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Accounting and Tax Planning

A Tax-planning Checklist

By Dan Eger

 

It is that time again, your favorite and mine, tax season!

As we have made it through hopefully the worst of the pandemic, dealing with all the ups and downs of learning this new normal in life, one thing will remain the same — the IRS still wants our money. At some things have not changed due to COVID-19.

Here are some steps to take now to help make filing for the 2020 tax season easier. Below is a list of items to gather. These are the most common required forms and items. The list is not all-inclusive, as everyone’s tax situation is different. Also included are a few other things for you to consider as you prepare to file your 2020 tax return.

 

Documentation of Income

• W-2 – Wages, salaries, and tips

• W-2G – Gambling winnings

• 1099-Int and 1099-OID – Interest income statements

• 1099-DIV – Dividend income statements

• 1099-B – Capital gains (sales of stock, land, and other items)

• 1099-G – Certain government payments

— Statement of state tax refunds

— Unemployment benefits

• 1099-Misc – Miscellaneous income

• 1099-S – Sale of real estate (home)

• 1099-R – Retirement income

• 1099-SSA – Social Security income

• K-1 – Income from partnerships, trusts, and S-corporations

 

Documentation for Deductions

If you think all your deductions for Schedule A will not add up to more than $12,400 for single, $18,650 for head of household, or $24,800 for married filing jointly, save yourself the time required to itemize deductions and just plan to take the standard deduction.

 

• Medical Expenses (out of pocket, limited to 7.5% of adjusted gross income)

— Medical insurance (paid with post-tax dollars)

— Long-term-care insurance

— Prescription medicine and drugs

— Hospital expenses

— Long-term care expenses (in-home nurse, nursing home, etc.)

— Doctor and dentist payments

— Eyeglasses and contacts

— Miles traveled for medical purposes

 

• Taxes You Paid (limited to $10,000)

— State withholding from your W-2

— Real-estate taxes paid

— Estimated state tax payments and amount paid with prior year return

— Personal property (excise)

 

• Interest You Paid

— 1098-Misc – mortgage-interest statement

— Interest paid to private party for home purchase

— Qualified investment interest

— Points paid on purchase of principal residence

— Points paid to refinance (amortized over life of loan)

— Mortgage-insurance premiums

 

• Gifts to Charity (For 2020, filers who claim the standard deduction can take an additional deduction up to $300 for cash contributions.)

— Cash and check receipts from qualified organization

— Non-cash items, which need a summary list and responsible gift calculation (IRS tables). If the gift is more than $5,000, a written appraisal is required.

— Donation and acknowledgement letters (over $250)

— Gifts of stocks (you need the market value on the date of gift)

 

• Additional Adjustments (Non-Schedule A)

— 1098-T – Tuition statement

— Educator expenses (up to $250)

— 1098-E – Student-loan interest deduction

— 5498 HSA – Health savings account contributions

— 1099-SA – Distributions from HAS

— Qualified child and dependent care expenses

— Verify any estimated tax payments (does not include taxes withheld)

 

Sole proprietors (Schedule C) or owners of rental real estate (Schedule E, Part I) need to compile all income and expenses for the year. You need to retain adequate documentation to substantiate the amounts that are reported.

 

Other Items to Consider

Identity-protection PIN

If you are a confirmed identity-theft victim, the IRS will mail you a notice with your IP PIN each year. You need this number to electronically file your tax return.

Starting in 2021, you may opt into the IP PIN program. Visit www.irs.gov/identity-theft-fraud-scams/get-an-identity-protection-pin to set up your IP PIN. An IP PIN helps prevent someone else from filing a fraudulent tax return using your Social Security number.

 

What If You Have Been Compromised?

How do you know if someone has filed a return with your information? The most common way is that your tax return will get rejected for e-file. These scammers file early. You may also get a letter from the IRS requesting you verify certain information.

If this does happen, there are steps to take to get this rectified:

1. File Form 14039 (Identity Theft Affidavit).

2. Paper-file your return.

3. Visit identitytheft.gov for additional steps.

 

New for 2021: Recovery Rebate Credit

Eligible individuals who did not receive a 2020 economic impact payment (stimulus check), or received a reduced amount, may be able to claim the Recovery Rebate Credit on their 2020 tax return. There is a worksheet to use to figure the amount of credit for which you are eligible based on your 2020 tax return. Generally, this credit will increase the amount of your tax refund or lower the amount of the tax you owe.

 

Who Will Prepare My Return?

Are you going to be preparing your tax return, or will you hire someone to file on your behalf? You might want to plan that out now so you know the required information you will need and the fee structure you can expect to pay for completion of all applicable forms. In addition to all the items listed above, the tax preparer will ask you for a copy of your last tax return that was filed. The IRS offers a ‘file free platform’ to file your tax return if your income is under $72,000. You can find this at irs.gov or the IRS2Go app. There are also some local tax-assistance and counseling programs, depending on your age and income levels (VITA/TCE).

 

Interactive Tax Assistant

The Interactive Tax Assist (ITA) is an IRS online tool (irs.gov) to help you get answers to several tax-law items. ITA can help you determine what income is taxable, which deductions are allowed, filing status, who can be claimed as a dependent, and available tax credits.

 

Be Vigilant

Finally, be especially careful during this time of year to protect yourself against those trying to defraud or scam you. The IRS will never — let me repeat that: NEVER — call you directly unless you are already in litigation with them. They will not initiate contact by e-mail, text, or social media. The IRS will contact you by U.S. mail.

However, you still need to be wary of items received by mail. Anything requesting your Social Security number or any credit-card information is a dead giveaway. Watch out for websites and social-media attempts that request money or personal information and for schemes tied to economic impact payments. You can check the irs.gov website to research any notice you receive or any concerns you may have. You can also contact your tax practitioner for help and assistance.

 

Dan Eger is a senior associate at Holyoke-based accounting firm Meyers Brothers Kalicka; (413) 536-8510.

Banking and Financial Services

Tax Planning in a Gig Economy

By Ian Coddington

 

In recent years, we have seen a rise in so-called side hustles and gig work, where individuals take on part-time jobs or project-based work for additional income.

This ‘gig economy’ has been accelerated by the effects of the coronavirus outbreak; Americans are being laid off or have to remain at home or socially distance. Without a primary income source, people have turned to other solutions to pay their bills.

Ventures like DoorDash, Uber, Amazon, and Fiver all offer individuals the ability to earn income by doing work for companies and individuals. However, this does not make up the entire market of gig work.

Ian Coddington

Ian Coddington

“This form is different from your W-2 in that 1099 income is considered self-employment earnings, which is taxed differently than W-2 wages.”

People who sell artwork or wrap Christmas presents, handymen, and movers are all examples of individuals who could earn income on the side. We have seen how some side hustles can turn into profitable ventures, while others just use it to have extra spending money. If you took on additional sources of income during the pandemic, there might be some tax considerations you might not be aware of.

 

Self-employed Vs. W-2

Unlike a normal employed job where you receive a Form W-2, most gig work will consider workers independent contractors, and issue you a Form 1099. The most common form received for this work was a 1099-MISC, which is now replaced with the new Form 1099-NEC.

If you were paid at least $600 from a business that was not your employer, you can expect one of these forms come tax time. This form is different from your W-2 in that 1099 income is considered self-employment earnings, which is taxed differently than W-2 wages. When you work for an employer, they will withhold a percentage of your wages for taxes. However, when you are self-employed, you are subject to self-employment taxes and might be subject to estimate payments.

