With summer winding down it is time to start thinking about your finances. In this edition of our monthly update, we address some important developments in Congress with possible tax reform 2.0, and we cover some tax changes that may affect you or your business, including changes to the kiddie tax and your corporate tax rates. In addition, watch out for the September 17 S Corporation extension filing deadline and the 1040 extension deadline coming October 15 for most taxpayers.
Our goal is to provide you with an unparalleled level of client service. If you see something that you want to talk about, please contact us to explore the possibilities. We rely on satisfied clients as the primary source of new business, and your reviews and referrals are both welcomed and most sincerely appreciated!
Tricia McCullough, President
Tax Reform 2.0 Is in the Works
- Tax Reform 2.0
- House Ways and Means Committee
- Talking Points
The dust has not yet settled from the Tax Cuts and Jobs Act (TCJA), passed into law in December 2017, and the House Ways and Means Committee is already considering another round of tax changes. The committee chair, Kevin Brady, Republican from Texas, wants to include input from stakeholders such as business groups, think tanks and other relevant organizations. Historically, major tax reforms have been decades apart, so the committee chair is looking for another approach to the way Washington deals with tax policy.
As with all tax legislation, it begins with talking points. From what we can gather, it appears the focus of Tax Reform 2.0 will include:
- Making the first round of individual and pass-through business deductions permanent.
- Focusing on retirement savings and creating a flexible universal savings account so individuals are accustomed to saving for retirement earlier in life.
- Making it easier for small businesses to participate in multi-employer retirement plans.
- Looking for ways to help the Treasury implement the TCJA.
- Providing new business start-ups with greater expensing options for start-up costs.
- Identifying technical corrections needed for the TCJA.
Commentators believe that making the selected TCJA changes permanent will be a tough sell in Congress at this time, as there is little to no support from the Democratic side of the aisle. However, the retirement savings ideas will probably have a favorable reception and have a good chance of passing.
Stay tuned for further developments.
Tax Reform Eases the Alternative Minimum Tax – But It’s Still There
- What Is AMT?
- AMT Triggers
- Medical Deductions
- Deduction for Taxes Paid
- Home Mortgage Interest
- Miscellaneous Itemized Deductions
- Personal Exemptions
- Standard Deduction
- Incentive Stock Options
Although Congress has been promising to repeal the alternative minimum tax (AMT), they failed to do that when they passed tax reform in 2017. Instead, they lessened the effects of the AMT by increasing AMT exemptions (an amount of income exempt from AMT taxation) and raising the income thresholds for when the exemptions are phased out. These two steps and some other changes covered below lessen your chances of being hit by the AMT, but it is still there, so it is wise to be aware of how the AMT is determined and the things that might trigger it.
There are two ways to determine your tax: the regular way, which most everyone is familiar with, and the alternative method. Your tax will be the higher of the two.
So, what is the alternative tax and why might you get hit with it? Well, many, many years ago, Congress, in an effort to curb tax shelters and tax preferences of wealthy taxpayers, created an alternative method for computing tax that disallows certain deductions and adds preference income and called it the AMT. Although originally intended to apply to the wealthy, years of inflation caused more than just wealthy taxpayers to be caught up in the tax.
What Triggers the AMT? The list of tax deductions and preferences not allowed when computing the AMT is substantial and, at times, complicated. However, the typical taxpayer does not encounter most of them. In the past, the seven following items routinely caused taxpayers to be hit by the AMT. As you will note, tax reform has lessened or eliminated the impact of some of these.
- >Medical Deductions — For many years, medical deductions were allowed to the extent they exceeded 7.5% of a taxpayer’s income for regular tax purposes and 10% for the AMT computation. The 2.5% difference was one of the items that added to the AMT tax. (For 2013 through 2016, the percentage for taxpayers under age 65 was 10% for both regular tax and AMT, and they had no AMT adjustment.) For 2017 and 2018, tax reform made the medical limit 7.5% for both regular and AMT purposes. After 2018, the percentage of income that reduces medical expenses will be 10% for both regular tax and AMT. Therefore medical expenses also will not impact the AMT in 2019 and later years.
- Deduction for Taxes Paid — When itemizing deductions on a federal return, a taxpayer is allowed to deduct a variety of state and local taxes, including real property, personal property, and state income or sales tax. But, for AMT purposes, none of these taxes is deductible, thus creating an AMT adjustment. However, tax reform imposed a $10,000 limit on state and local tax deductions, lessening the difference in the regular tax and AMT adjustment, especially for higher income taxpayers and those living in states with high taxes. However, when combined with other triggering items, the state and local taxes deducted for regular tax can still create an AMT.
- Home Mortgage Interest — For both the regular tax and AMT computations, interest paid on a debt to acquire or substantially improve a main home or second home is deductible as long as the $1 million debt limit ($750,000 for loans incurred after 2017) isn’t exceeded. Prior to 2018, for regular tax purposes, the interest on up to $100,000 of equity debt on first and second homes was also deductible, creating a difference between the regular tax and AMT deduction, as equity debt interest is not allowed for AMT purposes. Additionally, interest on debt to acquire a motor home or boat that is used as a taxpayer’s home or second home is deductible for regular tax purposes but not for AMT purposes. Starting in 2018, tax reform no longer allows homeowners to deduct the interest on equity debt, which eliminates another difference between what is deductible for regular tax and the AMT and reduces the chances of being saddled with the AMT.
- Miscellaneous Itemized Deductions — The category of miscellaneous deductions, which includes employee business expenses and investment expenses, is not deductible for AMT purposes. For certain taxpayers with deductible employee business expenses or high investment advisor fees, this has created a significant AMT. Here again, tax reform has eliminated these same miscellaneous deductions for regular tax beginning in 2018, thus eliminating another difference between the AMT and the regular tax computation.
