Tag: tax reform

Posted on Jan 15, 2018

The most immediate concrete change the Tax Cuts and Jobs Act (TCJA) will bring about for employers is new payroll tax withholding rates. Here’s the latest word from the IRS: “We anticipate issuing the initial withholding guidance in January reflecting the new legislation, which would allow taxpayers to begin seeing the benefits of the change as early as February. The IRS will be working closely with the nation’s payroll and tax professional community during this process.”

Under the new law, the tax rates are 10%, 12%, 22%, 24%, 32%, 35% and 37%. Under prior law, the tax rates were 10%, 15%, 25%, 28%, 33%, 35% and 39.6%

Sexual Harassment Subject to Nondisclosure Agreement

Under the new law, effective for amounts  paid or incurred after December 22, 2017, no tax deduction is allowed for settlements, payouts, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.

In general, a taxpayer generally is allowed a deduction for ordinary and necessary expenses paid or incurred in carrying on a trade or business. However, among other exceptions, there’s no deduction for: illegal bribes, illegal kickbacks or other illegal payments; certain lobbying and political expenses; fines or similar penalties paid to a government for the violation of any law; and two-thirds of treble damage payments under the antitrust laws.

Family and Medical Leave

Another change involves tax incentives to encourage employers to pay employees — though not necessarily their full salaries — when they’re absent due to their own sickness or that of a family member. (Employers in several areas are already required to do so by  their own state laws.)

To receive a general business tax credit in 2018 and 2019, employers must grant full-time employees a minimum of two weeks of annual family and medical leave during which they receive at least half of their normal wages. Ordinary paid leave that employees are already entitled to, such as vacation or personal leave, or any form of leave already required by state and local laws, doesn’t qualify for the tax credit.

Employees whose paid family and medical leave is covered by this provision must have worked for the employer for a year or more, and not had pay in the preceding year exceeding 60% of the highly compensated employee threshold, set at $120,000 for 2018 (which works out to $72,000).

The minimum credit equals 12.5% of the eligible employee’s wages paid during that leave, up to a maximum of 25%. Within that range, the amount of the credit rises as employees are paid more than the minimum of half their normal compensation during their leave period. Employers that qualify may claim the tax credit for a maximum of 12 days per year of family and medical leave.

Save the Savings?

While most authors of the TCJA are probably hoping employees who will see a higher paycheck will use the difference to stimulate the economy by spending it immediately, there’s another scenario employers might consider: Employers that are concerned their employees aren’t saving enough for retirement could suggest that some might elect to “bank” their tax cut “raise” in the form of an increased 401(k) contribution.

One tool for motivating employees to save more for the future is to provide some illustrations of the long-term impact of a higher savings rate. For example, a $50 increase in 401(k) savings deducted from a biweekly paycheck would accumulate around $50,000 in greater savings over a 20-year period, assuming a 6% annual growth rate.

It’s also noteworthy that early versions of the TCJA would have drastically reduced employee opportunities to save for retirement in a 401(k) using pre-tax dollars. One proposal that would’ve hit many taxpayers hard would have limited contributions by requiring them to combine participation in multiple plans, including mandatory employee contributions to defined benefit pensions.

Those ideas were dropped.

401(k) Loan Rule Change

The TCJA did, however, make some technical changes in the retirement plan arena. Most notable is that the new law gives a break to plan participants that have outstanding 401(k) loan  balances when they leave their employers. Under current law, a participant with such a loan who fails to make timely payments due to his or her separation from the employer is deemed to have received a distribution in the amount of that outstanding balance, triggering adverse tax consequences. The participant, however, is permitted to roll that amount — assuming he or she has sufficient funds available — into an IRA without tax penalty if he or she does so within 60 days.

Under the new law, former employees in that situation have until the due date of their tax returns to move funds equal to the outstanding loan balances into IRAs without penalty. The same opportunity would apply if they were unable to repay their loans due to their plans’ termination.

