Category: Tax Services

Posted on Mar 27, 2018

A U.S. District court recently ruled that a company president was a “responsible person” who was liable for the trust fund recovery penalty. The court found that the president’s failure to pay over employment taxes was willful despite the fact there was a security agreement with a lender requiring the lender’s approval before any payments could be made. In addition, the court wasn’t convinced that the company’s co-owner had more control over the company’s finances than the president did.

Basics about the Trust Fund Recovery Penalty

Under Internal Revenue Code Section 6672, if an employer fails to pay its employment tax liability to the IRS, the tax agency can impose the trust fund recovery penalty against any person who:

  • Is responsible for collecting, accounting for, and paying over payroll taxes; and
  • Willfully fails to perform this responsibility.

Facts of the Case

During the four-year period in question, a construction contracting company had

two co-owners. The president managed the company’s field operations and was responsible for the hiring and firing of employees. The co-owner served as the company’s bookkeeper and she managed the finances and office staff. However, the president had signing authority on the business checking account and would sign payroll and vendor checks prepared by the co-owner when she wasn’t available.

The company withheld money from its employee paychecks to pay federal payroll tax obligations. But it didn’t send the money to the IRS. Instead, the funds were diverted to pay creditors, operating expenses and the personal obligations of the co-owners.

The company entered into an agreement with a bank for a line of credit. In exchange, the company provided a security interest in its assets, including its accounts receivable. The company also entered into a commercial security agreement with the bank. Under the deal, the company agreed it would not assign, convey, lease, sell or transfer any of the collateral (for example, physical assets, accounts receivable or cash on hand) without the bank’s prior written consent.

The president became aware of the company’s failure to remit withheld payroll taxes to the IRS but he never asked the company to rectify the tax delinquencies with the IRS.

The IRS assessed nearly $1 million in tax penalties against the president, personally, for non-payment of the employment taxes. He challenged the assessment.

The Court’s Ruling

The district court ruled that the president was a responsible person with respect to the company’s failure to remit delinquent employment taxes during the period at issue.

The court found that, throughout the company’s life span, the president was a corporate officer of the business, held company stock, and had the ability to hire and fire staff members. Although his co-owner exercised considerable, if not dominant, control over the company’s finances, it was apparent that she did so effectively by the president’s delegation of that authority, and not because the president lacked the power to control the company’s finances.

In addition, the court found that the president acted willfully in failing to use company funds to pay unpaid payroll taxes. It was undisputed that the president had not even asked the bank for permission to use some of the company’s line of credit to pay the delinquent taxes that both he and the bank knew existed. (Davis, DC CO, 121 AFTR 2d 2018-508)

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Posted on Mar 26, 2018

Most 401(k) plans permit hardship withdrawals, though plan sponsors aren’t required to allow them. As it stands today, employees seeking to take money out of their 401(k) accounts are limited to the funds they contributed to the accounts themselves, and only after they’ve first taken a loan from the same account. Loans must be repaid, of course. The theory behind the loan requirement is that employees would be less apt to permanently deplete their 401(k) accounts with hardship withdrawals.

Thanks to the Bipartisan Budget Act (BBA) enacted in February, the rules change, beginning in 2019. Under the BBA, the employees’ withdrawal limit will include not just amounts they have contributed. It also includes accumulated employer matching contributions plus earnings on contributions. If an employee has been participating in your 401(k) for several years, this modification could add substantially to the amount of funds available for withdrawal in the event of a legitimate hardship.

Liberalized Participation Rule

In addition to the changes above, the BBA also eliminates the current six-month ban on employee participation in the 401(k) plan following a hardship withdrawal. This is good news on two fronts: Employees can stay in the plan and keep contributing, which allows them to begin recouping withdrawn amounts right away. And for plan sponsors, it means they won’t be required to dis-enroll and then re-enroll employees after that six-month hiatus.

One thing that hasn’t changed: Hardship withdrawals are subject to a 10% tax penalty, along with regular income tax. That combination could take a substantial bite out of the amount withdrawn, effectively forcing account holders to take out more dollars than they otherwise would have in order to wind up with the same net amount.

For example, an employee who takes out a $5,000 loan from his or her 401(k) isn’t taxed on that amount. But an employee who takes a hardship withdrawal and needs to end up with $5,000 will have to take out around $7,000 to allow for taxes and the 10% penalty.

Hardship Criteria

The BBA also didn’t change the reasons for which hardship withdrawals can be made. Here’s a  reminder of the criteria, as described by the IRS: Such a withdrawal “must be made because of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need.” That can include the need of an employee’s spouse or dependent, as well as that of a non-spouse, non-dependent beneficiary.

The IRS goes on to say that the meaning of “immediate and heavy” depends on the facts of the situation. It also assumes the employee doesn’t have any other way to meet the needs apart from a hardship withdrawal. However, the following are examples offered by the IRS:

  • Qualified medical expenses (which presumably don’t include cosmetic surgery);
  • Costs relating to the purchase of a principal residence;
  • Tuition and related educational fees and expenses;
  • Payments necessary to prevent eviction from, or foreclosure on, a principal residence;
  • Burial or funeral expenses; and
  • Certain expenses for the repair of damage to the employee’s principal residence.

The IRS gives two examples of expenses that would generally not qualify for a hardship withdrawal: buying a boat and purchasing a television.

Finally, a financial need could be deemed immediate and heavy “even if it was reasonably foreseeable or voluntarily incurred by the employee.”

Deadline Extension

Another important and somewhat related change in 401(k) rules was included in the 2017 Tax Cuts and Jobs Act (TCJA) that took effect this year; it pertains to plan loans. Specifically, prior to 2018, if an employee with an outstanding plan loan left your company, that individual would have to repay the loan within 60 days to avoid having it deemed as a taxable distribution (and subject to a 10% premature distribution penalty for employees under age 59-1/2).

