Is Bunching Right for You?

 Note: The is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

The Act increased the standard deduction and placed new limitations on itemized deductions. Beginning with 2018 tax returns, the standard deductions will be:

  • $12,000 for single individuals and married people filing separately,
  • $18,000 for heads of household, and
  • $24,000 for married taxpayers filing jointly.

If your deductions exceed the standard deduction amount for your filing status, you are allowed to itemize the following deductions:

  • Medical expenses, to the extent they exceed 7.5% of your adjusted gross income (AGI);
  • Taxes paid during the year (for state or local income or sales tax and for real property or personal property taxes), limited to $10,000;
  • Home mortgage interest;
  • Investment interest;
  • Charitable contributions;
  • Gambling losses, to the extent of your gambling winnings; and
  • Certain infrequently encountered tier-1 miscellaneous deductions.

Are your itemized deductions typically roughly equal to the new standard deduction amount? If so, think about using a tax strategy known as bunching. In this technique, you take the standard deduction in one year and then itemize in the next. This is accomplished by planning the payment of your deductible expenses so as to maximize them in the years when you itemize deductions. Commonly bunched deductible expenses include medical expenses, taxes, and charitable contributions.

To clearly illustrate how bunching works, here are a few examples of deductible payments that generally provide enough flexibility:

  • Medical Expenses – Say that you contract with a dentist for your child’s braces. This dentist offers you the option of an up-front lump-sum payment or a payment plan. If you make the lump-sum payment, the entire cost will be credited in the year you paid it, thereby dramatically increasing your medical expenses for that year. If you do not have the cash available for the up-front payment, then you can pay by credit card, which is treated as a lump-sum payment for tax purposes. If you do so, you must realize that the interest on that payment is not deductible; you need to determine whether incurring the interest is worth the increased tax deduction. Another important issue related to medical deductions is that only the amount of medical expenses that exceeds 7.5% of your AGI is actually deductible. In addition, this 7.5% floor will increase to 10% after 2018. There is thus no tax benefit to bunching medical deductions if the total will be less than 7.5% of your AGI (or 10% beginning in 2019).
    If you have abnormally high income in the current year, you may wish to put off medical expense payments until the following year (e.g., if 10% of the following year’s income will be less than 7.5% of this year’s income).
  • Taxes – Property taxes are generally billed annually at midyear; most locales allow for these tax bills to be paid in semiannual or quarterly installments. Thus, you have the option of paying them all at once or paying them in installments. This provides the opportunity to bunch the tax payments by paying only one semiannual installment (or 2 quarterly installments) in one year and pushing off the other semiannual (or 2 quarterly) installments until the next year. Doing so allows you to deduct 1½ years of taxes in one year and half a year of taxes in the other. However, if you are thinking of making late property tax payments as a means of bunching, you should be cautious. Late payment penalties are likely to wipe out any potential tax savings.
    If you reside in a state that has a state income tax, any such tax that is paid or withheld during the year is deductible on federal taxes. For instance, if you are making quarterly estimated state tax payments, the fourth quarter estimated payment is generally due in January of the subsequent year. This gives you the opportunity to either make that payment before December 31 (thus enabling you to deduct the payment on the current year’s return) or pay it in January before the due date (thus enabling you to use it as a deduction in the subsequent year).
    Here is a word of caution about itemized tax deductions: Under the Act, a maximum of $10,000 is allowed under itemized tax deductions, so there is no benefit gained by prepaying taxes when your tax total is already $10,000 or more. In addition, taxes are not deductible at all under the alternative minimum tax, so individuals under that tax generally derive no benefits from itemized deductions.
  • Charitable Contributions – Charitable contributions are a nice fit for bunching because they are entirely at the taxpayer’s discretion. For example, if you normally tithe to your church, you can make your normal contributions during the year but then prepay the entire subsequent year’s tithe in a lump sum in December of the current year. If you do this for all contributions that you generally make to qualified organizations, you can double up on your contributions in one year and have no charitable deductions in the next year. Normally, charities are very active in their solicitations during the holiday season, which gives you the opportunity to make forward-looking contributions at the end of the current year or to simply wait a short time and make them after the end of the year. Charitable deductions do have a limit, but for most types of contributions, it is high: 60% of AGI, beginning in 2018.

