First-Year Start-Up Tax Issues

If creating a start-up business were an easy thing to do, then a lot more people would be doing it. For those who make the decision to fulfill their dreams and go for it, success relies on being fully prepared. Some of the most common stressors encountered by entrepreneurs involve tax liabilities, whether business is booming or they’re struggling to keep their head above water. The best way to avoid these pitfalls is to learn about them ahead of time. Here’s what every entrepreneur needs to know.

Give Careful Consideration to the Type of Business Organization You Choose
The entity that you choose for your start-up will have a big impact on how your taxes are handled, so make sure you’ve done your research to find the option that works best for your specific situation. Factors like the state where you’re doing business and the type of business you’re operating will be a consideration, and so will your ownership profile. Businesses that don’t plan on adding partners or shareholders in the future or that anticipate changing owners in the near future are probably limited to establishing as a C corporation or an S corporation, with the former offering more flexibility on ownership shifts, as well as the possibility of international investors.

Though there’s no law to prevent you from shifting to another type of entity in the future, doing so can be disruptive, so it makes sense to take your time and choose the option that fits best and makes the most sense based on your current ownership plans.

Choosing an Accounting Method
Unless you’re an accountant or have experience and significant knowledge of accounting, it’s a good idea to sit down with a professional to determine whether you’re going to use a cash accounting method, an accrual method, or a hybrid of the two. If you don’t have a background in bookkeeping and taxes, it may seem like an academic question, but it plays a big part in determining your tax liability. A lot of the determination will also depend on the type of business you run. An experienced accountant will be able to walk you through the decision that makes the most sense and that will be easiest to implement in compliance with IRS regulations.

Putting Internal Controls in Place
As a start-up, there are certain internal controls you need to put in place to ensure that your business is running smoothly and according to your stated objectives and goals. You also want to be sure that you’re set up to provide comprehensive information for external investors. Company policies need to be written and communicated with an eye to regulations. A CPA will be invaluable in helping you get these controls in place.

Paying Attention to Compliance
Every entrepreneur likes to do things their own way, but there are some issues where compliance is key. Failure to follow the rules and regulations could lead to stiff penalties and fines, or even to your business either temporarily or permanently being shut down. In addition to paying taxes on your business’s income, you also need to find out whether your locale requires a business license and what the rules are if you’re selling either a digital or physical product over state lines. Sales tax will need to be paid, workers’ compensation insurance will need to be purchased and a policy put in place if you have even a single employee, and if you’ve organized yourself as a Delaware corporation, then you’ll need to have an annual franchise tax report prepared, filed and paid, whether you generate income or not.

Creating a Way to Track Performance and Stay on Budget
One of the biggest mistakes new business owners make is failing to create a budget and stick to it. Failure to do so can easily lead to a shortfall in available funds, including those you need to pay your tax liability. Take the time to make a reasonable budget and establish what your start-up’s key performance indicators (KPIs) are for both cutting expenses and generating income. With those issues addressed, you give yourself a solid way to measure how you’re doing, and you’re likely to find both short-term and long-term tax planning easier too.

Starting a new business is a dream come true for many, but your focus has to go beyond your own area of expertise and interest. By working with a tax professional, you can be sure that you’ve addressed the tax-related problems that have tripped up many start-up organizations.

Please call us with any questions related to creating a start-up business.

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.

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.

Surprise! Extender Bill Passed: Do You Benefit?

Congress passed the Budget Bill, and the President signed it on Friday, February 9th. To the surprise of many, the bill included a number of extenders that retroactively apply to 2017 returns. Were you lucky enough to benefit?

Needless to say, these last-minute changes may create a problem for taxpayers who have already filed their returns and will need to file amended returns to take advantage of these extenders. The retroactive changes will cause the IRS some headaches as well. Since the 2017 forms do not accommodate some of the extended provisions, the IRS will have redesign and issue updated forms or provide workaround procedures.

Listed below are the extenders that apply to individuals and small businesses. Please review them to determine if any of them may apply to you. If you have already filed, please give this office a call and let us know, so that an amended return can be prepared to take advantage of any of these changes. In some cases, it may be necessary to wait for IRS guidance if the current 2017 forms do not accommodate the extended provisions. If you have not filed yet and any of the provisions apply to you, be sure to bring them to our attention.