The TCJA changed that deadline to the latest date the former employee can file his or her tax return for the tax year in which the loan amount would otherwise be treated as a plan distribution. So, for example, if an employee with an outstanding loan of $5,000 left your company and took a new job on Dec. 31, 2017, that individual would have until April 15 (or, with a six-month fling extension, Oct. 15) 2018 to repay the loan.

Alternatively, the former employee could make a contribution of the same amount owed ($5,000, in this example) to an IRA or the former employee’s new employer’s plan, assuming the new plan permitted it. In effect, that $5,000 contribution to a new plan would be treated the same as a rollover from the old plan.

While this new flexibility might seem like a boon to plan participants, it could also represent a financial trap. Employees typically aren’t accumulating enough dollars to put themselves on track to retire comfortably at a traditional retirement age. Therefore, although you can’t prevent a plan participant from taking advantage of the new rules if they qualify, you can redouble your efforts to help employees understand the importance of thinking of their retirement savings as just that — savings for retirement, and not a “rainy day” fund.

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Posted on Mar 22, 2018

Most employers had no problems meeting the February 15, 2018, deadline to begin using the 2018 federal income tax withholding tables, which reflect changes made by the Tax Cuts and Jobs Act (TCJA). However, many employees question how the TCJA will affect them.Those are findings of a recent American Payroll Association survey of 1,000 payroll and finance professionals.  The Tax Reform Membership Survey found that about 97% of respondents said they began using the tables by the February 15 deadline. Nearly 84% of participants said that the tax law didn’t place any additional burden on year-end processing. Almost 63% noted that they process payrolls in-house.

The annual withholding tables typically come out in December but were delayed until January 11 due to the enactment of the TCJA. Employers only had until February 15 to begin using the tables. Of the survey respondents, about 17% said they started using the tables between January 15-19, 27% started the week of January 22, and about 32% began the week of January 29.

Changes in the Law

The TCJA brings many modifications, effective Jan. 1, 2018, including:

  • Lower personal income tax rates,
  • Elimination of personal exemptions,
  • Significantly increased standard deductions for 2018 to $24,000 for married joint-filing couples, $18,000 for heads of households, and $12,000 for others, and
  • Elimination of some tax-free benefits.

On the other hand, many employees have expressed concerns about the long-term impact the law will have on their finances. Fourteen percent of employers said they received a large number of employee questions, but the majority, 61% say they received only a few inquiries. Among the most common questions were:

  • How will this affect my income taxes next year?
  • Will my taxes go up or down?
  • Should I change my W-4?
  • Will I need to complete a new Form W-4 to make sure I’m not being under withheld?
  • How should I adjust my withholding allowances?
  • How do I increase the withholding to avoid owing money at the end of 2018?
  • Do I need to change my exemptions to match my new tax liability?
  • Why is my net pay increasing?
  • How will this affect the bicycle commuter benefit?
  • What’s the effect of moving expenses paid to a moving company?

“Input from our survey made it clear employees are worried they’ll be negatively affected by the new law once tax time 2019 rolls around,” said Michael O’Toole, Esq., Senior Director of Publications, Education, and Government Relations for the APA. “It will be important for employees to quickly review their withholdings once the new Form W-4 is available to make sure they are not under withholding on their federal taxes.”

Reaching Out to Employees

Asked if they had been proactively communicating with employees to let them know how the TCJA could affect their paychecks, about 57% said yes, 10% said they plan to do so; 30% said no.

The APA has more than 20,000 members who represent 17,000 employers.

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Posted on Mar 19, 2018

The Roth IRA remains an attractive retirement planning vehicle for many individuals after the changes made by the Tax Cuts and Jobs Act (TCJA). Here’s what you need to know about Roth IRAs and Roth IRA conversions under the new law.

Tax Advantages

Roth IRAs offer several important tax advantages over traditional IRAs. First and foremost, unlike traditional IRA withdrawals, qualified Roth IRA withdrawals are federal-income-tax-free — and they’re usually state-income-tax-free, too. In general, a qualified withdrawal is one that’s taken after the Roth account owner has met both of the following requirements:

    • The owner has had at least one Roth IRA open for over five years, and
  • The owner has reached age 59½, become disabled or died.

For purposes of meeting the five-year requirement, the clock starts ticking on the first day of the tax year for which you make your initial contribution to your first Roth account. That initial contribution can be a regular annual contribution, or it can be a conversion contribution.

The second reason Roth IRAs are beneficial is that they’re exempt from the required minimum distribution (RMD) rules. So, unlike with traditional IRAs, you don’t have to start taking RMDs from Roth IRAs after reaching age 70½. Roth IRAs can be left untouched for as long as you live. This important privilege makes your Roth IRA a great asset to leave to your heirs (unless you need the money to help finance your own retirement).

New Tax Law Eliminates Reversal Privilege for Roth IRA Conversions

Did you know that the Tax Cuts and Jobs Act (TCJA) contains a provision that negatively affects Roth IRA conversions?

Under prior law, you had until October 15 of the year after an ill-advised conversion to reverse it to avoid the conversion tax hit. Thanks to the TCJA, for 2018 and beyond, you can no longer reverse the conversion of a traditional IRA into a Roth account. This elimination of the conversion reversal privilege is permanent.

However, the IRS recently clarified, in Frequently Asked Questions (FAQs) posted on its website, that, if you converted a traditional IRA into a Roth account in 2017, you can reverse the conversion as long as it’s done by October 15, 2018. (That deadline applies regardless of whether you extend the deadline for filing your 2017 federal income tax return to October 15.)

In IRS jargon, a Roth conversion reversal “recharacterizes” the Roth account back to traditional IRA status. Your Roth IRA trustee or custodian (or tax advisor) can help you fill out the requisite paperwork.

