How to Save for a Child’s College Education

A frequently asked question is, “How might I save for a child’s college education?” The answer depends on how much the education is expected to cost and how much time is left until the child heads off to college or university.

The amount of funds that will be required will depend upon whether your child will be attending a local college, attending a local college and then transferring into a university, or going straight to the university. If attending college locally, you generally only need to be concerned about tuition, and the child can live at home, whereas attending a university, unless it is local, will add the cost of housing and food on top of substantially higher university tuition. Another factor is whether the student will leave school after obtaining a bachelor’s degree or will be doing graduate studies for an advanced degree.

When the time comes, your child may qualify for a scholarship or grant, but you can’t depend on that when working out a college savings plan.

The federal tax code has two beneficial savings plans that can be used. In both plans, there is no tax benefit to making any contributions. The benefit is that growth due to appreciation in investments, if any, and earnings (dividends and interest) are tax-free when withdrawn for qualified education expenses. Thus, the sooner the plan is started, the better, because it will have more years to grow in value.

More tax benefit is gained by front-loading the contributions and thus having a larger amount on which to compound the growth and earnings. You should also be aware that anyone, not just you, can make a contribution to the child’s college savings plans. So if your child has any well-heeled grandparents, other relatives or friends who would like to help, they can also contribute.

The two savings plans currently available for college savings are the Coverdell Education Savings Account and the Qualified Tuition Plan, most commonly referred to as a Sec. 529 Plan (529 denotes the section of the tax law code that governs it).

Coverdell Education Savings Account – This plan only allows up to $2,000 in contributions per year, and although it allows withdraws for kindergarten education and above, the contribution limitations generally rule it out as a practical method for college savings.

Sec 529 Plan – This approach is likely your best option. State-run Sec. 529 plan benefits are limited to postsecondary education, but they allow significantly larger amounts to be contributed; multiple people can each contribute up to the gift tax limit each year without being subjected to gift tax reporting. This limit is $14,000 for 2017, and it is periodically adjusted for inflation; in 2018, it increases to $15,000. A special rule allows contributors to make up to five years of contributions in advance (for a total of $70,000 in 2017).

Sec. 529 plans allow taxpayers to put away larger amounts of money, limited only by the contributor’s gift tax concerns and the contribution limits of the intended plan. There are no limits on the number of contributors, and there are no income or age limitations. The maximum amount that can be contributed per beneficiary (the intended student) is based on the projected cost of college education and will vary between the states’ plans. Some states base their maximum on an in-state four-year education, but others use the cost of the most expensive schools in the U.S., including graduate studies. Most have limits in excess of $200,000, with some topping $370,000. Generally, additional contributions cannot be made once an account reaches that level, but that doesn’t prevent the account from continuing to grow.

When the time comes for college, the distributions will be part earnings/growth in value and part contributions. The contribution part is never taxable, and the earnings part is tax free if used to pay for qualified college expenses. In addition, the portion of the distribution that represents the return on the contributions and is used for qualified education expenses qualifies for the American Opportunity Tax Credit, which can be as much as $2,500, provided your income level does not phase it out.

For additional details or assistance in planning for a child’s higher education, please give us a call.

Unique Charitable Giving Options

The end of the year and holiday season is the time of the year when everyone is feeling charitable, and a time when you are likely flooded with solicitations for charitable contributions. Before deciding about your charitable giving for the year, you may benefit from reading this article and learning ways to contribute that will help you tax-wise.

Some recent special tax deduction changes make 2017 a unique year for charitable giving. This article provides you a guide to these special provisions in addition to those that have historically provided tax benefits.

Normally, deductible charitable contributions are limited by a percentage of your income, more specifically your adjusted gross income (AGI), which is the number on your tax return before your deductions and exemptions are subtracted. For most charitable contributions the tax deduction limit is 50% of your AGI, but it can drop to 30% or even 20% in certain situations. Additionally, overall itemized deductions, including those for charitable contributions, are phased out for high-income taxpayers.

