Anderson ZurMuehlen Blog

Be Sure Your Employee Travel Expense Reimbursements will pass muster with the IRS

Does your business reimburse employees’ work-related travel expenses? If you do, you know that it can help you attract and retain employees. If you don’t, you might want to start, because changes under the Tax Cuts and Jobs Act (TCJA) make such reimbursements even more attractive to employees. Travel reimbursements also come with tax benefits, but only if you follow a method that passes muster with the IRS. 

The TCJA’s impact

Before the TCJA, unreimbursed work-related travel expenses generally were deductible on an employee’s individual tax return (subject to a 50% limit for meals and entertainment) as a miscellaneous itemized deduction. However, many employees weren’t able to benefit from the deduction because either they didn’t itemize deductions or they didn’t have enough miscellaneous itemized expenses to exceed the 2% of adjusted gross income (AGI) floor that applied. 

For 2018 through 2025, the TCJA suspends miscellaneous itemized deductions subject to the 2% of AGI floor. That means even employees who itemize deductions and have enough expenses that they would exceed the floor won’t be able to enjoy a tax deduction for business travel. Therefore, business travel expense reimbursements are now more important to employees. 

The potential tax benefits

Your business can deduct qualifying reimbursements, and they’re excluded from the employee’s taxable income. The deduction is subject to a 50% limit for meals. But, under the TCJA, entertainment expenses are no longer deductible.

To be deductible and excludable, travel expenses must be legitimate business expenses and the reimbursements must comply with IRS rules. You can use either an accountable plan or the per diem method to ensure compliance.

Reimbursing actual expenses

An accountable plan is a formal arrangement to advance, reimburse or provide allowances for business expenses. To qualify as “accountable,” your plan must meet the following criteria:

  • Payments must be for “ordinary and necessary” business expenses.
  • Employees must substantiate these expenses — including amounts, times and places — ideally at least monthly.
  • Employees must return any advances or allowances they can’t substantiate within a reasonable time, typically 120 days.

The IRS will treat plans that fail to meet these conditions as nonaccountable, transforming all reimbursements into wages taxable to the employee, subject to income taxes (employee) and employment taxes (employer and employee). 

Keeping it simple

With the per diem method, instead of tracking actual expenses, you use IRS tables to determine reimbursements for lodging, meals and incidental expenses, or just for meals and incidental expenses, based on location. (If you don’t go with the per diem method for lodging, you’ll need receipts to substantiate those expenses.) 

Be sure you don’t pay employees more than the appropriate per diem amount. The IRS imposes heavy penalties on businesses that routinely overpay per diems. 

What’s right for your business?

To learn more about business travel expense deductions and reimbursements post-TCJA, contact us. We can help you determine whether you should reimburse such expenses and which reimbursement option is better for you.

©2018

2018 Q4 Tax Calendar: Key Deadlines for Businesses and Other Employers

Here are some of the key tax-related deadlines affecting businesses and other employers during the fourth quarter of 2018. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

October 15

  • If a calendar-year C corporation that filed an automatic six-month extension:
    • File a 2017 income tax return (Form 1120) and pay any tax, interest and penalties due.
    • Make contributions for 2017 to certain employer-sponsored retirement plans.

October 31

  • Report income tax withholding and FICA taxes for third quarter 2018 (Form 941) and pay any tax due. (See exception below under “November 13.”)

November 13

  • Report income tax withholding and FICA taxes for third quarter 2018 (Form 941), if you deposited on time and in full all of the associated taxes due.

December 17

  • If a calendar-year C corporation, pay the fourth installment of 2018 estimated income taxes.

Questions?  Need assistance?  Let’s talk.

© 2018

Do You Need to Make an Estimated Tax Payment by September 17?

To avoid interest and penalties, you must make sufficient federal income tax payments long before your April filing deadline through withholding, estimated tax payments, or a combination of the two. The third 2018 estimated tax payment deadline for individuals is September 17.

If you don’t have an employer withholding tax from your pay, you likely need to make estimated tax payments. But even if you do have withholding, you might need to pay estimated tax. It can be necessary if you have more than a nominal amount of income from sources such as self-employment, interest, dividends, alimony, rent, prizes, awards or the sales of assets.

A two-prong test

Generally, you must pay estimated tax for 2018 if both of these statements apply:

1. You expect to owe at least $1,000 in tax after subtracting tax withholding and credits, and

2. You expect withholding and credits to be less than the smaller of 90% of your tax for 2018 or 100% of the tax on your 2017 return — 110% if your 2017 adjusted gross income was more than $150,000 ($75,000 for married couples filing separately).

If you’re a sole proprietor, partner or S corporation shareholder, you generally have to make estimated tax payments if you expect to owe $1,000 or more in tax when you file your return.

Quarterly payments

Estimated tax payments are spaced through the year into four periods or due dates. Generally, the due dates are April 15, June 15 and September 15 of the tax year and January 15 of the next year, unless the date falls on a weekend or holiday (hence the September 17 deadline this year).