Depending on your level of income and other withholdings, one benefit of this is a self-employment tax deduction, where you can deduct what an employer would have paid on your tax return. For delivery drivers, it is important to track your mileage, as you can deduct the allowable mileage expense against your self-employed earnings. If you used a home office for business, you could potentially deduct a portion of your mortgage, utilities, and even repairs to that space. Prior to taking this deduction, you should review the rules closely.

 

Meet with an Advisor

These benefits sound good, but what if you have unique situations for your side hustle? What if you are paid through cash apps like Venmo or Zelle? Can you deduct the transaction fees paid to payment processors like PayPal or Stripe? What if you receive a Form 1099-K? Questions like these can be answered by an advisor, like a licensed tax preparer. Here is a quick list of things to bring to a meeting with a tax preparer:

• Any W-2s or 1099s received;

• Personal or business bank statements;

• Information on your home office, including square footage;

• Log of mileage; and

• Purchases for the business.

Working a side hustle can be an exciting and hopefully profitable venture; however, it can add complexity to your tax return. Take charge of the additional complexity, gather the required documentation, and minimize your tax liability.

 

Ian Coddington is an associate at the Holyoke-based accounting firm Meyers Brothers Kalicka, P.C.; (413) 536-8510.

 

Accounting and Tax Planning Coronavirus Special Coverage

Year-end Tax Planning

By Kristina Drzal Houghton, CPA, MST

 

This year has been unlike any other in recent memory. Front and center, the COVID-19 pandemic has touched virtually every aspect of daily living and business activity in 2020. In addition to other financial consequences, the resulting fallout is likely to have a significant impact on year-end tax planning for both individuals and small businesses.

Kristina Drzal Houghton

Kristina Drzal Houghton

Furthermore, if the election of Joe Biden is confirmed and the Republican party does not hold a majority in the Senate following the runoff elections in Georgia, it is likely to affect the tax situation in 2021 and beyond. This article will first address 2020 planning and then summarize some of the Biden tax proposals at the end.

In response to the pandemic, Congress authorized economic-stimulus payments and favorable business loans as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act also features key changes relating to income and payroll taxes. This new law follows close on the heels of the massive Tax Cuts and Jobs Act (TCJA) of 2017. The TCJA revised whole sections of the tax code and includes notable provisions for both individuals and businesses.

This is the time to paint your overall tax picture for 2020. By developing a year-end plan, you can maximize the tax breaks currently on the books and avoid potential pitfalls.

 

BUSINESS TAX PLANNING

Depreciation-related Deductions

Under current law, a business may benefit from a combination of three depreciation-based tax breaks: the Section 179 deduction, ‘bonus’ depreciation, and regular depreciation.

• Place qualified property in service before the end of the year. Typically, a small business can write off most, if not all, of the cost in 2020.

• The maximum Section 179 allowance for 2020 is $1,040,000 provided asset purchases do not exceed $2,590,000.

• Be aware that the Section 179 deduction cannot exceed the taxable income from all your business activities this year. This could limit your deduction for 2020.

• If you buy a heavy-duty SUV or van for business, you may claim a first-year Section 179 deduction of up to $25,000. The ‘luxury car’ limits do not apply to certain heavy-duty vehicles.

• If your deduction is limited due to either the income threshold or the amount of additions, a first-year bonus depreciation deduction of 100% for property placed in 2020 is also available.

• Massachusetts does not follow the bonus depreciation, but does allow the increased Section 179 expense; however, many states do not follow that increased expense either.

 

Business Interest

• Prior to 2018, business interest was fully deductible. But the TCJA generally limited the deduction for business interest to 30% of adjusted taxable income (ATI). Now the CARES Act raises the deduction to 50% of ATI, but only for 2019 and 2020.

• Determine if you qualify for a special exception. The 50%-of-ATI limit does not apply to a business with average gross receipts of $25 million (indexed for inflation) or less for the three prior years. The threshold for 2020 is $26 million.

 

Bad-debt Deduction

During this turbulent year, many small businesses are struggling to stay afloat, resulting in large numbers of outstanding receivables and collectibles.

• Increase your collection activities now. For instance, you may issue a series of dunning letters to debtors asking for payment. Then, if you are still unable to collect the unpaid amount, you can generally write off the debt as a business bad debt in 2020.

• Generally, business bad debts are claimed in the year they become worthless. To qualify as a business bad debt, a loan or advance must have been created or acquired in connection with your business operation and result in a loss to the business entity if it cannot be repaid.

 

Miscellaneous

• If you pay year-end bonuses to employees in 2020, the bonuses are generally deductible by your company and taxable to the employees in 2020. A calendar-year company operating on the accrual basis may be able to deduct bonuses paid as late as March 15, 2021 on its 2020 return.

• Generally, repairs are currently deductible, while capital improvements must be depreciated over time. Therefore, make minor repairs before 2021 to increase your 2020 deduction.

• Switch to cash accounting. Under a TCJA provision, a C-corporation may use this simplified method if average gross receipts for last year exceeded $26 million (up from $5 million).

• An employer can claim a refundable credit for certain family and medical leaves provided to employees. The credit is currently scheduled to expire after 2020.

• Investigate Paycheck Protection Program (PPP) forgiveness. Under the CARES Act, PPP loans may be fully or partially forgiven without tax being imposed. Despite recent guidance, this remains a complex procedure, so consult with your professional tax advisor about the details.

 

INDIVIDUAL TAX PLANNING

Charitable Donations

Generally, itemizers can deduct amounts donated to qualified charitable organizations, as long as substantiation requirements are met. Be aware that the TCJA increased the annual deduction limit on monetary contributions from 50% of adjusted gross income (AGI) to 60% for 2018 through 2025. Even better, the CARES Act raises the threshold to 100% for 2020.

• In addition, the CARES Act authorizes an above-the-line deduction of up to $300 for monetary contributions made by a non-itemizer in 2020 ($600 for a married couple).

• In most cases, you should try to ‘bunch’ charitable donations in the year they will do you the most tax good. For instance, if you will be itemizing in 2020, boost your gift giving at the end of the year. Conversely, if you expect to claim the standard deduction this year, you may decide to postpone contributions to 2021.

• For donations of appreciated property that you have owned longer than one year, you can generally deduct an amount equal to the property’s fair market value (FMV). Otherwise, the deduction is typically limited to your initial cost. Also, other special rules may apply to gifts of property. Notably, the annual deduction for property donations generally cannot exceed 30% of AGI.

• If you donate to a charity by credit card in December — for example, if you make an online contribution — you can still write off the donation on your 2020 return, even if you do not actually pay the credit-card charge until January.

 

Family Income Splitting

The time-tested technique of family income splitting still works. Currently, the top ordinary income-tax rate is 37%, while the rate for taxpayers in the lowest income tax bracket is only 10%. Thus, the tax rate differential between you and a low-taxed family member, such as a child or grandchild, could be as much as 27% — not even counting the 3.8% net investment-income tax (more on this later).

• Shift income-producing property, such as securities, to family members in low tax brackets through direct gifts or trusts. This will lower the overall family tax bill. But remember that you are giving up control over those assets. In other words, you no longer have any legal claim to the property.