When do reversals make sense? Suppose you converted two traditional IRAs (Accounts A and B) into two Roth IRAs in 2017. The value of Account A has increased since the conversion date. Unfortunately, Account B has plummeted in value, and it’s now worth significantly less than it was on the conversion date. In this situation, you’d be required to pay income tax on Account B’s value on the conversion date — and some of that value is now gone.

Fortunately, through October 15, 2018, you have the option of recharacterizing Account B back to traditional IRA status. After the reversal, it’s as if the ill-fated conversion never happened, so you won’t owe any 2017 income tax on the conversion of Account B. And you can still leave Account A in Roth IRA status.

Annual Roth IRA Contributions

The idea of making annual Roth IRA contributions makes the most sense for those who believe they’ll pay the same or higher tax rates during retirement. Higher future taxes can be avoided on Roth account earnings, because qualified Roth withdrawals are tax-free. The downside is that you get no deductions for making Roth contributions.

If you expect to pay lower tax rates during retirement, current tax deductions may be worth more to you than tax-free withdrawals later. So, you might be better off making deductible traditional IRA contributions, assuming your income is below the phaseout threshold (below).

Roth contributions also make sense when you’ve maxed out on deductible retirement contribution possibilities but you want to sock away additional money for retirement.

There are limits to annual Roth IRA contributions, however. The maximum amount you can contribute for any tax year is the lesser of:

    • Your earned income for the year (including wages, salaries, bonuses, alimony and self-employment income), or
  • The annual contribution limit for that year.

For 2018, the annual Roth contribution limit is $5,500 (or $6,500 if you will be age 50 or older as of year end). In addition, for 2018, eligibility to make annual Roth contributions is phased out between modified adjusted gross income (MAGI) of $120,000 and $135,000 for unmarried individuals. For married joint filers, the 2018 phaseout range is between MAGI of $189,000 and $199,000.

The deadline for making annual Roth contributions is the same as the deadline for annual traditional IRA contributions, which is the original due date of your return. For example, the contribution deadline for the 2018 tax year is April 15, 2019. However, you can make a 2018 contribution anytime between now and then. The sooner you contribute, the sooner you can start earning tax-free income.

Important: Making contributions to traditional IRAs is off limits for the year you reach age 70½ and beyond. In contrast, people age 70½ or older can still make annual Roth IRA contributions (assuming the eligibility requirements explained above are met). So, Roth IRAs can be a smart savings tool for older individuals as well as for younger ones.

In addition, if you’re an employee, research whether your employer offers a Roth 401(k) option. This retirement savings tool is similar to a Roth IRA: It allows you to make after-tax contributions. Qualified withdrawals from a Roth 401(k) are generally federal and state tax-free. But these accounts are not exempt from the RMD rules. And, unlike Roth IRAs, there are no income level phaseouts for contributing to Roth 401(k) accounts, so they can be a tax-wise move for higher income individuals who are above the income thresholds for contributing to a Roth IRA.

Roth Conversions

The quickest way to get a significant sum into a Roth IRA is by converting a traditional IRA to Roth status. The conversion is treated as a taxable distribution from your traditional IRA, because you’re deemed to receive a payout from the traditional account for the money that will go into the new Roth account. So converting your IRA before year end will trigger a bigger federal income tax bill for this year — and possibly a bigger state income tax bill, too. The good news: There are no income limits on Roth conversions, and the amount you convert isn’t hit with the 10% early IRA withdrawal penalty tax even if you are under age 59½.

More good news for conversions: Today’s federal income tax rates might be the lowest you’ll see for the rest of your life. For most individuals, the tax rates for 2018 through 2025 will be lower than what you paid in prior years. In 2026, the pre-TCJA rates and brackets are scheduled to come back into force, but many people doubt that will happen.

So, if you convert your traditional IRA into a Roth IRA in 2018, you’ll pay today’s low tax rates on the extra income triggered by the conversion and completely avoid the potential for higher future rates on all the postconversion income that will be earned in your new Roth account. That’s because qualified Roth withdrawals taken after age 59½ are totally federal-income-tax-free after you’ve had at least one Roth account open for over five years.

To be clear, the best candidates for the Roth conversion strategy are people who believe that their tax rates during retirement will be the same or higher than their current tax rates.

A word of caution: Converting a traditional IRA with a significant balance could push you into a higher tax bracket. For example, if you’re single and expect your 2018 taxable income to be about $100,000, your marginal federal income tax bracket is 24%. Converting a $100,000 traditional IRA into a Roth account in 2018 would cause a big chunk of the extra income from the conversion to be taxed at 32%. (For 2018, the 32% tax bracket starts at $157,501 for single  people.) But if you spread the $100,000 conversion equally between 2018 and 2019, the extra income from converting would be taxed at 24% (assuming Congress leaves the current tax rates in place through at least 2019).

To Roth or Not to Roth?

Should you incorporate a Roth IRA into your retirement savings program? Roth IRAs offer significant tax advantages, if you’re eligible to make annual contributions or if you convert a traditional IRA into a Roth account. Today’s comparatively low federal income tax rates under the TCJA provide an extra incentive to consider the Roth conversion strategy right now. Contact your tax advisor to help understand the pros and cons of Roth IRAs and Roth conversions under the new tax law.

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Posted on Mar 16, 2018

The Tax Cuts and Jobs Act (TCJA), which was signed into law on December 22, 2017, made significant changes to the child credit. This credit is generally available to taxpayers with children under the age of 17, but the new law adds a new (smaller) credit for other dependents. Here are the details.

Old Rules

Under prior tax law, the child credit was $1,000 per “qualifying child.” But the credit was reduced for married couples filing jointly by $50 for every $1,000 (or part of $1,000) by which their adjusted gross income (AGI) exceeded $110,000. The phaseout thresholds were $75,000 for unmarried taxpayers and $55,000 for married couples filing separately.

