The recent tax act that reforms the U.S. Tax Code beginning in 2018 changes the rules for how the IRS treats expenses taxpayers incur for lobbying local government bodies, local government officials and Indian Tribal Governments. Under the new law, taxpayers may no longer deduct these costs for influencing local legislation, regardless of whether taxpayers incur them directly or through an outside consulting firm.
Historically, the tax laws disallowed taxpayers from deducting expenses paid or incurred in connection with influencing legislation at the federal and state levels. An exception to this rule existed for taxpayers who incurred these “ordinary and necessary” business or trade expenses in connection with influencing legislation at the local level. More specifically, the law allowed a deduction for expenses that were:
- in direct connection with appearances before, submission of statements to, or sending communications to the committees or individual members of such council or body with respect to legislation or proposed legislation of direct interest to the taxpayer, or
- in direct connection with communication of information between the taxpayer and an organization of which the taxpayer is a member with respect to any such legislation or proposed legislation which is of direct interest to the taxpayer and such organization, and
- that portion of the dues paid or incurred with respect to any organization of which the taxpayer is a member which is attributable to the expenses of the activities described in (1) or (2) carried on by such organization.
The new law repeals this deduction for local lobbying expenses.
While lobbying at the federal and state levels has been relatively easy to discern, this is not always true at the local level, where there are a large number of local government bodies and officials as well as an array of different types of activities, transactions and interactions that may or may not qualify as lobbying. As a result, it is imperative that business taxpayers begin to analyze and assess the expenditures they pay in 2018 to influence local governments, including, but not limited to, promoting or opposing zoning and other local law and regulation changes where the taxpayer has a direct interest, and communications with local government officials with respect to such activities. Careful attention should be paid to review the activities, arrangements and related agreements to determine whether lobbying expenditures are deductible under the new law.
The advisors and accountants with Berkowitz Pollack Brant work closely with businesses in the real estate, healthcare and hospitality industry to comply with complex tax laws while minimizing tax liabilities.
About the Author: Thomas L. Smitha, JD, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant, where he provides accounting and consulting services, as well as tax planning and tax structuring counsel to private and publicly held companies. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.
According to the IRS, the number of tax returns that the agency examines under audit has decreased each year since 2010. However, the IRS’s shrinking budget and limited resources are not enough to give taxpayers a reprieve from an audit. Following are 10 of the top red flags that could trigger IRS scrutiny.
- Not reporting or misreporting income that is a matching item. Income that is reported on W-2s and 1099s should match the numbers that you report on your federal income tax return.
- Earning more than $1 million. In 2017, the IRS audited 4.4 percent of tax returns with income exceeding $1 million, 0.8 percent of returns reporting income of more than $200,000, and just 0.2 percent of returns with less than $200,000 in income;
- Big changes in income from year-to-year, including a significant increase or significant decrease in amount you report;
- Abnormally high charitable deductions will be easier to spot for the 2018 tax year thanks to the tax reform law that increases the standard deductions and will reduce the number of taxpayers who itemize;
- Unusually low compensation paid to an S Corporation owner;
- Incorrect Social Security Numbers;
- Claiming hobby losses could draw the attention of the IRS, which follows very specific rules regarding the treatment of income earned from a business or from an expensive hobby;
- Showing consecutive years of losses on Schedule C, Profit or Loss from a Business;
- Excessive use of a home office deduction, or unreimbursed employee expenses;
- Excessive claims for meals and entertainment deductions, which the Tax Cuts and Jobs Act limits in 2018.
About the Author: Richard Cabrera, JD, LLM, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where he provides tax planning, consulting, and mergers and acquisition services to businesses located in the U.S. and abroad. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at email@example.com.
With the 2017 April tax-filing deadline in the rearview mirror, now is a good time to revisit the provisions of the Tax Cuts and Jobs Act (TCJA), which the IRS codified for tax years beginning in 2018. The following information will apply to the tax returns that individuals file in 2019.
Lower Individual Tax Brackets through 2025
While the TCJA lowers the tax rates that apply to most income levels, it does not make income taxes any simpler. A seven-bracket system remains in effect with a low rate of 10 percent for taxable income up to $9,525 for individuals, or $19,050 for married couples filing jointly, to a high of 37 percent for taxable income above $500,000 for individuals, or $600,000 for married couples filing jointly. Figuring out an individual’s actual taxable income depends upon his or unique situation, including filing status, sources of income and claims for credits, deductions and exemptions that can potentially reduce tax liabilities.
Higher Gift and Estate Tax Exemption
The estate and gift-tax exemptions double in 2018, allowing individuals to exclude from their taxable estate up to $11.18 million in assets, or $22.36 million for married couples filing joint tax returns. Estates valued above these thresholds will be subject to a 40 percent tax. The estate tax exemption will be indexed for inflation until 2026, when it will revert to its 2017 pre-TCJA level.