Taxing Employee Awards

Some TCJA provisions affecting employee benefits seek to recoup tax relief granted in other parts of the law. For example, the TCJA tightens up the definition of employee achievement awards eligible for tax deductions on the part of employers, and exclusion from income taxation for the employees.

“Tangible” achievement awards still qualify, but the following award categories are no longer considered tangible: cash and cash equivalents, gift cards, gift coupons, gift certificates, vacations, meals, lodging, tickets to theater or sporting events, stocks and bonds.

The Inflation Effect and Other Changes

Another section of the law alters the inflation index used to periodically adjust the limits on contributions to health flexible spending accounts, health savings accounts, and the threshold for the value of health benefits subject to the 40% “Cadillac tax” (currently scheduled to take effect in 2020).

Instead of using the regular consumer price index (also known as the CPI-U), annual limit adjustments will be set using the “chained CPI-U.” That “chained” version tends to rise at a slower rate than the unchained index. The same formula change was made applicable to IRA contribution limits.

Finally, here are three other changes affecting employee benefits:

  • Employees’ ability to exclude the value of employer-provided reimbursements for moving expenses has been taken away. (An exception is made for active-duty military personnel, however.)
  • Employers can no longer deduct the cost of qualified transportation fringe benefits granted to employees, such as reimbursement for commuting expenses. And, similarly:
  • Employers can no longer deduct payments to employees who commute to work by bicycle.

When you add it all up, many employers and employees are likely to be happy with the overall effects of the TCJA. The task of digesting all the changes might cause a few headaches in the short run, however.

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Posted on Jan 9, 2018

As you’ve heard by now, the Tax Cuts and Jobs Act (TCJA) includes a number of changes that will affect individual taxpayers in 2018 and beyond. Significant attention has been given to the reduced tax rates for most individuals and the new limit on deducting state and local taxes. But there is more to the story. Here’s a summary of some of the lesser-known provisions in the new law.

Repeal of the ACA Penalty for Individuals

The Affordable Care Act (ACA) requires individuals to pay a penalty if they aren’t covered by a health plan that provides at least minimum essential coverage. That penalty is also known as the “shared responsibility payment.” Unless an exception applies, the penalty is imposed for any month that an individual doesn’t have minimum essential coverage in effect.

The new tax law permanently repeals the ACA penalty for individuals for months beginning in 2019. But the penalty is still in force for all of 2018. The new tax law doesn’t change the ACA mandate for employers, however.

Revamped “Kiddie Tax”

Under prior law (in effect before the TCJA), unearned income of children above an annual threshold was taxed at their parents’ rates if those rates were higher. This so-called “kiddie tax” is imposed on individuals up to age 24 if they’re full-time students. For 2017, the unearned income threshold was $2,100. Unearned income beneath the threshold was taxed at the children’s rates. Earned income was also taxed at the children’s rates.

For 2018 through 2025, the TCJA stipulates that a child’s earned income is taxed at the standard rates for single taxpayers while unearned income is taxed using the rates and brackets that apply to trusts and estates. This change will make the kiddie tax much easier to calculate.

Restriction on Casualty and Theft Loss Deductions

For 2018 through 2025, the TCJA eliminates deductions for personal casualty and theft losses. However, it provides an exception for losses incurred in federally-declared disasters.

Another exception for losses, which aren’t due to federally-declared disasters, allows deductions for personal casualty and theft losses if the taxpayer has personal casualty gains. That happens when insurance proceeds exceed the basis of the damaged, destroyed or stolen property. In this situation, personal casualty and theft losses are allowed up to the amount of the taxpayer’s personal casualty gains.

Itemized Deduction Phase-Out Rule Eliminated

Under prior law, individuals with high levels of income were subject to a phase-out rule that could eliminate up to 80% of the most common itemized deductions, including the tax breaks for mortgage interest, property taxes and charitable donations.

For 2018 through 2025, the TCJA eliminates the itemized deduction phase-out rule. But some of the itemized deduction rules are changed (and limited) by other provisions in the new law. For example, the TCJA limits the deduction for state and local income and property taxes to a combined total of $10,000 ($5,000 for married people who file separately).

