. Under the TCJA, affected corporate and noncorporate businesses generally can’t deduct interest expense in excess of 30% of “adjusted taxable income,” starting with tax years beginning after December 31, 2017. For tax years beginning in 2018 through 2021, adjusted taxable income is calculated by adding back allowable deductions for depreciation, amortization and depletion. After that, these amounts aren’t added back in calculating adjusted taxable income.

Business interest expense that’s disallowed under this limitation is treated as business interest arising in the following taxable year. Amounts that can’t be deducted in the current year can generally be carried forward indefinitely. Small and medium-size businesses and certain real estate and farming ventures are exempt from this anti-taxpayer change.

Reduced or eliminated business deductions for business meals and entertainment. Under the TCJA, deductions for most business-related entertainment expenses are disallowed for amounts paid or incurred after December 31, 2017. Meal expenses incurred while traveling on business are still 50% deductible, but the 50% disallowance rule now also applies to meals provided via an on-premises cafeteria or otherwise on the employer’s premises for the convenience of the employer. After 2025, the cost of meals provided through an on-premises cafeteria or otherwise on the employer’s premises will be nondeductible.

Eliminated deductions for certain employee fringe benefits.The TCJA disallows employer deductions for the cost of providing commuting transportation to an employee (such as hiring a car service), unless the transportation is necessary for the employee’s safety. The law also eliminates employer deductions for the cost of providing qualified employee transportation fringe benefits (for example, parking, mass transit passes and van pooling).

Wait and See

As these examples show, state legislatures have plenty of tax conformity issues to consider this year. Both individual taxpayers and businesses will be affected by tax conformity outcomes. Your tax advisor is atop the latest developments and, as your state tackles these issues, can help determine how you, your family and your business will be affected.

 

Traditional Approaches to State Tax Conformity

In many states, the calculation of state taxable income for individual taxpayers starts with their federal adjusted gross income (AGI).

To Adjust or Not to Adjust?

Federal AGI includes all federal taxable income items and certain write-offs, such as:

  • Self-employed retirement plan contributions,
  • Deductible IRA contributions,
  • HSA contributions,
  • Student loan interest, and
  • Alimony payments.

From there, states may allow their own exemptions and deductions. They also may mandate other adjustments to arrive at state taxable income.

However, some states conform more closely by mirroring federal exemptions and deductions all the way to the state taxable income amount.

How to React to Changes?

States also have different procedures for reacting to federal tax law changes. Some automatically conform to all federal changes unless the state legislature specifically decouples from certain changes. Other states follow the federal rules that are in effect for a particular year and must adopt any changes to those rules.

However, these approaches to conformity are generalizations, because no two states conform (or decouple) in exactly the same way. For example, a few states allow you to deduct your federal income tax payments in calculating your state taxable income, but most don’t. Some states require you to add back any federal itemized deduction for state income taxes, but others don’t. Some states give you a credit for a percentage of your state and local property tax bills, but most don’t. Some states adjust their tax brackets every year to conform to the federal tax bracket inflation adjustments, but some don’t. The differences go on and on.

Conformity issues also exist for business state income tax returns. For example, some states haven’t allowed previous increases to the federal Section 179 first-year depreciation allowance.

Differences in tax rules across state lines add complexity to filing personal and business tax returns, especially for individuals and businesses that earn income in more than one state or move during a tax year.

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Posted on Jun 6, 2018

The Tax Cuts and Jobs Act (TCJA) may have put a crimp in some of your summer plans by eliminating or scaling back certain tax breaks. But individuals and small business owners still have plenty of opportunities to save taxes. Here are six ideas to save taxes that you may consider this summer.

1. Host an Outing for Employees

Under prior law, businesses could deduct 50% of the cost of its entertainment and meal expenses, with certain exceptions. For example, you could write off 100% of the cost of a company outing for employees, such as a 4th of July barbecue or company picnic. This special tax law provision wasn’t touched by the TCJA.

However, there has always been a catch to claim this tax break: You must invite the entire staff. In other words, you can’t restrict the get-together to just the higher-ups. Inviting a few friends or family members won’t jeopardize the deduction, but you can’t write off the costs attributable to those social guests.

2. Combine Business Travel with Pleasure

Small business owners can generally deduct the cost of business travel — such as airfare and lodging — if the primary purpose of the trip is business-related. If you add a few extra vacation days to the trip, you   can generally still write off your business-related expenses, including the entire cost of a round-trip airline ticket and lodging expenses and 50% of meal expenses for the business days. But the number of business days vs. personal days is critical to establish the primary business purpose test.

Business travelers should remember that the TCJA eliminates deductions for most business-related entertainment expenses, including the cost associated with facilities used for most of these activities. For instance, you can no longer deduct the cost of tickets to sporting events, sailing or golf outings, and theater tickets for events that immediately follow or precede a substantial business meeting.

You can still deduct 50% of your meal expenses while away on business, but the exact rules for deducting meals with business contacts aren’t clear yet. Expect the IRS to issue detailed guidance sometime this year. In the meantime, keep detailed records of what you spend to take advantage of any deductions that turn out to be available.