• Also, be aware of potential complications caused by the ‘kiddie tax.’ Generally, unearned income above $2,200 received in 2020 by a child younger than age 19, or a child who is a full-time student younger than age 24, is taxed at the top marginal tax rate of the child’s parents. (Recent legislation reverses a TCJA change on the tax treatment.) The kiddie tax could affect family income-splitting strategies at the end of the year.

 

Higher-education Expenses

The tax law provides tax breaks to parents of children in college, subject to certain limits. This often includes a choice between one of two higher-education credits and a tuition-and-fees deduction.

• Typically, you can claim either the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC). The maximum AOTC of $2,500 is available for qualified expenses of each student, while the maximum $2,000 LLC is claimed on a per-family basis. Thus, the AOTC is usually preferable. Both credits are phased out based on modified adjusted gross income (MAGI).

• Alternatively, you may claim the tuition-and-fees deduction, which is either $4,000 or $2,000 before it is phased out based on MAGI. The tuition-and-fees deduction, which has expired and been revived several times, is scheduled to end after 2020, but could be reinstated again by Congress.

• When appropriate, pay qualified expenses for next semester by the end of this year. Generally, the costs will be eligible for a credit or deduction in 2020, even if the semester does not begin until 2021.

 

Medical and Dental Expenses

Previously, taxpayers could only deduct unreimbursed medical and dental expenses above 10% of their AGI. When it is possible, accelerate non-emergency qualifying expenses into this year to benefit from the lower threshold. For instance, if you expect to itemize deductions and have already surpassed the 7.5%-of-AGI threshold this year, or you expect to clear it soon, accelerate elective expenses into 2020. Of course, the 7.5%-of-AGI threshold may be extended again, but you should maximize the tax deduction when you can.

 

Estimated Tax Payments

The IRS requires you to pay federal income tax through any combination of quarterly installments and tax withholding. Otherwise, it may impose an ‘estimated tax’ penalty.

However, no estimated tax penalty is assessed if you meet one of these three ‘safe harbor’ exceptions under the tax law:

• Your annual payments equal at least 90% of your current liability;

• Your annual payments equal at least 100% of the prior year’s tax liability (110% if your AGI for the prior year exceeded $150,000); or

• You make installment payments under an ‘annualized income’ method. This option may be available to taxpayers who receive most of their income during the holiday season.

If you have received unemployment benefits in 2020 — for example, if you lost your job due to the COVID-19 pandemic — remember that those benefits are subject to income tax. Factor this into your estimated tax calculations for the year.

 

Capital Gains and Losses

Frequently, investors time sales of assets such as securities at year-end to produce optimal tax results. For starters, capital gains and losses offset each other. If you show an excess loss for the year, it offsets up to $3,000 of ordinary income before being carried over to the next year. If you sell securities at a loss and reacquire substantially identical securities within 30 days of the sale, the tax loss is disallowed.

• Long-term capital gains from sales of securities owned longer than one year are taxed at a maximum rate of 15%, or 20% for certain high-income investors. Conversely, short-term capital gains are taxed at ordinary income rates reaching up to 37% in 2020.

• Review your investment portfolio. Depending on your situation, you may harvest capital losses to offset gains realized earlier in the year or cherry-pick capital gains that will be partially or wholly absorbed by prior losses.

 

Net Investment-income Tax

In addition to capital-gains tax, a special 3.8% tax applies to the lesser of your net investment income (NII), or the amount by which your modified adjusted gross income (MAGI) for the year exceeds $200,000 for single filers or $250,000 for joint filers. (These thresholds are not indexed for inflation.) The definition of NII includes interest, dividends, capital gains, and income from passive activities, but not Social Security benefits, tax-exempt interest, and distributions from qualified retirement plans and IRAs.

• Assess the amount of your NII and your MAGI at the end of the year. When it is possible, reduce your NII tax liability in 2020 or avoid it altogether.

 

Required Minimum Distributions

As a general rule, you must receive required minimum distributions (RMDs) from qualified retirement plans and IRAs after reaching age 72 (70½ for taxpayers affected prior to 2020). The amount of the RMD is based on IRS life-expectancy tables and your account balance at the end of last year

• Take RMDs in 2020 if you need the cash. Otherwise, you can skip them this year, thanks to a suspension of the usual rules by the CARES Act. There is no requirement to demonstrate any hardship relating to the pandemic. Finally, although RMDs are no longer required in 2020, consider a qualified charitable distribution (QCD). If you are age 70½ or older, you can transfer up to $100,000 of IRA funds directly to a charity. Although the contribution is not deductible, the QCD is exempt from tax. This may benefit your overall tax picture.

 

IRA Rollovers

If you receive a distribution from a qualified retirement plan or IRA, it is generally subject to tax unless you roll it over into another qualified plan or IRA within 60 days. In addition, you may owe a 10% tax penalty on taxable distributions received before age 59½. However, some taxpayers may have more leeway to avoid tax liability in 2020 under a special CARES Act provision.

• Take your time redepositing the funds if it qualifies as a COVID-19-related distribution. The CARES Act gives you three years, instead of the usual 60 days, to redeposit up to $100,000 of funds in a plan or IRA without owing any tax.

• To qualify for this tax break, you (or your spouse, if you are married) must have been diagnosed with COVID-19 or experienced adverse financial consequences due to the virus (e.g., being laid off, having work hours reduced, or being quarantined or furloughed). If you do not replace the funds, the resulting tax is spread evenly over three years.

• This may be a good time to consider a conversion of a traditional IRA to a Roth IRA. With a Roth, future payouts are generally exempt from tax, but you must pay current tax on the converted amount. Have a tax professional help you determine if this makes sense for your situation.

 

Estate and Gift Taxes

Since the turn of the century, Congress has gradually increased the federal estate-tax exemption, while eventually establishing a top estate-tax rate of 40%. The TCJA doubled the exemption from $5 million to $10 million for 2018 through 2025, inflation-indexed to $11.58 million in 2020.

Under the ‘portability provision’ for a married couple, the unused portion of the estate-tax exemption of the first spouse to die may be carried over to the estate of the surviving spouse. This tax break is now permanent.

Finally, guidance has been published establishing that, when the exemption is decreased in the future, a recapture or ‘claw-back’ of the extra exemption used will not be required.

Update your estate plan to reflect current law. You may revise wills and trusts to accommodate the rule allowing portability of the estate-tax exemption. Additionally, consider the maximum gifting currently as allowable in your financial position.

 

Miscellaneous

You can contribute up to $19,500 to a 401(k) in 2020 ($26,000 if you are age 50 or older).

 

BIDEN’S NOTABLE TAX PROPOSALS

Business Tax

• The statutory corporate tax rate would be increased from 21% to 28%.

• The benefits of the Section 199A/qualified business-income deduction would be phased out for individuals with taxable income greater than $400,000.

• The real-estate industry will potentially be impacted. The Biden campaign had suggested potential changes to the §1031 like-kind exchange provisions as well as changes to effectively limit losses that may be utilized by real-estate investors.

 

Individual Tax

Many of the revenue-raising aspects of the Biden tax proposal for individuals apply only to those taxpayers with taxable income over $400,000. It has not been specified whether this threshold is to be adjusted for filing status.

• The top ordinary rate would be restored to 39.6% for taxpayers with income over $400,000. This reflects a return to pre-2017 tax reform when the top ordinary rate was dropped to 37%.

