Increased Business-Vehicle Deductions Due to Tax Reform

The Tax Cuts and Jobs Act of 2018 and other tax reforms have brought about significant changes in the way that vehicle use is deducted for business purposes. Before getting into these changes, it is appropriate to first provide a review of the two methods for deducting the use of a business vehicle.

It is important to understand that both methods require keeping track of (1) the vehicle’s total annual mileage and (2) the vehicle’s annual mileage for business purposes. When using the optional mileage rate (also referred to as the standard mileage rate), only business miles are counted. When using the actual-expense method, the operating expenses and depreciation must be prorated based on the proportion of the total mileage that was for business purposes. To document the total mileage, deduct the odometer reading on the first day of the year from that on the last day of the year. For the business mileage, keep a daily record in an appropriate ledger. Keep in mind that the IRS states that all vehicles are used personally to some extent; it will look for a proration between business and (nondeductible) personal use.

Optional Mileage Rates – The standard mileage rates for the business use of a car, van, or pickup or panel truck are shown below:

OPTIONAL MILEAGE RATES FOR BUSINESS USE
Year

Deduction per Business Mile

Imputed Depreciation*per Business Mile

2018
54.5 cents
25.0 cents
2019
58.0 cents
26.0 cents

 

*This is the amount of depreciation included in the optional mileage rate.

However, a business cannot use the standard mileage rates if it has previously used the actual-expense method (via Sec. 179, bonus depreciation, or depreciation). This rule is applied on a vehicle-by-vehicle basis. In addition, the standard mileage rate for business use cannot be applied to any vehicle that is used for hire, such as taxi, or to more than four vehicles simultaneously.

Actual-Expense Method – Taxpayers always have the option of calculating the actual costs of a vehicle’s business use rather than using the standard mileage rates. Using the actual-expense method in the year when a vehicle is placed into business service may be worthwhile due to the potential for higher fuel prices, the extension and expansion of the bonus depreciation, or increased depreciation limitations for passenger vehicles as a result of the Tax Cuts and Jobs Act. Actual expenses include the costs of the following:

  • Gasoline
  • Oil and Other Fluids
  • Lubrication
  • Repairs
  • Registration
  • Insurance
  • Depreciation (or lease payments)
  • Interest

Vehicle Depreciation – The so-called luxury-vehicle rules limit the annual depreciation deduction for vehicles that weigh 6,000 pounds or less.

The recent tax reform substantially increased these limits by providing much larger first- and second-year deductions for more expensive vehicles. The table below displays the limits for vehicles that were placed into service in 2018. These rates will be adjusted based on inflation in future years.

The recent tax reform also included the option for the taxpayer to add a 100% bonus depreciation to the first-year luxury-vehicle rates (see the amount for “First Year with Bonus” in the table below). However, if a vehicle was purchased before September 28, 2017 (but was not put into service until 2018), the first-year depreciation cap with the bonus is reduced from $18,000 to $16,400.

Prior to 2018, the depreciation values for vans and light trucks were different from those for cars. In 2018, the depreciation limits are the same for both categories, but in future years, the limits may diverge because separate inflation adjustments will apply to the two categories.

LUXURY-VEHICLE DEPRECIATION LIMITS
2018
2019
First Year
$10,000
These rates will be inflation-adjusted, but the IRS has not yet provided the 2019 amounts.
First Year with Bonus
$18,000
Second Year
$16,000
Third Year
$9,600
Each Year Thereafter
$5,760

SUVs – Because vehicles that weigh more than 6,000 pounds are not subject to the luxury-vehicle limits, the first-year deductions for such vehicles can be larger than those for smaller vehicles. The bonus depreciation for SUVs is 100% (through 2022), so the portion of the use that is for business can be fully expensed in the year when the SUV is placed in service. SUVs with gross vehicle weight of more than 6,000 pounds but less than 14,000 pounds are qualified for Sec. 179, which allows a business to expense up to $25,000 if the vehicle is placed in service during 2018 or $25,500 if it is put into service in 2019.

Interest Expenses – Self-employed taxpayers may also deduct the business-use portion of the interest paid on vehicle loans on Schedule C. regardless of whether they use the standard mileage rate or the actual-expense method.

Business-Vehicle Sales or Trade-ins – Under prior law, a good tax strategy was to trade in a vehicle instead of selling it if the sale would result in a gain, as this would defer the gain into the replacement vehicle and thus avoid tax on the gain. Conversely, it was good practice to sell a vehicle for a loss so as to take advantage of the tax loss. Unfortunately, since the recent tax reform, tax-deferred exchanges are no longer allowed, except for real estate. The aforementioned strategies are thus no longer valid, and all vehicle trade-ins are treated as sales: Any gain is taxable, and any loss is deductible. However, if a vehicle is used solely for personal purposes, a loss from a sale is not deductible; if a vehicle is used for both business and personal reasons, then only the business portion of a loss on a sale is deductible.

Employees – The recent tax reform also eliminated the itemized deductions for employees’ business expenses. Before 2018, employees could deduct the business use of their vehicles, but, starting with the 2018 returns, employees can no longer deduct business-vehicle expenses.

