Welcome to Tax Season! Details on the New 199A Deduction

Tax season has begun. This week, I examine a new section to the Internal Revenue Code that intends to give some degree of parity to certain types of small businesses—you can find the details below.

The New Section 199A Deduction

Congress added a new section to the Internal Revenue Code. Section 199A is intended to give some degree of parity to small businesses that operate as partnerships, S corporations, sole proprietorships, trusts, publicly traded partnerships, and REITS. Since C corporations are now taxed at 21%, Congress decided to give small flow-through businesses taxed at the higher individual level a break. The deduction is limited to the lower of 20% of Qualified Business Income or 20% of the individual’s taxable income.

If you are a Service Trade or Business, i.e. health, law, accounting, actuarial services, performing arts, consulting, athletics, financial services, brokerage services, or any other trade or business that relies on the reputation or skill of one or more of its employees, then your deduction is only allowed if your taxable income is below $315,000 if filing MFJ and $157,500 for all others.

For businesses other than service—businesses whose owners have taxable income above the phase out limit of $415,000 for MFJ and $207,500 for all others—there are deduction limitations based on W-2 wages and depreciable assets. It is a little complicated, but it is a great deduction.

Tax Season Has Begun

The IRS has begun accepting 2018 tax returns and is issuing refunds. Now is the time to begin gathering your tax data and making an appointment with your tax preparer. If you need a tax preparer and would like to use our firm, then do not hesitate to give me a call and we will set an appointment for you.

That is all today. I look forward to visiting with you next week. In the meantime, don’t hesitate to reach out if you have a question—you can call my office at (713) 785-8939 or leave a comment on this post. I’d love to hear from you.

Happy New Year – Remember to File Your Personal Income Tax Return

I hope everyone had a restful and spiritual holiday season. As you know, it is my job to remind you that the New Year brings about your renewed responsibility to file your personal income tax return. It will be due on April 15, 2019. Also due on April 15 are your Trust returns on Form 1041 and your C Corporation returns on Form 1120. On March 15, 2019, your S Corporations on Form 1120S and your Partnerships on Form 1065 are due. These deadlines can all be extended.

You may also want to know that your Property Renditions are due to the HCAD by April 1, 2019 and your Texas Franchise Tax Reports are due to the State Comptroller by May 15, 2019. I probably don’t need to tell you that your payroll reports, which include your W-3, W-2s, Form 941, Form 940, and your TWC Report are due at the end of January.

I Want To Help You Understand the New Tax Law

I would like for you to consider having me come to your business to give a short (hour or less) seminar on the new tax law to your employees. I would talk about how the Tax Cuts and Jobs Act affects your business in particular and how it affects your employees. There are many changes that will seriously impact many taxpayers, and this would be a great opportunity to educate them. Afterward, we could have a Q&A session. We can discuss the content that would benefit your employees. There would be no obligation and it would be free.

That is all today. I look forward to visiting with you next week. In the meantime, don’t hesitate to reach out if you have a question—you can call my office at (713) 785-8939 or simply leave a comment on this post. I’d love to hear from you.

A Gift That Lasts a Lifetime – The Roth IRA

You should consider giving your child or grandchild a Roth IRA.  

In 2018, you can contribute up to $5,500 to a Roth IRA. The contribution cannot exceed the child’s earnings and if the child has no earnings, you should consider filing a Schedule C with their return and reporting and paying tax on an amount equal to their contribution up to the maximum. The $5,500 pay-in for your child or grandchild counts against your $15,000 gift tax exclusion ($30,000 if you are married).

Some of the advantages and disadvantages of the Roth IRA are…

  • The earnings grow tax deferred and, when taken out at age 59 ½, the entire distribution is tax free.
  • The original contributions are always tax free, even if you withdraw them before age 59 ½.
  • The contributions to a Roth IRA are not tax deductible.

When your child grows up she can continue the contributions…

  • When the child reaches age 50 she can contribute an additional $1,000 or $6,500.
  • When your child reaches age 70 ½, she will not be required to make minimum distributions.
  • If your child is single, the allowable contribution begins to phase out with adjusted gross income between $120,000 and $135,000… and if she’s married, the allowable contribution phases out between $189,000 and $199,000.
  • She can make contributions after age 70 ½.
  • She is not required to take distributions from her Roth IRA… ever.
  • To avoid the 10 percent penalty and any income tax on the earnings, there must not be any distributions during the 5 year period beginning with the first tax year a contribution was made, except if made on or after attaining age 59 ½, the individual’s death or disability, or to pay for first-time home buyer expenses.