  • Mortgage Insurance Premiums – For years 2007 through 2016, premiums paid on mortgage insurance contracts, in connection with acquisition debt, issued after 2006 were deductible as home mortgage interest. The deductibility of these premiums has been retroactively extended through 2017. The deductible amount of the premiums phases out ratably by 10% for each $1,000 by which the taxpayer’s AGI exceeds $100,000 (10% for each $500 by which a married separate taxpayer’s AGI exceeds $50,000). If your AGI is over $109,000 ($54,500 for married separate), the deduction is totally phased out. If you itemize your deductions and have deducted the insurance premiums in the past, you generally will be able to deduct them on your 2017 return. Please note that the 2017 Schedule A does not have an entry for mortgage insurance premiums; we will have to wait for IRS guidance on how to report it on the tax return.
  • Above-the-Line Education Expenses – For years 2001 through 2016, taxpayers had the option to take a deduction, without itemizing, for higher-education tuition and related expenses. The deduction has been retroactively extended for 2017. The deduction is capped at $4,000 for an individual whose adjusted gross income (AGI) does not exceed $65,000 ($130,000 for joint filers) or $2,000 for an individual whose AGI does not exceed $80,000 ($160,000 for joint filers). Individuals who were unable to claim an education credit generally take this deduction. This deduction is claimed on Form 1040, but the current form does not provide an entry for this deduction, so we will have to wait for IRS guidance on how to handle this deduction.
  • Exclusion of Home Cancellation of Debt Income – When a lender takes a home back and the home’s fair market is less than the balance on the loan, the taxpayers will generally have cancellation of debt (COD) income. For years 2007 and through 2016 taxpayers were able to exclude up to $2 million ($1 million for married taxpayers filing separate) of the COD income. This exclusion is limited to debt that was used purchase or substantially improves a taxpayer’s primary residence and has been extended through 2017.
  • Credit For Nonbusiness Energy Property – The provision to make existing homes more energy efficient has been extended through 2017. The provision allows a credit of 10% of the amount paid or incurred by the taxpayer for qualified energy-efficient improvements such as qualifying exterior doors, windows and skylights, metal and asphalt roofs, qualifying heating and AC systems and certain insulation materials or systems, all of which must meet energy-savings requirements certified by the manufacturer. This is a lifetime credit, meaning the $500 maximum credit is reduced by credit taken in any prior year, going back as far as 2006.

The following are less frequently encountered provisions that were also extended:

  • Extension of Credit for New Qualified Fuel Cell Motor Vehicles – This provision extends through 2017 the credit for purchases of new qualified fuel cell motor vehicles. The provision allows a credit of between $4,000 and $40,000, depending on the weight of the vehicle.
  • Extension of Credit for Alternative Fuel Vehicle Refueling Property – This provision extends through 2017 the credit for installing non-hydrogen alternative fuel vehicle refueling property. (Under current law, hydrogen-related property is already eligible for the credit.) Taxpayers are allowed a credit of up to 30% of the cost to install the qualified alternative fuel vehicle refueling property.
  • Extension of Credit for 2-Wheeled Plug-In Electric Vehicles – This provision extends through 2017 the 10% credit for two-wheeled plug-in electric vehicles (capped at $2,500).
  • Extension of Credit for Energy-Efficient New Homes – The provision extends through 2017 the tax credit for manufacturers of energy-efficient residential homes. An eligible contractor may claim a tax credit of $1,000 or $2,000 for the construction or manufacture of a new energy-efficient home that meets qualifying criteria.
  • Extension of the Classification of Certain Race Horses as 3-Year Property – The provision extends the 3-year recovery period for racehorses to property placed in service during 2017.
  • Extension of Energy-Efficient Commercial Buildings Deduction – The provision extends through 2017 the deduction for energy efficiency improvements to lighting, heating, cooling, ventilation and hot water systems of commercial buildings.