- Personal Exemptions — Through 2017, a deduction for personal exemptions was allowed for regular tax but not for the AMT, creating a difference in the computation and adding to the chance of being subject to the AMT. As of 2018, exemptions are no longer allowed for regular tax, which eliminates yet another difference.
- Standard Deduction — For regular tax purposes, a taxpayer can choose to itemize their deductions or use the standard deduction. However, for the AMT, only itemized deductions are allowed. Tax reform substantially increased the standard deduction used to figure regular tax, and this can increase chances of being affected by the AMT. There is a strategy that can be used to mitigate the AMT for taxpayers who would normally use the standard deduction, which is forcing itemized deductions even if they total an amount that is less than the standard deduction amount. Even the smallest of charitable deductions will benefit at a minimum of 26% (the lowest bracket for the AMT). This strategy is tricky and best left to a tax professional to figure out.
- Exercising Incentive Stock Options and Holding the Stock — Many employers offer stock options to their employees. One type of option is called a qualified or incentive stock option. The taxpayer does not recognize income when the options are exercised and becomes qualified for long-term capital gain treatment upon sale of the stock acquired from the option if the stock is held more than a year after the option was exercised and two years after the option was granted. However, for AMT purposes, the difference between the option price and the exercise price is AMT income in the year the option is exercised, which frequently triggers an AMT tax when large blocks of stock are exercised. Tax reform did not change this provision.
Although your chances of being snagged by the AMT have significantly diminished, there is still a possibility you can be affected by it, especially if you have investment or business interests that are subject to AMT adjustments not encountered by the average taxpayer (and not discussed in this article). The AMT is an extremely complicated area of tax law that requires careful planning to minimize its effects. Please contact this office for further assistance.
After Tax Reform, Which Is Right for You: S Corp or C Corp?
The Tax Cuts and Jobs Act has left many of today’s businesses with big questions. Incorporation remains a hot topic, but this law is shaking things up. It’s quick to assume your company should be one or the other, but without careful consideration of the facts, your organization may end up facing financial loss, hefty tax penalties or missed tax savings.
The goal of this type of incorporation is to minimize tax burdens, but the wrong decision can be costly. In a C Corp, the company pays corporate taxes to the Internal Revenue Service. But, in an S Corp, there’s no entity tax. Rather, taxes are paid through an individual return.
The New Law Changes
The new law, which went into effect for the 2018 tax year, brought changes to both S Corp and C Corp businesses. In fact, both types of corporations benefited here. For C Corps, the tax rate was dropped from 35 percent down to just 21 percent. For an S Corp the new law provides a deduction equal to 20% of the pass-through income from the corp subject to limitations for higher-income taxpayers. At best, this reduces the effective tax rate to 29.6 percent from 37 percent. In both cases, there are specific restrictions here to know.
One thing to remember about these tax changes is that there are many components to determining which method is right for your business. Don’t make a quick judgment here. Rather, invest in some one-on-one time with your tax professional to determine the best possible scenario for your individual company. To help, consider these key areas.
S Corp and C Corp Ownership
A key component in deciding how to incorporate your business relates to ownership. In the S Corp, there is a limit of 100 shareholders within the company. These must be domestic organizations operated in the United States where all of the company’s shareholders are also living in the United States. Additionally, this structure allows for a single stock classification. As a business, you cannot offer common stocks as well as preferred shares, for example.
Comparatively, C Corps allow for fewer restrictions. There is no limit on ownership at all. There is no limit on the number of shareholders the company can have. Any small- to a medium-sized company planning an IPO or simply obtain investors outside of the traditional domestic structure will find C Corps offer far more flexibility.
Another key factor about C Corps relates to the differences within your shareholders. These corporations can issue several types of stock. As a result, it is not uncommon for some shareholder votes to be more important than others. This, too, can influence the decision you make in choosing one or the other model.
Corporation Taxation — Choosing the Best Taxation Structure
Most companies will focus most of their decision on S Corp or C Corp options based on ownership as a starting point. However, every company also wants to keep costs low. Taxation is one of the most expensive hurdles any organization must manage. And, each type of structure offers a different look.
For example, consider how a C Corp is taxed. It is commonly referred to as a “double taxation structure.” This is because the company (the entity itself) will pay a corporate tax. Then, the stockholders pay taxes on their income from the business. While this has long been a concern for any business owner using the C Corp structure (paying taxes twice on income is very costly), the new tax law changes this a bit. As noted previously, the tax rate for C Corp has changed from 35 percent to just 21 percent. However, the dividends will still be faced with double taxation.
The slashing to 21 percent means every company is paying the same rate, neither the size of the company nor the type of organization matters. That’s an important consideration when choosing which type of structure is right for your company.
With the help of a tax professional, it is also important to consider other tax strategies available. For example, an S Corp shareholder pays taxes every year on the money the company earns during that year. This is a simpler, straightforward scenario. But, in a C Corp, the taxes are only paid when the company decides to distribute dividends. It can also occur if a shareholder realizes capital gains (such as when selling ownership). This provides the C Corp with an ability to minimize taxes just by timing dividends properly.
Making the Right Decision for Your Needs
This is only the very top edge of considerations for which is best for your company. However, there are a few things that can influence your decision.
Stable Small Businesses
If you own a smaller company, you’ll benefit from an S Corporation for various reasons. First, the income passes through and is taxable to the stockholders on their 1040s, thereby eliminating double taxation. Plus the lower tax rate and the 20% pass-through deduction are very beneficial to an S-Corporation structure.