Changes to Charitable Deduction Rules

The TCJA also increases the charitable deduction limit for some gifts. Under prior law, the deduction for cash contributions to public charities and certain private foundations was limited to 50% of your adjusted gross income (AGI).

For 2018 and beyond, the new law increases the deduction limit to 60% of AGI. Deductions that are disallowed by the 60% rule can generally be carried forward for five years.

But not all changes to the charitable deduction rules are taxpayer friendly. The TCJA also eliminates deductions for donations to obtain seating rights at college athletic events, for 2018 and beyond.

Under prior law, you could treat 80% of such payments as a charitable donation if:

    • The payment was to or for the benefit of a college, and
    • The payment would be treated as a deductible charitable donation except for the fact that the payment entitled you to receive (directly or indirectly) the right to buy tickets to athletic events of the college.

Restrictions on Deducting Gambling-Related Expenses

For 2018 through 2025, the TCJA limits deductions for a year’s out-of-pocket gambling-related expenses and gambling losses (combined) to that year’s gambling winnings.

Under prior law, a professional gambler could deduct out-of-pocket gambling-related expenses as a business expense. Only deductions for actual gambling losses were limited to gambling winnings.

Sweeping Changes

The TCJA is the biggest piece of tax reform legislation that’s been enacted since the landmark Tax Reform Act of 1986. It’s expected to have a major impact on individual taxpayers in 2018. Want to learn more? Consult with your tax advisor; it’s never too soon to plan for this year and beyond.

New Law Eliminates Miscellaneous Itemized Deductions

The new tax law eliminates most itemized deductions, starting in 2018. Under prior law, the following deductions were deductible if they exceeded 2% of your adjusted gross income. For 2018 through 2025, this change eliminates deductions for a wide variety of expenses, such as:

Tax-Related Expenses

  • Tax preparation expenses,
  • Tax advice fees, and
  • Other fees and expenses incurred in connection with the determination, collection, or refund of any tax.

Expenses Related to Taxable Investments

  • Investment advisory fees and expenses,
  • Clerical help and office rent for office used to manage investments,
  • Expenses for home office used to manage investments,
  • Depreciation of computer and electronics used to manage investments,
  • Fees to collect interest and dividends,
  • Your share of investment expenses passed through to you from partnership, limited liability company or S corporation,
  • Safe deposit box rental fee for box used to store investment items and documents, and
  • Other investment-related fees and expenses.

Expenses Related to Production of Taxable Income

  • Hobby expenses (limited to hobby income),
  • IRA trustee/custodian fees if separately billed to you and paid by you as the account owner,
  • Loss on liquidation of traditional IRAs or Roth IRAs,
  • Bad debt loss for uncollectible loan made to employer to preserve your job, and
  • Damages paid to former employer for breach of employment contract.

Unreimbursed Employee Business Expenses

  • Education expenses related to your work as an employee,
  • Travel expenses related to your work as an employee,
  • Passport fees for business trips,
  • Professional society dues,
  • Professional license fees,
  • Subscriptions to professional journals and trade publications,
  • Home office used regularly and exclusively in your work as an employee and for the convenience of your employer,
  • Depreciation of a computer that your employer requires you to use,
  • Tools and supplies used in your work as an employee,
  • Union dues and expenses,
  • Work clothes and uniforms if required for your work and not suitable for everyday use,
  • Legal fees related to your work as an employee, and
  • Job search expenses to seek new employment in your current profession or occupation.

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Posted on Jan 8, 2018

long-term contracts

Many commercial construction projects can extend beyond one year. Federal tax law provides special rules for accounting for these long-term contracts (Internal Revenue Code Section 460). The rules apply to all long-term contracts unless the contract is exempt due to several exceptions provided by the tax law.

Not a Long-term Contract

These contracts are not considered a long-term contract, and are therefore exempt from the accounting for long-term contract rules.