There are additional provisions that generally apply to utilities, large businesses and special interests and are not included in this article.

If you have questions related to any of the above, please contact us.

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.

2018 Standard Mileage Rates Announced

As it does every year, the Internal Revenue Service recently announced the inflation- adjusted 2018 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable or medical purposes.

Beginning on Jan. 1, 2018, the standard mileage rates for the use of a car (or a van, pickup or panel truck) are:

  • 54.5 cents per mile for business miles driven (including a 25-cent-per-mile allocation for depreciation). This is up from 53.5 cents in 2017;
  • 18 cents per mile driven for medical purposes. This is up from 17 cents in 2017; and
  • 14 cents per mile driven in service of charitable organizations.

The business standard mileage rate is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical purposes is based on the variable costs as determined by the same study. The rate for using an automobile while performing services for a charitable organization is statutorily set (it can only be changed by Congressional action) and has been 14 cents per mile for over 15 years.

Important Consideration: The 2018 rates are based on 2017 fuel costs. Based on the potential for substantially higher gas prices in 2018, it may be appropriate to consider switching to the actual expense method for 2018, or at least keeping track of the actual expenses, including fuel costs, repairs, maintenance, etc., so that the option is available for 2018.

Taxpayers always have the option of calculating the actual costs of using their vehicle for business rather than using the standard mileage rates. In addition to the potential for higher fuel prices, the extension and expansion of the bonus depreciation as well as increased depreciation limitations for passenger autos in the Tax Cuts and Jobs Act may make using the actual expense method worthwhile during the first year a vehicle is placed in business service. However, the standard mileage rates cannot be used if you have used the actual method (using Sec. 179, bonus depreciation and/or MACRS depreciation) in previous years. This rule is applied on a vehicle-by-vehicle basis. In addition, the business standard mileage rate cannot be used for any vehicle used for hire or for more than four vehicles simultaneously.

Employer Reimbursement – When employers reimburse employees for business-related car expenses using the standard mileage allowance method for each substantiated employment-connected business mile, the reimbursement is tax-free if the employee substantiates to the employer the time, place, mileage and purpose of employment-connected business travel.

The Tax Cuts and Jobs Act eliminated employee business expenses as an itemized deduction, effective for 2018 through 2025. Therefore, employees may no longer take a deduction on their federal returns for unreimbursed employment-related use of their autos, light trucks or vans.

Faster Write-Offs for Heavy Sport Utility Vehicles (SUVs) – Many of today’s SUVs weigh more than 6,000 pounds and are therefore not subject to the limit rules on luxury auto depreciation; taxpayers with these vehicles can utilize both the Section 179 expense deduction (up to a maximum of $25,000) and the bonus depreciation (the Section 179 deduction must be applied before the bonus depreciation) to produce a sizable first-year tax deduction. However, the vehicle cannot exceed a gross unloaded vehicle weight of 14,000 pounds. Caution: Business autos are 5-year class life property. If the taxpayer subsequently disposes of the vehicle before the end of the 5-year period, as many do, a portion of the Section 179 expense deduction will be recaptured and must be added back to your income (SE income for self-employed individuals). The future ramifications of deducting all or a significant portion of the vehicle’s cost using Section 179 should be considered.

If you have questions related to the best methods of deducting the business use of your vehicle or the documentation required, please give us a call.

New Tax Law Cracks Down on Home Mortgage Interest

Note: The 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. These articles offer strategies you might employ to reduce your tax liability under the new tax laws.

For years, taxpayers have been able to deduct home mortgage interest on their primary and second homes as an itemized deduction, subject to certain limitations. The interest deduction was limited to the interest on up to $1 million of acquisition debt and $100,000 of equity debt.

Acquisition debt is debt incurred to purchase, construct or substantially improve a taxpayer’s principal or second home. So when you purchased your home, that original loan was acquisition debt, and if you later borrowed additional money that you used to add a room, pool, etc., that loan was also acquisition debt. However, if the total of all of your acquisition loans exceeded the $1 million limit, then the interest on the excess debt over $1 million was not deductible as acquisition debt interest.