Growing Small Businesses
If your company is growing — or you plan to go public and take on new ownership, the C Corporation offers the opportunity to do so. It allows for a larger number of investors, and international investments are possible. Additionally, as a smaller business, you may not be likely to issue dividends any time soon. As a result, this can reduce the amount of income reported to the IRS on an annual basis.
For larger organizations, the C Corp tends to offer the best structure overall. Other options limit investor access and may create scenarios where the company cannot grow. The effective tax rate is significantly lower — competitive to any company no matter the size. The new tax reform provides the most advantages to this buyer in particular.
Making the Decision for Your Needs
Many organizations today have jumped on the new tax reform as an opportunity to incorporate more tax savings. However, a clear picture is important. It’s important to slow down before making any type of drastic decisions like this. They have far-reaching implications and can create a financial burden or limitations on an organization if the wrong decision occurs. However, with the help of a tax professional or attorney, it is possible to make better decisions based specifically on the type of business structure you have, the business’s short-term and long-term goals, as well as new laws and taxation rates. Before you make a change as an entrepreneur, know what you are really getting.
Do You Need to Renew Your ITIN?
- Over 2 Million ITINs Require Renewal
- Failure to Renew Can Affect Tax Filings and Refunds in 2019
- Family Renewal Option
- Three Ways to Renew
- Avoiding Common Mistakes
The IRS has announced that more than 2 million Individual Taxpayer Identification Numbers (ITINs) are set to expire at the end of 2018. An ITIN is a nine-digit number issued by the IRS to individuals who are required for U.S. federal tax purposes to have a U.S. taxpayer identification number but who do not have and are not eligible to get a Social Security number (SSN).
Failure to renew an ITIN in a timely manner can delay one’s ability to file a tax return, and with 2.7 million expected ITIN renewals, acting now to renew ITIN numbers will help taxpayers avoid delays that could affect their tax filing and refunds in 2019.
Under the Protecting Americans from Tax Hikes (PATH) Act, ITINs that have not been used on a federal tax return at least once in the last three consecutive years, as well as ITINs with specified middle digits (see below), will expire on Dec. 31, 2018. These affected taxpayers who expect to file a tax return in 2019 must submit a renewal application as soon as possible.
Who Needs to Renew Their ITIN?
- Taxpayers whose ITIN is expiring or whose ITIN includes the middle digits listed below and who need to file a tax return in 2019 must submit a Form W-7 renewal application. ITINs with the middle digits 73, 74, 75, 76, 77, 81 or 82 (for example: 9NN-73-NNNN) need to be renewed even if the taxpayer has used it in the last three years. Other ITIN holders do not need to take any action. The IRS has begun sending the CP-48 Notice, “You Must Renew Your Individual Taxpayer Identification Number (ITIN) to File Your U.S. Tax Return,” in early summer to affected taxpayers. The notice explains the steps to take to renew the ITIN if it will be included on a U.S. tax return filed in 2019. Taxpayers who receive this notice after taking action to renew their ITIN do not need to take further action, unless another family member is affected.
- ITINs with middle digits of 70, 71, 72, 78, 79 or 80 have previously expired. Taxpayers with these ITINs who haven’t previously gone through the renewal process can still renew at any time.
- Spouses or dependents residing inside the United States should renew their ITINs. However, spouses and dependents residing outside the United States do not need to renew their ITINs unless they anticipate being claimed for a tax benefit (for example, after they move to the United States) or unless they file their own tax return. That’s because the deduction for personal exemptions has been suspended for tax years 2018 through 2025 by the Tax Cuts and Jobs Act. Consequently, spouses or dependents outside the United States who would have been claimed for this personal exemption benefit and no other benefit do not need to renew their ITINs this year.
Family Renewal Option — Taxpayers with an ITIN that has middle digits 73, 74, 75, 76, 77, 81 or 82, as well as all previously expired ITINs, have the option to renew ITINs for their entire family at the same time. Those who have received a renewal letter from the IRS can choose to renew their family’s ITINs together, even if family members have an ITIN with middle digits that have not been identified as expiring. Family members include the tax filer, the filer’s spouse and any dependents claimed on the tax return.
How to Renew an ITIN — To renew an ITIN, a taxpayer must complete a Form W-7 and submit all required documentation. Taxpayers submitting a Form W-7 to renew their ITIN are not required to attach a federal tax return. However, taxpayers must still note a reason for needing an ITIN on the Form W-7. See the Form W-7 instructions for detailed information.
There are three ways to submit the W-7 application package. Taxpayers can:
- Mail the Form W-7, along with original identification documents or copies certified by the agency that issued them, to the IRS address listed on Form W-7’s instructions. The IRS will review the identification documents and return them within 60 days
- Work with Certified Acceptance Agents (CAAs) authorized by the IRS to help taxpayers apply for an ITIN. CAAs can authenticate all identification documents for primary and secondary taxpayers, verify that an ITIN application is correct before submitting it to the IRS for processing and authenticate the passports and birth certificates of dependents. This saves taxpayers from mailing original documents to the IRS.
- In advance, call and make an appointment at a designated IRS Taxpayer Assistance Center to have each applicant’s identity authenticated in person, instead of mailing original identification documents to the IRS. Applicants should bring a completed Form W-7 along with all required identification documents. See the TAC ITIN authentication page on the IRS website for more details.
Avoid Common Errors and Delays Next Year — Federal tax returns that are submitted in 2019 with an expired ITIN will be processed. However, certain tax credits and any exemptions will be disallowed. Taxpayers will receive a notice in the mail advising them of the change to their tax return and of their need to renew their ITIN. Once the ITIN is renewed, applicable credits and exemptions will be restored, and any refunds will be issued.
