Category: Tax Services

Posted on Dec 14, 2017

The IRS is always skeptical when individual taxpayers claim deductions for bad debt losses. Why? Losses from purported loan transactions often fail to meet the tax-law requirements for bad debt loss deductions.

For example, a taxpayer might try to write off a capital contribution to a business entity that underperformed. Or a taxpayer might have advanced cash to a friend or relative with the unrealistic hope that the money would be paid back, but nothing was put in writing.

To claim a deductible bad debt loss that will survive IRS scrutiny, you must first prove that the loss was from a legitimate loan transaction gone bad — not merely some other ill-fated financial move. Then, you must make another important distinction: Is it a business or nonbusiness bad debt?

Bad Debt Losses

Bad debt losses that arise in the course of the taxpayer’s business are treated as ordinary losses. In general, ordinary losses are fully deductible without any limitations. In addition, partial deductions can be claimed for business debts that partially go bad.

An exception to these general rules occurs when a taxpayer makes an uncollectible loan to his or her employer that results in a business bad debt loss. Under IRS rules, this type of write-off is classified as an unreimbursed employee business expense, which is combined with other miscellaneous itemized deductions (such as investment expenses and tax preparation fees) and is deductible only to the extent that the total exceeds 2% of the taxpayer’s adjusted gross income. In addition, miscellaneous itemized deductions are completely disallowed if you are liable to pay the alternative minimum tax. Unfortunately, this unfavorable exception has been upheld by previous U.S. Tax Court decisions.

Nonbusiness Bad Debts

Bad debt losses that don’t arise in the course of an individual taxpayer’s business are treated as short-term capital losses. As such, they’re subject to the capital loss deduction limitations.

Specifically, taxpayers who incur a net capital loss for the year can deduct up to $3,000 (or $1,500 for those who use married filing separately status) of the net loss against income from other sources (such as salary and self-employment income). Any remaining net capital loss is carried over to the next tax year.

So if you have a major nonbusiness bad debt loss and capital gains that amount to little or nothing, it can take several years to fully deduct the bad debt loss. In addition, losses can’t be claimed for partially worthless nonbusiness bad debts.

Case in Point

A recent U.S. Tax Court decision — Owens v. Commissioner (TC Memo 2017-157) — focused on the issue of whether an uncollectible loan was a business bad debt or a nonbusiness bad debt. Here, the taxpayer began a series of loan transactions in 2002 with Lowry Investments, a  partnership that owned the largest commercial laundry business in the San Francisco Bay Area. The business served all the major hotel chains and several hospitals.

The taxpayer worked at two family businesses: Owens Financial Group, Inc. (a mortgage-brokerage company that arranged commercial loans) and the Owens Mortgage Investment Fund. He also made loans for his own account using his personal funds, starting in 1986.

In late 2008, the laundry business filed for bankruptcy, and Lowry Investments followed suit. Then, in early 2009, the founder of Lowry Investments filed for bankruptcy. Lowry’s founder had personally guaranteed the laundry business’s loans, and he claimed that his assets totaled $2.8 million against liabilities in excess of $50 million when he filed for bankruptcy. When all the bankruptcy liquidation proceedings finally concluded in 2012, the taxpayer found that he was unable to recover any of the money he’d loaned to Lowry Investments.

On his 2008 return, the taxpayer claimed a $9.5 million business bad debt loss, which resulted in a net operating loss (NOL) that was carried back to 2003 through 2005 and forward to 2009 and 2010.

The IRS audited the taxpayer and denied his bad debt deduction and the related NOL carrybacks and carryforwards. The IRS argued that the taxpayer’s lending activities didn’t amount to a business. Even if it did, the IRS claimed that the loans were more akin to equity than debt — and even if transactions qualified as debt, they didn’t become worthless in 2008.

The court disagreed with the IRS, concluding that the taxpayer was indeed in the business of lending money during the years in question, as evidenced by written promissory notes between the taxpayer and Lowry Investments that included maturity dates. The court ruled that the taxpayer’s advances constituted bona fide business debts that became worthless in 2008 when Lowry Investments and its founder filed for bankruptcy and left the taxpayer out to dry (so to speak). Therefore, the taxpayer was entitled to the $9.5 million business bad debt deduction that he claimed on his 2008 federal income tax return.

Consult with Your Tax Pro

Before you enter into a business or nonbusiness loan, always seek professional tax advice. Inadequate attention to the relevant rules can lead to unintended and unfavorable tax consequences. For example, the IRS may claim that an ill-fated advance should be classified as a personal gift or a capital contribution, which can’t be written off as a bad debt loss.

 

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Posted on Dec 11, 2017

As 2017 winds down, it’s time to consider making some moves to lower your federal income tax bill and position yourself for tax savings in future years. This year, the big unknown factor is which major tax reform changes will be enacted.

Even if all goes according to the GOP timeline, the changes generally won’t take effect until next year at the earliest. So your 2017 return will follow the current rules. Here are five year-end moves for you to consider.

1. Prepay Deductible Expenditures

If you itemize deductions, accelerating deductible expenditures into this year to produce higher 2017 write-offs makes sense if you expect to be in the same or lower tax bracket next year. If you expect to be in a higher tax bracket next year, the reverse could make sense — but that situation is less likely if tax reform proposals take effect in 2018.

Tax reform considerations related to prepaid expenses. Tax rates would be lower in 2018 and beyond for most taxpayers under congressional tax reform proposals. If you turn out to be in a lower bracket next year, deductions claimed this year will be worth more than the same deductions claimed next year.

In addition, proposed tax reforms would reduce or eliminate many itemized deductions. Both the House and Senate proposals would eliminate the following itemized deductions starting in 2018:

  • Tax preparation fees,
  • Foreign property taxes,
  • State and local income taxes,
  • Unreimbursed employee business expenses, and
  • Most other miscellaneous items.

But there are some differences between the House and Senate proposals.

