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Accounting and Tax Planning

Million-dollar Question

Anew poll of Massachusetts voters conducted by Suffolk University, the Boston Globe, NBC10 Boston, and Telemundo found that 58% of respondents support ballot Question 1, compared to 37% in opposition. Question 1, on the Massachusetts ballot on Nov. 8, would create a 4% tax on the portion of a person’s annual income above $1 million and require that the funds be spent only on transportation and public education.

“Tens of thousands of educators, workers, small-business owners, parents, faith leaders, municipal officials, drivers and transit riders, and more than 500 organizations across the state are all working together to pass Question 1 in November,” said Lillian Lanier, field director for Fair Share for Massachusetts, the leading advocacy group working to pass the ballot initiative. “We’re supporting Question 1 because we know it will help improve our schools and transportation infrastructure, and only the very rich will pay more. A few billionaires are trying to mislead voters about what Question 1 does, but our grassroots supporters are having thousands of conversations every day to combat their misinformation.”

That survey result may be concerning to the Coalition to Stop the Tax Hike Amendment, the leading collection of organizations opposed to the initiative, claiming to represent more than 25,000 small businesses, in addition to thousands of homeowners, retirees, farmers, and large employers.

“If passed, Question 1 would be one of the highest tax hikes in Massachusetts history, immediately and permanently implementing an 80% tax increase and threatening small businesses across the state,” the coalition argues. “Question 1 captures tens of thousands of small-business owners who do not make more than $1 million per year and are working hard to rebuild after the negative impacts of the pandemic. At a time when we should be helping our small businesses recover, small-business owners will instead be left reeling from a new, unprecedented financial hit.”

As written, the proposed amendment to Article 44 of the Massachusetts Constitution states that, “to provide the resources for quality public education and affordable public colleges and universities, and for the repair and maintenance of roads, bridges, and public transportation, all revenues received in accordance with this paragraph shall be expended, subject to appropriation, only for these purposes.

“In addition to the taxes on income otherwise authorized under this article, there shall be an additional tax of 4% on that portion of annual taxable income in excess of $1 million reported on any return related to those taxes.

“To ensure that this additional tax continues to apply only to the Commonwealth’s highest-income taxpayers, this $1 million income level shall be adjusted annually to reflect any increases in the cost of living by the same method used for federal income tax brackets. This paragraph shall apply to all tax years beginning on or after January 1, 2023.”

The Coalition to Stop the Tax Hike Amendment argues that Question 1 impacts the tens of thousands of small businesses across the state that file taxes as pass-through entities, noting that these small businesses file their business’ revenue as personal income, even though much of it is reinvested back into their business. The coalition notes that many of these small businesses are operating on razor-thin margins and take home very little profit, yet the proposed amendment treats their business revenue as if they are a high-earning individual, threatening their business’ viability.

“Our organization represents 4,000 small businesses across the state, with a vast majority of these businesses set up as pass-through entities,” said Jon Hurst, president of the Retailers Assoc. of Massachusetts. “Many of these organizations could see their taxes nearly double under Question 1. This constitutional amendment will devastate our local economy and threaten small businesses statewide.”

The coalition also argues that Question 1 robs the nest eggs of small-business owners who are relying on the sale of their business to fund their retirement. Unlike federal taxes on personal income, this measure treats one-time gains — such as those from selling a business, home, or farm — as regular income, pushing many retirees into the new, higher tax bracket, and nearly doubling their taxes.

Among the organizations that have united against the amendment are the Massachusetts High Tech Council, Associated Industries of Massachusetts, the Western Massachusetts Economic Development Council, the National Federation of Independent Business, the Massachusetts Fiscal Alliance, the Massachusetts Farm Bureau, the Massachusetts Retail Lumber Dealers Assoc., the Springfield Regional Chamber and many other chambers of commerce, the Alliance of Automotive Service Providers of Massachusetts, the Massachusetts Seafood Collaborative, and the Massachusetts Business Roundtable.

But Question 1 does have supporters, as the Yes on Question 1 campaign has been endorsed by 87 labor unions; 72 community organizing groups; 18 faith-based groups; more than 75 businesses; 64 city councils, select boards, and school committees; 89 local Democratic town and ward committees; and 115 other social-service and not-for-profit organizations focused on housing, education, transportation, public health, and the environment.

Supporters call the amendment an opportunity for Massachusetts to improve schools and colleges, fix roads and bridges, create jobs, and boost the economy, all without 99% of taxpayers paying a single cent more.

As a tax on personal income over $1 million, Fair Share for Massachusetts argues, business taxes would not be affected, and Question 1 doesn’t apply to any business revenues. It notes that fewer than 3% of businesses owners in Massachusetts have taxable personal income over $1 million that would be subject to Question 1, and many of them are primarily investors or shareholders, not people running a business day-to-day.