• For top income earners, this rate is currently capped at 20% (plus 3.8% to the extent subject to the net investment-income tax). Under the Biden plan, capital gains and qualified dividends will be subject to the top rate of 39.6% for individuals with more than $1 million in income.

• The Section 199A/qualified business-income deduction would begin to phase out for individuals over $400,000 in taxable income.

• Itemized deductions would be capped to 28% of value. Additionally, benefits would begin to phase out for individuals with taxable income over $400,000.

• The child and dependent care credit would be increased to a maximum of $8,000 for low-income and middle-class families. In addition, the credit would be made refundable.

• First-time homebuyers could receive up to $15,000 of refundable and advanceable tax credit.

• There could be temporary expansion of the child tax credit, depending on the progression of the pandemic and economic conditions. This expansion would increase the credit from $2,000 to $3,000 for children 17 or younger with an additional $600 for children under 6. The credit would also be refundable and allowable to be received in monthly installments.

 

Gift and Estate Tax

The gift- and estate-tax exemption amount would be reduced. Many are suggesting that Biden is looking to reduce the gift- and estate-tax exemption to the pre-TCJA levels.

 

Conclusion

This year-end tax-planning letter is based on the prevailing federal tax laws, rules, and regulations. Of course, it is subject to change, especially if additional tax legislation is enacted by Congress before the end of the year.

Finally, remember that this article is intended to serve only as general guideline. Your personal circumstances will likely require careful examination. u

 

Kristina Drzal Houghton, CPA, MST is partner, Executive Committee, and director of Taxation Services at Meyers Brothers Kalicka; (413) 536-8510.

Law

Taxing Decisions

By Hyman G. Darling, Esq.

As this article is being written, the election is pending, and many people are trying to consider the options relative to tax issues for the end of 2020 and going into 2021. Since no one can predict with 100% accuracy what the tax laws will be in the future, even beyond 2021, it is important to consider the options available. Taking action now will allow you (or your heirs) to save funds.

Hyman Darling

Hyman Darling

Before proceeding, a refresher on federal estate and gift taxes may be needed. The federal estate-tax and gift-tax exemption is what is known as a unified credit, which means the amount may be used to make gifts during one’s lifetime or at death, or a combination of both.

The amount currently is set at $11.58 million for 2020. If the law does not change, this amount is due to reduce to $5 million in 2026 (indexed for inflation as of 2010, so this amount will probably be $6 million). This means a person may gift up to $11.58 million during his or her lifetime or at death before any tax is due. If this amount is exceeded, a tax rate of 40% applies to the excess. Since the unified credit may be reduced, larger gifts may be considered prior to year-end before a new law is enacted next year that could be effective as of Jan. 1, 2021.

Many misconceptions apply to gifts, the most popular being the annual exclusion of $15,000 per recipient. Most people believe that, if the $15,000 amount is exceeded, the donor or the recipient must pay a tax. The law states that a person may gift up to $15,000 each year without reporting any gifts. If this amount is exceeded, then a gift-tax return is required to be filed by April 15 of the year following the gift.

But, again, no tax is due until the $11.58 million is exceeded. For example, if a person gifts to their child, there is a requirement to file a return, but the first $15,000 is ‘free,’ and the next $100,000 merely reduces the credit from $11.58 million to $11.48 million, which is still available to gift during the lifetime or at death. Thus, a person does not have to limit a gift to $15,000 as, in most cases, they will not be paying a tax. (Note that this rule is a tax rule, and does not have a relation to Medicaid planning, which treats all gifts as disqualifying for the five-year look-back period.)

If the estate credit is reduced after 2020, it is anticipated that the credit utilized this year will not adversely affect the amount a person will have available under a new law when he or she dies. So, if a person wishes to make significant gifts, they should make them before the end of the year to utilize as much of the credit as they may want.

For income-tax purposes, there are several options to consider. One easy one is the ‘above-the-line’ charitable deduction for up to $300 if given to a qualified charity. This is not for donations of clothing, as it must be a gift of cash, and it qualifies for everyone, even if a person is not itemizing.

Another significant option is that, in 2020, a minimum deduction is not required to be made from an IRA or other qualified plan. However, some people who have little to no other taxable income may still want to take a distribution as their tax bracket may be low enough to eliminate taxes this year.

“If the estate credit is reduced after 2020, it is anticipated that the credit utilized this year will not adversely affect the amount a person will have available under a new law when he or she dies. So, if a person wishes to make significant gifts, they should make them before the end of the year to utilize as much of the credit as they may want.”

In addition to this option, there is also the benefit for those age 70½ and older who may wish to make a donation to charity. Funds may be paid directly to a charity (or multiple charities) from the retirement account, and this donation will not be taxable income. The annual limit is $100,000, but the distribution does satisfy the required minimum distribution (RMD). If the taxpayer is going to make donations in any event, the IRA should be used to fund the donations.

The amount does not get added to taxable income, so the taxable amount will be less, Social Security payments may then not be taxable, and the Medicare premium will not be higher as the RMD does not get factored into the calculation.

If a taxpayer has losses to report, they may be taken and either reduce income up to $3,000 or perhaps offset gains of other assets. If a person has gains, they may wish to take the gain in 2020 with the anticipation that capital-gains rates could increase and/or income-tax rates may increase.

As with all tax and estate-planning considerations, there are many general rules with specific exceptions, so a qualified professional should be consulted prior to making any decisions. But be sure to get started soon, as decisions should be made and implemented prior the end of 2020.

 

Attorney Hyman G. Darling is a shareholder and the head of the probate/estates team at Bacon Wilson, P.C. He is a past president of the National Academy of Elder Law Attorneys and has been a frequent presenter for the Massachusetts Bar Assoc., MCLE, and many Springfield civic and professional groups. He is a member of the Special Needs Alliance and many local planned-giving committees, as well as an adjunct faculty member in the LLM Program at Western New England University School of Law and Bay Path University; (413) 781-0560; [email protected]

Banking and Financial Services

Seeking Relief

By Lisa White and Malik Javed

 

On March 27, the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law. The Act has provided taxpayers with much-needed relief during this pandemic by establishing additional funding sources, such as the Paycheck Protection Program (PPP); by creating new tax credits, such as the Employee Retention Credit; and by significantly changing several existing tax provisions.

Lisa White

Lisa White

Malik Javed

Malik Javed

When reviewing what relief is available, taxpayers should consider all possible opportunities, including cost-segregation studies, which help identify misclassified Qualified Improvement Property (QIP); by reviewing current- and prior-year capital expenditures for retirements, dispositions, or repair deductions; and by considering accounting-method changes necessary to take full advantage of the new provisions in the tax law.

Two key changes to existing tax law within the CARES Act that provide cash flow for taxpayers include changes to the cost-recovery period for QIP and changes to the application and recognition of Net Operating Losses (NOLs).

 

Qualified Improvement Property

Qualified Improvement Property (QIP) is defined as any improvement made by the taxpayer to an interior portion of a commercial building as long as the improvement is placed into service after the building was first placed into service by any taxpayer. Additionally, QIP specifically excludes expenditures for the enlargement of a building, elevators or escalators, and the internal structural framework of a building.

Prior to the CARES Act, a drafting error in the tax law required QIP placed in service after Dec. 31, 2017 to use a 39-year tax life, making it ineligible for bonus depreciation. The CARES Act retroactively changed the recovery period for QIP to 15 years, thus making it eligible for bonus depreciation through 2026 (100% through 2022).