  • Contracts with architects, engineers or construction management
  • Contracts for industrial and commercial painting
  • Contracts completed before the end of the same tax year the contract commenced
  • Contracts with de minimis (minor) elements of eligible construction activities

Exempt for AMT Purposes

Any individual business owner who is subject to Alternative Minimum Tax (AMT) must use the percentage of completion accounting method on long-term contracts, unless the business structure is a small C Corp (eff. 2018) or engages exclusively in home construction contracts (80% or more of the estimated total costs are expected to be attributable to 1) buildings containing 4 or less dwelling units and 2) improvements to real property located at the building site and directly related to the dwelling unit)

Talk to your CPA to determine if you will be subject to the increased AMT threshold for single or married filing jointly tax status.

long-term contractsTo track expenses and income on non-exempt long-term contracts, contractors are typically required to use the “percentage of completion” accounting method for income tax reporting. The main disadvantage of this method is the inability to do much tax planning or tax deferment for things like accrued losses, uninstalled materials or retainage receivables, which can result in accelerated taxable income when compared with other accounting methods.

One of the exceptions to the tax law applies to companies with average gross receipts for the prior three years under $10 million. Under the new tax law effective for 2018, that threshold has been raised to $25 million. Now, long-term contracts of companies with average annual gross receipts under $25 million are considered exempt from the restrictive and complicated rules of Code Section 460.

For companies with average annual gross receipts above $25 million, compliance with the tax rules under Code Section 460 remains your only option.

If your CPA has not talked to you about the potential tax saving benefits of a different accounting method for your non-exempt long-term contracts — or explored if your company’s long-term contract status is now exempt — this year is a good time to ask about it. Because the accounting method chosen for each long-term contract must remain the same through the life of each contract, choosing the right accounting method is critical for any new long-term construction contract in 2018.

What is a long-term contract?

Before we explore various accounting methods, here is the simple definition of a long-term contract according to the tax code.

  • Long-term contracts are those that on the contract commencement date are reasonably expected to not be completed by the end of the tax year.

Ironically, under this definition, a contract that is expected to take a week to complete could be a long-term contract.  For example, if a contractor with a calendar year-end begins work on December 27 and expects to end on January 2 – the contract is a long-term contract.

Due to the complexity of accounting for long-term contracts tax rules — with their exceptions — as well as the variable nature of construction revenue, we often find that contractors are using a catch-all accounting method across all contracts. The key pitfalls of using the same accounting method for all long-term contracts over time may include:

  • paying tax earlier than necessary;
  • potential noncompliance with IRS rules as the company’s revenue grows;
  • and noncompliance discovered during an IRS tax audit, which could result in additional taxes and penalties.

Are you compliant?

Interestingly, contractors that may have used a noncompliant accounting method under the former $10 million threshold may now be compliant under the new $25 million threshold for 2018 contracts.

Let’s say that a contractor’s average annual gross receipts for three trailing tax years were $15 million. The company wasn’t using the percentage of completion accounting method per the tax law for 2016 and prior years. The contractor is non-compliant with its accounting for long-term contracts with respect to 2016 and earlier years.  If the IRS were to audit 2016 (and earlier) years, the non-compliance could result in significant tax, penalties, and interest.

Unfortunately for the contractor, the company is stuck with the non-compliant method in accounting for 2017 because changes from non-compliant methods in accounting must be filed prior to the end of the tax year.  The risk of being assessed significant tax, penalties, and interest remains.

However, this same company will not need to change the accounting method for new long-term contracts in 2018 because, due to the increased threshold in the new tax law, these new contracts are exempt from Section 460.

Alternatively, companies under the $10 million threshold that have used the percentage of completion accounting method for long-term contracts could do an evaluation by comparing the amount of income tax they would have paid in past years (considering both regular tax and AMT if the company is a partnership or S-corporation) had they used a different method of accounting. If there is significant tax savings, a change in accounting method should be considered. This will not qualify as an automatic change in accounting method. A user fee of $9,500 will apply and Form 3115 notifying the IRS of the desired change will need to be filed before the end of the 2018 tax year.  