“If a business is generating more than a million dollars in personal profit for the owner, even after they deduct all their business expenses, let’s be real: it’s not a small business, and that super-rich business owner can afford to pay their fair share in taxes,” said Gerly Adrien, business director of Fair Share for Massachusetts and owner of Tipping Cow Ice Cream in Somerville and Boston.

Accounting and Tax Planning

Cryptocurrency Taxation

By Jonathan Cohen-Gorczyca, CPA, MSA and Tyler Pickunka

 

Jonathan Cohen-Gorczyca

Jonathan Cohen-Gorczyca

Tyler Pickunka

Tyler Pickunka

Cryptocurrency has become ever more popular over the past few years, so much so that there are athletes being paid in it, sports arenas are changing names to cryptocurrency exchanges and platforms, and even commercials are being aired during the big football game; it has transcended into everyday culture.

Now, cryptocurrency is more accessible than ever, and with so many new phone and computer applications, anyone can buy and sell the digital currency at any time. As it has become more popular, government and regulatory agencies have taken notice and are dedicating more time and funds to changing laws, issuing notices for non-reporting and tax avoidance, and closing the gap in treating it like any other tradable security.

What follows are some basic, but frequently asked, questions to assist you with your cryptocurrency, tax filings, and common treatment for taxation.

 

How do I obtain cryptocurrency?

Cryptocurrency can be purchased on numerous online platforms whether on your computer or phone. Some of these platforms are strictly cryptocurrency only, while others also allow the trading of publicly traded securities. Certain traditional investment companies have created funds to allow you to purchase, hold, and sell shares of cryptocurrency with your regular investments. This can remove some of the perceived risk of buying and selling on the online platforms.

 

How is cryptocurrency taxed?

Cryptocurrency is taxable when a taxpayer sells virtual currency for U.S. dollars, exchanges one type of virtual currency for another, receives virtual currency for services, and mines virtual currency. While trading, exchanging, receiving, or giving virtual currency for services are considered capital gains or losses for tax purposes, mining virtual currency is considered ordinary income.

Mining virtual currency is the actual process where new cryptocurrency is created and enters into markets.

 

Can I gift cryptocurrency?

Yes, but cryptocurrency is not exempt from gift-tax filing requirements if you want to transfer holdings to someone else. The fair market value at the time of the gift, and not the basis, is the value used for gift tax purposes. Your existing basis of the Cryptocurrency transfers to the giftee; this treatment is like stocks. The holding period is transferred as well when determining short- or long-term capital gains if the giftee is to sell or transfer the gift.

 

When do you check the box on the tax return?

In recent years, the Internal Revenue Service (IRS) has added a question to page 1 of the Form 1040 regarding cryptocurrency to better regulate the taxation of cryptocurrency and hold taxpayers accountable for reporting their taxable transactions. The box on the tax return should be checked for all taxpayers who received, sold, exchanged, or disposed of any financial interest in any virtual currency. If you buy and are holding onto virtual currency and have not done any of the above, you do not need to check this box. If you select “No” and are involved in the active buying and selling of cryptocurrency, this could be considered perjury on an official government form.

 

Do you have recommendations that make tax reporting easier?

Dissimilar to publicly traded securities, most cryptocurrency platforms do not issue a Consolidated 1099 statement tracking gains or losses. A taxpayer will most likely receive a 1099 MISC or 1099-K. These two tax forms do not provide enough information to make determinations such as if the cryptocurrency was held short-term or long-term, but rather just an aggregate of all activity. One option is to find an online platform that provides this report at year-end.

Another option is to use a third-party software where you can consolidate your trading activities and can generate a report at year-end to hand to your accountant. If you are just provided with multiple ledgers, it is very difficult (almost impossible) to decipher your activity throughout the year.

Understanding the tax implications for cryptocurrency is a must if you have or plan to have it. Contact your accountant for additional information about cryptocurrency and what that may mean for your specific tax situation.

 

Jonathan Cohen-Gorczyca, CPA, tax manager, has been with Melanson for 10 years andspecializes in individual and business tax returns, compilations, and review engagements; Tyler Pickunka is a recent graduate from Westfield State University who has been a part of the Melanson tax team since 2020.

Estate Planning

State of Uncertainty

By Cheryl Fitzgerald

 

Over the past year, a number of words and phrases have worked themselves into the lexicon, and our everyday usage: pandemic, quarantine, super spreader, and social distancing all make that list. As does the three-word phrase working from home, which quickly morphed into an acronym — WFH.

Indeed, in March 2020, many businesses large and small required or encouraged their employees to work from home as a way to help stop the spread of the coronavirus. At the time, it clearly was intended to be a short-term measure. Nobody could have predicted that, a year later, some of the same employees continue to work from home, whether mandated by their employees or as a way of life now.

However, this has created unintended consequences for businesses and individuals. Employees working in a state other than the company’s home (i.e., their home and business are in different states) could potentially create a need for the business to file in that other state (known as nexus).

