The U.S. Supreme Court’s June 2018 decision in South Dakota v. Wayfair has far-reaching impact on the state and local sales tax (SALT) obligations and previous competitive advantages of online and foreign businesses that sell products into the U.S.
The court’s ruling eliminates the prevailing physical presence test, which requires sellers to collect sales tax from customers who live in states where they own property or employ workers.
Instead, the court, under Wayfair, introduces an economic nexus test based on the sellers’ sales volume into each state. More specifically, U.S. states may now impose sales tax collection obligations on sellers, foreign or domestic, that conduct more than $100,000 in sales or more than 200 transactions in their jurisdictions in a given year regardless of whether the sellers has a physical presence in that locale. This economic nexus standard varies by state.
For example, if a foreign company that sells tangible goods from its headquarters in South America into the U.S. meets the sufficient dollar/transaction threshold in a particular U.S. state, the company would be required to collect sales and/or use tax on all orders received from customers in that state. This would apply even if the company does not have a permanent establishment (PE) in that state. When the company’s sales meet the test for establishing a meaningful and substantial presence in multiple states, it would need to collect and remit sales tax in each of those jurisdictions. With economic nexus laws, states will now be able to enact or enforce sales or transaction threshold and compel more companies outside of their borders to collect tax on sales made to in-state customers.
The Wayfair decision places a significant administrative burden on foreign businesses. International tax treaties generally apply solely to income taxes on the federal level. As a general rule, tax treaties do not apply to U.S. states, and bilateral tax treaties generally do not apply to non-income taxes at the state level. Therefore, foreign companies with U.S. customers may not escape sales and use tax obligations on the state and local levels. Instead, non-U.S. companies have a potential U.S. tax collection and filing responsibility when they meet the sufficient dollar/transaction threshold in a particular state regardless of whether or not they have a permanent establishment (PE) there.
It is important to note that while the U.S. Commerce Clause prohibits states from imposing excessive burdens on interstate commerce without Congressional approval, the Supreme Court has demonstrated its authority to “formulate rules to preserve the free flow of interstate commerce” when Congress fails to enact legislation. In its opinion in Wayfair, the court affirms that the dollar/transaction threshold satisfies South Dakota’s burden to establish economic nexus and impose tax on businesses that are “fairly related to the services provided by the state,” including “the benefits of a trained workforce and the advantages of a civilized society”. This final factor, which demonstrates a fair relationship between the tax imposed and the services provided by a state, can be easily applied to foreign companies that conduct business in U.S. states.
Foreign businesses must consider how the Wayfair decision will affect their sales and profits, and they must take steps to comply with state-level taxation going forward. This may involve assessing the volume of their transactions in each U.S. state, gaining an understanding of and a method for applying the SALT regimes in each U.S. state to their sales orders, and developing communication to let customers know that sales tax will be added onto future purchases.
About the Author: Karen A. Lake, CPA, is state and local tax (SALT) specialist and an associate director of Tax Services with Berkowitz Pollack Brant, where she helps individuals and businesses navigate complex federal, state and local tax laws, and credits and incentives. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.
With real estate values appreciating and interest rates still relatively low, an increasing number of consumers have been using the equity in their homes as collateral against lines of credit that they can use to immediately pay for large expenses, including home upgrades, medical bills, college tuition, and even lavish vacations. However, the new tax laws limit homeowners’ ability to deduct interest on home equity lines of credit (HELOC) for eight tax years beginning in 2018.
Under the Tax Cuts and Jobs Act, interest deductions are available only on a combined total of new mortgage loans and HELOCS originating in 2018 through 2025 that are $750,000 or less. In addition, the law allows taxpayers to deduct the interest on HELOCs only when they use the loan proceeds to buy, build or substantially improve a primary home or a second qualifying residence. Interest is not deductible when taxpayers use a HELOC for any other purposes.