  • 2017 Hurricane Relief – After the devastation inflicted by Hurricanes Harvey, Irma and Maria, Congress passed a provision that allows taxpayers to donate money to hurricane relief charities without any percentage-of-AGI limitation. Further, the phaseout of itemized deductions for high-income taxpayers will also not apply to hurricane relief contributions. So, for example, if your AGI is $100,000 and you contribute $70,000 to a qualified hurricane relief charity in 2017, the full $70,000 will be deductible instead of being limited to $50,000. However, if you made other contributions during the year, they will be subject to the normal percentage-of-AGI limitations, and then the hurricane relief donation will be deductible for the balance of your AGI.To qualify, the contributions must have been made in cash between August 23 and December 31, 2017, and the donation documentation must verify that the donation is for Hurricane Harvey, Irma or Maria relief. If you contribute more than is deductible for 2017, the excess will carry forward to your tax returns for up to the next five years.
  • Donate Unused Employee Time Off – As it has done before in the wake of disasters, including Hurricane Katrina and Superstorm Sandy, the Internal Revenue Service is providing special relief that allows employees to donate their unused paid vacation, sick leave and personal leave time to Hurricane Harvey, Irma and Maria relief efforts.Here is how it works: If your employer is participating, you can relinquish any unused and paid vacation time, sick leave and personal leave, and your employer will then donate the cash equivalent to Hurricane Harvey, Irma and Maria relief charities. Your employer can deduct the amount donated as a business expense. You don’t get a deduction for a charitable contribution, but better yet, you won’t have to report the income, which is beneficial for both individuals who itemize deductions and those who use the standard deduction. This special relief applies to all leave-based donations made before January 1, 2019, giving individuals over a year to forgo their unused paid vacation, sick and leave time and have the cash value donated to a worthy cause.If your employer is unaware of this program, refer them to IRS Notice 2017-48 (related to Hurricane Harvey) for further details. Note: Notices 2017-52 and 2017-62 were later released, adding Irma and Maria, respectively, to the list. Your employer will also benefit from not being liable for payroll taxes on the money contributed.
  • Contributions of Appreciated Assets – Although this is not a new strategy, taxpayers can donate appreciated long-term capital gain assets to a charity and deduct the fair market value (FMV) of the assets as a charitable deduction. For example, suppose you donate to your church’s building fund a stock that is worth $10,000 but that only cost you $2,000. Your charitable contribution would be $10,000, and you do not have to pay tax on the $8,000 appreciation in the stock. This strategy can also apply to land, homes, rentals, equipment, etc. Determining the FMV for listed stock is easy since the value of the stock can be determined from quoted stock prices on the day of the contribution. For other capital assets, a certified appraisal is generally required. It would be good practice to contact this office before making a gift of appreciated property to make sure that it is appropriate for your tax bracket and that the appraisal is properly performed and documented.
  • IRA to Charity Contributions – For some time this unique method of making charitable contributions was a temporary provision of the tax law, but Congress made it permanent in 2016. This charitable contribution provision is limited to taxpayers age 70.5 and older. They can directly transfer up to $100,000 a year from their IRA to a qualified charity. So if you are 70.5 or older and make an IRA-to-charity transfer you won’t get a charity deduction, but instead and even better, you will not have to pay taxes on the distribution, and because your AGI will be lower, you can benefit from other tax provisions that are pegged to AGI, such as the amount of Social Security income that’s taxable and the cost of Medicare B insurance premiums for higher-income taxpayers. As an additional bonus, the transfer also counts toward your annual required minimum distribution.
  • Cash Contributions – Cash contributions include those paid by cash, check, electronic funds transfer, or credit card. To claim a cash contribution, you must be able to document that contribution with a bank record, receipt, or a written communication from the qualified organization; this record must include the name of the qualified organization, the date of the contribution, and the amount of the contribution. Valid types of bank records include canceled checks, bank or credit union statements, and credit card statements. In addition, to deduct a contribution of $250 or more, you must have certain payroll deduction records or an acknowledgment of your contribution from the qualified organization.
  • Non-cash Contributions – This is a type of contribution with which you can easily run afoul of the IRS because the contribution deduction is based on the FMV of the item being contributed, not the item’s original cost, and most used items such as clothing and household goods depreciate substantially.Do not include items of de minimis value, such as undergarments and socks, in the deductible amount of your contribution, as they are specifically not allowed. It is not uncommon to see taxpayers over-valuate their contributions. That is why the IRS has four levels of verification and documentation requirements for non-cash contributions, with each becoming more stringent as the valuation increases:
    Caution: The value of similar items of property that are donated in the same year must be combined when determining what level of documentation is needed. Similar items of property are items of the same generic category or type, such as clothing, household goods, coin collections, paintings, books, jewelry, privately traded stock, land and buildings.A. Deductions of Less Than $250 You must obtain and keep a receipt from the charitable organization that shows:

    1. The name of the charitable organization,
    2. The date and location of the charitable contribution, and
    3. A reasonably detailed description of the property.

    Note: The taxpayer is not required to have a receipt if it is impractical to get one (for example, if the property was left at a charity’s unattended drop site). This exception only applies if all the non-cash contributions for the year are less than $250.

    B. Deductions of At Least $250 But Not More Than $500 You must provide the same information as in the previous category and add:

    4. Whether or not the qualified organization gave the taxpayer any goods or services as a result of the contribution (other than certain token items and membership benefits).

    If the deduction includes more than one contribution of $250 or more, the taxpayer must have either a separate acknowledgment for each donation or a single acknowledgment that shows the total contribution.

    C. Deductions Over $500 But Not Over $5,000 You must provide the same acknowledgment and written records that are required for the two previous categories plus:

    5. Attach a completed IRS Form 8283 to the income tax return that reports:

      • a. How the property was obtained (for example, purchase, gift, bequest, inheritance, or exchange),
        b. The approximate date the property was obtained or—if created, produced, or manufactured by the taxpayer—the approximate date when the property was substantially completed, and
        c. The cost or other basis, and any adjustments to this basis, for property held for less than 12 months and (if available) the cost or other basis for property held for 12 months or more.

    D. Deductions Over $5,000 These donations require time-sensitive appraisals by a “qualified appraiser” in addition to other documentation (this requirement, however, does not apply to publicly traded securities). When contemplating such a donation, please call this office for further guidance about the documentation and forms that will be needed.

To help you document some of these noncash contributions, you can download a fillable Noncash Charitable Contribution statement. The statement includes an area for the charity’s agent to verify the contribution and a check box denoting whether the qualified organization provided any goods or services as a result of the contribution. Although not specifically endorsed by the IRS, this statement includes everything needed for noncash contributions of up to $500—provided, of course, that you and the charitable organization’s representative accurately complete the form.

Unfortunately, legitimate charities face competition from fraudsters, so if you are thinking about giving to a charity with which you are not familiar, do your research so that you can avoid swindlers who are trying to take advantage of your generosity. They show up in droves after disasters like the hurricanes and the California firestorms. Here are tips to help make sure that your charitable contributions actually go to the cause that you support:

  • Donate to charities that you know and trust. Be alert for charities that seem to have sprung up overnight in connection with current events.
  • Ask if a caller is a paid fundraiser, who he/she works for, and what percentages of your donation go to the charity and to the fundraiser. If you don’t get clear answers—or if you don’t like the answers you get—consider donating to a different organization.
  • Don’t give out personal or financial information—such as your credit card or bank account number—unless you know for sure that the charity is reputable.
  • Never send cash. You can’t be sure that the organization will receive your donation, and you won’t have a record for tax purposes.
  • Never wire money to someone who claims to be from a charity. Scammers often request donations to be wired because wiring money is like sending cash: Once you send it, you can’t get it back.
  • If a donation request comes from a charity that claims to help a local community group (for example, police or firefighters), ask members of that group if they have heard of the charity and if it is actually providing financial support.
  • Don’t make a contribution if it is solicited in an email claiming to be from the IRS. The IRS does not send emails to individuals and does not ask for donations to organizations related to natural disasters. Scammers are using this ploy to extract money from taxpayers who think their contributions will go for hurricane relief or to wildfire victims.
  • Check out the charity’s reputation using the Better Business Bureau’s Give.org or Charity Watch.

