Despite the reduction in individual federal income tax rates, tax reform dealt a significant blow to residents of high-tax states, such as New York, New Jersey and California. Beginning in 2018, taxpayers across the country are limited to a $10,000 cap on the amount of state and local taxes (SALT), including property taxes, they may deduct on their federal tax returns in a given year.
Prior to the enactment of the Tax Cuts and Jobs Act (TCJA) in December 2017, high-income individuals who itemized their deductions could subtract from their gross income the full amount of state and local taxes they paid. In an effort to cushion the financial blow this cap will have on their residents, several high-tax states have been busy developing workaround legislation that would also help them keep their tax coffers full.
For example, New York passed legislation in April that introduces a new, 5 percent payroll tax on employees earning more than $40,000 per year in exchange for an employee income tax credit. While employers would be able to deduct the payroll tax, it would ultimately reduce the amount of money workers take home. According to the state, the tax credit against state and local taxes should offset any reduction in pay.
In addition, the New York law would provide its residents with the ability to satisfy their state tax liabilities and receive a fully deductible federal income tax charitable deduction when they make voluntary contributions to charitable trusts established and managed by the state and local municipalities to help fund public school education, health care and other social services. Similar strategies that would allow taxpayers to characterize state and local tax payments as charitable deductions for federal income tax purposes are in the works in other states as well.
A key issue with this type of legislation on the state level is that only federal law can control how taxpayers may characterize tax payments and deduction for federal income tax purposes. In fact, the IRS has issued warnings that it intends to ban laws that states enact to circumvent federal tax law. In response, several states have cautioned that they will continue to fight against challenges to any laws that preserve SALT deductions.
During this period of uncertainty, it is recommended that taxpayers wait for further guidance from the IRS before implementing any strategies that relate to the new limit on SALT deductions.
About the Author: Karen A. Lake, CPA, is SALT (state and local tax) 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 email@example.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.
Preventative care is critical to averting serious (and often costly) emergencies. Just as annual medical exams can help prevent disease, and proactive vehicle maintenance can protect against major automobile repairs, regular check-ups with accountants can help individuals avoid a surprise tax bill and penalties come the April tax-filing deadline.
One benefit of a mid-year tax check-up is to confirm that you are paying the government your fair share of taxes through estimated payments and/or withholding from paychecks in compliance with the U.S.’s pay-as-you-go system of taxation. This is more important than ever in light of the new tax laws that went into effect on Jan. 1, 2018. Some provisions of the Tax Cuts and Jobs Act (TCJA) that affect workers include a reduction in the federal tax rates, a substantial increase in the standard deduction and various modifications to many of the itemized deductions that qualifying taxpayers may have claimed in the past. In addition, the TCJA lowers the corporate tax rate and introduces a complex tax regime for sole proprietors and pass-through business entities.
Following are some considerations individuals should address with their advisors and accountants during a mid-year tax check-up.
I am a Salaried Employee who Receives a W-2
Salaried workers must complete IRS Form W-4 to help their employers calculate how much taxes to withhold from their wages and pay on their behalf directly to the government. The amount withheld will depend on various factors, including the employee’s taxable earnings, marital status, number of dependents, and the credits and deductions to which he or she may be entitled. While a W-4 is required for all new employees, workers can update these forms anytime during a year to reflect changes in their lives, such as a new marriage, a divorce or the birth of a child, which, in turn, may affect their withholding amount.
If you are a salaried employee who also has unearned income from investments, rental property, a second job or other non-wage sources, you may elect to have your employer withhold additional tax from your paycheck to reduce your risk of an unexpected tax bill. However, if your employer withholds too much tax from your paycheck, you may be entitled to a tax refund. As exciting as it may seem to receive money back from the government, you should remember that a refund is essentially a return of the money you willingly loaned to the government, interest-free, the prior year.
I am an Independent Contractor who Receives a 1099
Independent contractors, also called freelancers or gig workers, bear the responsibility for reporting and paying taxes on all income they earn, including earnings received in cash, less any deduction or credits to which they may be entitled.
Under most circumstances, if you qualify as an independent contractor, you should consider pre-paying your self-employment tax, income, Social Security and Medicare tax liabilities by making four quarterly estimated tax payments directly to the IRS in April, June, September and January. Alternatively, if you also have a salaried job, you may elect to update your Form W-4 to have your employer withhold additional tax from your paycheck to account for the untaxed income you earn as an independent contractor.
I am a Self-Employed Owner of a Pass-Through Business
Income earned by pass-through businesses organized as S Corporations, partnerships, LLCs and sole proprietorships typically flows directly from the businesses to their individual owners, who pay the resulting income tax liabilities and self-employment taxes, at their individual income tax rates. However, as a business owner, you may qualify to deduct certain expenses from your gross income and ultimately reduce the amount of tax you owe.
For 2018, the TCJA introduces a new potential tax savings for owners of pass-through businesses in the form of a 20 percent deduction on certain qualified business income (QBI). Meeting the eligibility requirements for this deduction depends on a taxpayer’s line of business, the type and amount of income they earn, as well as the amount of W-2 wages the business pays to employees and the depreciable income-producing property it owns. Due to the complexity of this provision of the new tax law, it behooves owners of pass-through businesses to engage the counsel of professional accountants and tax advisors, in order to develop an appropriate strategy that meets their unique circumstances and maximizes their potential tax savings.
I Itemized Deductions on my 2017 Tax Returns
Because the TCJA nearly doubles the standard deduction for tax years beginning in 2018, it is expected that far fewer taxpayers will itemize their deductions in the future. However, should you continue to itemize, you should be aware that the new law limits, and in some cases eliminates, some of the deductions you may have taken in the past. For example, gone are deductions for moving expenses; fees paid to legal, tax and financial advisors; and theft and casualty losses that occur outside a federal disaster area declared by the president. In addition, there is now a $10,000 limit on the amount of state and local taxes you may deduct on your federal tax returns as well as a cap on the amount of casualty losses you may deduct and the size of a mortgage loan for which you may deduct interest. With these changes in mind, it may make sense for you to meet with a tax advisor who can project whether it makes sense for you to continue itemizing deductions in the future.
Tax reform is a game-changer that can have a significant effect on individuals’ tax bills, especially when considering how they earn wages, the types of income they earn and the way in which they structure any business entities in which they have an ownership interest. If you have not already addressed the impact of tax reform on your situation, you still have time to meet with qualified accountants to put into place an appropriate strategy to maximize tax efficiency for the remainder of the year.
About the Author: Nancy M. Valdes, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where she works with U.S. and foreign-based entrepreneurs and closely held businesses to manage cash flow, protect assets and maintain tax efficiency. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.