by Greg Yoder
One of the biggest changes to come with the Tax Cut and Jobs Act (TCJA) of 2017 was the addition of Section 199A, or the qualified business income deduction. The stated purpose of this deduction was to provide a lower rate of tax for owners of and investors in certain types of business so that their rates would be closer to corporate rates.
In the simplest possible terms, taxpayers get a deduction for 20% of their qualified business income (QBI). QBI can come from a business that a taxpayer participates in directly (e.g., a Schedule C business or Schedule E rental property) or it can come from various kinds of pass-through entities (partnerships, LLCs, S corporations, REITs, etc.). This deduction is taken separately from and after either itemized deductions or the standard deduction.
Qualified Trade or Business
Because QBI can only be generated by a qualified trade or business, the first step in determining the deduction is determining whether the taxpayer’s business is qualified. In general, a trade or business is a qualified trade or business if it’s based in the U.S. and it is NOT one of the “specified service trade or businesses.” These businesses include:
- Actuarial science
- Brokerage services
- Dealing in securities
- Financial services
- Investing and investment management
- Performing arts
- Any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners
While it’s fairly obvious what constitutes some of these businesses (accounting, for example), other categories are defined more broadly or narrowly than you might expect. A health spa, for example, would generally not be considered a health business as defined in the regulations under §199A, so income from a health spa would qualify for the deduction. On the other hand, income from a medical practice (which does meet the regulatory definition of health services) would not qualify for the deduction.
Because being an employee is also specifically excluded by the law from being a qualified trade or business, the wage income of employees is not QBI.
The calculation of QBI for a particular business is beyond the scope of this article, but let’s summarize by saying, “It’s complicated.” Just as an example, businesses that engage in multiple activities may find that some of their activities are qualified but others aren’t. In general, these businesses will need to allocate their income and deductions between qualified and non-qualified businesses. Treasury regulations released this summer provide methods for allocating income and expenses for such entities.
Limits and Exceptions
While the general rule for the QBI deduction is 20% of QBI, there are multiple limits on the amount of the deduction. The first of these is the wage limitation. In general, a qualified business must also generate U.S. wages to generate a deduction. The amount that can be deducted with respect to a particular trade or business is the lesser of a) 20% of the QBI from that business and b) 50% of the W-2 wages paid during the year by that business. A special rule added to favor real estate investors provides that in lieu of the 50% of wages limitation, a business can deduct up to 25% of its wages PLUS 2.5% of the unadjusted basis of its qualified property. That means that a business that pays no wages but uses a large amount of qualified property may still generate a deductible amount.
The deductible amount is determined on a business-by-business basis, and then the amounts are aggregated to determine a taxpayer’s overall QBI deduction. Businesses that generate deductible losses will generate negative QBI, thereby reducing the overall deduction.
There are two principal exceptions to QBI limitations that were added to favor taxpayers with incomes below a certain level. The calculation of these limitations is (wait for it) complicated, but if a married taxpayer filing a joint return has taxable income (before the QBI deduction) of less than $315,000 ($157,500 for other filing statuses), then the taxpayer will typically be able to take a QBI deduction even if he or she has income from a business that doesn’t meet the wage limitation. Similarly, taxpayers with the same level of income will be able to take a deduction for QBI from one of the specified service trades or businesses, even though that business doesn’t meet the definition of a qualified trade or business.
Another limitation provides that the QBI deduction can’t be greater than 20% of the taxable income before the QBI deduction. In making this calculation, any income taxed at long-term capital gains rates can’t be included.
As an example, assume that a taxpayer has adjusted gross income of $400,000, made up of $250K of QBI and $150K of net long-term capital gains. The taxpayer also has itemized deductions of $100,000. In this case, the taxpayer would be entitled to a QBI deduction of $30,000, calculated thusly:
|Qualified Business Income||250,000||[A]|
|Long Term Capital Gains||150,000|
|Adjusted Gross Income||400,000|
|Taxable Income before QBI Deduction||300,000|
|Less Long Term Capital Gains||(150,000)|
|Taxable Income before QBI Deduction Net of Long Term Capital Gains||150,000||[B]|
|QBI Deduction||30,000||20% of lesser of [A] or [B]|
Of the taxpayer’s $270K taxable income, $150K would be taxed at long term capital gain rates, and the remainder would be taxed at regular graduated income tax rates.
This was — honestly — the simplest example I could come up with. For most taxpayers who can take the deduction, the calculation will be substantially more complicated, and there are plenty of additional complications that I’ve left out of this article.