3. Navigate a Deduction for a Boat

Under the TCJA, the mortgage interest deduction for 2018 through 2025 for one or two qualified residences is limited to interest paid on the first $750,000 of acquisition debt. (Prior home acquisition debts are grandfathered under prior law.)

The TCJA limit on home acquisition debt is down from $1 million, while the deduction for interest on the first $100,000 of home equity debt is generally repealed (unless the home equity debt is used to buy, build or substantially improve the home secured by the debt, in which case it can be treated as acquisition debt). Depending on the size of your mortgage(s), you might have enough slack to benefit from a little-known tax break for boats.

For this purpose, a “qualified residence” can be your primary residence and one other home. The IRS definition of a qualified residence includes a boat that has sleeping, cooking and toilet facilities. Therefore, a vessel should qualify if it has a galley, sleeping quarters and a bathroom. If you’re shopping for a new boat, remember to stay within the current home acquisition debt limit of $750,000.

4. Schedule Time at Your Vacation Home

If you own a vacation home and rent it out part of the year, you can generally deduct related expenses against the rental income. You might even be able to claim a rental loss if your personal use for the year doesn’t exceed the greater of:

14 days, or
10% of the rental time.
Keep an eye on these two personal use tests as the year progresses. If it helps you out tax-wise, you might forgo some personal vacation or rent out the place a little longer. Also, remember that a day spent cleaning the vacation home or making repairs doesn’t count as a personal use day — even if the rest of the family tags along.

5. Camp Out for Dependent Care Credits

If you pay for child care costs while you work and the kids are out of school, you may be eligible for a dependent care credit. Generally, the credit is equal to 20% of the first $3,000 of qualified expenses for one child or 20% of up to $6,000 of qualified expenses for two or more children. So, the maximum credit is usually $600 for one child or $1,200 for two or more children.

The list of qualified expenses includes the cost of day camp where your child participates in recreational activities, such as swimming or hiking. The credit is even available for costs of specialty camps for athletics, academics or other pursuits. However, no credit can be claimed for an overnight summer camp.

6. Hire Your Kids

While staffing your business this summer, you might add a teenager or 20-something who’s off from school. Not only does this provide a meaningful and financially rewarding activity for your child, but you can also claim a business deduction for the wages, assuming the amount is reasonable for the services performed.

When interviewing applicants for summer help, consider hiring your own child or grandchild. He or she will probably earn less than the standard deduction for a dependent — which the TCJA increased for 2018 to the greater of:

  • $1,050, or
  • $350 plus earned income limited to $12,000.

So, your child or grandchild probably won’t owe any federal income tax on the wages. A child can even avoid withholding by claiming an exemption when filing his or her W-4. As a bonus, wages paid to an under-age-18 child or grandchild are exempt from Social Security and Medicare taxes, if you run your business as:

  • A sole proprietorship,
  • A limited liability company (LLC) treated as a sole proprietorship for tax purposes,
  • A husband-wife partnership, or
  • A husband-wife LLC treated as a partnership for tax purposes.

A similar exemption for FUTA tax applies to wages paid to a child or grandchild under age 21.

Hot Planning Strategies

Could any of these strategies work for you or your business? Although the recent tax law may have complicated tax matters, it still provides some tax-saving opportunities. Contact your tax advisor for more information on these strategies and many other ideas that may apply to your personal or business tax situation.

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Posted on Jun 1, 2018

Would you like to invest in a business that allows you to subsequently sell your stock tax-free? That may be possible with qualified small business corporation (QSBC) stock that’s acquired on or after September 28, 2010. Sales of QSBC stock are potentially eligible for a 100% federal income tax exclusion. That translates into a 0% federal income tax rate on your profits from selling stock in a QSBC.

Here’s what you need to know about the 100% stock sale gain exclusion rules, including important restrictions and how this deal may be even sweeter under the Tax Cuts and Jobs Act (TCJA).

Tax-Free Gain Rollovers for QSBC Stock Sales

Sales of qualified small business corporation (QSBC) stock may potentially be eligible for a gain exclusion. (See main article.) But that’s not all. There’s also a tax-free stock sale gain rollover privilege — similar to what happens with like-kind exchanges of real property.

Under the rollover provision, the amount of QSBC stock sale gain that you must recognize for federal income tax purposes is limited to the excess of the stock sales proceeds over the amount that you reinvest to acquire other QSBC shares during a 60-day period beginning on the date of the original sale. The rolled-over gain reduces the basis of the new shares. You must hold the original shares for over six months to qualify for the gain rollover privilege.

Essentially, the gain rollover deal allows you to sell your original QSBC shares without owing any federal income tax and without losing eligibility for the gain exclusion break when you eventually sell the replacement QSBC shares.

The Basics

Whether you’re considering starting up your own business or investing in someone else’s start-up, it’s important to learn about QSBCs. In general, they’re the same as garden-variety C corporations for legal and tax purposes — except shareholders are potentially eligible to exclude 100% of QSBC stock sale gains from federal income tax. There’s also a tax-free gain rollover privilege for QSBC shares. (See “Tax-Free Gain Rollovers for QSBC Stock Sales” at right.)