Plug-in Electric Vehicles – Purchasing a plug-in electric vehicle may qualify a taxpayer for a tax credit of up to $7,500 (depending on the manufacturer) in the year of the purchase. The credit for a given car is based on the kilowatt capacity of its battery; the full credit applies to the first 200,000 vehicles that each manufacturer sells, after which there is a phase-out regime. Tesla is the first manufacturer to enter the phase-out period, as it reached the 200,000-vehicle cap in 2018. Thus, the credit for 2019 is limited to $3,750 for Tesla vehicles acquired in January through June and $1,875 for those acquired in July through December. After 2019, there will be no credit for Tesla purchases. The amount of credit for each vehicle is available on the IRS’s website. Note that this credit is per vehicle, not per taxpayer, so a taxpayer who purchases multiple vehicles during a given year can claim the credit for each (subject to certain limitations).

When a plug-in electric vehicle is used for both business and personal purposes, its credit is prorated based on the mileage for each usage. The personal portion of the credit is a nonrefundable personal credit that cannot be carried over. The business portion of the credit is also nonrefundable, but it is added to the general business credit and can be carried backward for one year and forward for 20 years or until the credit is used up, whichever occurs first.

The tax rules for business vehicles can be quite complicated. To maximize your benefits, please contact us for assistance.

Big Tax Changes for Divorce Decrees after 2018

Welcome to 2019 and a delayed provision of the tax reform, also known as the Tax Cuts and Jobs Act (TCJA). For divorce agreements entered into after December 31, 2018, or pre-existing agreements that are modified after that date to expressly provide that alimony received is not included in the recipient’s income, alimony will no longer be deductible by the payer and won’t be income to the recipient.

This is in stark contrast to the treatment of alimony payments under decrees entered into and finalized before the end of 2018, for which alimony will continue to be deductible by the payer and income to the recipient.

Having the alimony treated one way for one segment of the population and the exact opposite for another group of individuals seems unfair and may ultimately make its way into the court system. But in the meantime, parties to a divorce action need to be aware of the change and compensate for it in their divorce negotiations, for a decree entered into after 2018.

This is not the first time Congress has tinkered with alimony. Way back in the mid-1980s, the definition of alimony was altered to prevent property settlements and child support from being deducted as alimony. Under the definition of alimony since then, payments:

(1) Must be in cash, paid to the spouse, the ex-spouse, or a third party on behalf of a spouse or ex-spouse, and the payments must be made after the divorce decree. If made under a separation agreement, the payment must be made after execution of that agreement.

(2) Must be required by a decree or instrument incident to divorce, a written separation agreement, or a support decree that does not designate payments as non-deductible by the payer or excludable by the payee. Voluntary payments to an ex-spouse do not count as alimony payments.

(3) Cannot be designated as child support. Child support is not alimony.

(4) Are valid alimony only if the taxpayers live apart after the decree. Spouses who share the same household can’t qualify for alimony deductions. This is true even if the spouses live separately within a dwelling unit.

(5) Must end on the death of the payee (recipient) spouse. If the divorce decree is silent, courts will generally consider state law, and where state law is vague, judges may make their own decision based on the facts and circumstances of the case.

(6) Cannot be contingent on the status of a child. That is, any amount that is discontinued when a child reaches 18, moves away, etc., is not alimony.

Taxable alimony payments under pre-2019 decrees and agreements are treated as earned income for IRA contribution purposes, allowing the spouse receiving the alimony to make IRA contributions based upon the alimony. The ability to make IRA contributions under pre-2019 decrees and agreements remains unchanged. However, for alimony received as a result of a post-2018 decree or agreement, the alimony can no longer be used as a basis for making an IRA contribution.

To summarize:
Pre-2019 Decrees – For decrees entered into before 2019 and unmodified after 2018:

  • Alimony continues to be deductible by the payer spouse/ex-spouse.
  • Alimony is includable in the income of the recipient spouse/ex-spouse.
  • The recipient spouse/ex-spouse can make IRA contributions based upon the alimony received.

Post-2018 Decrees– For decrees entered into after 2018 (and pre-2019 decrees that are modified and include the TCJA alimony rules): Alimony is not deductible by the payer-spouse/ex-spouse.

  • Alimony is not includable in the income of the recipient spouse/ex-spouse.
  • The recipient spouse/ex-spouse cannot make IRA contributions based upon the alimony received.

One additional complication is if state tax treatment is different than that at the federal level. Some states, such as California, have not conformed to the TCJA; as a result, the state treatment of alimony paid under both pre-2019 and post-2018 decrees in these states will continue to follow pre-2019 law, with alimony payments continuing to be deductible and alimony received being taxable.

If you have questions related to alimony or about how your state will tax alimony beginning in 2019, please give us a call.

Will Gifts Now Using the Temporarily Increased Gift-Estate Exclusion Harm Estates after 2025?