I don’t need to tell you that the IRA could grow for 45 to 50 years and when she reaches age 59 ½ she could make withdrawals tax free. You should probably talk to your financial advisor to get the advice you need to reach your goals. Call me if you need a recommendation.

That is all today.  I look forward to visiting with you next week.  Please don’t hesitate to reach out if you have a question—you can reach me at (713) 785-8939.

Tax Reform Update—Here’s What to Expect

The IRS is working on implementing the changes created by the Tax Cuts and Jobs Act (TCJA).  Here are some of the major tax reform changes you can expect.

New Business Deduction Form

One of the most exciting TCJA changes is the new form the IRS is developing for taxpayers to calculate the qualified business income deduction (QBI). Self-employed taxpayers, partners, and S corporation shareholders will use this form to claim the QBI deduction on their tax return. If you are in this group then stay tuned for IRS guidance expected to come out during 2018 and be sure to work with your tax preparer to maximize your QBI deduction. I will keep you informed.

TCJA Changes for Individuals

One important change: You won’t claim a dependent exemption for your children or other dependents or a personal exemption for yourself or your spouse. You will still need to provide the information needed to take the credits for your children and non-child dependents if you qualify. Another change is the doubling of the standard deduction to $24,000 for taxpayers who are married and filing jointly. But your total allowable deduction for state and local taxes such as sales tax, state income tax, real estate tax, and personal property tax is limited to $10,000. The interest payments on your home equity loan might not be deductible. As we discussed in recent weeks, you can no longer deduct employee business expenses on Form 2106 and you can no longer deduct miscellaneous itemized deductions. Casualty and theft losses are no longer deductible unless they occur in a federally declared disaster area. And lastly, medical expenses are only deductible to the extent they exceed 7.5% of AGI. I hope this helps—I will continue to review TCJA tax law changes in the weeks and months to come.

That is all today. I look forward to visiting with you next week. Let me know if you have a question—you can reach my office at (713) 785-8939. You can also leave a comment on this post.

Attention Small Business Owners: Don’t Forget Your Franchise Tax Report

Everyone seems to remember their federal tax returns, but for small business owners, state tax returns are also due. If you have a small business and you filed Articles with the Secretary of State to get state law protection in some form, such as an LLC, or a corporation, or another form of protection suitable to your needs, then you will need to file a Texas Franchise Tax Report and a Public Information Report by May 15, 2018.

These reports must be filed electronically and to file electronically you must have your Webfile Number. The Texas Comptroller of Public Accounts sent you a reminder last week that your Franchise Tax Report is coming due. This reminder will have all the information your CPA (or you) will need to file the return electronically, including your Webfile Number. Please be sure to keep this form and get it to your CPA as soon as possible along with your federal tax information — and definitely before May 15.

Hurricane Harvey Casualty Loss and Form 4684

As Tax Day draws nearer, I’ve had a number of questions about Hurricane Harvey and casualty loss. Today, I’ll walk you through what you need to file Form 4684 for casualty loss deductions with your 2017 tax return.

Form 4684, Casualties and Thefts was designed especially for storms like Hurricane Harvey. In 2017, you will be able to take an itemized deduction by completing the form and attaching it to your Form 1040. Also, it’s important to know that twenty counties along the Texas Gulf Coast, including Harris County, were Presidentially Declared Disaster Areas. Once the President declares an area a Presidentially Declared Disaster Area, then the IRS can administratively make temporary changes to the law, such as extending the due dates of returns and estimated tax payments, and they can lift the 10% of AGI threshold for casualty losses. And that is what they did. If your home was flooded and your personal possessions were lost in the flood, then you need to complete Form 4684.

Here is what you will need to complete the form:

  • The cost or basis of your home
  • Your insurance or other reimbursement (ie: FEMA)
  • Your fair market value before the storm
  • Your fair market value after the storm

This is the information you will need to complete your casualty loss deduction. If you struggle with any of these items, such as the FMV of your home after the storm, don’t hesitate to ask your realtor or real estate appraiser, or contact the Harris County Appraisal District. If you need any help with any of this, then please give me a call.

That is all today. I look forward to visiting with you next week. In the meantime, please let me know if you have any questions — you can call my office at (713) 785-8939 or leave a comment on this post to get in touch.