Additionally, several common errors can slow down and hold up some ITIN renewal applications. These mistakes generally center on missing information or insufficient supporting documentation, such as for name changes. The IRS urges any applicant to check over their form carefully before sending it to the IRS.
As a reminder, the IRS no longer accepts passports that do not have a date of entry into the U.S. as a standalone identification document for dependents from a country other than Canada or Mexico as well as for dependents of U.S. military personnel overseas. The dependent’s passport must have a date-of-entry stamp; otherwise, at least one the following documents to prove U.S. residency is required:
- U.S. medical records for dependents under age 6.
- U.S. school records for dependents aged 6 to 17.
- U.S. school records (if a student), rental statements, bank statements or utility bills listing the applicant’s name and U.S. address, if age 18 or over.
If you have questions related to a need for an ITIN or the renewal process, please give this office a call.
IRA Missteps to Avoid
- Selecting a Type of IRA
- Missing out on the Saver’s Credit
- Taking Distributions before Retirement Age
- Failure to Keep Designated Beneficiaries Current
- Overlooking the Spousal IRA
- Failing to Recognize Low Tax Distribution Opportunities
- Social Security Income and Traditional IRA Distributions
- Rollover Errors
- Failing to Take a Required Minimum Distribution
- Knowing the Beneficiary Options
- Understanding the Special Spousal Beneficiary Options
- Disclaiming an Inherited IRA
- Failing to Realize Your Child Can Have an IRA
- Not Taking Advantage of IRA-to-Charity Distributions
If you have an IRA account or are considering one, there are a number of potential missteps you will want to avoid. Some of them can lead to unwanted taxes and penalties, and of course, we are talking about your retirement funding, so it is an important issue. Here are a number of issues to keep in mind:
Selecting a Type of IRA Account — The first decision you will have to make is whether to choose a traditional IRA or a Roth IRA. A traditional IRA provides a tax deduction for the contribution and tax-deferred growth, but any withdrawal from the account is fully taxable. On the other hand, Roth IRA contributions are not deductible, but distributions after retirement are tax-free. A Roth IRA offers tax-free accumulation, meaning the earnings build up over the life of the IRA tax-free. Making the decision involves a number of factors, some of which will be discussed later in this article.
For those currently with low income and on a limited budget with little extra income to spare for IRA contributions, the traditional IRA offers a tax deduction, which will allow them to make a larger contribution and is better than having no retirement funds at all. In addition, lower-income individuals may qualify for the Saver’s Credit, discussed later, which provides a tax credit that might help them to afford a contribution.
For younger individuals, a Roth IRA provides tax-free accumulation, meaning the earnings will be tax-free when distributed at retirement. Thus, the longer one has a Roth IRA, the more tax-free income it can provide.
Missing out on the Saver’s Credit — As mentioned previously, the Saver’s Credit helps lower-income individuals to save for retirement by providing a credit to help cover the cost of their IRA contribution. The credit can be as much as 50% of the first $2,000 contributed to an IRA (either traditional or Roth), depending upon your income for the year. It is not allowed for individuals under the age of 18, individuals claimed as dependents of another or full-time students. The credit is non-refundable, meaning it can only be used to offset one’s tax liability, so lower-income taxpayers may not have enough tax to benefit.
Taking Distributions before Retirement Age — If a distribution is taken from a traditional IRA before reaching the age of 59½, that distribution will not only be taxable but will also be subject to a 10% early withdrawal penalty. So, consider it carefully before taking an early distribution. Assuming you are in the 22% tax bracket, every $100 of an early distribution will result in you owing $32 of tax, including the penalty. Only take an early distribution if you are desperate. There are exceptions to the 10% early withdrawal penalty, but not for the tax on the early distributions. The common penalty exceptions include limited withdrawals for a home purchase, medical expenses, disability and higher education expenses.
Failure to Keep Designated Beneficiaries Current — A number of life events can change who you want to be the beneficiary of your IRA account when you pass. Divorce and the death of a beneficiary are probably the most common, but regardless of the reason, it is important to keep your IRA trustee or custodian apprised about the current names of your beneficiaries, or else the account could end up in the hands of someone you didn’t want it to be.
Overlooking the Spousal IRA — You may not be aware, but a non-working spouse can also make an IRA contribution based upon the working spouse’s income. The amount that can be contributed is the smaller of the annual IRA contribution limit or the working spouse’s compensation less any IRA contribution made by the working spouse. Contributions to spousal IRAs do not need to be divided equally between spouses, but neither spouse may make a contribution of more than the annual limit. The deduction for contributions to both spouses’ IRAs may be further limited if either spouse is covered by an employer’s retirement plan.
Failing to Recognize Low Tax Distribution Opportunities — Occasionally, a taxpayer will have an abnormally low-income year, or the individual’s deductions will be abnormally high, resulting in a negative or very low taxable income. When this occurs, traditional IRA distributions by those age 59½ or older can be taken with little or a minor tax liability. Because the distribution must be taken before the end of the year, the key is to recognize this possibility, determine how much of a withdrawal will provide the best result and then take the distribution before year’s end.
Also low-income taxable years can provide an opportunity to convert some portion of a traditional IRA to a Roth IRA with minimal or no tax liability.
Social Security Income and Traditional IRA Distributions — If you are retired and drawing Social Security, remember that Social Security income does not become taxable until one-half of the Social Security income plus your other income exceeds $32,000 for a married couple, or $25,000 for most other filing statuses. Even if you don’t need the funds from an IRA distribution, it may be appropriate for you to withdraw enough from your IRA (or other qualified plans) so that your overall income closely matches the taxable Social Security threshold. Then, you can put those withdrawals away for a future major expense item or unexpected financial liability and avoid a large distribution in one year that would cause the SS to be taxed.
