If you are an employee who works for tips and received more than $20 in tips during July, you are required to report them to your employer on IRS Form 4070 no later than August 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.
QuickBooks Online is more than just an online bookkeeper. It can help improve your cash flow, your customer relationships, your inventory readiness, and your future.
If you’re already using QuickBooks Online, you know how much impact its bookkeeping abilities have had on your company’s accounting operations. You’re saving time, which in-turn saves money, and you’re reducing errors. When a customer or vendor calls with a question, or you yourself need to track down a critical detail to solve a problem, you’re able to find solutions quickly.
You may already have learned, though, that QuickBooks Online’s benefits include much more than simply getting the numbers right. When you take advantage of all it can offer, you’re likely to notice more far-reaching effects.
Let’s look at how QuickBooks Online accomplishes all of this. You can do much of it on your own, but we’re trained to help small businesses get the most out of QuickBooks Online. We can help you maximize the effectiveness of your accounting time so your company can:
Better balance between income and expenses.
QuickBooks Online provides quick, real-time overviews of your sales status.
You can’t begin to improve your company’s cash flow until you understand where the financial bottlenecks are. QuickBooks Online provides that information for both income and expenses in a variety of ways. In the image above, you can see that there are seven past-due invoices. Click on the orange bar to see a list of them, and you can automatically send reminders. QuickBooks Online also automates the process of sending statements.
You can also run accounts receivable and accounts payable reports that will show where you stand with customers and vendors, like Open Invoices, Uninvoiced Time, Unpaid Bills, and Accounts Payable Aging Detail. If you determine that one of your consistent problems with cash flow is late customer payments, you can set up a merchant account through QuickBooks Online to support credit card payments and bank transfers.
More repeat business because of improved customer interaction.
Your customers are like gold. To build the best relationships possible with them, you need a clear, updated picture of their transactions, their payment details and history, and your interaction with them. QuickBooks Online provides templates for Customer Information records that provide all of that, along with their contact information and a real-time update of the status of their invoices and payments, estimates, time activities, etc. The latter is provided in the form of an interactive list with links to immediate actions you can take.
A more stable, profitable inventory of products.
If your business sells products, you know that you have to be smart about inventory levels. Stock too much and you have too much money tied up unnecessarily. Too little, and you’ll be turning customers away and possibly losing their future business. QuickBooks Online’s inventory-tracking tools help you achieve and maintain that balance, so you know both when and how much to reorder.
It’s easy to evaluate your inventory status very quickly in QuickBooks Online.
QuickBooks Online also offers multiple inventory reports, like Inventory Valuation Detail, Physical Inventory Worksheet, and Sales by Product/Service Detail.
Readiness for growth.
You may never want to acquire another company, or move into more spacious offices, or employ dozens of individuals. However, it’s not often that a company doesn’t want to be in a position to grow. And you never know when an opportunity will present itself that would require additional capital. Would you be ready?
If you’ve never applied for a business loan or tried to attract investors, you don’t know how much financial information you’ll need to provide, or in what format. There are very specific reports your potential lenders or investors will want to see, standard financial statements. QuickBooks Online includes templates for these, which include a Balance Sheet, Profit and Loss, and Statement of Cash Flows.
Like the reports we mentioned earlier, they’re easy to generate on the site, thanks to intelligent, customizable templates. Analyzing them, though, and making sure they’re ready to be seen by third-parties takes professional expertise. We can provide that for you. We can also help you better understand and use other elements of QuickBooks Online so that you’re taking advantage of all of its benefits. Contact us soon to set up an initial consultation.
We’re all responsible for paying our fair share of taxes each year. But what happens when the amount that you owe is simply out of reach? What happens if you failed to make payments in a timely manner and your financial circumstances have shifted to the point where your cumulative debt is beyond your ability to pay? In the face of this untenable position, your best option for paying the IRS may be what is known as an Offer in Compromise.
The Goal of the Offer in Compromise
The Offer in Compromise, or OIC, was created to accomplish two goals: it allows American taxpayers who are unable to pay the full amount of their tax debt a way to negotiate a payment that is in keeping with their ability to pay, while at the same time providing the IRS with the ability to collect at least a portion of the amount that is owed to them. The process is neither simple nor fast: it generally takes at least one to two years for both sides to come to an agreement on an amount to be paid.
Even so, it has certain advantages for both sides.