To the extent the $1,000-per-child credit exceeded your tax liability, it resulted in a refund of up to 15% of your earned income (for example, wages or net self-employment income) above $3,000. For taxpayers with three or more qualifying children, the excess of the taxpayer’s Social Security taxes for the year over the taxpayer’s earned income credit for the year was refundable. In all cases, the refund was limited to $1,000 per qualifying child.

Important: These “old” rules still apply to tax returns that you’re filing for the 2017 tax year (which must be filed or extended by April 17, 2018).

New Law

For 2018 through 2025, the TCJA doubles the child credit to $2,000 per qualifying child under the age of 17. It also allows a new credit of $500 for any dependent who isn’t a qualifying child under age 17. There’s no age limit for the $500 credit, but the tax tests for dependency must be met.

Examples of dependents who qualify for the new credit include:

  • A qualifying 17- or 18-year-old,
  • A full-time student under age 24,
  • A disabled child of any age, and
  • Other qualifying (nonchild) relatives if all the requirements are met.

The TCJA also substantially increases the phaseout thresholds for the credit. For 2018 through 2025, the total credit amount allowed to a married couple filing jointly is reduced by $50 for every $1,000 (or part of $1,000) by which their AGI exceeds $400,000 (up from $110,000 under prior law). The threshold is now $200,000 for all other taxpayers.

So, if you were previously prohibited from taking the credit because your AGI was too high, you may now be eligible to claim the credit. But, beware, these phaseouts are not indexed for inflation.

In addition, under current law, the refundable portion of the credit has been increased to a maximum of $1,400 for each qualifying child. And the earned income threshold has been decreased to $2,500 (from $3,000 under prior tax law) — which could potentially result in a larger refund. The $500 credit for dependents other than qualifying children is nonrefundable.

Say Goodbye to Dependency Exemptions … For Now

The new tax law isn’t all good news for families. For the 2017 tax year, you can claim an exemption of $4,050 from taxable income for each qualifying dependent (subject to phaseouts at higher income levels). But that deduction has temporarily been suspended, for 2018 through 2025.

Many families still expect to come out ahead under the new law, however. That’s because credits reduce your tax bill dollar for dollar. By contrast, exemptions and deductions only reduce your taxable income, which is the amount that you’re taxed on.

However, families with older kids may be at a disadvantage under the new law. Why? Under prior law, dependency exemptions were available for qualifying dependents up to age 24 if they were full-time students. But a young person is ineligible for the child credit starting the year he or she turns 17. (However, older kids may still qualify for the new $500 credit for nonchild dependents, as well as various education credits, under the new law.)

Your tax advisors can help you take advantage of the tax breaks that may be available for raising children and caring for other family members.

Claiming Your Credit

To claim the credit, you must include the qualifying child’s Social Security number (SSN) on your tax return. Under prior law, you could also use an individual taxpayer identification number (ITIN) or adoption taxpayer identification number (ATIN).

If a qualifying child doesn’t have an SSN, you won’t be able to claim the $1,400 credit. But you can claim the $500 credit for that child using an ITIN or ATIN. The SSN requirement doesn’t apply for nonqualifying-child dependents, but you must provide an ITIN or ATIN for each dependent for whom you’re claiming a $500 credit.

Consult a Tax Pro

Thanks to the TCJA, more families will receive tax breaks to help offset the costs of raising kids and taking care of other nonchild dependents. If you have children under 17 or other dependents, contact your tax advisor to determine if these changes can benefit you.

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Posted on Mar 14, 2018

The Tax Cuts and Jobs Act enacted at the end of last year will give your company a tax credit if you initiate a new paid family and medical leave benefit. Although the IRS has yet to issue its interpretive regulations, the text of the law itself gives you enough to go on to at least consider whether doing so would be a worthwhile exercise.

The Basics

In case you missed it, here’s a recap of the basics. First, the tax credit is available this year and next, but it could be extended beyond 2019 if Congress decides it’s working well. It primarily relies on leave eligibility criteria laid out by the Family and Medical Leave Act.

The size of the credit tops out at 25% of the wages paid to employees during their new family leave benefit. To qualify for that maximum credit, employees must be paid 100% of their wages during the leave period.

For your company to get the minimum credit (12.5% of wages earned), employees must be paid at least 50% of their normal earnings. The credit percentage inches up (toward the maximum of 25% credit) as the proportion of wages paid to the employee on leave increases.

More Nuts and Bolts

This tax credit is for new programs only, so it cannot be claimed for paid time off programs that you already have in place. Also, the minimum duration of the new family leave benefit is two weeks, and it must be offered both to full- and part-time employees who have been on board for a year or longer. You can’t take the credit against benefits paid to employees earning more than $72,000, a figure will be inflation-indexed in following years.

If you decide to take advantage of the tax credit, you’ll need to define the new benefit in writing for employees. The description should then go in your employee handbook, assuming you have one.

Should you take advantage of this program? People and organizations that have been advocating for paid family and medical leave for many years always marshal justifications for doing so based on concrete benefits to the employer. They assert that such policies improve employee productivity and make workers more loyal. No doubt in many instances that’s true but, of course, there’s no guarantee it that will happen at your company.

What Else Should You Consider?