Therefore, a taxpayer can deduct interest on a HELOC they enter into in 2018 to replace a home’s roof, build an addition or renovate a kitchen or bath, as long as the total loan amount is below the limit. Loan interest is neither deductible when the combined total of loans used to buy, build or improve the taxpayer’s main home and second home exceeds the $750,000 threshold nor when taxpayers use the proceeds to pay off credit card debt, pay down student loans or help them afford a new car. This does not mean that taxpayers cannot borrow against the equity in their home to access cash. Rather, they just cannot deduct the loan interest they pay annually.
In light of these new limitations, homeowners with liquidity needs should meet with their tax accountants and financial advisors to identify other tax-efficient strategies for paying needed expenses without exposing themselves to any additional risks.
About the Author: Joanie B. Stein, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where she works with individuals and closely held businesses to implement sound strategies that are intended to preserve wealth and improve tax-efficiency. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.
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.
The IRS recently issued its first round of proposed guidance concerning the pass-through deduction that tax reform introduced to qualifying business owners and to beneficiaries of trusts and estates beginning in the 2018 tax year. Taxpayers who own interests in pass-through businesses structured as LLCs, partnerships, S Corporations, or sole proprietorships now have guidance from the IRS on how they may qualify for and calculate a tax deduction of up to 20 percent of their U.S.-source qualified business income (QBI) that passes from each of their qualifying businesses through to their personal income tax returns. Taxpayers can use the proposed guidance for tax planning in 2018 and future years until the IRS issues final regulations, which are not expected until October 2018 at the earliest.
What is QBI?
The Tax Cuts and Jobs Act (TCJA) introduced the concept of QBI and defined it as the net amount of income, gains, deductions, and losses effectively connected with a taxpayer’s qualified U.S.-source trade or business, including LLCs, partnerships, S Corporations, sole proprietorships, and trusts and estates. QBI also includes qualified dividends taxpayers receive from real estate investment trusts (REITs), qualified cooperative dividends, qualified income from publicly traded partnerships (PTPs), and income generated from rental property or from trusts and estates with interests in qualifying entities. Under this definition, the QBI deduction may apply to U.S. citizens, resident aliens, and nonresident aliens (or foreign taxpayers) who receive qualified U.S.-source income from a trade or business, business trust, or estates of decedents.
QBI excludes income not effectively connected with a U.S.-source trade or business, investment income, interest income, and capital gains and losses.
How is the QBI Deduction Calculated?
For tax years 2018 through 2025, the maximum amount that a qualifying business owner, trust or estate may deduct from its QBI is the lesser of:
- 20 percent of QBI from each of the taxpayer’s trades or businesses plus 20 percent of the taxpayer’s qualified REIT dividends and PTP income; or
- 20 percent of the portion of the taxpayer’s taxable income that exceeds the taxpayer’s net capital gain.
Taxpayers must calculate the QBI deduction separately for each of their trades or businesses. Qualified taxpayers will then report their QBI, net of the QBI deduction, on their individual income tax returns. Taxpayers eligible for the full 20 percent QBI deduction are subject to a top effective tax rate of 29.6 percent on their QBI.
Are there QBI Deduction Limitations?
Yes. Once annual taxable income (before the QBI deduction) exceeds $157,500 for individuals, or $315,000 for married couples filing jointly, the QBI deduction is subject to restrictions based upon the amount of wages paid to W-2 employees and the unadjusted tax basis of qualified property immediately after acquisition (UBIA). Note that the QBI deduction calculated from qualified REIT dividends and PTP income is not subject to these limitations.
When taxable income exceeds the annual threshold of $157,500 for individuals or $315,000 for married couples filing jointly, the QBI deduction is limited to the lesser of (1) or (2):
- 20 percent of QBI, or
- the greater of:
-
- 50 percent of the entity’s W-2 wages; or
- 25 percent of W-2 wages plus 2.5 percent of the UBIA (or the original purchase price) of depreciable tangible property, including real estate, furniture, fixtures, and equipment, that the business owns and uses to generate qualifying business or trade income.