Estimated tax is calculated by factoring in expected gross income, taxable income, deductions and credits for the year. The easiest way to pay estimated tax is electronically through the Electronic Federal Tax Payment System. You can also pay estimated tax by check or money order using the Estimated Tax Payment Voucher or by credit or debit card.

Confirming withholding

If you determine you don’t need to make estimated tax payments for 2018, it’s a good idea to confirm that the appropriate amount is being withheld from your paycheck. To reflect changes under the Tax Cuts and Jobs Act (TCJA), the IRS updated the tables that indicate how much employers should withhold from their employees’ pay, generally reducing the amount withheld.

The new tables might cause some taxpayers to not have enough withheld to pay their ultimate tax liabilities under the TCJA. The IRS has updated its withholding calculator (available at irs.gov) to assist taxpayers in reviewing their situations.

Avoiding penalties

Keep in mind that, if you underpaid estimated taxes in earlier quarters, you generally can’t avoid penalties by making larger estimated payments in later quarters. But if you also have withholding, you may be able to avoid penalties by having the estimated tax shortfall withheld.

To learn more about estimated tax and withholding — and for help determining how much tax you should be paying during the year —  contact us.

© 2018

 

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IRS Regs Detail How Businesses Can “Aggregate” For the Pass-Through Income Deduction

The Tax Cuts and Jobs Act (TCJA) contains a provision that ties revenue recognition for book purposes to income reporting for tax purposes, for tax years starting in 2018. This narrow section of the law could have a major impact on certain industries, especially as companies implement the updated revenue recognition standard under U.S. Generally Accepted Accounting Principles (GAAP).

Recognizing revenue under GAAP

Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, went into effect for public companies this year; it will go into effect for private companies next year. The updated standard requires businesses to all use a single model for calculating the top line in their income statements under GAAP, as opposed to following various industry-specific models.

The standard doesn’t change the underlying economics of a business’s revenue streams. But it may change the timing of when companies record revenue in their financial statements. The standard introduces the concept of “performance obligations” in contracts with customers and allows revenue to be recorded only when these obligations are satisfied. It could mean revenue is recorded right away or in increments over time, depending on the transaction.

The changes will be most apparent for complex, long-term contracts. For example, most software companies expect to record revenues in their financial statements earlier under ASU 2014-09 than under the old accounting rules.

Matching book and tax records

Starting in 2018, the TCJA modifies Section 451 of the Internal Revenue Code so that a business recognizes revenue for tax purposes no later than when it’s recognized for financial reporting purposes. Under Sec. 451(b), taxpayers that use the accrual method of accounting will meet the “all events test” no later than the taxable year in which the item is taken into account as revenue in a taxpayer’s “applicable financial statement.”

The TCJA also added Sec. 451(c), referred to as the “rule for advance payments.” At a high level, the rule can require businesses to recognize taxable income even earlier than when it’s recognized for book purposes if the company receives a so-called “advance payment.”

Some companies delivering complex products, such as an aerospace parts supplier making a custom component, can receive payments from customers years before they build and deliver the product. Under ASU 2014-09, a business can’t recognize revenue until it’s completed its performance obligations in the contract, even if an amount has been paid in advance. However, under Sec. 451(c), companies may be taxed before they recognize revenue on their financial statements from contracts that call for advance payments.

Will the changes affect your business?

Changes in the TCJA, combined with the new revenue recognition rules under GAAP, will cause some companies to recognize taxable income sooner than in the past. In some industries, this could mean significantly accelerated tax bills. However, others won’t experience any noticeable differences. We can help you evaluate how the accounting rule and tax law changes will affect your company, based on its unique circumstances.

© 2018

 

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IRS Regs Detail How Businesses Can “Aggregate” For the Pass-Through Income Deduction

One of the most valuable tax breaks in the Tax Cuts and Jobs Act (TCJA) is the new deduction for up to 20% of qualified business income (QBI) from pass-through entities. The IRS recently issued proposed regulations that help clarify who can benefit from the deduction. One of the issues the regs clarify is how taxpayers can elect to aggregate, or combine, their trades or businesses for purposes of the QBI deduction (also called the pass-through or Section 199A deduction).

Aggregating businesses for QBI deduction purposes

QBI is the net amount of qualified items of income, gain, deduction and loss with respect to any pass-through entity. If a taxpayer owns interests in several qualifying businesses, he or she can potentially choose to aggregate them and treat them as a single business for purposes of:

  • Calculating QBI, and
  • Calculating the QBI deduction limitations.

The QBI deduction limitations begin to phase in when a taxpayer’s taxable income exceeds the threshold of $157,500 ($315,000 for married joint filers). This is calculated before any QBI deduction.