Remember that if you want to deduct a charitable contribution on your tax return, the donation must be to a legitimate charity. Contributions may only be deducted if they are to religious, charitable, scientific, educational, literary or other institutions that are incorporated or recognized as organizations by the IRS. Sometimes, these organizations are referred to as 501(c)(3) organizations (after the code section that allows them to be tax-exempt). Gifts to federal, state or local government, qualifying veterans’ or fraternal organizations, and certain nonprofit cemetery companies also may be deductible. Gifts to other kinds of nonprofits, such as business leagues, social clubs and homeowner’s associations, as well as gifts to individuals, cannot be deducted.

Be aware that, to claim a charitable contribution, you must also itemize your deductions. If you only marginally itemize your deductions, it may be beneficial for you to group your deductions in a single year and then to skip deductions in the next year.

Please contact us if you have questions related to the tax benefits associated with charitable giving for your particular tax situation.

Year-End Tax Planning To Take Advantage Of Possible Tax Reform

With the prospect of major tax reform on the horizon, some strategies can be employed before the end of the year that can substantially reduce your 2017 tax bill.

Itemized deductions under current law include 5 major categories: medical, taxes, interest, charitable gifts and miscellaneous deductions. Under the proposed tax reform, these deductions would be limited or eliminated. If that is the case, then taxpayers who itemize in 2017 should take the following actions before the year’s end to maximize their 2017 deductions:

  1. Medical – The House version of tax reform does away with medical deductions beginning in 2018 while the Senate version retains them. So to be on the safe side you may want to consider paying all outstanding medical bills, but keep in mind that the total amount of unreimbursed medical expenses is only deductible to the extent that it exceeds 10% of your adjusted gross income (AGI). Some anticipated medical expenses can be prepaid. An example would be a dental bill, if you have a child receiving orthodontic treatment for braces and you are on an installment payment plan. You can pay off the bill and increase your medical deductions for 2017, and the dentist might even give you a discount for paying early. But if you can’t reach the 10% of AGI threshold, don’t make a special effort to pay any outstanding medical bills.
  2. Property Tax – The Senate version of tax reform eliminates all property tax itemized deductions beginning in 2018, while the House versions retains a limited deduction. If the property taxes on your home, second home or vacant property are being paid in installments with an installment due in 2018, it may be appropriate pay that balance in 2017 to increase your tax deductions for this year.
  3. State Income Tax – Both the House and the Senate versions of tax reform eliminate the deduction for state and locale income taxes beginning in 2018. If you reside in a state that has a state income tax, estimate your 2017 state tax liability and make sure your full liability is paid before the year’s end. You can ask your employer to boost the amount of your state withholding by a reasonable amount, or if you are self-employed, pay your 4th-quarter estimate due in January in December and increase your deduction.
    A word of caution: taxes are not deductible for alternative minimum tax (AMT) purposes. The tax-maximizing strategy could trigger the alternative minimum tax (AMT).
  4. Miscellaneous Deductions – This deduction category includes unreimbursed employee business expenses, investment expenses, certain legal fees, casualty losses, gambling losses and others. Generally, few of these expenses would support payments other than when they occur, and this category is only deductible to the extent that the deductions exceed 2% of your AGI.

Even though the strategy of prepaying tax-deductible expenses this year may yield tax savings, be thoughtful about borrowing money to execute this strategy. Interest on borrowed money can dampen the tax benefits.

Three Other Strategies
If you are an investor, a popular year-end strategy is to review your stock portfolio and sell off losers to offset your gains. Also remember: you are allowed to deduct a loss of up to $3,000 ($1,500 for married filing separate taxpayers) from the sale of investments. However, your investment strategies should take precedent over selling stocks to develop a loss.

Make the most of post-secondary education tax credits. Both the Lifetime Learning Credit and the American Opportunity Credit allow qualified taxpayers to prepay tuition bills in 2017 for an academic period that begins by the end of March 2018. This means that if you are eligible to take the credit and you have not yet reached the 2017 maximum for qualified tuition and related expenses paid, you can bump up your credit by paying the tuition for early 2018 before the end of 2017. This strategy may not apply to you if you’ve been paying tuition expenses for the entire 2017 tax year, but if your student just started college this fall, it will probably provide you with some additional help.

If you own a business and are considering purchasing equipment before the end of the year, take note that most equipment purchased by a small business can be expensed and will provide a substantial tax deduction. Keep in mind that just purchasing the equipment will not give you a tax deduction. You also must place the equipment in service before the end of the year, so you need to plan ahead and not wait until the last minute.

If you would like to make an appointment to develop a year-end tax strategy, please give us a call.

Year-end moves to make in light of tax reform legislation

Dear Client:

Congress appears poised to enact a major tax reform law that could potentially make fundamental changes in the way you and your family calculate your federal income tax bill, and the amount of federal tax you will pay. This letter is designed to help you cope with the changes Congress is hammering into shape right now-to take advantage of tax breaks that may be heading your way, and to soften the impact of any crackdowns. Keep in mind, however, that while most experts expect a major tax law to be enacted this year, it’s by no means a sure bet. So keep a close eye on the news and don’t swing into action until the ink is dry on the President’s signature of the tax reform bill.

Lower tax rates coming. Both the tax bill passed the House of Representatives and the one before the Senate would reduce tax rates for many taxpayers, effective for the 2018 tax year. Additionally, businesses may see their tax bills cut, although the final form of the relief isn’t clear right now.

The general plan of action to take advantage of lower tax rates next year would be to defer income into next year. Some possibilities follow:

  • If you are an employee who believes a bonus is coming your way before year end, consider asking your employer to delay payment of the bonus until next year.
  • If you are thinking of converting a regular IRA to a Roth IRA, postpone your move until next year. That way you’ll defer income from the conversion until next year and hopefully have it taxed at lower rates.
  • If you run a business that renders services and operates on the cash basis, the income you earn isn’t taxed until your clients or patients pay. So if you hold off on billings until next year-or until so late in the year that no payment can be received this year-you will succeed in deferring income until next year.
  • If your business is on the accrual basis, deferral of income till next year is difficult but not impossible. For example, you might, with due regard to business considerations, be able to postpone completion of a job until 2018, or defer deliveries of merchandise until next year. Taking one or more of these steps would postpone your right to payment, and the income from the job or the merchandise, until next year. Keep in mind that the rules in this area are complex and may require a tax professional’s input.
  • The reduction or cancellation of debt generally results in taxable income to the debtor. So if you are planning to make a deal with creditors involving debt reduction, consider postponing action until January to defer any debt cancellation income into 2018.

