Tax Reform Changes Affecting Businesses

With respect to businesses, some of the more notable items included in the Tax Bill are:

Reduction in Corporate Tax Rate

The Tax Bill eliminates the graduated corporate rate structure and instead taxes corporate taxable income at 21 percent. It also eliminates the special tax rate for personal service corporations and repeals the maximum corporate tax rate on net capital gain as obsolete. For taxpayers subject to the normalization method of accounting (e.g., regulated public utilities), the Tax Bill provides for the normalization of excess deferred tax reserves resulting from the reduction of corporate income tax rates (with respect to prior depreciation or recovery allowances taken on assets placed in service before the date of enactment).

The Tax Bill proposals would be effective for taxable years beginning after December 31, 2017.

Reduction of Dividends Received Deductions to Reflect Lower Corporate Tax Rate

The Tax Bill reduces the 70 percent dividends received deduction available to corporations who receive a dividend from another taxable domestic corporation to 50 percent. It also reduces the 80 percent dividends received deduction for dividends received from a 20-percent owned corporation to 65 percent.

The Tax Bill proposals would be effective for taxable years beginning after December 31, 2018.

Corporate Alternative Minimum Tax (AMT)

The Tax Bill repeals the Corporate AMT. In the case of a corporation, the Tax Bill allows the AMT credit to offset the regular tax liability for any taxable year. In addition, the AMT credit is refundable for any taxable year beginning after 2017 and before 2022 in an amount equal to 50 percent (100 percent in the case of taxable years beginning in 2021) of the excess of the minimum tax credit for the taxable year over the amount of the credit allowable for the year against regular tax liability. Thus, the full amount of the minimum tax credit would be allowed in taxable years beginning before 2022.

The Tax Bill provisions would be effective for taxable years beginning after December 31, 2017.

Enhanced Expensing Through Bonus Depreciation

The Tax Bill extends and modifies the additional first-year (i.e., “bonus”) depreciation deduction through 2026 (through 2027 for longer production period property and certain aircraft). Under the Tax Bill, the 50-percent additional depreciation allowance is increased to 100 percent for property placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for longer production period property and certain aircraft), as well as for specified plants planted or grafted after September 27, 2017, and before January 1, 2023.

The 100-percent allowance is phased down by 20 percent per calendar year for property placed in service, and specified plants planted or grafted, in taxable years beginning after 2022 (after 2023 for longer production period property and certain aircraft). Thus, for property placed in service after December 31, 2022, and before January 1, 2024 (January 1, 2025, for longer production period property and certain aircraft), the bonus percentage is 80 percent; for property placed in service after December 31, 2023, and before January 1, 2025 (January 1, 2026, for longer production period property and certain aircraft), the bonus percentage is 60 percent; for property placed in service after December 31, 2024, and before January 1, 2026 (January 1, 2027, for longer production period property and certain aircraft), the bonus percentage is 40 percent; for property placed in service after December 31, 2025, and before January 1, 2027 (January 1, 2028, for longer production period property and certain aircraft), the bonus percentage is 20 percent. The general bonus depreciation percentages also apply to certain specified plants bearing fruits or nuts.

Observation: Under current law, the bonus depreciation is scheduled to end for qualified property acquired and placed in service before January 1, 2020 (January 1, 2021, for longer production period property and certain aircraft) and the 50-percent bonus depreciation amount is scheduled to be phased down for property placed in service after December 31, 2017, including certain specified plants bearing fruits or nuts planted or grafted after such date. Thus, the Tax Bill repeals the current-law phase-down of the additional first-year depreciation deduction for property placed in service after December 31, 2017, as well as the phase down also scheduled for certain specified plants bearing fruits or nuts planted or grafted after such date.

The Tax Bill also provides that the present-law phase-down of bonus depreciation is maintained for property acquired before September 28, 2017, and placed in service after September 27, 2017. Under the provision, in the case of property acquired and adjusted basis incurred before September 28, 2017, the bonus depreciation rates are as follows: 50 percent if placed in service in 2017 (2018 for longer production period property and certain aircraft), 40 percent if placed in service in 2018 (2019 for longer production period property and certain aircraft), 30 percent if placed in service in 2019 (2020 for longer production period property and certain aircraft), and zero percent if placed in service in 2020 (2021 for longer production period property and certain aircraft).

The Tax Bill maintains the bonus depreciation increase amount of $8,000 for luxury passenger automobiles placed in service after December 31, 2017.

Observation: Under current law, the $8,000 increase in depreciation for luxury passenger automobiles (as defined in Code Sec. 280F(d)(5)) is scheduled to be phased down to $6,400 and $4,800 for property placed in service in 2018 and 2019, respectively.

As a conforming amendment to the repeal of the corporate AMT, the Tax Bill repeals the election to accelerate corporate AMT credits in lieu of bonus depreciation.

The Tax Bill extends the special rule under the percentage-of-completion method for the allocation of bonus depreciation to a long-term contract for property placed in service before January 1, 2027 (January 1, 2028, in the case of longer production period property).

Qualified Property. The Tax Bill removes the requirement that, in order to qualify for bonus depreciation, the original use of qualified property must begin with the taxpayer. Thus, the provision applies to purchases of used as well as new items. To prevent abuses, the additional first-year depreciation deduction applies only to property purchased in an arm’s-length transaction. It does not apply to property received as a gift or from a decedent. In the case of trade-ins, like-kind exchanges, or involuntary conversions, it applies only to any money paid in addition to the traded-in property or in excess of the adjusted basis of the replaced property. It does not apply to property acquired in a nontaxable exchange such as a reorganization, to property acquired from a member of the taxpayer’s family, including a spouse, ancestors, and lineal descendants, or from another related entity as defined in Code Sec. 267, nor to property acquired from a person who controls, is controlled by, or is under common control with, the taxpayer. Thus, it does not apply, for example, if one member of an affiliated group of corporations purchases property from another member, or if an individual who controls a corporation purchases property from that corporation. The Tax Bill also removes computer equipment from the category of listed property (as defined in Code Sec. 280F(b)(2)), thus eliminating the depreciation limitation on such property.

The Tax Bill also expands the definition of qualified property eligible for the additional first-year depreciation allowance to include qualified film, television and live theatrical productions, effective for productions placed in service after September 27, 2017, and before January 1, 2023. For this purpose, a production is considered placed in service at the time of initial release, broadcast, or live staged performance (i.e., at the time of the first commercial exhibition, broadcast, or live staged performance of a production to an audience).

The Tax Bill excludes from the definition of qualified property certain public utility property, i.e., property used predominantly in the trade or business of the furnishing or sale of:

(1) electrical energy, water, or sewage disposal services;

(2) gas or steam through a local distribution system; or

(3) transportation of gas or steam by pipeline, if the rates for such furnishing or sale, as the case may be, have been established or approved by a state or political subdivision thereof, by any agency or instrumentality of the United States, or by a public service or public utility commission or other similar body of any state or political subdivision thereof.

The Tax Bill also excludes from the definition of qualified property any property used in a trade or business that has had floor plan financing indebtedness, unless the taxpayer which has such trade or business is not a tax shelter prohibited from using the cash method and is exempt from the interest limitation rules by meeting the small business gross receipts test of Code Sec. 448(c).

The Tax Bill proposals would generally apply to property placed in service after September 27, 2017, in taxable years ending after such date, and to specified plants planted or grafted after such date. A transition rule would provide that, for a taxpayer’s first taxable year ending after September 27, 2017, the taxpayer may elect to apply a 50-percent allowance.

Enhanced Expensing Through Section 179 Expense Deductions

Expansion of Code Section 179 Expensing. The Tax Bill increases the maximum amount a taxpayer may expense under Code Sec. 179 to $1,000,000, and increases the phase-out threshold amount to $2,500,000. Thus, the proposal provides that the maximum amount a taxpayer may expense, for taxable years beginning after 2017, is $1,000,000 of the cost of qualifying property placed in service for the taxable year. The $1,000,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2,500,000. The $1,000,000 and $2,500,000 amounts, as well as the $25,000 sport utility vehicle limitation, are indexed for inflation for taxable years beginning after 2018.

The Tax Bill expands the definition of Code Sec. 179 property to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging.

Observation: Property used predominantly to furnish lodging or in connection with furnishing lodging generally includes, for example, beds and other furniture, refrigerators, ranges, and other equipment used in the living quarters of a lodging facility such as an apartment house, dormitory, or any other facility (or part of a facility) where sleeping accommodations are provided.

The Tax Bill also expands the definition of qualified real property eligible for Code Sec. 179 expensing to include any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.

The Tax Bill proposals would apply to property placed in service in taxable years beginning after December 31, 2017.

Modifications to Depreciation Limitations on Luxury Automobiles and Personal Use Property

The Tax Bill increases the depreciation limitations under Code Sec. 280F that apply to listed property. For passenger automobiles that qualify as luxury automobiles (i.e., gross unloaded weight of 6,000 lbs or more) placed in service after December 31, 2017, and for which the additional first-year depreciation deduction is not claimed, the maximum amount of allowable depreciation is $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period. The limitations are indexed for inflation for luxury passenger automobiles placed in service after 2018.

The Tax Bill removes computer or peripheral equipment from the definition of listed property. Such property is therefore not subject to the heightened substantiation requirements that apply to listed property.

The Tax Bill proposal would be effective for property placed in service after December 31, 2017.

Modifications of Treatment of Certain Farm Property

The Tax Bill shortens the recovery period from 7 to 5 years for any machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming business, the original use of which begins with the taxpayer and is placed in service after December 31, 2017.

The Tax Bill also repeals the required use of the 150-percent declining balance method for property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property). The 150-percent declining balance method will continue to apply to any 15-year or 20-year property used in the farming business to which the straight line method does not apply, or to property for which the taxpayer elects the use of the 150-percent declining balance method.

The proposal in the Tax Bill would be effective for property placed in service after December 31, 2017.

Modification of Net Operating Loss (NOL) Deduction

The Tax Bill limits the NOL deduction to 80 percent of taxable income (determined without regard to the deduction). Carryovers to other years are adjusted to take account of this limitation, and may be carried forward indefinitely.

The proposal repeals the two-year carryback and the special carryback provisions in current law, but provides a two-year carryback in the case of certain losses incurred in the trade or business of farming. In addition, the Tax Bill provides a two-year carryback and 20-year carryforward for NOLs of a property and casualty insurance company.

The Tax Bill provision would apply to losses arising in taxable years beginning after December 31, 2017.

Modification of Like-Kind Exchange Rules

The Tax Bill modifies the provision providing for nonrecognition of gain in the case of like-kind exchanges by limiting its application to real property that is not held primarily for sale.

The Tax Bill proposal would generally apply to exchanges completed after December 31, 2017. However, an exception is provided for any exchange if the property disposed of by the taxpayer in the exchange is disposed of on or before December 31, 2017, or the property received by the taxpayer in the exchange is received on or before such date.

Modification of Alternative Depreciation System Recovery Period for Residential Rental Property

The Tax Bill shortens the alternative depreciation system (ADS) recovery period for residential rental property from 40 to 30 years. It also allows an electing real property trade or business to use the ADS recovery period in depreciating real and qualified improvement property.

Observation: The Senate Bill had shortened the recovery period for determining the depreciation deduction with respect to nonresidential real property from 39 years to 25 years and for residential rental property from 27.5 years to 25 years. Under the Senate Bill, such property placed in service before 2018 would have been treated as having a new placed-in-service date of January 1, 2018, if it resulted in more advantageous deductions. However, this provision was eliminated in the Tax Bill.

Elimination of Separate Definitions Relating to Qualified Leasehold Improvements, Qualified Restaurant, and Qualified Retail Improvement Property

The Tax Bill eliminates the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property, and provides a general 15-year recovery period for qualified improvement property, and a 20-year ADS recovery period for such property. Thus, for example, qualified improvement property placed in service after December 31, 2017, is generally depreciable over 15 years using the straight line method and half-year convention, without regard to whether the improvements are property subject to a lease, placed in service more than three years after the date the building was first placed in service, or made to a restaurant building. Restaurant building property placed in service after December 31, 2017, that does not meet the definition of qualified improvement property is depreciable over 39 years as nonresidential real property, using the straight line method and the mid-month convention.

As a conforming amendment, the Tax Bill replaces the references in Code Sec. 179(f) to qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property with a reference to qualified improvement property.

The Tax Bill also requires a real property trade or business electing out of the limitation on the deduction for interest to use ADS to depreciate any of its nonresidential real property, residential rental property, and qualified improvement property.

The Tax Bill proposals would be effective for property placed in service after December 31, 2017.

Modification of Treatment of S Corporation Conversions to C Corporations

The Tax Bill provides that any Code Sec. 481(a) adjustment of an eligible terminated S corporation attributable to the revocation of its S corporation election (i.e., a change from the cash method to an accrual method) is taken into account ratably during the six-taxable-year period beginning with the year of change. An eligible terminated S corporation is any C corporation which (1) is an S corporation the day before the enactment of the Tax Bill, (2) during the two-year period beginning on the date of such enactment revokes its S corporation election under Code Sec. 1362(a), and (3) all of the owners of which on the date the S corporation election is revoked are the same owners (and in identical proportions) as the owners on the date of such enactment.

Under the provision, in the case of a distribution of money by an eligible terminated S corporation, the accumulated adjustments account shall be allocated to such distribution, and the distribution shall be chargeable to accumulated earnings and profits, in the same ratio as the amount of the accumulated adjustments account bears to the amount the accumulated earnings and profits.

The Tax Bill provision would be effective upon enactment.

Modification of Orphan Drug Credit

The Tax Bill reduces the Orphan Drug Credit rate to 25 percent (instead of current law’s 50 percent rate) of qualified clinical testing expenses, has reporting requirements similar to those required in Code Sec. 48C and Code Sec. 48D, and, would strike any base amount calculation and strike the limitation regarding qualified clinical testing expenses to the extent such testing relates to a drug which has previously been approved under Section 505 of the Federal Food, Drug, and Cosmetic Act.

The Tax Bill provision would apply to amounts paid or incurred in taxable years beginning after December 31, 2017.

Small Business Cash Accounting Method Reform and Simplification

The Tax Bill expands the universe of taxpayers that may use the cash method of accounting. Under the provision, the cash method of accounting may be used by taxpayers, other than tax shelters, that satisfy a gross receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $25 million for the three prior taxable-year period (the “$25 million gross receipts test”) to use the cash method. The $25 million amount is indexed for inflation for taxable years beginning after 2018.

The provision expands the universe of farming C corporations (and farming partnerships with a C corporation partner) that may use the cash method to include any farming C corporation (or farming partnership with a C corporation partner) that meets the $25 million gross receipts test.

The Tax Bill retains the exceptions from the required use of the accrual method for qualified personal service corporations and taxpayers other than C corporations. Thus, qualified personal service corporations, partnerships without C corporation partners, S corporations, and other passthrough entities are allowed to use the cash method without regard to whether they meet the $25 million gross receipts test, so long as the use of such method clearly reflects income.

The Tax Bill provisions to expand the universe of taxpayers eligible to use the cash method apply to taxable years beginning after December 31, 2017. The change to the cash method is a change in the taxpayer’s method of accounting for purposes of Code Sec. 481

Modification of Inventory Classification Rules for Small Businesses

The Tax Bill exempts certain taxpayers from the requirement to keep inventories. Specifically, taxpayers that meet the $25 million gross receipts test are not required to account for inventories under Code Sec. 471, but rather may use a method of accounting for inventories that either (1) treats inventories as non-incidental materials and supplies, or (2) conforms to the taxpayer’s financial accounting treatment of inventories.

The Tax Bill expands the exception for small taxpayers from the uniform capitalization rules. Under the provision, any producer or reseller that meets the $25 million gross receipts test is exempted from the application of Code Sec. 263A. The provision retains the exemptions from the uniform capitalization rules that are not based on a taxpayer’s gross receipts. Finally, the provision expands the exception for small construction contracts from the requirement to use the percentage-of-completion method. Under the provision, contracts within this exception are those contracts for the construction or improvement of real property if the contract: (1) is expected (at the time such contract is entered into) to be completed within two years of commencement of the contract and (2) is performed by a taxpayer that (for the taxable year in which the contract was entered into) meets the $25 million gross receipts test.

Under the Tax Bill, a taxpayer who fails the $25 million gross receipts test would not be eligible for any of the aforementioned exceptions (i.e., from the accrual method, from keeping inventories, from applying the uniform capitalization rules, or from using the percentage-of completion method) for such taxable year.

The Tax Bill provisions to exempt certain taxpayers from the requirement to keep inventories, and expand the exception from the uniform capitalization rules is a change in the taxpayer’s method of accounting for purposes of Code Sec. 481. Application of the exception for small construction contracts from the requirement to use the percentage-of-completion method is applied on a cutoff basis for all similarly classified contracts (hence there is no adjustment under Code Sec. 481(a) for contracts entered into before January 1, 2018).

The Tax Bill provisions to expand the universe of taxpayers eligible to use the cash method, exempt certain taxpayers from the requirement to keep inventories, and expand the exception from the uniform capitalization rules apply to taxable years beginning after December 31, 2017. The provision to expand the exception for small construction contracts from the requirement to use the percentage-of-completion method applies to contracts entered into after December 31, 2017, in taxable years ending after such date.