If you have questions about bunching your deductions, or if you wish to do some in-depth strategizing about how this technique could benefit you, please call for an appointment.

Tax Reform Limits Sec 1031 Exchanges to Defer Taxes

Note: This is one of a series of articles explaining how the various tax changes made by the GOP’s Tax Cuts & Jobs Act (referred to as the “Act” in the article), passed late in December 2017, might affect you and your family in 2018 and future years, and offering strategies you might employ to reduce your tax liability under the new tax laws.

Whenever you sell business or investment property and have a gain, you generally have to pay tax on the gain at the time of sale. In the past, the tax code provided an exception and allowed you to postpone paying tax on the gain if you reinvested the proceeds into similar property as part of a qualifying like-kind exchange. These types of exchanges are commonly called Sec. 1031 exchanges (referring to the tax code section that allows them). These rules have applied to real estate, cars, farm animals and other business and investment items that are like-kind property.

However, under the Act, and beginning in 2018, Sec. 1031 exchanges will only be allowed for exchanges of real property that is not held primarily for sale. It is important to note that real property located in the U.S. and real property located outside of the U.S. are not like-kind property for the purposes of these rules. Thus, exchanges of personal property and intangible property will no longer qualify for tax-deferred treatment.

Transition Rule – The provision generally applies to exchanges completed after December 31, 2017. However, an exception is provided for any exchange if the taxpayer disposes of the property disposed in the exchange on or before December 31, 2017, or if the taxpayer receives the property in the exchange on or before this date.

An example of this law change’s impact is when a business property such as a vehicle or machinery is traded in for a replacement. In the past, it was a tax strategy to sell the old property if its disposition resulted in a deductible tax loss and trade it in toward the new property if the disposition would result in a gain, thereby deferring the gain into the future. The Act has taken away that option, and now even trade-ins will result in a taxable transaction, whether it is a gain or loss.

Another example is investors in virtual currency who trade one type of virtual currency for another. They will be required to report their trades as capital gains/losses and won’t be able to use the 1031 tax-deferral rules.

If you have questions about how this change will impact your business or investment transactions, please give us a call.

Living Abroad? Here Is How Tax Reform May Affect You

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which was passed in late December 2017, could affect you and your family, in both 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

If you are an expatriate living abroad, you may be wondering how the provisions of the Tax Cuts and Jobs Act (TCJA) will impact you. This is the most extensive tax change in over 30 years, and although it was touted as tax simplification when it was in the planning stages, nothing was simplified related to U.S. citizens and resident aliens working abroad. The following is an overview of how things will play out for you beginning in 2018.

The Foreign Earned Income Exclusion Is Still Alive and Well – The inflation-adjusted maximum exclusion for 2018 is $104,100 (up from $102,100 in 2017). However, the Act did change the measure of inflation so that the inflation adjustments in future years will be lower. The housing exclusion was also retained, and for 2018, the maximum is $14,574 (up from $14,294 in 2017). For certain high-cost areas, the IRS allows higher housing exclusions.

Foreign Information Reporting Remains the Same – The troublesome burden of reporting foreign financial relationships continues unchanged. So if the aggregate value of the foreign financial accounts that you have a financial interest in or signature authority over exceeds $10,000 any time during the year, you are generally required to file Form 114 (commonly referred to as FBAR) with FinCEN. If you have specified foreign financial assets generally having a year-end value of $200,000, or $300,000 at any time during the year (double those amounts for married taxpayers), you are required to file Form 8938 with your tax return. Other reporting requirements include Form 5471 to report ownership or voting power in a foreign corporation, Form 3520 for ownership or transactions with foreign trusts and for reporting foreign gifts or bequests and Form 3520-A when a foreign trust has a U.S. owner.