Rollover Errors — You are allowed to take a distribution from your IRA accounts, and the distribution won’t be taxable if the same amount is returned to your IRA within 60 days. However, you are allowed only one tax-free rollover in a 12-month period. So, unless you need the funds for just a short period, it is always best to arrange for a trustee-to-trustee transfer, for which there is no frequency limit, when you want to move IRA funds from one IRA to another.
Failing to Take a Required Minimum Distribution — If you have a traditional IRA, you must begin taking required minimum distributions (RMDs) from your IRA once you reach age 70½. Failure to do so can result in a penalty equal to 50% of the amount that should have been distributed. Luckily, at least so far, the IRS has been very liberal about waiving that penalty for almost any reasonable excuse when a request is made.
You can take out as much as you like each year, but it cannot be less than the RMD. If you withdraw more than the RMD, the excess can’t be applied to the following year’s RMD. The RMD amount for any year is the balance of your non-Roth IRA accounts on December 31 of the prior year divided by your remaining life expectancy. The remaining life expectancy is based upon the Uniform Lifetime Table, which appears in IRS Publication 590-B.
There is no requirement for the owner of a Roth IRA to take distributions, but the distribution requirements apply to the beneficiary of a Roth account after the owner passes away.
Understanding the Beneficiary Options — Beneficiaries of a traditional IRA where the decedent had already begun taking RMDs will also be subject to an RMD requirement, even if the beneficiary’s age is less than 70½ years. They must begin taking RMDs over the longer of the deceased owner’s life expectancy or the beneficiary’s remaining life expectancy. If there are multiple beneficiaries, the age of the oldest is used in the determination (but see the section on dividing an inherited IRA later). As an option, a beneficiary may elect to take the entire account at any time before the end of the fifth year following the year of the owner’s death.
If the decedent had not yet begun taking RMDs, the beneficiary can choose either to take the five-year payout or begin taking distributions over their lifetime. For lifetime payouts, the distributions must begin no later than Dec. 31 of the calendar year immediately following the calendar year during which the IRA owner died.
Knowing an Inherited IRA Can Be Divided — When an IRA has multiple beneficiaries, conflicting interests can arise. One beneficiary may want the money all up front, while another one may want to spread it out over time. There can also be conflicting investment strategies. In addition, the distribution period is determined using the oldest beneficiary’s age, which accelerates the payout. These conflicts can be avoided by dividing the account. The law allows an IRA to be divided into separate accounts for each beneficiary, thus giving each the opportunity to select the option that best suits his or her particular circumstances.
Understanding the Special Spousal Beneficiary Option — Spouse beneficiaries not only have the same options as other beneficiaries but also have the irrevocable option to treat the inherited IRA as their own, which is accomplished by re-titling the deceased spouse’s IRA or simply transferring the IRA balance to the surviving spouse’s own IRA. A surviving spouse may also be deemed as having elected to treat the IRA as his or her own if he or she fails to take RMDs as a beneficiary within the applicable deadline or if the surviving spouse makes contributions to the IRA.
Disclaiming an Inherited IRA — If you, as a beneficiary, do not want to inherit an IRA for some reason, the law allows a designated beneficiary to disclaim an inherited IRA and permits the naming of a new beneficiary by the executor of the estate.
Realizing Your Child Can Have an IRA — It may not even occur to parents or grandparents that if a child has income from working (earned income), they can contribute to an IRA. There is no minimum age requirement for establishing and contributing to an IRA. With the tax reform’s new higher standard deduction of $12,000 (2018) for singles, most children won’t even owe any taxes from their part-time or summer jobs, so the obvious choice for starting a retirement program for a child would be to contribute to a Roth IRA. However, most youngsters will balk at the idea, since retirement is the furthest thing from their minds at this stage of their life, and they will have other spending plans for their hard-earned money.
This is where parents, grandparents or others with the financial means can step in and gift the child the money to make an IRA contribution. The child’s contribution is limited to the lesser of their earned income or $5,500, the maximum contribution allowed for IRAs in 2018. Think what that Roth IRA contribution would be worth after 50 years of tax-free earnings accumulation.
Taking Advantage of IRA-to-Charity Distributions — Taxpayers age 70.5 and older can directly transfer up to $100,000 a year from their IRA to a qualified charity. They won’t get a charitable deduction, but instead — and even better — they will not have to pay taxes on the distribution, and because their AGI will be lower, they will benefit from other tax provisions that are pegged to AGI, such as the amount of Social Security income that’s taxable and the cost of Medicare B insurance premiums for higher-income taxpayers. As an additional bonus, the transfer also counts toward their annual required minimum distribution. If you want to take advantage of this tax benefit, be sure the transfer from your IRA to the qualified charity is a direct transfer from the IRA trustee to the charitable organization and that you get the required acknowledgment from the organization to substantiate the deduction.
If you have questions related to IRAs or the issues discussed, please give this office a call.
Kiddie Tax No Longer Based on Parents’ Tax Rate
- Parents Attempting to Shift Income to Children
- Kiddie Tax
- Tax Reform Changes
- Tax on Child’s Unearned Income
- Tax on Child’s Earned Income
Some years back, it was not uncommon for parents to put their investments in their dependent children’s names to take advantage of their children’s lower tax rates. Although the Uniform Gift to Minors Act legally made a child the owner of money put into his or her name, this didn’t stop parents from routinely putting their child’s name and social security number on the accounts so that the tax would be determined at the child’s lower marginal rate.