Exceptions to Using Uniform Capitalization Rules Expanded

The Tax Bill expands the exception for small taxpayers being subject to the uniform capitalization accounting method rules. Under the proposal, any producer or reseller that meets a $25 million gross receipts test is exempted from the application of Code Sec. 263A. In the case of a sole proprietorship, the $25 million gross receipts test is applied as if the sole proprietorship is a corporation or partnership. The proposal retains the exemptions from the uniform capitalization rules that are not based on a taxpayer’s gross receipts.

If a taxpayer changes its method of accounting because it is either no longer required or is required to apply Code Sec. 263A by reason of this proposal, such change is treated as initiated by the taxpayer and made with the consent of the Secretary.

The Tax Bill proposal would apply to taxable years beginning after December 31, 2017. Application of these rules would be a change in the taxpayer’s method of accounting for purposes of Code Sec. 481.

Increase in Gross Receipts Test for Construction Contract Exception to Percentage of Completion Accounting Method

The Tax Bill expands the exception for small construction contracts from the requirement to use the percentage-of-completion accounting method. Under the proposal, contracts within this exception are those contracts for the construction or improvement of real property if the contract:

(1) is expected (at the time such contract is entered into) to be completed within two years of commencement of the contract; and

(2) is performed by a taxpayer that (for the taxable year in which the contract was entered into) meets the $25 million gross receipts test.

In the case of a sole proprietorship, the $25 million gross receipts test is applied as if the sole proprietorship is a corporation or partnership. The Tax Bill proposal would apply to contracts entered into after December 31, 2017, in taxable years ending after such date. Application of this rule would be a change in the taxpayer’s method of accounting for purposes of Code Sec. 481, but is applied on a cutoff basis for all similarly classified contracts (hence there is no adjustment under Code Sec. 481(a) for contracts entered into before January 1, 2018).

Modification of Accounting Method Rules Relating to Income Recognition

The Tax Bill revises the rules associated with the recognition of income. Specifically, the proposal requires a taxpayer to recognize income no later than the taxable year in which such income is taken into account as income on an applicable financial statement or another financial statement under rules specified by the Secretary, but provides an exception for long-term contract income to which Code Sec. 460 applies.

The proposal also codifies the current deferral method of accounting for advance payments for goods and services provided by the IRS under Rev. Proc. 2004-34. That is, the proposal allows taxpayers to defer the inclusion of income associated with certain advance payments to the end of the tax year following the tax year of receipt if such income also is deferred for financial statement purposes.

In addition, the proposal directs taxpayers to apply the revenue recognition rules under Code Sec. 451 before applying the OID rules under Code Sec.1272.

Observation: Thus, for example, to the extent amounts are included in income for financial statement purposes when received (e.g., late payment fees, cash-advance fees, or interchange fees), such amounts generally are includable in income at such time in accordance with the general recognition principles under Code Sec. 451.

In the case of any taxpayer required by this proposal to change its method of accounting for its first taxable year beginning after December 31, 2017, such change is treated as initiated by the taxpayer and made with the consent of the Secretary.

The Tax Bill proposal would apply to taxable years beginning after December 31, 2017, and application of these rules would be a change in the taxpayer’s method of accounting for purposes of Code Sec. 481.

Changes to Interest Deduction Rules

Under the Tax Bill, in the case of any taxpayer for any taxable year, the deduction for business interest is limited to the sum of business interest income plus 30 percent of the adjusted taxable income of the taxpayer for the taxable year. There is an exception to this limitation, however, for floor plan financing, which is a specialized type of financing used by car dealerships and certain regulated utilities.

The Tax Bill also exempts from the limitation taxpayers with average annual gross receipts for the three-taxable year period ending with the prior taxable year that do not exceed $25 million. In addition, for purposes of defining floor plan financing, the Tax Bill modifies the definition of motor vehicle by deleting the specific references to an automobile, a truck, a recreational vehicle, and a motorcycle because those terms are encompassed in the phrase, “any self-propelled vehicle designed for transporting persons or property on a public street, highway, or road.”

At the taxpayer’s election, any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business is not treated as a trade or business for purposes of the limitation, and therefore the limitation does not apply to such trades or businesses. The limitation also does not apply to certain regulated public utilities. Specifically, the trade or business of the furnishing or sale of (1) electrical energy, water, or sewage disposal services, (2) gas or steam through a local distribution system, or (3) transportation of gas or steam by pipeline, if the rates for such furnishing or sale, as the case may be, have been established or approved by a State or political subdivision thereof, by any agency or instrumentality of the United States, or by a public service or public utility commission or other similar body of any State or political subdivision thereof is not treated as a trade or business for purposes of the limitation.

The amount of any interest not allowed as a deduction for any taxable year may be carried forward indefinitely. The limitation applies at the taxpayer level. In the case of a group of affiliated corporations that file a consolidated return, it applies at the consolidated tax return filing level. A farming business, including agricultural and horticultural cooperatives, may elect not to be subject to this limitation if the business uses the alternative depreciation system to depreciate any property used in the farming business with a recovery period of 10 years or more. An electing real property trade or business may also elect out of the interest deduction limitation if the business also uses the alternative depreciation system to depreciate its property.

Business interest means any interest paid or accrued on indebtedness properly allocable to a trade or business. Any amount treated as interest for purposes of the Internal Revenue Code is interest for purposes of the proposal. Business interest income means the amount of interest includible in the gross income of the taxpayer for the taxable year which is properly allocable to a trade or business. Business interest does not include investment interest, and business interest income does not include investment income, within the meaning of Code Sec. 163(d).

By including business interest income in the limitation, the rule operates to limit the deduction for net interest expense to 30 percent of adjusted taxable income. That is, a deduction for business interest is permitted to the full extent of business interest income. To the extent that business interest exceeds business interest income, the deduction for the net interest expense is limited to 30 percent of adjusted taxable income.

Generally, adjusted taxable income means the taxable income of the taxpayer computed without regard to:

(1) any item of income, gain, deduction, or loss which is not properly allocable to a trade or business (but see below for special rules for tax years beginning after 2017 and before 2022);

(2) any business interest or business interest income;

(3) the 23 percent deduction for certain pass-through income; and

(4) the amount of any net operating loss deduction.

However, under the Tax Bill, for taxable years beginning after December 31, 2017 and before January 1, 2022, adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, or depletion. Additionally, because the Tax Bill repeals Code Sec. 199 effective December 31, 2017 (see discussion below), adjusted taxable income is computed without regard to such deduction.

The Tax Bill would authorize the IRS to provide other adjustments to the computation of adjusted taxable income.

Application to pass-through entities. In the case of any partnership, the limitation is applied at the partnership level. Any deduction for business interest is taken into account in determining the nonseparately stated taxable income or loss of the partnership. To prevent double counting, special rules are provided for the determination of the adjusted taxable income of each partner of the partnership. Similarly, to allow for additional interest deduction by a partner in the case of an excess amount of unused adjusted taxable income limitation of the partnership, special rules apply. Similar rules apply with respect to any S corporation and its shareholders.

Double counting rule. The adjusted taxable income of each partner (or shareholder, as the case may be) is determined without regard to such partner’s distributive share of the nonseparately stated income or loss of such partnership. In the absence of such a rule, the same dollars of adjusted taxable income of a partnership could generate additional interest deductions as the income is passed through to the partners.

Additional deduction limit. The limit on the amount allowed as a deduction for business interest is increased by a partner’s distributive share of the partnership’s excess taxable income. The excess taxable income with respect to any partnership is the amount which bears the same ratio to the partnership’s adjusted taxable income as the excess (if any) of 30 percent of the adjusted taxable income of the partnership over the amount (if any) by which the business interest of the partnership exceeds the business interest income of the partnership bears to 30 percent of the adjusted taxable income of the partnership. This allows a partner of a partnership to deduct additional interest expense the partner may have paid or incurred to the extent the partnership could have deducted more business interest. The Tax Bill requires that excess taxable income be allocated in the same manner as nonseparately stated income and loss.

Carryforward of disallowed business interest. The amount of any business interest not allowed as a deduction for any taxable year is treated as business interest paid or accrued in the succeeding taxable year. Business interest may be carried forward indefinitely. With respect to the limitation on deduction of interest by domestic corporations which are United States shareholders that are members of worldwide affiliated groups with excess domestic indebtedness, whichever rule imposes the lower limitation on the deduction of interest with respect to the taxable year (and therefore the greatest amount of interest to be carried forward) governs.

The trade or business of performing services as an employee is not treated as a trade or business for purposes of the limitation. As a result, for example, the wages of an employee are not counted in the adjusted taxable income of the taxpayer for purposes of determining the limitation.

The Tax Bill proposal would apply to taxable years beginning after December 31, 2017.

Repeal of Domestic Activities Production Deduction

Under the Tax Bill, the deduction in Code Sec. 199 for domestic production activities is repealed.

The Tax Bill provision applies to taxable years beginning after December 31, 2017.

Limitation on Deduction by Employers of Expenses for Fringe Benefits

The Tax Bill provides that no deduction is allowed with respect to –

(1) an activity generally considered to be entertainment, amusement or recreation;

(2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes; or

(3) a facility or portion thereof used in connection with any of the above items.

Thus, the proposal repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer’s trade or business (and the related rule applying a 50 percent limit to such deductions). The Tax Bill also disallows a deduction for expenses associated with providing any qualified transportation fringe to employees of the taxpayer, and except as necessary for ensuring the safety of an employee, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment.

Taxpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel). For amounts incurred and paid after December 31, 2017 and until December 31, 2025, the provision expands this 50 percent limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer. Such amounts incurred and paid after December 31, 2025 are not deductible.

The Tax Bill proposal generally applies to amounts paid or incurred after December 31, 2017. However, for expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer, amounts paid or incurred after December 31, 2025 are not deductible.

Repeal of Deduction for Local Lobbying Expenses

The Tax Bill disallows deductions for lobbying expenses with respect to legislation before local government bodies (including Indian tribal governments), effective for amounts paid or incurred on or after the date of enactment.

Limitation on Deduction Relating to FDIC Premiums

Under the Tax Bill, no deduction is allowed for the applicable percentage of any FDIC premium paid or incurred by certain large financial institutions. For taxpayers with total consolidated assets of $50 billion or more, the applicable percentage is 100 percent. Otherwise, the applicable percentage is the ratio of the excess of total consolidated assets over $10 billion to $40 billion. The proposal does not apply to taxpayers with total consolidated assets (as of the close of the taxable year) that do not exceed $10 billion. The provision applies to taxable years beginning after December 31, 2017.

Contributions to Capital

While the Tax Bill retains Code Sec. 118, a provision the House Bill had sought to repeal, it provides that the term “contributions to capital” does not include –

(1) any contribution in aid of construction or any other contribution as a customer or potential customer, and

(2) any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such).

The Conference Report states that the conferees intend that, as modified, Code Sec. 118, which under current law provides that the gross income of a corporation does not include any contributions to capital, will continue to apply only to corporations.

The Tax Bill provision will apply to contributions made after the date of enactment. However, the provision will not apply to any contribution made after the date of enactment by a governmental entity pursuant to a master development plan that has been approved prior to such date by a governmental entity.

Tax Credits

The Tax Bill modifies the rehabilitation credit in Code Sec. 47.

Observation: While both the House Bill and the Senate Bill would have repealed the deduction in Code Sec. 196 for certain unused business credits, the repeal of that provision did not make it into the Tax Bill.

Change in Determination of Cost Basis of Specified Securities

The Tax Bill does not include a controversial provision in the Senate Bill which would have required that the cost of any specified security sold, exchanged, or otherwise disposed of on or after January 1, 2018, generally be determined on a first-in first-out basis except to the extent the average basis method is otherwise allowed (as in the case of stock of a regulated investment company). The Senate’s proposal had included several conforming amendments, including a rule restricting a broker’s basis reporting method to the first-in first-out method in the case of the sale of any stock for which the average basis method was not permitted.

Repeal of Rollover of Publicly Traded Securities Gain into Specialized Small Business Investment Companies

The Tax Bill repeals the election that could be made by a corporation or individual to roll over tax-free any capital gain realized on the sale of publicly-traded securities to the extent of the taxpayer’s cost of purchasing common stock or a partnership interest in a specialized small business investment company within 60 days of the sale. The amount of gain that an individual could elect to roll over under this provision for a taxable year was limited to (1) $50,000 or (2) $500,000 reduced by the gain previously excluded under this provision. For corporations, these limits were $250,000 and $1 million, respectively.

The Tax Bill provision would apply to sales after December 31, 2017.

Certain Self-Created Property Not Treated as a Capital Asset

The Tax Bill amends Code Sec. 1221(a)(3), resulting in the exclusion of a patent, invention, model or design (whether or not patented), and a secret formula or process which is held either by the taxpayer who created the property or a taxpayer with a substituted or transferred basis from the taxpayer who created the property (or for whom the property was created) from the definition of a “capital asset.” Thus, gains or losses from the sale or exchange of a patent, invention, model or design (whether or not patented), or a secret formula or process which is held either by the taxpayer who created the property or a taxpayer with a substituted or transferred basis from the taxpayer who created the property (or for whom the property was created) will not receive capital gain treatment.

The Tax Bill proposal would apply to dispositions after December 31, 2017.

Repeal of Technical Termination of Partnerships

The Tax Bill repeals the Code Sec. 708(b)(1)(B) rule providing for technical terminations of partnerships. The provision does not change the present-law rule of Code Sec. 708(b)(1)(A) that a partnership is considered as terminated if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership.

The Tax Bill provision would apply to partnership taxable years beginning after December 31, 2017

Recharacterization of Certain Gains in The Case of Partnership Profits Interests Held in Connection With Performance of Investment Services

The Tax Bill provides for a three-year holding period in the case of certain net long-term capital gain with respect to any applicable partnership interest held by the taxpayer. The Tax Bill clarifies the interaction of Code Sec. 83 with the provision’s three-year holding requirement, which applies notwithstanding the rules of Code Sec. 83 or any election in effect under Code Sec. 83(b). Under the provision, the fact that an individual may have included an amount in income upon acquisition of the applicable partnership interest, or that an individual may have made a Code Sec. 83(b) election with respect to an applicable partnership interest, does not change the three-year holding period requirement for long-term capital gain treatment with respect to the applicable partnership interest. Thus, the provision treats as short-term capital gain taxed at ordinary income rates the amount of the taxpayer’s net long-term capital gain with respect to an applicable partnership interest for the taxable year that exceeds the amount of such gain calculated as if a three-year (not one-year) holding period applies. In making this calculation, the provision takes account of long-term capital losses calculated as if a three-year holding period applies.

The Tax Bill provision would apply to tax years beginning after December 31, 2017.

Compensation and Benefits

Modification of Limitation on Excessive Employee Remuneration. The Tax Bill revises the definition of covered employee to include both the principal executive officer and the principal financial officer. Further, an individual is a covered employee if the individual holds one of these positions at any time during the taxable year. The proposal also defines as a covered employee the three (rather than four) most highly compensated officers for the taxable year (other than the principal executive officer or principal financial officer) who are required to be reported on the company’s proxy statement for the taxable year (or who would be required to be reported on such a statement for a company not required to make such a report to shareholders). The proposal would apply to tax years beginning after December 31, 2017. However, there is a transition rule which provides that the proposed changes do not apply to any remuneration under a written binding contract which was in effect on November 2, 2017, and which was not modified after this date in any material respect, and to which the right of the covered employee was no longer subject to a substantial risk of forfeiture on or before December 31, 2016.

Excise Tax on Excess Tax-Exempt Organization Executive Compensation. Under the Tax Bill, an employer is liable for an excise tax equal to 21 percent of the sum of the (1) remuneration (other than an excess parachute payment) in excess of $1 million paid to a covered employee by an applicable tax-exempt organization for a taxable year, and (2) any excess parachute payment (under a new definition for this purpose that relates solely to separation pay) paid by the applicable tax-exempt organization to a covered employee. Accordingly, the excise tax applies as a result of an excess parachute payment, even if the covered employee’s remuneration does not exceed $1 million. The proposal would apply to tax years beginning after December 31, 2017.

Treatment of Qualified Equity Grants. Under the Tax Bill, a qualified employee can elect to defer, for income tax purposes, the inclusion in income of the amount of income attributable to qualified stock transferred to the employee by the employer. An election to defer income inclusion (inclusion deferral election) with respect to qualified stock must be made no later than 30 days after the first time the employee’s right to the stock is substantially vested or is transferable, whichever occurs earlier. If an employee elects to defer income inclusion under the provision, the income must be included in the employee’s income for the taxable year that includes the earliest of (1) the first date the qualified stock becomes transferable, including, solely for this purpose, transferable to the employer; (2) the date the employee first becomes an excluded employee (as described below); (3) the first date on which any stock of the employer becomes readily tradable on an established securities market; (4) the date five years after the first date the employee’s right to the stock becomes substantially vested; or (5) the date on which the employee revokes her inclusion deferral election. Deferred income inclusion applies also for purposes of the employer’s deduction of the amount of income attributable to the qualified stock. The provision generally applies with respect to stock attributable to options exercised or RSUs settled after December 31, 2017.