The House tax reform bill would eliminate itemized deductions for 2018 and beyond, except for 1) charitable contributions, 2) state and local property taxes (subject to a $10,000 limit), and 3) a scaled-back home mortgage interest deduction. Specifically, the home mortgage deduction would:

  • Be subject to a lower debt limit of only $500,000 for new loans vs. $1 million under current law, and
  • Allow deductions for only one residence vs. two residences under current law and eliminate the deduction for interest of up to $100,000 of home equity debt allowed under current law.

The Senate tax reform bill also would eliminate most itemized deductions, except:

  • Home mortgage interest, subject to the current-law debt limit of $1 million but with no deduction allowed for interest on home equity loans,
  • Medical expenses, and
  • Personal casualty losses in federally declared disaster areas.

Plus, the property tax deductions would be completely eliminated under the Senate bill.

The bottom line is that, under both the House and Senate proposals, increased standard deduction amounts would offset some or all of the itemized deductions lost to tax reform, depending on your specific circumstances. In any case, prepaying deductible items before the end of 2017 will generally help lower this year’s tax bill.

But watch out for the alternative minimum tax (AMT): If you’ll owe AMT for 2017, the prepayment strategy may backfire. That’s because write-offs for state and local taxes are completely disallowed under the AMT rules and so are miscellaneous itemized deductions subject to the 2%-of-AGI rule. So prepaying these expenses may do little or no tax-saving good for AMT victims.

There’s mixed tax reform news for AMT victims. The House bill would eliminate the AMT for 2018 and beyond. (But, of course, that won’t help for 2017.)  The Senate bill includes a provision to keep the current individual alternative minimum tax (AMT), but with a higher exemption threshold. An earlier version of the Senate bill repealed the AMT.

Which bills should you consider prepaying for 2017?

Mortgage payment for January. Accelerating the mortgage payments for your primary residence and/or vacation home that are due in January 2018 will allow you to deduct 13 months of mortgage interest in 2017, unless you prepaid for January 2017, in which case you’ll have 12 months of mortgage interest deductions for your 2017 return.

State and local taxes due in early 2018. Prepaying state and local income and property taxes that would otherwise be due in early 2018 will increase your itemized deductions for 2017, thereby reducing your federal income tax bill for this year.

Medical and miscellaneous expenses. Consider prepaying expenses that are subject to deduction limits based on your adjusted gross income (AGI). For example, under current law, medical expenses are deductible only to the extent they exceed 10% of AGI. So loading up on elective procedures, dental care, prescription medicine, glasses and contacts before year end could get you over the 10%-of-AGI hurdle on this year’s return.

Likewise, under current law, miscellaneous deductions — for investment expenses, job-hunting expenses, fees for tax preparation and unreimbursed employee business expenses — count only to the extent they exceed 2% of AGI. If you can bunch these kinds of expenditures into 2017, you’ll have a chance of clearing the 2%-of-AGI hurdle this year.

2. Evaluate Charitable-Giving Options

Prepaying tax-deductible charitable donations that you would otherwise make next year can reduce your 2017 federal income tax bill. Donations charged to credit cards before year end will count as 2017 contributions, even though you won’t pay the credit card bills until early next year.

Charitable deductions claimed this year will be worth more than deductions claimed next year if your tax rate goes down next year, which is likely to happen for most taxpayers if tax reform proposals are enacted.

Your tax advisor may have other creative year-end tax planning ideas for charitably inclined taxpayers to consider. For example, if you own appreciated stock or mutual fund shares that you’ve held for more than a year, you might consider donating the assets to an IRS-approved charity, instead of donating cash. Doing so will allow you to claim an itemized charitable deduction for the full market value at the time of the donation and avoid any capital gains tax hit.

Alternatively, if you own marketable securities that have decreased in value since you bought them, consider selling them and donating the proceeds. This strategy will generally allow you to claim an itemized charitable deduction for the cash donation, as well as take the resulting tax-saving capital loss.

Charitably inclined seniors (over age 70½) can also make up to $100,000 in cash donations to IRS-approved charities directly out of their IRAs. These donations — known as qualified charitable distributions (QCDs) — are tax-free. Although you can’t deduct QCDs from your tax bill, they count as withdrawals for purposes of meeting the required minimum distribution (RMD) rules that apply to your traditional IRAs after age 70½.

So, if you haven’t yet taken your 2017 RMDs, you can arrange to take tax-free QCDs before year end in place of taxable RMDs. That way you can meet your 2017 RMD obligations in a tax-free manner while also satisfying your philanthropic goals.

3. Deduct State and Local Sales Tax Instead of Income Tax

If you’ll owe little or nothing for state and local income taxes in 2017, you can choose to instead deduct state and local general sales taxes on this year’s return. You can deduct a prescribed sales tax amount from an IRS table based on where you live and other factors. However, if you’ve kept receipts that support a larger deduction, you can use that amount instead.

For example, you might want to deduct the actual sales tax amounts for major purchases, like a vehicle, motor home, boat, plane, prefabricated mobile home, or a substantial home improvement or renovation. You can also include actual state and local general sales taxes paid for a leased motor vehicle. So purchasing or leasing an item before year end could give you a bigger sales tax deduction and cut this year’s federal income tax bill.

State tax deductions affected by federal tax reform. Both the House and Senate tax reform proposals would eliminate the deduction for state and local income taxes (along with the option to deduct state and local sales taxes instead) for 2018 and beyond. So, if you don’t use this strategy in 2017, you’ll probably lose out if tax reform legislation is enacted.

4. Prepay Tuition Cost for Postsecondary Education

If you or your children qualify for either the American Opportunity or Lifetime Learning credits, consider prepaying tuition bills due in early 2018 for academic periods that begin in January through March 2018. Doing so may result in a bigger credit for higher education costs in 2017.

However, these credits are phased out for individuals with income above thresholds. Specifically:

  • The American Opportunity credit is gradually phased out for single individuals with modified AGI of between $80,000 and $90,000 and married joint filers with modified AGI between $160,000 and $180,000.
  • The Lifetime Learning credit is also gradually phased out for single individuals with modified AGI of between $56,000 and $66,000 and married joint filers with modified AGI between $112,000 and $132,000.