The IRS had no easy way to combat parents taking advantage of their children’s lower tax rates, so Congress came up with a unique way of taxing children’s investment income (unearned income) such as interest, dividends and capital gains. When this law was originally passed over 30 years ago, it only applied to children under age 14, but Congress expanded it over time to include children with unearned income under the age of 19 and full-time students under the age of 24 who aren’t self-supporting.
The way it worked prior to the 2017 tax reform, the first $1,050 of a child’s income was tax-free, the next $1,050 was taxed at just 10% and any unearned income above $2,100 was taxed at his or her parents’ higher tax rate. A child’s earned income (generally income from wages) was taxed at the single rate, and the child could use the regular standard deduction for single individuals ($6,350 in 2017) to reduce his or her taxable earned income. The computation got more complicated when the child’s siblings also had unearned income.
With tax reform, for years 2018 through 2025, the first $2,100 of the child’s unearned income is being taxed as before, with the first $1,050 being tax-free and the next $1,050 being taxed at 10%. However, instead of the balance being taxed at the parents’ tax rate, the balance is taxed at the income tax rates for estates and trusts, which for 2018 hits 37% when the balance of the unearned income reaches $12,500. The income tax rates for trusts and estates are illustrated below.
|2018 Federal Tax Rate Schedule – Estates & Trusts|
|If the taxable income is:||The tax is:|
|Over||But not over||Of the amount over|
|2,550||9,150||$255.00 + 24%||2,550|
|9,150||12,500||1,839.00 + 35%||9,150|
|12,500||3,011.50 + 37%||12,500|
On the bright side, tax reform increased the standard deduction for singles to $12,000 (2018), meaning that a child can make up to $12,000 of earned income tax-free. The standard deduction is inflation adjusted for future years.
Uncoupling the child’s return from the parents’ return also solved another problem. If a child had taxable unearned income, they previously would have to wait for the parents’ return to be prepared to know what the parents’ top tax rate was before the child’s return could be prepared. It was not uncommon for young adults, in a rush for their tax refund, to jump the gun and file their own return while ignoring the kiddie tax rules, only to have to amend their returns. That is no longer the case.
If you have questions, please give this office a call.
What Are The Penalties For Not Filing Your Tax Return?
Everybody knows the old saying about death and taxes, yet a surprising number of people fail to file an income tax return. If you’re one of those people and you think you’ll be able to slide by, you need to reconsider your position. Even if you’re unable to pay your taxes, you need to file a return. Not doing so will eventually lead to a domino effect of negative consequences.
No matter how many people have told you that it’s no big deal, or that the IRS has “bigger fish to fry” than you, the employees of the Internal Revenue Service have a job to do and a process that they follow. Even if no legal action is taken against you, failure to file a return will end up working against you. Let’s take a look at the rules regarding filing your taxes and the various outcomes that you risk:
Most are Required to File Tax Returns
If your income is less than the standard deduction and you don’t owe self-employment taxes, ACA penalties or refunds or qualify for a refundable credit, then you probably don’t have to file a tax return. However, these days with health and family assistance all tied to the tax return the number no required to file a return is shrinking. So just about all individuals, estates and trusts have to file a return and may have to pay taxes. Those are two different things, and there are penalties involved with ignoring or rejecting each of them. Even people who don’t have the money available to pay the tax that they owe are better off sending in a tax return rather than skipping the process. Here’s why:
- The IRS imposes a fee for not paying your taxes, and they impose a separate fee for not filing. The larger of the two is imposed for not filing – it’s 4.5%, compared to just 0.5% for not paying, and that fee gets charged every single month. You can end up paying up to 22.5% for failure to file and 25% for not paying (plus interest on unpaid taxes accrues from the return’s due date until you pay). The bottom line is that whether you can pay or not, you’ll save yourself big fees by submitting the required paperwork.
- In addition to incurring fees, consideration must also be given to the actions that the IRS takes when they haven’t received a tax return from a taxpayer. The process involves the preparation of a substitute return which will be completed without consideration of tax advantages, deductions or write-offs, which leads to a higher calculated amount owed than would be the case if you prepared and filed your return for yourself.
- The IRS is limited by a rule known as the “statute of limitations” that gives them just three years from the date that you file to perform an audit. The three-year clock starts when you file a return, so the sooner you get the paperwork in, the sooner your risk of being audited expires. That statute also applies to any refund you might have coming, after three from the date of filing you forfeit any refund. Beyond audit, if the IRS allows ten years from the date of your filing to go by without pursuing your taxes owed, they lose their ability to collect taxes, penalty or interest. The same is true of your ability to include your tax debt, interest debt or penalty debt in a Chapter 7 Bankruptcy discharge is based upon the date of your tax filing (generally two to four years after your tax return is filed).
What happens if you file your return without submitting the money you owe?
Once the IRS processes a return that is not accompanied by payment or discovers a taxpayer’s failure to file and pay taxes, they issue a Notice of Tax Due and Demand for Payment that will detail how much you owe in taxes, interest, and penalties. You are able to submit payment via cash, money order, credit card, check or electronic funds transfer, and the sooner you submit payment the better, as penalties and interest will continue to accumulate. If you don’t have the funds available, it is better to contact the IRS and discuss your problem with them than to ignore the notification. Options for resolving your payment issue include:
- Allowing a temporary delay. This is generally offered after a review of your situation, during which time the agency may file a Notice of Federal Tax Lien. This document will allow the government to put a placeholder on the amount that you owe them until such time that you are able to pay.
- Setting up an installment agreement. This allows you to make smaller monthly payments based on what you can afford.
- Settling through an Offer in Compromise. This is an agreement that is only possible after all other options have been exhausted, allowing you to pay a lower amount than what is owed. It is issued after a complete review of your financial situation and addresses penalties and interest along with the original tax amount itself. Reaching an Offer in Compromise requires filing an application that costs $150.