Ownership in a Foreign Corporation – The Act transforms the U.S. into a territorial system of taxation for corporations instead of a worldwide system. As a result, all U.S. taxpayers who own at least 10% of a foreign corporation must include in their income pro rata shares of all accumulated post-1986 deferred foreign income that has not previously been taxed. After all of the adjustments, this deferred foreign income is generally taxed at an effective rate of 15.5%. The TCJA allows, by election, for this tax to be spread over a period of 8 years.

Foreign Tax Credit – The foreign tax credit remains unchanged, although the TCJA does not allow it to offset the tax on accumulated post-1986 deferred income, as previously discussed.

Other 1040 Changes – It seems that the Act’s only attempts at simplification were eliminating personal exemptions (which were $4,050 each for taxpayer, spouse and dependent in 2017); limiting itemized deductions (or suspending some deductions through 2025); and increasing the standard deduction to $12,000 for single taxpayers, $18,000 for head-of-household filers and $24,000 for those filing married joint. The Act also suspended the deduction for foreign property tax as itemized deduction.

The new tax law increased the child tax credit to $2,000, and up to $1,400 is refundable. However, if you exclude foreign earned income or the foreign housing allowance, you are prohibited from claiming the refundable part of the child tax credit. You must include the Social Security number of each qualifying child on your return for whom you claim the credit, and the Social Security number must be issued before the due date of your return. The Act added a new $500 nonrefundable credit for qualifying dependents other than qualifying children. The AGI threshold at which the child tax credit begins to phase out was substantially raised: to $400,000 for those filing a married joint return and $200,000 for others.

Moving Deduction – If you are planning a move in the future, the Act did deal you a bad hand. The deduction for moving expenses is suspended until after 2025, and to make matters worse, any moving reimbursement provided by your employer is taxable.

There have been, of course, many other changes brought about by the Act. If you have questions related to taxes and living abroad, please give us a call.

Tax Reform Puts a Cap on Deducting Business Losses

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

Under the Act, deductible business losses of noncorporate taxpayers will be limited beginning in 2018. Many have misconstrued this new law to mean that no losses are allowed.

Fortunately, that is not the case. The Act does not allow “excess business losses” to be deducted. An “excess business loss” is the excess of the taxpayer’s aggregate trade or business deductions for the tax year (determined without regard to whether the deductions are disallowed for that tax year) over the sum of the taxpayer’s aggregate gross income or gain for the tax year from those trades or businesses, plus $250,000 (200% of that amount for a joint return (i.e., $500,000)). This amount will be adjusted for inflation after 2018.

More simply put, deductible losses for the year are generally limited to $250,000 ($500,000 for married couples filing jointly).

Example: A single taxpayer, in 2018, has two businesses. The combined deductions from the two businesses total $500,000. The taxpayer’s gross income from those two businesses is $200,000. After netting the income and deductions, there is a net loss of $300,000 ($200,000 – $500,000). Prior to the Act, the deductible loss would have been $300,000. However, under the Act the excess business loss is equal to $50,000 ($500,000 – ($200,000 + $250,000)). And since excess business losses are not deductible, the taxpayer can only deduct $250,000 ($300,000 – $50,000) in 2018.
On the bright side, the nondeductible excess business loss ($50,000 in our example) is treated as a net operating loss (NOL) carried forward to the next year’s return, where it is deductible from the taxpayer’s gross income, including nonbusiness income. Under the Act, an NOL is carried forward indefinitely until it is used up. The Act did, however, limit NOLs in the future to offsetting only 80% of a taxpayer’s income for any year.

If you have questions related to “excess business loss,” please give us a call.

Business Owners Beware – New Tax Law Severely Limits Entertainment Deductions

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

If you are a business owner who is accustomed to treating clients to sporting events, golf getaways, concerts and the like, we have some bad news for you. The GOP’s tax-reform bill that President Trump signed on December 22nd of last year eliminated the business-related deduction for entertainment, amusement or recreation expenses, effective beginning in 2018.

This doesn’t mean you can’t still entertain your clients; it just means you can no longer deduct 50% of the cost of that entertainment as a business expense, making it more costly for you to entertain clients.