From a business perspective, some guidelines have been issued for businesses to follow. Some states have provided relief and have said the presence of an employee working in a state due to shelter-in-place restrictions will not create nexus for tax purposes in that state.

“Employees working in a state other than the company’s home (i.e., their home and business are in different states) could potentially create a need for the business to file in that other state (known as nexus).”

Some states provided a temporary safe harbor or waiver from state withholdings and tax liability for remote work in a different state during the pandemic. And still others have provided that they will not use someone’s relocation during the pandemic as the basis for exceeding the de minimis activity the business can have in the state without it becoming a taxable issue for them.

Massachusetts in particular has provided corporations tax relief in situations in which employees work remotely from Massachusetts due solely to the COVID-19 pandemic to minimize disruption for corporations doing business in Massachusetts. The Bay State has indicated it will not change the intent of whether or not an employee who has started to ‘work’ in Massachusetts because that is his or her home (i.e., a company situated in another state now has an employee physically working in the state of Massachusetts) is subject to Massachusetts corporate tax. These rules are intended to be in place for Massachusetts until 90 days after the state of emergency is lifted.

For employees that had normally worked in Massachusetts, but are now working at home in a different state, Massachusetts has stated that, since this is for pandemic-related circumstances, they will continue to be treated as performing the service in Massachusetts and subject to Massachusetts individual taxes. Most states (but not all) have adopted similar sourcing rules. Most of these rules were put in place for the year 2020. However, some states are still under the same rules and guidelines, and this will continue during 2021.

The intent for most states is to minimize any tax impact for both employees and employers if an employee’s work location has changed solely due to the COVID-19 pandemic.

However, one state has decided the Massachusetts provisions are unfair to its residents. Prior to the pandemic, New Hampshire’s southern border saw a steady stream of workers heading into Massachusetts on a normal workday. With the pandemic and the stay-at-home orders, many of these employees converted to working at their residence in New Hampshire, which does not have an individual income tax.

Therefore, with Massachusetts indicating that these wages were still going to be considered Massachusetts wages and therefore taxable, the governor of New Hampshire felt this was unfair to their residents and has filed a lawsuit in the U.S. Supreme Court over Massachusetts’ “unconstitutional tax grab.”

New Hampshire Gov. Chris Sununu has argued that “Massachusetts cannot balance its budget on the backs of our citizens and punish our workers for working from home to keep themselves, their families, and those around them safe.” This lawsuit was filed in October 2020. Stay tuned.

Remote working becomes even more complicated when employees telecommute in a different state from which they typically work, and this will begin to impact the employee’s eligibility for local leave (i.e., sick leave).

As the pandemic continues, and with some states having set ending dates for some of these relief provisions, employers may continue to have employees who work remotely, either by choice or convenience. The taxability of which state the wages should be taxed in will need to be revisited by employers and employees alike.

 

Cheryl Fitzgerald, CPA is a senior manager at Holyoke-based accounting firm Meyers Brothers Kalicka, P.C.; (413) 536-8510.

Accounting and Tax Planning

A Primer on RMDs

By Bob Suprenant, CPA, MST

Bob Suprenant, CPA, MST

With all that’s happened in the world this year, the SECURE Act, signed into law on Dec. 20, 2019, seems to have been robbed of the celebration it deserves.

Let’s give it its due and weave our way through the 2020 rules for what are known as RMDs.

First, what is an RMD, or required minimum distribution? It’s the minimum amount you must take out of your retirement plan — 401(k), IRA, 403(b), etc. — once you reach a certain age. The theory is that the amount in your retirement plan will be liquidated as you age.

To calculate the RMD, as a general rule, you divide the balance in your account at the end of the previous year — for this year, it would be Dec. 31, 2019 — by the distribution period found in the Uniform Lifetime Table. These tables currently run through age 115. Seriously.

Who Must Take an RMD?

This is where we blow the party horns and throw the confetti. These rules changed on Dec. 20, 2019. If you reached age 70½ in 2019, you were required to take your first distribution by April 1, 2020. If you reach age 70½ in 2020, you are not required to take your first distribution until April 1, 2022.

At the risk of putting a wet blanket on the fun, if you do not take the full amount of your RMD and/or you do not take it by the applicable deadline, there is a penalty. The penalty is an additional tax of 50% of the deficiency. The additional tax can be waived if due to reasonable error and you take steps to remedy the shortfall.

Did COVID-19 Change This?

Yes, the CARES Act, which was signed into law on March 27, 2020, included provisions that waived the requirement for RMDs in 2020. This also happened in 2009 when the stock market crashed. In 2020, RMDs are not required. The RMD waiver also applies to inherited IRAs.

It keeps getting better. On June 23, 2020, the IRS released Notice 2020-51, which allows those who have taken an RMD in 2020, but wish they hadn’t, to return the money to the retirement plan by Aug. 31.