Individuals with large estates generally want to gift portions of their estate to beneficiaries while they are still living, to avoid or lessen the estate tax when they pass away. That can be done through annual gifts (up to the inflation-adjusted annual limit for each gift recipient each year – $15,000 for 2019) and/or by utilizing the unified gift-estate exclusion for gifts in excess of the annual exclusion amount. The tax reform virtually doubled the unified gift-estate exclusion for years 2018 through 2025, after which – unless further extended by Congress – it will return to its inflation-adjusted former amount. This has caused concerns related to what the tax consequences will be for post-2025 estates if the decedent, while alive, had made gifts during the 2018-through-2025 period utilizing the higher unified gift-estate exclusion. Would that cause a claw back due to the reduced exclusion?

The Treasury Department has proposed taxpayer-friendly regulations to implement changes made by the tax reform, the 2017 Tax Cuts and Jobs Act (TCJA). As a result, individuals planning to make large gifts between 2018 and 2025 can do so without concern that they will lose the tax benefit of the higher exclusion level for those gifts once the exclusion decreases after 2025.

In general, gift and estate taxes are calculated using a unified rate schedule on taxable transfers of money, property, and other assets. Any tax due is determined after applying a credit based on an applicable exclusion amount.

The applicable exclusion amount is the sum of the basic exclusion amount established in the statute plus other elements (if applicable) described in the proposed regulations. The credit is first used during life to offset gift tax, and any remaining credit is available to reduce or eliminate estate tax.

The TCJA temporarily increased the basic exclusion amount from $5 million to $10 million for tax years 2018 through 2025, with both dollar amounts adjusted for inflation. For 2018, the inflation-adjusted basic exclusion amount is $11.18 million; for 2019, it is $11.4 million. In 2026, the basic exclusion amount will revert to the 2017 level of $5 million, adjusted for inflation.

To address concerns that an estate tax could apply to gifts exempt from gift tax through the increased basic exclusion amount, the proposed regulations provide a special rule that allows the estate to compute its estate tax credit using the higher of the basic exclusion amount applicable to gifts made during life or the basic exclusion amount applicable on the date of death.

If you have any questions related to gifting and estate planning, please give call us to schedule a consultation.

Year-end Tax Planning Is Not Business as Usual: Things You Need to Know

This has been a tumultuous year for taxes, with the tax reform that passed in late 2017 generally becoming effective in 2018, often with significant changes for both individuals and businesses. This is the first major tax reform legislation in more than 30 years. To implement it, the IRS will have to create or revise approximately 450 forms, publications and instructions and modify around 140 information technology systems. All of these changes are to ensure it can accommodate the newly revised or created tax forms, not to mention writing tax regulations for all of these changes – a daunting task for sure. The following issues could affect you and you may need to plan ahead.

Refund or Tax Due? – Most taxpayers are equating the recent tax reform to a larger refund when their 2018 tax return is prepared. However, that may not be the case because your tax refund is the difference between what you prepaid through payroll withholding and estimated tax payments and what you owe. Even if your tax bill is lower, if your prepayments were also lower, then your refund may not be as expected.

The passage of tax reform came on December 20, 2017, just days before employers needed Form W-4 – the Employee’s Withholding Allowance Certificate – for 2018 withholding information from their employees, which did not give the IRS time to adjust the form and withholding tables for the new law. It was not until late February that the IRS published revised withholding tables and an updated Form W-4. Even then, there was concern that some employers might be using the old W-4 with the new tables. On top of that, many taxpayers and tax professionals were finding that the revised W-4 and withholding tables did not produce an accurate result. The bottom line is that there is a real concern that many taxpayers are in for an unpleasant surprise at tax time – so much so that the IRS has been issuing almost daily notices warning taxpayers that they may be under-withheld. This is a real concern for 2018 returns, and you may wish to fine-tune your withholding before year’s end.

Underpayment of Taxes: Should your liability be greater than your prepayments by $1,000 or more, you may also be subject to underpayment penalties. This could simply be the result of under-withholding on your wages or underpaying estimated tax if you are self-employed, or of out-of-the-ordinary income, such as stock gains, sale of a business or rental or even winning big from the lottery. There are safe harbor prepayments to avoid a penalty, which require prepaying:

  • 90% of the current year’s tax liability,
  • 100% of the prior year’s tax liability, or
  • 110% of the prior year’s tax liability, if the prior year’s AGI was over $150,000.

If you are underpaid, there is still time to make adjustments and avoid or mitigate the penalty. Adjusting your payroll withholding is the best option, since withholding is treated as being paid ratably throughout the year, and the penalty is computed on a quarterly basis based on the prepayments through that quarter. However, as the end of the year gets closer, there is less and less time for revised withholding to kick in, so don’t delay in notifying your employer if you need to increase your withholding.

Alternative Minimum Tax (AMT): Although Congress had promised to repeal both individual and corporate AMT, they only repealed the corporate AMT. However, even though they didn’t repeal it for individuals, the tax reform act did increase the exemption amounts and phase-out thresholds, and it eliminated certain deductions that triggered the AMT, so that the AMT will impact fewer taxpayers, giving rise to these possible strategies:

Exercise Incentive Stock Options – These changes to the AMT may allow larger blocks of incentive stock options to be exercised, and the stock that’s issued can be held long-term and thus enjoy the lower capital gains tax rates without triggering the AMT. Some tax planning may be required, which may be a multi-year endeavor.