Effects of the Tax Cuts and Jobs Act on the Wealthy

Let’s discuss the impact the new tax law will have on two high levels of income. The first example is an attorney making $500,000 who is married with no children. In 2017, the household will have itemized deductions made up of state and local taxes of $37,285, home mortgage interest of $39,000, and business expenses exceeding 2% of AGI of $10,000. Their itemized deductions will be $80,699 after the Pease deduction (this is a stealth tax from the ACA). Their personal exemptions are totally phased out. Their taxable income will be $419,301 and their regular tax will be $113,638, but their AMT will be $122,671. The effect of the additional Medicare tax from the ACA will not be considered because it is the same in 2017 and 2018. In 2017, their tax liability will be $122,671.  

In 2018, if our same family makes $500,000, then they will have state and local taxes limited to $10,000, they will get all their home mortgage interest of $39,000, and their business expenses from Form 2106 are no longer deductible. Personal and dependent exemptions are repealed.  Their taxable income will be $451,000 and their regular tax liability will be $109,229. AMT is less than the regular tax because the AMT exemption is greater and doesn’t begin to phase out until $1M for couples. Their 2018 tax liability is $109,229. This is a tax savings of $13,442 or put another way, a savings of 11% from 2017 to 2018.

In our second example, we have a married couple with no children. They file jointly and in 2017 they make $1,500,000. They live in beautiful, sunny California and they own their home. Because beautiful California has a 13.3% state income tax and they own their home, they will have $300,000 in state and local tax; they also have $39,000 in home mortgage interest, and their Form 2106 Employee Business Expenses do not exceed 2% of AGI. After the Pease deduction, their itemized deductions are $303,414, their exemptions are phased out and their taxable income is $1,196,586.  Their regular tax liability is $419,079. AMT is not even in the picture.

In 2018, the same family making $1,500,000 will have taxable income of $1,451,000.  Remember SALT deductions are limited to $10,000 plus home mortgage interest of $39,000, and personal and dependency exemptions were repealed. Their tax in 2018 will be $476,249. This is a tax increase of $57,170.  

Please remember that there are those who oppose any type of tax cut for the American people. For most Americans the new law is a tax cut, especially if you live in a low-tax state like Texas. But if you live in a high-tax state like California or you own expensive real estate, then you will very likely have a tax increase. In my experience, most high income taxpayers own a successful small business and they use any tax savings to hire someone young and tech savvy to make their business more efficient. Remember, the American people can allocate their capital and spend their money more equitably and efficiently in the marketplace than the federal government, which is wasteful, inefficient, and inclined toward political favors for special interests.      

That is all today. I look forward to visiting with you next week. In the meantime, please let me know if you have a question. You can call my office at (713) 785-8939 or leave a comment on this post. 

The Tax Cuts and Jobs Act – The Middle Class

Let’s discuss the impact the new tax law will have on two levels of middle class income. The first example is a school teacher who is single with no children and is making $60,000. In 2017, she will get a standard deduction of $6,350 and a personal exemption of $4,050, so her statutory deductions will total $10,400 and her taxable income will be $49,600. In 2017 her tax liability will be $8,139.

In 2018, if our same teacher makes $60,000, she will get a standard deduction of $12,000 and no personal exemption. Her taxable income will be $48,000 and her tax liability will be $6,500. This is a tax savings of $1,639, or put another way, a savings of 20.1% from 2017 to 2018.

In our second example we have a married couple with two children under age 17. They file jointly and together they make $250,000. They own their home and they have $20,000 in home mortgage interest, $21,000 in real estate tax and sales tax (state and local tax), and $10,000 in charitable contributions. In 2017, their taxable income is $182,800 and their tax liability is $38,069. In 2018, the same family making $250,000 will have taxable income of $210,000 ($250,000 -$20,000 -$10,000 -$10,000). Remember, they only get $10,000 for SALT deductions and personal and dependency exemptions were repealed. Their tax in 2018 will be $34,979. They get a $2,000 child tax credit for each child and the phase-out for joint filers begins at $400,000. This is a tax savings of $3,090 or a savings of 8.1% from 2017 to 2018.

Remember, you can deduct all of your real estate taxes in your business or when related to income-producing property. State and local income taxes are not deductible for a business and only to the extent of $10,000 when combined with all state and local taxes for individuals.

Next week, we will discuss the Tax Cuts and Jobs Act and how it affects those taxpayers with income over $500,000.

That is all today. I look forward to visiting with you next week. In the meantime, let me know if you have a question. Feel free to leave a comment on this post or give me a call to get in touch.