As you can see, there are nuances to this area of the federal tax code. To prepare for the changes in 2018, each company should review accounting methods for long-term contracts with a CPA knowledgeable in this area of the federal tax code.

Continue Reading: What are Accounting Methods for Long-Term Contracts?

 

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 Jan 4, 2018

The following are the primary accounting methods for long-term contracts, explained briefly, for smaller and larger contractors.

Smaller Contractors

Ave. Gross Receipts < $10 million (or < $25 million starting in 2018)

Completed Contract Method

  • No revenue is reported or costs deducted until the contract is complete:
  • Generally considered complete when 95% of expected costs have been incurred
  • Aggressive billing and collections do not impact income
  • Biggest tax deferral opportunity

The disadvantages of this method occur when several contracts finish in the same year, causing a spike in income and a spike in the tax rate. Contractors also cannot deduct losses on a contract until the job is complete.

Note that home contracts are exempt from Section 460 and that the completed contract method is generally used by home builders.

Cash Method

  • Revenue reported when collected
  • Costs deducted when paid
  • Large deferral opportunities by managing billings and acceleration of payment of costs

The disadvantages of the cash accounting method with long-term contracts is that contractors must spend cash to claim deductions and delay receipts to defer income, which is counter to smart business planning. Aggressive billing may result in acceleration of income.  Also, a declining economy could mean large tax bills in down years due to the inevitable reversal of income deferrals.

Accrual Method

  • Revenue reported when billed
  • Costs deducted when incurred

The disadvantages to the accrual accounting method are that aggressive billing generally results in acceleration of revenue, accrued losses on contracts are not deductible until the job is complete and tax planning techniques may be counter to business planning.

Percentage of Completion Method

  • Ongoing recognition of revenue and income, computed by the stage of project completion when compared to total costs to complete the project
  • Based on estimated future costs

The disadvantages to the percentage of completion accounting method are that accrued losses on contracts are not deductible and income can be accelerated due to things like uninstalled materials charged to jobs, overbillings by subcontractors or underestimated total costs to complete a job. The accuracy of the method is dependent upon the accuracy of estimates. Inaccurate estimates could result in inaccurate reporting of tax.

A Note About Alternative Minimum Tax (AMT)

For C-corporations, AMT was repealed for 2018 forward.

The 2018 tax law increased the AMT exemptions for individuals, however AMT continues to apply.  Percentage of completion is required for AMT purposes.  Thus the difference in income between percentage of completion and the income under the taxpayer’s method of accounting for long-term contracts is an adjustment for AMT purposes. If the contractor is organized as a partnership, S-corporation, or sole proprietorship, the owners should evaluate the effect of AMT when selecting their accounting method.

Home builders, as an exception, are permitted to use the completed contract method for AMT.

Larger Contractors

Ave. Gross Receipts > $10 million (or > $25 million starting in 2018)

Larger contractors are required to use the Percentage of Completion method under Code Section 460.

To offset the potential for accelerated income, companies may elect a 10% method, which defers recognition of revenue or costs until a job is at least 10% complete. This method is also allowable under AMT. It may be useful in instances when a contract commences toward the end of a tax year.

Larger companies are also required to use a look-back approach once a job is complete. Income in prior years is recalculated using actual costs, which may result in a change in gross profit for the prior year. Tax is recalculated and compared to tax actually paid for the year. Interest is calculated on the resulting over or under payment.

Code Section 460 also requires companies to allocate certain overhead costs to contracts. This may provide a deferral opportunity if the contractor is diligent in estimating overhead costs that may be allocated to the contract in future years.

To select the most advantageous accounting method or to determine if your company should change its accounting method in 2018, controllers and CFOs may need the guidance of a CPA knowledgeable in accounting for long-term contract rules. It helps to get a second opinion to support the right accounting method for your contracts that is both tax law compliant and offers the best potential for tax planning or deferral.