An Offer in Compromise generally allows for resolution to be accomplished outside of court, with the agreed-to payment reflective of income and assets rather than the actual amount of debt that has accrued. Though it may seem a loss for the IRS, the agency ends up recovering more as a result of settling than they are likely to through a strong-arm collection process.
Understanding the Available Offer in Compromise Options
Taxpayers interested in pursuing an Offer in Compromise generally have three different options available to them under federal law. They are to suggest that they do not actually owe the tax debt that they are being charged with; to indicate that there simply are not enough assets or income to make a payment on the debt that has accrued; or to pursue a compromise based on either exceptional circumstances or economic hardship. This last option falls under the category of “effective tax administration,” and is notable because the taxpayer makes no argument as to either their ability to pay or whether they, in fact, owe the named amount.
Applying for an Offer in Compromise
The OIC process is both time-consuming and complicated. Applications require specific forms as well as extensive documentation, and all must be accurately prepared in keeping with IRS regulations. When mistakes are made or forms are incomplete the applications are quickly returned without the benefit of a review. To minimize both delay and frustration, it is strongly suggested that taxpayers looking to avail themselves of an OIC employ tax professionals for both the preparation of their paperwork and the negotiation of its terms.
Not Every OIC Application is Approved
It is also important to remember that an application for an OIC by no means guarantees the desired outcome. Submitting the specifics of your situation to a qualified tax professional will provide you with the ability to have your case reviewed by an expert who understands the process and the IRS criteria for approval, and who will be able to give you a reasoned perspective on the viability of your request.
Working with a professional will also provide you with reasonable expectations regarding the amount of time that the process will take and what your chances are of having your initial offer accepted. The program generally takes about two years from start to finish, and it is common for the IRS to make a counteroffer when the agency believes it will be able to collect more than the amount proffered by the applicant.
In evaluating your case, the Internal Revenue Service will likely pay less attention to the actual amount that is owed than the amount that the taxpayer is able to pay. This determination will be made on the basis of numerous factors, including income, assets, previous earnings capacity and anticipation of your earnings capacity in the future. Living expenses will also be taken into consideration.
The good news is that from the time that an application is sent in and while an IRS evaluation is taking place, most collection efforts are frozen. This generally provides tremendous relief from stress for taxpayers who have fallen behind in their payments and who feel unable to submit the amount that they owe.
If you have found yourself in this situation, contact us today to discuss your options. An experienced and knowledgeable tax expert will help you to understand, anticipate, and prepare for all aspects of the Offer in Compromise process, and will act as your advocate during sensitive negotiations.
The process of starting a small business can be an arduous one; there are numerous steps that need to be taken — and often in a precise order — to legally establish a business. As a result, the process can be overwhelming. Unfortunately, it’s also easy to overlook some important details and steps along the way. By being aware of a few of the most common legal and compliance mistakes made by small business owners when starting out, you can be better prepared for future success.
1. Misclassifying Employees as Independent Contractors
Regulators are coming down hard on misclassifications. The IRS estimates that this problem includes millions of workers. It is best to talk this through with an expert, but you can get some background on the guidelines at the United States Department of Labor website.
2. Choosing the Wrong Business Structure
One of the first major decisions you’ll need to make in regards to your small business is the type of business structure you will select. This can range anywhere from a basic sole proprietorship (which doesn’t require any special forms or paperwork) to a more complex structure, such as a corporation or LLC. Keep in mind that different types of business structures offer different tax benefits and other protections, so it’s important to thoroughly explore your options and select the structure that’s best for your unique needs. You’ll also need to go through the legal process of establishing your business under your desired structure, which may require help from a legal or other type of professional.
3. Failing to Apply for an Employer Identification Number
Unless you plan on operating your business strictly as a sole proprietorship (in which case, you will use your personal Social Security number when filing taxes), you’ll also need to apply for a unique Employer Identification Number (EIN). This number will be specifically associated with your business, and it can be helpful to think of it as a business Social Security number of sorts; it’s used to file your business taxes, open up dedicated business bank accounts, and the like.
4. Overlooking Important Permits and Licenses
Depending on the specific industry in which your business will be operating and your location, you may also be required to obtain specialized licenses and/or permits in order to legally operate. Otherwise, you’ll run the risk of being shut down or finding yourself in serious legal trouble down the road. Take some time to research the specific types of permits or licenses that you may need to obtain, as well as the steps you’ll need to take in order to acquire them. Sometimes, this process can be time-consuming and even costly, so it’s not something you’ll want to put off until the last minute.