Tax reform considerations related to higher-education credits. The Senate tax reform proposal would leave the existing rules in place for both higher education credits. The House bill would eliminate the Lifetime Learning credit for 2018 and beyond and liberalize the American Opportunity credit to cover the first five years of undergraduate education vs. four years under the current rules.

If the Lifetime Learning credit is eliminated, no credit will be available for graduate school or other postsecondary education beyond the first five years of undergraduate study. So if you don’t take advantage of the Lifetime credit this year, you could possibly lose out.

 

5. Time Investment Gains and Losses for Tax Savings

Evaluate investments held in your taxable brokerage firm accounts and identify securities that have appreciated in value. For most people, the federal income tax rate on long-term capital gains is still much lower than the rate on short-term gains. If you plan on selling an investment, try to hold onto it for at least a year and a day before selling in order to qualify for the lower long-term capital gains rate.

Another tax-saving move is to consider selling securities that are currently worth less than you paid for them before year end. The resulting capital losses will offset any capital gains from earlier sales in 2017, including high-taxed short-term gains from securities that you owned for one year or less. In other words, you don’t have to worry about paying a high rate on short-term gains that you’ve successfully sheltered with capital losses.

If your capital losses exceed your capital gains, you’ll have a net capital loss for 2017. You can use it to shelter up to $3,000 of this year’s high-taxed ordinary income from such sources as salaries, bonuses and self-employment income ($1,500 if you’re married and file separately).

Any excess net capital loss is carried over to 2018 and beyond until you use it up. So it won’t go to waste. You can use it to shelter both future short- and long-term gains.

Tax reform considerations when selling securities. These tax planning strategies will continue to be viable regardless of whether congressional tax reform legislation is enacted. Both the House and Senate proposals would retain the existing three federal income tax rates for long-term capital gains and dividends (0%, 15%, and 20%) and the existing rate brackets. So the 2018 brackets would be the same as the 2017 brackets with minor adjustments for inflation.

Act Soon

Right now, nobody is certain whether major tax changes will be enacted or when they’ll go into effect. But these strategies are worth considering regardless of whether tax reform happens. As Congress works on lower tax rates and simplifying the tax law, stay in touch with your CJ tax advisor. Cornwell Jackson is monitoring tax reform and will help you take the most favorable path in your situation.

 

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Posted on Nov 9, 2017

The drumbeats for tax reform are growing louder.

The Trump administration, in conjunction with the president’s hand-picked “Big Six”1 group of GOP leaders, has released a nine-page outline of tax reform proposals. Not only would the plan overhaul numerous individual provisions, it would have a major impact on corporations and pass-through business entities, including significant changes for the manufacturing sector.

Manufacturers are likely to look favorably on the tax plan’s provisions. The quarterly survey by the National Association of Manufacturers released at the end of September 2017 found that a strong majority of small and large manufacturers said the promise of tax reform will spur growth and create jobs. The survey found that 64% of manufacturers would expand, 57% would hire more workers and 52% would raise wages and benefits if the GOP proposals are passed.

Generally, the tax reform provisions don’t include any effective dates, nor is enactment assured, with or without modifications. Here is an overview of the key proposals and their expected impact.

Corporate Tax Proposals

These key changes for C corporations, including incorporated manufacturing firms, are designed to stimulate business growth:

  • Reduce the top corporate tax rate from 35% to 25%. Trump’s initial proposal lowered the rate to 15%.
  • Allow immediate “expensing” for at least five years of new investments in depreciable assets, other than buildings, purchased after September 27, 2017.
  • Partially limit interest deductions for C corporations (details weren’t provided).
  • Repeal the corporate alternative minimum tax (AMT).
  • Preserve the research credit (Congress would review most other business credits).
  • Repeal the Section 199 deduction for domestic production activities. This deduction is currently available to all business entities.

The list of corporations that might profit from these proposed changes is long. Larger corporations would benefit from a reduction in the top corporate tax rate and businesses of all sizes could use the expensing allowance.

However, partially limiting interest expense deductions will likely play a significant role in C corporations’ investing and financing decisions and affect corporations carrying significant debt. It’s unclear how Congress will handle carryforwards of any credits that are eliminated. Many manufacturing firms would miss the Section 199 deduction.

Pass-Through Tax Proposals

The tax outlook for pass-through business entities — including partnerships, S Corporations and Limited Liability Companies (LLCs) — will be very different if the new tax reform plan is approved. It proposes that:

  • Business income received by pass-through entities be taxed at a maximum rate of 25%. Currently, this income is taxed at ordinary income rates for individuals, which can be as high as 39.6%. It isn’t clear if personal services firms would qualify for the tax break.
  • The lower rate on income for pass-through entities be coordinated with tax law provisions that don’t permit wages to be treated as business profits.
  • Congress be required to determine the ramifications for pass-through entities and sole proprietorships of the partial limits on interest expense deductions.

This series of tax reforms could change the thinking of business owners. In theory, the shift away from the current tax format is designed to align C Corporations and pass-through entities. However, some experts fear that this could lead to an unfair tax advantage for wealthier business owners.

With the top tax rate now set at 39.6% and a proposed maximum 35% rate, owners may have an opportunity to slash their tax bills. Restricting these changes to qualified small businesses has been discussed and could be put into effect.

International Tax Proposals

The Trump campaign pledged to bring business back from overseas. In support of that objective, the tax reform plans proposes several changes relating to manufacturing:

  • Impose a one-time repatriation levy on offshore profits to encourage a return of U.S. multinational corporations from so-called tax havens. However, the proposals don’t specify a rate or time period for this change.
  • Adopt a territorial method of international taxation that would include an exemption for dividends from foreign subsidiaries if the U.S. company owns at least 10% of the subsidiary.
  • Authorize a global minimum tax on foreign profits of U.S. multinational corporations. Congress would be directed to “even the playing field” between companies headquartered in the United States and those based in foreign jurisdictions.

If these proposals have their desired effect, certain multinational corporations would be encouraged to shift more business operations to the United States. This would represent an historic shift in the way that companies are taxed. But the proposed guidelines leave as many questions as they provide answers, including how foreign tax credits would be used against repatriated earnings.