Excise Tax on Stock Compensation in an Inversion Transaction. The Tax Bill increases the excise tax on stock compensation in an inversion transaction from 15 percent to 20 percent. The Tax Bill provision applies to corporations first becoming expatriated corporations after the date of enactment.

Partnerships

Tax Gain on the Sale of a Partnership Interest on a Look-through Basis. Under the Tax Bill, gain or loss from the sale or exchange of a partnership interest is effectively connected with a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange. The proposal requires that any gain or loss from the hypothetical asset sale by the partnership be allocated to interests in the partnership in the same manner as nonseparately stated income and loss.

The Tax Bill also requires the transferee of a partnership interest to withhold 10 percent of the amount realized on the sale or exchange of a partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation. If the transferee fails to withhold the correct amount, the partnership is required to deduct and withhold from distributions to the transferee partner an amount equal to the amount the transferee failed to withhold.

The Tax Bill provision treating gain or loss on sale of a partnership interest as effectively connected income is effective for sales, exchanges, and dispositions on or after November 27, 2017. The portion of the provision requiring withholding on sales or exchanges of partnership interests is effective for sales, exchanges, and dispositions after December 31, 2017.

Modification of the Definition of Substantial Built-in Loss on Transfers of a Partnership Interest. The Tax Bill modifies the definition of a substantial built-in loss for purposes of Code Sec. 743(d), affecting transfers of partnership interests. Under the proposal, in addition to the present-law definition, a substantial built-in loss also exists if the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all partnership’s assets in a fully taxable transaction for cash equal to the assets’ fair market value, immediately after the transfer of the partnership interest.

Example: ABC Partnership has three taxable partners (partners A, B, and C). ABC has not made an election pursuant to Code Sec. 754. The partnership has two assets, one of which, Asset X, has a built-in gain of $1 million, while the other asset, Asset Y, has a built-in loss of $900,000. Pursuant to the ABC partnership agreement, any gain on sale or exchange of Asset X is specially allocated to partner A. The three partners share equally in all other partnership items, including in the built-in loss in Asset Y. In this case, each of partner B and partner C has a net built-in loss of $300,000 (one third of the loss attributable to asset Y) allocable to his partnership interest. Nevertheless, the partnership does not have an overall built-in loss, but a net built-in gain of $100,000 ($1 million minus $900,000). Partner C sells his partnership interest to another person, D, for $33,333. Under the Senate’s proposal, the test for a substantial built-in loss applies both at the partnership level and at the transferee partner level. If the partnership were to sell all its assets for cash at their fair market value immediately after the transfer to D, D would be allocated a loss of $300,000 (one third of the built-in loss of $900,000 in Asset Y). The partnership does not have a substantial built-in loss, but a substantial built-in loss exists under the partner-level test, and the partnership adjusts the basis of its assets accordingly with respect to D.

The Tax Bill proposal would apply to transfers of partnership interests after December 31, 2017.

Charitable Contributions and Foreign Taxes Taken into Account in Determining Limitation on Allowance of Partner’s Share of Loss. The Tax Bill modifies the basis limitation on partner losses to provide that a partner’s distributive share of items that are not deductible in computing the partnership’s taxable income, and not properly chargeable to capital account, are allowed only to the extent of the partner’s adjusted basis in its partnership interest at the end of the partnership taxable year in which the expenditure occurs. Thus, the basis limitation on partner losses applies to a partner’s distributive share of charitable contributions and foreign taxes. A partner’s distributive share of loss takes into account the partner’s distributive share of charitable contributions and foreign taxes for purposes of the basis limitation on partner losses. In the case of a charitable contribution of property whose fair market value exceeds its adjusted basis, the basis limitation on partner losses does not apply to the extent of the partner’s distributive share of such excess.

The Tax Bill proposal would apply to partnership taxable years beginning after December 31, 2017.

Amortization of Research and Experimental Expenditures

Under the Tax Bill, amounts defined as specified research or experimental expenditures are required to be capitalized and amortized ratably over a five-year period, beginning with the midpoint of the taxable year in which the specified research or experimental expenditures were paid or incurred. Specified research or experimental expenditures which are attributable to research that is conducted outside of the United States are required to be capitalized and amortized ratably over a period of 15 years, beginning with the midpoint of the taxable year in which such expenditures were paid or incurred. Specified research or experimental expenditures subject to capitalization include expenditures for software development. Specified research or experimental expenditures do not include expenditures for land or for depreciable or depletable property used in connection with the research or experimentation, but do include the depreciation and depletion allowances of such property. Also excluded are exploration expenditures incurred for ore or other minerals (including oil and gas).

This rule would be applied on a cutoff basis to research or experimental expenditures paid or incurred in taxable years beginning after December 31, 2025 (hence there is no adjustment under Code Sec. 481(a) for research or experimental expenditures paid or incurred in taxable years beginning before January 1, 2026).

The Tax Bill proposal would apply to amounts paid or incurred in taxable years beginning after December 31, 2025.

Employer Credit for Paid Family and Medical Leave

This Tax Bill allows eligible employers to claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave (FMLA) if the rate of payment under the program is 50 percent of the wages normally paid to an employee. The credit would be increased by 0.25 percentage points (but not above 25 percent) for each percentage point by which the rate of payment exceeds 50 percent.

The Tax Bill proposal would generally be effective for wages paid in taxable years beginning after December 31, 2017.

Modify Tax Treatment of Alaska Native Corporations and Settlement Trusts

The Tax Bill addresses the tax treatment of Alaska Native Corporations and settlement trusts in three separate but related sections. The first section would allow a Native Corporation to assign certain payments described in the Alaska Native Claims Settlement Act (ANCSA) to a Settlement Trust without having to recognize gross income from those payments, provided the assignment is in writing and the Native Corporation has not received the payment prior to assignment. The Settlement Trust is required to include the assigned payment in gross income when received. The second section allows a Native Corporation to elect annually to deduct contributions made to a Settlement Trust. The third section of the proposal requires any Native Corporation which has made an election to deduct contributions to a Settlement Trust as described above to furnish a statement to the Settlement Trust containing: (1) the total amount of contributions; (2) whether such contribution was in cash; (3) for non-cash contributions, the date that such property was acquired by the Native Corporation and the adjusted basis of such property on the contribution date; (4) the date on which each contribution was made to the Settlement Trust; and (5) such information as the Secretary determines is necessary for the accurate reporting of income relating to such contributions.

The Tax Bill proposal relating to the exclusion for ANCSA payments assigned to Settlement Trusts would be effective to taxable years beginning after December 31, 2016. The proposal relating to the reporting requirement would apply to taxable years beginning after December 31, 2016.

Expansion of Qualifying Beneficiaries of an Electing Small Business Trust (ESBT)

The Tax Bill allows a nonresident alien individual to be a potential current beneficiary of an ESBT. The proposal would take effect on January 1, 2018.

Charitable Contribution Deduction for ESBTs

The Tax Bill provides that the charitable contribution deduction of an ESBT is not determined by the rules generally applicable to trusts but rather by the rules applicable to individuals. Thus, the percentage limitations and carryforward provisions applicable to individuals apply to charitable contributions made by the portion of an ESBT holding S corporation stock.

The Tax Bill proposal would apply to taxable years beginning after December 31, 2017.

Deductibility of Penalties and Fines for Federal Income Tax Purposes

The Tax Bill denies deductibility for any otherwise deductible amount paid or incurred (whether by suit, agreement, or otherwise) to or at the direction of a government or specified nongovernmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law. An exception applies to payments that the taxpayer establishes are either restitution (including remediation of property) or amounts required to come into compliance with any law that was violated or involved in the investigation or inquiry, that are identified in the court order or settlement agreement as restitution, remediation, or required to come into compliance. In the case of any amount of restitution for failure to pay any tax and assessed as restitution under the Code, such restitution is deductible only to the extent it would have been allowed as a deduction if it had been timely paid. Restitution or included remediation of property does not include reimbursement of government investigative or litigation costs.

The proposal applies only where a government (or other entity treated in a manner similar to a government under the provision) is a complainant or investigator with respect to the violation or potential violation of any law. An exception also applies to any amount paid or incurred as taxes due.

The Tax Bill proposal would be effective for amounts paid or incurred after the date of enactment, except that it would not apply to amounts paid or incurred under any binding order or agreement entered into before such date. Such exception does not apply to an order or agreement requiring court approval unless the approval was obtained before such date.

Aircraft Management Services

The Tax Bill exempts certain payments related to the management of private aircraft from the excise taxes imposed on taxable transportation by air, effective for amounts paid after the date of enactment.

Qualified Opportunity Zones

The Tax Bill provides for the temporary deferral of inclusion in gross income for capital gains reinvested in a qualified opportunity fund and the permanent exclusion of capital gains from the sale or exchange of an investment in the qualified opportunity fund. The proposal allows for the designation of certain low-income community population census tracts as qualified opportunity zones, where low-income communities are defined in Code Sec. 45D(e). The designation of a population census tract as a qualified opportunity zone remains in effect for the period beginning on the date of the designation and ending at the close of the tenth calendar year beginning on or after the date of designation. The proposal would be effective on the date of enactment.

Expensing of Certain Costs of Replanting Citrus Plants Lost by Reason of Casualty

The Tax Bill modifies the special rule for costs incurred by persons other than the taxpayer in connection with replanting an edible crop for human consumption following loss or damage due to casualty. Under the proposal, with respect to replanting costs paid or incurred after the date of enactment, but no later than a date which is ten years after such date of enactment, for citrus plants lost or damaged due to casualty, such costs may also be deducted by a person other than the taxpayer if (1) the taxpayer has an equity interest of not less than 50 percent in the replanted citrus plants at all times during the taxable year in which the replanting costs are paid or incurred and such other person holds any part of the remaining equity interest, or (2) such other person acquires all of the taxpayer’s equity interest in the land on which the lost or damaged citrus plants were located at the time of such loss or damage, and the replanting is on such land.

Denial of Deduction for Settlements Subject to a Nondisclosure Agreement Paid in Connection with Sexual Harassment or Sexual Abuse

Under the Tax Bill, no deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement. The proposal is effective for amounts paid or incurred after the date of enactment.

Repeal of Tax Credit Bonds

The Tax Bill prospectively repeals authority to issue tax-credit bonds and direct-pay bonds. The provisions would apply to bonds issued after December 31, 2017.

 

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Tax Reform Changes Affecting Individuals

With respect to individuals, some of the more notable items included in the Tax Bill are:

  • the provision of seven tax brackets, with a top rate of 37 percent (the top rate under present law is 39.6 percent);
  • a repeal of the personal exemption deductions and an increase in the standard deduction amounts to $24,000 for joint filers and surviving spouses, $18,000 for heads of household, and $12,000 for unmarried taxpayers and married filing separately (additional amounts for the elderly and blind are retained);
  • a $10,000 limit on the deduction for state and local taxes, which can be used for both property taxes and income taxes (or sales taxes in lieu of income taxes);
  • a $750,000 limit on the loan amount for which a mortgage interest deduction can be claimed by individuals, with existing loans grandfathered, and the repeal of interest deductions on home equity indebtedness;
  • a repeal of miscellaneous itemized deductions subject to the 2 percent of adjusted gross income floor;
  • a repeal of the personal deduction for casualty and theft losses, except for losses incurred in presidentially declared disaster areas;
  • an increase in the child tax credit to $2,000 ($1,400 is refundable) and an increase in the phaseout threshold amounts to $400,000 for joint filers and $200,000 for all others (the credit is $1,000 under present law and is fully refundable);
  • an increase in the alternative minimum tax (AMT) exemption amounts and the adjusted gross income thresholds at which the exemption amount begins to phase out;
  • a repeal of the deduction for alimony paid and corresponding inclusion in income by the recipient, effective for tax years beginning in 2019 (alimony paid under separation agreement entered into prior to the effective date is generally grandfathered);
  • permanent repeal of the individual shared responsibility payment (individual healthcare mandate) enacted as part of the Affordable Care Act (ACA); and
  • the expiration of most individual tax provisions after December 31, 2025.

The Tax Bill also provides a 20 percent deduction against qualified business income from passthrough business entities. The provision includes relatively relaxed rules for calculating qualified business income for individuals with taxable income below certain thresholds ($315,000 for joint filers, $157,500 for all others), and stricter ones that are phased in for individuals with taxable income above the thresholds.

The Tax Bill would reduce the corporate tax rate to 21 percent and fully repeals the corporate alternative minimum tax. Both changes would be effective for tax years beginning after December 31, 2017.

Other important business-related changes include (1) 100% bonus depreciation for qualified property placed in service before January 1, 2023; (2) a permanent increase in the Section 179 expensing limit to $1,000,000 (up from $500,000 under present law) and a permanent increase in the phase-out threshold amount to $2,500,000 (up from $2,000,000 under present law); (3) a reduction in the gross receipts amount under which a business can qualify to use the cash method of accounting; and (4) an exemption from the requirement to use inventories for certain taxpayers.

The Tax Bill also makes changes to certain partnership rules, including (1) the repeal of the technical termination of partnership rule in Code Sec. 708(b); (2) the recharacterization of certain gains in the case of partnership profits interests held in connection with the performance of investment services; (3) the modification of the definition of substantial built-in loss in the case of the transfer of a partnership interest; and (4) a modification of the basis limitation on partner losses to account for a partner’s distributive share of partnership charitable contributions and foreign taxes.

Affordable Care Act (ACA) Individual Healthcare Mandate

Under the Tax Bill, the amount of the individual shared responsibility payment (aka, the “individual healthcare mandate”) enacted as part of the ACA would be reduced to zero, effective with respect to health coverage status for months beginning after December 31, 2018.

Individual Tax Rates and Brackets

The Tax Bill would replace the current set of seven individual tax rates with a different set of seven individual tax rates. Under the Conference Bill, the highest marginal tax rate is 37%, as compared to the top tax rate of 39.6% under present law. The current tax rates of 10%, 15%, 25%, 28%, 33%, 35%, 39.6% rates would be replaced with tax rates of 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

The income tax bracket thresholds are all adjusted for inflation after December 31, 2018, and then rounded to the next lowest multiple of $100 in future years. Unlike present law (which uses a measure of the consumer price index for all-urban consumers), the new inflation adjustment uses the chained consumer price index for all-urban consumers.

Tax rates and brackets are as follows:

 

 

Bracket Beginning Point
Rate

(%)

Married Filing Jointly/Surviving Spouse

($)

Head of Household

($)

Single Individuals 

($)

Married Filing Separately

($)

Estates and Trusts

($)

10 0 0 0 0 0
12 19,050 13,600 9,525 9,525 N/A
22 77,400 51,800 38,700 38,700 N/A
24 165,000 82,500 82,500 82,500 2,550
32 315,000 157,500 157,500 157,500 N/A
35 400,000 200,000 200,000 200,000 9,150
37 600,000 500,000 500,000 300,000 12,500

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Estate and Trust Tax Rates and Brackets

Under the Tax Bill, the tax rate for estates and trusts would be 10% of taxable income up to $2,550, 24% of the excess over $2,550 but not over $9,150; 35% of the excess over $9,150 but not over $12,500; and 37% of the excess over $12,500.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Simplification of Tax on Unearned Income of Children

The Tax Bill simplifies the “kiddie tax” by effectively applying ordinary and capital gains rates applicable to trusts and estates to the net unearned income of a child. Thus, taxable income attributable to earned income is taxed according to an unmarried taxpayer’s brackets and rates. Taxable income attributable to net unearned income is taxed according to the brackets applicable to trusts and estates, with respect to both ordinary income and income taxed at preferential rates. The child’s tax is no longer affected by the tax situation of the child’s parent or the unearned income of any siblings.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Maximum Rates on Capital Gains and Qualified Dividends

The Tax Bill generally retains the present-law maximum rates on net capital gain and qualified dividends. The breakpoints between the zero- and 15-percent rates (“15-percent breakpoint”) and the 15- and 20-percent rates (“20-percent breakpoint”) are the same amounts as the breakpoints under current law, except the breakpoints are indexed using the Consumer Price Index for all Urban Consumers (C-CPI-U) in taxable years beginning after 2017. Thus, for 2018, the 15-percent breakpoint is $77,200 for joint returns and surviving spouses (one-half of this amount for married taxpayers filing separately), $51,700 for heads of household, $2,600 for estates and trusts, and $38,600 for other unmarried individuals. The 20-percent breakpoint is $479,000 for joint returns and surviving spouses (one-half of this amount for married taxpayers filing separately), $452,400 for heads of household, $12,700 for estates and trusts, and $425,800 for other unmarried individuals.

As under current law, unrecaptured Code Sec. 1250 gain generally is taxed at a maximum rate of 25 percent, and 28-percent rate gain is taxed at a maximum rate of 28 percent.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Increase in Individual AMT Exemption and Phaseout Amounts

The Tax Bill provides for increased AMT exemptions. For 2018, the exemptions would be $109,400 (up from $84,500 in 2017) in the case of a joint return or the return of a surviving spouse; $70,300 (up from $54,300 in 2017) in the case of an individual who is unmarried and not a surviving spouse; $54,700 (up from $39,375 in 2017) in the case of a married individual filing a separate return. Additionally, the Conference Bill would increase the alternative minimum taxable income limit where the exemptions begin to phase out. Under the Conference Bill, the exemption amount of any taxpayer is reduced by an amount equal to 25 percent of the amount by which the alternative minimum taxable income of the taxpayer exceeds $1,000,000 (up from $160,900 in 2017) in the case of a joint returns; and $500,000 for all others (up from amounts ranging from $80,450 to $120,700 in 2017).