But all is not lost! The Act does retain a deduction for business meals that are directly related to or associated with the active conduct of your business. The term “directly related” means that actual business discussions were conducted during the meal and you anticipated a specific business benefit from the meal. The term “associated with” is more liberal and includes meals either preceding or following a bona fide business discussion. In either case, the business deduction continues to be 50% of the actual expense. Also remember that business meals must be documented, including the amount, business purpose, date, time, place and names of the guests as well as their business relationship with you.

That’s not all! In the past, employers have been accustomed to deducting 100% of the cost of food and beverages provided to employees at or near the place of business. That too has changed, and the Act now subjects food and beverages supplied to employees to the 50% limitation. But that deduction is only allowed through 2025. As of 2026, employers’ costs for food and beverages furnished to employees will not be deductible.

Meals while traveling out of town on business continue to be deductible and are also subject to the 50% limitation.

If you have questions related to entertainment and meal expenses, please give us a call.

Personal Casualty Losses Axed by the New Tax Law

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

A casualty loss occurs when there is property damage from a sudden, unanticipated event, not from gradual, progressive damage. Examples of events qualifying as a casualty include: acts of nature like hurricanes, tornadoes, floods, storms, and volcanic eruptions; shipwrecks; sonic booms; vandalism; fires; car accidents; theft; and terrorist attacks.

For tax years 2018 through 2025, the Act has suspended the itemized deduction for personal casualty and theft losses. Prior to this change in law, personal casualty or theft losses were only deductible to the extent they exceeded $100 per casualty or theft event. In addition, the aggregate net casualty and theft losses for the year were deductible by those who itemized their deductions but only to the extent that the loss exceeded 10% of an individual’s adjusted gross income (AGI).

There is an exception to the suspension, in which a taxpayer has a gain as a result of another casualty (the insurance or other reimbursement is more than the loss), in which case the loss would be allowed to the extent of another casualty gain.

The Act did, however, retain a deduction for qualified disaster-related personal casualty losses for years 2018 through 2025. A qualified disaster-related personal casualty loss is one that occurs in a presidentially declared disaster area and is a result of the disaster.

For example, if your home was destroyed by a hurricane within an area the president has declared to be a disaster area and you have a casualty loss, you are able to deduct the loss. However, if your home is destroyed by a fire that was not in a disaster area (say, due to a fire that started in your kitchen when cooking), you cannot claim a casualty loss, even though your loss would be as great as that of the individual residing in the disaster zone.

In light of these changes, you may not qualify for any tax relief as the result of a casualty, and you are cautioned to review your risks for a casualty and your insurance coverage, should you be unfortunate enough to incur a non-deductible casualty loss. Because of inflation, make sure you are not underinsured.

If you have questions related to casualty losses, please give us a call.

Employee Business Expenses & Tax Reform

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

If you are an employee (i.e., a W-2 wage earner) with substantial work-related business expenses, the Act was not kind to you. It suspended (and effectively repealed), for 2018 through 2025, all miscellaneous itemized deductions, which were previously only subject to a floor of 2% of adjusted gross income (AGI). Employee business expenses are included in that category of miscellaneous itemized deductions.

This change affects those who are compensated as employees and who have work-related expenses—including salespeople with travel and entertainment expenses, long-haul truck drivers with away-from-home expenses, mechanics with tool expenses, and any other employees with large but unreimbursed business expenses. These employees, beginning in 2018, will no longer be able to count such expenses as itemized deductions.

Will this change hurt you? That depends. Because employee business expenses could previously only be deducted to the extent that they exceeded 2% of AGI, the effects of the Act will depend upon the extent of your expenses. Another consideration is whether your total itemized deductions would have exceeded the new standard deduction, which has increased for 2018.

As a remedy, you may want to contact your employer and try to negotiate an “accountable plan,” which is a business-expense reimbursement plan under which the employer can reimburse you, tax-free, for business expenses. With this arrangement, you would need to substantiate your business expenses to your employer and would have to return (within a specified time limit) any reimbursements that your employer pays in excess of the substantiated amount.