Individual Tax Proposals

The new tax plan features a wide variety of changes that would affect individuals, including:

  • Consolidating the current seven income tax brackets into three brackets of 12%, 25% and 35%. There are no details about the potential bracket thresholds. An add-on tax for the wealthiest taxpayers was discussed, but not finalized.
  • Increasing the standard deduction from $6,500 to $12,000 for single filers and from $13,000 to $24,000 for married couples filing jointly. All personal exemptions would be repealed.
  • Repealing most itemized deductions other than those for charitable contributions and mortgage interest.
  • Eliminating the AMT.
  • Condensing several tax breaks for families. Along with the repeal of dependency exemptions, the new plan features a proposed $500 credit for non-child dependents.

Again, the experts are divided as to whether these changes would mostly benefit the low-to-middle or upper-income classes. In many cases, it makes sense for individuals to accelerate deductions into 2017, unless there are special circumstances that prevent that.

Expect Some Modifications

Although the tax reform plan has some momentum, there’s still a long way to go before it becomes law. Even if key tax reforms are enacted, some modifications can be expected.

What about the Estate Tax?

The tax reform plan would repeal the federal estate tax. This would include elimination of the generation-skipping tax (GST), which applies to most direct transfers from grandparents to grandchildren, even those made through a trust. However, if the proposed legislation is passed as a reconciliation bill, as many believe it will be, the estate tax could reappear in ten years when Congress would have to address it again.

The tax reform plan doesn’t call for the repeal of gift taxes.

1The Big Six: Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Cohn, Senate Majority Leader Mitch McConnell (R, KY), Senate Finance Committee Chair Orrin Hatch (R, UT), Speaker of the House of Representative Paul Ryan (R, WI) and House Ways and Means Committee Chair Kevin Brady (R, TX).

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Posted on Nov 7, 2017

Historic Tax Reform Compared to Today

The alternative minimum tax (AMT) arose as part of the Reagan administration’s tax reforms. In addition to simplifying capital gains rates and taxation, the top marginal tax rate dropped from 70 percent to 28 percent. The AMT and passive activity rules were put in place as a way to close “loopholes.”

Lower tax rates sound good until we note the loss of certain itemized deductions that have never returned, such as deducting credit card interest and a dependent’s student loan interest. However, marginal tax rates were raised over and over again through the 90s. Additionally, since that time, more middle class Americans who saw their incomes rise during the industrial and tech booms have been getting caught in the AMT trap.

Therefore, if additional itemized deductions and other “loopholes” are removed or curtailed, history shows that they will not come back even though the federal government still has the option to raise marginal tax rates. This could be really costly to taxpayers in the long run.

Your Tax Planning Prediction

If I were to look into my crystal ball on tax reform, I would predict that the “reform” that eventually passes will look a whole lot different than this initial framework.

My standard guidance to clients is to look at their own individual tax situation and continue to leverage opportunities that range from tax-deferred savings to keeping track of potential itemized deductions. If a major event has occurred or is on the horizon this year, talk to your CPA about its potential tax impact under the current tax code.

For companies, it is too early to tell if a change in business structure is a good move for tax purposes. We recommend that clients sit tight with their current business structure until we have more clarity on how different business structures will be taxed.

Ultimately, consider your business goals and planning for investments or equipment purchases. Consider the current equipment expensing and bonus depreciation rules, the time frame for which your company will need the equipment, and your projected profits when making the decision whether to invest this year or next. The same holds true for estate planning. Planning with the guidance of your trusted advisors keeps you and your family in more control regardless of the next version of federal tax legislation.

As soon as we see some actual legislation from the Hill, there may be more to discuss for you or your company. Think of Cornwell Jackson if you are in need of longer-range planning, reporting support or guidance. And stay tuned!

Download the whitepaper: Tax Reform 2017 – How New Tax Legislation Will Affect Businesses and Individuals

Scott Allen, CPA, joined Cornwell Jackson as a Tax Partner in 2016, bringing his expertise in the Construction and Oil and Gas industries, and 25 years of experience in the accounting field. As the Partner in Charge of the Tax practice at Cornwell Jackson, Scott provides proactive tax planning and tax compliance to all Cornwell Jackson tax clients. Contact him at Scott.Allen@cornwelljackson.com or 972-202-8032.

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Posted on Nov 7, 2017

Monthly Social Security and Supplemental Security Income (SSI) benefits for more than 66 million Americans will increase just 2.0% in 2018, the federal government recently announced.

The 2.0% cost-of-living adjustment (COLA) will begin with benefits that more than 61 million Social Security beneficiaries will receive in January 2018. Increased payments to more than 8 million SSI beneficiaries will begin on December 29, 2017.

The purpose of the COLA, the Social Security Administration explained, is to ensure that the purchasing power of benefits is not eroded by inflation. The COLA is based on inflation changes as measured by the Consumer Price Index.

Estimated Average Monthly Social Security Benefits in 2018

Type of Benefit
or Family		 Before
2.0% COLA		 After
2.0% COLA		 Increase
Benefit Type All retired workers $1,377 $1,404 $27
All disabled workers $1,173 $1,197 $24
Family Type Disabled worker, spouse and one or more children $2,011 $2,051 $40
Aged couple, both receiving benefits
 $2,294 $2,340 $46
Aged widow or widow(er) alone $1,310 $1,336 $26
Widowed mother and 2 children $2,717 $2,771 $54
— Source: Social Security Administration

 

Through the Years: Social Security Cost-Of-Living Adjustments
Year COLA Year COLA Year COLA Year COLA
1975 8.0 1986 1.3 1997 2.1 2008 5.8
1976 6.4 1987 4.2 1998 1.3 2009 0.0
1977 5.9 1988 4.0 1999* 2.5 2010 0.0
1978 6.5 1989 4.7 2000 3.5 2011 3.6
1979 9.9 1990 5.4 2001 2.6 2012 1.7
1980 14.3 1991 3.7 2002 1.4 2013 1.5
1981 11.2 1992 3.0 2003 2.1 2014 1.7
1982 7.4 1993 3.6 2004 2.7 2015 0.0
1983 3.5 1994 2.8 2005 4.1 2016 0.3
1984 3.5 1995 2.6 2006 3.3 2017 0.3
1985 3.1 1996 2.9 2007 2.3 <align=center>2018</align=center> <align=center>2.0</align=center>
*The COLA for December 1999 was originally determined as 2.4% based on CPIs published by the Bureau of Labor Statistics. Pursuant to Public Law 106-554, however, this COLA is effectively now 2.5%.