There is a bit of a catch here, though. Most who take RMDs have federal and state tax withholdings on their distributions. Under this relief, the entire distribution must be returned to the retirement plan, not the distribution net of taxes.

By way of example, if you have a gross RMD of $20,000 and there is $3,000 in federal and state withholding, your net distribution is $17,000. To have none of your RMD taxed, the $20,000 must be returned to the retirement plan by Aug. 31. If you return only $17,000, you will be taxed on a $3,000 distribution.

Do I Take an RMD In 2020?

I know I don’t need to take an RMD in 2020, but should I? The answer is … it depends. And you should consult your tax advisor. Ask this individual to run projections to see what the best amount is for you to take as a distribution. For married joint filers, the 12% federal tax bracket includes taxable income up to $79,000. For amounts over $79,000, the tax bracket is at least 22%, a full 10% increase.

For many of my clients, I try to take full advantage of the lower tax bracket and get their incomes as close to the $79,000 as possible. Other clients, who use their retirement-plan distributions to make their charitable contributions (a very wise idea as you will generally save state taxes in addition to possibly saving federal taxes), should probably take a retirement-plan distribution in 2020.

Those who are aged may also want to take a distribution. Under the inherited IRA rules, your IRA beneficiaries will be required to take distributions, so consider their tax rates compared with yours.

As always, in the tax code, there are exceptions to exceptions, and this brief summary is only the cocktail hour. Be aware that you are not required to take an RMD for 2020. If you have taken an RMD, you can return it by Aug. 31. Do some tax planning to determine the best amount for your 2020 retirement-plan distribution.

Bob Suprenant, CPA, MST is a director of Special Tax Services at MP CPAs in Springfield. His focus is working with closely held businesses and their owners and identifying and implementing sophisticated corporate and business tax-planning strategies.

Home Improvement

Green-building Tax Breaks

By Lisa White, CPA, CJ Aberin, CCSP, and Brandon Val Verde, CEPE

On Dec. 20, 2019, a pair of tax provisions, Sections §45L and §179D, made their way into the government’s year-end spending package. These often-overlooked incentives provide a lucrative tax-saving strategy for the real-estate industry.

Not only were the 45L credit and 179D deduction extended through 2020, but the benefits can also be retroactively claimed if missed on prior tax returns. Real-estate developers, builders, and architects that may be unfamiliar with the provisions should take a closer look to avoid a missed opportunity.

45L: Tax Credit for Residential Real Estate

The 45L credit is a federal incentive worth up to $2,000 per qualified unit and is designed to reward homebuilders and multi-family developers of apartments, condos, or production homes. To qualify, a dwelling unit must provide a level of heating and cooling energy consumption that is 50% less than the 2006 International Energy Conservation Code (IECC) Standards.

Of this 50% reduction, a minimum of 10% must come from the building envelope. All residential developments and apartment buildings completed within the last four years are worth assessing for potential 45L tax credits. Eligible construction also includes substantial reconstruction and rehabilitation. The credit is available in all 50 states; however, developments must be three stories or less above grade in height.

Here’s an example of now the credit works:

A building owner has an apartment complex consisting of three, two-story buildings, and each building has 20 units. All 60 units meet the qualifications to claim the credit. In year one, 48 of the units go under lease. The credit in year one would be $96,000 ($2,000 x 48). In year two, if the remaining 12 go under lease, a credit of $24,000 can be claimed in that year.

Of course, there are some costs for this benefit. The amount of basis in the building will need to be reduced by the amount of the credit claimed. Since a credit is a dollar-for-dollar reduction in tax liability, taking a credit over a deduction usually results in a more favorable tax position. There is also the cost for the study and certification, but this expenditure would qualify as a business deduction.

The credit can be claimed in the year the dwelling unit is leased or sold, and there is no limit on the number of qualifying units that can be claimed. The amount of the credit applied is limited to the tax liability (meaning it’s not a refundable credit), and the credit cannot be used to offset AMT. However, any unused credit can be carried back one year or carried forward for 20 years.

The following types of projects should be evaluated, as there are typically benefits available for:

• Affordable housing (LIHTC);

• Apartment buildings;

• Assisted-living facilities;

• Production-home developments;

• Residential condominiums; and

• Student housing.

179D: Tax Deduction for Commercial Real Estate

While 45L typically applies to residential properties, 179D is designed for energy-efficient commercial buildings and offers a tax deduction of up to $1.80 per square foot for energy-efficient lighting, HVAC systems, and the building envelope.

Unlike most deductions, which are based on the amount spent, this deduction is primarily based on square footage. New construction and a wide range of improvements, from simple lighting retrofits to full-scale construction projects, are eligible for this beneficial tax break.

Improvements are limited to the affected area, and to be eligible, they must reduce energy and power costs by making investments in any of the following categories: a building’s envelope, HVAC and hot water, and/or interior lighting systems.