Recapture AMT – The higher exemptions and phase-outs provide a greater opportunity for taxpayers with AMT tax credit carryover to recapture AMT paid in prior years. If the current year’s regular tax exceeds the AMT, a taxpayer can claim the AMT credit carryover for the difference.

Avoid the Minimum Required Distribution Penalties: Once taxpayers reach the age of 70.5, they are required to take what is known as a “required minimum distribution” from their qualified retirement plan or IRA every year. If this is the first year that this rule applies to you and you haven’t taken your money out yet, there’s no need to panic – you don’t have to do so until some time during the first quarter of next year. Of course, if you wait until 2019 to take your 2018 distribution, you’re going to end up having to take two distributions in one year: one for 2018 and one for 2019. For those who fell into this category before 2018, you only have until December 31st to withdraw your 2018 distribution to avoid penalties.

Convert into a Roth IRA: If you have a traditional IRA and your income for 2018 has been very low, you may want to consider converting your traditional IRA into a Roth IRA and taking advantage of the tax-free distribution benefits of a Roth IRA in the future, especially if you can do so with little or no tax on the conversions. This will probably require a tax projection to determine an amount to convert and the tax cost, if any, of the conversion. However, the tax reform made conversions permanent, and once made, the conversion cannot be undone.

Review Portfolio for Losses: The conventional strategy is to offset as much of your gains as possible with losses from selling other assets in your portfolio. If you have an overall loss, the loss that can be used to offset income other than capital gains is limited to $3,000 ($1,500 for married taxpayers filing separately), and any excess loss carries over to the next year. Keep in mind that losses from the sale of business assets are generally separately allowed in full in the year of sale and are not mixed with the losses from the sale of capital assets.

Assets that are sold and not held long-term, referred to as short-term capital gains, do not receive the benefit of the special rates afforded to long-term capital gains. Taxpayers achieve a better overall tax benefit if they can arrange their transactions to offset short-term capital gains with long-term capital losses.

Make the Most of Higher Education Tax Credits: Both the Lifetime Learning education credit and the American Opportunity Credit allow qualified taxpayers who prepaid tuition bills in 2018 for an academic period that begins by the end of March 2019 to use the prepayments when claiming the 2018 credit. That means that if you are eligible to take the credit and you have not yet reached the 2018 maximum credit for qualified tuition and related expenses paid, you can bump up your credits by paying early for 2019 now. This may not apply to you if you’ve been paying tuition expenses for the entire 2018 tax year, but it will probably provide you with some additional help if your student just started college this fall.

Optimize Health Savings Account Contributions: Did you become eligible to make contributions to a Health Savings Account this year? If so, then you can make deductible contributions into that account up to its maximum amount, no matter when you became eligible. For 2018, the maximum deduction for self-only coverage is $3,450; for family coverage, it is $6,900. Empty Flexible Spending Accounts: If you have a flexible spending account, double-check to see if any remaining account balance can be used for medical expenses, including eyeglasses and/or other health care items covered by the FSA. Remember: funds not used by the account deadline will be forfeited.

Bunch Charitable Deductions: Many people who itemize take advantage of the ability to take a deduction for their donation to their favorite charity or house of worship. Did you know that you can choose to pay all or part of your 2019 planned giving in 2018 to increase the amount you deduct in 2018? Though this may not be appealing to those who itemize every year, you may find this to be an effective strategy if you only marginally itemize every year. Implementing this strategy means you will alternate between taking the standard deduction one year and itemizing the next, giving you a big boost in deductions on the year when you itemize.

Additionally, those who are required to take a required minimum distribution from their IRA because they are 70.5 or older can have their RMD paid directly to a qualified charity, and instead of getting a charitable deduction, the distribution is tax-free, which in turn might reduce the amount of your taxable Social Security income. If this strategy appeals to you, don’t wait until the last minute to implement it, as your IRA trustee or custodian will need time to process the paperwork and make the distribution to the charity or charities you designate.

Deductions – Although the tax reform increased the standard deduction, possibly making it a better choice for the federal return for some, most states did not conform to the federal changes, making it business as usual for itemizing on the state return.

Remember the Annual Gift Tax Exemption: One of the best ways to ultimately reduce your estate taxes and at the same time give to those you love is to take advantage of the annual gift tax exemption. Although the gifts are not tax-deductible, for tax year 2018, you are able to give $15,000 to each of as many people as you want without having to report the transfer to the government or pay any gift tax. If this is something that you want to do, make sure that you do so by the end of the year, as you are not able to carry the $15,000 over into 2019.

Home Equity Debt: The interest on home equity debt is not allowed as an itemized deduction for years 2018 through 2025. (Note: the term equity debt has a different meaning for tax purposes than for lenders. For tax purposes what lenders refer to as equity debt can actually be acquisition debt and may still be deductible if used to purchase or substantially improve a taxpayers home or second home.) But that doesn’t mean equity interest can’t be deducted somewhere else on your return as investment interest or business interest, if you can trace the use of the loan funds to a deductible use.