5. Not Knowing When to Speak to a Professional
When starting up a small business, it’s not uncommon to run a one-man (or woman) operation. After all, you may not have the cash flow or even the need to hire outside help in the early stages. Still, when it comes to making sure your business is squared away from a legal/compliance standpoint, it can certainly be worth the money to consult with tax and accounting professionals early in the game. You don’t necessarily need to onboard these experts full-time, but being able to turn to them for advice and guidance when you need it will help you avoid serious legal issues later on.
6. Putting Off Domain Name Registration
As soon as you have your business name picked out and registered, it’s also in your best interest to go ahead and register your website domain as soon as possible. Even if you don’t plan on setting up and launching your website any time soon, domain names are cheap, and having yours registered now will help you avoid a situation where the domain name you want is taken by somebody else later on.
7. Lack of a Comprehensive Business Plan
One of the biggest mistakes small business owners make when first starting out is that of not having a well thought-out and articulated business plan. A business plan is an important document that outlines in detail what your goals for your business are and how you will achieve them. This document is important not just for you and other members of your immediate team, but for potential investors as well. Should you seek financing for your company at any point, an investor is going to want to see and scrutinize your business plan — and it will likely have a major impact on the final decision.
8. Not Having Finances Squared Away
Another common mistake new business owners make is that of poor financial planning, which can lead to a lack of funding to get you through your first months successfully. Ideally, you’ll want to make sure your business plan accounts for all the company-related expenses you’ll incur during the first year of operation, as well as any personal expenses as well. Unfortunately, this is something that many small business owners overlook or miscalculate with disastrous results. The easiest way to avoid this mistake is to consult with a small business accountant during the early stages of drafting your business plan.
9. Failing to File Patents on Products or Ideas
It’s (hopefully) no surprise that you’ll want to be proactive about filing for patents for any unique products, prototypes or designs you may have. However, what many small business owners first starting out don’t realize is that they’ll also want to file patents on ideas, such as intellectual property, that could otherwise be stolen or copied and used by other entrepreneurs. After all, intellectual property can be just as valuable as a product prototype — so you’ll want to plan and protect these kinds of ideas accordingly.
Be careful to also avoid the mistake of waiting too long to file for relevant patents; the process can often be long and drawn out, so getting started as early as possible will be in your best interest.
10. Being Blind to Important Compliance Requirements
Last, but not least, make sure you’re aware of any and all compliance requirements that may apply to your business based on its structure, location, industry or other factors. For example, even if you’re keeping things “simple” by operating as a sole proprietorship, you’re going to be required to file and pay quarterly estimated taxes under that structure. Failing to meet compliance and other requirements can result in serious legal trouble, including fines and penalties, down the road.
When it comes to compliance requirements, such as annual reporting and tax filing, it’s always a good idea to keep a calendar of important dates, so you don’t forget anything. After all, you’ll have enough deadlines to worry about and remember on your own — especially during that first year of business operation. This is yet another situation where having a compliance expert, such as a tax or accounting professional, can really come in handy. He or she can assist you with annual compliance reviews, reminders on impending deadlines and the like.
From selecting a name and business structure to making sure your small business remains in compliance at all times, there are, unfortunately, a lot of opportunities to make mistakes as a new business owner. By keeping this information in mind and by working alongside the right types of professionals as you prepare to launch your new business, hopefully, you’ll be able to avoid these issues. From there, you can maximize your chances for success in the first year of operation and beyond.
The Health Savings Account (HSA) is one of the most misunderstood and underused benefits in the Internal Revenue Code. Congress created HSAs as a way for individuals with high-deductible health plans (HDHPs) to save for medical expenses that are not covered by insurance due to the high-deductible provisions of their insurance coverage.
However, an HSA can act as more than just a vehicle to pay medical expenses; it can also serve as a retirement account. For some taxpayers who have maxed out their retirement-plan options an HSA provides them another resource for retirement savings – one that isn’t limited by income restrictions in the way that IRA contributions are.
Although the tax code refers to these plans as “health” savings accounts, they can also be used for retirement, as there is no requirement that the funds be used to pay medical expenses. Thus, a taxpayer can pay medical expenses with other funds, thus allowing the HSA to grow (through account earnings and further tax-deductible contributions) until retirement. In addition, should the need arise, the taxpayer can still take tax-free distributions from the HSA to pay medical expenses.