Disappearing deductions, larger standard deduction. Beginning next year, both the House-passed tax reform bill and the version before the Senate would repeal or reduce many popular tax deductions in exchange for a larger standard deduction. Here’s what you can do about this right now:

  • The House-passed tax reform bill would eliminate the deduction for nonbusiness state and local income or sales tax, but would allow an up-to-$10,000 deduction for real estate taxes on your home. The bill before the Senate would ban all nonbusiness deductions for state and local income, sales tax, and real estate tax. If you are an employee who expects to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding on those taxes. That way, additional amounts of state and local taxes withheld before the end of the year will be deductible in 2017. Similarly, pay the last installment of estimated state and local taxes for 2017 by Dec. 31 rather than on the 2018 due date, or prepay real estate taxes on your home.
  • Neither the House-passed bill nor the bill before the Senate would repeal the itemized deduction for charitable contributions. But because most other itemized deductions would be eliminated in exchange for a larger standard deduction (e.g., in both bills, $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for many. If you think you will fall in this category, consider accelerating some charitable giving into 2017.
  • The House-passed bill, but not the one before the Senate, would eliminate the itemized deduction for medical expenses. If this deduction is indeed chopped in the final tax bill, and you are able to claim medical expenses as an itemized deduction this year, consider accelerating “discretionary” medical expenses into this year. For example, order and pay for new glasses, arrange to take care of needed dental work, or install a stair lift for a disabled person before the end of the year.

Other year-end strategies. Here are some other “last minute” moves that could wind up saving tax dollars in the event tax reform is passed:

  • The exercise of an incentive stock option (ISO) can result in AMT complications. But both the Senate and House versions of the tax reform bill call for the AMT to be repealed next year. So if you hold any ISOs, it may be wise to hold off exercising them until next year.
  • If you’ve got your eye on a plug-in electric vehicle, buying one before year-end could yield you an up-to-$7,500 discount in the form of a tax credit. The House-passed bill, but not the one before the Senate, would eliminate this credit after 2017.
  • If you’re in the process of selling your principal residence and you wrap up the sale before year end, up to $250,000 of your profit ($500,000 for certain joint filers) will be tax-free if you owned and used the property as your main home for at least two of the five years before the sale. However, under the House-passed bill and the bill before the Senate, the $250,000/$500,000 tax free amounts would apply to post-2017 sales only if you own and use the property as your main home for five out of the previous eight years.
  • Under current rules, alimony payments generally are an above-the line deduction for the payor and included in the income of the payee. Under the House-passed tax bill but not the version before the Senate, alimony payments would not be deductible by the payor or includible in the income of the payee, generally effective for any divorce decree or separation agreement executed after 2017. So if you’re in the middle of a divorce or separation agreement, and you’ll wind up on the paying end, it would be worth your while to wrap things up before year end if the House-passed bill carries the day. On the other hand, if you’ll wind up on the receiving end, it would be worth your while to wrap things up next year.
  • Both the House-passed bill and the version before the Senate would repeal the deduction for moving expenses after 2017 (except for certain members of the Armed Forces), so if you’re about to embark on a job-related move, try to incur your deductible moving expenses before year-end.

Please keep in mind that we’ve described only some of the year-end moves that should be considered in light of the tax reform package currently before Congress—which, it bears emphasizing, may or may not actually become law. If you would like more details about any aspect of how the proposed legislation may affect you, please call us.

Very truly yours,

Tarlow & Co., CPA, PC

 

Following Congress on its Path to Tax Reform

As Congress begins debating tax reform, you might be interested in an overview of the GOP’s proposed changes so you’ll have an understanding of what the proposals actually entail as you follow the debate and won’t have to rely on politically motivated analysis by the various media sources. It is important to understand that the GOP’s tax reform proposal is actually only an overall framework of the tax legislation that will be formulated later by congressional committees. So it only provides the “big picture,” with details to be added later. However, the devil is always in the details, and you frequently have to read between the lines and listen to and read comments by Washington insiders to glean additional detail. Based upon that, the following are the provisions of the proposed tax reform that will apply to individual taxpayers and small businesses.

Filing Status
Current Law: The current law includes five filing statuses: single (unmarried), married taxpayers filing jointly (MFJ), head of household, married filing separately (MFS) and surviving spouse. The head of household (HH) status is for single individuals and some married but separated individuals who are maintaining a home for a dependent. MFS is a filing status that applies to a married individual who is not filing a joint return with their spouse (it keeps married individuals from filing as single and abusing the intent of the tax laws). Surviving spouse is a status that allows a widow or widower with a dependent child to continue to use the joint tax rates for 2 years after the year of death of their spouse.

Proposed Law: It appears that the proposal would retain only the single and married taxpayers filing jointly statuses in an effort to simplify the tax law. If this is the actual intent, it would greatly streamline the tax code, which is littered with special treatment for HH and MFS taxpayers. Potential losers under this proposal are HH filers, who currently enjoy a standard deduction that is higher than that of a single filer as well as lower tax rates.

Personal Exemptions
Current Law: A deduction from adjusted gross income (AGI), called an exemption allowance, is permitted for the filer of the return, his or her spouse if filing jointly, and each dependent claimed on the return. For 2017, each exemption allowance is $4,050. So, for example, a married couple filing jointly with two dependent children would be entitled to an exemption allowance of $16,200. However, the exemption deduction phases out for higher-income taxpayers.

Proposed Law: Personal exemptions would be eliminated, but child and other dependent credits might take their place, as described later in this article.

Standard Deduction
Current Law: The standard deduction is for taxpayers without enough deductions to file a Schedule A and itemize their deductions. Currently a standard deduction is set for each filing status and is adjusted for inflation each year. For 2017, the standard deduction is $6,350 for single and married separate, $9,350 for head of household, and $12,700 for married joint and surviving spouse. There are also add-on amounts for each filer and spouse who is age 65 or over, plus an additional amount for blindness.