If you have questions related to the loss of this deduction or about how the change will impact your specific tax situation, please call us.

Tax Reform Cracks Down on IRA Recharacterizations

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

If you have been or are anticipating converting your traditional IRA to a Roth IRA, you should be aware of a tax trap that Congress built into the Act.

Background: There are two types of IRA accounts:

  • Traditional IRA – Is a retirement plan that generally provides a taxpayer with a tax deduction when a contribution is made to the account. Then when distributions are taken from the account they are fully taxable, including earnings.
  • Roth IRA – Is also a retirement plan, but unlike the traditional IRA, a Roth IRA does not provide a tax deduction for the contribution. Thus, once a taxpayer reaches retirement age, all of the distributions are totally tax-free.

The big benefit here is that all the Roth account earnings over the years end up being tax-free as opposed to those from the traditional IRA, which are taxable. For that reason, many taxpayers take advantage of a provision in the law that allows them to convert a traditional IRA to a Roth IRA. However, for the year that a traditional IRA is converted to a Roth IRA, the converted amounts are taxable. Therefore, most IRA owners carefully plan the amount and timing of the conversions to be done in a year when they are in lower-than-normal tax brackets.

Prior law included a provision that allowed taxpayers to change their minds and undo a conversion by recharacterizing the Roth converted amounts back to traditional IRAs and thus also undoing the tax liability. This was helpful for those who had underestimated the tax liability, did not have money available to pay the tax, saw the value of the converted IRA drop (which would mean they’d be paying tax on a phantom value) or just changed their mind.

Unfortunately, the Act pulled the plug on recharacterizations, and beginning in 2018, taxpayers can no longer undo a conversion. Once a conversion is made, the IRA owner will have to live with the tax consequences. This rule applies for conversions from a traditional IRA, SEP or SIMPLE to a Roth IRA. The new law also prohibits recharacterizing amounts rolled over to a Roth IRA from other retirement plans, such as 401(k) or 403(b) plans.

However, for taxpayers who made a conversion to a Roth IRA in 2017, the IRS has announced the conversion may be recharacterized as a contribution to a traditional IRA if the recharacterization is made by October 15, 2018. A Roth IRA conversion made on or after January 1, 2018, cannot be recharacterized.

Recharacterization is still permitted with respect to other contributions. For example, an individual may make a contribution to a Roth IRA for a particular year and, before the due date for their income tax return for that year, recharacterize it as a contribution to a traditional IRA or vice versa.

If you have questions related to converting a traditional IRA to a Roth IRA, please give this office a call. If you would like to strategize on how to minimize the tax on a conversion, please contact us.

Have Business Income? If So, You Score Big With The New Tax Reform

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

As part of the Act, Congress changed the tax-rate structure for C-corporations to a flat rate of 21% instead of the former graduated rates that topped out at 35%. Needing a way to equalize the rate reduction for all taxpayers with business income, Congress came up with a new deduction for businesses that are not organized as C-corporations.

As a result, the Act has provided a new and substantial tax benefit for most non-C- corporation business owners in the form of a deduction that is equal to 20% of their qualified business income (QBI). This deduction is most commonly known as a pass-through income deduction because it applies to income from pass-through business entities such as partnerships and S-corporations. This category also includes income from sole proprietorships, rentals, and farms; Real Estate Investment Trust (REIT) dividends; pass-through income from publicly traded partnerships; and cooperative dividends. The shorthand term for this deduction is the Sec 199A deduction, as 199A is the Internal Revenue Code section number for this provision. Let’s look at how this deduction works.

QBI – QBI is defined as the net amount of income, gains, deductions, and losses with respect to trades or businesses that are conducted within the United States. QBI does not include:

  • Limitation thresholds
  • Wage limit
  • Capital gains or losses,
  • Interest income,
  • Dividends or payments in lieu of dividends,
  • Annuity income not received in connection with a trade or business,
  • Gain or loss from foreign currency transactions,
  • Trade or business of being an employee,
  • Reasonable compensation from an S-corporation, or
  • Guaranteed payments from a partnership.