Consumer debt interest, such as interest on auto loans and credit card debt, is not deductible as an itemized deduction. However, years ago, Congress allowed homeowners to deduct the interest on up to $100,000 of equity debt. This allowed homeowners to use the equity in their homes for any purpose and deduct the interest on the equity debt as an itemized deduction.

Well, That Has All Changed. For 2018 through 2025, the new tax law reduces the $1 million limit on home acquisition debt to $750,000 ($375,000 for married separate filers), except that the lower limit won’t apply to indebtedness incurred before December 15, 2017. That is, the $1M cap continues to apply to acquisition mortgages on primary and second residences that were already in existence prior to December 15, 2017, as well as for taxpayers who entered into a binding written contract before that date to close on the purchase of a principal residence before January 1, 2018, and who purchase that residence before April 1, 2018.

The Equity Debt Interest Deduction Is No More – Congress has yanked the rug out from under those with equity debt on their homes. Beginning in 2018, interest paid on equity debt will no longer be allowed as a deduction, regardless of when the debt was incurred.

This seems a little unfair and can have an adverse impact on individuals who used their home as a piggy bank for personal expense purposes.

Whether any of this makes any difference in light of the new higher standard deduction amounts for 2018, and whether you should be looking for ways to pay down the equity debt, will depend upon the amounts of your other itemized deductions. Please call us if you have questions.

Will Your 2018 Withholding Be Right?

Note: The 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 effect you and your family in 2018 and future years. These articles offer strategies you might employ to reduce your tax liability under the new tax laws.

One of the first trouble spots of the new tax reform is the W-2 withholding for 2018. Passage of the new law in late December hasn’t given the IRS much time to develop new withholding tables. This can be a big issue, as the recent Tax Cuts & Jobs Act (TCJA) substantially altered the tax rates and standard deductions, did away with exemption deductions, and increased the child tax credits—all elements of how the withholding allowances and tables have been structured in the past.

On January 11, the IRS released modified withholding tables for employers to use for determining employee withholding. Supposedly the new withholding tables have been crafted to use the information employers already have from employees’ prior Form W-4s on file to adjust their employees’ withholding, taking into account the tax cuts for individuals included in the TCJA.

The IRS is also working on revising the Form W-4 to reflect additional modifications in the new law, such as changes in available itemized deductions, increases in the child tax credit, the new dependent credit and repeal of the dependent exemptions deduction.

When available, the new Form W-4 can be used by employees who wish to update their withholding in response to the new law or changes in their personal circumstances in 2018 and by workers starting a new job. Until a new Form W-4 is issued, employees and employers should continue to use the 2017 Form W-4.

You are cautioned to keep an eye on your take-home pay to ensure your withholding has not changed too drastically once your employer starts using the new IRS tables. Most wage earners should see a decrease in withholding (and a larger net paycheck), but if the change is too radical you could end up owing tax next year when you file your 2018 return.

If you are self-employed and/or have other sources of taxable income in addition to wages, or if you itemize your deductions, the wage withholding by your employer based upon your existing Form W-4 probably will not provide the correct withholding, and you may need to make adjustments to your withholding allowances or even make estimated tax payments.

As 2018 is the first year that the vast majority of the provisions of TCJA will apply, you should be cautious that your withholding is not too little, resulting in a tax due next filing season, or too high, denying you the benefits of the tax cut until you receive your refund next year.

Please call us if you need assistance in determining your withholding or if you have questions about the new tax law.

Important Facts to Know About IRAs

The individual retirement account (IRA) is one of the favored ways to save money for retirement. There are two types of IRAs: the traditional IRA and the Roth IRA. The annual maximum that an individual can be contributing between the two types of IRAs is $5,500, unless the individual is 50 years of age or older, and then the maximum is increased to $6,500. The basic contribution amount is inflation adjusted annually and the amount quoted is for 2017, while the additional amount for those 50 and older is fixed at $1,000. Contributions to an IRA may or may not be tax deductible depending on the type of IRA and, in some cases, the amount of the taxpayer’s income for the contribution year and whether the taxpayer participates in an employer’s retirement plan.