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Posted on Nov 7, 2017

Are you planning to sell real estate before the end of the year? Naturally, you hope to entice a qualified buyer who has plenty of cash on hand. But being open to the idea of an installment sale may help you seal the deal. Fortunately, installment sales also offer tax savings for sellers. Here’s how these deals work.

Qualifying as an Installment Sale

With installment sales, the buyer makes payments to the seller over time, rather than handing over a lump sum at closing. The buyer’s obligation to make future payments to the seller may be spelled out in a deed of trust, note, land contract, mortgage or other evidence of debt.

Under the tax code, an installment sale allows the seller to defer tax on a gain from the sale and possibly reduce the overall tax liability by spreading out the tax liability over several years. So, it’s a popular tax planning technique for real estate owners.

To qualify as an installment sale under the tax law, you must receive at least one payment after the year of the sale. For example, if you sell real estate in October and receive a total of three monthly payments in October, November and December, you aren’t eligible for installment sale reporting. Conversely, if you arrange to receive only two payments — say, one in December 2017 and the other in January 2018 — you qualify.

Moreover, if it suits your needs, you can “elect out of” installment sale treatment when you file your 2017 tax return. (See “Should You Elect Out of Installment Sale Treatment?” at right.) Also note that the installment sale rules apply only to gains, not losses.

Should You Elect Out of Installment Sale Treatment?

When you sell real estate on the installment basis, you can elect out of installment sale reporting by paying tax on the entire gain in the year of the sale. Why  would you ever do that? There are several possible reasons.

For example, you might expect to pay lower tax rates in 2017 than in 2018 or 2019. In that case, you may prefer to pay the full amount of tax due on your 2017 tax return.

Or you might have capital losses or suspended passive losses that will offset the tax on an installment sale gain. Therefore, you may benefit by reporting all  your gain in the year of the sale, instead of spreading it out over time.

Not sure how to report your sale? Your tax advisor can calculate your cumulative tax liability with and without installment sale reporting. Then you’ll have the information needed to make an informed choice on your 2017 tax return.

Understanding the Exclusions

The following types of transactions are not eligible for installment sale reporting:

  • Sale of inventory of personal property,
  • Sales of personal property by a dealer (a person who regularly sells or otherwise disposes of this type of personal property on the installment basis), unless the property is used or produced in farming,
  • Sales of timeshares and residential lots by dealers, unless the buyer elects to pay a special interest charge, and
  • Sales of stock or securities traded on an established securities market.

For these types of transactions, you must report the entire gain on the sale in the year in which it occurs.

Reaping the Tax Benefits

Although installment sales require you to wait several years to receive the property’s full fair market value, they offer three key tax advantages:

1. Long-term capital gains treatment. With an installment sale of real estate, any gain is taxed as tax-favored long-term gain if you’ve owned the property for longer than one year. Under current tax law, the maximum long-term capital gains rate is 15%, or 20% if you are in the top ordinary income tax bracket of 39.6%. Even if you’re also liable for the 3.8% net investment income tax (NIIT), the maximum combined federal tax rate is limited to 23.8%.

2. Tax deferral. Instead of paying tax on the entire gain in one year, only a portion of your gain is taxable in the year of the sale. The remainder is taxable in the years payments are received.

The taxable portion of each payment is based on the “gross profit ratio.” To calculate this ratio, divide the gross profit from the sale by the price.

For example, in November 2017, you sell a small apartment building that you acquired in 2005 with an adjusted tax basis of $600,000. The buyer agrees to pay $1.5 million in three annual installments of $500,000 each. Because your gross profit is $900,000 ($1.5 million – $600,000), the taxable percentage of each installment received is 60% ($900,000 / $1.5 million). When you report the sale on your 2017 tax return, you have to pay tax on only $300,000 of the gain (60% x $500,000). You’ll also be taxed on $300,000 of gain in 2018 and 2019.

3. Lower tax liability. Because your gain from an installment sale is spread out over several years, you may benefit from the tax rate differential in each of those years. For simplicity, let’s assume that you arrange a five-year installment sale where $50,000 of the gain is taxed at the 15% rate each year instead of the 20% rate (if the entire gain had been taxed in the year of sale). As a result, you save $2,500 ($50,000 x 5% tax rate differential) each year for a total savings of $12,500 ($2,500 x 5 years). These rates may change in the future if tax reforms are enacted, however.

Navigating Other Tax Hurdles

Beware: The tax law contains some hidden “tax traps” for the unwary when property is sold on the installment sale basis. First, any depreciation claimed on the property must be recaptured as ordinary income to the extent it exceeds the amount allowed under the straight-line method. The adjusted basis of the property is increased by the amount of recaptured income, thereby decreasing the gain realized in future years.

In addition, if the sales price of your property (other than farm property or personal property) exceeds $150,000, interest must be paid on the deferred tax to the extent that your outstanding installment obligations exceed $5 million.

Finally, sales of depreciable property to related parties are prohibited unless you can demonstrate that tax avoidance wasn’t a principal purpose of the sale. Furthermore, if the related party disposes of the property within two years, either by resale or some other method, the remaining tax is due immediately.

Important note: The definition of a “related party” isn’t limited to immediate family members, such as your spouse, children, grandchildren, siblings and parents. It also includes a partnership or corporation in which you have a controlling interest or an estate or trust that you’re connected to. To avoid any negative tax results when deals involve related parties, consider adding a clause that stipulates that the property can’t be disposed of within two years.