W-2 wages are limited to the compensation amount the trade or business pays and reports to its common law employees on Form W-2. For this purpose, the proposed regulations clarify that payments made by Professional Employer Organizations (PEOs) and similar entities on behalf of trades or businesses can qualify as W-2 wages, provided that the PEOs issue the W-2’s to persons considered common law employees by the trades or businesses.
Under these limitations, pass-through businesses that pay large sums of W-2 wages may be able to take a larger QBI deduction than businesses that pay less W-2 wages or have fewer W‑2 employees. Similarly, capital-intensive businesses may be in a better position to maximize their QBI deductions than entities without a significant amount of tangible assets.
Are there Additional Limitations?
Yes. The TCJA introduced a new concept of specified service trades or businesses (SSTBs), which are subject to additional QBI deduction limitations. SSTBs are entities that involve the delivery of services in any of the following fields:
- accounting;
- actuarial science;
- athletics;
- brokerage services;
- consulting;
- financial services;
- health;
- investing and investment management, trading, or dealing in securities, partnership interests or commodities;
- law;
- performing arts; or
- any trade or business that generates income based on the taxpayer’s fame or celebrity.
Once a taxpayer has taxable income (before the QBI deduction) in excess of $207,500 ($415,000 for jointly filing taxpayers), the QBI deduction attributable to an SSTB is completely phased out. However, the new law does provide an exception for a trade or business with SSTB receipts to qualify for the QBI deduction when it meets either of the following tests:
- Annual gross receipts from all operations are less than $25 million, and less than 10 percent of that amount comes from SSTB services; or
- Annual gross receipts from all operations are more than $25 million, and less than 5 percent of that amount is derived from SSTB services.
How Can I Maximize Tax Savings from the QBI Deduction?
The rules for qualifying and calculating the new QBI deduction are complex and should not be addressed without guidance from experienced tax professionals. This is especially true when considering that the law and proposed guidance provide taxpayers with opportunities to improve their tax savings while maintaining compliance with the regulations.
For example, taxpayers may reduce their exposure to QBI deduction limitations when they increase the number of their W-2 employees or purchase equipment they currently lease. In addition, high-income taxpayers may be able to receive a larger QBI deduction when they aggregate their ownership interests in multiple qualifying businesses and treat them as a single business for calculating QBI, W-2 wages, and UBIA of property. Outside of QBI, some taxpayers may benefit by changing their entity to a C Corporation, which is subject to a flat 21 percent tax rate beginning in 2018. These decisions are neither easy, nor should they be made without weighing other key factors beyond the tax implications.
Taxpayers should meet with experienced tax advisors who not only understand the nuances of the law but who also can apply and substantiate claims of tax benefits based on the language of the guidance while adhering to the law’s anti-abuse provisions.
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 info@bpbcpa.com.
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.
The IRS has issued a series of proposed guidance in response to the way in which many states have sought to help their residents work around the new tax law’s limit on the amount of state and local sales, income and property taxes (SALT) that are deductible for federal income tax purposes beginning in 2018.
The Tax Cuts and Jobs Act (TCJA) introduces a $10,000 cap on individuals’ state and local tax deductions ($5,000 for married couples filing separately), which represents a loss of significant tax savings for residents in high-tax states where property taxes alone often exceed the cap. In response, states such as New York, New Jersey and Connecticut, quickly established programs that would allow their residents to treat certain SALT payments in excess of the cap as either tax credits for contributions to state-run agencies or fully deductible charitable contributions.
On August 23, the IRS issued its first round of guidance restricting itemizing taxpayers from claiming a federal charitable deduction for the full amount of the state and local tax credits they receive. Instead, the regulations require taxpayers to reduce those deductions by the value of the state and local tax credits they receive from their local government. This is similar to existing tax laws that require taxpayers who receive something of value, such as a t-shirt, pen or tax credit, as a part of, or in return for, a donation to a qualifying charity, they must subtract the fair market value of that item from the amount they can claim as a charitable deduction.