When the limitations are fully phased in, the QBI deduction is limited to the greater of: 1) the taxpayer’s share of 50% of W-2 wages paid to employees and properly allocable to QBI during the tax year or 2) the sum of the taxpayer’s share of 25% of W-2 wages plus the taxpayer’s share of 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property.

The UBIA of qualified property generally equals the original cost of the property. “Qualified property” means depreciable tangible property (including real estate) that: 1) is owned by a qualified business as of the tax year end, 2) is used by that business at any point during the tax year for the production of QBI, and 3) hasn’t reached the end of its depreciable period as of the tax year end.

Aggregation basics

Aggregating businesses can allow a taxpayer with high taxable income to claim a higher QBI deduction when the limitations based on W-2 wages and the UBIA of qualified property would otherwise preclude a larger deduction.

A taxpayer can potentially aggregate qualified businesses that are operated directly, such as through a sole proprietorship or a single-member limited liability company (LLC). The taxpayer must calculate the QBI, W-2 wages and UBIA of qualified property for each business and then aggregate those amounts to calculate QBI for the aggregated businesses and apply the QBI deduction limitations for the aggregated businesses.

Similarly, a taxpayer can potentially aggregate businesses that are operated via pass-through entities, such as S corporations, partnerships or LLCs. All owners of pass-through entities need not aggregate in the same fashion.

5 aggregation requirements

Bear in mind that the aggregation privilege isn’t automatic. In general, a taxpayer can aggregate businesses only if the five aggregation requirements listed below are satisfied:

1. The same person or group of persons directly or indirectly owns 50% or more of each business to be aggregated. For businesses operated by an S corporation, that means owning 50% or more of the issued and outstanding shares. For businesses operated by partnerships (including LLCs treated as partnerships for tax purposes), that means owning 50% or more of the capital or profits interests. For purposes of applying the 50% ownership rule, a taxpayer is also considered to own the interest in each business that’s owned directly or indirectly by his or her spouse, children, grandchildren or parents.

2. The preceding 50% ownership picture exists for a majority of the tax year in which the items for each business to be aggregated are included in the taxpayer’s income.

3. All the tax items attributable to each business to be aggregated are reported on returns with the same tax year end.

4. None of the businesses to be aggregated is a specified service business. Income from a specified service business generally doesn’t count as QBI. The service business disallowance rule is phased in over the same taxable income ranges that apply to the limitations based on W-2 wages and the UBIA of qualified property.

5. The businesses to be aggregated must satisfy at least two of the following three requirements:

  • The businesses provide products and services that are the same or customarily offered together (for example, a gas station and a car wash).
  • The businesses share facilities or significant centralized business elements (such as personnel, accounting, legal, manufacturing, purchasing, human resources or information technology).
  • The businesses are operated in coordination with or in reliance on each other. (For example, they have supply chain interdependencies.)

Options for aggregating

A taxpayer can choose to aggregate some businesses for which aggregation is allowed while not aggregating others for which aggregation isn’t.

How a taxpayer groups or doesn’t group businesses for purposes of applying the passive activity loss (PAL) rules doesn’t affect how the taxpayer can aggregate or not aggregate businesses for purposes of applying the QBI deduction rules. In other words, PAL groupings or nongroupings are irrelevant for purposes of the QBI deduction rules.

Netting of negative and positive QBI amounts

If a taxpayer has at least one business that produces negative QBI (including aggregated businesses that are treated as a single business), he or she must offset the QBI from each business that has positive QBI (including aggregated businesses that are treated as a single business) with an amount of negative QBI in proportion to the relative amount of positive QBI of each business that has positive QBI. However, the W-2 wages and UBIA of qualified property from a business that produces negative QBI aren’t taken into account in calculating W-2 wages and the UBIA of qualified property when applying the QBI deduction limitations.

If a taxpayer has overall negative QBI for the tax year, the negative amount is treated as a loss from a qualified business in the following tax year. This carryover rule doesn’t affect the deductibility of losses under any other tax law provisions.

An aggregation example

The aggregation rules are confusing stuff, so here’s an example to help provide clarification.

Alexandra is a single, calendar-year small business owner with taxable income of $300,000 before any QBI deduction. She’s subject to the QBI deduction limitations based on W-2 wages and the UBIA of qualified property.

She owns and operates a catering business and a restaurant via separate single-member LLCs (SMLLCs) that are treated as sole proprietorships owned by her for tax purposes. The two operations share centralized purchasing and accounting, all done by Alexandra. She also maintains a website and does print advertising for both operations. The restaurant kitchen is used to prepare food for the catering business, but the catering business employs its own staff and owns equipment and trucks that aren’t used by the restaurant.

The catering business has QBI of $300,000, but no W-2 wages because all the work is done by independent contractors hired job-by-job. The restaurant business has QBI of only $50,000, but it has regular employees with $200,000 of W-2 wages.

If Alexandra keeps the two businesses separate for QBI deduction purposes, her deduction from the catering business is $0 (50% × W-2 wages of $0), and her deduction from the restaurant is $10,000 (20% × QBI of $50,000), for a total deduction of only $10,000.