Higher Standard Deduction
The TCJA eliminates personal exemptions in 2018 while increasing the standard deduction to $12,000 for individual taxpayers, or $24,000 for married taxpayers filing jointly. In future years, these amounts will be adjusted annually for inflation until 2026 when the deduction it is set to expire.
Limits to Itemized Deductions
Taxpayers continue to have the option to either claim a standard deduction or itemize each deduction for which they may be entitled. With the new, higher standard deduction in 2018, it is expected that fewer taxpayers will itemize. However, for high-net-worth individuals whose itemized deductions may exceed the higher standard deduction, itemizing may continue to be the best option, especially when considering that the TCJA suspends the overall 3 percent of adjusted gross income (AGI) limitation on itemized deductions.
With this in mind, taxpayers should consider the following changes to common deductions.
- Casualty and Theft Losses are no longer deductible unless they result from a president-declared federal disaster, such as the 2017 hurricanes or California wildfires.
- Charitable Deductions are available only to taxpayers who itemize their deductions. However, the amount of cash contributions that an eligible taxpayer can deduct increases to 60 percent of his or her AGI. Benevolent taxpayers can maximize their tax-deductible gifts by bunching together several years of small donations into one year when the contributed amount will exceed the standard deduction. Similarly, taxpayers may realize tax benefits and stretch their philanthropic dollars by focusing their giving toward donor-advised funds and/or private foundations.
- The Foreign Earned Income Exclusion for 2018 increases to $103,900.
- Medical and Dental Expenses are deductible to the extent they exceed 7.5 percent of an itemizing taxpayer’s AGI.
- Miscellaneous Itemized Deductions are disallowed beginning in 2018. This includes deductions for use of a home office, unreimbursed job expenses, expenses incurred while searching for a job, as well as tax preparation and other professional service fees.
- Mortgage Interest is deductible on new loans executed on or after Jan. 1, 2018, on acquisition indebtedness of $750,000 or less for individual taxpayers. This dollar limit does not apply to mortgages existing on or before December 15, 2017. For 2018, taxpayers who refinance loans existing on or before December 15, 2017, will be able to deduct interest on up to $1 million of indebtedness. In 2018, there is no longer a deduction for interest paid on a home equity line of credit (HELOC).
- Moving expenses are no longer deductible regardless of whether or not they resulted from a taxpayer’s job change.
- Property Tax, and State and Local Tax (SALT) deductions are limited to a combined total of $10,000 for single and married filing jointly taxpayers. A number of U.S. states, including New York, New Jersey and California, have or are planning to introduce laws to reduce the impact of the SALT deduction limit on its residents. How the IRS will treat these state-level provisions is unclear at this time.
- Retirement Savers continue to receive favorable tax treatment when making annual contributions to retirement accounts. In 2018, the maximum amount that taxpayers may contribute to a 401(k) and receive a tax deduction is $18,500, or $24,500 for taxpayers age 50 and older. The limit on contributions to traditional and Roth IRAs remains at $5,500, or $6,500 for individuals age 50 and older. In addition, because the TCJA increases the income thresholds for taxpayers to contribute to IRAs and Roth IRAs, more taxpayers will be able to take advantage of these qualified retirement plans to save for the future.
- Student Loan Interest continues to be deductible up to $2,500, regardless of whether taxpayers choose to itemize or not. However, the deduction begins to phase out when taxpayers’ modified adjusted gross income (MAGI) exceeds $65,000, or $135,000 for married filing jointly. The deduction is not available to taxpayers whose MAGI reaches $80,000, or $165,000 for married couples filing joint returns.
A Mixed Bag for Families with Children
529 Savings Plans continue to be tax-efficient vehicles for families to save for a child’s future college education. New for 2018 is the ability for families to take from 529 plans tax-free distributions of up to $10,000 per year to pay for a child’s K through 12 private or religious school tuition. Annual 529 savings plan contributions of $15,000 per beneficiary, or $30,000 per beneficiary for married couples filing jointly, are generally not subject to federal gift taxes. There are also planning opportunities that allow taxpayers to elect to treat contributions in excess of the annual gift tax exclusion as if they were spread over a five-year period.
An Adoption Credit is available for families to recover up to $13,810 in adoption-related expenses. Families that adopt children with special needs are treated as having paid the maximum $13,810 credit regardless of the actual expenses they incur. This nonrefundable credit is subject to a phaseout when MAGI exceeds $207,140 and completely phases out when MAGI exceeds $247,140.
The Child Tax Credit increases to $2,000 per qualifying child and is refundable up to $1,400, depending on a family’s AGI. Once a taxpayer’s AGI reaches $200,000, or $400,000 for married taxpayers filing jointly, the Child Tax Credit begins to phase out.