Three Exceptions to the Three-Year Statute of Limitations for Tax Assessments & Refund Claims

Statutes of limitations are provisions of law that require actions to be initiated for prior events within a certain maximum prescribed time period. Therefore, if an action is to be brought or pursued for a prior event, it typically must be initiated before the maximum prescribed time period expires. The purpose of statutes of limitations is to allow for the best evidence that is available to be presented in the pursuit of the action. As time expires, evidence may become lost or unavailable, witnesses may no longer be available, and prosecuting such untimely actions and defending them will become very difficult. Therefore, statutes of limitations are designed to compel action be initiated before evidence becomes unavailable. Failure to initiate such action within this specified maximum prescribed time period is a valid defense and precludes the pursuit of the action.

Statutes of limitations apply for federal income tax matters, as well as other legal matters, civil and criminal. The Internal Revenue Code prescribes specific provisions for when prior tax matters may be pursued by either the IRS or the taxpayer. It depends on whether the IRS is seeking an additional assessment of tax or the taxpayer is seeking a claim for refund. The general rule for imposing additional tax or claiming a refund is three years from the date the tax return is filed or the due date, whichever is later.

As with any rule, there are exceptions.

There are two exceptions from the general rule for IRS assessment of additional tax. The first exception applies to the substantial omission of income. In the case of substantial omission of income, the statute of limitation for the general rule described above is extended to six years. For this exception to apply, substantial omission of income is defined as more than 25% of the gross income is omitted on the tax return. For example, if the taxpayer has $126,000 of gross income and only reports $100,000, then this will trigger the six-year statute of limitation. If the taxpayer had reported $102,000, then the general rule three year statute of limitation would still apply. It is noteworthy to recognize that the six-year statute of limitation applies only to the substantial omission of income and not to other items such as claiming excessive deductions, etc.

The second exception to the general rule for assessments applies to fraud (the willful intent to evade tax) or to tax returns not filed at all. In either of these cases there is no statute of limitations. There is no time limit for the IRS to assess additional tax or initiate a court action. The burden of proof generally remains with the IRS in cases of fraudulent tax returns or tax returns not filed.

The third exception has to do with how long a taxpayer has to claim a refund for the overpayment of tax. A claim for refund must generally be made within three years from the date the tax return was filed or the due date, whichever is later. If no tax return is filed, then the claim for refund must be made within two years from the date the tax was paid. Any tax deducted and withheld from the wages of a taxpayer is treated as paid on April 15. My advice: If you have a refund, then be sure to file within two years of the due date of the return.

Important Update on Corporate Tax Reform

A new tax plan recently passed through the House, and this week, everyone in Washington is talking about corporate tax reform. I parsed the legislation and have summarized some key points below. The implications for S and C Corporations are especially great.

Tax Reform – Don’t Get Excited Unless You’re a “C Corporation”

Unfortunately that’s true. It appears the only real winners are your regular corporations, or C corporations as they are called. Their rate reduction is expected to go from 35% down to 20%. Individual taxpayers may discover that they, depending on your circumstances, got very little from this version of tax reform. I’m not saying your tax liability won’t go down at all, I’m just saying that the House bill takes away too many deductions and the rates are not significantly different from the rates we now have. There are other changes that make the bill good such as repeal of the AMT, a significant increase in the unified credit (for estates and gifts), and the doubling of the standard deduction, but rate reduction is the true solution to creating jobs.

The House Bill and S Corporations – A Major Tax Increase and More Complication

The House Bill passed last week has a top rate of 25% for S Corporations and other pass-through businesses, but in many cases the real rate is significantly higher. S Corporation shareholders need to pay attention. If you are a professional service firm, the 25% rate doesn’t apply to professional service businesses. Specifically, the bill excludes businesses engaged in “the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees, or investing, trading, or dealing in securities, partnership interests, or commodities.”

What this means is that the top tax rate prescribed in H.R. 1 is the new rate for personal service corporations. For active owners of non-professional services corporations, the bill imposes a separate limitation on the 25% pass-through rate. It would cap the owner’s profit eligible for the 25% rate at 30% of the sum of their wages and profits from the business. The remaining 70% would be subject to the higher personal rates. It gets even more complicated, because H.B. 1 makes S Corporation profits subject to the self-employed payroll tax and your state and local income, sales, and property taxes are not deductible.

Next Week

Next week we will discuss Records Retention and how long you need to keep those old tax records. We will also review H.B. 1 changes to tax credits and other tax items related to paying for college.

Thanks for reading. Wishing you and your family a happy Thanksgiving.