It’s important to remember that if you receive a tax bill that you think is incorrect, ignoring it is just as big a mistake as not filing a return. Instead, take positive action by contacting your local IRS office, taking all pertinent documentation along with you to prove your case.
The bottom line
Perhaps more important than all other reasons, you need to be aware that if you fail to file a tax return and you owe income tax, there is a possibility of consequences that go beyond the financial. You could end up vulnerable to criminal prosecution, as well as a whole lot of stress. By following the rules and staying in touch with the IRS, you’ll save yourself a huge headache, and a fair amount of money too.
States Sue U.S. to Void $10,000 Cap on State and Local Tax Deduction
- Four States Sue Federal Government
- High-Tax States
- Challenging the $10,000 Itemized Deduction for State and Local Taxes
- Charitable Deduction Work-Around
- Substance over Form
- Proposed IRS Regulations to Counter Work-Arounds
- Taxpayers Should Exercise Caution
Four states — New York, Connecticut, Maryland and New Jersey — have sued the federal government to void the tax-reform cap on the federal itemized deduction for state and local taxes, contending that limiting the deduction is unconstitutional. The taxes at issue include state and local income taxes, real property (real estate) taxes and personal property taxes.
These states — all Democratic (blue states), with some of the highest state and local tax rates in the nation — saw this deduction limitation as political retribution from the Republican-controlled Congress and have passed state legislation attempting to circumvent the tax reform provision limiting the federal itemized deduction for state and local taxes (SALT) to $10,000.
Both NY and NJ have created charitable funds that their state constituents can contribute to and allows them to receive a credit against their state and local taxes. NY’s legislation allows 85% of the amount contributed to the fund as a credit against taxes, while NJ allows 90%. The Connecticut law allows municipalities to create charitable organizations that taxpayers can contribute to in support of town services, from which they then receive a corresponding credit on their local property taxes. Each of these measures essentially circumvents the $10,000 limitation on SALT deductions.
However, two big questions are whether a donation for which a donor receives personal benefit is really a deductible charitable contribution and whether the state legislatures really thought this through. These work-arounds overlook one of the long-standing definitions of a deductible charitable contribution: the donor cannot receive any personal benefit from the donation.
Recently, the IRS waded into the issue with Notice 2018-54 and an accompanying news release, informing taxpayers that it intends to propose regulations addressing the federal income tax treatment of certain payments made by taxpayers to state-established “charitable funds,” for which the contributors receive a credit against their state and local taxes — essentially, the work-arounds adopted or proposed by the states noted above and others. In general, the IRS indicated that the characterization of these payments would be determined under the Code, informed by substance-over-form principles and not the label assigned by the state.
The proposed regulations will:
- “Make clear” that the requirements of the Code, informed by substance-over-form principles (see below), govern the federal income tax treatment of such transfers; and
- Assist taxpayers in “understanding the relationship between the federal charitable contribution deduction and the new statutory limitation” on the SALT deduction.
Substance over form is a judicial doctrine in which a court looks to the objective economic realities of a transaction, rather than to the particular form the parties employed. In essence, the formalisms of a transaction are disregarded, and the substance is examined to determine its true nature.
The implication of the IRS’s reference to the substance-over-form doctrine is likely that the formal mechanisms for implementing the state work-arounds — e.g., charitable contributions to “charitable gifts trust funds” — will not dictate their tax treatment. That is to say, the IRS will not recognize a charitable contribution deduction that is a disguised SALT deduction.
While the notice only mentions work-arounds involving transfers to state-controlled funds, another type of work-around has been enacted, and others have been proposed. In addition to the “charitable gifts trust funds” described above, New York also created a new “employer compensation expense tax” that essentially converts employee income taxes into employer payroll taxes. The IRS stated in Information Release 2018-122 that it is “continuing to monitor other legislative proposals” to “ensure that federal law controls the characterization of deductions for federal income tax filings.”
Allowing these work-arounds to stand would open Pandora’s Box to other schemes to circumvent the charitable contribution rules. For example, a church could take donations and then give the parishioner credit for the parishioner’s children’s tuition at the church’s school — something that is not currently allowed.
Have these states set their citizens up for IRS troubles if they utilize these work-arounds? Are these states now concerned that their work-arounds might not pass muster and will be ruled invalid after several years in the courts, so they are now pre-emptively suing the federal government?
Taxpayers in states with work-arounds should carefully consider all potential ramifications when deciding whether to get involved with something that could drag through the courts for years, with potential interest and penalties on taxes owed if (more likely, when) the IRS prevails.
Not Using QuickBooks Online? What You’re Missing Out On
If you dread every minute of the time you spend on accounting, you should know how QuickBooks Online can change your outlook.
How long would it take you to determine:
- What your total expenses for this quarter are?
- Whether or not your business is profitable as of today?
- How much you’ve sold every month this year?
- Which invoices are overdue?
If you’re using QuickBooks Online, you can get answers to all those questions—and more—in the time it takes you to sign on to the website.
That’s not an exaggeration. The first thing QuickBooks Online displays is what’s called its Dashboard. This is the site’s home page, which contains an array of charts and account balances that provide a quick overview of your finances. Click on an element here—say, a checking account balance—and you’ll be able to drill down and see the details behind it (in this case, an online account register). Click on the Expense graph, and a transaction report opens.
Your First Hours with QBO
QuickBooks Online is not one-size-fits-all. Its setup tools help you customize it to meet your own company’s needs.
QuickBooks Online works like other online productivity applications you may have used. It uses toolbars and buttons for navigation, drop-down lists and blank fields for data entry, and clickable links to open new related screens to trigger actions. Which is to say, the site is easy to use once you understand its structure. We can walk you through the early steps that are required, which involves tasks like:
- Using the provided setup tools to customize the site.