The pass-through deduction is not a business deduction, as it is deducted after a taxpayer’s adjusted gross income. It can be claimed regardless of whether the taxpayer claims the standard deduction or itemizes deductions. Since it is not a business deduction, it does not affect the computation of self-employment tax. Where QBI is less than zero, it is treated as a loss from a qualified business on the next year’s taxes.

Complicated Computation – Congress ignored simplification for this deduction, which is quite complicated and which includes limitations at the entity level and for the combined deductions from all entities; furthermore, it is subject to a limitation based on taxable income.

Threshold – When determining the 20% of QBI deduction for each entity, the deductible amount may be reduced, phased-out or phased-in based on that year’s taxable income (without regard to the deduction itself). The thresholds for each limitation are $157,500 for individuals and $315,000 for joint filers. The maximum of any phase-out or phase-in is $50,000 more than the threshold for individuals and $100,000 more for joint filers, so the maximums are $207,500 for individuals and $415,000 for joint filers.

Specified Service Business – Special rules apply to specified service businesses, which are generally businesses that rely on the skill and reputation of the owners or employees. These include businesses focusing on health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and so on. This category specifically does not include engineering or architecture businesses and trades or businesses whose services consist of investment-type activities. For specified service businesses, if the taxable income is equal to or below the threshold, the entity’s deductible amount is the full 20% of QBI. When the taxable income is above the threshold, the deduction is pro rata phased out between the threshold and the cap. Thus, a specified service business entity has no deduction when the taxable income exceeds $207,500 for individuals or $415,000 for joint filers.

Wage Limit – Before learning how the deduction is determined for other business entities, one must understand the wage limit and how it is determined. An entity’s deduction is limited to the lesser of 20% of QBI or the wage limit. The wage limit is the greater of

  • 50% of the W-2 wages from the business or
  • 25% of the W-2 wages from the business plus 2.5% of the unadjusted basis of the business’s qualified property.

Other Businesses – Computing the deduction for other entities gets significantly more complicated depending upon the taxable income. The computations fall into three categories:

  • Taxable income below the threshold ($157,500 for individuals or $315,000 for joint filers),
  • Taxable income above the threshold but less than the cap, and
  • Taxable income exceeding the cap ($207,500 for individuals or $415,000 for joint filers).

Income below the threshold – The entity’s deductible amount is the full 20% of QBI.

Income above the threshold but less than the cap – This is the most complicated computation because the wage limit is phased-in between the threshold and the cap; it only applies to a pro rata portion of the deduction.

Income above the cap – The deduction is equal to the lesser of the wage limit or 25% of QBI.

Example: A single taxpayer has a taxable income of $125,000. He runs a small car-repair business that has a net profit (QBI) of $100,000. Because his taxable income is below the threshold, his deduction for the business entity is $20,000 (20% of $100,000).

Example: A married taxpayer with a taxable income of $500,000 is a shareholder in an S-corporation. The K-1 from the S-corporation shows pass-through income (QBI) of $300,000. The pro rata share of that taxpayer’s wages that were paid by the corporation is $100,000, and the pro rata share of the taxpayer’s qualified business property is $75,000.

Because the taxable income is above the cap, the deduction for this business entity is the lesser of the wage limitation or 20% of the QBI. The wage limitation is the greater of $50,000 (50% of the $100,000 in wages) or $26,875 (25% of the $100,000 in wages plus 2.5% of the $75,000 in qualified business property). Thus, the wage limitation is $50,000. This is less than $60,000 (20% of the $300,000 in QBI), so the taxpayer’s deduction for this business is limited to $50,000.

Aggregating Amounts – Once the deductions have been determined for each of a taxpayer’s business entities, they are combined in a rather complicated computation. First, the total deduction is added to 20% of the taxpayer’s REIT dividends and all of the taxpayer’s publicly traded partnership income and cooperative dividends (after limitations). The final step is to compare this combined deduction amount to the taxpayer’s adjusted taxable income (i.e., taxable income minus capital gains); the lesser of the two becomes the actual deductible amount.