Taxpayers who want to take advantage of deducting the cost of improvements to real estate must segregate between interior and exterior improvements, as well as identify items excluded from QIP. Since budgets and design plans should be reviewed to identify these items, cost-segregation engineers can be engaged to assist with this analysis.

Tenant improvements often include items that are not eligible for QIP treatment. For example, HVAC costs in a retail shopping center might include both ductwork inside the building that is eligible for QIP and package units on the roof that are not eligible. Other examples include certain storefronts and interior seismic retrofits. When evaluating QIP, taxpayers should not assume all tenant improvements automatically qualify. Although QIP is now eligible for 100% bonus depreciation for federal income taxes, many states do not conform to bonus deprecation and require a 39-year tax life. For higher-taxed states, cost segregation can still make sense when interior improvements are significant.

Taxpayers who elected out of the business interest expense limitation under 163(j) are required to use a 20-year ADS life for QIP and are not eligible for bonus depreciation. In these cases, a cost-segregation study is greatly beneficial because the items segregated into personal-property categories do not get ADS treatment and are therefore eligible for bonus depreciation.

There is also an additional interplay with the business interest expense limitation provision. Part of the calculation to determine the amount of limited business interest expense for a given year includes determining the adjusted taxable income (ATI). This calculation favorably considers tax depreciation, but only for one more year. For tax years beginning after 2021, the deduction for depreciation, amortization, or depletion are not taken into account in calculating ATI. Thus, any bonus depreciation recognized on assets identified through a cost-segregation study will incrementally increase the ATI.

 

Net Operating Losses

Prior to the CARES Act, the Tax Cuts and Jobs Act (TCJA) and other legislation severely constrained the ability to use net operating losses to lower tax liabilities. TCJA restricted carrybacks of NOLs generated in tax years after Dec. 31, 2017 and limited carryforwards to 80% of taxable income.

The CARES Act made two significant changes to NOLs that provides cash flow for businesses:

• Net operating losses (NOLs), which are generated in 2018, 2019, or 2020, can now be carried back five years. Businesses that paid federal income taxes in 2013 to 2017 may be able to claim a tax refund as a result of 2018, 2019, or 2020 NOLs. Procedurally, NOLs are carried back to the earliest of their five-year period and then to subsequent tax years. But taxpayers may elect to forgo the five-year carryback and carry NOLs forward.

• The CARES Act suspends the 80% limit on carryforwards, allowing NOLs to fully offset taxable income until the end of 2020. An NOL carryback can also free up unclaimed federal tax credits and other tax attributes from closed tax years. If the NOL carryback results in credits no longer being used in the closed year, these items are eligible to be carried forward. In addition, if credits or other tax attributes were missed on the original return (e.g. unclaimed Research Tax Credit), the taxpayer may determine the unclaimed credits in the closed year and carry them forward without having to amend returns.

The calculation of NOLs for tax years beginning in 2019 and 2020 may be greater because of changes in the CARES Act to Section 163(j). The changes allow certain taxpayers to increase their business interest expense deduction based on a higher percentage of adjusted taxable income. Taxpayers should also consider the impact of additional tax depreciation on shorter-lived assets eligible for bonus depreciation, such as QIP, that can be identified from a cost-segregation study. For tax years beginning in 2020, the CARES Act also allows taxpayers to substitute their 2020 ATI with 2019 ATI if it results in a more favorable NOL calculation.

In these unprecedented times, taxpayers should take advantage of the many tax opportunities provided in the CARES Act to maximize tax deductions. Reach out to a tax specialist to discuss how these changes may impact your tax situation.

 

Lisa White, CPA is a tax manager at Meyers Brothers Kalicka, focusing primarily on federal and state income-tax compliance and planning within the construction and real-estate industries. Malik Javed, CCSP is a principal at KBKG and oversees engineering operations for cost-segregation projects from KBKG’s Northeast practice.

Accounting and Tax Planning

Complicating Matters

By Kristina Drzal Houghton, CPA, MST

Year-end tax planning in 2019 remains as complicated as ever. Notably, we are still coping with the massive changes included in the biggest tax law in decades — the Tax Cuts and Jobs Act (TCJA) of 2017 — and pinpointing the optimal strategies. This monumental tax legislation includes myriad provisions affecting a wide range of individual and business taxpayers.

Among other key changes for individuals, the TCJA reduced tax rates, suspended personal exemptions, increased the standard deduction, and revamped the rules for itemized deductions. Generally, the provisions affecting individuals went into effect in 2018, but are scheduled to “sunset” after 2025. This provides a limited window of opportunity in some cases.

Kristina Drzal Houghton

Kristina Drzal Houghton

The impact on businesses was just as significant. For starters, the TCJA imposed a flat 21% tax rate on corporations, doubled the maximum Section 179 ‘expensing’ allowance, limited business interest deductions, and repealed write-offs for entertainment expenses. Unlike the changes for individuals, most of these provisions are permanent, but could be revised if Congress acts again.

For your convenience, this article is divided into two sections: individual tax planning and business tax planning. Be aware that the concepts discussed in this article are intended to provide only a general overview of year-end tax planning. It is recommended that you review your personal situation with a tax professional.

INDIVIDUAL TAX PLANNING

Age-old Planning

Postpone income until 2020 and accelerate deductions into 2019 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2019 that are phased out over varying levels of adjusted gross income (AGI). These include deductible IRA contributions, child tax credits, higher-education tax credits, and deductions for student-loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. In some cases, however, it may pay to actually accelerate income into 2019. For example, that may be the case where a person will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or expects to be in a higher tax bracket next year.

“Generally, the provisions affecting individuals went into effect in 2018, but are scheduled to ‘sunset’ after 2025. This provides a limited window of opportunity in some cases.”

If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA in 2019 if eligible to do so. Keep in mind, however, that such a conversion will increase your AGI for 2019, and possibly reduce tax breaks geared to AGI (or modified AGI).

It may be advantageous to try to arrange with your employer to defer, until early 2020, a bonus that may be coming your way. This could cut as well as defer your tax.

Capital-gain Planning

Long-term capital gain from sales of assets held for more than one year is taxed at 0%, 15%, or 20%, depending on the taxpayer’s taxable income. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, is not more than the maximum zero-rate amount (e.g., $78,750 for a married couple).

YEAR-END ACTION: If the 0% rate applies to long-term capital gains you took earlier this year. For example, if you are a joint filer who made a profit of $5,000 on the sale of stock bought in 2009, and other taxable income for 2019 is $70,000, then before year-end, try not to sell assets yielding a capital loss because the first $5,000 of such losses won’t yield a benefit this year. And if you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains sheltered by the 0% rate.

Itemized Deductions

Among the most prominent tax changes for individuals, the TCJA essentially doubled the standard deduction while modifying the itemized-deduction rules for 2018 through 2025. For 2019, the inflation-indexed standard deduction is $12,200 for single filers and $24,400 for joint filers.

YEAR-END ACTION: With the assistance of your professional tax advisor, figure out if you will be claiming the standard deduction or itemizing deductions in 2019. The results of this analysis will likely dictate your tax planning approach at the end of the year.

Some or all of these TCJA provisions on itemized deductions may affect the outcome:

• The deduction for state and local taxes (SALT) is limited to $10,000 annually. This includes any combination of SALT payments for (1) property taxes and (2) income or sales taxes.