Beneficiaries of this deduction may include:

• Building owners (commercial or residential);

• Tenants making improvements; and

• Architects and designers of government-owned buildings.

Added Benefits for Architects and Designers of Government Buildings

Architects and designers who implement energy-efficient designs on government buildings are also eligible for the 179D tax deduction if their design meets the criteria. Because government entities cannot use the tax deduction, they can assign the deduction to the designer in the year that the building was placed in service. Since 179D was extended retroactively, architects, engineers, and building contractors should review government projects from prior years to obtain all the deductions for which they are eligible.

Claiming the Benefit

Pursuant to the IRS guidance on claiming these green-building tax breaks, taxpayers are required to certify the tax credit or deduction with a detailed engineering analysis. These supporting studies can be generated by a third-party provider.

While a taxpayer may have missed out on tax credits or deductions when filing original tax returns, the good news is that the tax benefits can be claimed retroactively, dependent on the taxpayer’s situation. A tax preparer can assist in the finer details while working with a qualified professional that has expertise in securing both 45L and 179D tax incentives.

Lisa White, CPA is a tax manager with Holyoke-based public accounting firm Meyers Brothers Kalicka, P.C.; [email protected]

CJ Aberin is a principal at KBKG and oversees the Green Building Tax Incentive practice. Over the last several years, he has performed green building tax incentive studies and cost segregation for clients in various industries that range from Fortune 500 companies to individual real estate investors.

Brandon Val Verde is a certified energy plans examiner and senior manager within the Green Building Tax Incentives practice of KBKG. His understanding of various energy standards and codes such as ASHRAE 90.1, IECC, and Title 24 allow him to identify opportunities for Green Building Tax Incentives.

 

 

 

Banking and Financial Services

Understanding Section 199A

By Kristina Drzal-Houghton, CPA, MST

Kristina Drzal Houghton

Kristina Drzal Houghton

At the close of every year, most individuals and business owners begin to think about taxes. Currently, many are anxious to find out what their liability will look like considering the law change known as the Tax Cuts and Jobs Act (TCJA).

One major provision is a new tax deduction for passthrough entities (S-corporations, partnerships, and sole proprietorships) under Sec. 199A. The deduction generally provides owners, shareholders, or partners a 20% deduction on their personal tax returns on their qualified business income (QBI). Various limitations apply based on the type of business operated and the amount of income the business has.

While the calculation of the deduction amount is beyond the scope of this discussion, a summary follows of the limitations that apply to specified service trades or businesses (SSTBs) and other benefits which may be available.

The Internal Revenue Code has historically treated professional service businesses more harshly than any other type of business, and this continues with the Sec. 199A deduction. For example, before the TCJA, professional service corporations were taxed at a flat 35% tax rate rather than the graduated tax rates applicable to other C-corporations. Under the new rules, the same corporations will benefit from a flat 21% tax. Pass-through entities did not fare as well; the 20% deduction does not apply to certain enumerated SSTBs if the taxpayer’s taxable income is above certain threshold amounts.

The threshold amounts are $315,000 for taxpayers filing jointly and $157,500 for all other taxpayers, with a deduction-phaseout range, or limitation phase-in range, of $100,000 and $50,000, respectively, above these amounts.

SSTBs are broken into two distinct categories:

1.Trades or businesses performing services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of that trade or business is the reputation or skill of one or more of its employees (specifically excluded are engineering and architecture); or

2. Any trade or business that involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities.

QBI also does not include compensation, even compensation paid to the shareholders of an S-corporation, or any guaranteed payments paid to a partner for services rendered with respect to the trade or business, or any payment to a partner for services rendered with respect to the trade or business. As a result, if your practice is a partnership that pays out all of its income in guaranteed payments, you may want to switch to a model that instead specially allocates that income to the partners, as a special allocation of income is eligible for the 20% deduction, while the guaranteed payments are not.

This could allow individual partners whose income falls below the above thresholds to benefit from the QBI deduction even if the activity is otherwise an SSTB.

What happens if a trade or business has multiple lines of businesses, where one of the lines is an SSTB? The regulations include a de minimis rule for this situation. If a taxpayer has $25 million or less in gross receipts for the tax year from SSTB activities, it will not be considered an SSTB if less than 10% of the receipts are generated by the SSTB activity. If the taxpayer has more than $25 million in gross receipts, it will not be an SSTB if less than 5% of those receipts are generated by the SSTB activity.

The regulations do provide a couple of anti-abuse provisions to prevent taxpayers from incorrectly trying to take advantage of the tax law. The first relates to a common question I am often asked at networking functions where an employee now desires to be treated as an independent contractor to take advantage of this new tax deduction. The regulations provide that former employees are presumed to still be employees even if subsequently treated as an independent contractor. The IRS provides several tests and factors to consider if a worker is an independent contractor or employee which should be considered by an employer before changing a worker’s classification.