Obamacare Shared Responsibility Penalty
Taxpayers who go without health insurance in 2018 will continue to be subject to the Affordable Care Act’s individual mandate. The penalty for failing to have health coverage for any month during the year is the greater of 2.5 percent of AGI, or $695 per adult and $347.50 per child up to a maximum of $2,085. The individual mandate is scheduled to be eliminated beginning in 2019.
Tax reform is a game-changer for most U.S. taxpayers. However, leveraging the benefits of the new law and mitigating the risk of exposure to an increased tax burden in 2018 and in future years requires careful planning under the guidance of experienced tax advisors and accountants.
About the Author: Tony Gutierrez, CPA, is a director with Berkowitz Pollack Brant’s International Tax Services practice, where he focuses on tax and estate planning for high-net-worth individuals, family offices, and closely held businesses in the U.S. and abroad. He can be reached at the CPA firm’s Miami office at 305-379-7000 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
It can be argued that U.S. businesses and their shareholders will be the biggest winners from the Tax Cuts and Jobs Act (TCJA). However, because the law falls short of its aim to simplify the tax code, significant advance planning under the guidance of professional advisors is recommended to help taxpayers dig through the law’s complexity and reap its potential benefits.
One of the most significant provisions of the TCJA is an immediate and permanent reduction in the corporate tax rate from 35 percent to a flat 21 percent and a complete repeal of the corporate alternative minimum tax. This historically low rate takes the U.S. off its perch as the country with the highest corporate tax rate and puts it a more competitive position compared with other advanced economies around the globe.
For businesses organized as pass-through entities, which represent more than 90 percent of all U.S. businesses, the new law is far more complicated. In general, the TCJA introduces a potential 20 percent deduction on certain income that flows from S Corporations, partnerships, LLCs and sole proprietors through to their owners’ individual income tax returns. However, there are a number of limitations and exclusions to this deduction based on such factors as the new concept of qualified business income (QBI), the amount of W-2 wages a business pays and the cost of the depreciable income-producing property owned by the business. Additional limitations apply to “specified service businesses” in the fields of health, law, accounting, actuarial sciences, performing arts, consulting, and financial and brokerage services or any other business whose primary asset is the reputation or skill of its owner or employees. How the IRS will interpret this provision remains to be seen as of today. What is known if that, unlike the corporate tax reduction, the treatment of pass-through businesses, is scheduled to expire in 2025.
With just these provisions in mind, it makes sense for some pass-through businesses to weigh the pros and cons of restructuring as C corporations in the near future. Consideration should be given to such matters as state and local tax liabilities and deductibility, exposure to double taxation and the tax treatment of retained profits and dividends paid to owners and partners of C corporations. If business owners intend to reinvest profits in their companies, a C corporation structure may make the most sense. Alternatively, if businesses intend to pull profits out their companies to distribute them to their owners, a C corporation with double-tax treatment may be more expensive. Based on the taxpayer’s specific and unique facts and circumstances, a conversion may not be the best option for minimizing tax liabilities.
Credits and Deductions
The TCJA provides corporations with a mixed bag of both limited and enhanced credits and deductions that may require careful planning in 2018 to minimize future tax liabilities.
For example, gone are deductions for domestic production activities. In addition, businesses may no longer deduct expenses for entertainment, including costs they incur for seats or suites at entertainment venues, tickets and meals for sporting events and concerts, and dues for membership in in business, recreational and social organizations.
The costs that a taxpayer incurs when treating clients or prospective customers to a business-focused lunch or dinner remains 50 percent deductible, as long as the meal occurs outside of an entertainment facility. Similarly, a company may continue to deduct 50 percent of the reimbursement for meals they provide to traveling employees and 100 percent of costs for a holiday party or similar employee event. However, under tax reform, businesses have until Dec. 31, 2025, to deduct on an annual basis only 50 percent of the costs for meals they provide to their employees for their benefit or in an employer’s on-site cafeteria. Despite these limitations, the law does provide businesses with some enhanced benefits.
Net Operating Losses (NOLs)
Net operating losses are a prime example of the ying and yang of tax reform. While NOL carrybacks areno longer allowed beginning in 2018, unused losses that were previous limited to 20 years of carryforwards are now permitted to be carried forward indefinitely. Yet, only 80 percent of taxable income will be can be offset with an NOL carryforward. As a result, corporations will no longer be able to use NOLs to bring their tax liabilities to zero.