This provision would be effective for tax years beginning after December 31, 2017.

Paid Preparer Due Diligence Requirement for Head of Household Status

The Tax Bill directs the Secretary of the Treasury to issue due diligence requirements for paid preparers in determining eligibility for a taxpayer to file as head of household. A penalty of $500 would be imposed for each failure to meet these requirements.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Increase in Standard Deduction

The Tax Bill increases the basic standard deduction for individuals across all filing statuses. Under the provision, the amount of the standard deduction is increased to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other taxpayers. The amount of the standard deduction is indexed for inflation using the chained consumer price index for all-urban consumers for taxable years beginning after December 31, 2018. The additional standard deduction for the elderly and the blind is not changed by the provision.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Repeal of the Deduction for Personal Exemptions

The Tax Bill repeals the deduction for personal exemptions.

In addition, the provision modifies the requirements for those who are required to file a tax return. In the case of an individual who is not married, such individual is required to file a tax return if the taxpayer’s gross income for the taxable year exceeds the applicable standard deduction. Married individuals are required to file a return if that individual’s gross income, when combined with the individual’s spouse’s gross income for the taxable year, is more than the standard deduction applicable to a joint return, provided that: (1) such individual and his spouse, at the close of the taxable year, had the same household as their home; (2) the individual’s spouse does not make a separate return; and (3) neither the individual nor his spouse is a dependent of another taxpayer who has income (other than earned income) in excess of $500 (indexed for inflation).

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Repeal of Deduction for Alimony Paid

The Tax Bill repeals the deduction for alimony paid and the corresponding inclusion of alimony in income by the recipient. The provision is effective for any divorce or separation instrument executed after December 31, 2018, or for any divorce or separation instrument executed on or before December 31, 2018, and modified after that date, if the modification expressly provides that the amendments made by this section apply to such modification. Thus, alimony paid under a separation agreement entered into prior to the effective date is generally grandfathered.

Temporary Reduction in Medical Expense Deduction Floor

The Tax Bill provides special rules for medical expense deductions for years 2013 through 2018. For a tax year beginning after 2012 and ending before 2017, in the case of a taxpayer or a taxpayer’s spouse who has attained age 65 before the close of the year, and for a tax year beginning after 2016, and ending before 2019, in the case of any taxpayer, the adjusted-gross-income floor above which a medical expense is deductible is reduced from 10 percent to 7.5 percent.

Limitation on Deduction for State and Local Taxes

The Tax Bill limits the deduction for state and local property, income, war profits, and excess profits taxes to $10,000 ($5,000 in the case of a married individual filing a separate return), unless such taxes are paid or accrued in carrying on a trade or business or an activity described in Code Sec. 212 (relating to expenses for the production of income). The Conference Bill also repeals the deduction for foreign property taxes. As under current law, taxpayers may elect to deduct state and local sales taxes in lieu of state and local income taxes.

Caution: The Tax Bill includes a provision blocking taxpayers from prepaying state and local income tax relating to the 2018 tax year in 2017 in order to circumvent the new limitation on the deduction. Specifically, the bill provides that, in the case of an amount paid in a tax year beginning before January 1, 2018, with respect to a state or local income tax imposed for a tax year beginning after December 31, 2017, the payment will be treated as paid on the last day of the tax year for which such tax is imposed for purposes of applying the provision limiting the dollar amount of the deduction.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Limitation on Mortgage Interest Deduction

The Tax Bill provides that a taxpayer may treat no more than $750,000 as acquisition indebtedness ($375,000 in the case of married taxpayers filing separately) for purposes of the mortgage interest deduction. In the case of acquisition indebtedness incurred before December 15, 2017, the limitation is the same as it is under current law: $1,000,000 ($500,000 in the case of married taxpayers filing separately).

The Tax Bill repeals the deduction for home equity indebtedness.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Modification to Deduction for Charitable Contributions

The Tax Bill –

(1) increases in the income-based percentage limit described in Code Sec. 170(b)(1)(A) for certain charitable contributions by an individual taxpayer of cash to public charities and certain other organizations from 50 percent to 60 percent;

(2) denies a charitable deduction for payments made in exchange for college athletic event seating rights; and

(3) repeals the substantiation exception in Code Sec. 170(f)(8)(D) for certain contributions reported by the donee organization.

The Conference Bill provisions that increase the charitable contribution percentage limit and deny a deduction for stadium seating payments would be effective for contributions made in taxable years beginning after December 31, 2017. The provision that repeals the substantiation exception for certain contributions reported by the donee organization would be effective for contributions made in taxable years beginning after December 31, 2016.

Partial Repeal of Deduction for Casualty and Theft Losses

The Tax Bill temporarily modifies the deduction for personal casualty and theft losses. Under the provision, a taxpayer may claim a personal casualty loss, subject to the applicable limitations in Code Sec. 165(h), only if such loss was attributable to a disaster declared by the President under Section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act.

The above-described limitation does not apply with respect to losses incurred after December 31, 2025.

Repeal of Miscellaneous Itemized Deductions Subject to the 2-Percent Floor

The Tax Bill repeals all miscellaneous itemized deductions that are subject to the two-percent of adjusted-gross-income floor.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Increased Percentage Limitation for Charitable Contributions of Cash to Public Charities

The Tax Bill increases the income-based percentage limit described in Code Sec. 170(b)(1)(A) for certain charitable contributions by an individual taxpayer of cash to public charities and certain other organizations from 50 percent to 60 percent.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Repeal of Charitable Deduction for Athletic Event Seating

The Tax Bill provides that no charitable deduction is allowed for any amount described in Code Sec. 170(l)(2), generally, a payment to an institution of higher education in exchange for which the payor receives the right to purchase tickets or seating at an athletic event.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Repeal of Overall Limitation on Itemized Deductions

The Tax Bill repeals the overall limitation on itemized deductions.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Relief for 2016 and 2017 Disaster Areas – Relaxation of Casualty Loss Deduction Rules

The Tax Bill provides tax relief relating to a “2016 disaster area,” which is defined as any area with respect to which a major disaster was declared by the President under Section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act during calendar year 2016 and 2017. In the case of a personal casualty loss which arose after December 31, 2015, and before January 1, 2018, and was attributable to the events giving rise to the Presidential disaster declaration, such losses are deductible without regard to whether aggregate net losses exceed ten percent of a taxpayer’s adjusted gross income. Under the provision, in order to be deductible, the losses must exceed $500 per casualty. Additionally, such losses may be claimed in addition to the standard deduction.

The provision is effective on the date of enactment.

Relief for 2016 Disaster Areas – Relaxation of Retirement Plan Distribution Rules

The Tax Bill provides special rules for using retirement funds and taking a casualty loss deduction with respect to a “2016 disaster area.” The term “2016 disaster area” means any area with respect to which a major disaster has been declared by the President under Section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act during calendar year 2016. The term “qualified 2016 disaster distribution” means any distribution from an eligible retirement plan made on or after January 1, 2016, and before January 1, 2018, to an individual whose principal place of abode at any time during calendar year 2016 was located in 2016 disaster area and who has sustained an economic loss by reason of the events giving rise to the Presidential declaration which was applicable to such area.

Under the provision, the early withdrawal penalties under Code Sec. 72(t) do not apply to a qualified 2016 disaster distribution to the extent the amount withdrawn does not exceed $100,000 over the aggregate amounts treated as qualified 2016 disaster distributions received by such individual for all prior years. Amounts required to be included in income as a result of such distributions may be included ratably over a three-taxable year period. The provision also allows a casualty loss deduction with respect to a loss relating to a 2016 disaster area.

Although the Tax Bill’s relaxation of retirement plan distribution rules only applies to disasters occurring in 2016 (for which qualified retirement plan distributions can be made in either 2016 or 2017), victims of several major 2017 disasters were granted similar disaster relief by Pub. L. 115-63., “Hurricane Harvey, Irma, and Maria Relief” for an explanation of those relief provisions.

 

Repeal of Exclusion for Qualified Bicycle Commuting Reimbursement

The Tax Bill repeals the exclusion from gross income and wages for qualified bicycle commuting reimbursements.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Repeal of Exclusion for Qualified Moving Expense Reimbursements

The Tax Bill repeals the exclusion from gross income and wages for qualified moving expense reimbursements except in the case of a member of the Armed Forces of the United States on active duty who moves pursuant to a military order.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Repeal of Deduction for Moving Expenses

The Tax Bill repeals the deduction for moving expenses. However, under the provision, rules providing for exclusions of amounts attributable to in-kind moving and storage expenses (and reimbursements or allowances for these expenses) for members of the Armed Forces of the United States (or their spouse or dependents) are not repealed.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Repeal of Certain Deductions Relating to Employee Achievement Awards

The Tax Bill prohibits a deduction for cash, gift cards, and other non-tangible personal property given to an employee as an achievement award, effective for amounts paid or incurred after December 31, 2017.

Repeal of Deductions for Living Expenses of Members of Congress

The Tax Bill repeals a provision which allows members of Congress to deduct up to $3,000 annually for certain living expenses, effective for tax years beginning after the date of enactment.

Modification to Gambling Losses

The Tax Bill clarifies the scope of “losses from wagering transactions” as that term is used in Code Sec. 165(d). The provision provides that this term includes any deduction otherwise allowable incurred in carrying on any wagering transaction.

The provision is intended to clarify that the limitation on losses from wagering transactions applies not only to the actual costs of wagers incurred by an individual, but to other expenses incurred by the individual in connection with the conduct of that individual’s gambling activity. The provision clarifies, for instance, an individual’s otherwise deductible expenses in traveling to or from a casino are subject to the limitation under Code Sec. 165(d).

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Reform of Child Tax Credit

The Tax Bill increases the child tax credit to $2,000 per qualifying child under the age of 17.

The credit is further modified to provide for a $500 nonrefundable credit for qualifying dependents other than qualifying children. The provision generally retains the present-law definition of dependent.

Under the Tax Bill, the modified adjusted gross income threshold at which the credit begins to phase out is increased to $400,000 for joint filers and $200,000 for all other taxpayers. These amounts are not indexed for inflation.

The provision lowers the earned income threshold for the refundable child tax credit to $2,500. The maximum amount refundable may not exceed $1,400 per qualifying child (up from $1,000 under present law). Under the provision, the maximum refundable amount is indexed for inflation with a base year of 2017, rounding up to the nearest $100. In order to receive the refundable portion of the child tax credit, a taxpayer must include a social security number for each qualifying child for whom the credit is claimed on the tax return.

This provision would be effective after December 31, 2017, and expire after December 31, 2025.

Increased Contributions to ABLE Accounts and Allowance of Contributions to be Eligible for Saver’s Credit

The Tax Bill increases the contribution limitation to ABLE accounts under certain circumstances. While the general overall limitation on contributions (the per-donee annual gift tax exclusion ($14,000 for 2017)) remains the same, the limitation is increased with respect to contributions made by the designated beneficiary of the ABLE account. Under the provision, after the overall limitation on contributions is reached, an ABLE account’s designated beneficiary can contribute an additional amount, up to the lesser of (1) the federal poverty line for a one-person household; or (2) the individual’s compensation for the taxable year. Additionally, the provision allows a designated beneficiary of an ABLE account to claim the saver’s credit for contributions made to his or her ABLE account.

The provision would be effective for tax years beginning after the date of enactment and would sunset after December 31, 2025.

Use of 529 Plan Distributions for Elementary or Secondary Schools

The Tax Bill modifies Section 529 plans to allow such plans to distribute not more than $10,000 in expenses for tuition incurred during the tax year in connection with the enrollment or attendance of the designated beneficiary at a public, private or religious elementary or secondary school. This limitation applies on a per-student basis, rather than a per-account basis. Thus, under the provision, although an individual may be the designated beneficiary of multiple accounts, that individual may receive a maximum of $10,000 in distributions free of tax, regardless of whether the funds are distributed from multiple accounts. Any excess distributions received by the individual would be treated as a distribution subject to tax under the general rules of Code Sec. 529.

The provision also modifies the definition of higher education expenses to include certain expenses incurred in connection with a homeschool. Those expenses are –

(1) curriculum and curricular materials;

(2) books or other instructional materials;

(3) online educational materials;

(4) tuition for tutoring or educational classes outside of the home (but only if the tutor or instructor is not related to the student);

(5) dual enrollment in an institution of higher education; and

(6) educational therapies for students with disabilities.

The provision would apply to distributions made after December 31, 2017.

Rollovers Between 529 Plans and Qualified ABLE Programs

The Tax Bill allows for amounts from qualified tuition programs (also known as Section 529 accounts) to be rolled over to an ABLE account without penalty, provided that the ABLE account is owned by the designated beneficiary of that Section 529 account, or a member of such designated beneficiary’s family. Such rolled-over amounts count towards the overall limitation on amounts that can be contributed to an ABLE account within a taxable year. Any amount rolled over that is in excess of this limitation will be includible in the gross income of the distributee in a manner provided by Code Sec. 72.

The provision would apply to distributions after December 31, 2017, and would sunset after December 31, 2025.

Extension of Time Limit to Contest IRS Levy

The Tax Bill extends from nine months to two years the period for returning the monetary proceeds from the sale of property that has been wrongfully levied upon. The provision also extends from nine months to two years the period for bringing a civil action for wrongful levy.

The provision would be effective with respect to: (1) levies made after the date of enactment; and (2) levies made on or before the date of enactment provided that the nine-month period has not expired as of the date of enactment.

Treatment of Certain Individuals Performing Services in the Sinai Peninsula of Egypt

The Tax Bill grants combat zone tax benefits to the Sinai Peninsula of Egypt, if as of the date of enactment of the provision any member of the Armed Forces of the United States is entitled to special pay under Section 310 of title 37, United States Code (relating to special pay; duty subject to hostile fire or imminent danger), for services performed in such location. This benefit lasts only during the period such entitlement is in effect.

The provision would generally be effective beginning June 9, 2015. The portion of the provision related to wage withholding would apply to remuneration paid after the date of enactment.

Treatment of Student Loans Discharged on Account of Death or Disability

The Tax Bill modifies the exclusion of student loan discharges from gross income, by including within the exclusion certain discharges on account of death or total and permanent disability of the student. Loans eligible for the exclusion under the provision are loans made by (1) the United States (or an instrumentality or agency thereof), (2) a state (or any political subdivision thereof), (3) certain tax-exempt public benefit corporations that control a state, county, or municipal hospital and whose employees have been deemed to be public employees under state law, (4) an educational organization that originally received the funds from which the loan was made from the United States, a State, or a tax-exempt public benefit corporation, or (5) private education loans (for this purpose, private education loan is defined in Section 140(7) of the Consumer Protection Act).

The provision applies to discharges of loans after December 31, 2017, and before January 1, 2026.

 

Business Loss Limitation Rules Applicable to Individuals

Under the Tax Bill, for taxable years beginning after December 31, 2017 and before January 1, 2026, excess business losses of a taxpayer other than a corporation are not allowed for the taxable year. Such losses are carried forward and treated as part of the taxpayer’s net operating loss (“NOL”) carryforward in subsequent taxable years. Under this provision, NOL carryovers generally are allowed for a taxable year up to the lesser of the carryover amount or 80 percent of taxable income determined without regard to the deduction for NOLs.

An excess business loss for the taxable year is the excess of aggregate deductions of the taxpayer attributable to trades or businesses of the taxpayer (determined without regard to the limitation of the provision), over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount. The threshold amount for a taxable year is $250,000 (or twice the otherwise applicable threshold amount in the case of a joint return). The threshold amount is indexed for inflation after 2018.

In the case of a partnership or S corporation, the provision applies at the partner or shareholder level. Each partner’s distributive share and each S corporation shareholder’s pro rata share of items of income, gain, deduction, or loss of the partnership or S corporation are taken into account in applying the limitation under the provision for the taxable year of the partner or S corporation shareholder. Regulatory authority is provided to apply the provision to any other passthrough entity to the extent necessary to carry out the provision. Regulatory authority is also provided to require any additional reporting as the Secretary determines is appropriate to carry out the purposes of the provision.

The provision applies after the application of the passive loss rules.

For taxable years beginning after December 31, 2017, and before January 1, 2026, the present-law limitation relating to excess farm losses does not apply.

The Conference Bill provision would be effective for taxable years beginning after December 31, 2017.

Estate and Gift Tax Changes

Increase in Estate and Gift Tax Exemption

The Tax Bill doubles the estate and gift tax exemption amount. This is accomplished by increasing the basic exclusion amount provided in Code Sec. 2010(c)(3) from $5 million to $10 million. The $10 million amount is indexed for inflation occurring after 2011.

The provision would be effective for decedents dying, generation-skipping transfers, and gifts made after December 31, 2017, and would expire for years beginning after December 31, 2025.