But if Alexandra is allowed to aggregate the two businesses, her deduction is $70,000 — the lesser of $70,000 (20% × aggregated QBI of $350,000) or $100,000 (50% × aggregated W-2 wages of $200,000). If she can aggregate the businesses, her QBI deduction would be $60,000 higher. But is she allowed to aggregate them?

Because the restaurant and catering businesses are held in SMLLCs that are treated as sole proprietorships owned by Alexandra, she’s treated as directly owning and operating both businesses. Because common ownership of the businesses (100% by Alexandra) exists for the entire tax year, and because all the tax items attributable to both businesses are reported on Alexandra’s calendar-year return, aggregation requirements 1, 2 and 3 are satisfied.

Neither business is a specified service business, so aggregation requirement 4 is also satisfied. Because both businesses offer prepared food to customers and share the same kitchen facilities, and also because they both share centralized purchasing, accounting and marketing functions, aggregation requirement 5 is satisfied.

Therefore, Alexandra can aggregate the catering and restaurant businesses for purposes of calculating her QBI and for purposes of applying the QBI deduction limitations based on W-2 wages and the UBIA of qualified property. Thus, she can claim a QBI deduction of $70,000.

Variation: Let’s say Alexandra’s taxable income (before any QBI deduction) is $157,500 or less. In that case, she’s unaffected by QBI deduction limitations based on W-2 wages and the UBIA of qualified property. Thus, there’s no advantage to aggregating the catering and restaurant businesses. Her QBI deduction from the catering business would be $60,000 (20% × QBI of $300,000), and her QBI deduction from the restaurant business would be $10,000 (20% × QBI of $50,000) for a total deduction of $70,000.

Bottom line: As the example and its variation illustrate, aggregation is advantageous only when the taxpayer’s taxable income is high enough to be affected by the QBI deduction limitations based on W-2 wages and the UBIA of qualified property.

Aggregation consistency requirement  

After a taxpayer chooses to aggregate two or more businesses for QBI deduction purposes, he or she must continue to aggregate the businesses in all subsequent tax years. However, a taxpayer can add a newly created or newly acquired business to an existing aggregated group of businesses if the five aggregation requirements are met.

If there’s a change in facts and circumstances so that a taxpayer’s prior aggregation of businesses no longer qualifies for aggregation, the taxpayer must reapply the requirements to determine a new permissible aggregation (if any).

Required annual disclosure of aggregation

For each tax year, a taxpayer must attach a statement to his or her federal income tax return for that year identifying each business that’s been aggregated. The statement must include, among other things, the name and employer identification number of each entity. If a taxpayer fails to attach the required statement, the IRS can disaggregate the businesses.

Use the QBI deduction to your advantage

The aggregation rules for the QBI deduction are complex, but they may allow certain businesses to achieve more favorable tax results. We can help you get the most out of this provision and all other tax breaks in the TCJA.

© 2018

 

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Back-To-School Time Means a Tax Break for Teachers

When teachers are setting up their classrooms for the new school year, it’s common for them to pay for a portion of their classroom supplies out of pocket. A special tax break allows these educators to deduct some of their expenses. This educator expense deduction is especially important now due to some changes under the Tax Cuts and Jobs Act (TCJA).

The old miscellaneous itemized deduction

Before 2018, employee expenses were potentially deductible if they were unreimbursed by the employer and ordinary and necessary to the “business” of being an employee. A teacher’s out-of-pocket classroom expenses could qualify.

But these expenses had to be claimed as a miscellaneous itemized deduction and were subject to a 2% of adjusted gross income (AGI) floor. This meant employees, including teachers, could enjoy a tax benefit only if they itemized deductions (rather than taking the standard deduction) and all their deductions subject to the floor, combined, exceeded 2% of their AGI.

Now, for 2018 through 2025, the TCJA has suspended miscellaneous itemized deductions subject to the 2% of AGI floor. Fortunately, qualifying educators can still deduct some of their unreimbursed out-of-pocket classroom costs under the educator expense deduction.

The above-the-line educator expense deduction

Back in 2002, Congress created the above-the-line educator expense deduction because, for many teachers, the 2% of AGI threshold for the miscellaneous itemized deduction was difficult to meet. An above-the-line deduction is one that’s subtracted from your gross income to determine your AGI.

You don’t have to itemize to claim an above-the-line deduction. This is especially significant with the TCJA’s near doubling of the standard deduction, which means fewer taxpayers will benefit from itemizing.

Qualifying elementary and secondary school teachers and other eligible educators (such as counselors and principals) can deduct up to $250 of qualified expenses. If you’re married filing jointly and both you and your spouse are educators, you can deduct up to $500 of unreimbursed expenses — but not more than $250 each.

Qualified expenses include amounts paid or incurred during the tax year for books, supplies, computer equipment (including related software and services), other equipment and supplementary materials that you use in the classroom. For courses in health and physical education, the costs of supplies are qualified expenses only if related to athletics.