Proposed Law: The GOP’s framework would replace both the current standard deduction and the personal exemptions with new higher standard deductions. In addition, the proposal would do away with the additional standard deductions for the seniors and people with visual impairments.

When the proposed higher standard deductions were first announced some months ago, those using the standard deduction were excited to think their standard deductions would be roughly doubled. But now that we have a few more details, we find that personal exemptions would no longer be allowed, which changes the outcome significantly. The table below compares the current standard deduction and exemptions for different filing statuses and number of exemptions to the proposed standard deduction replacement.

As you can see, the proposed change favors the smaller family size, but this is supposed to be compensated for with a larger and partially refundable child tax credit that is discussed below.

Itemized Deductions
Current Law: Medical deductions are allowed to the extent that they exceed 10% of the taxpayer’s AGI, tax deductions for state and local (city) income taxes or sales tax, plus real and personal property taxes. Also included is interest paid on qualified first and second home mortgage acquisition and equity debt, provided the acquisition debt doesn’t exceed $1 million and the equity debt isn’t over $100,000. The debt amounts of the first and second homes are combined for this limitation. Other categories of itemized deduction are charitable contributions and miscellaneous itemized deductions.

Proposed Changes: The tax reform would eliminate all deductions except for charitable contributions and those that encourage home ownership, such as home mortgage interest.

There is already pushback from members of Congress whose constituents reside in states that impose an income tax on their residents. Taking away the ability to deduct state and local income tax, referred to as the SALT deduction, would most significantly impact taxpayers living in states that have income taxes, and thus they would be double-taxed on the same income. All but seven states have income tax, with California, New York and New Jersey imposing the highest rates.

Eliminating medical deductions will significantly impact senior citizens who require expensive elder care and taxpayers who incur extraordinary medical expenses.

Casualty, theft and disaster losses are currently included in itemized deductions, and the proposal is silent as to what will become of these all-important deductions. Also unaccounted for is the deduction for gambling losses, the elimination of which will force recreational gamblers to pay tax on all winnings even if they have a net loss.

Individual Tax Rates:
Current Law: There are seven tax rates (10%, 15%, 25%, 28%, 33%, 35% and 39.6%), with the tax progressively increasing as the taxpayer’s taxable income increases. Each tax rate is applied to ever-increasing ranges of taxable income, referred to as tax brackets, with the 2017 top brackets kicking in at $418,400 for single taxpayers and $470,700 for married taxpayers filing jointly.

Proposed Changes: The tax reform would reduce the number of tax rates to three: 12%, 25% and 35%, with possibly a fourth rate for the “highest-income” taxpayers. The proposal is silent as to the ranges of taxable income these rates will apply to, making it impossible to make comparisons between the current law and the proposed changes. However, should the three rates be made into law, the wealthiest taxpayers would enjoy a significant tax cut.

Child Tax Credit (CTC)
Current Law:  Allows a tax credit of $1,000 for each qualifying child dependent under the age of 17. The credit is generally nonrefundable (meaning it can only offset your tax liability and any excess is lost). However, when a taxpayer’s income is low or there are three or more qualifying children, a portion of the credit is refundable. The credit is also phased out for higher-income taxpayers.

Proposed Changes: The reform would increase the amount of the credit by an unspecified amount and make the first $1,000 of the CTC refundable. It would also add a nonrefundable credit of $500 for other dependents of the taxpayer that do not meet the child criteria. This presumably eliminates the current complicated calculation for the refundable portion of the child tax credit. The proposal intends that the income phaseout ranges be adjusted so more taxpayers will be eligible for the credit, but the higher phaseout levels are not specified. These adjustments to the CTC are touted to make up for the loss of personal exemptions, but without knowing the amount of the credit increase and the high-income phaseout ranges, it is impossible to make comparisons between the current and proposed regimes.

Alternative Minimum Tax (AMT)
Current Law: The AMT was originally initiated to keep higher-income taxpayers from benefiting from certain tax provisions. Over the years, inflation has caused the AMT to significantly impact more taxpayers than originally intended. Determining whether the AMT applies and computing the tax adds a layer of complexity to preparing the return.

Proposed Changes: The reform would eliminate the AMT.

Estate Tax
Current Law: The current code imposes a 40% tax on the estate of a decedent whose estate’s value exceeds $5.49 million. The $5.49 million is adjusted down for certain gifts made during the decedent’s lifetime. Beneficiaries of estates receive inheritances at the fair market value of the property inherited as of the decedent’s date of death. Thus beneficiaries who inherit property and then sell it are subject to tax only on the appreciation from the time they inherited the property.

Proposed Changes: The reform would eliminate the estate tax. Unanswered in the proposal is whether a beneficiary will continue to receive inherited property at fair market value or whether the heir will inherit the decedent’s basis in the property. If the latter, then when the beneficiary sells the property the beneficiary will be stuck with paying income tax on the entire appreciation in value from the time the property was acquired by the decedent. Also unanswered is whether the gift tax will continue to apply.

Top Tax Rate for Small Businesses
Current Law: At present, business income from a Schedule C, LLC, Partnership and S-Corporation is passed through to the owner of the business and included on his or her 1040 individual return and taxed at rates ranging rom 10% to 39.6%.

Proposed Changes: As mentioned previously, the proposed changes would reduce the current seven tax rates to three. For pass-through businesses, the proposed changes limit the tax on pass-through small business income to 25%, the middle rate of the three new proposed rates. Unfortunately, the term “small business” is not defined in the proposal. This proposed change would favor successful businesses that would otherwise be subject to the highest proposed tax rates.

Expensing Business Purchases
Current Law: Generally, capital purchases by a business, such as machinery, vehicles, or computer systems, must be depreciated (written off) over their useful lives—usually 3, 5 or 7 years for most purchases by small businesses. A special allowance, usually referred to as bonus depreciation, is available in the first year for certain types of property. There is also a provision that allows expensing up to $510,000 worth of purchases in lieu of depreciating the cost of the property.

Proposed Changes: The reform would allow 100% first-year expensing of capital purchases (other than structures) after September 27, 2017. The full expensing provision would not be permanent, but would be in the tax code for a minimum of five years. A future Congress could decide to extend the provision or make it permanent.