Compensation – In order to contribute to either type of IRA, the taxpayer must have compensation equal to the amount of the contribution. Compensation includes wages, tips, bonuses, professional fees, commissions and net income from self-employment. Alimony recipients may treat alimony as compensation for purposes of making IRA contributions. Also, members of the military receiving excludable combat pay may count the excluded amount as compensation for IRA purposes.

Active Participation in Another Retirement Plan – When an individual is an active participant in another retirement plan, such as an employer qualified pension, profit sharing or stock bonus plan, a qualified annuity, tax-sheltered annuity, government plan or simplified employee pension plan (SEP), the deductible IRA contribution is phased out for higher-income taxpayers. For 2017, the adjusted gross income (AGI) phaseout ranges are illustrated below.

Filing Status
Single and
Head of Household
Married Joint and
Surviving Spouse
Married Filing Separate
Phaseout Range
$62,000 to $72,000
$99,000 to $119,000
$0 to $10,000

There is a special rule for those who are married and filing jointly when one spouse is not an active participant in another retirement plan. That spouse’s phase-out range is increased to AGIs between $186,000 and $196,000.

Example: Sally, age 45 and single, is employed and her only income for 2017 is W-2 wages in the amount of $67,000. She is also an active participant in her employer’s 401(k) plan. She has no adjustments to her income, so her AGI for the year is also $67,000. Since she participates in her employer’s pension plan her IRA contribution is subject to the phaseout limitations. Her AGI is halfway through the phaseout range, so her deductible IRA contribution is limited to $2,750 (1/2 of $5,500). If Sally’s AGI had been $72,000 or more, she would not be able to make a deductible IRA contribution.

These phaseout limitations only apply to the deductible amount of a traditional IRA contribution. An individual can still contribute the full amount, limited by his or her compensation, but the excess amount is treated as a nondeductible contribution to the traditional IRA and establishes a basis. Then in the future, when an IRA distribution is taken, a prorated amount of the distribution will be nontaxable.

Nondeductible Contributions – In addition to making nondeductible contributions that are ineligible for IRA deductions due to active participation and income limits, an individual can also elect to treat otherwise deductible contributions as nondeductible. However, before making nondeductible IRA contributions, an individual should first consider a Roth IRA, discussed below, as an alternative.

Spousal IRA – An often-overlooked opportunity for maximizing IRA contributions is what is referred to as a “spousal IRA.” This allows a spouse with no or very little earned income to contribute to his or her IRA as long as the other spouse has sufficient earned income to cover them both.

Example: Tony is employed and his W-2 for 2017 is $100,000. His wife, Rosa, age 45, has a small income from a part-time job totaling $900. Since her own compensation is less than the contribution limits for the year, she can base her contribution on their combined compensation of $100,900. Thus, Rosa can contribute up to $5,500 to an IRA for 2017. Without this special rule, Rosa’s contribution would be limited to $900, the amount of her own compensation.

Roth IRA – An alternative to a traditional IRA is the Roth IRA. Whereas traditional IRAs provide a tax-deductible contribution and tax-deferred accumulation, Roth IRAs provide no tax deduction but have tax-free accumulation. Thus, when retirement distributions are taken from a Roth IRA, they are tax-free. On the other hand, those taken from a traditional IRA are fully taxable except for the non-deductible contributions discussed above.

However, contributions to Roth IRAs are never tax-deductible and the allowable contribution is phased out for higher income taxpayers, regardless of whether they actively participate in an employer’s retirement plan. For 2017, the adjusted gross income (AGI) phaseout ranges for Roth IRA contributions are illustrated below.

Filing Status
Single and
Head of Household
Married Joint
Married Filing Separate
Phaseout Range
$118,000 to $133,000
$186,000 to $196,000
$0 to $10,000

Example: Rosa, in the previous example, can designate her IRA contribution to be either a deductible traditional IRA or a nondeductible Roth IRA because the couple’s AGI is under $186,000. Had the couple’s AGI been $191,000, Rosa’s allowable contribution to a deductible traditional or Roth IRA would have been limited to $2,750 because of the phaseout. The other $2,750 could have been contributed to a nondeductible traditional IRA.