The second anti-abuse provision has to do with related party businesses. Here the IRS has stated that, if a business that otherwise wouldn’t be considered an SSTB has 50% or more common ownership with an SSTB (including related parties) and is providing substantially all its property or services to the related SSTB, it will be considered an SSTB. ‘Substantially all’ is defined to be 80% or more of its total property or services to the related SSTB. This is designed to prevent taxpayers from shifting income to non-SSTB businesses by adjusting the purchase price on related party sales to take advantage of the tax break.

There are several other provisions of the TCJA that benefit all businesses regardless of form. These provisions are all effective Jan. 1, 2018 unless otherwise indicated and include:

• The maximum amount allowed to be expensed under Code Section 179 is increased to $1 million, and the phaseout threshold is increased to $2.5 million. These amounts are indexed for inflation after 2018.

• The definition of qualified real property under Code Section 179 is expanded to include certain depreciable personal property used in the lodging industry, as well as certain improvements to nonresidential real property after the date such property was placed in service, such as roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.

• For property acquired and placed in service after Sept. 27, 2017 and before Jan. 1, 2023, the first-year deduction is increased to 100%.

• After 2022, the deduction percentage phases down by 20% per year until it sunsets after 2026.

• Most states, including Massachusetts, have decided to decouple from the new bonus-depreciation rules.

• No deduction is allowed for entertainment, amusement, or recreation; membership dues for a club organized for business, pleasure, recreation, or other social purposes; or a facility used in connection with any of the above.

• Costs for entertainment expenses such as tickets to sporting events, taking clients to play golf, and similar activities are no longer deductible.

• Meals provided for the convenience of the employer, through an eating facility or other de minimis food and beverage, are no longer 100% deductible, but now fall into the 50% category. They become non-deductible after 2025.

• Qualified transportation fringe benefits provided to employees continue to be excluded from the employees’ income but are no longer deductible by the business.

• Between Jan. 1, 2018 and Dec. 31, 2019, the TCJA allows a credit of 12.5% of the amount of wages paid to qualifying employees during any period during which such employees are out on family and medical leave, provided that the rate of payment is 50% of the wages normally paid to an employee. The credit increases by 0.25% (but not above 25%) for each percentage point by which the wages exceed 50%.

• Wage expense is reduced when the credit is taken as an alternative.

On Jan. 18, the IRS released guidance on many Sec. 199A issues when it issued final regulations. The IRS noted that the final regulations had been modified somewhat from the proposed regulations issued last August as a result of comments it received and testimony at a public hearing it held. The final regulations apply to tax years ending after their publication in the Federal Register; however, taxpayers may rely on the proposed regulations for tax years ending in 2018.

The combination of the proposed regulation and final regulations has altered some of the planning techniques originally thought to increase the tax benefits available to SSTBs under the provisions of Sec. 199A. If your business previously adopted planning techniques before the August and January regulations, you should revisit the projected benefits with your tax adviser.

Kristina Drzal-Houghton, CPA, MST is a partner at Holyoke-based Meyers Brothers Kalicka and director of the firm’s Taxation Division; (413) 535-8510.

Banking and Financial Services

Giving Some Insight

By Terri Judycki

Terri Judycki, CPA, MST

Terri Judycki, CPA, MST

The Tax Cuts and Jobs Act (TCJA) has resulted in many changes for taxpayers. One area in particular is charitable giving.

For those who regularly make charitable contributions, changing philanthropic giving habits may result in greater tax benefits. This article will explore various strategies for maximizing the tax benefit of charitable giving under the new law.

The TCJA increases the standard deduction to $12,000 for a single taxpayer and $24,000 for a married couple filing a joint tax return. In addition, the itemized deduction for taxes has been capped at $10,000 for all combined state and local tax payments. The Congressional Budget Office estimates that these changes will reduce the number of taxpayers who itemize deductions by more than half.

To maximize the benefit of the higher standard deduction, consider bunching charitable contributions in alternating years. For example, if a married couple with no mortgage ordinarily gives $12,000 to charity each year, they will likely take advantage of the $24,000 standard deduction ($12,000 to charity plus $10,000 in state and local states is less than the $24,000 standard deduction). If, instead, they give $24,000 every other year, they will use the $24,000 standard deduction in the ‘off’ year and $34,000 in itemized deductions in the year with the gifts ($24,000 charitable contributions plus $10,000 state and local taxes), resulting in lower taxable income without any increase in cash expenditures.

From the charity’s perspective, though, this could leave some budget challenges.

Another way to bunch deductions without bunching the charities’ income is through the use of a donor-advised fund (DAF). DAFs are funds controlled by 501(c)(3) organizations in which the person establishing the fund has advisory privileges as to the ultimate distribution to charities.

In our example above, the married couple might establish a DAF with $24,000 in one year and direct or ‘advise’ that donations be made to specific charities over time. Amounts used to establish the DAF are deductible charitable contributions when transferred to the sponsoring organization.