To be classified as tax-favored QSBC stock, the shares must meet a complex list of requirements set forth in Internal Revenue Code Section 1202. Major hurdles to clear include the following:

  • You must acquire the shares after August 10, 1993.
  • The stock generally must be acquired upon original issuance by the corporation or by gift or inheritance.
  • The corporation must be a QSBC on the date the stock is issued and during substantially all the time you own the shares.
  • The corporation must actively conduct a qualified business. Qualified businesses don’t include 1) services rendered in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or other businesses where the principal asset is the reputation or skill of employees, 2) banking, insurance, leasing, financing, investing or similar activities, 3) farming, 4) production or extraction of oil, natural gas or other minerals for which percentage depletion deductions are allowed, or 5) the operation of a hotel, motel, restaurant or similar business.
  • The corporation’s gross assets can’t exceed $50 million immediately after your shares are issued. However, if the corporation grows and exceeds the $50 million threshold after the stock is issued, it won’t cause the corporation to lose its QSBC status with respect to your shares.

This is only a partial list. Consult your tax advisor to determine whether your venture can meet all the requirements of a QSBC.

Gain Exclusion Rules and Restrictions

To take advantage of the gain exclusion break, the stock acquisition date is critical. The 100% gain exclusion is available only for sales of QSBC shares acquired on or after September 28, 2010. However, a partial exclusion may be available in the following situations:

  • For QSBC shares acquired between February 18, 2009, and September 27, 2010, you can potentially exclude up to 75% of a QSBC stock sale gain.
  • For QSBC shares acquired after August 10, 1993, and before February 18, 2009, you can potentially exclude up to 50% of a QSBC stock sale gain.

The tax code further restricts QSBC gain exclusions for:

C corporation owners. Gain exclusions aren’t available for QSBC shares owned by another C corporation. However, QSBC shares held by individuals, S corporations and partnerships are potentially eligible.

Shares held for less than five years. To take advantage of the gain exclusion privilege, you must hold the QSBC shares for a minimum of five years. So, for shares that you haven’t yet acquired, the 100% gain exclusion break will be available for sales that occur sometime in 2023 at the earliest.

TCJA Impact

The new tax law makes QSBCs even more attractive. Why? Starting in 2018, the law permanently lowers the corporate federal income tax rate to a flat 21%.

So, if you own shares in a profitable QSBC and eventually sell those shares when you’re eligible for the 100% gain exclusion, the flat 21% corporate rate will be the only federal income tax that the corporation or you will owe.

Right for Your Venture?

Conventional wisdom says it’s best to operate private businesses as pass-through entities, meaning S corporations, partnerships or limited liability companies (LLCs). But that logic may not be valid if your venture meets the definition of a QSBC.

The QSBC alternative offers three major upsides: 1) the potential for the 100% gain exclusion break when you sell your shares, 2) a tax-free stock sale gain rollover privilege, and 3) a flat 21% federal corporate income tax rate. Your tax advisor can help you assess whether QSBC status is right for your next business venture.

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Posted on May 22, 2018

The Tax Cuts and Jobs Act (TCJA) introduced a flat 21% federal income tax rate for C corporations for tax years beginning in 2018 and beyond. Under prior law, profitable C corporations paid up to 35%. This change has caused many business owners to ask: What’s the optimal choice of entity for my start-up business?

QBI Deductions for Pass-Through Businesses

For tax years beginning after December 31, 2017, the latest tax law establishes a new deduction based on a noncorporate owner’s share of a pass-through entity’s qualified business income (QBI). This break is available to eligible individuals, estates and trusts. The deduction generally equals 20% of QBI, subject to restrictions that can apply at higher income levels.

The QBI deduction isn’t allowed in calculating the noncorporate owner’s adjusted gross income (AGI), but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction.

Limitation Based on W-2 Wages and Capital Investments

The QBI deduction generally can’t exceed the greater of the noncorporate owner’s share of:

  • 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year, or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property (to allow capital-intensive businesses to claim meaningful QBI deductions).

“Qualified property” means depreciable tangible property (including real estate) owned by a qualified business as of the tax year end and used by the business at any point during the tax year for the production of QBI.

Under an exception, the W-2 wage / qualified property limitation doesn’t apply until an individual owner’s taxable income exceeds $157,500, or $315,000 for a married individual who files jointly. Above those income levels, the W-2 wage / qualified property limitation is phased in over a $50,000 taxable income range, or over a $100,000 range for married individuals who file jointly.

Disallowance Rule for Service Businesses

The QBI deduction generally isn’t available for income from specified service businesses, such as most professional practices. Under an exception, however, the service business disallowance rule does not apply until an individual owner’s taxable income exceeds $157,500, or $315,000 for a married individual who files jointly. Above those income levels, the service business disallowance rule is phased in over a $50,000 taxable income range, or over a $100,000 range for married joint-filers.

Important note: The W-2 wage / qualified property limitation and the service business disallowance rule don’t apply as long as your taxable income is under the applicable threshold. In that case, you should qualify for the full 20% QBI deduction.

Choosing the Optimal Business Structure

Under prior tax law, conventional wisdom was that most small and midsize businesses should be set up as sole proprietorships, or so-called “pass-through entities,” including:

  • Single-member limited liability companies (LLCs) treated as sole proprietorships for tax purposes,
  • Partnerships,
  • LLCs treated as partnerships for tax purposes, and
  • S corporations.