Bottom Line

Installment sales aren’t right for every real estate transaction, but for patient sellers who aren’t strapped for cash, installment sales can help finalize an agreement. Your tax advisor can help you cement a profitable deal with favorable tax consequences.

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Posted on Nov 6, 2017

Could your data be hacked? Unfortunately, every organization — including for-profit businesses, not-for-profits and government agencies — is vulnerable to cyberattacks today.

Examples abound. In September, Equifax reported a data breach that exposed the credit histories and other information of 145.5 million Americans. Shortly thereafter, the Securities and Exchange Commission (SEC) reported a hacking incident that occurred in 2016.

These incidents have raised concerns from individuals and lawmakers about delays in reporting breaches. However, breach response requires a delicate balance. Organizations that are hacked have a responsibility to make a measured, comprehensive assessment of the situation before reporting a breach to the public at large. Here are details of the SEC breach incident and guidance for victim-organizations on how (and when) to report a data breach.

Breach Response Legislation in the Works

Following the SEC and Equifax incidents, the Personal Data Notification and Protection Act was reintroduced in the House. This bill aims to expedite data breach response time. Representative Jim Langevin (D-RI) originally proposed this bill in 2015. He claims that, if the legislation had been in effect when the Equifax breach occurred, Equifax would have had to disclose its breach to the Federal Trade Commission and the Department of Homeland Security within 30 days, not six weeks later.

“This bill will replace the patchwork of 48 state breach notification laws with a single nationwide standard that would clarify and strengthen companies’ obligations to report intrusions that compromise consumers’ personal information,” Langevin said. “Americans put a lot of trust in companies by giving them personal and private information, and they should have confidence that their data is secure. While I do not believe that breach notification is the only legislative response required following Equifax, it is an important first step in building accountability and protecting consumers.”

Under the proposed legislation, companies that fail to meet the requirements would be severely penalized, including fines of up to $1 million per violation. They could also be targeted for civil penalties in lawsuits from states across the country. The legislation doesn’t include any limit on damages in the event a corporation is found to have acted “willfully or intentionally.”

Critics of the bill argue that organizations could be hamstrung by stricter reporting requirements, especially if they are forced to report every isolated incident. Premature or inaccurate reports may cause consumers and other stakeholders to unnecessarily panic or become confused. Some also fear that “data breach fatigue” will eventually lead to public indifference.

We’re monitoring this controversial bill as it works its way through Congress. The recent Equifax and EDGAR breaches are helping it pick up momentum, however.

SEC Announces Breach

In September, SEC Chairman Jay Clayton announced that the agency was expanding a probe into a 2016 data breach of its electronic filing system, known as EDGAR (short for Electronic Data Gathering, Analysis and Retrieval). The investigation will primarily focus on a review of when agency officials learned that the EDGAR system had been hacked. The FBI and U.S. Secret Service have also launched investigations into the breach.

What exactly is EDGAR? It’s the electronic filing system that the SEC created to increase efficiency and accessibility to corporate filings. Most publicly traded companies must submit documents to the SEC using EDGAR. However, some smaller companies may be exempt from these EDGAR mandates if they don’t meet certain thresholds.

Examples of documents that the SEC requires companies to file through EDGAR include annual and quarterly corporate reports and information pertaining to institutional investors. This time-sensitive information is often critical to investors and analysts.

Hackers Exploit Outdated System

EDGAR was launched in the 1990s, and it’s been routinely updated and modified over the last two decades. Like many legacy systems, however, EDGAR has some weaknesses and glitches, and the system will eventually need to be replaced.

In September 2016, the SEC awarded a $6.1 million contract to a firm to collect information needed to completely redesign EDGAR. The SEC anticipates that the information-gathering phase will extend through March 2018. A further extension may be requested to provide additional support for the redesign.

Based on the SEC’s preliminary investigation, it appears that hackers were able to breach EDGAR by using authentic financial data when they were testing the agency’s corporate filing system. The breach occurred in October 2016 and was reportedly detected that month. The cyberattack appears to have been routed through a server in Eastern Europe.

The SEC’s enforcement division discovered the breach as part of an ongoing investigation. Although SEC Chair Clayton was vague on the details, he admitted, “Information they gained caused them to question whether there had been a breach of the system.”

Furthermore, it’s not entirely clear what kind of information was breached. Corporate filings contain detailed financial information about company performance, but such information is usually available to investors in press releases prior to SEC disclosure. According to industry insiders, one potential target could be Forms 8-K. These are unscheduled filings regarding material events that companies are legally required to disclose. These disclosures in EDGAR begin before the official word gets out to the rest of the world.

Media sources say that the FBI’s investigation has homed in on trading activities conducted in connection with the breach. One possibility is that the EDGAR breach is connected to a group of hackers that intercepted electronic corporate press releases in a previous case handled by the FBI team.

SEC Chair Clayton, who took office in May 2017, claims to have first learned of the breach in August 2017. Although he didn’t blame his predecessors, Clayton can’t guarantee that there haven’t been other breaches. “I cannot tell you with 100% certainty that this is the only breach we have had,” Clayton said, reiterating that the investigation was “ongoing.”

Take Control of Breach Response

Public response to the SEC incident, which was announced at roughly the same time as the high-profile Equifax breach, has focused significant attention on the lag between when an organization detects a breach and when it’s announced to the public.

The media and congressional investigations have cast doubt on the intentions of SEC Chair Clayton and the management team at Equifax: Were the delayed responses actually attempts to hide the truth, thereby exposing investors and other stakeholders to even greater potential losses?

Before anyone jumps to conclusions, however, it’s also important to consider the perspective of the victim-organization. It takes time to investigate a breach before announcing it to the public. A knee-jerk response that needs to subsequently be revised can cause major damage to the organization’s reputation with its stakeholders.

What should you do as soon as you suspect that your organization’s data has been breached? First, call your attorney, who will help assemble a team of data response specialists. The preliminary goal is to answer two fundamental questions:

  1. How were the systems breached?
  2. What data did the hackers access?

Once these questions have been answered, forensic experts can help evaluate the extent of the damage. Sometimes, a breach occurs, but the hackers don’t actually steal any data.