Many rules, many changes

Some additional rules apply to the educator expense deduction. Contact us for more details or to discuss other tax deductions that may be available to you this year. The TCJA has made significant changes to many deductions for individuals.

© 2018

 

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Business Tips for Back-To-School Time

Late summer and early fall, when so many families have members returning to educational facilities of all shapes and sizes, is also a good time for businesses to creatively step up their business development efforts, whether it’s launching new marketing initiatives, developing future employees or simply generating goodwill in the community. Here are a few examples that might inspire you.

Becoming a sponsor

A real estate agency sponsors a local middle school’s parent-teacher organization (PTO). The sponsorship includes ads in the school’s weekly e-newsletter and in welcome packets for new PTO members. Individual agents in the group also conduct monthly gift card drawings for parents and teachers who follow them on Facebook.

The agency hopes parents and teachers will remember its agents’ names and faces when they’re ready to buy or sell their homes.

Planting the seeds of STEM

An engineering firm donates old computers and printers to an elementary school that serves economically disadvantaged students. The equipment will be used in the school district’s K-12 program to get kids interested in careers in science, technology, engineering and math (STEM) disciplines.

At back-to-school time, a firm rep gives presentations at the schools and hands out literature. Then, in the spring, the company will mentor a select group of high school seniors who are planning to pursue engineering degrees in college.

Participating in STEM programs fosters corporate charity and goodwill. It can also pay back over the long run: When the firm’s HR department is looking for skilled talent, kids who benefited from the firm’s STEM efforts may return as loyal, full-time employees.

Launching an apprenticeship program

The back-to-school season motivates a high-tech manufacturer to partner with a vocational program at the local community college to offer registered apprenticeships through a state apprenticeship agency. In exchange for working for the manufacturer, students will receive college credits, on-the-job training and weekly paychecks. Their hourly wages will increase as they demonstrate proficiency.

The company hopes to hire at least some of these apprentices to fill full-time positions in the coming year or two.

Finding the right fit

Whether schools near you are already in session or will open soon, it’s not too late to think about how your business can benefit. Sit down with your management team and brainstorm ways to leverage relationships with local schools to boost revenues, give back to your community and add long-term value. We can provide other ideas and help you assess return on investment.

© 2018

 

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IRS Issues Proposed Regulations on the Pass-Through Business Income Deduction

The IRS recently released highly anticipated regulations addressing the deduction for up to 20% of qualified business income (QBI) from pass-through entities. The deduction was a major component of the Tax Cuts and Jobs Act, which became law late last year. It has also been referred to as the pass-through deduction, the QBI deduction or the Section 199A deduction.

Defining the deduction

For tax years beginning in 2018 and ending in 2025, the QBI deduction can be up to 20% of a pass-through entity owner’s QBI, subject to restrictions that can apply at higher income levels and another restriction based on the owner’s taxable income.

For QBI deduction purposes, pass-through entities are defined as sole proprietorships, single-member (one owner) LLCs that are treated as sole proprietorships for tax purposes, S corporations, partnerships, and LLCs that are treated as partnerships for tax purposes.

The QBI deduction is available only to individuals, estates and trusts. The newly proposed regulations refer to all three as “individuals.” For the purposes of this article, let’s follow that terminology to be consistent with the language used in the proposed regs.

This deduction is scheduled to sunset after 2025 unless Congress extends it. Even though the new QBI deduction regs are in proposed form, you can rely on them until final regs are issued.

Operational rules and definitions

The proposed regs supply operational rules for determining allowable QBI deductions, including how to apply the phaseout rules that can reduce or eliminate QBI deductions for individuals with taxable income (calculated before any QBI deduction) that exceeds the phaseout threshold of $157,500 ($315,000 for married joint filers). Phaseout is complete when an owner’s taxable income reaches $207,500 ($415,000 for married joint filers). At that point: 1) QBI deductions for a nonservice business must be based on the business’s W-2 wages or its W-2 wages plus the basis of qualified property used in the business, and 2) no QBI deduction can be claimed based on income from a specified service trade or business (SSTB), as defined below.

Definitions of new terms used to apply the QBI deduction rules are also included in the proposed regs, including the definition of QBI and of specified service trades or businesses (SSTBs).

In defining what constitutes an eligible business for QBI deduction purposes, the IRS decided to go with the Internal Revenue Code Section 162 definition of a trade or business, because that definition is derived from longstanding case law and IRS guidance dealing with a broad range of industries.

Deduction limitations and when businesses can be “aggregated”

When an individual owns interests in several qualifying non-SSTB businesses, the individual can potentially choose to aggregate and treat them as a single business for purposes of:

  • Calculating QBI and
  • Calculating the QBI deduction limitation based on 50% of W-2 wages paid by a business to generate QBI or the limitation based on 25% of such W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property used to generate QBI.