• The deduction for mortgage interest expenses is modified, but you can still write off interest on ‘acquisition debt’ within generous limits.

• The deduction for casualty and theft losses is eliminated (except for disaster-area losses).

• The deduction for miscellaneous expenses is eliminated, but certain reimbursements made by employers may be tax-free to employees.

• The threshold for deducting medical and dental expenses, which was temporarily lowered to 7.5% of adjusted gross income (AGI), reverts to 10% of AGI, beginning in 2019.

TIP: Depending on your situation, you may want to accelerate deductible expenses into the current year to offset your 2019 tax liability. However, if you do not expect to itemize deductions in 2019, you might as well postpone these expenses to 2020 or beyond.

Charitable Donations

Generally, itemizers can deduct amounts donated to qualified charitable organizations, as long as substantiation requirements are met. The TCJA increased the annual deduction limit for monetary contributions from 50% of AGI to 60% for 2018 through 2025. Any excess is carried over for up to five years.

If you are age 70½ or older by the end of 2019, have traditional IRAs, and particularly if you can’t itemize your deductions, consider making 2019 charitable donations via qualified charitable distributions from your IRAs. Such distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. But the amount of the qualified charitable distribution reduces the amount of your required minimum distribution, which can result in tax savings.

YEAR-END ACTION: Absent extenuating circumstances, try to ‘bunch’ charitable donations in the year they will do you the most tax good. For instance, if you will be itemizing in 2019, boost your gift giving at the end of the year. Conversely, if you are claiming the standard deduction this year, you may decide to postpone contributions to 2020.

For donations of appreciated capital-gain property that you have owned longer than one year, such as stock, you can generally deduct an amount equal to the property’s fair market value (FMV). Otherwise, the deduction is typically limited to your initial cost. Also, other special rules may apply to gifts of property. Notably, the annual deduction for property donations generally cannot exceed 30% of AGI.

If you intend to donate securities to a charity, you might choose securities you have held longer than one year that have appreciated substantially in value. Conversely, it usually is preferable to keep securities you have owned less than a year.

TIP: If you donate to a charity by credit card late in the year — for example, if you are making an online contribution — you can write off the donation on your 2019 return, even if you do not actually pay the credit-card charge until 2020.

Alternative Minimum Tax

Briefly stated, the alternative minimum tax (AMT) is a complex calculation made parallel to your regular tax calculation. It features several technical adjustments, inclusion of ‘tax preference items,’ and subtraction of an exemption amount (subject to a phase-out based on your income). After comparing AMT liability to regular tax liability, you effectively pay the higher of the two.

YEAR-END ACTION: Have your AMT status assessed. Depending on the results, you may then shift certain income items to 2020 to reduce AMT liability for 2019. For instance, you might postpone the exercise of incentive stock options (ISOs) that count as tax preference items.

Thanks to the TCJA, the AMT is now affecting fewer taxpayers. Notably, the TCJA substantially increased the AMT exemption amounts (and the thresholds for the phase-out), unlike the minor annual ‘patches’ authorized by Congress in the recent past.

TIP: The two AMT rates for single and joint filers for 2019 are 26% on AMT income up to $194,800 ($97,400 if married and filing separately) and 28% on AMT income above this threshold. Note that the top AMT rate is still lower than the top ordinary income-tax rate of 37%.

Education Tax Breaks

The tax law provides tax benefits to parents of children in college, within certain limits. These tax breaks, including a choice involving two higher-education credits, have been preserved by the TCJA.

YEAR-END ACTION: If you pay qualified expenses for next semester by the end of the year, the costs will be eligible for a credit in 2019, even though the semester does not begin until 2020.

Typically, you must choose between the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). The maximum AOTC of $2,500 is available for qualified expenses of each student, while the maximum $2,000 LLC is claimed on a per-family basis. Thus, the AOTC is usually preferable. Both credits are phased out based on modified adjusted gross income.

The TCJA also allows you to use Section 529 plan funds to pay for up to $10,000 of K-12 tuition expenses tax-free. Previously, qualified expenses only covered post-secondary schools.

TIP: If your student may be graduating in 2020, you may want to hold off and pay the spring 2020 tuition in early January 2020. The student can usually use this credit to offset their own 2020 tax liability even if the parent’s income exceeds the thresholds.

Estimated Tax Payments

The IRS requires you to pay federal income tax through any combination of quarterly installments and tax withholding. Otherwise, it may impose an ‘estimated tax’ penalty.

YEAR-END ACTION: No estimated tax penalty is assessed if you meet one of these three ‘safe-harbor’ exceptions under the tax law. These exceptions consider the timing of quarterly estimates as well as your withholdings. You should review your payments with a tax professional prior to year-end.

BUSINESS TAX PLANNING

Depreciation-related Deductions

Under the TCJA, a business may benefit from a combination of three depreciation-based tax breaks: (1) the Section 179 deduction, (2) ‘bonus’ depreciation, and (3) regular depreciation.

YEAR-END ACTION: Acquire property and make sure it is placed in service before the end of the year. Typically, a small business can then write off most, if not all, of the cost in 2019.

1. Section 179 deductions: This tax-code section allows you to ‘expense’ (i.e., currently deduct) the cost of qualified property placed in service during the year. The maximum annual deduction is phased out on a dollar-for-dollar basis above a specified threshold.

The maximum Section 179 allowance has been raised gradually over the last decade, but the TCJA gave it a massive boost. In 2017, the deduction limit was $510,000, and the phase-out threshold was $2.03 million. Those figures rose to $1 million and $2.5 million in 2018, and $1.02 million and $2.55 million in 2019.

However, note that the Section 179 deduction cannot exceed the taxable income from all your business activities this year. This could limit your deduction for 2019.

2. Bonus depreciation: The TCJA doubled the previous 50% first-year bonus depreciation deduction to 100% for property placed in service after Sept. 27, 2017. It also expanded the definition of qualified property to include used, not just new, property.

Note that the TCJA gradually phases out bonus depreciation after 2022. This tax break is scheduled to disappear completely after 2026.

3. Regular depreciation: Finally, if there is any remaining acquisition cost, the balance may be deducted over time under the Modified Accelerated Cost Recovery System (MACRS).

TIP: A MACRS depreciation deduction may be reduced if the cost of business assets placed in service during the last quarter of 2019 (Oct. 1 through Dec. 31) exceeds 40% of the cost of all assets placed in service during the year (not counting real estate). Additionally, many states, including Massachusetts and Connecticut, do not recognize bonus depreciation. This should be included in your planning considerations.

Travel Expenses

Although the TCJA repealed the deduction for entertainment expenses beginning in 2018, you can still deduct expenses for travel and meal expenses while you are away from home on business and in other limited situations. The primary purpose of the expense must meet strict business-related rules.

If you travel by car, you may be able to deduct your actual expenses, including a depreciation allowance, or opt for the standard mileage deduction. The standard mileage rate for 2019 is 58 cents per business mile (plus tolls and parking fees). Annual depreciation deductions for ‘luxury cars’ are limited, but the TCJA generally enhanced those deductions for vehicles placed in service in 2018 and thereafter.

TIP: The IRS recently issued a ruling that explains when food and beverage costs are deductible when those costs are stated separately from entertainment on invoices or receipts.