As you can see, this deduction provides a great tax benefit for business owners, but it can be quite complicated. Please contact us with any questions.

Medical Deductions & The New Tax Law

Note: The is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

The Act’s final version retained the itemized deduction for medical expenses even though the original House version would have done away with this deduction altogether.

The medical deduction was not just retained; its adjusted gross income (AGI) floor was lowered from 10% to 7.5% for 2017 and 2018 (after which it returns to 10%). The AGI floor is meant to eliminate deductions for minor medical costs by only allowing those that are in excess of the given percentage of your AGI.

Example: You have wages of $100,000 for 2018 and no other income, losses, or adjustments, so your AGI for the year is $100,000. In this case, for the year, the first $7,500 (7.5% of $100,000) of your otherwise deductible medical expenses is not deductible. Thus, if you have $8,000 of medical expenses, only $500 ($8,000 – $7,500) is deductible. If you have the same amount of income and medical expenses in 2019, none of your medical costs will be deductible because of the 10% floor; 10% of a $100,000 AGI is $10,000, which is greater than the $8,000 of medical expenses. Of course, there’s always a chance that Congress will extend the reduced 7.5% floor beyond 2018, but you shouldn’t count on it. 

Here is where it gets a little complicated. Because medical deductions are itemized, to get any benefit from them, your itemized deductions must exceed the new standard deduction, which is $24,000 for a married couple filing jointly (or for a surviving spouse with a dependent child), $18,000 for a head of household, and $12,000 for anyone else.

Retaining the medical deduction is a necessary for the families of disabled individuals and for senior citizens who require extraordinary care. Without this deduction, those groups could have been saddled with enormous medical costs without any tax relief. However, this deduction is not just for disabled individuals, senior citizens, and their families. Regarding medical bills, you never know what will happen in the future.

Bunching Deductions – One strategy that works well for itemized deductions is to bunch deductions. That means paying as much of your medical expenses as possible in a single year so that the total will exceed the AGI floor and so that your overall itemized deductions will exceed the standard deduction.

Example: Your child is having orthodontic work that will cost a total of $12,000, and the dentist offers a payment plan. If you pay in installments, you will spread the payments out over several years and may not exceed the medical AGI floor in any given year. However, by paying all at once, you will exceed the floor and get a medical deduction.

Being Aware of Medical Deductions – Being aware of what is and is not deductible as a medical expense can also help you to maximize your medical deductions. Unreimbursed costs such as those from doctors, dentists, hospitals, and medical insurance premiums are deductible. The following is a list of some deductible medical expenses that you may not be aware of:

  • Adoptive children’s pre-adoption medical costs
  • Prescriptions for birth control pills
  • Chiropractors
  • Christian Science practitioners
  • Decedent’s medical costs
  • Adult diapers
  • Drug-addiction rehabilitation costs
  • Egg-donation expenses
  • Elderly devices
  • Medical equipment and supplies
  • Fertility enhancements
  • Guide dogs
  • Household nursing services
  • Impairment-related home modifications
  • In vitro fertilization costs
  • Lactation aids
  • Lead-based paint removal
  • Learning-disability tuition expenses
  • Medical-related legal fees
  • Meals from inpatient care
  • Medical-conference expenses
  • Medicare premiums
  • Nonhospital institution costs
  • Nursing-home expenses
  • Organ-donation costs
  • Smoking-cessation programs
  • Sterilization expenses
  • Weight-loss programs (limited)

Some of the foregoing have special requirements, so please call if you have any questions.

Under certain circumstances, you may even be able to deduct the medical expenses that you pay for others.

Medical dependents – This applies only if you had a dependent (a qualified child or other relative) either at the time the medical services were provided or at the time the expenses were paid. For medical purposes, an individual can be a dependent even if his or her gross income precludes qualification as a dependent.

Divorced parents – A child of divorced parents is considered a dependent of both parents for the purpose of medical expense, so each parent can deduct the medical expenses that he or she pays for the child.

If you have questions related to the deductibility of specific medical expenses or about how such deductions apply to your tax situation, please give us a call.