Withdrawals from an HSA that aren’t used for medical expenses are taxable and – depending on the taxpayer’s age – can be subject to penalty. Once a taxpayer has reached age 65, nonmedical distributions are taxable but not subject to a penalty (the same as for a traditional IRA). At the same time, regardless of age, a taxpayer can always take tax-free distributions to pay medical expenses.
Example: Henry is age 70 and has an HSA account from which he withdraws $10,000 during the year. He also has unreimbursed medical expenses of $4,000. Of his $10,000 withdrawal, $6,000 ($10,000 – $4,000) is added to Henry’s income for the year, and the other $4,000 is tax-free.
Eligible Individual – To be eligible for an HSA in a given month, an individual
must be covered under a HDHP on the first day of the month;
must NOT also be covered by any other health plan (although there are some exceptions);
must NOT be entitled to Medicare benefits (i.e., generally must be younger than age 65); and
must NOT be claimed as a dependent on someone else’s return.
Any eligible individual – whether employed, unemployed or self-employed – can contribute to an HSA. Unlike with an IRA, there is no requirement that the individual have compensation, and there are no phase-out rules for high-income taxpayers. If an HSA is established by an employer, then the employee and/or the employer can contribute. Not just family members but any other person can also make contributions to HSAs on behalf of eligible individuals. Both employer contributions and employee contributions made via the employer’s cafeteria plan are excluded from the employee’s gross income. Employees who make HSA contributions outside of their employers’ arrangements are eligible to take above-the-line deductions – that is, they don’t need to itemize deductions – for those contributions.
The Monetary Qualifications for a HDHP –
Example – Family Plan Does Not Qualify: Joe has purchased a medical-insurance plan for himself and his family. The plan pays the covered medical expenses of any member of Joe’s family if that family member has incurred covered medical expenses of over $1,000 during the year, even if the family as a whole has not incurred medical expenses of over $2,700 during that year. Thus, if Joe’s medical expenses are $1,500 during the year, the plan would pay $500. This plan does not qualify as a HDHP because it provides family coverage with an annual deductible of less than $2,700.
Example – Family Plan Qualifies: If the coverage for Joe and his family from the example above included a $5,000 family deductible and provided payments for covered medical expenses only if any member of Joe’s family incurred over $2,700 of expenses, the plan would then qualify as a HDHP.
Maximum Contribution Amounts – The amounts that can be contributed are determined on a monthly basis and are calculated by dividing the annual amounts shown below by 12. Thus, if an individual’s health plan only qualified that person for an HSA for 6 months out of the year, then that person’s contribution amount would be half of the amount shown.
In addition to the amounts shown, an eligible individual who is age 55 and older can contribute an additional $1,000 per year.
How HSAs Are Established – An eligible individual can establish one or more HSAs via a qualified HSA trustee or custodian (an insurance company, bank, or similar financial institution) in much the same way that an individual would establish an IRA. No permission or authorization from the IRS is required. The individual also is not required to have earned income. If employed, any eligible individual can establish an HSA, either with or without the employer’s involvement. Joint HSAs between a husband and wife are not allowed, however; each spouse must have a separate HSA (and only if eligible).
If you have questions related to how an HSA could improve your long-term retirement planning or health coverage, please call this office.
Tax Reform Suspension of Employee Business Expenses
Section 107 of the Internal Revenue Code provides that a minister of the gospel’s gross income doesn’t include the rental value of a home (parsonage) provided; if the home itself isn’t provided, a rental allowance paid as part of compensation for ministerial services is excludable. The benefit is generally referred to as a parsonage allowance. Thus, a minister can exclude the fair rental value (FRV) of the parsonage from income under IRC Sec. 107(1), or the rental allowance under Sec. 107(2), for income tax purposes. The Sec. 107(2) rental allowance is excludable only to the extent that it is for expenses such as rent, mortgage payments, utilities, repairs, etc., used in providing the minister’s main home, and only up to the amount of the FRV of the home.
However, either type of parsonage allowance is only excludable for income tax purposes and is subject to self-employment taxes, although for years before 2018 and after 2025, the amount subject to self-employment tax can be reduced by the minister of the gospel’s employee business expenses.