The big reason that pass-through entities were popular was that income from C corporations is potentially taxed twice. First, the C corporation pays entity-level income tax. And then, corporate shareholders pay tax on dividends and capital gains. The use of pass-through entities avoids the double taxation issue, because there’s no federal income tax at the entity level.

Although C corporations are still potentially subject to double taxation under the TCJA, the new 21% corporate federal income tax rate helps level the playing field between C corporations and pass-through entities.

This issue is further complicated by another provision of the TCJA that allows noncorporate owners of pass-through entities to take a deduction of up to 20% on qualified business income (QBI). (See “QBI Deductions for Pass-Through Businesses” at right.)

There’s no universal “right” answer when deciding how to structure your business to minimize taxes. The answer depends on your business’s unique situation and your situation as an owner. Here are three common scenarios and choice-of-entity implications to help you decide what’s right for your start-up venture.

1. Business Generates Tax Losses

If your business consistently generates losses, there’s no tax advantage to operating as a C corporation. Losses from C corporations can’t be deducted by their owners. So, it probably makes sense to operate as a pass-through entity. Then, the losses will pass through to your personal tax return (on Schedule C, E, or F, depending on the type of entity you choose).

2. Business Distributes All Profits to Owners

Let’s suppose your business is profitable and pays out all of its income to the owners. Here are the implications of operating as a C corporation vs. a pass-through entity under this scenario.

Results with a C corporation. After paying the flat 21% federal income tax rate at the corporate level, the corporation pays out all of its after-tax profits to its shareholders as taxable dividends eligible for the 20% maximum federal rate.

So, the maximum combined effective federal income tax rate on the business’s profits — including the 3.8% net investment income tax (NIIT) on dividends received by shareholders — is 39.8%. That equals 21% for the corporate level tax, plus the personal level tax rate on the dividends, which are reduced by the corporate level tax [(20% + 3.8%) x (100% – 20%)]. While you would still have double taxation here, the 39.8% rate is lower than it would have been under prior law.

Results with a pass-through entity. For a pass-through entity that pays out all of its profits to its owners, the maximum effective federal income tax rate on the venture’s profits is 40.8%. That equals the highest federal income tax rate for individuals (37%), plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the self-employment (SE) tax (whichever applies). This example assumes that, if the SE tax applies, the additional 0.9% Medicare tax on high earners increases the rate for the Medicare tax portion of the SE tax to 3.8%.

If you can claim the full 20% QBI deduction, the maximum federal income tax rate is reduced to 33.4%. That equals the highest federal income tax rate for individuals on passed-through income reduced to reflect the QBI deduction [37% x (100% – 20%)], plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the SE tax (whichever applies). However, the QBI deduction is allowed only for 2018 through 2025, unless Congress extends it.

In this scenario, operating as a pass-through entity is probably the way to go if significant QBI deductions are available. If not, it’s basically a toss-up. But operating as a C corporation may be simpler from a tax perspective.

3. Business Retains All Profits to Finance Growth

Let’s suppose your business is profitable, but it socks away all of its profits to fund future growth strategies. Here are the implications of operating as a C corporation vs. a pass-through entity under this scenario.

Results with a C corporation. In this example, we’re going to assume that retained profits increase the value of the corporation’s stock dollar-for-dollar, and that shareholders eventually sell the shares and pay federal income tax at the maximum 20% rate for long-term capital gains.

The maximum effective combined federal income tax rate on the venture’s profits is 39.8%. That equals 21% for the corporate level tax, plus the personal level tax on gain that is reduced to reflect the 21% corporate tax [(20% + 3.8%) x (100% – 21%)]. While you would still have double taxation here, the 39.8% rate is better than it would have been under prior law. Plus, shareholder-level tax on stock sale gains is deferred until the stock is sold.

If the corporation is a qualified small business corporation (QSBC), the 100% gain exclusion may be available for stock sale gains. If so, the maximum combined effective federal income tax rate on the venture’s profits can be as low as 21%. Ask your tax advisor if your venture is eligible for QSBC status.

Results with a pass-through entity. Under similar assumptions for a pass-through entity, the maximum effective federal income tax rate on the venture’s profits is 40.8%. That equals the highest federal income tax rate for individuals (37%), plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the SE tax (whichever applies). That’s slightly higher than the 39.8% rate that applies with the C corporation option.

However, here’s the key difference: For a pass-through entity, all taxes are due in the year that income is reported. With a C corporation, the shareholder-level tax on stock sale gains are deferred until the shares are sold.

If you can claim the full 20% QBI deduction, the maximum effective rate for a pass-through entity is reduced to 33.4%. That equals the highest federal income tax rate for individuals on passed-through income that is reduced to reflect the QBI deduction [37% x (100% – 20%)], plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the SE tax (whichever applies). However, the QBI deduction is allowed only for 2018 through 2025, unless Congress extends it.

In this scenario, operating as a C corporation is probably the way to go if the corporation is a QSBC. If QSBC status is unavailable, operating as a C corporation is still probably preferred — unless significant QBI deductions would be available at the owner level. If you expect to be eligible for the full 20% QBI deduction, pass-through entity status might be preferred. Discuss this issue with your tax advisor to evaluate all of the pros and cons.