Continue Reading: Plan Ahead in 2018 for Accounting for New Long-Term Contracts

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 Dec 27, 2017

Let’s say that your company established the completed contract method of accounting for long-term contracts that are exempt from Code Section 460 because its gross receipts fell under the $10 million threshold.

As the company grew, it continued to use this accounting method. It had two very good years in 2015 and 2016. In 2017 average annual gross receipts for 2014-2016 exceeded $10 million for the first time. For contracts that were open in 2016, the company will continue to report income from those contracts under the completed contract method. For contracts that were started in 2017, the company will be required to report under the percentage of completion method in accordance with Code Section 460 for every year until the contracts are complete.

However, for contracts started in 2018, because the gross receipts threshold was adjusted to $25 million, those contracts are exempt from complying with Code Section 460. The company will report those contracts under the completed contract method since it is the company’s established accounting method for exempt contracts.

Then again, if it was decided that it made sense to report 2018 contracts under a different accounting method other than completed contract, the company will need to file for a change in accounting method with the IRS.  The change is not classified as an automatic change; Form 3115 will need to be filed with the IRS prior to year-end.  A user fee (currently $9,500) will also need to be paid in order for the Form 3115 to be processed.

The bottom line is that companies with three-year trailing average gross receipts under the $25 million threshold in 2018 should do an analysis to determine if a change in accounting method makes sense. The analysis should include the following factors:

  • Whether an overall method of accounting of cash or accrual is the most advantageous;
  • The amount of taxable income deferred under the various accounting methods for long-term contracts;
  • The effect of AMT on the owners’ returns given the new AMT exemptions and elevated phase-outs;
  • The expected growth rate for the company and the length of time before it is expected to reach the $25 million threshold.

With thoughtful consideration and planning, the proper accounting method for long-term contracts can result in the deferral of a significant amount of income tax, which will help your company manage working capital more effectively.

Download the Whitepaper: 2017 Tax Law Impacts Accounting for Long-Term Contracts

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 Dec 20, 2017

On December 19, the House approved H.R. 1, the “Tax Cuts and Jobs Act,” the sweeping tax reform measure, by a vote of 227 to 203. Shortly thereafter, the Senate encountered some procedural complications and ultimately passed a revised version of the bill later that night by a margin of 51 to 48. The revised version of the bill carries the title “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.” This special report refers to the Act by its former and commonly used name: The “Tax Cuts and Job Act.” The revised bill was again approved by the House on Wednesday, December 20th, and is now on its way to President Trump’s desk for his expected signature.

The bill has taken shape at breakneck pace over the past two months, making it difficult for even seasoned tax practitioners to know exactly where things stand. The bill itself is massive and contains many tax law changes, some of which are extremely complex, and many of which go into effect in a matter of weeks.

This special report explains the changes that affect the taxation of individuals. In addition to providing a summary of the changes, it also clearly sets out the effective dates (which in many cases include an expiration date, or “sunset”), the Code section(s) affected, the bill’s section number, and a recitation of prior law to put the amendment into context.

This information will help practitioners prepare for the year ahead, which will likely include squeezing in last-minute tax planning moves in 2017 to take advantage of provisions still on the books that won’t be available next year. For example, a taxpayer who will itemize in 2017 but will likely be taking the larger standard deduction next year may benefit from making charitable contributions this year instead of next and from accelerating certain discretionary medical expenses into this year, for which a retroactively lower “floor” limiting medical expense deductions is in effect. In many cases, 2017 itemizing taxpayers should pay all of 2017 state and local taxes (“SALT”) this year (even if the due date for the last installment is in 2018) and consider making prepayments (e.g., of property taxes) in light of the significant reduction in the SALT deduction going into effect next year. Many taxpayers should also consider ways of deferring income to take advantage of the lower rates going into effect next year.

This report sets out all of these changes, as well as many others including dramatic changes to the tax treatment of alimony and a new rule that disallows the use of a re-characterization to unwind Roth IRA conversions.

Download the Special Study here.

To learn more about how the new tax laws will affect you, contact one of Cornwell Jackson’s tax specialists today.

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 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 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 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 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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