Back in October 6, 2017, in the US District Court for the Western District of Wisconsin, Judge Barbara B. Crabb, in Gaylor v. Mnuchin (the treasury secretary), concluded that Section 107(2) of the Internal Revenue Code is unconstitutional. Specifically, she concluded that this code section violates the Establishment Clause of the First Amendment because it does not have a secular purpose or effect and because a reasonable observer would view the statute as being an endorsement of religion.
The code section under judicial fire is the part of code Sec. 107 allowing churches and other religious organizations the ability to provide tax-free housing to their ordained ministers, even though the housing is not provided in kind by the church or the religious organization. This provision of the code was envisioned to provide ministers of the gospel with modest tax-free housing. However, it contains no limitations on its application and, as a result, also applies to:
Televangelists like Joel Osteen, who uses this tax provision to live tax-free in his multi-million dollar mansion.
Other ordained ministers working in church-affiliated schools as teachers and administrators who also benefit from the provision.
It has been estimated that the government foregoes in excess of $800 million in tax revenues because of the provision.
Judge Crabb, in issuing her decision, directed the parties to file supplemental materials regarding what additional remedies are appropriate, if any. The judge subsequently stayed injunctive relief until 180 days after the final resolution of all appeals. The additional time will allow Congress, the IRS and affected individuals and organizations to adjust to the substantial change. This case will certainly be appealed to the circuit court and eventually to the Supreme Court. So, we will need to keep our eyes on this case and see how it plays out in the long run.
It should be emphasized that Sec. 107(1), which permits an amount equal to the rental value of a parsonage furnished to a minister as part of his or her compensation to be excluded from income, is not affected by Judge Crabb’s ruling; thus, this benefit continues to be income-tax free.
Ministers of the gospel will also feel one of the negative aspects of the Tax Cuts & Jobs Act of 2017 (aka tax reform), which suspended the deduction for employee business expenses. Thus, beginning in 2018 and through 2025, ministers of the gospel will no longer be able to reduce the amount of their housing allowance by their employee business expenses when computing their self-employment taxes.
If you have questions related to taxation issues for ministers of the gospel, please call.
In the past, the business use of a vehicle was determined either by using the standard mileage rate for business or using actual expenses plus vehicle depreciation limited by the luxury auto caps. That continues to be the case, except the luxury auto depreciation limit has been substantially increased. In addition, there are other changes as detailed below.
Standard Mileage Rates – The standard mileage rates for the business use of a car (or a van, pickup, or panel truck) are:
STANDARD MILEAGE RATES FOR BUSINESS
53.5 Cents Per Mile
54.5 Cents Per Mile
However, the standard mileage rates cannot be used if you have used the actual expense method (using Sec. 179, bonus depreciation and/or MACRS depreciation) in previous years. This rule is applied on a vehicle-by-vehicle basis. In addition, the business standard mileage rate cannot be used for any vehicle used for hire or for more than four vehicles simultaneously.
Actual Expense Method – Taxpayers always have the option of calculating the actual costs of using their vehicle for business rather than using the standard mileage rates. In addition to the potential for higher fuel prices, the extension and expansion of the bonus depreciation, as well as increased depreciation limitations for passenger autos in the Tax Cuts and Jobs Act, may make using the actual expense method worthwhile during the first year a vehicle is placed in business service. Actual expenses include:
Vehicle registration fees
Depreciation (or lease payments).
However, these expenses must be allocated between deductible business use and nondeductible personal use, making it necessary to keep records of business miles and total miles in order to document the allocation between business and personal use.
Vehicle Depreciation – The so-called “luxury auto” rules limit the annual deduction for depreciation. Tax reform substantially increased these limits providing much larger first and second-year deductions for more expensive vehicles. The table below displays the limits that apply to vehicles placed in service in 2017 and 2018 and shows the substantial increase for 2018. These rates are inflation adjusted in subsequent years.
Tax reform also included 100% bonus depreciation, which, at the election of the taxpayer, can be added to the first-year luxury auto rates (see the amounts for “First Year with Bonus” in the table below). However, instead of an $8,000 increase, if the vehicle was purchased before September 28, 2017, but not put into service until 2018 or 2019, the increase to the first year depreciation cap is only $6,400 or $4,800, respectively, rather than $8,000.
LUXURY AUTO DEPRECIATION LIMITS
Trucks & Vans
First Year with Bonus
Vehicle Interest Expenses – Regardless of whether the standard mileage rate or actual expense method is used, a self-employed taxpayer may also deduct the business use portion of interest paid on an auto loan on their Schedule C. However, employees may not deduct interest paid on a consumer car loan.