Retirement Savings: Be sure to maximize your retirement plan contributions before year-end. Once the year is gone, you have forever lost an opportunity to make this year’s annual tax-advantaged addition to your savings for future retirement, which won’t be all that pleasant without a substantial retirement nest egg. If your employer matches some of the amount you contribute to your 401(k) or another eligible retirement plan, be sure to contribute as much as you can to take full advantage of this perk. If the contributions are tax-deductible, such as to a traditional IRA, or made with pre-tax income, maximizing the contributions may also cut your tax bill.

Divorce in the Future: If you or someone you know is contemplating divorce, you should be aware of a big tax change related to alimony. For divorces finalized by the end of 2018, alimony payments are deductible by the one paying them and considered income to the one receiving them. However, for divorces finalized after 2018, alimony is no longer deductible by the payer and is no longer taxable for the recipient. This can have a significant impact on the terms negotiated during a divorce.

Maximize Business Expenses: Beginning in 2018, business owners are able to write off most business purchases using the very liberal 100% bonus depreciation and the Sec. 179 expensing allowance. But to benefit, the business asset must not only be purchased before year’s end, it must also be placed into service by year’s end.

New Flow-Through Deduction: Individuals with taxable incomes (net of capital gains) less than $157,500 and married couples filing jointly with taxable incomes less than $315,000 will enjoy the benefits of the new 20% pass-through deduction from business entities other than C-corporations. Taxpayers with higher incomes will want to determine if any change in compensation structure might increase the deduction.

Additionally, S-corporation employee-stockholders will need to make sure their salary meets the “reasonable compensation” requirements, since the wages are a critical factor in determining the flow-through deduction from an S-corporation.

Every taxpayer’s situation is unique, not all of the suggestions offered here may apply to you, and by no means does the list include all the changes brought about by tax reform. However, they cover many of the major issues for taxpayers and small businesses. If you had any major business, income, or family changes or if any of the issues discussed affect you, a year-end tax planning appointment may be appropriate. The best way to ensure that you are putting yourself into the best tax-advantaged position is to consider all of your tax options. Please call us with questions or to schedule an appointment.

Tax Reform 2.0 Is in the Works

The dust has not yet settled from the Tax Cuts and Jobs Act (TCJA), passed into law in December 2017, and the House Ways and Means Committee is already considering another round of tax changes. The committee chair, Kevin Brady, Republican from Texas, wants to include input from stakeholders such as business groups, think tanks and other relevant organizations. Historically, major tax reforms have been decades apart, so the committee chair is looking for another approach to the way Washington deals with tax policy.

As with all tax legislation, it begins with talking points. From what we can gather, it appears the focus of Tax Reform 2.0 will include:

  • Making the first round of individual and pass-through business deductions permanent.
  • Focusing on retirement savings and creating a flexible universal savings account so individuals are accustomed to saving for retirement earlier in life.
  • Making it easier for small businesses to participate in multi-employer retirement plans.
  • Looking for ways to help the Treasury implement the TCJA.
  • Providing new business start-ups with greater expensing options for start-up costs.
  • Identifying technical corrections needed for the TCJA.

Commentators believe that making the selected TCJA changes permanent will be a tough sell in Congress at this time, as there is little to no support from the Democratic side of the aisle. However, the retirement savings ideas will probably have a favorable reception and have a good chance of passing.

Stay tuned for further developments and if you have any questions or concerns in the interim, please do not hesitate to contact us.

Clergy Tax Benefits Under Fire

Section 107 of the Internal Revenue Code provides that a minister of the gospel’s gross income doesn’t include the rental value of a home (parsonage) provided; if the home itself isn’t provided, a rental allowance paid as part of compensation for ministerial services is excludable. The benefit is generally referred to as a parsonage allowance. Thus, a minister can exclude the fair rental value (FRV) of the parsonage from income under IRC Sec. 107(1), or the rental allowance under Sec. 107(2), for income tax purposes. The Sec. 107(2) rental allowance is excludable only to the extent that it is for expenses such as rent, mortgage payments, utilities, repairs, etc., used in providing the minister’s main home, and only up to the amount of the FRV of the home.

However, either type of parsonage allowance is only excludable for income tax purposes and is subject to self-employment taxes, although for years before 2018 and after 2025, the amount subject to self-employment tax can be reduced by the minister of the gospel’s employee business expenses.

Back in October 6, 2017, in the US District Court for the Western District of Wisconsin, Judge Barbara B. Crabb, in Gaylor v. Mnuchin (the treasury secretary), concluded that Section 107(2) of the Internal Revenue Code is unconstitutional. Specifically, she concluded that this code section violates the Establishment Clause of the First Amendment because it does not have a secular purpose or effect and because a reasonable observer would view the statute as being an endorsement of religion.

The code section under judicial fire is the part of code Sec. 107 allowing churches and other religious organizations the ability to provide tax-free housing to their ordained ministers, even though the housing is not provided in kind by the church or the religious organization. This provision of the code was envisioned to provide ministers of the gospel with modest tax-free housing. However, it contains no limitations on its application and, as a result, also applies to:

  • Televangelists like Joel Osteen, who uses this tax provision to live tax-free in his multi-million dollar mansion.
  • Other ordained ministers working in church-affiliated schools as teachers and administrators who also benefit from the provision.