A comprehensive data response includes the following services:

  • Legal,
  • Forensic,
  • Information technology (IT),
  • Communications / public relations, and
  • Credit monitoring services.

Whether your organization is small or large, for-profit or not-for-profit, the goal in breach response is essentially the same: to provide accurate, detailed information about the incident as quickly as possible to help minimize losses and preserve trust with customers, employees, investors, creditors and other stakeholders.

Once investigative and response procedures are underway, management needs to take proactive measures to fortify controls. This final step helps minimize the risk that another data breach will occur in the future.

Plan Ahead

Data breaches are an inevitable part of today’s interconnected, technology-driven world. How an organization responds to a breach can set it apart from others and affect its goodwill with stakeholders.

Proactive organizations don’t wait for a breach to strike, however. Work with your legal and forensic accounting professionals to help prevent and detect breaches, as well as to establish policies and procedures for investigating and responding to suspected hacking incidents.

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Posted on Nov 6, 2017

There are more interesting proposed tax changes for individuals than on the business level. The proposal calls for seven individual tax brackets to be replaced by just three, potentially 12, 25 and 35 percent.  It also calls for eliminating the so-called “marriage penalty” and expanding the standard deduction. However, some of these proposed changes could end up hurting some taxpayers more than helping them.

According to the Wolters Kluwer report, the math for some taxpayers under the proposed higher standard deduction vs. taking the current standard deduction plus personal exemptions does not seem to add up well.

“Under the inflation adjusted amounts for 2017, a family of four filing a joint return could claim a standard deduction of $12,700, plus $16,200 for four personal exemptions of $4,050. The result reduces adjusted gross income by $28,900. Under the GOP framework, the standard deduction for married filing jointly is only $24,000 with no exemptions. The result would be that the family’s taxable income would be increased by $4,900 as compared to 2017 inflation adjusted amounts.”  

The framework calls for an expansion of the child tax credit.  The amount of the credit would increase and be made available to more income groups.

The framework also proposes significant changes to itemized deductions. Nearly all the itemized deductions will be eliminated except for mortgage interest and charitable deductions. Note that property, sales, and income tax deductions are targeted for elimination.

A significant impact on our clients is the proposed concept of capping itemized deductions. President Trump had called for a cap of $100,000 in itemized deductions for single filers up to a $200,000 cap for married filing jointly. People with high out-of-pocket medical expenses (currently amounts beyond 7.5 percent of adjustable gross income), for example, would lose that option to reduce their taxable income. In addition, the opportunity for large charitable contributions and mortgage interest deductions may be impacted. There was also discussion during President Trump’s campaign that all personal exemptions and head-of-household status would be eliminated, but all of these potential deductions are expected to undergo discussion in committee.

Tax Planning Changes for Individuals

My standard guidance to clients is to look at their own individual tax situation and continue to leverage opportunities that range from tax-deferred savings to keeping track of potential itemized deductions. If a major event has occurred or is on the horizon this year, talk to your CPA about its potential tax impact under the current tax code.

Ultimately, consider your business goals and planning for investments or equipment purchases. Consider the current equipment expensing and bonus depreciation rules, the time frame for which your company will need the equipment, and your projected profits when making the decision whether to invest this year or next. The same holds true for estate planning. Planning with the guidance of your trusted advisors keeps you and your family in more control regardless of the next version of federal tax legislation.

As soon as we see some actual legislation from the Hill, there may be more to discuss for you or your company. Think of Cornwell Jackson if you are in need of longer-range planning, reporting support or guidance. And stay tuned!

Continue Reading: Today’s Reform and Tax Planning Predictions

Scott Allen, CPA, joined Cornwell Jackson as a Tax Partner in 2016, bringing his expertise in the Construction and Oil and Gas industries, and 25 years of experience in the accounting field. As the Partner in Charge of the Tax practice at Cornwell Jackson, Scott provides proactive tax planning and tax compliance to all Cornwell Jackson tax clients. Contact him at Scott.Allen@cornwelljackson.com or 972-202-8032.

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Posted on Nov 3, 2017

As year end approaches, you may be thinking about making some charitable donations. Here’s a rundown of the potential tax breaks for your generosity.

Itemized Deductions

You can claim write-offs for contributions of cash and other items donated to charitable organizations, such as United Way and Goodwill. What you might not realize is that not all contributions to charities qualify for tax breaks.

First, you receive tax savings from charitable donations only if you itemize deductions on your personal tax return. For 2017, the standard deduction amounts are:

  • $6,350 for singles,
  • $9,350 for heads of households, and
  • $12,700 for married joint-filers.

Unless your total itemized deductions, including any charitable donations, exceed the applicable standard deduction, you won’t get any tax savings for your generosity. In general, most people who don’t own homes don’t itemize.

Also, be aware that some not-for-profit organizations aren’t qualified charities for federal income tax purposes. You can search for IRS-approved charities on the IRS website or ask your tax advisor for help. And of course, you can’t deduct money or property you give to an individual.

In addition, there are limits on the amount of itemized charitable donations that you can deduct in any one year. For most types of donations, the limit is 50% of adjusted gross income (AGI). However, lower limits apply to certain types of donations.

Any amount of charitable contribution that’s disallowed under the applicable percent-of-AGI limitation is carried forward to the following five tax years. If you can’t use up the carryover amount during the five-year period, the remainder can’t be deducted.

Donating Clothing and Household Items

When it comes to your old clothes, furniture, linens, electronics, appliances, and the like, the general rule is that you can claim deductions only for items in “good condition or better.” However, you can deduct the fair market value of an item that’s not in good condition or better if you attach a written qualified appraisal that values the item at more than $500. For example, this rule might apply to a Persian rug that’s valuable despite being in only “fair” condition.

Supporting Documentation

The tax rules also require proper documentation for charitable contribution deductions. The type of documentation depends on the size and nature of the donation.

Cash contribution under $250. These donations require a written receipt from the organization showing its name, the date and place of the contribution, and the amount. Alternatively, you can save canceled checks or credit card statements.