The Tax Bill omits a provision from the House Bill that would have repealed the estate and generation-skipping transfer tax beginning in 2025.

III. Deduction for Qualified Business Income of an Individual (Passthrough Break)

Under the Tax Bill, for taxable years beginning after December 31, 2017, and before January 1, 2026, an individual taxpayer generally may deduct an amount equal to the sum of –

(1) the lesser of (a) the combined qualified business income amount for the taxable year; or (b) an amount equal to 20 percent of the excess (if any) of taxpayer’s taxable income for the taxable year over the sum of any net capital gain and qualified cooperative dividends, plus

(2) the lesser of 20 percent of qualified cooperative dividends for the taxable year or taxable income (reduced by net capital gain).

This sum may not exceed the taxpayer’s taxable income for the taxable year (reduced by net capital gain).

Under the provision, the 20-percent deduction with respect to qualified cooperative dividends is limited to taxable income (reduced by net capital gain) for the year. The combined qualified business income amount for the taxable year is the sum of the deductible amounts determined for each qualified trade or business carried on by the taxpayer and 20 percent of the taxpayer’s qualified REIT dividends and qualified publicly traded partnership income.

The deductible amount for each qualified trade or business is the lesser of –

(1) 20 percent of the taxpayer’s qualified business income with respect to the trade or business; or

(2) the greater of 50 percent of the W-2 wages (defined below) with respect to the trade or business or the sum of 25 percent of the W-2 wages with respect to the trade or business and 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property.

The 20-percent deduction is not allowed in computing adjusted gross income, and instead is allowed as a deduction reducing taxable income. Thus, for example, the provision does not affect limitations based on adjusted gross income.

Qualified Trade or Business

For purposes of the deduction for qualified business income, the Conference Bill provides that qualified business income is determined for each qualified trade or business of the taxpayer. The term “qualified trade or business” means any trade or business other than –

(1) a specified service trade or business (defined below); or

(2) the trade or business of performing services as an employee.

Specified Service Trade or Business. A specified service trade or business means any trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or 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 owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities. For this purpose, a security and a commodity have the meanings provided in the rules for the mark-to-market accounting method for dealers in securities (Code Sec. 475(c)(2) and Code Sec. 475(e)(2), respectively).

The rule disqualifying specified service trades or businesses does not apply to taxpayers with taxable income at or below specified threshold amounts and is phased in for taxpayers with taxable income above the thresholds (threshold amounts and phase-in provisions for specified service trades or businesses are discussed below).

Qualified Business Income

Qualified business income does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer. Similarly, qualified business income does not include any guaranteed payment for services rendered with respect to the trade or business, and to the extent provided in regulations, does not include any amount paid or incurred by a partnership to a partner who is acting other than in his or her capacity as a partner for services.

For any taxable year, qualified business income is the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer. The determination of qualified items of income, gain, deduction, and loss takes into account these items only to the extent included or allowed in the determination of taxable income for the year.

Example: During the taxable year, a qualified business has $100,000 of ordinary income from inventory sales, and makes an expenditure of $25,000 that is required to be capitalized and amortized over five years under applicable tax rules. Qualified business income is $100,000 minus $5,000 (current-year ordinary amortization deduction), or $95,000. The qualified business income is not reduced by the entire amount of the capital expenditure, only by the amount deductible in determining taxable income for the year.

If the net amount of qualified business income from all qualified trades or businesses during the taxable year is a loss, it is carried forward as a loss from a qualified trade or business in the next taxable year. Similar to a qualified trade or business that has a qualified business loss for the current taxable year, any deduction allowed in a subsequent year is reduced (but not below zero) by 20 percent of any carryover qualified business loss.

Example: Sean has qualified business income of $20,000 from qualified business A and a qualified business loss of $50,000 from qualified business B in Year 1. Sean is not permitted a deduction for Year 1 and has a carryover qualified business loss of $30,000 to Year 2. In Year 2, Sean has qualified business income of $20,000 from qualified business A and qualified business income of $50,000 from qualified business B. To determine the deduction for Year 2, Sean reduces the 20 percent deductible amount determined for the qualified business income of $70,000 from qualified businesses A and B by 20 percent of the $30,000 carryover qualified business loss.

Domestic Business Items

Items are treated as qualified items of income, gain, deduction, and loss only to the extent they are effectively connected with the conduct of a trade or business within the United States. In the case of a taxpayer who is an individual with otherwise qualified business income from sources within the commonwealth of Puerto Rico, if all the income is taxable under Code Sec. 1 (income tax rates for individuals) for the taxable year, the “United States” is considered to include Puerto Rico for purposes of determining the individual’s qualified business income.

Treatment of Investment Income

Qualified items do not include specified investment-related income, deductions, or loss. Specifically, qualified items of income, gain, deduction and loss do not include (1) any item taken into account in determining net long-term capital gain or net long-term capital loss, (2) dividends, income equivalent to a dividend, or payments in lieu of dividends, (3) interest income other than that which is properly allocable to a trade or business, (4) the excess of gain over loss from commodities transactions, other than those entered into in the normal course of the trade or business or with respect to stock in trade or property held primarily for sale to customers in the ordinary course of the trade or business, property used in the trade or business, or supplies regularly used or consumed in the trade or business, (5) the excess of foreign currency gains over foreign currency losses from Code Sec. 988 transactions, other than transactions directly related to the business needs of the business activity, (6) net income from notional principal contracts, other than clearly identified hedging transactions that are treated as ordinary (i.e., not treated as capital assets), and (7) any amount received from an annuity that is not used in the trade or business of the business activity. Qualified items under this provision do not include any item of deduction or loss properly allocable to such income.

Phase-in of Specified Service Business Limitation

There is an exclusion from the definition of a qualified business for specified service trades or businesses for certain taxpayers. This exclusion phases in for a taxpayer with taxable income in excess of a threshold amount. The threshold amount is $315,000 for joint filers and $157,500 for all other taxpayers (the “threshold amount”). The threshold amount is indexed for inflation. The exclusion from the definition of a qualified business for specified service trades or businesses is fully phased in for a taxpayer with taxable income in excess of the threshold amount plus $50,000 ($100,000 in the case of a joint return). For a taxpayer with taxable income within the phase-in range, the exclusion applies as follows.

In computing the qualified business income with respect to a specified service trade or business, the taxpayer takes into account only the applicable percentage of qualified items of income, gain, deduction, or loss, and of allocable W-2 wages. The applicable percentage with respect to any taxable year is 100 percent reduced by the percentage equal to the ratio of the excess of the taxable income of the taxpayer over the threshold amount bears to $50,000 ($100,000 in the case of a joint return).

Example: Tom, and unmarried taxpayer, has taxable income of $187,500, of which $150,000 is attributable to an accounting sole proprietorship. Assume that the sole proprietorship’s W-2 wages are high enough that the W-2 wage limitation (see below) will not affect Tom’s deduction. Tom has an applicable percentage of 40 percent [$187,500 – $157,500 (Tom’s threshold amount) = $30,000 / $50,000 (phaseout range) = 60 percent; 100 percent – 60 percent = 40 percent]. In determining includible qualified business income, Tom takes into account 40 percent of $150,000, or $60,000. Because we’re assuming that the W-2 wage limitation doesn’t apply, Tom’s deduction for qualified business income is 20 percent of $60,000, or $12,000.

W-2 Wage Limitation on Deduction for Qualified Business Income

There is a limitation on the deduction for qualified business income which is based on either W-2 wages paid, or wages paid plus a capital element. The limitation is phased in above a threshold amount of taxable income (see below). Specifically, the limitation is the greater of (1) 50 percent of the W-2 wages paid with respect to the qualified trade or business, or (2) the sum of 25 percent of the W-2 wages with respect to the qualified trade or business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property.

Example: Susan owns and operates a sole proprietorship that sells cupcakes. The business is not a specified service business and Susan’s filing status for Form 1040 is single. The cupcake business pays $100,000 in W-2 wages and has $350,000 in qualified business income. For the sake of simplicity, assume the business had no qualified property, and that Susan has no other items of income or loss (putting her taxable income at a level where she’s fully subject to the W-2 wage limitation). Susan’s deduction for qualified business income is $50,000, which is the lesser of (a) 20 percent of $350,000 in qualified business income ($70,000), or (b) the greater of (i) 50 percent of W-2 wages ($50,000) or (ii) 25 percent of W-2 wages plus 2.5 percent of qualified property ($25,000 total = 25 percent of $100,000 + 2.5 percent of $0).

For purposes of this provision, qualified property means tangible property of a character subject to depreciation that is held by, and available for use in, the qualified trade or business at the close of the taxable year, and which is used in the production of qualified business income, and for which the depreciable period has not ended before the close of the taxable year. The depreciable period with respect to qualified property of a taxpayer means the period beginning on the date the property is first placed in service by the taxpayer and ending on the later of (1) the date 10 years after that date, or (2) the last day of the last full year in the applicable recovery period that would apply to the property under Code Sec. 168 (without regard to Code Sec. 168(g)).

Example: Walter (who is subject to the limitation on the deduction for qualified business income) does business as a sole proprietorship conducting a widget-making business. The business buys a widget-making machine for $100,000 and places it in service in 2020. The business has no employees in 2020. The limitation in 2020 is the greater of (a) 50 percent of W-2 wages, or $0, or (b) the sum of 25 percent of W-2 wages ($0) plus 2.5 percent of the unadjusted basis of the machine immediately after its acquisition: $100,000 x .025 = $2,500. The amount of the limitation on the Walters deduction is $2,500.

In the case of property that is sold, for example, the property is no longer available for use in the trade or business and is not taken into account in determining the limitation. The Conference Bill provides that the IRS must provide rules for applying the limitation in cases of a short taxable year of where the taxpayer acquires, or disposes of, the major portion of a trade or business or the major portion of a separate unit of a trade or business during the year. The IRS is required to provide guidance applying rules similar to the rules of Code Sec. 179(d)(2) to address acquisitions of property from a related party, as well as in a sale-leaseback or other transaction as needed to carry out the purposes of the provision and to provide anti-abuse rules, including under the limitation based on W-2 wages and capital. Similarly, the IRS must provide guidance prescribing rules for determining the unadjusted basis immediately after acquisition of qualified property acquired in like-kind exchanges or involuntary conversions as needed to carry out the purposes of the provision and to provide anti-abuse rules, including under the limitation based on W-2 wages and capital.

Reasonable Compensation and Guaranteed Payments

Qualified business income does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer. Similarly, qualified business income does not include any guaranteed payment for services rendered with respect to the trade or business, and to the extent provided in regulations, does not include any amount paid or incurred by a partnership to a partner who is acting other than in his or her capacity as a partner for services.

W-2 Wages

W-2 wages are the total wages subject to wage withholding, elective deferrals, and deferred compensation paid by the qualified trade or business with respect to employment of its employees during the calendar year ending during the taxable year of the taxpayer. W-2 wages do not include any amount which is not properly allocable to the qualified business income as a qualified item of deduction. In addition, W-2 wages do not include any amount which was not properly included in a return filed with the Social Security Administration on or before the 60th day after the due date (including extensions) for such return.

In the case of a taxpayer who is an individual with otherwise qualified business income from sources within the commonwealth of Puerto Rico, if all the income is taxable under Code Sec. 1 (income tax rates for individuals) for the taxable year, the determination of W-2 wages with respect to the taxpayer’s trade or business conducted in Puerto Rico is made without regard to any exclusion under the wage withholding rules for remuneration paid for services in Puerto Rico.

Phase-in of W-2 Wage Limitation

The application of the W-2 wage limitation phases in for a taxpayer with taxable income in excess of the following threshold amounts: $315,000 for joint filers and $157,500 for all other taxpayers, indexed for inflation. For purposes of phasing in the wage limit, taxable income is computed without regard to the 20 percent deduction.

The W-2 wage limitation applies fully for a taxpayer with taxable income in excess of the threshold amount plus $50,000 ($100,000 in the case of a joint return). For a taxpayer with taxable income within the phase-in range, the wage limit applies as follows. With respect to any qualified trade or business, the taxpayer compares –

(1) 20 percent of the taxpayer’s qualified business income with respect to the qualified trade or business; with

(2) the W-2 wage limitation (see above) with respect to the qualified trade or business.

If the amount determined under (2) is less than the amount determined (1), (that is, if the wage limit is binding), the taxpayer’s deductible amount is the amount determined under (1) reduced by the same proportion of the difference between the two amounts as the excess of the taxable income of the taxpayer over the threshold amount bears to $50,000 ($100,000 in the case of a joint return).

Qualified REIT dividends, cooperative dividends, and publicly traded partnership income A deduction is allowed under the provision for 20 percent of the taxpayer’s aggregate amount of qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income for the taxable year. Qualified REIT dividends do not include any portion of a dividend received from a REIT that is a capital gain dividend or a qualified dividend. A qualified cooperative dividend means a patronage dividend, per-unit retain allocation, qualified written notice of allocation, or any similar amount, provided it is includible in gross income and is received from either (1) a tax-exempt benevolent life insurance association, mutual ditch or irrigation company, cooperative telephone company, like cooperative organization, or a taxable or tax-exempt cooperative that is described in Code Sec. 1381(a), or (2) a taxable cooperative governed by tax rules applicable to cooperatives before the enactment of subchapter T of the Code in 1962. Qualified publicly traded partnership income means (with respect to any qualified trade or business of the taxpayer), the sum of the (1) the net amount of the taxpayer’s allocable share of each qualified item of income, gain, deduction, and loss (that are effectively connected with a U.S. trade or business and are included or allowed in determining taxable income for the taxable year and do not constitute excepted enumerated investment-type income, and not including the taxpayer’s reasonable compensation, guaranteed payments for services, or (to the extent provided in regulations) Code Sec. 707(a) payments for services) from a publicly traded partnership not treated as a corporation, and (2) gain recognized by the taxpayer on disposition of its interest in the partnership that is treated as ordinary income (for example, by reason of Code Sec. 751).

Special Rules for Partnerships and S Corporations

The Tax Bill provides that, in the case of a partnership or S corporation, the business income deduction applies at the partner or shareholder level. Each partner takes into account the partner’s allocable share of each qualified item of income, gain, deduction, and loss, and is treated as having W-2 wages for the taxable year equal to the partner’s allocable share of W-2 wages of the partnership. The partner’s allocable share of W-2 wages is required to be determined in the same manner as the partner’s share of wage expenses. For example, if a partner is allocated a deductible amount of 10 percent of wages paid by the partnership to employees for the taxable year, the partner is required to be allocated 10 percent of the W-2 wages of the partnership for purposes of calculating the wage limit under this deduction. Similarly, each shareholder of an S corporation takes into account the shareholder’s pro rata share of each qualified item of income, gain, deduction, and loss, and is treated as having W-2 wages for the taxable year equal to the shareholder’s pro rata share of W-2 wages of the S corporation.

Treatment of Agricultural and Horticultural Cooperatives

For taxable years beginning after December 31, 2017, but not after December 31, 2025, a deduction is allowed to any specified agricultural or horticultural cooperative equal to the lesser of (1) 20 percent of the cooperative’s taxable income for the taxable year or (2) the greater of 50 percent of the W-2 wages paid by the cooperative with respect to its trade or business or the sum of 25 percent of the W-2 wages of the cooperative with respect to its trade or business plus 2.5 percent of the unadjusted basis immediately after acquisition of qualified property of the cooperative. A specified agricultural or horticultural cooperative is an organization to which subchapter T applies that is engaged in (1) the manufacturing, production, growth, or extraction in whole or significant part of any agricultural or horticultural product, (2) the marketing of agricultural or horticultural products that its patrons have so manufactured, produced, grown, or extracted, or (3) the provision of supplies, equipment, or services to farmers or organizations described in the foregoing.

Treatment of Trusts and Estates

The Tax Bill provides that trusts and estates are eligible for the 20-percent deduction. Rules similar to the rules under present-law Code Sec. 199 (as in effect on December 1, 2017) apply for apportioning between fiduciaries and beneficiaries any W-2 wages and unadjusted basis of qualified property under the limitation based on W-2 wages and capital.

Effective Date

The Tax Bill provision is effective for taxable years beginning after December 31, 2017, and does not apply to taxable years beginning after December 31, 2025.

 

 

2017 Year-End Tax Planning for Businesses

As the year draws to a close, it is important that we meet to calculate your business’s tax liability for 2017 so we can determine if additional actions are needed to reduce that liability. In addition, we need to ensure that enough estimated taxes have been paid to avoid any underpayment of estimated tax penalties.

If you’ve been following the news out of Washington, you probably know that corporate tax reform is a real possibility, as is the passage of new tax breaks that would reduce tax rates on income generated by some pass-through businesses. The details of these proposals and whether they’ll ultimately pass Congress are still up in the air. So, in analyzing how we may reduce your 2017 tax burden, we should start with what we do know and how it may affect you, and avoid putting too much weight on proposed changes.