Notwithstanding the enormous complexities involved in the QBI deduction, it represents a tremendous tax savings opportunity for a select group of taxpayers. If you have questions about whether you qualify for and how much benefit you can expect from this deduction (or any of the many other provisions of the TCJA), please get in touch with us for tax planning. For many taxpayers, there are actions you can take prior to year-end to maximize the deduction — and minimize your taxes.
by Steve Braunstein
As we approach the end of 2018, many personal service C-Corporations will have to address the impact of net operating losses in their tax planning strategies, due to the changes enacted by the Tax Cuts and Jobs Act. (“TCJA”)
A net operating loss (“NOL”) is created when deductions for the year are more than income. This can apply to certain business entities, individuals, estates and trusts. Under pre-TCJA law, an NOL for any tax year was generally first carried back two years, and then carried forward 20 years. Taxpayers could elect to forego the carryback.
The TCJA repeals the general two-year NOL carryback. The Act also provides that NOLs may be carried forward indefinitely. This is in effect for NOLs arising in tax years ending after December 31, 2017. This effective date means that NOLs that arose in tax years ending before January 1, 2018, will be subject to the pre-TCJA law.
In past years, many of our small business personal service corporations managed their taxable income to an amount close to break even or a small taxable loss. They did this by paying out bonuses to the owners, because the federal tax rate for personal service corporations was a flat 35%. Beginning in 2018, the corporate tax rate was reduced to a flat 21% for all types of C-Corporations, including personal service corporations. The change in tax rates coupled with the treatment of net operating losses generated after 2018 will likely impact the tax planning strategies for these types of businesses.
For net operating losses generated after 2017, and once the pre- 2018 NOL is utilized in full, a C-Corporation will be limited to using the NOL Deduction in an amount equal to 80% of the taxable income, determined without regard to the NOL deduction. Previously, a C-Corporation could use an NOL to offset 100% of their income.
For example, under pre-TCJA law, if a business generated a loss of $100,000 in 2018 and then had taxable income of $100,000 in 2019 they would have zero taxable income for 2019, because they could net the full 2018 loss with the 2019 income. Under the new law, in the second year when the business generates $100,000 of income, they will only be able to utilize $80,000 of the NOL, resulting in taxable income of $20,000 and the corresponding federal income tax at 21%. The remaining $20,000 will carryforward indefinitely until it is utilized.
With the end of the year quickly approaching, it is important for your personal service C-Corporation to understand the NOL’s they have available and consider when to utilize them, given the current low federal corporate tax rates. The treatment of an NOL is just one of the many TCJA changes that taxpayers will need to consider as they plan to minimize their 2018 tax obligation.
By Camille Smith
Quietly working its way through the US Supreme Court is a tax case that could possibly upend how trusts are structured and taxed. In the case of North Carolina Department of Revenue(NC) v. Kimberly Rice Kaestner 1992 Family Trust, NC asserts that it should be able to tax the trust’s income in the current year, based only on the beneficiaries’ residency in that state.
State taxation of trusts revolves around situs, trustee administration, and the beneficiaries’ residency. It is most common for states to tax trust income based upon situs or administration, under the theory that the state has extended legal protections/benefits to the trust. Currently, Georgia, North Carolina, and Tennessee tax the income of a trust based solely on the beneficiaries’ residency.
North Carolina’s only connection to the Kaestner trust is the beneficiaries’ residency in that state. The trust was formed in New York and administered in Connecticut. Given that the beneficiaries have neither access to nor control over the assets in the trust, North Carolina would traditionally not be considered to have sufficient connection to the trust to tax its income until it is distributed to the beneficiaries.
However, North Carolina asserts that the economic reality is that the income from the trust ultimately belongs to the beneficiaries. That “economic reality” combined with the beneficiaries’ NC residency gives the state sufficient nexus to tax the trust income in the current year, regardless of distributions (or the lack thereof).
Why not simply wait until the beneficiaries receive distributions? NC argues that the “gamesmanship” common to trusts will deprive it of its ability to tax the income; prior to the trustee making distributions, the beneficiaries will move to a state without income tax. In essence, North Carolina seeks to tax the beneficiaries’ future distributions now, under the presumption that it will not be able to do so later.