Other issues: Other issues generally not impacting small businesses or individuals include reducing the corporate tax rate to 20% – which is below the 22.5% average of the industrialized world – with the intent to make U.S. businesses more competitive with their foreign rivals. The corporate alternative minimum tax would also be eliminated. The proposed changes would also repeal the domestic production activities deduction and most business tax credits, except the low-income housing and the research and development credits.

The current consensus is that the changes, other than the business expensing, would not be effective until 2018. We hope this provides you with insight into the GOP’s proposed tax reform. But keep in mind that these proposals could, and probably will, change as the proposal works its way through Congress.

Tax Reform Framework Released

President Trump announced a nine-page framework for tax cuts on September 27, 2017. The Framework capitalizes on many ideas previously presented in the President’s Tax Outline and in the House Republican Blueprint. Congressional tax-writing committees have a lot of work to do in refining the details, but it gives us an idea of where tax reform may be headed.

Individual Tax Rates

The current rates now fall into seven brackets, ranging from 10% to 39.6%. The proposed plan would consolidate the current individual tax brackets into three: 12%, 25% and 35%. An additional top tax rate may be added and apply to the “highest-income taxpayers,” but it fails to mention the income level at this might take effect, or the rate that would be imposed.

The plan also does not specify which income levels would be taxed at each rate— and if the highest rate is set at 35 percent—it would greatly benefit the wealthiest taxpayers, who currently pay a top rate of 39.6 percent on income greater than $418,400 for single filers.

Child and Dependent Care Credits

Although the rate applied to the lowest income bracket would increase, typical families in the existing 10 percent bracket may be better off because of a larger child tax credit as well as an increase in the standard deduction. The child tax credit would be “significantly” increased, including a refundable portion offered to taxpayers who have higher levels of income than current law allows.

A new, non-refundable credit of $500 for those caring for non-child dependents (such as an elderly parent) would be added.

Standard and Itemized Deductions

Most itemized deductions would be eliminated, meaning that large medical expenses, state and local income taxes, real estate taxes, investment expenses and investment interest expense would no longer be deductible. However, home mortgage interest, charitable contributions, and tax benefits encouraging work, higher education and retirement savings would be retained.

The standard deduction and personal exemptions would be combined into one larger standard deduction: $12,000 for single filers and $24,000 for married taxpayers filing jointly. Home mortgage interest, charitable contributions, and tax benefits encouraging work, higher education and retirement savings would be retained. This means that Such a revision of the tax code, if enacted, would greatly increase the number of taxpayers choosing the standard deduction. The new, single deduction would be higher for many filers, except those who claim multiple children

The Alternative Minimum Tax (AMT) and the federal estate tax and generation-skipping transfer tax would be repealed under this framework. It is suspected that that the repeal will apply to gift taxes, as well.

Business and Corporate Taxes

The tax rate would be reduced for regular or “C” corporations from 35% to 20%. The corporate Alternative Minimum Tax (“AMT”) would be eliminated along with other methods to reduce the double taxation of corporate earnings.

Many small businesses are structured as “S” corporations, partnerships, limited liability companies (LLCs), or sole proprietorships; all of which pass through business profits and losses to their owners’ personal tax returns. Thus, “C” corporation income taxes may be avoided but the owners face personal tax rates as high as 39.6%. Pass-throughs now make up about 95 percent of businesses in the country and the bulk of corporate tax revenue for the government.

Under the proposed framework, business income from these “pass-through entities” would be taxed at a rate no higher than 25%. Such a measure would need to be drafted carefully in order to prevent personal income of wealthy individuals from being reclassified into lower-taxed business income. Whether these distributions would then be subject to a second level of tax at the individual owner level also needs to be addressed.

Deductions and Tax Credits

Most special deductions and tax credits, other than the R&D credit and the low-income housing tax credit, would be eliminated. It’s not clear which deductions will be eliminated; however, the Section 199 deduction was specifically mentioned as being eliminated.

Replace system of taxing companies’ worldwide income with a 100% exemption for dividends from foreign subsidiaries in which U.S. parent has a 10% stake or more. Reduce tax rate and tax on a global basis the foreign profits of U.S. multinational corporations.

Tax Write Offs for Depreciable Assets

Businesses that invest in depreciable assets, other than buildings, after September 27, 2017 would write them off immediately. This tax benefit, with no upper limit, would be in place for at least five years. As a tradeoff, the tax-deductibility of interest expense incurred by most taxable corporations would be partially limited.

If you have questions about how the proposed tax reform might affect you, please call us.

 

Are Your Important Tax Documents Safe in Case of a Disaster?

You may think a natural or man-made disaster will never happen to you, but it can be a nightmare when it does. The 2017 hurricane season is a good example, not to mention the wildfires in the West, the tornados in the Midwest, plus the potential for inevitable earthquakes.

You could lose all of your tax records, business records, insurance policies, birth certificates, and other key documents.

You can help yourself by storing duplicates of important or irreplaceable documents in a waterproof container away from the original set. If you think this will be too difficult, at least keep the original documents in a waterproof container.

If you are computer savvy, an easier way to keep your records out of harm’s way is to store digital copies of the documents on a remote server (i.e., in the cloud). It may cost a few bucks, but the digital files will be there when you need them, regardless of what happens to your home or business location.

Most financial institutions these days provide all of their documents digitally, and you can store those documents on your remote server or even retrieve them from the financial institution’s website. However, before relying on the financial institutions, make sure they retain your records for long enough to meet your needs.

For example, you generally need to keep individual tax records for up to 3 years after the tax return due date for the tax year or the date when you filed the return, if it was filed after the due date. For example, your 2016 return was due April 18, 2017. If you filed it on or before April 18, the statute of limitations for the 2016 return would not run out until April 15, 2020. So, you would have to keep the records until then for the 2016 tax return. (The statute of limitations runs for 4 years for some states, and some records need to be kept longer for both federal and state purposes.) If some of your files are not already available digitally, you can always scan the originals to create digital copies.

Another very important thing to everyone is family photos. Modern-day pictures are digital, so you can save them on a remote server, or many photo services will save them online for you. For the older important ones, you can scan them or take digital pictures of them with your camera.