Other than a tax act providing relief to hurricane victims, no significant tax legislation was enacted in 2017. However, big changes will take effect for partnerships beginning in 2018. Effective for partnership tax years beginning after 2017, the current partnership audit procedures will be replaced with a single centralized audit system. While some partnerships may elect out of the new regime, most partnerships will be subject to the new rules. Under the new system, the IRS will examine a partnership’s items of income, gain, loss, deduction, credit and partners’ distributive shares for a particular year of the partnership (i.e., the reviewed year). Any adjustments will be taken into account by the partnership, and not the individual partners, in the year that the audit or any judicial review is completed (i.e., the adjustment year). Thus, it’s possible for current year partners to be liable for mistakes or errors committed in prior years when they were not partners. The new rules provide certain exceptions to allow current year partners to escape such liability, including an election that must be made no later than 45 days after the date of a notice of final partnership adjustment. If you are in a partnership, it’s imperative to have the partnership agreement reviewed and revised, if necessary, to take into account these new rules.

In October, there was a big development which will impact tax planning for family owned businesses. The IRS withdrew proposed regulations that would have imposed major restrictions on valuation discounts for transfers of interests in such businesses among family members. Also in October, the IRS announced that it is considering revoking proposed and temporary regulations governing how liabilities are allocated for purposes of the partnership disguised sale rules. As issued, those regulations could significantly impact the tax treatment of many partnership formations because they apply the rules relating to nonrecourse liabilities to formations of partnerships involving recourse liabilities. Many felt this rule was issued without adequate consideration of its impact. Other recently issued regulations which the IRS has identified as being subject to revocation or substantial revision include (1) the documentation requirements in final and temporary regulations relating to the determination of whether an instrument is debt or equity; and (2) temporary regulations amending the rules relating to transfers of property by C corporations to real estate investment trusts and regulated investment companies. Some say those rules cause too much gain to be recognized.

In addition, the Treasury Department also indicated that it could repeal up to 200 regulations, but did not identify which rules it was talking about. We will keep you abreast of any developments in these areas as they occur.

The following are some year-end strategies we should review with respect to your business.

Section 179 Expensing and Bonus Depreciation

If you are looking to reduce your business’s taxable income, two of the biggest deductions from which your business may benefit are the Code Sec. 179 expense deduction and bonus depreciation. For 2017, the maximum amount of qualifying property that your business can expense is $510,000. That amount is reduced one-for-one to the extent qualifying property purchased during the year exceeds $2,030,000.

In addition, a bonus depreciation deduction is available which allows a business to claim a 50-percent additional first-year depreciation deduction on qualified property placed in service in 2017. Next year, the bonus depreciation percentage goes down to 40 percent, so if you are looking to maximize deductions in 2017, bonus depreciation is a big consideration. Thus, for example, if your business purchases $800,000 of qualifying equipment in 2017, the total first year deduction would be $684,000 ($800,000 – $510,000 (maximum Code Sec. 179 deduction) – $145,000 (50% depreciation x remaining basis of $290,000) – $29,000 (normal depreciation of 20% x remaining basis of $145,000)).

Vehicle-Related Deductions and Substantiation of Deductions

Expenses relating to business vehicles can add up to major deductions. If your business could use a large passenger vehicle, consider purchasing a sport utility vehicle weighing more than 6,000 pounds. Vehicles under that weight limit are considered listed property and deductions are more limited. However, if the vehicle is more than 6,000 pounds, up to $25,000 of the cost of the vehicle can be immediately expensed.

Vehicle expense deductions are generally calculated using one of two methods: the standard mileage rate method or the actual expense method. If the standard mileage rate is used, parking fees and tolls incurred for business purposes can be added to the total amount calculated.

Since the IRS tends to focus on vehicle expenses in an audit and disallow them if they are not property substantiated, you should ensure that the following are part of your business’s tax records with respect to each vehicle used in the business: (1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance); (2) the amount of mileage for each business or investment use and the total miles for the tax period; (3) the date of the expenditure; and (4) the business purpose for the expenditure. The following are considered adequate for substantiating such expenses: (1) records such as a notebook, diary, log, statement of expense, or trip sheets; and (2) documentary evidence such as receipts, canceled checks, bills, or similar evidence. Records are considered adequate to substantiate the element of a vehicle expense only if they are prepared or maintained in such a manner that each recording of an element of the expense is made at or near the time the expense is incurred.

Retirement Plans and Other Fringe Benefits

Benefits are very attractive to employees. If you haven’t done so already, you may want to consider using benefits rather than higher wages to attract employees. While your business is not required to have a retirement plan, there are many advantages to having one. By starting a retirement savings plan, you not only help your employees save for the future, you can also use such a plan to attract and retain qualified employees. Retaining employees longer can impact your bottom line as well by reducing training costs. In addition, as a business owner, you can take advantage of the plan yourself, and so can your spouse. If your spouse is not currently on the payroll, you may want to consider adding him or her and paying a salary up to the maximum amount that can be deferred into a retirement plan. So, for example, if your spouse is 50 years old or over and receives a salary of $24,000, all of it could go into a 401(k), leaving your spouse with a retirement account but no taxable income.

By offering a retirement plan, you also generate tax savings to your business because employer contributions are deductible and the assets in the retirement plan grow tax free. Additionally, a tax credit is available to certain small employers for the costs of starting a retirement plan. Please let me know if this is an option you would like to discuss further.

Increasing Basis in Pass-thru Entities

If you are a partner in a partnership or a shareholder in an S corporation, and the entity is passing through a loss for the year, you must have enough basis in the entity in order to deduct the loss on your personal tax return. If you don’t, and if you can afford to, you should consider increasing your basis in the entity in order to take the loss in 2017.

De Minimis Safe Harbor Election

It may be advantageous to elect the annual de minimis safe harbor election for amounts paid to acquire or produce tangible property. By making this election, and as long as the items purchased don’t have to be capitalized under the uniform capitalization rules and are expensed for financial accounting purposes or in your books and records, you can deduct up to $2,500 per invoice or item (or up to $5,000 if you have an applicable financial statement).

S Corporation Shareholder Salaries

For any business operating as an S corporation, it’s important to ensure that shareholders involved in running the business are paid an amount that is commensurate with their workload. The IRS scrutinizes S corporations which distribute profits instead of paying compensation subject to employment taxes. Failing to pay arm’s length salaries can lead not only to tax deficiencies, but penalties and interest on those deficiencies as well. The key to establishing reasonable compensation is being able to show that the compensation paid for the type of work an owner-employee does for the S corporation is similar to what other corporations would pay for similar work. If you are in this situation, we need to document the factors that support the salary you are being paid.

Tax Reform

As I mentioned before, Congress is attempting to tackle tax reform. There are several ideas floating around and it’s unclear when any tax legislation would be effective if it does eventually pass. Some of the proposals being discussed are a reduction in the corporate tax rate to 20 percent and a establishing a new 25 percent top tax rate for business entity pass-through income (i.e., business income from partnerships, LLCs, S corporations, and Schedule C companies) These rate reductions are proposed to be offset by the repeal of various tax breaks, only a couple of which have been named.

I’m hesitant to speculate what the end result will be, or to make plans based on proposed changes that may or may not become law. That said, the potential for sharp rate reductions for some businesses is not something we should ignore. In some cases, it may create an additional incentive to accelerate deductions into the current year and/or defer income into next year. That’s something we can discuss when we meet.

Please call me at your convenience so we can set up an appointment and discuss your business’s tax situation before year end.

 

Andy Farkas, CPA | President

FARKAS TAX ADVISORS INC.

2173 Salk Ave., Suite 250 | Carlsbad, CA  92008

Office (760) 237-4000 | Cell (619) 204-605

Website

 

Disclaimer: Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, our firm would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.
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32 Key Differences Between the House and Senate Tax Reform Bills

As the House prepares to vote on its tax reform bill (House Bill) and the Senate Finance Committee debates and amends its own bill (Senate Bill), there remain dozens of differences between the two proposals.

Individual Tax Reform

  1. Individual Mandate Repeal. The Senate Bill would repeal the individual shared responsibility payment enacted as part of the Affordable Care Act, effective with respect to health coverage status for months beginning after December 31, 2018.

    The House Bill does not contain this provision.

  1. Tax Rates and Brackets. The Senate Bill would keep the same number of tax brackets as under current law – seven and reduce the top tax rate to 38.5 percent. The tax rates in the Senate Bill are 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 38.5 percent.

    The House Bill would reduce the number of tax brackets to four, but would keep the current-law highest tax rate of 39.6 percent. The tax rates in the House Bill are 12 percent, 25 percent, 35 percent, and 39.6 percent.

  1. State and Local Tax Deduction. The Senate Bill would repeal the deduction for state and local taxes. The House Bill would repeal the deduction for state and local taxes except it would allow a deduction of up to $10,000 for property taxes.
  1. Mortgage Interest Deduction. The Senate Bill would continue to allow the current law mortgage interest deduction rule for a primary residence, which allows an interest deduction on a mortgage of up to $1,000,000 ($500,000 in the case of a married individual filing a separate return). However, the Senate Bill would repeal any interest deduction on a second home and on home equity debt.

    The House Bill would limit the primary residence interest deduction to mortgages of $500,000 ($250,000 in the case of a married individual filing a separate return) and also repeal any interest deduction on a second home and on home equity debt.

  1. Deductions for Medical Expenses, Casualty Losses, Etc. The House Bill would repeal deductions for medical expenses, casualty losses, theft losses, adoption expenses, qualified tuition and related expenses, teacher expenses, and student loan interest.

    The Senate Bill does not contain these provisions. However, the Senate Bill does contain a provision that would increase the deduction for teacher expenses from $250 to $500. The Senate Bill would also limit casualty losses to those incurred in presidentially-declared disaster areas.

  1. Education-Related Incentives. The House Bill includes provisions aimed at reforming the education-related incentives.

    The Senate Bill does not contain these provisions.

  1. Miscellaneous Itemized Deductions. The Senate Bill would repeal the deduction for miscellaneous itemized deductions (which includes deductions for expenses for the production of income, such as investment advice, IRA custodian fees, etc.).

    The House Bill would repeal many deductions that are classified as miscellaneous itemized deductions, such as business expenses incurred by an employee (e.g., a home office deduction), but does not specifically repeal the deduction for miscellaneous itemized expenses. Thus, the House Bill would leave intact deductions for expenses relating to the production of income.

  1. Child Tax Credit. The Senate Bill would allow a child tax credit of $2,000, but the credit would phaseout for couples with income over $500,000.

    The House Bill would allow a child tax credit of $1,600 credit, but the credit would phaseout for couples with income over $230,000.

  1. Elderly and Disabled Credit. The House Bill would repeal the elderly and disabled credit.

    The Senate Bill does not contain this provision.

  1. Exclusion of Gain on the Sale of a Principal Residence. Both the House Bill and the Senate Bill would extend the length of time a taxpayer must own and use a residence to qualify for the exclusion of gain on the sale of a principal residence. The House Bill also phases out the exclusion by one dollar for every dollar a taxpayer’s AGI exceeds $250,000 ($500,000 if married filing a joint return).

    The Senate Bill does not contain the phase-out provision.

  1. Tax Break for Passthrough Business Income. The House Bill would generally tax an individual’s qualified business income from a partnership, S corporation, or sole proprietorship at a rate no higher than 25 percent. However, a special 9 percent rate would be created in lieu of the individual tax rate of 12 percent for income from pass-thru entities for the first $75,000 of net business taxable income for an active owner or shareholder with taxable income under $150,000. This rate would be phased in over five years. Qualified business income means, generally, all net business income from a passive business activity plus the capital percentage of net business income from an active business activity, reduced by carryover business losses and by certain net business losses from the current year, as determined under the provision.

    The Senate Bill, taking a fundamentally different approach, would allow an individual taxpayer to deduct 17.4 percent of domestic qualified business income from a partnership, S corporation, or sole proprietorship but the deduction would be limited to 50 percent of the taxpayer’s allocable or pro rata share of W-2 wages of the partnership or S corporation or 50 percent of the W-2 wages of the sole proprietorship. The deduction would not apply to specified service businesses (i.e., any trade or business activity involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or 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), except in the case of a taxpayer whose taxable income does not exceed $500,000 (for married individuals filing jointly; $250,000 for other individuals) but the deduction is phased out over the next $100,000 of taxable income for married individuals filing jointly or $50,000 for other individuals.

  1. IRS Levy Relief. The Senate Bill would extend from nine months to two years the period for returning the monetary proceeds from the sale of property that has been wrongfully levied upon by the IRS. The proposal also extends from nine months to two years the period for bringing a civil action for wrongful levy. The proposal is effective with respect to: (1) levies made after the date of enactment; and (2) levies made on or before the date of enactment provided that the nine-month period has not expired as of the date of enactment.

    The House Bill does not include this provision.

  1. Carried Interest Loophole. The House Bill addresses the carried interest provision that allows investment managers to have their gains taxed at lower rates by increasing the holding period that investments must be held in order to have the related gain taxed at capital gain, rather than ordinary income, rates.

    The Senate Bill does not include this provision.

  1. Combat Zone Tax Benefits. The Senate Bill would grant combat zone tax benefits to the Sinai Peninsula of Egypt, if as of the date of enactment of the proposal, any member of the Armed Forces of the United States is entitled to special pay under Section 310 of title 37, United States Code (relating to special pay; duty subject to hostile fire or imminent danger), for services performed in such location. This benefit would last only during the period such entitlement is in effect. The proposal would generally effective beginning June 9, 2015.

    The House Bill does not include this provision.

  1. Head of Household Due Diligence Requirements. The Senate Bill directs the Secretary of the Treasury to issue due diligence requirements for paid preparers in determining eligibility for a taxpayer to file as head of household. A penalty of $500 would be imposed for each failure to meet these requirements.

    The House Bill does not include this provision.

  1. Installment Agreements User Fees. The Senate Bill would generally prohibit increases in the amount of user fees charged by the IRS for installment agreements for agreements entered into on or after the date that is 60 days after the date of enactment.

    The House Bill does not include this provision.

  1. Simplified Filing for Senior Citizens. The Senate Bill requires that the IRS publish a simplified income tax return form designated a Form 1040SR, for use by persons who are age 65 or older by the close of the taxable year. The form is to be as similar as possible to the Form 1040EZ.

    The House Bill does not include this provision.

Business Tax Reform

  1. Corporate Tax Rates. The Senate Bill would eliminate the graduated corporate rate structure and instead tax corporate taxable income at 20 percent, effective for tax years beginning after 2018. The Senate Bill would also eliminate the special tax rate for personal service corporations.

    The House Bill would eliminate the graduated corporate rate structure and instead tax corporate taxable income at 20 percent, effective for tax years beginning after 2017. The House Bill would tax personal service corporations at 25 percent.

  1. Section 179 Expensing. The Senate Bill would provide a maximum Code Sec. 179 expense deduction of $1,000,000, with a phase-out threshold of $2.5 million.

    The House Bill would provide a maximum Code Sec. 179 expense deduction of $5 million, with a phase-out threshold of $20 million.

  1. Bonus Depreciation. The provision in the House Bill and the Senate Bill regarding 100 percent additional first-year depreciation (bonus depreciation) are generally the same. But, the Senate Bill would expand the definition of qualified property eligible for bonus depreciation to include qualified film, television and live theatrical productions, effective for productions placed in service after September 27, 2017, and before January 1, 2023.

    The House Bill does not contain this provision.

  1. Sale of Partnership Interests. The Senate Bill would (1) tax gain on the sale of a partnership interest on a look-through basis; (2) modify the definition of substantial built-in loss on transfers of a partnership interest; and (3) take into account charitable contributions and foreign taxes in determining the limitation on a partner’s share of partnership loss.

    The House Bill does not contain these provisions.

  1. Recovery Period for Residential Rental Property. The Senate Bill would shorten the alternative depreciation system recovery period for residential rental property from 40 years to 30 years, effective for property placed in service after December 31, 2017.

    The House Bill does not contain this provision.

  1. Contributions of Capital. The House Bill would repeal the provision in Code Sec. 118 under which, generally, a corporation’s gross income does not include contributions of capital to the corporation. Further, the House Bill would provide that a contribution to capital, other than a contribution of money or property made in exchange for stock of a corporation or any interest in an entity would be included in the gross income of a taxpayer.

    The Senate Bill does not contain this provision.

  1. Employer Credit for Paid Family and Medical Leave. The Senate Bill would allow eligible employers to claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave if the rate of payment under the program is 50 percent of the wages normally paid to an employee. The credit would be increased by 0.25 percentage points (but not above 25 percent) for each percentage point by which the rate of payment exceeds 50 percent.

    The House Bill does not include this provision.

  1. Changes to ESBT Rules. The Senate Bill would allow a nonresident alien individual to be a potential current beneficiary of an electing small business trust (ESBT). The Senate Bill would also provide that a charitable contribution deduction of an ESBT would not be determined by the rules generally applicable to trusts but rather by the rules applicable to individuals. Thus, the percentage limitations and carryforward provisions applicable to individuals would apply to charitable contributions made by the portion of an ESBT holding S corporation stock.

    The House Bill does not include this provision.

  1. Deductibility of Penalties and Fines. The Senate Bill would deny a deduction for any otherwise deductible amount paid or incurred (whether by suit, agreement, or otherwise) to or at the direction of a government or specified nongovernmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law.

    The House Bill does not include this provision.