Here’s some more food for thought:

  • To what extent will you actually be able to use the tax credit? The answer depends not only upon how many employees take advantage of it, but also the size of your tax liability. If you’re not anticipating much of a tax bill for 2018 and 2019, the credits might not do you much good from a purely financial standpoint.
  • How much money are we really talking about? Assume the following: You have 100 employees earning an average of $40,000. Your benefits call for full wage replacement, entitling you to the maximum 25% tax credit. And, over the course of a year, 25 employees use the new benefit, averaging two weeks each (the minimum leave to qualify for the credit). Based on those assumptions, the pre-tax added cost of the benefit would be around $38,462, and the 25% tax credit would reduce it on an after-tax basis to $28,847, if your company’s tax liability exceeds the credit amount.
  • What happens if you launch a paid family and medical leave benefit based on the prospect of its diminished after-tax cost but Congress doesn’t extend the program after 2019? At that point, you might find it difficult to pull the plug on this benefit.
  • What if you were already giving serious consideration to providing a paid family and medical leave benefit without expecting a new financial incentive? The tax credit would be icing on the cake.
  • Even if you weren’t contemplating such a program, are you having challenges attracting and keeping new and old employees on board? Unless the benefit is abused, its dollar cost might be well worth the possible boost it would give to your reputation as a good place to work.
  • Do you have the administrative capacity to judge the merits of paid borderline family and medical absence requests? It’s possible that you’ll experience more leave requests once employees know they’ll be paid during that leave period than when they weren’t.

Employee Attitudes

It’s also important to try to gauge how much employees would value this benefit. You might want to poll your workers on their preference for some new benefit possibilities, not just paid family and medical leave.

For example, you might consider giving them a choice between paid family and medical leave and a larger match to their 401(k) contributions, using a match amount that would be similar in cost to a paid leave plan. Such a survey might reveal a strong employee preference for the higher 401(k) match. If so, those results could make the choice an easier one.

It’s true that not all tax incentives are the right fit for every company. Even so, this new tax credit for paid family and medical leave is certainly worth a look. Ask your trusted financial advisor to run the numbers so you can make an informed decision.

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Posted on Mar 13, 2018

The IRS recently announced that in many cases, taxpayers can continue to deduct interest paid on home equity loans. The tax agency issued the clarification because there were questions and concerns that such expenses were no longer deductible under the Tax Cuts and Jobs Act (TCJA), which was signed into law on December 22, 2017.

Background Basics

Taxpayers can deduct interest on mortgage debt that’s “acquisition debt” under the tax law. Acquisition debt means debt that is:

1. Secured by the taxpayer’s principal home and/or a second home, and

2. Incurred in acquiring, constructing, or substantially improving the home. This rule hasn’t been changed by the TCJA.

Under prior law, the maximum amount that was treated as acquisition debt for the purpose of deducting interest was $1 million ($500,000 for married individuals filing separate tax returns). This meant that a taxpayer could deduct interest on no more than $1 million of acquisition debt. Taxpayers could also deduct interest on home equity debt. “Home equity debt,” as specially defined for purposes of the mortgage interest deduction, meant debt that:

  • Was secured by the taxpayer’s home, and
  • Wasn’t “acquisition indebtedness.” (In other words, it wasn’t incurred to acquire, construct, or substantially improve the home.)

Therefore, the rule allowed taxpayers to deduct interest on home equity debt and enabled taxpayers to deduct interest on debt that wasn’t incurred to acquire, construct, or substantially improve a home — in other words, debt that could be used for any purpose. As with acquisition  debt, the rules in place before the TCJA limited the maximum amount of “home equity debt” on which interest could be deducted; here, the limit was the lesser of $100,000 ($50,000 for a married taxpayer filing separately), or the taxpayer’s equity in the home.

Under the TCJA, for tax years beginning after December 31, 2017 and before January 1, 2026, the limit on acquisition debt is reduced to $750,000 ($375,000 for a married taxpayer filing separately). The $1 million, pre-TCJA limit applies to acquisition debt incurred before December 15, 2017, and to debt arising from refinancing pre-December 15, 2017 acquisition debt, to the extent the debt resulting from the refinancing doesn’t exceed the original debt amount.

Under the TCJA, for tax years beginning after December 31, 2017 and before January 1, 2026, there’s no longer a deduction for interest on “home equity debt.” The elimination of the deduction for interest on home equity debt applies regardless of when the home equity debt was incurred.

New Release

In the IRS’s Internal Release 2018-32, the tax agency stated that despite the newly-enacted restrictions on home mortgages under the TCJA, taxpayers can often still deduct interest on a home equity loan, home equity line of credit (HELOC), or second mortgage, regardless of how the loan is labeled.

The IRS clarified that the TCJA suspends the deduction for interest paid on home equity loans and lines of credit, unless they’re used to buy, build or substantially improve the taxpayer’s home that secures the loan.

For example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses — such as credit card debts — isn’t deductible. As under pre-TCJA law, for the interest to be deductible, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.

For anyone considering taking out a mortgage, the TCJA imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction. The lower limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home.

In its release, the IRS provided the following examples:

Illustration 1: In January 2018, John takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, he takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total doesn’t exceed the cost of the home. Because the total amount of both loans doesn’t exceed $750,000, all of the interest paid on the loans is deductible. However, if John used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards,   then the interest on the home equity loan wouldn’t be deductible.

Illustration 2: In January 2018, Mary takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, she takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages doesn’t exceed $750,000, all of the interest paid on both mortgages is deductible. However, if Mary   took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan wouldn’t be deductible.

Illustration 3: In January 2018, Bob takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, he takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. Only a percentage of the total interest paid is deductible.

If you have questions about home equity loans or other provisions of the TCJA, consult with your Cornwell Jackson Tax Advisor.

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Posted on Mar 12, 2018

The Tax Cuts and Jobs Act (TCJA) is the biggest overhaul of the tax code in more than 30 years.

For instance, the TCJA cuts income tax rates for individuals and corporations, doubles the standard deduction, eliminates personal exemptions and repeals or modifies numerous deductions. It will have a major impact in 2018 and beyond.