This move is designed to prevent taxpayers from getting more money back in tax breaks than they contribute in donations. For example, if a taxpayer makes a charitable donation of $50,000 to pay property taxes in New York and receives an 85 percent state tax credit of $42,500, the amount they may deduct on their federal income tax returns is only $7,500, and only if they itemize their deductions beginning in 2018. However, when a state provides tax credits of 15 or less of the amount of their resident’s donations, the donor taxpayers can write-off the full amount of their contributions from their federal tax bills. For example, a taxpayer may deduct the full amount of a $50,000 donation to a state-run charitable agency if the tax credit he or she receives in return is less than $7,500.
It is important to note that charitable deductions made in 2018 through 2025 are available only to those taxpayers who itemize their deductions during those years. Because the new tax law doubles the standard deduction available to all taxpayers, it is estimated that far fewer taxpayers will choose to itemize in the future.
The SALT cap will continue to evolve as the IRS issues further guidance, and lawsuits brought against the federal government by states challenging the legality of the cap advance through the courts. In the meantime, taxpayers should err of the side of caution and meet with experienced SALT advisors to understand their options, risks and opportunities before taking any action.
About the Author: Karen A. Lake, CPA, is state and local tax (SALT) specialist and an associate director of Tax Services with Berkowitz Pollack Brant, where she helps individuals and businesses navigate complex federal, state and local tax laws, and credits and incentives. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.
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.
Thanks to the equity market’s wild bull market run since bottoming out in 2009, many investors’ portfolios look rather rosy. However, with these impressive returns come taxes on capital gains. While the Tax Cuts and Jobs Act retains the 0%, 15%, and 20% tax rates on qualified dividends and long-term capital gains resulting from the sale of assets held for more than one year, the new law changes the income brackets that apply to these rates. For 2018 through 2025, the following rates will apply based on an individual’s taxable income and filing status:
| Tax Rate |
Single Filers |
Married Filing Jointly |
| 0% |
$0 to $38,600 |
$0 to $77,200 |
| 15% |
$38,601 to $425,800 |
$77,200 to $479,000 |
| 20% |
$425,801 and above |
$479,001 and above |
Taxpayers should note that these brackets apply only to long-term capital gains and dividends, which may also be subject to the 3.8 percent Net Investment Income Tax (NIIT) for high-income earners. Conversely, the tax rates for short-term capital gains resulting from the sale of assets held for one year or less will continue to be tied to the seven ordinary income tax brackets, which beginning in 2018 are reduced to 10%, 12%, 22%, 24%, 32%, 35% or 37%.
Although these changes under the new law will result in many taxpayers owing less to the federal government, it is important for high-income taxpayers, in particular, to meet with their advisors and accountants and implement strategies that could reduce their long-term capital gain tax liabilities even further.
For example, taxpayers may take advantage of the TCJA’s higher standard deduction, which nearly doubles in 2018 to $12,000 for single filers and $24,000 for married filing jointly, in order to reduce their taxable income (including long-term gains and dividends) to a lower threshold and qualify for a lower tax rate.
Another strategy available to taxpayers is to remove appreciated assets and any related capital gains from their investment portfolios. One option is to donate appreciate assets held for more than one year to a charity or a donor-advised fund. The assets can continue to grow tax-free to the charity and provide the taxpayers with an immediate charitable deduction, subject to limitations. Alternatively, taxpayers may remove appreciated assets from their taxable income by gifting them to family members. In fact, in 2018, individuals may gift up to $15,000 in cash or assets to as many people as they choose without incurring gift taxes. When the taxpayer is married, he or she can annually gift as much as $30,000 per recipient tax-free. The amount of this gift tax exclusion is adjusted annually for inflation.
Finally, the tried and true method of harvesting capital losses to offset capital gains may be difficult to employ since many investors will be hard-pressed to find losses after the recent market run-ups. Yet it is critical for investors to pay attention to their capital gains and be prepared to take action if, and when, the amount of their resulting tax liability is beyond their budget.
About the Author: Adam Slavin, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practices, where he provides tax planning and consulting services to high-net-worth individuals and closely held business. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at info@bpbcpa.com.