Sale or Trade-in of a Business Vehicle – Under prior law, it was good tax strategy to trade-in a vehicle that would result in a gain, thus deferring the gain into the replacement vehicle and avoiding the tax on the gain. On the other hand, it was good practice to sell a vehicle for a loss and take advantage of the tax loss. Unfortunately tax reform no longer allows tax-deferred exchanges for anything but real estate. This does away with the aforementioned strategies, and now all sales and trade-ins are treated as sales, with any gain being taxable and any loss being deductible. However, a loss on the sale of a vehicle used solely for personal purposes is not deductible, and if the vehicle was used both for business and personal reasons, only the business portion of the loss is deductible.
Employees – Tax reform also eliminates the itemized deduction for employee business expenses; this is the place on the tax return where employees could deduct the business use of their vehicle for their employer. Thus, business vehicle expenses are no longer deductible by employees.
Please call if you have questions related to the business use of your vehicle.
Taxpayers with higher 1040 taxable incomes who are self-employed but are not “specified service businesses” may find it beneficial to structure new businesses, or restructure an existing business, as an S corporation to avoid taxable income limitations that apply to the new 20% Sec. 199A pass-through deduction.
To make up for the tax reform’s reduction of the C corporation tax rate to 21%, from which other forms of business activities do not benefit, Congress created a new deduction and code section: 199A. The 199A deduction is for taxpayers with other business activities – such as sole proprietorships, rentals, partnerships and S corporations – since, unlike C corporations, which are directly taxed on their profits, the income from the other business activities flows through to the owner’s tax return and is taxed at the individual level, i.e., at the individual’s tax rate, which can be as high as 37%.
This new Sec. 199A deduction is 20% of the pass-through income from these business activities. But not every owner of these flow-through businesses will benefit from this deduction because, as in all things tax, there are limitations.
Whether or not a taxpayer will benefit from the deduction will depend in great part upon the taxpayer’s 1040 taxable income figured without the Sec. 199A deduction. Married taxpayers with a taxable income below $315,000 (or below $157,500, for others) will benefit from the full 20% deduction.
However, limitations begin to apply when a taxpayer’s 1040 taxable income exceeds those amounts. The most restrictive limitation is the one placed on “specified service businesses.” Once married taxpayers filing jointly have a 1040 taxable income exceeding $415,000 (or above $207,500, for others), they receive no Sec 199A deduction benefit from any pass-through income derived from a specified service business. Specified service businesses include trades or businesses involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services or any trade or business in which the principal asset of the trade or business is the reputation or skill of one or more of its employees or owners. Note that an engineering or architecture business is not a specified service business for this deduction.
On the other hand, a taxpayer can still benefit from pass-through income from other business activities, even when the taxpayer’s 1040 taxable income exceeds the $415,000/$207,500 limits, provided the business activity pays wages and/or has qualified business property, the combination of which make up what is referred to as the wage limitation. Without getting too complicated, the Sec. 199A deduction is the lesser of 20% of one’s pass-through income or the wage limitation. If the wage limit is zero, then the Sec. 199A deduction would also be zero for these high-income taxpayers. The wage limitation itself is the greater of 50% of the wages paid by the business activity or 25% of the wages paid plus 2.5% of the cost of qualified business property. Perhaps this is best explained by example.
Example #1: Peter and his wife have a 1040 taxable income of $475,000. Peter has a self-employed business (not a specified service business), from which he has a net profit of $300,000, and his tentative 199A deduction is $60,000 (20% of $300,000). However, because his taxable income exceeds $415,000, his Sec. 199A deduction is the lesser of $60,000 or the wage limit. Peter has no employees or qualified business property, so his wage limitation is zero; thus, his Sec. 199A deduction is also zero.
Example #2: Same as example #1, except Peter’s business is organized as an S corporation. Of his net profit of $300,000, it is determined that a reasonable compensation (wage) for the services Peter provides to the S corporation is $150,000, which the S Corporation pays as a salary to Peter. The other $150,000 is pass-through income. Now, Peter’s Sec. 199A deduction is the lesser of 20% of the pass-through income – $30,000 (20% of $150,000) – or the wage limitation, which is 50% of the wages paid by the S Corporation or $75,000 (50% of $150,000).