QBI Deductions

The TCJA authorized a deduction of up to 20% of the ‘qualified business income’ (QBI) earned by a qualified taxpayer. This deduction may be claimed by owners of pass-through entities — partnerships, S corporations, and limited liability companies (LLCs) — as well as sole proprietors.

YEAR-END ACTION: The QBI deduction is reduced for some taxpayers based on the amount of their income. Depending on your situation, you may accelerate or defer income at the end of the year, according to the figures.

First, however, it must be determined if you are in a ‘specified service trade or business’ (SSTB). This includes most personal-service providers. Then three key rules apply:

1. If you are a single filer with income in 2019 below $160,725 or a joint filer below $321,400, you are entitled to the full 20% deduction.

2. If you are a single filer with income in 2019 above $210,700 or a joint filer above $421,400, your deduction is completely eliminated if you are in an SSTB. For non-SSTB taxpayers, the deduction is reduced, possibly down to zero.

3. If your income falls between the thresholds stated above, your QBI deduction is reduced, regardless of whether you are in an SSTB or not.

TIP: Other rules and limits may apply, including new guidelines for real-estate activities. Consult with your tax advisor for more details about your situation.

Business Repairs

While expenses for business repairs are currently deductible, the cost of improvements to business property must be written off over time. The IRS recently issued regulations that clarify the distinctions between repairs and improvements.

YEAR-END ACTION: When appropriate, complete minor repairs before the end of the year. The deductions can offset taxable business income in 2019.

Estimated Tax Payments

A corporation (other than a large corporation) that anticipates a small net operating loss for 2019 (and substantial net income in 2020) may find it worthwhile to accelerate just enough of its 2020 income (or to defer just enough of its 2019 deductions) to create a small amount of net income for 2019.

YEAR-END ACTION: This will permit the corporation to base its 2020 estimated tax installments on the relatively small amount of income shown on its 2019 return, rather than having to pay estimated taxes based on 100% of its much larger 2020 taxable income.

Bottom Line

These are just some of the year-end steps that can be taken to save taxes. As previously mentioned, be aware that the concepts discussed in this article are intended to provide only a general overview of year-end tax planning. It is recommended that you review your personal situation with a tax professional.

Kristina Drzal-Houghton, CPA, MST is the partner in charge of Taxation at Holyoke-based Meyers Brothers Kalicka, P.C.; (413) 536-8510.

Accounting and Tax Planning

2018 Tax Planning (in 2019)

By Brendan Healy, CPA

Brendan Healy

Even though we’re into 2019, there are still tax-saving opportunities available for the 2018 tax year.

This article summarizes a number of options that businesses and taxpayers should consider to help minimize their tax burden when they file their 2018 tax returns. As with any tax-savings strategy, you should discuss these post-2018 year-end planning techniques with your tax advisor before implementing them.

Retirement-plan Contributions

Although some retirement plans needed to have been in place before Dec. 31 to be used for the 2018 year, there are plans that could be set up in 2019, funded, and then used as deductions for the 2018 tax return.

A simplified employee pension (or SEP) IRA, for example, can be set up after year-end and funded up to the due date (including extensions) of the taxpayer’s business.

New Opportunity-zone Funds

The new tax law created a significant tax incentive to encourage capital investment in certain locations that need development. If you sell an asset with a large capital gain, you may be able to defer that gain if you essentially reinvest that gain into an “opportunity-zone fund” within six months of that sale. If done properly, you wouldn’t recognize the tax gain until the latter of when your new investment is sold or Dec. 31, 2026. You can also get up to 15% of the deferred gain forgiven entirely for holding the investment for specified time period. And if you held the investment for an additional 10 years, you’d pay no tax on subsequent capital gains.

Capital-expenditure Tax Writeoff

The new tax law allows businesses to write off (or expense) larger amounts of fixed-asset purchases. The new law not only applies to personal property (machinery, equipment, computers, office furniture, etc.) but also increases the ability to write off certain real-estate improvements. It also increases the amount of tax deduction available for business-owned automobiles. These capital-expense writeoff elections are made at the time you file the tax return.

State Tax Planning

If you ship product to different states or if you sell over the internet across the country, there may be state tax-planning strategies available for your business. Certain businesses can take advantage of apportioning their revenue across several states. And if they do not have to file tax returns in those states, that apportioned revenue may never be subject to state income tax.

There have been significant changes this past year in the way states are allowed to (or not allowed to) tax out-of-state shipments entering their state. You should review your state income tax plan as well as your state sales tax reporting process in light of these new and significant changes.

Tax Credits

The tax law provides certain incentives to businesses by offering tax credits. The research and experimentation tax credit, for example, allows a business to convert a dollar of deduction into a dollar of tax credit. Since tax credits reduce taxes on a dollar-for-dollar basis, a tax credit is more valuable to the business than a tax deduction. So if the business is allowed to convert an expenditure into a credit, the tax savings could be substantial.

Many businesses (such as manufacturers or software companies) are not taking advantage of this tax credit that may be available to them.

Estate Planning and Gifts During Lifetime

The new tax law significantly increases the ability for families to transfer wealth upon death as well as allowing gifts during lifetime on a tax-free basis. Although estate and gift planning can get very complicated, the limits available today (which will expire in about seven years) are substantially higher than they have been in the past and allow for great flexibility in wealth-transfer planning.

Bottom Line

Just because 2018 is over does not mean we should stop thinking about tax-planning strategies for 2018 tax returns that will be filed over the next several months.

There are many tax incentives written into the tax law to encourage business and individual taxpayers to reinvest. It is up to you to make sure you are taking advantage of every one available to you and your business.

Brenden Healy, CPA, a partner at Whittlesey, is an expert in state and federal tax matters who consults with businesses and individuals and focuses his practice on closely held businesses in the real-estate, manufacturing and distribution, and retail industries.

Features

It’s That Time of Year

By Kristina Drzal-Houghton, CPA, MST

Year-end planning for 2018 takes place against the backdrop of a new tax law — the Tax Cuts and Jobs Act — that makes major changes in the tax rules for individuals and businesses.

Kristina Drzal Houghton

Kristina Drzal Houghton

For individuals, there are new, lower-income tax rates, a substantially increased standard deduction, severely limited itemized deductions and no personal exemptions, an increased child-tax credit, and a watered-down alternative minimum tax (AMT), among many other changes. For businesses, the corporate tax rate is cut to 21%, the corporate AMT is gone, there are new limits on business interest deductions, and significantly liberalized expensing and depreciation rules. And there’s a new deduction for non-corporate taxpayers with qualified business income from pass-through entities. The following is a brief synopsis of these and other changes.

Businesses and Business Owners

• For tax years beginning after 2017, taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2018, if taxable income exceeds $315,000 for a married couple filing jointly, or $157,500 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as healthcare), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business.

The limitations are phased in for joint filers with taxable income between $315,000 and $415,000 and for all other taxpayers with taxable income between $157,500 and $207,500.

• Deferring income to the next taxable year is a time-honored year-end planning tool. If you expect your taxable income to be higher in 2018 than in 2019, or if you operate as anything except a C corporation and you anticipate being in the same or a higher tax bracket in 2018 than in 2019, you may benefit by deferring income into 2019. With the passage of tax reform largely going into effect in 2018, new considerations may need to be made for the end of 2018. Of course, if an individual is subject to the alternative minimum tax, standard tax planning may not be warranted. The rules are quite complex, so don’t make a move in this area without consulting your tax adviser.

• Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2018, the expensing limit is $1,000,000, and the investment ceiling limit is $2,500,000. Expensing is generally available for most depreciable property (other than buildings), and off-the-shelf computer software.

For property placed in service in tax years beginning after Dec. 31, 2017, expensing also is available for qualified improvement property (generally, any interior improvement to a building’s interior, but not for enlargement of a building, elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems. The generous dollar ceilings that apply this year mean that many small and medium-sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment.

What’s more, the expensing deduction is not prorated for the time that the asset is in service during the year. The fact that the expensing deduction may be claimed in full (if you are otherwise eligible to take it) regardless of how long the property is held during the year can be a potent tool for year-end tax planning. Thus, property acquired and placed in service in the last days of 2018, rather than at the beginning of 2019, can result in a full expensing deduction for 2018.

• Businesses can also claim a 100% bonus first-year depreciation deduction for machinery and equipment bought used (with some exceptions) or new, if purchased and placed in service this year. The 100% write-off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2018.

• A charitable-donation deduction is available to businesses, but the actual deductibility depends on the business form. A corporation is allowed a deduction of up to 10% of its taxable income, whereas a pass-through entity is subject to an individual’s limitations. Specific types of assets may also have limited deductibility or may need to meet certain requirements. In addition, the substantiation and reporting regulations for charitable donations were recently updated. While most of the changes were relatively minor, qualified appraisals and qualified appraisers must now meet particular requirements. You should contact your tax advisor before making charitable donations, particularly inventory items, to ensure you meet the deduction requirements.

• Beginning in 2018 and until 2025, taxpayers other than C corporations are limited in their ability to deduct business loss. The excess business loss that is disallowed is instead carried forward as part of the taxpayer’s net operating loss in succeeding years.

Individuals

• As a general reminder, there are several ways in which you can file an income-tax return: married filing jointly, head of household, single, and married filing separately. A married couple, which includes same-sex marriages, may elect to file one return reporting their combined income, computing the tax liability using the tax tables or rate schedules for ‘Married Persons Filing Jointly.’

If a married couple files separate returns, in certain situations they can amend and file jointly, but they cannot amend a jointly filed return to file separately once the due date has passed. A joint return may be filed even though one spouse has neither gross income nor deductions. If one spouse dies during the year, the surviving spouse may file a joint return for the year in which his or her spouse died.

Certain married persons who do not elect to file a joint return may be entitled to use the lower head-of-household tax rates. Generally, in order to qualify as a head of household, you must not be a resident alien, you must satisfy certain marital status requirements, and you must maintain a household for a qualifying child or any other person who is your dependent.

• Higher-income earners must be wary of the 3.8% surtax on certain unearned income. The surtax is 3.8% of the lesser of net investment income (NII) or the excess of modified adjusted gross income (MAGI) over a threshold amount. As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and still other individuals will need to consider ways to minimize both NII and other types of MAGI.

• The 0.9% additional Medicare tax also may require higher-income earners to take year-end actions. It applies to individuals for whom the sum of their wages received with respect to employment and whose self-employment income is in excess of an unindexed threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case). Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax.

• Long-term capital gain from sales of assets held for over one year is taxed at 0%, 15%, or 20%, depending on the taxpayer’s taxable income. The 0% rate generally applies to the excess of long-term capital gain over any short-term capital loss to the extent that it, when added to regular taxable income, is not more than the ‘maximum zero-rate amount’ (e.g., $77,200 for a married couple). If the 0% rate applies to long-term capital gains you took earlier this year — for example, you are a joint filer who made a profit of $5,000 on the sale of stock bought in 2009, and other taxable income for 2018 is $70,000 — then before year-end, try not to sell assets yielding a capital loss because the first $5,000 of such losses won’t yield a benefit this year. And if you hold long-term appreciated-in-value assets, consider selling enough of them to generate long-term capital gains sheltered by the 0% rate.

• Postpone income until 2019 and accelerate deductions into 2018 if doing so will enable you to claim larger deductions, credits, and other tax breaks for 2018 that are phased out over varying levels of adjusted gross income. These include deductible IRA contributions, child tax credits, higher-education tax credits, and deductions for student-loan interest.

Postponing income is also desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2018. For example, that may be the case where a person will have a more favorable filing status this year than next (e.g., head of household versus individual filing status), or expects to be in a higher tax bracket next year.

• Beginning in 2018, many taxpayers who claimed itemized deductions year after year will no longer be able to do so. That’s because the basic standard deduction has been increased (to $24,000 for joint filers, $12,000 for singles, $18,000 for heads of household, and $12,000 for marrieds filing separately), and many itemized deductions have been cut back or abolished. No more than $10,000 of state and local taxes may be deducted, miscellaneous itemized deductions (e.g., tax-preparation fees, moving expenses, and investment expenses) and unreimbursed employee expenses are no longer deductible, and personal casualty and theft losses are deductible only if they’re attributable to a federally declared disaster.

You can still itemize medical expenses to the extent they exceed 7.5% of your adjusted gross income, state and local taxes up to $10,000, your charitable contributions, plus interest deductions on a restricted amount of qualifying residence debt, but payments of those items won’t save taxes if they don’t cumulatively exceed the new, higher standard deduction.

• Some taxpayers may be able to work around the new reality by applying a ‘bunching strategy’ to pull or push discretionary medical expenses and charitable contributions into the year where they will do some tax good. For example, if a taxpayer knows he or she will be able to itemize deductions this year but not next year, the taxpayer may be able to make two years’ worth of charitable contributions this year, instead of spreading out donations over 2018 and 2019.

• If you’re age 70½ or older by the end of 2018, have traditional IRAs, and particularly if you can’t itemize your deductions, consider making 2018 charitable donations via qualified charitable distributions from your IRAs. Such distributions are made directly to charities from your IRAs, and the amount of the contribution is neither included in your gross income nor deductible on Schedule A, Form 1040. But the amount of the qualified charitable distribution reduces the amount of your required minimum distribution, resulting in tax savings.

• Make gifts sheltered by the annual gift-tax exclusion before the end of the year and thereby save gift and estate taxes. The exclusion applies to gifts of up to $15,000 made in 2018 to each of an unlimited number of individuals. You can’t carry over unused exclusions from one year to the next. Such transfers may save family income taxes where income-earning property is given to family members in lower income-tax brackets who are not subject to the kiddie tax.

• For tax years beginning after Dec. 31, 2017, the unearned income of a child is subject to ordinary and capital-gains rates applicable to trusts and estates. The earned income of a child is taxed according to an unmarried taxpayer’s brackets and rates. The kiddie tax is not affected by the tax situation of the child’s parents or unearned income of any siblings. The kiddie tax applies to: (1) children under 18 who do not file a joint return; (2) 18-year-old children who have unearned income in excess of the threshold amount, do not file a joint return, and who have earned income, if any, that does not exceed one-half of the amount of the child’s support; and (3) children between the ages of 19 and 23 if, in addition to the above rules, they are full-time students. Investment earnings in excess of $2,100 will be taxed at the rates that apply to trusts and estates.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting your tax advisor, he or she can tailor a particular plan that will work best for you.

Kristina Drzal-Houghton, CPA, MST is the partner in charge of Taxation at Holyoke-based Meyers Brothers Kalicka, P.C.; (413) 536-8510.

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