Back-Door Roth IRAs – Those individuals whose incomes are too high to qualify for a Roth IRA contribution can make a traditional IRA contribution and then convert the contribution to a Roth IRA using an IRA conversion process, discussed later in this article, available to all taxpayers of any income level.

Contribution Timing – Because income (AGI) limitations apply to IRAs, contributions can be made after the close of the year, giving taxpayers time to accurately determine their AGIs for the year and the correct amount of their IRA contributions. The contribution must be made no later than the unextended due date for filing a return, which is April 15. However, if the due date falls on a weekend or holiday, the due date is extended to the next business day. So, 2017 contributions must be made by April 17, 2018.

Penalties – There is a 6% penalty on amounts contributed to an IRA in excess of the allowable contribution amount. This penalty continues to apply annually until the excess is corrected. There is also a 10% early distribution penalty on the taxable amount withdrawn from an IRA before reaching age 59½. However, some or all of the 10% penalty is waived under certain circumstances, such as for first-time homebuyers, to pay for higher education expenses, to pay for medical insurance by some unemployed individuals or when a taxpayer becomes disabled. For those wishing to retire early, the penalty can also be waived if distributions are a series of substantially equal payments over the taxpayer’s life and continue until the taxpayer reaches age 59½ or for a minimum of five years, whichever is later.

Rollovers – From time to time a taxpayer may need to take funds from the IRA. If they are returned within 60 days, the distribution is not taxable and the 10% early withdrawal penalty will not apply. However, this is only allowed once in any 12-month period. This restriction does not apply to direct trustee-to-trustee transfers when the IRA owner is switching trustees or investments. CAUTION: All IRA accounts are considered one, so this rule applies collectively to all IRA accounts, meaning that an individual cannot make an IRA-to-IRA rollover if he or she has made such a rollover involving any of his or her IRAs in the preceding 12-month period.

Conversions – To take advantage of the tax-free benefits of a Roth IRA, an IRA owner can convert a traditional IRA to a Roth IRA any time, but taxes must be paid on the amount of the taxable traditional IRA funds converted to a Roth IRA. Timing is key when making a conversion, because one would want to do that in a low-income year or make a series of conversions so as to spread the income over a number of years. If contemplating a conversion, it should be accomplished as early in life as possible to provide a longer period of tax-free accumulation.

If an IRA conversion is made and then the IRA owner later regrets making the conversion, the Roth IRA can be recharacterized as a traditional IRA up to the extended due date of the return, which for a 2017 return would be October 15, 2018. Typical reasons for recharacterizing include not being able to pay the tax on the conversion or if the IRA has dropped in value after the conversion. Starting in 2018, this will no longer be permitted.

Retirement Distributions – For both traditional and Roth IRAs, distributions can begin once a taxpayer reaches age 59½ without penalty. For traditional IRA owners, once they reach age 70½ they must begin taking what is referred to as a minimum required distribution (RMD) each year. The minimum amount is based upon current age and the value of the IRA account. Roth IRAs are not subject to the RMD requirement. Failing to take a distribution of the required minimum amount may result in a 50% penalty of the amount that should have been withdrawn but wasn’t. However, the IRS will waive the penalty under certain conditions. TIP: In any post-retirement year when your income is below the taxable threshold, you have an opportunity to withdraw from the IRA tax-free. You should consider doing so even if you don’t need the income. You can put it away in a savings account until you do need it.

As you can see, the rules regarding IRAs are complex, and this article has only covered the most commonly encountered ones. Please give us a call if you would like to discuss how IRAs would apply to your particular circumstances or if you are in need of assistance planning for your retirement.

Sold Your Home Last Year? Thinking of Selling? Read This!

If you sold your home last year, or if you are thinking about selling it, you should be aware of the many tax-related issues that could apply to that sale so that you will be prepared at tax time and not have to deal with unpleasant surprises. This article covers home sales and the home-sale gain exclusion, particularly when that gain exclusion applies and what portion of it applies. Certain special issues always affect home sales, such as the use of a portion of the home as an office or daycare center, previous use of the property as a rental, and acquisition in a tax-deferred exchange. Other frequently encountered issues are related to the “2 years out of 5” rules for ownership and use, as these rules must be followed to qualify for gain exclusion.