It has been estimated that the government foregoes in excess of $800 million in tax revenues because of the provision.

Judge Crabb, in issuing her decision, directed the parties to file supplemental materials regarding what additional remedies are appropriate, if any. The judge subsequently stayed injunctive relief until 180 days after the final resolution of all appeals. The additional time will allow Congress, the IRS and affected individuals and organizations to adjust to the substantial change. This case will certainly be appealed to the circuit court and eventually to the Supreme Court. So, we will need to keep our eyes on this case and see how it plays out in the long run.

It should be emphasized that Sec. 107(1), which permits an amount equal to the rental value of a parsonage furnished to a minister as part of his or her compensation to be excluded from income, is not affected by Judge Crabb’s ruling; thus, this benefit continues to be income-tax free.

Ministers of the gospel will also feel one of the negative aspects of the Tax Cuts & Jobs Act of 2017 (aka tax reform), which suspended the deduction for employee business expenses. Thus, beginning in 2018 and through 2025, ministers of the gospel will no longer be able to reduce the amount of their housing allowance by their employee business expenses when computing their self-employment taxes.

If you have questions related to taxation issues for ministers of the gospel, please call us.

Big Changes for Vehicle Tax Deductions

In the past, the business use of a vehicle was determined either by using the standard mileage rate for business or using actual expenses plus vehicle depreciation limited by the luxury auto caps. That continues to be the case, except the luxury auto depreciation limit has been substantially increased. In addition, there are other changes as detailed in this article.

Standard Mileage Rates – The standard mileage rates for the business use of a car (or a van, pickup, or panel truck) are:

STANDARD MILEAGE RATES FOR BUSINESS
2017
2018
53.5 Cents Per Mile
54.5 Cents Per Mile

However, the standard mileage rates cannot be used if you have used the actual expense 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.

Actual Expense Method – 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. Actual expenses include:

  • Gasoline
  • Oil
  • Lubrication
  • Repairs
  • Vehicle registration fees
  • Insurance
  • Depreciation (or lease payments).

However, these expenses must be allocated between deductible business use and nondeductible personal use, making it necessary to keep records of business miles and total miles in order to document the allocation between business and personal use.

Vehicle Depreciation – The so-called “luxury auto” rules limit the annual deduction for depreciation. Tax reform substantially increased these limits providing much larger first and second-year deductions for more expensive vehicles. The table below displays the limits that apply to vehicles placed in service in 2017 and 2018 and shows the substantial increase for 2018. These rates are inflation adjusted in subsequent years.

Tax reform also included 100% bonus depreciation, which, at the election of the taxpayer, can be added to the first-year luxury auto rates (see the amounts for “First Year with Bonus” in the table below). However, instead of an $8,000 increase, if the vehicle was purchased before September 28, 2017, but not put into service until 2018 or 2019, the increase to the first year depreciation cap is only $6,400 or $4,800, respectively, rather than $8,000.

LUXURY AUTO DEPRECIATION LIMITS
Trucks & Vans
Automobiles
2017
2018
2017
2018
First Year
3,560
10,000
3,160
10,000
First Year with Bonus
11,560
18,000
11,160
18,000
Second Year
5,700
16,000
5,100
16,000
Third Year
3,450
9,600
3,050
9,600
Thereafter
2,075
5,760
1,875
5,760

Vehicle Interest Expenses – Regardless of whether the standard mileage rate or actual expense method is used, a self-employed taxpayer may also deduct the business use portion of interest paid on an auto loan on their Schedule C. However, employees may not deduct interest paid on a consumer car loan.

Sale or Trade-in of a Business Vehicle – Under prior law, it was good tax strategy to trade-in a vehicle that would result in a gain, thus deferring the gain into the replacement vehicle and avoiding the tax on the gain. On the other hand, it was good practice to sell a vehicle for a loss and take advantage of the tax loss. Unfortunately tax reform no longer allows tax-deferred exchanges for anything but real estate. This does away with the aforementioned strategies, and now all sales and trade-ins are treated as sales, with any gain being taxable and any loss being deductible. However, a loss on the sale of a vehicle used solely for personal purposes is not deductible, and if the vehicle was used both for business and personal reasons, only the business portion of the loss is deductible.

Employees – Tax reform also eliminates the itemized deduction for employee business expenses; this is the place on the tax return where employees could deduct the business use of their vehicle for their employer. Thus, business vehicle expenses are no longer deductible by employees.

Please call us if you have questions related to the business use of your vehicle.

How Some High-Income Taxpayers Can Maximize the New 20% Pass-through Business Deduction

Taxpayers with higher 1040 taxable incomes who are self-employed but are not “specified service businesses” may find it beneficial to structure new businesses, or restructure an existing business, as an S corporation to avoid taxable income limitations that apply to the new 20% Sec. 199A pass-through deduction.