But there’s more. In addition to withholding changes already reflected in employees’ paychecks, the TJCA includes other benefit-related provisions affecting payroll. Following are six prime examples:

1. Credit for employer-paid family and medical leave.

This is brand new. The TCJA creates a tax credit for wages paid to qualifying employees on family and medical leave. This credit can be as high as 25% of the wages paid.

To qualify, an employer must offer at least two weeks of annual paid family and medical leave, as described by the Family and Medical Leave Act (FMLA), to qualified employees. The paid leave must provide at least 50% of the employee’s wages.

Qualified individuals are those who have been working for the employer for at least one year, and, in the preceding year, weren’t paid compensation that exceeded 60% of $72,000 (threshold will be indexed for inflation).

The credit equals 12.5% of the amount of wages paid during a leave period and tops out at 25%. The credit is increased gradually for payments above 50% of wages paid. No double-dipping: Employers can’t also deduct wages claimed for the credit.

Note that the new credit is only available for 2018 and 2019. It could, however, be extended by a future act of Congress.

2. Transportation benefits.

Prior to 2018, employers could deduct certain transportation benefits of up to $250 a month (indexed to $255 per month in 2017) that were provided tax-free to employees. These included:

  • Mass transit passes. This is any pass, token, fare card, voucher or similar item entitling a person to ride free of charge or at a reduced rate on mass transit or in a vehicle seating at least six adults plus the driver if the person operating the vehicle is in the business of transporting persons for pay or hire.
  • Commuter highway vehicle expenses. These vehicles must seat at least six adults plus the driver. There must have been a reasonable expectation that at least 80% of the vehicle mileage would be for transporting employees between their homes and workplaces. Employees also had to occupy at least 50% of the seats (not including the driver’s seat).
  • Qualified parking fees. This benefit covered employer-provided parking for employees on or near the business premises. It also provided fees for parking on or near the location from which employees commuted to work using mass transit, commuter highway vehicles or carpools, such as the parking lot of a train station.

A tax-free benefit of up to $20 a month was allowed for bicycle commuting.

The TCJA eliminates the tax deduction for these three main transportation benefits beginning in 2018. But the benefits remain tax-free to employees. The tax exclusion for bicycle commuting is repealed.

3. Entertainment expenses.

Under prior law, an employer could deduct 50% of the cost of business entertainment and meal expenses that were “directly-related to” or “associated with” the business. Notably, this included entertainment in a clear business setting and meals immediately preceding or following a “substantial business discussion.”

Tax regulations imposed strict recordkeeping requirements for deducting business entertainment expenses. For example, you had to record the time, place and date of the entertainment, the person or people entertained and the business relationships of the parties.

Beginning in 2018, this deduction is repealed. However, employers may still deduct 50% of the cost of business meals while traveling away from home.

4. On-premises meals.

In the past, employers could deduct certain meals provided to employees on the business premises if those meals qualified as a de minimis fringe benefit. For instance, the deduction could be applied to meals furnished while employees worked late hours, as well as food and beverages provided to employees at on-site eating facilities such as a company cafeteria. The value of these benefits was tax-free for employees.

An employer could deduct 100% of the cost of these benefits.

Under the TCJA, the deduction is reduced to 50% of the cost and is eliminated after 2025. However, the value continues to be tax-free to employees.

5. Moving expense reimbursements.

Previously, if employees qualified under a two-part test involving distance and time, they could deduct their out-of-pocket job-related moving expenses on their personal income tax returns. The deductions were claimed “above-the-line,” so they were available to both those who itemized and those who claimed the standard deduction. Alternatively, employers may have reimbursed employees tax-free for qualified moving expenses.

Now, starting in 2018, the TCJA repeals both the moving expense deduction and the tax exclusion except for active duty military personal.

6. Achievement awards.

Currently, an employer can deduct up to $400 of the value of achievement awards to employees for length of service or safety. The tax exclusion is multiplied by four to $1,600 for awards under a written nondiscriminatory achievement plan. On the receiving end, employees aren’t taxed on the value of the awards that don’t exceed the employer’s deduction.

Beginning in 2018, the TCJA clarifies that the tax deduction and corresponding tax exclusion don’t apply to cash, gift coupons or certificates, vacations, meals, lodging, tickets to sporting or theater events, securities and “other similar items.” However, the tax breaks are still available for gift certificates that allow the recipient to select tangible property from a limited range of items preselected by the employer.

Reminder: This is only an overview of six of the key tax law changes affecting payroll matters. Do you have any questions about the new law’s impact on benefits? Don’t hesitate to contact your payroll providers for more details.

Fringe Benefits Surviving the Axe

Several fringe benefit crackdowns threatened by Congress didn’t make it into the final version of the new tax law. The items on the chopping block that were eventually spared include:

  • Dependent care assistance plans,
  • Adoption assistance programs,
  • Employer-provided housing, and
  • Educational assistance programs.

Also, certain liberalizations of the hardship distribution safe-harbor rules were contemplated, but eventually skipped by the lawmakers.

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Posted on Mar 5, 2018

Do you own residential or commercial rental real estate? The New Tax Law – Tax Cuts and Jobs Act (TCJA) brings several important changes that owners of rental properties should understand.

In general, rental property owners will enjoy lower ordinary income tax rates and other favorable changes to the tax brackets for 2018 through 2025. In addition, the new tax law retains the existing tax rates for long-term capital gains. (See “Close-Up on Tax Rates” in the right-hand box.)

Close-Up on Tax Rates

If you own property as an individual or via a pass-through entity — meaning a sole proprietorship, a limited liability company (LLC) treated as a sole proprietorship for tax purposes, a partnership, an LLC treated as a partnership for tax purposes, or an S corporation — net income from rental properties is taxed at your personal federal income tax rates.