Home Sale Exclusion – Generally, the tax code allows for the exclusion of up to $250,000 ($500,000 for married couples) of gain from the sale of a primary residence if you lived in it and owned it for at least 2 of the 5 years immediately preceding the sale. You also cannot have previously taken a home-sale exclusion within the 2 years immediately preceding the sale. There is no limit on the number of times you can use the exclusion as long as you meet these time requirements. However, extenuating circumstances can reduce the amount of the exclusion. The home-sale exclusion only applies to a primary residence, not to a second home or a rental property.

2 out of 5 Rule – To qualify for the home-sale gain exclusion, you must have used and owned the home for 2 out the 5 years immediately preceding the sale. If you are married, both you and your spouse must meet the use requirement, but only one of you needs to meet the ownership requirement. Vacations, short absences and short rental periods do not reduce the use period. When only one spouse in a married couple qualifies, the maximum exclusion is limited to $250,000 instead of $500,000. Although this situation is quite rare, if you acquired the home as part of a tax-deferred exchange (sometimes referred to as a 1031 exchange), then you must have owned the home for a minimum of 5 years before the home-gain exclusion can apply.

Some provisions allow you to reduce your gain by a prorated amount if you were required to sell the home because of extenuating circumstances such as a job-related move, a health crisis or other unforeseen events. Another rule extends the 5-year period to account for the deployment of military members and certain other government employees. Please call this office if you have not met the “2 out of 5” rule to see if you qualify for a reduced exclusion.

Business Use of the Home – If you used your home for business—for instance, by claiming a tax deduction for a home office, storing inventory in the home or using it as a daycare center—that deduction probably included an amount to account for the home’s depreciation. In that case, up to the extent of the gain, the claimed depreciation cannot be excluded.

Figuring Gain or Loss from a Sale – The first step is to determine how much the home cost, combining purchase price and the cost of improvements. From this total cost, subtract any claimed casualty losses and any depreciation taken on the home. The result is your tax basis. Next, subtract the sale expenses and this tax basis from the sale price. The result is your net gain or loss on the sale of the home.

If the result is negative, the sale is a loss. However, losses on personal-use property such as homes cannot be claimed for tax purposes.

If the result is a gain, however, subtract any home-gain exclusion (discussed above) up to the extent of the gain. This is your taxable gain, which is, unfortunately, subject to income tax and possibly to the net-investment income tax as well. If you owned the home for at least a year and a day, the gain will a be a long-term capital gain; as such, it will be taxed at the special capital-gains rates, which range from zero for low-income taxpayers to 20% for high-income taxpayers. Depending on the amount of your income, the gain may also be subject to the 3.8% net investment income surtax that was added as part of the Affordable Care Act. The tax computation can be rather complicated, so please call us for assistance.

Another issue that can affect your home’s tax basis (discussed above) applies if you owned your home before May 7, 1997 and purchased it after selling another home. Prior to that date, instead of a home-gain exclusion, any gain from a sale was deferred to the replacement home. Although this is now rare, if it matches your situation, the deferred gain would reduce your current home’s tax basis and add to any gain.

Another Twist – If you previously used your home as a rental property, the law includes a provision that prevents you from excluding any gain attributable to the home’s appreciation while it was a rental. The law’s effective date was the beginning of 2009, which means that you only need to account for rental appreciation starting in that year. This law was passed to prevent landlords moving into their rentals for 2 years so that they could exclude the gains from those properties. Some landlords did this repeatedly.

Records – Assets that are worth hundreds of thousands of dollars, including your home, need your attention, particularly regarding records. When figuring your gain or loss, you will, at a minimum, need the escrow statement from the purchase, a list of improvements (not maintenance work) with receipts, and the final escrow statement from the sale. When you encounter any of the issues discussed in this article, you may need additional documentation.

A few other rare home-sale rules are not included here. As you can see, home-sale computations and tax reporting can be very complicated, so please call us if you need assistance.