The defense contends that the “economic reality” argument is insufficient to create NC nexus to the trust. While the trust is for the benefit of the Kaestners, the assets are owned neither legally nor in practice by them. Income and assets are only distributed at the trustee’s discretion. Moreover, taxation of future distributions now would not be equitable, as it is impossible to know when any future distributions would be made or how they would be structured. North Carolina’s proposed pro-rata tax would tax any future distributions not made in a pro-rata manner.
Given the ability to tax trust income on the basis of beneficiary residency, we could expect other states to follow suit if the Supreme Court rules in favor of the North Carolina Department of Revenue. Please contact your tax advisor if you have further questions on the case.
Update: The Supreme Court issued a decision in North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust—and it’s unanimous. The Court ruled that a trust beneficiary’s residence alone is not sufficient grounds for a state to tax a trust’s undistributed income.
by Evelyn Blue, CEP
There have been many changes in the estate tax arena. The following summarizes the most routine items to consider as you meet with your attorneys, financial advisors, and accountants to create and/or update your estate plan. If you have not visited your will and estate plan recently, the recent federal and state legislative changes provide a great opportunity to make this a priority for 2018.
- The annual gift tax exclusion has been adjusted for inflation and has increased from $14,000 to $15,000 for 2018.
- The basic exclusion amount for gift and estate tax has increased from $5.49 million to approximately $11.2 million in 2018. This means each individual can make gifts or reduce their estate amount by this $11.2 million. These provisions will remain in effect until December 31, 2025, unless Congress repeals or amends the current tax legislation. If there is no repeal or amendment, the basic exclusion will sunset after that date and revert back to the law in effect for 2017 with inflation adjustments.
DISTRICT OF COLUMBIA
- Effective May 2, 2018, estate representatives who are responsible for filing an estate tax return will be required to register for an account, file and submit payment via MyTax.DC.gov. Please see the link to the estate tax brochure here.
- In the beginning of 2018, the DC estate tax exclusion was equal to the Federal basic exclusion amount which is currently the $11.2 million. However, members of the DC Council joined in a bill to change the DC estate tax exclusion from $11.2 million to $5.6 million for 2018. This DC budget bill must be approved by Congress and is expected to be approved effective October 1, 2018. Assuming the bill becomes a law, a gross estate with a value over $5.6 million in 2018 will have to file an estate tax return. We will update our website when the bill officially is passed.
- The Maryland estate tax exclusion has increased to $4 Million for 2018. The Maryland General Assembly met and passed House Bill 308 which limits the estate tax exclusion to $5 million in 2019. In addition, Maryland will recognize portability between spouses in 2019, so a surviving spouse may elect to use, under certain circumstances, any portion of their deceased spouse’s unused Maryland estate tax exemption.
FLORIDA & VIRGINIA
- Florida and Virginia repealed its estate tax in 2005 and 2007, respectively, and continue to have no state estate tax.
by Maly Sevilla, CPA
The Tax Cuts and Jobs Act (TCJA) changed some of the most used deductions for purchases of qualified property. Code sections 179 and 168(k) (bonus depreciation) allow for the immediate deduction of part or all of the cost of qualified property. The TCJA favorably changes the limits for the deductions allowed under both of these code sections.
The TCJA increased the deduction for bonus depreciation from 50% to 100% and extended the period of phase-out. A 100% first year deduction is allowed for qualified property placed in service after September 27th, 2017 and before January 1st, 2024. The deduction will start phasing out in 2024 going down to 80%, with a decrease of 20% for each year after that, until it phases out completely in 2026.
The TCJA increased the maximum annual section 179 deduction from $500,000 to $1 million. This applies to qualified property placed in service after December 31, 2017. The new law increased the annual phase-out threshold from $2 million to $2.5 million. Thus, the deduction begins to phase out dollar-for-dollar after $2,500,000 is spent on qualified property.
The definition of qualified real property eligible for code section 179 expensing is also expanded by the new law to include the following improvements to nonresidential real property after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
Most states decouple from the federal laws that cover the deductions mentioned above. Some states eliminate these deductions all together and opt for a more traditional depreciation deduction. Others, however, allow a portion of these deductions and allow the rest of the cost to be deducted through depreciation deductions. Some states are still deciding what approach they will choose in regards to the TCJA and these deductions.
The TCJA is a sweeping tax act that changed many sections of the law. These changes and the related state conformity should be taken in to consideration when planning for 2018 and beyond. Please contact us to if you have any questions.
by Elizabeth Dentan, CPA
Based on a new report published by the Government Accountability Office, 30 million Americans are not currently withholding enough federal income tax from their paychecks, according to simulations run by the Treasury Department.