For 2018 through 2025, the TCJA retains seven tax rate brackets, but six of the rates are lower than before. The 2018 ordinary income rates and tax brackets are as follows:

Bracket Single Married, Filing Jointly Head of Household
10% tax bracket $0 – $9,525 $0 – $19,050 $0 – $13,600
Beginning of 12% bracket $9,526 $19,051 $13,601
Beginning of 22% bracket $38,701 $77,401 $51,801
Beginning of 24% bracket $82,501 $165,001 $82,501
Beginning of 32% bracket $157,501 $315,001 $157,501
Beginning of 35% bracket $200,001 $400,001 $200,001
Beginning of 37% bracket $500,001 $600,001 $500,001

In 2026, the rates and brackets that were in place for 2017 are scheduled to return.

In addition, the new law retains the current tax rates on long-term capital gains and qualified dividends. For 2018, the rate brackets are:

Bracket Single Married, Filing Jointly Head of Household
0% tax bracket $ 0 – $38,600 $0 – $77,200 $0 – $51,700
Beginning of 15% bracket $38,601 $77,201 $51,701
Beginning of 20% bracket $425,801 $479,001 $452,401

These brackets are almost the same as what they would have been under prior law. The only change is the way the 2018 inflation adjustments are calculated.

Additionally, as under prior law, you still face a 25% maximum federal income tax rate (instead of the standard 20% maximum rate) on long-term real estate gains attributable to depreciation deductions.

Unchanged Write-Offs

Consistent with prior law, you can still deduct mortgage interest and state and local real estate taxes on rental properties. While the TCJA imposes new limitations on deducting personal residence mortgage interest and state and local taxes (including property taxes on personal residences), those limitations do not apply to rental properties, unless you also use the property for personal purposes. In that case, the new limitations could apply to mortgage interest and real estate taxes that are allocable to your personal use.

In addition, you can still write off all the other standard operating expenses for rental properties. Examples include depreciation, utilities, insurance, repairs and maintenance, yard care and association fees.

Possible Deduction for Pass-Through Entities

For 2018 and beyond, the TCJA establishes a new deduction based on a noncorporate owner’s qualified business income (QBI) from a pass-through business entity — meaning a sole proprietorship, a limited liability company (LLC) treated as a sole proprietorship for tax purposes, a partnership, an LLC treated as a partnership for tax purposes, or an S corporation. The deduction generally equals 20% of QBI, subject to restrictions that can apply at higher income levels.

While it isn’t entirely clear at this point, the new QBI deduction is apparently available to offset net income from a profitable rental real estate activity that you own through a pass-through entity. The unanswered question is: Does rental real estate activity count as a business for purposes of the QBI deduction? According to one definition, a real property business includes any real property rental, development, redevelopment, construction, reconstruction, acquisition, conversion, operation, management, leasing or brokerage business.

Liberalized Section 179 Deduction Rules

For qualifying property placed in service in tax years beginning after December 31, 2017, the TCJA increases the maximum Section 179 deduction to $1 million (up from $510,000 for tax years beginning in 2017). Sec. 179 allows you to deduct the entire cost of eligible property in the first year it is placed into service.

For real estate owners, eligible property includes improvements to an interior portion of a nonresidential building if the improvements are placed in service after the date the building was placed in service. The TCJA also expands the definition of eligible property to include the expenditures for nonresidential buildings:

  • Roofs,
  • HVAC equipment,
  • Fire protection and alarm systems, and
    Security systems.

Finally, the new law expands the definition of eligible property to include depreciable tangible personal property used predominantly to furnish lodging. Examples of such property include:

  • Beds and other furniture,
  • Appliances, and
  • Other equipment used in the living quarters of a lodging facility, such as an apartment house, dormitory, or other facility where sleeping accommodations are provided and rented out.

Important: Sec. 179 deductions can’t create or increase an overall tax loss from business activities. So, you need plenty of positive business taxable income to take full advantage of this break.

Expanded Bonus Depreciation Deductions

For qualified property placed in service between September 28, 2017, and December 31, 2022, the TCJA increases the first-year bonus depreciation percentage to 100% (up from 50%). The 100% deduction is allowed for both new and used qualified property.

For this purpose, qualified property includes qualified improvement property, meaning:

  • Qualified leasehold improvement property,
  • Qualified restaurant property, and
  • Qualified retail improvement property.

These types of property are eligible for 15-year straight-line depreciation and are, therefore, also eligible for the alternative of 100% first-year bonus depreciation.

New Loss Disallowance Rule

If your rental property generates a tax loss — and most properties do, at least during the early years — things get complicated. The passive activity loss (PAL) rules will usually apply.

In general, the PAL rules only allow you to deduct passive losses to the extent you have passive income from other sources, such as positive income from other rental properties or gains from selling them. Passive losses in excess of passive income are suspended until you 1) have sufficient passive income or gains, or 2) sell the property or properties that produced the losses.

To complicate matters further, the TCJA establishes another hurdle for you to pass beyond the PAL rules: For tax years beginning in 2018 through 2025, you can’t deduct an excess business loss in the current year. An excess business loss is the excess of your aggregate business deductions for the tax year over the sum of:

  1. Your aggregate business income and gains for the tax year, plus
  2. $250,000 or $500,000 if you are a married joint-filer.

The excess business loss is carried over to the following tax year and can be deducted under the rules for net operating loss (NOL) carryforwards.

Important: This new loss deduction rule applies after applying the PAL rules. So, if the PAL rules disallow your rental real estate loss, you don’t get to the new loss limitation rule.

The idea behind this new loss limitation rule is to further restrict the ability of individual taxpayers to use current-year business losses (including losses from rental real estate) to offset income from other sources (such as salary, self-employment income, interest, dividends and capital gains). The practical result is that the taxpayer’s allowable current-year business losses (after considering the PAL rules) can’t offset more than $250,000 of income from such other sources or more than $500,000 for a married joint-filing couple.