Other Related Issues to Consider

Business owners can use a variety of strategies to help lower their tax bills, and those strategies may vary depending on the type of entity you choose. Before deciding on the optimal business structure for your start-up, here are some other issues to consider.

Deductions for capital expenditures. For the next few years, C corporations and pass-through entities will be able to deduct 100% of the cost of many types of fixed assets, thanks to the TCJA’s generous Section 179 rules, which are permanent, and the 100% first-year bonus depreciation deduction, which is generally available for qualifying property placed in service between September 28, 2017, and December 31, 2022.

These changes under the new tax law may significantly reduce the federal income tax hit on a capital-intensive business over the next few years. However, reducing pass-through income with these favorable first-year depreciation rules will also reduce allowable QBI deductions.

Deductions for “reasonable” compensation. Closely held C corporations have historically sought to avoid double taxation by paying shareholder-employees as much as possible in deductible salaries, bonuses and fringe benefits. However, salaries, bonuses and benefits must represent reasonable compensation for the work performed.

For 2018 through 2025, this strategy is a bit more attractive because the TCJA’s rate reductions for individual taxpayers mean that most shareholder-employees will pay less tax on salaries and bonuses. In addition, any taxable income left in the corporation for tax years beginning in 2018 and beyond will be taxed at only 21%. Finally, C corporations can provide shareholder-employees with some tax-free fringe benefits that aren’t available to pass-through entity owners.

S corporations have historically tried to do the reverse. That is, they’ve attempted to minimize salaries paid to shareholder-employees to reduce Social Security and Medicare taxes. The IRS is aware of this strategy, so it’s important to pay S corporation shareholder-employees reasonable salaries to avoid IRS challenges.

The TCJA makes this strategy even more attractive for many businesses, because it maximizes the amount of S corporation income that’s potentially eligible for the QBI deduction. Guaranteed payments to partners (including LLC members treated as partners for tax purposes) and reasonable salaries paid to S corporation shareholder-employees do not count as QBI. But S corporation net income (after deducting salaries paid to shareholder-employees) does qualify as QBI.

Appreciating assets. If your business owns real estate, certain intangibles and other assets that are likely to appreciate, it’s still generally inadvisable to hold them in a C corporation. Why? If the assets are eventually sold for substantial profits, it may be impossible to get the profits out of the corporation without double taxation.

In contrast, if appreciating assets are held by a pass-through entity, gains on sale will be taxed only once at the owner level. The maximum rate will generally be 23.8% or 28.8% for real estate gains attributable to depreciation.

Spin-offs. A major upside for pass-through entities is the QBI deduction. But the disallowance rule for service businesses may wipe out QBI deductions for certain types of businesses, such as medical practices and law firms, that are set up as pass-through entities.

However, a spin-off might allow you to take a partial QBI deduction. How? If you can spin off operations that don’t involve the delivery of specified services into a separate pass-through entity, income from the spin-off may qualify for the QBI deduction.

The IRS hasn’t yet issued guidance on this strategy. Plus, the QBI deduction is scheduled to expire after 2025, unless Congress extends it. So, making big changes to create QBI deductions may not be worth the trouble. Talk to your tax advisor before attempting a spin-off.

Need Help?

The TCJA has far-reaching effects on business taxpayers. Contact your tax advisor to discuss how your business should be set up on opening day to lower its tax bill over the long run.

For simplicity, this article focuses on start-ups. If you own an existing business and wonder whether your current business structure still makes sense, many of the same principles apply. But the tax rules and expense for converting from one type of entity to another add another layer of complexity. Discuss your concerns with a tax pro who can help you with the ins and outs of making a change.

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Posted on May 15, 2018

You might be in a rush to buy or sell a home before summer starts or interest rates increase even more. But, first, it’s important to review the tax rules related to home sales and deductions for mortgage interest, property taxes and work-related moving expenses. Beware: Some rules have changed under the Tax Cuts and Jobs Act (TCJA).

Average Mortgage Interest Rates

As of: 30 year 15 year
April 26, 2018 4.58 4.02
March 2018 4.44 3.91
February 2018 4.33 3.79
January 2018 4.03 3.48
2017 annual average 3.99 3.28
2016 annual average 3.65 2.93
2008 annual average 6.03 5.62

Source: Freddie Mac Weekly Mortgage Survey

Timing Counts

Spring and early summer are generally the optimal times to put your house on the market and shop for a new home. Why? The timing coincides with the school year — even if you don’t have school-aged children, this may be an important issue for the people on the other side of the negotiating table.

Plus, moving is generally easier when the weather is mild. And closing before fall leaves plenty of time to settle into your new digs and complete any desired renovations before the holiday season begins.

Rising mortgage interest rates may be another incentive for some home buyers to act sooner rather than later. Though rates are still relatively low compared to historical levels, they’ve been increasing since 2016 — and that trend is expected to continue in 2018. From December 31, 2017, to April 26, 2018, the average interest rate on a 30-year mortgage has increased more than a half percentage point (from 3.95% to 4.58%). (See “Average Mortgage Interest Rates” at right.)