Another important document to have is a list of your home’s and business facility’s contents for insurance purposes. The quick and easy way is to take a video or pictures throughout the house or business showing the furnishings and equipment. A better method is to take the pictures or video and back them up with a detailed list of the items in each room.

Self-Help Publications:

Please give us a call if you have questions about retaining records or if we can provide any other assistance.

Tax Breaks for Military Personnel

Military service members have special obligations and take risks while performing their service to our country, which impact their tax situation. As a result, they are entitled to a number of special tax breaks. The following are the predominant tax breaks available to military personnel:

  • Residence or Domicile – A military service member does not lose or acquire a residence or domicile for tax purposes due to being absent or present in any tax jurisdiction in the U.S. solely to comply with military orders. Thus, for example, a member of the military who is a resident of Texas and is assigned under military orders to a duty station in California continues to be treated as a Texas resident and is not subject to California state income tax.
    Another special rule exempts any personal service income of a military spouse from being taxed by any state other than the military spouse’s resident state. For the income to be exempt from the nonresident state’s taxes, the couple must have relocated to another state under military orders. They must also share the same “domicile” or true home outside the duty station state where they intend to return and relocate permanently.
  • Moving Expenses – A member of the Armed Forces on active duty who is required to move because of a permanent change of station can deduct the reasonable unreimbursed expenses of moving themselves and members of their household. They are not subject to the 50-mile distance test or 39-week employment test that civilians are subject to for claiming a moving expense deduction. Reasonable expenses include shipping, a moving van, truck rental, travel expenses (not meals), packing, insurance and storage en route, moving pets, and utility connect/disconnect charges.
  • Combat Pay Exclusion – If a member of the Armed Forces serves in a combat zone as an enlisted person or as a warrant officer for any part of a month, all of the military pay that he or she receives for military service that month is excluded from taxation. For officers, the monthly exclusion is capped at the highest enlisted pay plus any hostile fire or imminent danger pay received.
  • Living Allowances – The basic housing allowance and both housing and cost-of-living allowances abroad, whether paid by the U.S. Government or by a foreign government, are excluded from taxation.
  • Home Mortgage Interest and Taxes – A military taxpayer can deduct mortgage interest and real estate taxes on his or her tax return as an itemized deduction, even if they are paid with nontaxable military housing allowance pay.
  • Home Sale Gain Exclusion – In order to claim the $250,000 ($500,000 for qualifying married taxpayers) home gain exclusion, taxpayers must generally own and use the home for 2 of the 5 years immediately prior to the home’s sale. A military taxpayer may choose to suspend the 5-year look-back period for up to 10 years when on qualified official extended duty.
    A military taxpayer who sells his or her primary residence and does not meet the 2- of-5-years ownership and use tests due to a move to a new permanent duty station may qualify for a reduced maximum exclusion amount.
  • Reservist Travel Expenses – Armed Forces reservists who travel more than 100 miles away from home and stay overnight in connection with service as a member of a reserve component can deduct travel expenses as an adjustment to their gross income. This differs from the rules for other employees, who may only deduct job-related travel expenses as a miscellaneous itemized deduction (subject to the 2% of AGI limitation). Thus, this deduction can be taken even if the reservist does not itemize his or her deductions.
  • Reservist Early Withdrawal Exception – Qualified reservists are permitted penalty-free withdrawal from IRAs, 401(k)s, and other arrangements if ordered or called to active duty for a period in excess of 179 days and if the distribution is taken during the active duty period.
  • Extension of Deadlines – The time limit for taking care of certain tax matters can be postponed. The deadlines for filing tax returns, paying taxes, filing claims for refund, and taking other actions with the IRS are automatically extended for qualifying members of the military.
  • Uniform Cost and Upkeep – If military regulations prohibit you from wearing certain uniforms when off duty, the costs and upkeep of those uniforms can be deducted, but the deductible expense must be reduced by any allowance or reimbursement that is received.
  • Joint Returns – Generally, a joint return must be signed by both spouses. However, when one spouse may not be available due to military duty, a power of attorney may be used to file a joint return.
  • Tax Forgiveness – When members of the military lose their life in a combat zone or as the result of a terrorist action, their income taxes are forgiven for the year of their death and for any prior year that ends on or after the first day of service in a combat zone.
  • ROTC Students – Subsistence allowances paid to ROTC students participating in advanced training are not taxable. However, active duty pay – such as pay received during summer advanced camp – is taxable.
  • Transitioning Back to Civilian Life – You may be able to deduct some costs that are incurred while looking for a new job. Such expenses may include travel, resume preparation fees, and outplacement agency fees. Moving expenses may be deductible if your move is closely related to starting work at a new job location and if you meet certain tests.

If you or your spouse have questions about any of the above or questions related to your designated state of residence for state tax-filing purposes, please give us a call.

Taking Advantage of Tax-Free Gifting

If you are fortunate enough to have a large estate – one large enough to be subject to the estate tax upon your death – you might be considering ways to give away some of your wealth to your family and loved ones now, thereby reducing the estate tax when you pass on.

Frequently, taxpayers think that gifts of cash, securities, or other assets they give to other individuals are tax-deductible; in turn, the gift recipient sometimes thinks income tax must be paid on the gift received. Nothing can be further from the truth. To fully understand the ramifications of gifting, one needs to realize that gift tax laws are interrelated with estate tax laws, and Uncle Sam does not want you giving away your wealth before you pass away to avoid the estate tax. For 2017, Uncle Sam allows $5.49 million (lifetime estate tax exclusion) to pass to your heirs’ estate tax free, and any excess amount is subject to an estate tax as high as 40%.

Amounts you gift prior to your death reduce the lifetime estate tax exclusion and will therefore subject more of your estate to taxation.

The law does provide exceptions where gifts can be made without reducing the lifetime exclusion, including the following:

  • $14,000 each to any number of individuals during every tax year. The amount is periodically adjusted for inflation, but the amount for 2017 is $14,000. The recipient does not have to be a relative and can be a minor.
  • Directly pay medical expenses. This applies to amounts paid by one individual on behalf of another individual directly to a medical care provider as payment for that medical care. Payments for medical insurance qualify for this exclusion.
  • Directly pay education expenses. This applies to amounts paid by one individual on behalf of another individual directly to a qualifying educational organization as tuition for that other individual. The tuition can be for any level of schooling – elementary, secondary and post-secondary. Costs of room and board aren’t eligible as direct payments, nor are contributions to qualified tuition programs (also known as Sec. 529 plans), which have their own gifting rules not covered in this article.