The Tax Cuts and Jobs Act of 2017 (TCJA) revised the tax code, including the elimination of the personal exemption, increasing the standard deduction and changing the tax brackets and rates. As a result, the IRS issued a new withholding table, effective February 2018. This table incorporated these TCJA changes and adjusted withholdings accordingly. Many taxpayers may have noticed an increase in their take home pay earlier this year.
The revised withholding tables are designed to work with the current form W-4 (Employee’s Withholding Allowance Certificate). These tables are designed for taxpayers with straightforward tax profiles, mainly taxpayers with W-2 wages who take the standard deduction. While many taxpayers will experience a decrease in their federal income tax obligation, our experience has shown that a number of taxpayers could end up paying more in tax and with a reduction in federal withholding, these taxpayers could owe tax when they file their 2018 return next spring.
The IRS lists several situations in which taxpayers may want to re-evaluate their situations and complete a new W-4. These situations include:
- Two income families
- Taxpayers with two or more jobs
- Taxpayers with children who claim credits such as the child tax credit
- Taxpayers who itemize or used to itemize
For those taxpayers who may need to update their W-4, the IRS, through its website https://apps.irs.gov/app/withholdingcalculator offers a withholding calculator which incorporates the tax changes made through the TCJA. To use the calculator, the IRS recommends having your most recent paystub with the year to date withholding on it, and your prior year tax return handy.
We recommend that if you need help determining your withholding or help determining whether you are required to pay estimated taxes, that you contact your tax advisor at Snyder Cohn as the new tax law may significantly impact the calculation of your tax liability.
by Keith Jennings, CPA
A multitude of changes have occurred in the nonprofit industry in 2018. These changes effect both IRS/tax regulations as well as financial statement standards. In this newsletter, we will cover the tax issues.
Tax Cuts and Jobs Act Effect on Nonprofits
You may be surprised to find out that the recently enacted legislation substantially impacted the nonprofit industry. Under the rationale of aligning nonprofits with for-profit organizations with respect to tax law, some of these changes may affect the bottom line of your organization. Here are some of the changes that could affect your organization:
- Excise tax on nonprofit executive compensation – there will be penalty of 21% on compensation over $1 million.
- Unrelated business tax on transportation benefits for employees – starting in 2018, if a nonprofit pays commuting/parking benefits, those charges will be considered unrelated business income (UBI) to the nonprofit, and they will have to pay tax on that amount. From what we’ve seen so far in 2018, the response to this has been mixed. Some nonprofits are going to “bite the bullet” and continue to pay the benefit as well as the unrelated business income tax (UBIT). Some other organizations have been increasing staff salaries and then having the staff pay for the parking themselves on an “after-tax” basis. Others are getting rid of this benefit moving forward. One other possible effect of this tax law change going forward could be the potential renegotiating of office leases to include parking in the overall lease agreement. As far as we know, the IRS has not taken a stance on this subject, but stay tuned in the remainder of 2018 for any potential updates on this subject.
- Other changes to UBIT – if a nonprofit organization has multiple streams of UBI, in prior years the loss from one stream could cover the income from another. Starting in 2018 that will no longer be allowed. Also, starting in 2018 only 80% of UBI will be able to be covered by net operating losses. Prior year’s losses are grandfathered in.
The National Council of Nonprofit’s website is a great resource for nonprofit organizations. They highlighted many of these changes in a great checklist on their site – https://www.councilofnonprofits.org/sites/default/files/documents/tax-law-checklist-nonprofits.pdf.
Disclosure Requirements on Form 990 Schedule B for Certain Organizations
Nonprofit organizations are generally required to disclose on their Form 990 Schedule B each year the names and addresses of donors who contributed over $5,000 during the year. That information must be included in the filing with the IRS, but it is removed for public disclosure on websites such as www.guidestar.org. However, in July 2018 the IRS released Revenue Procedure 2018-38. It stated that starting in calendar year 2018 only 501 c 3 organizations (charities) are required to complete this information. Other types of nonprofit organizations such as 501 c 4 social welfare organizations and 501 c 6 trade associations are no longer required to complete Schedule B. This guideline does not affect private foundations.
The IRS states in the Revenue Procedure that this personally identifiable information is not needed or being used by them. Also, they state that the Schedule increases compliance costs, consumes IRS resources and poses a risk of inadvertent disclosure of private information. However, much like the Supreme Court decision in Citizens United, some citizens and watchdog groups favor stronger public disclosure rules for these types of organizations.