The limitation involving the UBIA of qualified property is for the benefit of capital-intensive businesses.

These QBI deduction limitations kick in when an individual’s (the pass-through business owner’s) taxable income (calculated before any QBI deduction) exceeds $157,500 ($315,000 for a married joint filer). When the limitations are fully phased in, the QBI deduction is limited to the greater of: 1) the individual’s share of 50% of W-2 wages paid to employees and properly allocable to QBI during the tax year or 2) the sum of the individual’s share of 25% of W-2 wages plus the individual’s share of 2.5% of the UBIA of qualified property.

In any case, the deduction can’t exceed 20% of QBI, and it can’t exceed 20% of the individual’s taxable income calculated before: 1) any QBI deduction and 2) any net capital gain amount (net long-term capital gains in excess of net short-term capital losses plus qualified dividends). The proposed regs explain how to calculate a business’s W-2 wages for purposes of applying the QBI deduction limitations.

A business’s UBIA of qualified property generally equals the original cost of the property. Qualified property is defined as depreciable tangible property (including real estate) that:

1. Is owned by a qualified business as of the tax year end,
2. Is used by the business at any point during the tax year for the production of QBI, and
3. Hasn’t reached the end of its depreciable period as of the tax year end.

Why aggregating businesses could pay off

Aggregating businesses can allow an individual with higher taxable income to claim a larger QBI deduction when the limitations based on W-2 wages and the UBIA of qualified property would otherwise reduce or eliminate the allowable deduction. For instance, if a high-income individual owns an interest in one business with high QBI but little or no W-2 wages and an interest in another business with minimal QBI but significant W-2 wages, aggregating the two could result in a healthy QBI deduction. Keeping them separate could result in a lower deduction or maybe no deduction at all. However, certain tests set forth in the proposed regs must be passed for businesses to be aggregated. Also, it’s important to remember that an SSTB cannot be aggregated with any other business, including another SSTB.

Specified service trades or businesses

The proposed regs define specified SSTBs. The status as an SSTB is important, because QBI deductions based on SSTB income begin to be phased out after an individual’s taxable income (calculated before any QBI deduction) exceeds $157,500 ($315,000 for a married joint filer).
The proposed regs also include an antiabuse rule intended to prevent service business owners from separating out parts of what otherwise would be an integrated SSTB, such as an optometrist practice’s sales of vision care items, in an attempt to qualify the separated part for the QBI deduction.

Defining SSTBs

In general, an SSTB is a trade or business that performs services in one or more of the following fields:

  • Health,
  • Law,
  • Accounting,
  • Actuarial science,
  • Consulting,
  • Financial, brokerage, investing or investment management,
  • Trading,
  • Performing arts, and
  • Athletics.

In addition, an SSTB can be any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.

You may ask: What’s a trade or business where the principal asset is the reputation or skill of an owner or employee? Good question. Before the proposed regs were released, there was concern that this SSTB definition could snare unsuspecting businesses, such as a restaurant with a well-regarded chef.

Thankfully, the proposed regs limit this definition to trades or businesses that meet one or more of the following descriptions:

  • One in which a person receives fees, compensation or other income for endorsing products or services,
  • One that licenses or receives fees, compensation or other income for the use of an individual’s image, likeness, name, signature, voice, trademark or any other symbol associated with that individual’s identity, or
  • One that receives fees, compensation or other income for appearing at an event or on radio, television or another media format.

Other QBI deduction issues

The proposed regs supply guidance on when QBI deductions can be claimed based on qualified income from publicly traded partnerships (PTPs) and qualified dividends from real estate investment trusts (REITs).

Finally, the proposed regs include special computational and reporting rules that pass-through entities, PTPs, trusts and estates may need to follow to provide their owners and beneficiaries with the information necessary to calculate allowable QBI deductions at the owner or beneficiary level.

Getting the best results

The proposed QBI deduction regs are lengthy and complex. This article only scratches the surface of the proposed rules. We can help you sort through the details to get the best QBI deduction results in your specific circumstances.

© 2018

 

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Home Equity Borrowers Get Good News From the IRS

Passage of the Tax Cuts and Jobs Act (TCJA) in December 2017 has led to confusion over some of the changes to longstanding deductions, including the deduction for interest on home equity loans. In response, the IRS has issued a statement clarifying that the interest on home equity loans, home equity lines of credit and second mortgages will, in many cases, remain deductible under the TCJA — regardless of how the loan is labeled.

Previous provisions

Under prior tax law, taxpayers could deduct “qualified residence interest” on a loan of up to $1 million secured by a qualified residence, plus interest on a home equity loan (other than debt used to acquire a home) up to $100,000. The home equity debt couldn’t exceed the fair market value (FMV) of the home reduced by the debt used to acquire the home.