Limitations to Business Interest Deduction
The deduction for business interest, including interest on related-party debt, is limited for certain taxpayers under the new law to 30 percent of earnings before interest taxes, depreciation and amortization (EBITDA) until 2021. At that point, the limitation is set to apply to earnings before interest taxes (EBIT). Any remaining business interest expense that is not allowed as a deduction may be carried forward indefinitely and applied to future tax years. An exception to the 30 percent limitations exists for businesses whose gross receipts for the three most recent tax ears are less than $25 million, as well as for qualifying taxpayers who accrued interest in real property trades or business that elect the slower alternative depreciation system or ADS. Additional guidance on this topic is forthcoming from the IRS.
Limitations to Carried Interest
The TCJA preserves the favorable long-term capital gains treatment of gains from partnership interest held by managers and partners for a share of a business or project’s future profits. Yet, it also limits the benefit to assets held for a minimum of three years, rather than the previous holding period of one year, unless a corporation owns the partnership interest. The new longer holding period applies to capital assets. Curiously, the law does not apply the longer holding period to trade or business assets, also known as Section 1231 assets, which typically include apartments, office buildings and other depreciable property used in a trade or business and held for more than one year. We will watch for additional guidance from the IRS and on this topic.
Expanded Opportunities to Expense Business Assets
One significant bright spot in corporate tax reform deductions is available for businesses that invest in capital assets. For one, qualifying tangible property that businesses acquire and put into service after Sept. 27, 2017, and before Jan. 1, 2023, may be eligible for 100 percent “bonus” depreciation in the year of purchase. The new law defines qualifying property as tangible personal property with a recovery period of 20 years or less and including for the first time used property. Prior to the TCJA, bonus depreciation was limited to 50 percent of the cost of new tangible property or non-structural improvements to the interiors of nonresidential building.
Expanded Definition and Expensing of Section 179 Property
The new law expands the definition of Section 179 qualifying improvement property and business assets to include improvements to nonresidential property, such as roofs; heating, ventilation and air-conditioning property; fire protection and alarm systems; and security systems improvements. In addition, the law increases the maximum amount a taxpayer may expense under Section 179 to $1 million per year. Previously, the Section 179 deduction was limited to $500,000, and it began to phase out at $2 million.
Changes in Accounting Methods
The TCJA qualifies a larger percentage of corporations and partnership to use the cash method of accounting when filing their tax returns, rather than the accrual method, by raising the gross receipts test from $5 million to $25 million over a three-year period. Moreover, taxpayers that meet the average gross receipts test are no longer required to account for inventory using the accrual method. Rather, taxpayers have the option to either treat inventory as non-incidental materials and supplies or rely on the same method of accounting they use for financial statement purposes.
In order for businesses to take advantage of what may be the largest corporate tax cut in history, proper and timely planning is required. The professional advisors with Berkowitz Pollack Brant work with domestic and international businesses to implement tax efficient strategies that comply with complex laws and minimize taxpayer’s liabilities.
About the Author: Laurence Bernstein, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant, where he provides tax and consulting service to high-net-worth families, entrepreneurs and growth-oriented business owners. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at email@example.com.
Information contained in this article is subject to change based on further interpretation of the law and guidance issued by the Internal Revenue Service.
Cost segregation studies have proven to be valuable tools for helping taxpayers who have constructed, purchased, expanded or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes. However, a recent Memorandum issued by the IRS highlights the fact that relying on a third party to perform a cost segregation study does not release taxpayers from potential negligence penalties associated with the underpayment of tax.
In the matter before the IRS Chief Counsel, a small business hired an engineer to conduct a cost segregation study, which the business ultimately used to accelerate depreciation deductions over five years, rather than 39, and create a significant tax loss for the years at issue. Nonetheless, the IRS determined that the business understated its tax liabilities by claiming excessive deductions based upon the engineer’s report, which the IRS characterized as “the most egregious misrepresentation” of the useful life of a building’s components. Ultimately, the IRS found the taxpayer to be negligent in meeting its tax burden while imposing penalties on the engineer for “aiding and abetting” the tax underpayment.
While it is true that the engineer will pay for his aggressive cost segregation study, it is important for real estate professionals to remember that just because they paid a licensed engineer to develop a report, does not mean that the report is accurate. Nor does it alleviate taxpayers of their responsibilities to substantiate all claims of income and deductions. This is especially true when considering the nuances in the tax laws relating to bonus depreciation, including appropriate allocations made between land and buildings, the definition of units of property (UoP) and the decision to capitalize or expense repairs and improvements.
With this in mind, it is critical that real estate professionals engage tax advisors and accountants to review cost segregation studies in order to identify potential inaccuracies and ensure that depreciation deductions and reclassifications of building components make sense. Having another professional agree that a cost segregation study is valid will help to reassure taxpayers that their claims have a better chance against a potential IRS audit.
About the Author: Angie Adames, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant, where she provides tax and consulting services to real estate companies, manufacturers and closely held business. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.