Good News on Home Sale Gain Exclusions

Before you talk to a realtor or get pre-approved for a loan, however, it’s important to think about taxes.

For example, you might be selling a house that’s increased substantially in value from when you bought it. Fortunately, the new tax law retains the home sale gain exclusion. If you qualify for this tax break, the profit from selling your principal residence will be free from federal income taxes (and possibly state income taxes, too).

The gain exclusion rules are fairly straightforward for most sellers. An unmarried homeowner can potentially sell a principal residence for a gain of up to $250,000 without owing any federal income tax. If you’re married and file jointly, you can potentially pay no tax on up to $500,000 of gain. To qualify, however, you generally must pass two tests.

1. Ownership Test. You must have owned the property for at least two years during the five-year period ending on the sale date.

2. Use Test. You must have used the property as a principal residence for at least two years during the same five-year period (periods of ownership and use need not overlap).

To be eligible for the maximum $500,000 joint-filer exclusion, at least one spouse must pass the ownership test, and both spouses must pass the use test.

If you excluded a gain from an earlier principal residence sale under these rules, you generally must wait at least two years before taking advantage of the gain exclusion break again. If you’re a joint filer, the $500,000 exclusion is only available when neither you nor your spouse claimed an exclusion for an earlier sale within two years of the sale date in question.

Important: If you make a “premature” sale that happens less than two years after an earlier sale for which you claimed an exclusion, don’t give up hope. There’s a favorable exception that might help: You can claim a reduced (prorated) exclusion if your premature sale is primarily due to:

  • A change in place of employment.
  • Health reasons.
  • Certain unforeseen circumstances outlined in IRS regulations.

If you qualify for the reduced exclusion, it can be generous enough to completely shelter your profit from federal income tax.

For example, let’s say you and your spouse own and use a home as your principal residence for 18 months. You’re forced to sell because your job is transferred to a distant state. Under these circumstances, you would qualify for a reduced gain exclusion of $375,000. This is 75% of the full $500,000 joint-filer exclusion, because you owned and lived in the home for 75% of the required two-year period.

Bad News on Home-Related Deductions

The TCJA also contains some unfavorable provisions for homeowners and people who relocate for a change in their place of employment. Specifically, for 2018 through 2025, the new law:

  • Limits the deduction for state and local taxes to $10,000 ($5,000 for separate filers) for the sum total of state and local property taxes and state and local income taxes (or sales taxes if you choose that option),
  • Reduces the mortgage “acquisition debt” limit for the home mortgage interest deduction,  to $750,000 ($375,000 for those who use married filing separate status) for newly purchased homes,
  • Eliminates the deduction for interest on home equity debt, unless it’s “acquisition debt” that’s used to buy, build or substantially improve the taxpayer’s home that secures the loan and meets other requirements,
  • Eliminates the above-the-line moving expense deduction (with an exception for members of the military in certain circumstances) for people who relocate for work-related reasons, and
  • Suspends an employee’s ability to exclude from taxable income the value of employer-provided reimbursements for moving expenses (with an exception for active-duty military personnel in certain circumstances).

These temporary provisions are set to expire on January 1, 2026, unless Congress extends them. In the meantime, the changes could adversely affect property values and the demand for expensive homes and homes in jurisdictions with high property taxes.

As buyers learn about these provisions, some properties may take longer to sell than under prior law. And, as banks adjust their underwriting standards to reflect the new tax rules, some buyers may no longer earn enough income to qualify for “jumbo” home mortgages.

Ask the Experts

Timing is just one consideration when buying or selling a home. It’s important to consider tax matters, too. The tax rules for the federal home sale gain exclusion and home-related tax deductions can get complicated in some situations. Whether you’re buying your first home, upgrading to a larger home or downsizing for retirement, discuss matters with your tax advisor before negotiating a deal.

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Posted on May 6, 2018

The Tax Cuts and Jobs Act (TCJA) expands the first-year depreciation deductions for vehicles used more than 50% for business purposes. Here’s what small business owners need to know to take advantage.

Depreciation Allowances for Passenger Vehicles

For new and used passenger vehicles (including trucks, vans and electric automobiles) that are acquired and placed in service in 2018 and used more than 50% for business purposes, the TCJA dramatically and permanently increases the so-called “luxury auto” depreciation allowances.

The maximum allowances for passenger vehicles placed in service in 2018 are:

  • $10,000 for the first year (or $18,000 if first-year bonus deprecation is claimed),
  • $16,000 for the second year,
  • $9,600 for the third year, and
  • $5,760 for the fourth year and beyond until the vehicle is fully depreciated.

If the vehicle is used less than 100% for business, these allowances are cut back proportionately. For 2019 and beyond, the allowances will be indexed for inflation.

Bad News for Employees with Unreimbursed Vehicle Expenses

The new tax law isn’t all good news. Under prior law, employees who used their personal vehicles for business-related travel could claim an itemized deduction for unreimbursed business-usage vehicle expenses. This deduction was subject to a 2%-of-adjusted-gross-income (AGI) threshold.

Unfortunately, for 2018 through 2025, the new tax law temporarily suspends write-offs for miscellaneous itemized expenses. So, an employee can no longer claim deductions for unreimbursed business-usage vehicle expenses incurred from 2018 through 2025.