For tax purposes, a qualified residence is the taxpayer’s principal residence and a second residence, which can be a house, condominium, cooperative, mobile home, house trailer or boat. The principal residence is where the taxpayer resides most of the time; the second residence is any other residence the taxpayer owns and treats as a second home. Taxpayers aren’t required to use the second home during the year to claim the deduction. If the second home is rented to others, though, the taxpayer also must use it as a home during the year for the greater of 14 days or 10% of the number of days it’s rented.

In the past, interest on qualifying home equity debt was deductible regardless of how the loan proceeds were used. A taxpayer could, for example, use the proceeds to pay for medical bills, tuition, vacations, vehicles and other personal expenses and still claim the itemized interest deduction.

The TCJA rules

The TCJA limits the amount of the mortgage interest deduction for taxpayers who itemize through 2025. Beginning in 2018, a taxpayer can deduct interest only on mortgage debt of $750,000. The congressional conference report on the law stated that it also suspends the deduction for interest on home equity debt. And the actual bill includes the section caption “DISALLOWANCE OF HOME EQUITY INDEBTEDNESS INTEREST.” As a result, many people believed the TCJA eliminates the home equity loan interest deduction.

On February 21, the IRS issued a release (IR 2018-32) explaining that the law suspends the deduction only for interest on home equity loans and lines of credit that aren’t used to buy, build or substantially improve the taxpayer’s home that secures the loan. In other words, the interest isn’t deductible if the loan proceeds are used for certain personal expenses, but it is if the proceeds go toward, for example, a new roof on the home that secures the loan. The IRS further stated that the deduction limits apply to the combined amount of mortgage and home equity acquisition loans — home equity debt is no longer capped at $100,000 for purposes of the deduction.

Some examples from the IRS help show how the TCJA rules work:

Example 1: A taxpayer took out a $500,000 mortgage to buy a principal residence with an FMV of $800,000 in January 2018. The loan is secured by the residence. In February, he takes out a $250,000 home equity loan to pay for an addition to the home. Both loans are secured by the principal residence, and the total doesn’t exceed the value of the home.

The taxpayer can deduct all of the interest on both loans because the total loan amount doesn’t exceed $750,000. If he used the home equity loan proceeds to pay off student loans and credit card bills, though, the interest on that loan wouldn’t be deductible.

Example 2: The taxpayer from the previous example takes out the same mortgage in January. In February, he also takes out a $250,000 loan to buy a vacation home, securing the loan with that home. Because the total amount of both mortgages doesn’t exceed $750,000, he can deduct all of the interest paid on both mortgages. But, if he took out a $250,000 home equity loan on the principal home to buy the second home, the interest on the home equity loan wouldn’t be deductible.

Example 3: In January 2018, a taxpayer took out a $500,000 mortgage to buy a principal home, secured by the home. In February, she takes out a $500,000 loan to buy a vacation home, securing the loan with that home. Because the total amount of both mortgages exceeds $750,000, she can deduct only a percentage of the total interest she pays on them.

Stay tuned

The new IRS announcement highlights the fact that the nuances of the TCJA will take some time to shake out completely. We’ll keep you updated on the most significant new rules and guidance as they emerge.

© 2018

 

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IRS Issues Guidance On New Bonus Depreciation Rules

The Tax Cuts and Jobs Act (TCJA) significantly expands bonus depreciation under Section 168(k) of the Internal Revenue Code for both regular tax and alternative minimum tax (AMT) purposes. Now, the IRS has released proposed regulations that clarify the requirements that businesses must satisfy to claim bonus depreciation deductions. Although the regs are only proposed at this point, the IRS will allow taxpayers to rely on them for property placed in service after September 27, 2017, for tax years ending on or after September 28, 2017.

Previous law

Under pre-TCJA law, businesses could claim a first-year bonus depreciation deduction equal to 50% of the basis of qualifying new (not used) assets placed in service in 2017. The deduction was available for the cost of qualifying new assets, including computers, purchased software, vehicles, machinery, equipment and office furniture. Used assets didn’t qualify for the deduction.

You also could claim 50% bonus depreciation for qualified improvement property (QIP), generally defined as any qualified improvement to the interior portion of a nonresidential building if placed in service after the building was placed in service. QIP costs didn’t include costs for the enlargement of a building, an elevator, an escalator, or a building’s internal structural framework.

TCJA changes

The TCJA allows 100% first-year bonus depreciation in Year 1 for qualifying assets placed in service between September 28, 2017, and December 31, 2022. The bonus depreciation percentage will begin to phase out in 2023, dropping 20% each year for four years until it expires at the end of 2026, absent congressional action to extend the break. (The phaseout reductions are delayed a year for certain property with longer production periods and aircraft.)

To qualify for 100% bonus depreciation, property generally must:

  • Fall within the definition of “qualified property,”
  • Be placed in service between September 28, 2017, and December 31, 2022, and
  • Be acquired by the taxpayer after September 27, 2017.

The proposed regs provide additional guidance on several of these elements.