“For those who regularly make charitable contributions, changing philanthropic giving habits may result in greater tax benefits.”

Whether the idea of bunching appeals to you or not, don’t overlook the benefits of gifting appreciated stock to charity. The stock must have been held for more than a year to take advantage of this planning opportunity. The charitable deduction is the fair market value on the date gifted. Gifting the stock instead of cash avoids income tax on the appreciation.

For example, if a taxpayer wants to make a gift of $10,000 to a charity and sells stock worth $10,000 for which he paid $7,000, he would have a $10,000 deduction and $3,000 taxable gain. If, instead, he directs his broker to transfer the stock to the charity, he is still entitled to a $10,000 deduction, but does not report the $3,000 gain.

Finally, taxpayers age 70½ or older have another option available. An individual who is 70½ or older on the transfer date can direct the trustee of his IRA to distribute directly to a qualified public charity. The distribution is called a qualified charitable distribution (QCD). The amount transferred counts as a distribution for purposes of meeting the minimum distribution requirement but is not included in the taxpayer’s income.

There are a few requirements. The charity cannot be a private foundation or a donor-advised fund. No more than $100,000 can be donated by an account owner each year. The gift to the charity must be one that would have been entirely deductible if made from the taxpayer’s other assets — for example, the donor should obtain adequate substantiation from the charity, and the donation should not be one that entitles the donor to attend a dinner, play golf, or receive any other benefit.

In our example above, the couple who makes a QCD from IRAs for the $12,000 each year reduces taxable income by $12,000 and still uses the standard deduction.

Another possible advantage is the effect the reduction may have on other taxable items. Depending on the taxpayer’s total income, reducing adjusted gross income could result in reduction of the amount of Social Security benefits that are taxed, an allowed loss from certain real-estate rentals, or a reduction in the net investment income tax (if the amount of excess AGI exceeds the net investment income).

Reducing income may also result in lower Medicare premiums that are based on income for higher-income taxpayers. In addition, some states do not provide deductions for charitable donations, but do follow the federal treatment of excluding the QCD from income.

These changes may result in tax savings that could be used to make an even larger donation to a favorite charity.

Terri Judycki is a senior tax manager with the Holyoke-based public accounting firm Meyers Brothers Kalicka, P.C.; (413) 322-3510; [email protected]

Banking and Financial Services

Take Caution with Section 199A

By Kristina Drzal Houghton, CPA, MST

Kristina Drzal Houghton

Kristina Drzal Houghton

On Dec. 22, 2017, the Tax Cuts and Jobs Act was signed into law, bringing the biggest changes to both corporations and individuals in the past 30 years. Having spoken before groups of medical professionals on this issue, I have found that many believe limitations in the law will prohibit physicians from benefiting from these tax reductions.

This article will focus on medical practices and highlight some techniques available to benefit from the 20% deduction which might otherwise be limited. Additionally, there will be detailed examples of said techniques that will help to provide perspective and clarity to practice owners and shareholders on this very complicated tax issue.

Over the past few decades, many practices have been formed as pass-through entities. In contrast to C-corporations, income earned by a sole proprietorship, S-corporation, or partnership is subject to only a single level of tax. There is generally no tax at the entity level; instead, owners of these businesses report their share of the business’ income directly on their tax return and pay the corresponding tax at ordinary rates.

The Tax Cuts and Jobs Act, signed into law this past December, reduced the top rate on ordinary income of individuals from 39.6% to 37%, and Section 199A further reduced the effective top rate on qualified business income earned by owners of sole proprietorships, S-corporations, and partnerships to 29.6%. Section 199A allows taxpayers other than corporations a deduction of 20% of qualified business income (QBI) earned in a qualified trade or business, subject to certain limitations.

Business owners below the applicable threshold amount — which is $157,500 of taxable income for all filers except joint filers, and $315,000 for those filing jointly —— can enjoy a QBI deduction for the lesser of 20% of their qualified business income or 20% of their taxable income. It does not matter what type of business is generating the income, nor is there a need to analyze W-2 wages paid by the business or depreciable assets owned by the business. The QBI deduction is what it is.

Business owners over their applicable threshold who derive their income from a business that is not a specialized trade or service business may also have their QBI deduction at least partially phased out, but the full deduction may be ‘saved’ based on how much they pay in W-2 wages and/or how much depreciable property they have in the business.

Business owners over their applicable threshold who derive their income from a ‘specified service’ business — which includes doctors, lawyers, CPAs, financial advisors, athletes, musicians, and any business in which the principal asset of the business is the skill or reputation of one or more of its employees — will have their QBI deduction phased out.

The phaseout range is $50,000 for all filers except joint filers, and $100,000 for those filing jointly. Once a business owner’s taxable income exceeds the upper range of their phase-out threshold ($207,500 for individuals and $415,000 for married filing jointly), they cannot claim a QBI deduction for income generated from a specialized trade or service business.