There’s a possible work-around, however: Employers can provide tax-free reimbursements for the business percentage of employees’ vehicle expenses under a so-called “accountable plan” expense reimbursement arrangement. Contact your tax advisor to find out if an accountable plan could work for you.

First-Year Bonus Depreciation for Passenger Vehicles

If first-year bonus depreciation is claimed for a new or used passenger vehicle that’s acquired and placed in service between September 28, 2017, and December 31, 2026, the TCJA increases the maximum first-year luxury auto depreciation allowance by $8,000. So, for 2018, you can claim a total deduction of up to $18,000 for each qualifying vehicle that’s placed in service. Allowances for later years are unaffected by claiming first-year bonus depreciation.

There’s an important caveat, however: For a used vehicle to be eligible for first-year bonus deprecation, it must be new to the taxpayer (you or your business entity).

The $8,000 bump for first-year bonus depreciation is scheduled to disappear after 2026, unless Congress takes further action.

Prior-Law Allowances for Passenger Vehicles

These expanded deductions represent a major improvement over the prior-law deductions. Under prior law, used vehicles were ineligible for first-year bonus depreciation. In addition, the depreciation allowances for passenger vehicles were much skimpier in the past.

For 2017, the prior-law allowances for passenger vehicles were:

  • $3,160 for the first year (or $11,160 for a new car with additional first-year bonus depreciation),
  • $5,100 for the second year,
  • $3,050 for the third year, and
  • $1,875 for the fourth year and beyond until the vehicle is fully depreciated.

Under prior law, slightly higher limits applied to light trucks and light vans for 2017.

Good News for Heavy SUVs, Pickups and Vans

Here’s where it gets interesting: The TCJA allows unlimited 100% first-year bonus depreciation for qualifying new and used assets that are acquired and placed in service between September 28, 2017, and December 31, 2022. However, as explained earlier, for a used asset to be eligible for 100% first-year bonus deprecation, it must be new to the taxpayer (you or your business entity).

Under prior law, the first-year bonus depreciation rate for 2017 was only 50%, and bonus depreciation wasn’t allowed for used assets.

Heavy SUVs, pickups and vans are treated for tax purposes as transportation equipment — so they qualify for 100% first-year bonus depreciation. This can provide a huge tax break for buying new and used heavy vehicles that will be used over 50% in your business.

However, if a heavy vehicle is used 50% or less for nonbusiness purposes, you must depreciate the business-use percentage of the vehicle’s cost over a six-year period.

Definition of a “Heavy Vehicle”

100% first-year bonus depreciation is only available when an SUV, pickup or van has a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds. Examples of suitably heavy vehicles include the Audi Q7, Buick Enclave, Chevy Tahoe, Ford Explorer, Jeep Grand Cherokee, Toyota Sequoia and lots of full-size pickups.

You can usually verify the GVWR of a vehicle by looking at the manufacturer’s label, which is usually found on the inside edge of the driver’s side door where the door hinges meet the frame.

Case in Point

To illustrate the potential savings from the new 100% first-year bonus depreciation break, suppose you buy a new $65,000 heavy SUV and use it 100% in your business in 2018. You can deduct the entire $65,000 in 2018.

What if you use the vehicle only 60% for business? Then your first-year deduction would be $39,000 (60% x $65,000).

Now, let’s assume you purchase a used heavy van for $45,000 in 2018. You can still deduct the entire cost in 2018, thanks to the 100% first-year bonus depreciation break. If you use the vehicle 75% for business, your first-year deduction is reduced to $33,750 (75% x $45,000).

Buy, Use, Save

The TCJA provides sweeping changes to the tax law. Many changes are complex and may take months for practitioners and the IRS to interpret. But the provisions that expand the first-year depreciation deductions for business vehicles are as easy as 1-2-3: 1) buy a vehicle, 2) use it for business, and 3) save on taxes.

If you have questions about depreciation deductions on vehicles or want more information about other issues related to the new law, contact your tax advisor.

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Posted on Mar 28, 2018

Bitcoin has been around for nearly a decade. But the tax rules related to “virtual currency” are still evolving. In fact, some Bitcoin investors may be in for a surprise when they file their 2017 returns. Tax matters will become even more complicated for 2018 returns because relevant provisions of the new tax law (the Tax Cuts and Jobs Act) took effect starting in 2018.

The Basics

Here’s what you should know about the brave relatively new world of virtual currency.

Bitcoin emerged in 2009, and it’s currently the most widely recognized form of virtual currency. It may also be referred to as digital, electronic or cryptocurrency.

Unlike cash or credit cards, your local pizza parlor or hair salon isn’t likely to accept Bitcoin payments for routine transactions. However, a growing number of larger businesses — including Overstock.com, the Sacramento Kings and online gaming company Zynga — now accept Bitcoin payments. And the trend is expected to continue.

Bitcoin has an equivalent value in real currency. It can be digitally traded between users. You can also purchase Bitcoin with real currencies (such as U.S. dollars or euros) and exchange Bitcoin for real currencies. The most common ways to obtain Bitcoin are through virtual currency ATMs or online exchanges that typically charge nominal transaction fees.