Cash contribution of $250 or more. The IRS won’t accept canceled checks or other evidence supplied by you for these donations. Instead, you must obtain a written acknowledgment from the charity by the time you file your federal tax return. If you don’t get a written acknowledgment and you do get audited, the IRS will reject your deduction, even if there’s no doubt that your donations were legitimate.

Noncash donation under $250. Here, you’ll need to obtain a receipt from the charity by the time you file your return. Keep it with your tax records for the year, but don’t file it with your return.

Noncash donation worth between $250 and $5,000. These donations require a contemporaneous written acknowledgment from the charity (more detailed than a receipt) that meets IRS guidelines. Keep it with your tax records, but don’t file it with your return.

A qualified acknowledgment must include the following information:

  • A description (but not the value) of the noncash item,
  • Whether the charity provided you with any goods or services in exchange for the donation (other than intangible religious benefits), and
  • A description and good-faith estimate of the value of any goods or services provided by the charity in exchange for your donation.

An acknowledgment meets the contemporaneous requirement if you obtain it on or before the earlier of 1) the date you file your Form 1040 for the year you made the donation, or 2) the due date (including any extension) for filing that return. If you don’t have a qualified acknowledgment in hand by the relevant date, you can’t claim a charitable deduction.

Noncash donation worth between $501 and $5,000. In addition to the aforementioned contemporaneous written acknowledgment from the charity, you’ll need to provide written evidence that supports the item’s acquisition date, fair market value and cost.

The written evidence — which may be as simple as your own handwritten notes — will be used to complete IRS Form 8283, “Noncash Charitable Contributions.” Keep the evidence with your tax records, but don’t file it with your return.

Noncash donation worth more than $5,000. In addition to a contemporaneous written acknowledgment and written evidence, these donations require a written qualified appraisal. Specific appraisal requirements apply to certain types of donated property and donations valued above certain amounts. However, no appraisal is required for donations of publicly traded securities.

Special restrictions apply to donations of vehicles, planes and boats. As a general rule, your charitable write-off will usually be limited to the amount the charity receives when it sells the vehicle, plane or boat (as opposed to the item’s fair market value).

Save Taxes by Donating

You can reap tax savings by making charitable donations, but the rules are complicated. Your tax advisor can help devise a plan that delivers the maximum tax savings for your generosity. Just don’t wait too long to get started: Year end will be here before you know it.

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Posted on Nov 1, 2017

Corporate Tax Reform

In the new tax reform bill, the framework proposes a 20 percent corporate tax rate, down from 35 percent, as well as a top rate of 25 percent for pass-through income. This change, if passed would particularly benefit small business owners and sole proprietorships, but provisions may be put in place to prevent certain service providers or wealthy business owners from converting compensation income to profits that would be taxed at a lower rate.

One proposed change that makes a lot of sense for business owners is elimination of the estate tax. For anyone who has an estate valued at more than $5.49 million (as of 2017) and wants to leave an inheritance to anyone beyond their spouse, that money is taxed at a fairly steep maximum federal rate of 40%. Fortunately for Texans, there isn’t an additional state inheritance tax, since that tax was eliminated in 2015. Because taxpayers have already paid tax on income gained over their lives, opponents consider the federal estate tax to be double taxation.

Some of the business owners particularly affected by the estate tax are ranchers and farmers, whose assets are not liquid but tied to the value of their land. It is not difficult to go beyond $5 million in estate value for several thousand acres of land. Families have been forced to sell their land to pay the tax.

There is some mention of the estate tax being replaced by a carryover basis rule as well as elimination of the generation-skipping transfer tax. This is one change that may have bipartisan support.

Business expensing

Many changes to business incentives are proposed in the tax framework, from elimination of the Domestic Production Activities Deduction (DPAD) to modernizing industry-specific tax breaks to reflect economic reality. If a maximum 20% corporate tax rate is attained, it may make sense to eliminate DPAD and any special incentives that allow only certain businesses to reduce their tax impact even further.

There will be considerable planning opportunities for changes to bonus depreciation or first-year expensing. A proposed 100 percent bonus depreciation for five years starting in 2017 may accelerate investments in property or equipment, but such investments should still make logical sense for the business. In addition, if a business elects to deduct or expense investments rather than capitalize and depreciate, this will result in reduced deductions and higher taxable income in future years. On the face, it seems like an easy analysis, but each business situation will be different.

Repatriation of Profits

Within the tax framework, businesses would be encouraged to bring profits back from foreign subsidiaries and reinvest them in U.S. assets as well as reshoring their headquarters. A one-time 10 percent tax on non-repatriated money has also been proposed. Currently, unless they are structured properly, companies with business outside the U.S. are taxed at the normal corporate tax rate. The new framework offers a reduced tax rate for U.S.-based businesses, likely intended to increase U.S. competitiveness with other countries.

Corporate Tax Planning Prediction

For companies, it is too early to tell if a change in business structure is a good move for tax purposes. We recommend that clients sit tight with their current business structure until we have more clarity on how different business structures will be taxed.

Ultimately, consider your business goals and planning for investments or equipment purchases. Consider the current equipment expensing and bonus depreciation rules, the time frame for which your company will need the equipment, and your projected profits when making the decision whether to invest this year or next. The same holds true for estate planning. Planning with the guidance of your trusted advisors keeps you and your family in more control regardless of the next version of federal tax legislation.

As soon as we see some actual legislation from the Hill, there may be more to discuss for you or your company. Think of Cornwell Jackson if you are in need of longer-range planning, reporting support or guidance. And stay tuned!

Continue Reading: Tax Reform 2017 – Changes for Individuals

Scott Allen, CPA, joined Cornwell Jackson as a Tax Partner in 2016, bringing his expertise in the Construction and Oil and Gas industries, and 25 years of experience in the accounting field. As the Partner in Charge of the Tax practice at Cornwell Jackson, Scott provides proactive tax planning and tax compliance to all Cornwell Jackson tax clients. Contact him at Scott.Allen@cornwelljackson.com or 972-202-8032.

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