- Connecting QuickBooks Online to your bank and credit card company websites so you can work with transactions.
- Creating records for your customers, vendors, and the products and services you sell (you’ll be able to add new ones as your business grows).
- Learning about QuickBooks Online’s pre-built reports.
- Familiarizing yourself with the site’s workflow.
- Making the transition from your current accounting system.
How You’ll Benefit
Once you’re comfortable using QuickBooks Online, you’ll discover what millions of small businesses have already learned, that the site helps you:
Get paid faster. You can sign up with a payment processor to accept credit cards and direct bank withdrawals, which can speed up your customers’ responses to invoices. You’ll also be able to accept payments when you’re out of the office on your mobile devices.
Minimize errors. Once you enter data, QuickBooks Online remembers it. No more duplicate data entry that can cause costly mistakes.
Find any detail in seconds. QuickBooks Online has powerful search tools that allow you to find what you’re looking for quickly.
Better service customers. Because your customer profiles include transaction histories, you’ll be able to deal with questions and problems quickly and accurately.
Bill time as well as invoice products. QuickBooks Online supports sales of time-based services with capable time-tracking tools.
Improve your customers’ and vendors’ perception of you. Your business associates will know that you’re using state-of-the-art technology by the forms you share and the customer service you provide.
Save money and time. It does take some time to make the transition to QuickBooks Online. But you’ll quickly make that up with the hours you’ll save on accounting tasks, and be able to concentrate on tasks that improve your bottom line.
Be prepared to grow. Because all of your financial data is organized and easily accessible, you’ll be able to quickly generate reports that help you plan for a more profitable future. Banks and investors will need some of these if you decide to seek financing.
Although you may do the bulk of your accounting work on your desktop or laptop, you’ll have access to many of the site’s features on your smartphone. Your home page displays both an abbreviated version of your browser-based dashboard and a list of recent transactions. You can view, edit, and build new customer, vendor, and product or service records. Snap a photo of a receipt to document an expense and look up or create invoices, estimates, and sales receipts. Record payments, view critical reports, and add notes. Of course, your mobile data is always synchronized with the site itself.
QuickBooks Online lets you do much of your accounting work when you’re away from the office with its mobile app
Happy to Help
QuickBooks Online was designed for small businesspeople, not accountants. But it includes features that are best used in conjunction with our consulting services, like advanced reports, payroll, and the Chart of Accounts. In fact, the site makes it easy for us to have access to your data so we have the ability to monitor and troubleshoot.
We’ve helped countless sole proprietors and small businesses move their accounting operations to QuickBooks Online, and we’ve seen the difference it’s made in their productivity as well as their attitude toward financial management. Contact us, and we’ll be happy to do the same for you.
September 2018 Individual Due Dates
September 1 – 2018 Fall and 2019
Tax Planning Contact this office to schedule a consultation appointment.
September 10 – Report Tips to Employer
If you are an employee who works for tips and received more than $20 in tips during August, you are required to report them to your employer on IRS Form 4070 no later than September 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.
September 17 – Estimated Tax Payment Due
The third installment of 2018 individual estimated taxes is due. Our tax system is a “pay-as-you-go” system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the “pay-as-you-go” requirement. These include:
- Payroll withholding for employees;
- Pension withholding for retirees; and
- Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.
When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is equal to the federal short-term rate plus 3 percentage points, and the penalty is computed on a quarter-by-quarter basis.
Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than $1,000 (the de minimis amount), no penalty is assessed. In addition, the law provides “safe harbor” prepayments. There are two safe harbors:
- The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of what is owed in the current year, you can escape a penalty.
- The second safe harbor is based on the tax owed in the immediately preceding tax year. This safe harbor is generally 100% of the prior year’s tax liability. However, for taxpayers whose AGI exceeds $150,000 ($75,000 for married taxpayers filing separately), the prior year’s safe harbor is 110%.
Example: Suppose your tax for the year is $10,000 and your prepayments total $5,600. The result is that you owe an additional $4,400 on your tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can’t avoid the penalty under this exception.
However, in the above example, the safe harbor may still apply. Assume your prior year’s tax was $5,000. Since you prepaid $5,600, which is greater than 110% of the prior year’s tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.
This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc. Timely payment of each required estimated tax installment is also a requirement to meet the safe harbor exception to the penalty. If you have questions regarding your safe harbor estimates, please call this office as soon as possible.
CAUTION: Some state de minimis amounts and safe harbor estimate rules are different than those for the Federal estimates. Please call this office for particular state safe harbor rules.
September 2018 Business Due Dates
September 17 – S Corporations
File a 2017 calendar year income tax return (Form 1120S) and pay any tax due. This due date applies only if you requested an automatic 6-month extension. Provide each shareholder with a copy of K-1 (Form 1120S) or a substitute Schedule K-1.
September 17 – Corporations
Deposit the third installment of estimated income tax for 2018 for calendar year
September 17 – Social Security, Medicare and withheld income tax
If the monthly deposit rule applies, deposit the tax for payments in August.
September 17 – Nonpayroll Withholding
If the monthly deposit rule applies, deposit the tax for payments in August.
September 17 – Partnerships
File a 2017 calendar year return (Form 1065). This due date applies only if you were given an additional 5-month extension. Provide each partner with a copy of K-1 (Form 1065) or a substitute Schedule K-1.
September 17 – Electing Large Partnerships
File a 2017 calendar year return (Form 1065-B). This due date applies only if you were given a 6-month extension. March 15 was the due date for furnishing Schedules K-1 or substitute Schedule K-1 to the partners.