Look for Part II in our next newsletter which will cover financial statement and accounting changes.
Snyder Cohn has been named one of the 2018 Best Accounting Firms to Work for. This makes the fourth time we have achieved this distinction. The annual list of the Best Accounting Firms to Work for was created by Accounting Today and Best Companies Group.
This survey and awards program is designed to identify, recognize and honor the best employers in the accounting industry, benefiting the industry’s economy, workforce and businesses. The list is made up of 100 companies nationwide.
Companies from across the United States entered the two-part survey process to determine the Best Accounting Firms to Work for. The first part consisted of evaluating each nominated Firms from across the United States entered the two-part survey process to determine Accounting Today’s Best Accounting Firms to Work for. The first part consisted of evaluating each nominated company’s workplace policies, practices, philosophy, systems and demographics. This part of the process was worth approximately 25% of the total evaluation. The second part consisted of an employee survey to measure the employee experience. This part of the process was worth approximately 75% of the total evaluation. The combined scores determined the top firms and the final ranking.
“The firms on this list represent the best workplaces in the accounting profession,” said Accounting Today Editor-in-Chief Daniel Hood. “They are outstanding places to build a career.”
We are honored by this recognition and thank our associates for being such a huge part of creating and maintaining an environment we can be proud of!
If you want to be part of an organization like ours, you may firstname.lastname@example.org us, as we are always looking for talented entry level and experienced CPAs to be part of our future.
by Greg Yoder, CPA
The Tax Cuts and Jobs Act – in addition to its more sweeping changes – made a number of small but impactful changes in the sorts of benefits and expenses that business taxpayers can deduct.
The new law contains a deduction disallowance for employer-provided transportation benefits, including parking. Under old law, employers could provide relatively generous parking allowances to employees, and these amounts would be both deductible by the employer and excludable by the employee. The new law maintains the employee exclusion but removes the employer deduction. Alternatively, the employer may deduct the amounts, but then must include them in the employee’s taxable compensation.
There is some ambiguity in the law, and we had hoped that by moving parking benefits to a salary reduction arrangement (SRA), employers would be able to deduct the allowances as compensation while maintaining the exclusion for employees. IRS has clarified that this strategy will NOT be effective: parking-related amounts paid under an SRA will not be deductible by the employer. This leaves employers with two unappealing choices: either report additional taxable compensation to the employee (and get the deduction) or lose the deduction to maintain the employee’s exclusion.
Under former law, most entertainment expenses were limited to 50% deductibility, provided taxpayers could establish a sufficient business purpose for the expenditures and meet some other requirements and limitations.
The new law eliminates the deduction for most entertainment expenses, including a complete elimination of deduction for entertainment activities and facilities. The change also eliminates any deduction for dues or fees paid to any “social, athletic, or sporting club or organization.” Club dues for business and social clubs continue to be disallowed in full, as under former law.
There are a few exceptions. Most notably, recreational expenses for employees continue to be deductible in full – as they were when other entertainment expenses were limited to 50% deductibility. These expenses won’t be deductible, however, if they primarily benefit highly compensated employees, another requirement that hasn’t changed from former law.
Food and Beverage Expenses
While the entertainment portion of “meals and entertainment” has largely been disallowed, the changes to the meals portion are more complicated. This area has always been one that is ripe for nitpicking, and it hasn’t gotten any simpler under the new law. There’s a mixture of full deductibility, 50% deductibility, and no deductibility at all. But what expenses fall into which category has changed slightly. Some of the changes apply to very narrow groups of taxpayers, but others apply more broadly.
Meals provided to employees for the benefit of the employer (e.g., busy season lunches and dinners for hard-working accountants) were previously deductible in full. Under the new law, these amounts will only be 50% deductible. (Note that meals provided as part of employee recreational/social activities remain deductible in full, raising the possibility that employer-provided meals could be fully deductible as long as the employees are having enough fun. Obviously, this is not an issue for hard-working accountants during tax season, but there may be a gray area in other cases.)
Under former law, expenses for employer-provided eating facilities were entirely deductible because they were considered de minimis fringe benefits. Under the new law, they’re 50% deductible for expenses arising between January 1, 2018 and December 31, 2025. Thereafter, these expenses will be disallowed in full.
As with many other Tax Cut and Jobs Act provisions, the details are more complicated than what we’ve summarized here, and it’s important to get the details right. If you have questions about any of these provisions, please contact us.
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