If the gift giver is married and both spouses agree, gifts to recipients made during a calendar year can be treated as split between the husband and wife, even if only one of them made the cash or property gift. Thus, by using this technique, a married couple can give $28,000 a year to each recipient under the annual limitation discussed previously.

Gifting Techniques:

High-Wealth Individuals – If you are a high-wealth individual who would like to pass on as much to your heirs as possible while living without reducing the lifetime exemption, you could directly pay your heirs’ medical expenses and education expenses in addition to annual gifts of cash or property of up to $14,000. You may want to do this, even if you are not a high-worth individual, to avoid having to file a gift tax return.

Medical Expenses – Except in rare circumstances, you cannot deduct the medical expenses you pay for another person, and they cannot deduct the expenses either, since they did not pay the expenses. Thus, careful consideration should be given regarding whether you make the gift directly to the individual, subject to the $14,000 annual limit – which would allow the recipient of your generosity to pay the medical expenses and claim the medical deduction on his or her tax return – or whether you pay the medical expenses directly. If the medical expenses you want to pay are greater than $14,000, then you could always gift $14,000 to the individual and pay the balance directly to the care provider(s) to avoid reducing your lifetime exclusion. Under rare circumstances, the recipient who will benefit from your gifts may qualify as your medical dependent, under which circumstance you would be able to deduct the medical expenses if they had been paid directly to the doctor, hospital or other provider.

Education Expenses – When you pay the qualified post-secondary education tuition for another individual, it does not mean – as is usually the case for medical expenses – that someone cannot benefit taxwise. Tax law says that whoever claims the exemption for the student is entitled to the American Opportunity Credit or Lifetime Learning Credit for higher education expenses if they otherwise qualify.

Gifts of Appreciated Property – Consider replacing your cash gifts with gifts of appreciated property, such as stock for which you have a “paper gain.” When you gift an appreciated asset, the potential gain on the asset transfers to the recipient. This works for individuals, except for children who are subject to the kiddie tax, which requires the child’s income to be taxed at the parent’s tax rate if it is higher than the child’s rate. It also works great for contributions to charitable organizations. Although not subject to the gift tax rules, not only does an appreciated asset gifted to a charity get you out of reporting any gain from the appreciation, but you also get a charitable tax deduction equal to the fair market value (FMV) of the asset. The deduction for these gifts is generally limited to 30% of your adjusted gross income (AGI), but the excess carries over for up to five years of future returns.

Please call this office if you need assistance with planning your gifting strategies.

Does Your Employer Misclassify You as an Independent Contractor Instead of as an Employee?

It is not uncommon for employers to misclassify employees as independent contractors, either to intentionally avoid their withholding and tax responsibilities or because they are not aware of the laws regarding the issue. If your employer reports your income on a Form 1099 (as opposed to a W-2), you are being treated as an independent contractor, not as an employee. This can have significant ramifications in terms of how much you have to pay in income, Social Security, and Medicare taxes.

The general distinction, of course, is that an employee is an individual who works under the direction and control of an employer, and an independent contractor is a business owner or contractor who provides services to other businesses.

To determine whether a worker is an independent contractor or an employee, the IRS examines the relationship between the worker and the business and considers all evidence regarding control and independence. This evidence falls into the following three categories:

(1) Behavioral control covers whether the business has the right to direct or control how the work is done through instructions, training, or other means. Employees are generally given instructions on when and where to work, what tools to use, where to purchase supplies, what order to follow, and so on.

(2) Financial control covers whether the business has the right to control the financial and business aspects of the worker’s job. This includes the extent to which the worker has unreimbursed business expenses; the extent of his or her investment in the facilities being used; the extent to which his or her services are made available to the relevant market; how he or she is paid; and the extent to which he or she can realize a profit or incur a loss.

(3) Type of relationship includes any written contracts that describe the relationship the parties intended to create; the extent to which the worker is available to perform services for other, similar businesses; whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay; the permanency of the relationship; and the extent to which the worker’s services are a key aspect of the company’s regular business.

When a worker’s status is in doubt, Form SS-8 (Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding) can be used. This form may be completed by an employer or a worker; it asks the IRS to determine whether the worker is an employee or an independent contractor for federal tax purposes. Form SS-8 is filed separately from the requestor’s tax return. The IRS does not issue determinations for proposed employment arrangements or hypothetical situations, and it will only issue a determination if the statute of limitations for the year at issue hasn’t expired.

If an employee wants to avoid paying self-employed tax on 1099-MISC income after he or she has already been determined to be an employee – or when he or she has filed an SS-8 but has not received a response – that individual can file Form 8919, which only requires payment of what would have been withheld if the worker had been treated as an employee. Form 8919 requires the employee to choose one of these codes:

Code A. I filed Form SS-8 and received a determination letter stating that I am an employee of this firm.
Code C. I received other correspondence from the IRS that states I am an employee.
Code G. I filed Form SS-8 with the IRS but have not received a reply.
Code H. I received a Form W-2 and a Form 1099-MISC from this firm for the same tax year. The amount on Form 1099-MISC should have been included as wages on the Form W-2.

If using Code H, do not file an SS-8. Here are some examples of amounts that are sometimes erroneously included (but not necessarily deliberately misclassified) on Form 1099-MISC and that should be reported as wages on Form W-2: employee bonuses, awards, travel expense reimbursements not paid under an accountable plan, scholarships, and signing bonuses.

If Code G is used, both the employee and the firm that paid the employee may be contacted for additional information. Use of this code is not a guarantee that the IRS will agree with the worker’s opinion as to his or her status. If the IRS does not agree that the worker is an employee, the worker may be billed an additional amount for the employment tax, as well as penalties and interest resulting from the change in the worker’s status.

If the IRS determination is for multiple open years, the employee can amend returns for open years to recover a portion of the self-employed tax paid.

If you have questions about being misclassified as an independent contractor, please give this office a call.