This demonstrates how a business activity can benefit from being organized as an S corporation, since S corporations are required to pay working shareholders a reasonable wage for their services provided in operating the business. They are able to divide the pass-through income between reasonable wages and pass-through income to enable a 199A deduction for a higher-income taxpayer. Other business entities do not provide this option, which is the reason why high-taxable-income taxpayers might explore the benefits of organizing new businesses as, or reorganizing their existing businesses into, an S corporation.
Of course, there are other issues involved as well, and some sole proprietors may not find it worth the expense or effort to switch to a different type of business entity. However, the higher the taxpayer’s income, the more beneficial it becomes. The same issues also apply to partnerships. To see if organizing or reorganizing your business activity into an S corporation can reduce your tax liability, call this office for an appointment.
The Tax Cuts and Jobs Act of 2017, more commonly referred to as tax reform, substantially altered the itemized deduction for home mortgage interest and affects just about everyone who has been deducting their home mortgage interest as an itemized deduction on their tax returns.
Background: To fully understand the impact of the law changes, we need to compare the prior tax law to the new tax reform. Under prior law, a taxpayer could deduct the interest he or she paid on up to $1 million of acquisition debt and $100,000 of equity debt secured by the taxpayer’s primary home and/or designated second home.
Qualified home acquisition debt is debt incurred to purchase, construct, or substantially improve a taxpayer’s primary home or second home and is secured by the home. The interest paid on up to $1 million of acquisition debt has been deductible as part of itemized deductions on Schedule A.
Home equity debt is debt that is not acquisition debt and is secured by the taxpayer’s primary home or second home, but only the interest paid on up to $100,000 of equity debt had been deductible as home mortgage interest. Often, home equity debt is used to purchase a new car, finance a vacation, or pay off credit card debt or other personal loans – all situations in which the interest on a consumer loan obtained for these purposes wouldn’t have been deductible.
The old law continues to apply to home acquisition debts by grandfathering the home acquisition debts incurred before December 16, 2017, to the limits that applied prior to the changes made by tax reform. As explained later in this article, equity debt interest didn’t survive in the tax reform’s legal changes.
New Acquisition Debt Limits: Under the new law, which took effect for home acquisition loans obtained after December 15, 2017, the acquisition debt limit has been reduced to $750,000. Thus, if a taxpayer is buying a home for the first time, the deductible amount of acquisition debt interest will now be limited to the interest paid on up to $750,000 of the debt. If the home acquisition debt exceeds the $750,000 limit, a prorated amount of the interest is still deductible.
If a taxpayer already has a home with grandfathered acquisition debt and wishes to finance a substantial improvement on the home or acquire a second home, the new acquisition debt, for which the interest would be deductible, would be limited to $750,000 less the grandfathered acquisition debt existing at the time of the new loan. This may be a tough pill to swallow for many future homebuyers, since the cost of housing is on the rise while Congress has seen fit to reduce the cap on acquisition debt, on which interest is deductible.
Equity Debt: Under the new law, equity debt interest is no longer deductible after 2017, and this even applies to interest on existing equity debt, essentially pulling the rug out from underneath taxpayers who had previously taken equity out of their homes for other purposes and who were benefiting from the itemized deduction.
Tracing Equity Debt Interest: Because home mortgage interest rates are generally lower than business or investment loan rates and easier to qualify for, many taxpayers have used the equity in their home to start businesses, acquire rental property, or make investments, or on other uses for which the interest would be deductible. With the demise of the Schedule A home equity debt interest deduction, taxpayers can now trace interest on equity debt to other deductible uses. However, if the debt cannot be traced to a deductible purpose, unfortunately, the equity interest will no longer be deductible.
Refinancing: Under prior law, a taxpayer could refinance existing acquisition debt and the allowable interest would be deductible for the full term of the new loan. Under tax reform, the allowable interest will only be deductible for the remaining term of the debt that was refinanced. For example, under the old rules, if you refinanced a 30-year term loan after 15 years into a new 25-year loan, the interest would have been deductible for the entire 25-year term of the new loan. However, under tax reform, the interest on the refinanced loan would only be deductible for 15 years – the remaining term of the refinanced debt.
Determining when home mortgage interest is deductible and how much was deductible was frequently complicated under the prior tax law, and the new rules have added a whole new level of complexity. Please call this office if you have questions about your particular home loan interest, refinancing, or equity debt interest tracing circumstances.