To make up for the tax reform’s reduction of the C corporation tax rate to 21%, from which other forms of business activities do not benefit, Congress created a new deduction and code section: 199A. The 199A deduction is for taxpayers with other business activities – such as sole proprietorships, rentals, partnerships and S corporations – since, unlike C corporations, which are directly taxed on their profits, the income from the other business activities flows through to the owner’s tax return and is taxed at the individual level, i.e., at the individual’s tax rate, which can be as high as 37%.

This new Sec. 199A deduction is 20% of the pass-through income from these business activities. But not every owner of these flow-through businesses will benefit from this deduction because, as in all things tax, there are limitations.

Whether or not a taxpayer will benefit from the deduction will depend in great part upon the taxpayer’s 1040 taxable income figured without the Sec. 199A deduction. Married taxpayers with a taxable income below $315,000 (or below $157,500, for others) will benefit from the full 20% deduction.

However, limitations begin to apply when a taxpayer’s 1040 taxable income exceeds those amounts. The most restrictive limitation is the one placed on “specified service businesses.” Once married taxpayers filing jointly have a 1040 taxable income exceeding $415,000 (or above $207,500, for others), they receive no Sec 199A deduction benefit from any pass-through income derived from a specified service business. Specified service businesses include trades or businesses involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services or any trade or business in which the principal asset of the trade or business is the reputation or skill of one or more of its employees or owners. Note that an engineering or architecture business is not a specified service business for this deduction.

On the other hand, a taxpayer can still benefit from pass-through income from other business activities, even when the taxpayer’s 1040 taxable income exceeds the $415,000/$207,500 limits, provided the business activity pays wages and/or has qualified business property, the combination of which make up what is referred to as the wage limitation. Without getting too complicated, the Sec. 199A deduction is the lesser of 20% of one’s pass-through income or the wage limitation. If the wage limit is zero, then the Sec. 199A deduction would also be zero for these high-income taxpayers. The wage limitation itself is the greater of 50% of the wages paid by the business activity or 25% of the wages paid plus 2.5% of the cost of qualified business property. Perhaps this is best explained by example.

Example #1: Peter and his wife have a 1040 taxable income of $475,000. Peter has a self-employed business (not a specified service business), from which he has a net profit of $300,000, and his tentative 199A deduction is $60,000 (20% of $300,000). However, because his taxable income exceeds $415,000, his Sec. 199A deduction is the lesser of $60,000 or the wage limit. Peter has no employees or qualified business property, so his wage limitation is zero; thus, his Sec. 199A deduction is also zero.

Example #2: Same as example #1, except Peter’s business is organized as an S corporation. Of his net profit of $300,000, it is determined that a reasonable compensation (wage) for the services Peter provides to the S corporation is $150,000, which the S Corporation pays as a salary to Peter. The other $150,000 is pass-through income. Now, Peter’s Sec. 199A deduction is the lesser of 20% of the pass-through income – $30,000 (20% of $150,000) – or the wage limitation, which is 50% of the wages paid by the S Corporation or $75,000 (50% of $150,000).

This demonstrates how a business activity can benefit from being organized as an S corporation, since S corporations are required to pay working shareholders a reasonable wage for their services provided in operating the business. They are able to divide the pass-through income between reasonable wages and pass-through income to enable a 199A deduction for a higher-income taxpayer. Other business entities do not provide this option, which is the reason why high-taxable-income taxpayers might explore the benefits of organizing new businesses as, or reorganizing their existing businesses into, an S corporation.

Of course, there are other issues involved as well, and some sole proprietors may not find it worth the expense or effort to switch to a different type of business entity. However, the higher the taxpayer’s income, the more beneficial it becomes. The same issues also apply to partnerships. To see if organizing or reorganizing your business activity into an S corporation can reduce your tax liability, call us for an appointment.


Has Tax Reform Taken Away Your Home Mortgage Interest Deduction?

The Tax Cuts and Jobs Act of 2017, more commonly referred to as tax reform, substantially altered the itemized deduction for home mortgage interest. It affects just about everyone who has been deducting their home mortgage interest as an itemized deduction on their tax returns.

Background: To fully understand the impact of the law changes, we need to compare the prior tax law to the new tax reform. Under prior law, a taxpayer could deduct the interest he or she paid on up to $1 million of acquisition debt and $100,000 of equity debt secured by the taxpayer’s primary home and/or designated second home.

Qualified home acquisition debt is debt incurred to purchase, construct, or substantially improve a taxpayer’s primary home or second home and is secured by the home. The interest paid on up to $1 million of acquisition debt has been deductible as part of itemized deductions on Schedule A.

Home equity debt is debt that is not acquisition debt and is secured by the taxpayer’s primary home or second home, but only the interest paid on up to $100,000 of equity debt had been deductible as home mortgage interest. Often, home equity debt is used to purchase a new car, finance a vacation, or pay off credit card debt or other personal loans – all situations in which the interest on a consumer loan obtained for these purposes wouldn’t have been deductible.

The old law continues to apply to home acquisition debts by grandfathering the home acquisition debts incurred before December 16, 2017, to the limits that applied prior to the changes made by tax reform. As explained later in this article, equity debt interest didn’t survive in the tax reform’s legal changes.