  1. Citrus Plants Casualty Losses. The Senate Bill would provide a special deduction rule for costs incurred by persons other than the taxpayer in connection with replanting an edible crop for human consumption following loss or damage of citrus plants due to casualty.

    The House Bill does not include this provision.

  1. Limit on NOL Deductions. The Senate Bill would limit a business’s net operating loss deduction to 80 percent of taxable income (determined without regard to the deduction) in taxable years beginning after December 31, 2023.

    The House Bill would limit a business’s net operating loss deduction to 90 percent of taxable income (determined without regard to the deduction) in taxable years beginning after December 31, 2017.

  1. Sexual Harassment or Sexual Abuse Settlements. The Senate Bill would provide that no deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.

    The House Bill does not include this provision.

Retirement-Related Tax Reform

  1. Hardship Distributions. The House Bill would modify the rules governing hardship distributions to make it easier to get such distributions and would delete the requirement that an employee be prohibited from making elective deferrals and employee contributions for six months after the receipt of a hardship distribution.

    The Senate Bill does not contain this provision.

  1. Contributions to Retirement Accounts of Levied Amounts Returned by IRS. The Senate Bill would add a provision that, if an amount withdrawn from an IRA (“original IRA”) or employer-sponsored plan pursuant to a levy is returned to an individual by the IRS, the individual may contribute the amount returned, and any interest thereon, either to the original IRA or to the employer-sponsored plan, if permissible, or to a different IRA to which a rollover from the original IRA or employer-sponsored plan would be permitted. The contribution is allowed without regard to the normally applicable limits on IRA contributions and rollovers. The proposal applies to a levied amount that is returned to the individual because the levy on the original IRA or employer-sponsored plan (1) was wrongful, or (2) is determined to be premature or otherwise not in accordance with administrative procedures.

    The House Bill does not include this provision.

Estate Tax Reform

  1. Estate Tax Repeal. The Senate Bill doubles the estate and gift tax exemption amount by increasing the basic exclusion amount provided in Code Sec. 2010(c)(3) from $5 million to $10 million. The $10 million amount is indexed for inflation occurring after 2011. The proposal would be effective for decedents dying, generation-skipping transfers, and gifts made after December 31, 2017.

    The House Bill has the same proposal, but also repeals the estate and generation-skipping transfer tax for decedents dying and generation-skipping transfers made after 2024.

“LAST MINUTE” YEAR-END 2016 TAX-SAVING MOVES FOR INDIVIDUALS

Although there are only three weeks left to go before the year ends, it’s not too late to implement some planning moves that can improve your tax situation for 2016 and beyond. This article reviews some actions that you can take before December 31 to improve your overall tax picture.

Make HSA contributions. Under Code Sec. 223(b)(8)(A), a calendar year taxpayer who is an eligible individual under the health savings account (HSA) rules for December 2016, is treated as having been an eligible individual for the entire year. Thus, an individual who first became eligible on, for example, Dec. 1, 2016, may then make a full year’s deductible-above-the-line contribution for 2016. If he makes that maximum contribution, he gets a deduction of $3,350 for individual coverage and $6,750 for family coverage (those age 55 or older also get an additional $1,000 catch-up amount).

Nail down losses on stock while substantially preserving one’s investment position. A taxpayer may have experienced paper losses on stock in a particular company or industry in which he wants to keep an investment. He may be able to realize his losses on the shares for tax purposes and still retain the same, or approximately the same, investment position. This can be accomplished by selling the shares and buying other shares in the same company or another company in the same industry to replace them, or by selling the original holding then buying back the same securities at least 31 days later.

Accelerate deductible contributions and/or payments of medical expenses. Individuals should keep in mind that charitable contributions and medical expenses are deductible when charged to their credit card accounts (e.g., in 2016) rather than when they pay the card company (e.g., in 2017). Additionally, for 2016, itemizing taxpayers age 65 or older can deduct medical expenses to the extent they exceed 7.5% of adjusted gross income (AGI), but that “floor” will rise to 10% in 2017 (i.e., to the same floor that currently applies to taxpayers under age 65). Thus, it may pay for itemizing taxpayers who are 65 or older to accelerate discretionary or elective expenses into this year.

Solve an underpayment of estimated tax problem. Because of the additional .9% Medicare tax and/or the 3.8% surtax on unearned income, more individuals may be facing a penalty for underpayment of estimated tax than in prior years. An employed individual who is facing a penalty for underpayment of estimated tax as a result of either of these new taxes or for any other reason should consider asking his employer—if it’s not too late to do so—to increase income tax withholding before year-end. Generally, income tax withheld by an employer from an employee’s wages or salary is treated as paid in equal amounts on each of the four estimated tax installment due dates. Thus, if an employee asks his employer to withhold additional amounts for the rest of the year, the penalty can be retroactively eliminated. This is because the heavy year-end withholding will be treated as paid equally over the four installment due dates.

Retirement plan distribution. An individual can take an eligible rollover distribution from a qualified retirement plan before the end of 2016 if he is facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution at a 20% rate and will be applied toward the taxes owed for 2016. He can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2016, but the withheld tax will be applied pro rata over the full 2016 tax year to reduce previous underpayments of estimated tax.

Accelerate big ticket purchases into 2016 to get sales tax deduction. Taxpayers who itemize their deductions rather than take the standard deduction have the option of deducting state and local sales taxes in lieu of state and local income taxes. As a result, individuals who are considering the purchase of a big-ticket item (e.g., a car or boat) should consider whether it is advantageous to elect on their 2016 return to do so.

Prepay qualified higher education expenses for first quarter of 2017. Unless Congress extends it again, the above-the-line deduction for qualified higher education expenses will not be available after 2016. Thus, individuals should consider prepaying in 2016 eligible expenses for 2017 courses if doing so will increase their 2016 deduction for qualified higher education expenses. Generally, a 2016 deduction is allowed for qualified education expenses paid in 2016 in connection with enrollment at an institution of higher education during 2016 or for an academic period beginning in 2016 or in the first three months of 2017. The deduction is limited to $4,000 for taxpayers with modified adjusted gross income (AGI) of not more than $65,000 ($130,000 for married taxpayers filing joint returns), and $2,000 for taxpayers with modified AGI of not more than $80,000 ($160,000 for married taxpayers filing joint returns).

Potential to earn tax-free gains. An individual may exclude all (or, in some cases, part) of the gain realized on the disposition of qualified small business stock (QSBS) held for more than five years. For QSBS acquired after Sept. 27, 2010, an individual can exclude all of the gain on the disposition of QSBS stock. For QSBS acquired after Feb. 17, 2009 and before Sept. 28, 2010, individuals can exclude 75% of any gain realized on the disposition of QSBS. For QSBS acquired before Feb. 18, 2009, individuals can exclude 50% of the gain on the disposition of QSBS. Taxpayers should consider these rules in determining which stock to sell to maximize their exclusion for 2016 or to not sell if the holding period hasn’t yet been satisfied.

Be sure to take required minimum distributions (RMDs). Taxpayers who have reached age 70-½ should be sure to take their 2016 RMD from their IRAs or 401(k) plans (or other employer-sponsored retired plans). Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Those who turned age 70-½ in 2016 can delay the first required distribution to 2017. However, taxpayers who take the deferral route will have to take a double distribution in 2017—the amount required for 2016 plus the amount required for 2017. That could make sense if the taxpayer will be subject to a lower tax rate next year.

Use IRAs to make charitable gifts. Taxpayers who have reached age 70-½, own IRAs and are thinking of making a charitable gift, should consider arranging for the gift to be made directly by the IRA trustee. Such a transfer (not to exceed $100,000) will neither be included in gross income nor allowed as a deduction on the taxpayer’s return. But, since such a distribution is not includible in gross income, it will not increase AGI for purposes of the phaseout of any deduction, exclusion, or tax credit that is limited or lost completely when AGI reaches certain specified level.

Make year-end gifts. A person can give any other person up to $14,000 for 2016 without incurring any gift tax. The annual exclusion amount increases to $28,000 per donee if the donor’s spouse consents to gift-splitting. Annual exclusion gifts take the amount of the gift and future appreciation in the value of the gift out of the donor’s estate, and shift the income tax obligation on the property’s earnings to the donee who may be in a lower tax bracket (if not subject to the kiddie tax).

 

Andy Farkas, CPA
Farkas Tax Advisors Inc.
2173 Salk Ave., Ste 250
Carlsbad, CA 92008
(760) 237-4000 Office
(619) 204-6052 Cell
andy@farkascpa.com
www.farkascpa.com

Disclaimer: Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

“LAST MINUTE” YEAR-END 2016 TAX-SAVING MOVES FOR BUSINESSES

As year-end approaches, you should consider whether you could benefit from the following “last minute” tax-saving moves, including adjustments to income to preserve favorable estimated tax rules for 2017, deferral of certain advance payments to next year, and fine-tuning bonuses to make the most of the Code Sec. 199 domestic production activities deduction.

Accelerating or deferring income can preserve estimated tax break. Corporations (other than certain “large” corporations) can avoid being penalized for underpaying estimated taxes if they pay installments based on 100% of the tax shown on the return for the preceding year. Otherwise, they must pay estimated taxes based on 100% of the current year’s tax. However, the 100%-of-last-year’s-tax safe harbor isn’t available unless the corporation filed a return for the preceding year that showed a liability for tax. A return showing a zero tax liability doesn’t satisfy this requirement. Only a return that shows a positive tax liability for the preceding year makes the safe harbor available.

A corporation (other than a “large” corporation; see below) that anticipates a small net operating loss (NOL) for 2016 (and substantial net income in 2017) may find it worthwhile to accelerate just enough of its 2017 income (or to defer just enough of its 2016 deductions) to create a small amount of net income for 2016. This will permit the corporation to base its 2017 estimated tax installments on the relatively small amount of income shown on its 2016 return, rather than having to pay estimated taxes based on 100% of its much larger 2017 taxable income. Also, by accelerating income from 2017 to 2016, the income may be taxed at a lower rate in 2016, e.g., at 15% instead of at 25% or 34%. However, where a 2016 NOL would result in a carryback that would eliminate tax in an earlier year, the value of the carryback should be compared to the cost of having to pay only a small amount of estimated tax for 2017.

Accrual-basis business can take a 2016 deduction for some bonuses not paid till 2017. An accrual-basis business can take a deduction for its current tax year for a bonus not actually paid to its employee until the following tax year if

  1. The employee doesn’t own more than 50% in value of the business,
  2. The bonus is properly accrued on its books for the current tax year, and
  3. The bonus is actually paid within the first 2 1/2 months of the following tax year (for a calendar year taxpayer, within the first 2 1/2 months of 2017).

The 2016 deduction won’t be allowed, however, if the bonus is paid by a personal service corporation to an employee-owner, by an S corporation to an employee-shareholder, or by a C corporation to a direct or indirect majority owner.

For employees on the cash basis, the bonus won’t be taxable income until the following year.

Accrual-basis taxpayers can defer inclusion of certain advance payments. Accrual-basis taxpayers generally may defer including in gross income advance payments for goods until the tax year in which they are properly accruable for tax purposes if the income inclusion for tax purposes isn’t later than it is under the taxpayer’s accounting method for financial reporting purposes.

An advance payment is also eligible for deferral—but only until the year following its receipt—if:

  1. Including the payment in income for the year of receipt is a permissible method of accounting for tax purposes;
  2. The taxpayer recognizes all or part of it in its financial statement for a later year; and
  3. The payment is for
    • Services
    • Goods (other than goods for which the deferral method discussed above is used)
    • The use of intellectual property (including by lease or license)
    • The occupancy or use of property ancillary to the provision of services
    • The sale, lease, or license of computer software
    • Guaranty or warranty contracts ancillary to the preceding items
    • Subscriptions in tangible or intangible format
    • Organization membership or
    • Any combination of the preceding items.

Example: An accrual-basis, calendar-year taxpayer received a payment on Nov. 1, 2016 for a contract under which it will repair a customer’s computer equipment for two years. In its financial statements, the taxpayer recognizes 25% of the payment in 2016, 50% in 2017, and 25% in 2018. For tax purposes, under the deferral method discussed above, the taxpayer can report 25% in 2016 and defer 75% to 2017.

The deferral method cannot be used for

  1. Rent
  2. Insurance premiums
  3. Payments on financial instruments (e.g., debt instruments, deposits, letters of credit, etc.)
  4. Payments for certain service warranty contracts
  5. Payments for warranty and guaranty contracts where a third party is the primary obligor
  6. Payments subject to certain foreign withholding rules and
  7. Payments in property to which Code Sec. 83 applies.

If an advance payment is only partially attributable to an eligible item, it may be allocated among its various parts, and the deferral rule may be used for the eligible part.

Taxpayers wishing to change to the above method may use automatic consent provisions (with certain modifications). Advance consent procedures apply in certain cases, e.g., where advance payments are allocated.

Businesses that qualify for the deferral should not let tax considerations keep them from accepting advance payments before the end of 2016.

Making the most of the domestic production activities deduction. Businesses can claim a domestic production activities deduction (DPAD) under Code Sec. 199 to offset income from domestic manufacturing and other domestic production activities.

The Code Sec. 199 deduction equals 9% of the smaller of—

  1. The taxpayer’s “qualified production activities income” or QPAI, for the tax year, or
  2. The taxpayer’s taxable income (modified adjusted gross income, for individual taxpayers), without regard to the Code Sec. 199 deduction, for the tax year.

However, the Code Sec. 199 deduction can’t exceed 50% of the W-2 wages of the employer for the tax year. And the otherwise allowable Code Sec. 199 deduction of a taxpayer with oil-related QPAI is subject to a special reduction.

Qualified production activities eligible for the deduction include items such as: the manufacture, production, growth or extraction of qualifying production property (i.e., tangible personal property such as clothing, goods, or food as well as computer software or music recordings) by a taxpayer either in whole or in significant part within the U.S.; construction or substantial renovation of real property in the U.S., including residential and commercial buildings and infrastructure such as roads, power lines, water systems, and communications facilities; and engineering and architectural services performed in the U.S. and relating to the construction of real property. (Code Sec. 199(c)(4))

Generally, wages are the sum of the aggregate amounts that must be included on the Forms W-2 of employees under Code Sec. 6051(a)(3) (i.e., wages subject to withholding) and Code Sec. 6051(a)(8) (elective deferrals). The wages must be allocable to the taxpayer’s domestic production activities, and they include tips and other compensation as well as elective deferrals to 401(k) and other plans.

It is important for businesses to calculate the tentative Code Sec. 199 deduction and the W-2 deduction cap before year-end. If the deduction cap will limit the otherwise available deduction—for example, in the case of a closely held business whose owners do not draw substantial salaries—the business may want to bonus out additional compensation to maximize the Code Sec. 199 deduction. Bear in mind that in some cases, an accrual-basis business can deduct a bonus that is declared before year-end but not paid until the following year (see discussion above).

Taxpayers also need to factor the Code Sec. 199 deduction into other year-end tax planning strategies. For example, when determining whether to defer or accelerate income, a taxpayer must determine the marginal tax rate for each year. Depending on the type of income or deduction that the taxpayer is dealing with when working on such strategies, the Code Sec. 199 deduction may have the effect of decreasing the taxpayer’s marginal rate.

 

Andy Farkas, CPA
Farkas Tax Advisors, Inc.
2173 Salk Ave., Ste 250
Carlsbad, CA 92008
(760) 237-4000 Office
(619) 204-6052 Cell
andy@farkascpa.com
www.farkascpa.com

Disclaimer: Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

YEAR-END MOVES FOR THOSE WHO BELIEVE PRESIDENT-ELECT TRUMP WILL CUT THEIR TAXES NEXT YEAR

In his first televised interview, President-elect Trump declared that a “major tax bill lowering taxes in this country” would be one of his top three priorities. Those middle and upper income taxpayers who are betting he can deliver on this promise, and put his tax reduction plan in place for 2017, should revisit their year-end tax moves to make the most of what might be windfall savings next year.

Defer income to 2017. The Trump tax plan would feature three tax brackets instead of current law’s seven, and a top tax rate of 33% instead of current law’s 39.6%. The upshot of these and other tax-reduction changes, if retained in the final tax plan, would be reduced taxes for middle and upper income taxpayers, with the biggest tax savings realized by the wealthiest taxpayers.

The standard year-end tax-savings wisdom always has been to defer income, where possible, into the coming year. This standard approach would make even more sense for middle and upper income taxpayers if the Trump tax plan prevails over others in Congress, and goes into effect for tax year 2017.