Examine your practice to determine if all your income is from a specified trade or business. A careful analysis of your practice could identify that it consists of multiple different trades or businesses. For example, an orthopedic practice might sell medical equipment. Breaking this portion of the practice off into its own LLC will decrease the specified service trade or business income and could potentially qualify for a QBI deduction with proper planning.

Shifting Business-owned Real Estate to New Entities and Paying Rent

Many practices own the real estate out of which they operate. If this is the case for a higher-earning business owner, there is an obvious way of converting some of the specified service-business income into income from a business that may qualify for a QBI deduction. In short, the business owner can create a new entity, transfer the real estate into that entity — provided the transfer is not tax prohibitive — and then lease that real estate back to the original business.

The original business’s profits, which are not eligible for the QBI deduction (assuming the business owner’s taxable income exceeds their applicable threshold), will decrease, and profits can be shifted to the new real-estate company, which could potentially qualify for at least a partial QBI deduction.

Example: John is a dentist and is the sole owner of an oral-surgery practice organized as an LLC. His income from the practice — which falls under the specified service business umbrella — is $900,000 per year. Thus, John is currently ineligible for any QBI deduction. Several years ago, the LLC purchased the medical offices out of which the practice operates for $2 million. The upkeep on the office space, the depreciation on the property, and other expenses currently reduce the net profit of the LLC by about $100,000 per year, but the property provides little else in the way of tax benefit for John.

One option to consider in a case like this would be to spin off the medical office building into a separate LLC, or other business structure, and have the dental practice rent space in the building. Those rent payments would be deductible for the medical practice, and taxable income for the new business … except the profit in the new business may be eligible for the QBI deduction.

For instance, suppose that, after spinning the medical office off into its own entity, the dental practice leases the office space at the rate of $220,000 per year. The net result of such a transaction would be reducing the dental practice’s net income $120,000 ($220,000 rental expense minus $100,000 prior expenses ‘lost’ = $120,000). The real-estate entity, on the other hand, would now have a profit of $120,000 — a net shift of zero — but the real estate’s income could qualify for the QBI deduction. Thus, the result is an equivalent amount of business income, but a $24,000 QBI deduction for John on his personal return that, at his tax rate, would save him nearly $9,000 in federal income taxes annually.

Shifting Other Business-owned Assets to Other Entities and Leasing Them Back

For some business owners, there’s the potential to continue to push the boundary even further on shifting depreciable property out of a business, and then leasing it back to the original business entity.

Example: Continuing the earlier example of John and the dental practice above, suppose the practice also owns X-ray machines and a variety of other depreciable medical equipment as well, with an unadjusted basis of $750,000. This equipment could be spun off into yet another business, and the dental practice could lease back the equipment.

The mechanics and potential tax benefits of this move are essentially the same as when real estate is moved into a separate entity. When it comes to the QBI deduction, depreciable business property is depreciable business property. The 2.5% limitation is not impacted by the type of depreciable property or the length of time over which it will be depreciated.

Of course, the limitation to this strategy is that not all small businesses have substantial (or much, or any) depreciable property to spin off into other entities in the first place … and at some point, any and all depreciable property that could be spun off will have been. So that’s it, right? Maybe not.

If You Can’t Lease Equipment, Lease People with an Employee-leasing Company

Many specified service businesses are labor intensive but may not necessarily require a great deal of depreciable property. Anesthesia and radiology practices are both good examples of this. Outside of some office furniture and some computers, these businesses can generate substantial profits without ever owning any significant amount of depreciable property since they operate out of hospital-owned facilities. They do, however, often employ a great number of people, and spend substantial amounts on human capital.

To that end, the language in Section 199A leaves the door open to the possibility of creating an employee-leasing company and leasing back one’s employees from that company. Some practitioners believe this to be a gaping hole in the rules, while other practitioners are a little more cautious at this time. Even on the conservative side, the billing and administrative employees could defensibly be split off into a separate LLC if it can be demonstrated that it is not a specified trade or business because it is not dependent on the skill or reputation of one or more of its employees.

Notwithstanding the benefits of the above strategy, some caution is merited. Tax advisers are understandably eager for answers, but unfortunately, Section 199A is just one small piece of the most significant overhaul of the tax law in 31 years. The IRS is now charged with the herculean task of providing guidance for a host of new and changed statutory provisions, and, as a result, it may be some time before tax advisers have certainty related to some of the strategies posed in this article.

Until that guidance arrives, Section 199A will best be approached cautiously, particularly considering the potential substantial-understatement penalty that comes with claiming a deduction under this provision.

Kristina Drzal Houghton, CPA, MST is a partner with the Holyoke-based accounting firm Meyers Brothers Kalicka, P.C. and director of the firm’s Taxation Division; [email protected]