New Acquisition Debt Limits: Under the new law, which took effect for home acquisition loans obtained after December 15, 2017, the acquisition debt limit has been reduced to $750,000. Thus, if a taxpayer is buying a home for the first time, the deductible amount of acquisition debt interest will now be limited to the interest paid on up to $750,000 of the debt. If the home acquisition debt exceeds the $750,000 limit, a prorated amount of the interest is still deductible.

If a taxpayer already has a home with grandfathered acquisition debt and wishes to finance a substantial improvement on the home or acquire a second home, the new acquisition debt, for which the interest would be deductible, would be limited to $750,000 less the grandfathered acquisition debt existing at the time of the new loan. This may be a tough pill to swallow for many future homebuyers, since the cost of housing is on the rise while Congress has seen fit to reduce the cap on acquisition debt, on which interest is deductible.

Equity Debt: Under the new law, equity debt interest is no longer deductible after 2017, and this even applies to interest on existing equity debt, essentially pulling the rug out from underneath taxpayers who had previously taken equity out of their homes for other purposes and who were benefiting from the itemized deduction.

Tracing Equity Debt Interest: Because home mortgage interest rates are generally lower than business or investment loan rates and easier to qualify for, many taxpayers have used the equity in their home to start businesses, acquire rental property, or make investments, or on other uses for which the interest would be deductible. With the demise of the Schedule A home equity debt interest deduction, taxpayers can now trace interest on equity debt to other deductible uses. However, if the debt cannot be traced to a deductible purpose, unfortunately, the equity interest will no longer be deductible.

Refinancing: Under prior law, a taxpayer could refinance existing acquisition debt and the allowable interest would be deductible for the full term of the new loan. Under tax reform, the allowable interest will only be deductible for the remaining term of the debt that was refinanced. For example, under the old rules, if you refinanced a 30-year term loan after 15 years into a new 25-year loan, the interest would have been deductible for the entire 25-year term of the new loan. However, under tax reform, the interest on the refinanced loan would only be deductible for 15 years – the remaining term of the refinanced debt.

Determining when home mortgage interest is deductible and how much was deductible was frequently complicated under the prior tax law, and the new rules have added a whole new level of complexity. Please call us if you have questions about your particular home loan interest, refinancing, or equity debt interest tracing circumstances.

A Mid-Year Tax Checkup May Be Appropriate

Taxes are similar to vehicles, in that they sometimes need a check-up to make sure they are performing as expected. That is especially true for 2018, with all of the changes brought about by tax reform.

One area of major concern is the amount of taxes individuals are withholding from their wages. Tax reform was passed late in 2017, and there was a considerable amount of confusion among employers related to the amount of taxes to withhold in 2018. It took the IRS a couple of months to come out with a revised Form W-4 (Employee’s Withholding Allowance Certificate) and withholding tables, and even then, there were concerns about whether the revised and more complicated W-4s were being filled out correctly by employees and whether the revised W-4s were actually being submitted to employers at all. The IRS has even been issuing notices cautioning taxpayers to be sure they are withholding enough.

While most people will see an overall tax reduction as a result of the tax reforms, the amount of their refund or tax due hinges on the amount of pre-payments, which include withholding and estimated tax payments. All this confusion related to withholding can lead to unpleasant surprises at tax time. If you count on a refund each year, it might be appropriate to have this office run a mid-year tax projection to ensure that the projected refund will be as expected.

This is also true for retirees receiving pensions and Social Security benefits and for self-employed taxpayers who are making pre-payments via estimated taxes. You obviously do not want to pay too much and generally don’t want to end up with a huge tax liability. A mid-year check-up will allow adjustments to the 3rd- and 4th-quarter estimated tax payments so that the end result will be as desired.

Married couples with two working spouses, individuals with multiple jobs and situations in which taxpayers are both wage earners and self-employed cause the most difficulty in getting the prepayments correct. If you would like a mid-year projection and withholding check-up, please call for an appointment.

There are a number of other circumstances that can impact your taxes, and you probably should not wait until tax time to see the results. You could even be missing opportunities to decrease your prepayments and obtain more cash flow. With mid-year tax planning, you may be able to take steps to mitigate the tax impact of certain events and thus avoid unpleasant surprises before it is too late to address them. Here are some events that can significantly impact your tax liability:

  • Getting married or divorced, or becoming widowed
  • Changing jobs or your spouse starting to work
  • Having a substantial increase or decrease in income
  • Having a substantial gain from the sale of stocks or bonds
  • Buying or selling a rental
  • Starting, acquiring, or selling a business
  • Buying or selling a main or vacation home
  • Retiring or going to retire this year
  • Being the beneficiary of an inheritance
  • Giving birth to or adopting a child
  • Making significant business purchases
  • Having substantial investment income or gains from the sale of investment assets
  • Making unplanned withdrawals from an IRA or pension plan

If you anticipate or have already encountered any of the above events or conditions, it may be appropriate to consult with us—preferably before the event and definitely before the end of the year.