Qualified property

Under the proposed regs, “qualified property” for bonus depreciation purposes is defined to include:

  • Property depreciated under the Modified Accelerated Cost Recovery System (MACRS) that has a recovery period of 20 years or less (generally, tangible personal property),
  • Certain computer software,
  • Water utility property,
  • Qualified film or television productions,
  • Qualified live theatrical productions, and
  • Specified plants.

For 50% first-year bonus depreciation, it also includes QIP acquired after September 27, 2017, and placed in service before January 1, 2018.

Congress intended for QIP placed in service after 2017 to have a 15-year MACRS recovery period, which would make it eligible for bonus depreciation. However, due to a drafting error, the 15-year recovery period for QIP isn’t reflected in the statutory language of the TCJA. Absent a technical correction to fix this glitch, QIP placed in service after 2017 has a 39-year MACRS recovery period and, therefore, is ineligible for bonus depreciation.

Qualified property also doesn’t encompass property that must be depreciated under the Alternative Depreciation System (ADS). That includes MACRS nonresidential real property, residential rental property and QIP held by real estate businesses that elect out of the TCJA’s limit on the business interest deduction. It also includes property with a recovery period of 10 years or more held by a farming business that elects out of the business interest limit.

The proposed regs detail how taxpayers can elect out of bonus depreciation. They also provide rules for electing 50% bonus depreciation, instead of 100% bonus depreciation, for property acquired after September 27, 2017, and placed into service during the taxable year that includes September 28, 2017.

Acquired used property

The proposed regs provide that the acquisition of used property is eligible for bonus depreciation if the property wasn’t used by the taxpayer or a predecessor at any time prior to acquisition of the property. Property is treated as used by the taxpayer or a predecessor before acquisition only if the taxpayer or a predecessor had a depreciable interest in the property at any time before the acquisition, regardless of whether the taxpayer or predecessor actually claimed depreciation.

Businesses that lease property, therefore, can acquire that property at the end of the lease and qualify for bonus depreciation. If a business has a depreciable interest in improvements made to lease property and subsequently acquires the property, the unadjusted depreciable basis of the property that’s eligible for the additional first-year depreciation excludes the unadjusted depreciable basis attributable to the improvements.

If a business initially acquires a depreciable interest in a part of a property and later acquires an additional depreciable interest in it, the additional interest isn’t treated as being previously used by the business. If, however, the business holds a depreciable interest in a portion of a property, sells that portion or part of it, and then acquires a depreciable interest in another part of the same property, it’s treated as previously having a depreciable interest in the property, up to the amount of the part for which the business held a depreciable interest in the property presale.

Used property also must satisfy certain related party and carryover basis requirements, as well as certain cost requirements. The proposed regs include antiabuse provisions for members of a consolidated group, certain acquisitions in accordance with a series of related transactions, and syndication transactions. And they explain how the new bonus depreciation rules apply to a variety of transactions involving partnerships holding assets that are otherwise eligible for bonus depreciation (for example, used machinery or vehicles).

Date of acquisition

The TCJA states that property won’t be treated as acquired after the date on which a “written binding contract” is entered into for the acquisition. The proposed regs clarify that the closing date, delivery date or other such date is irrelevant when determining the date of acquisition — only the date the contract is entered into matters for this purpose.

Under the proposed regs, a written contract is binding if it’s enforceable under state law against a taxpayer (or a predecessor) and doesn’t limit damages to a specified amount. A contractual provision that limits damages to at least 5% of the total contract price won’t be treated as limiting damages to a specified amount.

A letter of intent for an acquisition isn’t a binding contact, according to the proposed regs. Further, supply agreements aren’t treated as written binding contracts until a taxpayer provides the amount and design specifications of the property.

The proposed regs eliminate the safe harbor for property produced under a contract. Such property is no longer treated as self-constructed property, so the date that the contract is entered into generally is the date of acquisition.

Actual self-constructed property isn’t subject to the written binding contract requirement. The acquisition rules for self-constructed property are met if the taxpayer begins manufacturing, constructing or producing the property after September 27, 2017.

The rules regarding the eligibility of acquired used property could have a significant impact on mergers, acquisitions and divestitures. For example, buyers might prefer to structure a transaction as an asset purchase rather than a stock acquisition to take advantage of bonus depreciation. Businesses also should review transactions that have closed but are subject to the new rules to ensure they achieve the optimal tax treatment.

Amount of the deduction

According to the proposed regs, the amount of the first-year depreciation deduction equals the applicable percentage of the property’s unadjusted depreciable basis. The unadjusted depreciable basis generally is limited to the property’s basis attributable to manufacture, construction or production of the property before January 1, 2027.

Plan carefully

Businesses that wish to take advantage of the new rules for fiscal tax years beginning in 2017 but ending in 2018 may have several bonus depreciation options, and amended returns may be advisable in some cases. We can help you make the most of the new rules for fiscal tax years beginning in 2017 and going forward.

© 2018

 

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