Once you obtain Bitcoin, you can pay for goods or services using “Bitcoin wallet” software that can be installed on your computer or mobile device. When you make  a purchase, the software digitally posts the transactions to the global public ledger. This ensures that the same unit of virtual currency can’t be used multiple times.

Some merchants accept Bitcoin to avoid transaction fees charged by credit card companies and online payment providers (such as PayPal). It’s also popular in certain foreign countries (including Argentina and Iran) where national currencies are susceptible to inflation, corruption, capital controls or international sanctions.

The supply of Bitcoin is capped at 21 million units. As a result, some people have obtained them for investment purposes, hoping that the value will appreciate over time. The Financial Industry Regulatory Authority (FINRA) warns that Bitcoin is highly speculative and investors shouldn’t risk more in Bitcoin than they’re willing to lose.

Some of the limited Bitcoin supply hasn’t been issued yet. These new issues have been reserved for Bitcoin “miners.” These are the people who provide computing power to verify and record virtual currency payments into the global public ledger.

Ups and Downs of Cryptocurrency

Under the tax law, capital gains and losses are recognized when you cash in Bitcoin (and other forms of virtual currency) or use it to pay for goods and services. However, if you’ve held your Bitcoin for less than a year, the gain may be taxed at higher ordinary income tax rates, unless you’re a professional Bitcoin miner or broker.

For example, suppose you buy a $2,000 sofa on Overstock.com using Bitcoin. You originally acquired the Bitcoin that you exchanged for the sofa for $1,200 in 2016 using a Bitcoin ATM. Unless you’re a professional Bitcoin miner or broker, you must report an $800 capital gain ($2,000 – $1,200) on your personal tax return.

The transaction would be more complicated if your Bitcoin had been acquired at different dates and prices. Generally, taxpayers would prefer to exchange their highest-value Bitcoin first to minimize the taxable gain or generate a beneficial tax loss.

Initially, Congress was going to crack down on the “specific identification” technique for capital gains and losses in the new tax law, but the provision didn’t make the final cut.

Federal Tax Reporting

The use of virtual currency has triggered many tax-related questions. Unfortunately, the IRS has been slow to catch up with the new technology and has provided only limited guidance.

In a 2014 ruling, the IRS established that Bitcoin and other convertible virtual currency should be treated as property, not currency, for federal income tax purposes. (See “Ups and Downs of Cryptocurrency” at right.)

As a result, businesses that accept Bitcoin payments for goods and services must report gross income based on the fair market value of the virtual currency when it was received. This is measured in equivalent U.S. dollars.

From the buyer’s perspective, purchases made using Bitcoin result in a taxable gain if the fair market value of the property received exceeds the buyer’s adjusted basis in the Bitcoin exchanged. Conversely, a tax loss is incurred if the fair market value of the property received is less than its adjusted tax basis. The character of a gain or loss from the sale or exchange of Bitcoin depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

On the other hand, wages paid to employees using virtual currency are taxable to the employees. Such wages must be reported by employers on W-2 forms. And they’re subject to federal income tax withholding and payroll taxes, based on the fair market value of the virtual currency on the date of receipt.

Payments using virtual currency made to independent contractors, qualifying Bitcoin miners and other service providers are also taxable. The rules for self-employment tax generally apply, based on the fair market value of the virtual currency on the date of receipt. Normally, payers must issue 1099-MISC forms.

A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

Tax Treatment of Bitcoin Exchanges

One gray area related to virtual currency is how to treat the capital gains and losses realized by taxpayers who invest in Bitcoin and exchange it for real currency (such as U.S. dollars). Previously, some tax experts claimed that these exchanges qualify as “like-kind exchanges” of properties under Section 1031 of the tax code. With a like-kind exchange, no current tax is due on the exchange of investment or commercial properties. To qualify for the favorable tax treatment, the properties you relinquish and receive must be similar in nature.

This was an easy solution for Bitcoin traders. They could fall back on the rules for like-kind exchanges to avoid current tax bills.

But the Tax Cuts and Jobs Act eliminates tax-deferred like-kind exchanges — except for exchanges of real estate — for 2018 and beyond. However, prior-law rules that allow like-kind exchanges of property other than real estate still apply if one leg of an exchange was completed as of December 31, 2017, but one leg remained open on that date.

This change creates a burden for Bitcoin investors who trade in currencies: They must use the price of the Bitcoin when it was acquired and the price on the date of the exchange to calculate the resulting capital gain or loss. Unlike sales of securities, no authority is tracking these figures for investors. In addition, it’s unclear whether investors can deduct transaction costs and accounting fees related to virtual currency investments.

Costly Mistakes

Most taxpayers are unaware of the requirements for reporting virtual currency transactions. For the 2013 through 2015 tax years, the IRS estimates that fewer than 900 taxpayers declared Bitcoin earnings annually.

The IRS plans to ramp up compliance in this area. Underpayments of tax attributable to Bitcoin transactions could be subject to penalties, unless the taxpayer can establish that the failure to properly file was due to reasonable cause.

Bottom Line

The IRS is targeting virtual currency transactions as a potential source of additional tax revenue. But it’s issued very limited guidance on the reporting requirements. For the latest developments on reporting Bitcoin and other virtual currency exchanges, contact your tax advisor.

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