Here are some of the ways to defer income until 2017:

  • An employee who believes a bonus may be coming his way may be able to request that his employer delay payment of any bonus until early in the following year. For example, if a bonus would normally be paid on Dec. 15, 2016, an employee may ask the employer before Dec. 15 to defer any bonus coming his way until Jan. 2, 2017. By deferring the bonus, the employee will succeed in having it taxed in 2017. But note that if an employee waits until a bonus is due and payable to request a deferral, the tax on the bonus will not be deferred. Also, if the deferral extends beyond 2-½ months after the close of the tax year, the bonus will be treated as non-qualified deferred compensation (currently includible in income to the extent not subject to a “substantial risk of forfeiture” if the arrangement fails to meet certain distribution, acceleration of benefit, and election requirements).
  • Income that a cash basis taxpayer earns by rendering services isn’t taxed until the client, patient etc., pays. If the taxpayer (e.g., consultant, business person, medical professional) holds off billing until next year—or until so late in the year that no payment can be received in 2016—he will succeed in deferring taxable income until next year.
  • Defer “first year” required minimum distributions (RMDs) from an IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year a taxpayer reaches age 70-½. That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Although RMDs must begin no later than April 1 following the year in which the IRA owner attains age 70-½, the first distribution calendar year is the year in which the IRA owner attains age 70-½. Thus, if a taxpayer turns age 70-½ in 2016, he can delay the first required distribution to 2017, but if he does so, there will have to take a double distribution in 2017—the amount required for 2016 plus the amount required for 2017. Delaying 2016 distributions to 2017 thus will bunch income into 2017, but that would be beneficial if the taxpayer winds up in a substantially lower bracket that year.
  • Defer a traditional IRA-to-Roth IRA conversion until 2017. Such a conversion generally is subject to tax as if it were distributed from the traditional IRA or qualified plan and not recontributed to another IRA. Thus, a taxpayer who plans to make such a conversion should defer doing so if he believes the conversion will face a lower tax next year.

Defer property sales. The President-elect’s plan to repeal the Affordable Care Act (“Obamacare”) also would repeal the 3.8% surtax on investment income. This surtax applies to the lesser of

  1. Net investment income or
  2. The excess of modified adjusted gross income (MAGI) over the threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 for other taxpayers).

As a result, if the surtax is repealed for 2017, taxpayers within the reach of the surtax, and are contemplating the sale of property that would generate a large investment gain, would benefit by deferring the sale until next year (assuming of course that the sale price would stay more or less the same).

If the sale can’t be postponed, it may be possible to structure the deal as an installment sale. By making a sale this year with part or all of the proceeds payable next year or later, a non-dealer seller to whom the installment method applies becomes taxable in any year on only that proportion of his profit which the payments he receives that year bear to the total sale price. If the 3.8% surtax is repealed for tax years beginning after 2016, the profit on the post-2016 installment payments would escape the surtax. Note that the Trump tax plan would keep current law’s maximum tax rate of 20% of capital gains.

On the deduction side. Itemized deductions produce no tax savings for a year in which a taxpayer claims the standard deduction, and many more taxpayers would claim the standard deduction under President-elect Trump’s tax plan. It calls for a dramatically increased standard deduction: $30,000 for joint filers (up from $12,600 for 2016) and $15,000 for singles (up from $6,300). If the boosted standard deduction makes it into law for 2017, many taxpayers who itemize under current law and wouldn’t be able to under the Trump plan would be better off accelerating next year’s itemized deductions into this year, when they will generate a tax savings. And, even if the standard deduction proposal is watered down, itemized deductions still will be more valuable to a taxpayer this year than next if he expects to be in a lower marginal tax bracket in 2017.

For example, those whose medical expenses exceed the 10% of AGI floor (7.5% of AGI for those age 65 or older) could accelerate into this year discretionary or elective medical procedures or expenses, such as dental implants or expensive eyewear. Individuals could boost charitable contributions (e.g., making two years worth of contributions this year to a favorite cause), pay state income tax and local property tax a bit early (keeping in mind that such taxes are not deductible for alternative minimum tax purposes), or making a year-end mortgage payment.

 

Andy Farkas, CPA
Farkas Tax Advisors, Inc.
2173 Salk Ave., Ste 250
Carlsbad, CA 92008
(760) 237-4000 Office
(619) 204-6052 Cell
andy@farkascpa.com
www.farkascpa.com

Disclaimer: Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

THINGS TO COME? A LOOK AT TRUMP’S AND HOUSE REPUBLICANS’ TAX PROPOSALS

Beginning Jan. 20, 2017, the Republican Party will be in control of both houses of the U.S. Congress as well as the Presidency. On November 9, the day after the election, House Ways and Means Committee Chairman Kevin Brady (R-TX) and Senate Majority Leader Mitch McConnell (R-KY) indicated that they want to take up tax reform early in the next session of Congress. Here we present some of the recent tax proposals from both President-elect Donald Trump and House Republicans.

President-elect Trump’s proposals. As of Nov. 10, 2016, President-elect Trump’s Tax Plan website lists the following proposals:

For individual taxpayers:

    • Tax rates and breakpoints for Married-Joint filers would be:
      • Less than $75,000: 12%
      • More than $75,000 but less than $225,000: 25%
      • More than $225,000: 33%;

 

    • Brackets for single filers would be ½ of these amounts;
    • “Low-income Americans would have an effective income tax rate of 0”;
    • The existing capital gains rate structure (maximum rate of 20%) would be maintained, with tax brackets shown above;
    • Carried interest would be taxed as ordinary income;
    • The Affordable Care Act would be repealed; as part of this repeal, the 3.8% tax on investment income would be repealed;
    • The alternative minimum tax (AMT) would be repealed;
    • The standard deduction for joint filers would increase to $30,000, and the standard deduction for single filers would be $15,000;
    • Personal exemptions would be eliminated;
    • Head-of-household filing status would be eliminated;
    • Itemized deductions would be capped at $200,000 for Married-Joint filers and $100,000 for Single filers;
    • The estate tax would be repealed, but capital gains on property held until death and valued over $10 million would be subject to tax, with an exemption for small businesses and family farms. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives would be disallowed;
    • The Trump website makes no mention of the gift tax.

 

    • There would be the following child care and elder care rules:
      • An above-the-line deduction for children under age 13, that would be capped at state average for age of child, and for eldercare for a dependent. The exclusion would not be available to taxpayers with total income over $500,000 for Married-Joint or $250,000 for Single;
      • Rebates for childcare expenses to certain low-income taxpayers through the Earned Income Tax Credit (EITC). The rebate would be equal to 7.65% of remaining eligible childcare expenses, subject to a cap. This rebate would be available to married joint filers earning $62,400 ($31,200 for single taxpayers) or less;
      • All taxpayers would be able to establish Dependent Care Savings Accounts (DCSAs) for the benefit of specific individuals, including unborn children. Total annual contributions to a DCSA would be limited to $2,000 per year from all sources. The government would provide a 50% match on parental contributions of up to $1,000 per year for these households.

 

For business taxpayers:

    • The business tax rate would decrease from 35% to 15%;
    • The corporate AMT would be eliminated;
    • There would be a deemed repatriation of corporate profits held offshore at a one-time tax rate of 10%;
    • “Most corporate tax expenditures”, except for the research and development credit, would be eliminated;
    • Firms engaged in manufacturing in the U.S. could elect to expense capital investment and lose the deductibility of corporate interest expense. An election once made could only be revoked within the first three years of election; and
    • The annual cap for the business tax credit for on-site childcare would be increased to $500,000 per year (up from $150,000), and the recapture period would be reduced to five years (down from ten years).

 

The House Republican’s “A Better Way” plan. On June 24, House Republicans released an installment of their “A Better Way” Our Vision for a Confident America” that contained a number of tax reform proposals. At that time, the Republicans announced that the document (“blueprint”) was meant to serve as the basis of tax reform legislation which will be “ready for legislative action in 2017”. It reflects several months of deliberation by the Tax Reform Tax Force, led by Chairman Brady.

Previously, on June 22, House Republicans had released another installment of their “A Better Way” Our Vision for a Confident America”; this installment contained a number of health care reform proposals.

On November 9, both Chairman Brady and Speaker of the House Paul Ryan (R-WI) mentioned the blueprint as being taken up by Congress, in concert with Mr. Trump, at the beginning of the next session of Congress.

Among its tax provisions regarding individuals, the blueprint would:

    • Reduce both the top rate (to 33%) and the number of brackets (to three);
    • Provide for reduced and progressive tax rates on capital gains, dividends and interest income;
    • Eliminate the AMT;
    • Consolidate a number of existing family tax benefits into a larger standard deduction and a larger child and dependent tax credit;
    • Continue the EITC, but look for ways to improve it;
    • Simplify tax benefits for higher education;
    • Eliminate all itemized deductions except the mortgage interest deduction and charitable contribution deduction;
    • Continue current tax incentives for retirement savings; and
    • Repeal the estate and generation-skipping transfer taxes.
    • The blueprint makes no mention of the gift tax.

 

Business tax provisions in the blueprint include:

    • Creating a new business rate for small businesses that are organized as sole proprietorships or pass-through entities instead of taxing them at individual rates;
    • Reducing the corporate tax rate to 20%;
    • Providing for immediate expensing of the cost of business investments;
    • Allowing interest expense to be deducted only against interest income, with any net interest expense carried forward and allowed as a deduction against net interest income in future years (with special rules that will apply for financial services companies);
    • Allowing net operating losses (NOLs) to be carried forward indefinitely and increased by an interest factor, and eliminating NOL carrybacks;
    • Retaining the research credit (but evaluating options to make it more effective);
    • Generally eliminating certain (but unspecified) special interest deductions and credits;
    • Shifting to a territorial tax system;
    • Moving “toward a consumption-based tax approach”;
    • Providing a 100% exemption for dividends from foreign subsidiaries; and
    • Generally simplifying international tax rules, including elimination of most of the subpart F rules.

 

The blueprint suggests a number of IRS reforms, including provisions to:

    • “Streamline” the agency and center it on three major units: one for families and individuals, one for business, and a new “small claims court” unit that would be independent of IRS and designed to allow routine disputes to be resolved more quickly;
    • Reform IRS leadership so that it is headed by an Administrator, appointed by the President with the consent and advice of the Senate for a single 3-year term;
    • Have a “Service First” mission; and
    • Commit to taxpayer assistance.

 

And the health care reform proposals would:

    • Repeal the Affordable Care Act;
    • Make the following changes to health savings accounts (HSAs): allow spouses to make catch-up contributions to the same HSA account; allow qualified medical expenses incurred before HSA-qualified coverage begins to be reimbursed from an HSA account as long as the account is established within 60 days; set the maximum contribution to an HSA at the maximum combined and allowed annual deductible and out-of-pocket expense limits; and expand accessibility for HSAs to certain groups (e.g., those who get services through the Indian Health Service and TRICARE).
    • Allow certain purchasing platforms, like private exchanges, to expand. The plan would encourage the use of direct or “defined contribution” methods, such as health reimbursement accounts (HRAs).
    • Encourage the portability of health insurance. Everyone would have access to financial support for an insurance plan chosen by the individual, which could be taken with them job-to-job, to non-work environments and into retirement years. For those who do not have access to job-based coverage, Medicare, or Medicaid, the proposal would provide an advanceable, refundable tax credit. The portable payment would be increased as the recipient aged.

 

Comparing the Trump and House proposals. Both the Trump and House Republicans proposals would repeal the Affordable Care Act, significantly lower tax rates on both individuals and businesses, eliminate the AMT, eliminate estate taxes, lessen the relevance of itemized deductions, eliminate some business credits and deductions, and tighten the rules on business interest deductions.

On the other hand, Trump puts great emphasis on new child and elder care tax breaks, and the House Republicans do not. And, the House Republicans consider many changes to existing tax rules that Trump doesn’t mention. And, while the House Republicans’ plan contains, and previous proposals by Trump contained, a special tax rate for businesses that operate as pass-through entities, the current Trump website has no such proposal.

Things to come? Given the newness of the election and its surprise results, we are probably pretty far from understanding the dynamics of the workings of the 115th Congress that will begin its work in January-including whether the Republicans will attempt to pass tax legislation in the Senate under the legislative process called “reconciliation” which only requires a simple majority, or will, instead, allow the Senate filibuster rules to apply to the tax legislation. Similarly, we are probably pretty far from understanding the push and pull between Congressional leaders and President-elect Trump. Thus, even given the large overlap between the proposal of the House Republicans and that of Mr. Trump, we probably have a long way to go in predicting a lot of the specifics of 2017 tax legislation. However, some significant 2017 tax legislation and some significant health care reform legislation seem quite likely.

 

Farkas Tax Advisors, Inc.
2173 Salk Ave., Suite 250
Carlsbad, CA 92008
info@farkascpa.com
Phone: (760) 237-4000
http://www.farkascpa.com

TAX TIPS FOR THE 2016 GRADUATE

TAX TIP #1
Avoid over-withholding in 2016 by increasing the “number of allowances” on Form W-4. Remember to change to the proper “number of allowances” at the beginning of 2017.

TAX TIP #2
Be prepared to file the 2016 Federal income tax return early to obtain a refund. The refund can be hastened by labeling the envelope containing the return “REFUND” and using the appropriate post office box number. Alternatively, electronic filing will also shorten the time between filing and receiving a refund. Use of the direct deposit option is also recommended.

TAX TIP #3
Determine and document the source and reason for all interest payments during
2016. Pay particular attention to loans used to pay qualified education expenses
since up to $2,500 of interest is deductible when computing Adjusted Gross Income.

TAX TIP #4
Prepare and maintain a record of the expenses involved in moving to the first place
of employment. These include: the actual moving expenses; travel and lodging
costs incurred en route to the place of employment.

TAX TIP #5
Familiarize yourself with the types of deductible expenses incurred as part of your
employment. Prepare and maintain a record of these expenses which can include
travel, meals, lodging, entertainment and educational costs. Also, if possible, insist
on specific item reimbursement instead of a general allowance system.

TAX TIP #6
Don’t attempt to itemize deductions unless you’ve incurred substantial
unreimbursed medical costs, state and local income taxes, home mortgage interest,
real estate and/or personal property taxes during 2016 and expect this total to
surpass the 2016 standard deduction amount for your filing status.

TAX TIP #7
Claim the American Opportunity Tax Credit or Lifetime Learning Credit for 2016 tuition and fee payments (including prepayments) made to any “eligible educational institution.” Alert your parent(s) to the eligibility requirements that may allow the reporting of the American Opportunity Credit on their 2016 tax return.

TAX TIP #8
Examine situations that would enable you to recognize income in 2016, instead of 2017. Where possible, shift that income into 2016.

TAX TIP #9
Protect the dependency exemption of your parent(s) by (a) documenting your support spending before and after you are employed and (b) spending less on your support from your funds than the amount spent by your parent(s) and others who provided resources for your support.

TAX TIP #10
When you are not reported as a dependent by your parent(s), document the relationship of educational expenses to (a) requirement established by state or employer or (b) maintenance and/or improvement of skills required in your current trade or business. Following an up to $4,000 Tuition and Fees Deduction, determine whether your tax liability is reduced more by treating the remaining eligible educational expenses as a miscellaneous itemized deduction or by using all of the educational expenses in computing the Lifetime Learning Credit.

TAX TIP #11
Do not waste precious time and space maintaining information about spending that
has no tax consequences. Furthermore, tax returns and the supporting data should
be kept for at least three years.

TAX TIP #12
Establish an IRA (Individual Retirement Account) or similar retirement arrangement — such as a 401(k) Plan – as soon as possible. Contribute the maximum amount to the IRA and allow it to grow until retirement.

I hope this information is helpful. If you would like more details about these or any other aspect of the tax law, please do not hesitate to call at (760) 237-4000 or e-mail at andy@farkascpa.com.

REPUBLICAN WALKER PROPOSES HEALTH TAX CREDITS BY AGE, NOT INCOME

Republican presidential contender Scott Walker on Tuesday unveiled his healthcare plan: repeal Obamacare and replace it with age-based tax credits that Americans could use to offset the cost of purchasing their own coverage.
Under his plan, the Wisconsin governor said he would give up to $3,000 directly to taxpayers to buy health insurance. The amount would range from $3,000 in credits for those aged 50 to 64 and scale down to $900 for those age 17 and under, and go to those without health insurance from their jobs.

Walker also backed longstanding Republican health proposals to allow consumers to purchase insurance out-of-state, loosen restrictions on health savings accounts and reform medical malpractice lawsuits.

“This gives them a way to get an affordable healthcare plan,” he said in a speech in Minnesota, highlighting the plan’s tax credits.

Republicans have long vowed to repeal President Barack Obama’s signature 2010 healthcare law, commonly known as Obamacare. While most of the 17 Republican presidential candidates have echoed that pledge, few have offered detailed alternatives.

Under the law, consumers who do not get health insurance from their employer or government programs such as Medicare and Medicaid can buy it under federal or state-run insurance exchanges. Those who qualify receive a subsidy to offset the costs.

Walker criticized that system and the role of the Internal Revenue Service in overseeing the subsidies.

“Unlike ObamaCare policies that give subsidies to insurance companies, these tax credits belong to consumers,” Walker wrote in his plan, released on his website.

He said consumers should be able to buy health insurance across state lines, although it was not immediately clear where consumers would buy it or what would happen to the current exchanges.

Additionally, Walker called for overhauling Medicaid, the federal-state health insurance program for the poor, through block grants and other changes.

U.S. Senator Marco Rubio of Florida, another contender to be the Republican presidential nominee in the November 2016 election, also has called for healthcare changes. In an opinion piece in Politico late on Monday, he reiterated his promise to seek tax credits for Americans who buy their own health insurance but offered few new details.

Another candidate, Louisiana Governor Bobby Jindal, who laid out his healthcare policy ideas last year, criticized Walker’s plan. He said Walker was accepting the premise of Obamacare and “merely quibbling over the details.”