Loss Limitation Rules in the Real World

Dave is an unmarried individual who owns two strip malls. In 2018, he has $500,000 of allowable deductions and losses from the rental properties (after considering the PAL rules) and only $200,000 of gross income. So he has a $300,000 loss. He has no other business or rental activities.

Dave’s excess business loss for the year is $50,000 ($300,000 – the $250,000 excess business loss threshold for an unmarried taxpayer). The $50,000 excess business loss must be carried forward to Dave’s 2019 tax year and treated as part of an NOL carryfoward to that year. Under the TCJA’s revised NOL rules for 2018 and beyond, Dave can use the NOL carryforward to shelter up to 80% of his taxable income in the carryforward year.

Important: If Dave’s real estate loss is $250,000 or less, he won’t have an excess business loss, and he would be unaffected by the new loss limitation rule.

Like-Kind Exchanges

The TCJA still allows real estate owners to sell appreciated properties while deferring the federal income hit indefinitely by making like-kind exchanges under Section 1031. With a like-kind exchange, you swap the property you want to unload for another property (the replacement property). You’re allowed to put off paying taxes until you sell the replacement property — or you can arrange yet another like-kind exchange and continue deferring taxes.

Important: For 2018 and beyond, the TCJA eliminates tax-deferred like-kind exchange treatment for exchanges of personal property. However, prior-law rules that allow like-kind exchanges of personal property still apply if one leg of a personal property exchange was completed as of December 31, 2017, but one leg remained open on that date.

Need Help?

The new tax law includes several expanded breaks for real estate owners and one important negative change (the new loss limitation rule). At this point, how to apply the TCJA changes to real-world situations isn’t always clear, based solely on the language of the new law.

In the coming months, the IRS is expected to publish additional guidance on the details and uncertainties. Your tax advisor can keep you up to date on developments.

 

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Posted on Mar 3, 2018

Are you confused about the federal income tax rates on capital gains and dividends under  the Tax Cuts and Jobs Act (TCJA)? If so, you’re not alone. Here’s what you should know if you plan to sell long-term investments or expect to receive dividend payments from your investments.

Old Rules

Prior to the TCJA, individual taxpayers faced three federal income tax rates on long-term capital gains and qualified dividends: 0%, 15% and 20%. The rate brackets were tied to the ordinary-income rate brackets.

Specifically, if the long-term capital gains and/or dividends fell within the 10% or 15% ordinary-income brackets, no federal income tax was owed. If they fell within the 25%, 28%, 33% or 35% ordinary-income brackets, they were taxed at 15%. And, if they fell within the maximum 39.6% ordinary-income bracket, they were taxed at the maximum 20% rate.

In addition, higher-income individuals with long-term capital gains and dividends were also hit with the 3.8% net investment income tax (NIIT). So, many people actually paid 18.8% (15% + 3.8% for the NIIT) or 23.8% (20% + 3.8% for the NIIT) on their long-term capital gains and dividends.

New Rules

The TCJA retains the 0%, 15% and 20% rates on long-term capital gains and qualified dividends for individual taxpayers. However, for 2018 through 2025, these rates have their own brackets that are not tied to the ordinary-income brackets. Here are the 2018 brackets for long-term capital gains and qualified dividends:

Tax Rates Single Married Joint Filers Head of Household
0% $0 – $38,600 $0 – $77,200 $0 – $51,700
15% $38,601 – $425,800 $77,201 – $479,000 $51,701 – $452,400
20% $425,801 and up $479,001 and up $452,401 and up

After 2018, these brackets will be indexed for inflation.

The new tax law also retains the 3.8% NIIT. So, for 2018 through 2025, the tax rates for higher-income people who recognize long-term capital gains and dividends will actually be 18.8% (15% + 3.8% for the NIIT) or 23.8% (20% + 3.8% for the NIIT).

Rates for Trusts and Estates

For 2018, the brackets for trusts and estates that collect long-term capital gains and qualified dividends are as follows:

Tax Rate Long-term capital gains and qualified dividends
0% $0 – $2,600
15% $2,601 – $12,700
20% $12,701 and up

For 2018 through 2025, the TCJA stipulates that these trust and estate rates and brackets are also used to calculate the so-called “kiddie tax” when it applies to long-term capital gains and qualified dividends collected by dependent children and young adults. The kiddie tax can potentially apply until the year that a dependent young adult turns age 24. (Under prior law, the kiddie tax was calculated using the marginal rates paid by the parents of affected children and young adults.)

Got Questions?

In a nutshell, the new law keeps the same tax rates for long-term capital gains and qualified dividends, but the rate brackets are no longer tied to the ordinary-income tax brackets for individuals. If you have questions or want more information about how long-term capital gains and qualified dividends are taxed under the TCJA, contact your tax advisor.

Paying Taxes on Short-Term Capital Gains

As under prior law, the Tax Cuts and Jobs Act (TCJA) taxes short-term capital gains recognized by individual taxpayers at the regular ordinary-income rates. For 2018, the ordinary-income rates and brackets are as follows:

Tax Rates Single Married Joint Filers Head of Household
10% $0 – $9,525 $0 – $19,050 $0 – $13,600
12% $9,526 – $38,700 $19,051 – $77,400 $13,601 – $51,800
22% $38,701 – $82,500 $77,401 – $165,000 $51,801 – $82,500
24% $82,501 – $157,500 $165,001 – $315,000 $82,501 – $157,500
32% $157,501 – $200,000 $315,001 – $400,000 $157,501– $200,000
35% $200,001 – $500,000 $400,001 – $600,000 $200,001 – $500,000
37% $500,001 and up $600,001 and up $500,001 and up

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