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Navigating Tax Changes for Individuals & Businesses

Explore the impact of the Tax Cuts and Jobs Act on personal and business tax planning, including rates, deductions, and key changes for 2018. Analysis presented by Thomas M. Brinker, Jr., CPA. Understanding tax formulas and strategies for managing uncertainties.

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Navigating Tax Changes for Individuals & Businesses

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  1. FPA Northeastern New York ChapterOctober 18, 2018 Planning in Our Uncertain Tax Environment With a Focus On Individuals and Their Businesses (under the Tax Cuts and Jobs Act)Presented by:Thomas M. Brinker, Jr., LL.M., CPAProfessor of AccountingArcadia University

  2. Tax Formula for Individuals for 2017 Income (broadly conceived) - Exclusions = Gross Income - Deductions for AGI = AGI - the larger of: (a) itemized deductions or (b) the standard deduction - personal & dependency exemptions = Taxable Income Tax on Taxable Income less Credits and Prepayments = Taxes payable or refund due

  3. 2018 & 2013-17 Income Tax Rates • Individual Income: • 2018: 10%, 12%, 22%, 24%, 32%, 35%, and 37% • 2013-17: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% • Long-term Capital Gains and Qualifying Dividends: • 2010-12: 0% and 15% and 2013-18: 0%, 15% and 20%* • *(Rates apply at pre-Act breakpoints: i.e., $425,800 for Single, $452,400 for HH, and $479,000 for MFJ for 20% rate) • The Tax Cuts and Jobs Act of 2017 imposes a lower rate of 37% for 2018 on Taxable Income exceeding: • Single: $500,000; MFJ: $600,000; HH: $500,000 for 2018 • Single: $418,400; MFJ: $470,700; HH: $444,550 for 2017 (39.6%) • As of 2013, the maximum tax rate on long-term capital gains & qualifying dividends for TPs is 23.8% (3.8% Medicare surtax on net investment income).

  4. 2018 Capital Gains Tax Rates LTCG S MFJ HH MFS 0 $0 to $38,600 $0 to $77,200 $0 to $51,700 $0 to $38,600 15% …to $425,800 …to $479,000 …to $452,400 …to $239,500 20% >$425,800 >$479,000 >$452,400 >$239,500 *Short-term capital gains are taxed as ordinary income, but these tax brackets and rates will change. Also, the capital gains income thresholds do not match up perfectly with the tax brackets initially proposed for 2018…

  5. The Tax Cuts and Jobs Act of 2017 Key Individual Changes For 2018… --Standard deduction: The Act increases the standard deduction through 2025 for individual taxpayers to $24,000 for married taxpayers filing jointly, $18,000 for heads of households, and $12,000 for all other individuals. The additional standard deduction for elderly and blind taxpayers is retained. --Personal exemptions: Suspended as of 2018 through 2025. --The Affordable Care Act’s 3.8% net investment income tax and the 0.9% additional Medicare tax that apply to higher-income individuals was retained, as well the alternative minimum tax on individuals…

  6. The Tax Cuts and Jobs Act of 2017 • Significant Change for the Child Tax Credit! • The Tax Cuts and Jobs Act increases the child tax credit from $1,000 to $2,000 per child and increases the refundable portion of the credit to $1,400. The Act provides a $500 nonrefundable credit for a qualifying dependent other than a qualifying child (i.e., a 17 year old child or a parent). The Act also increases the phase-out threshold adjusted gross income levels for claiming the credit, to $400,000 from $110,000 (2017) for joint filers (MFJ) and $200,000 from $75,000 for S/HH and $55,000 for MFS (2017).

  7. The Tax Cuts and Jobs Act of 2017 Key Individual Changes For 2018… --Mortgage interest: The home mortgage interest deduction is modified and reduces the limit on acquisition indebtedness to $750,000 (from prior law’s $1 million - However, refinancing loan after December 15, 2017 for property purchased before such date does not change the $1 million maximum). --Home equity loans. The home equity loan interest deduction is suspended through 2025. --State and local taxes: Individuals are allowed to deduct up to $10,000 ($5,000 for those MFS) in state and local income or property taxes (not foreign real estate taxes). --Alimony: For any divorce or separation agreement executed after December 31, 2018, or executed before that date but modified after it, alimony and separate maintenance payments are not deductible by the payor spouse and are not included in the income of the payee spouse.

  8. The Tax Cuts and Jobs Act of 2017 Key Individual Changes For 2018… --Charitable contributions: The Actincreases the income-based percentage limit for charitable contributions of cash to public charities to 60% of AGI. It also denies a charitable deduction for payments made for college athletic event seating rights. --Miscellaneous itemized deductions: All miscellaneous itemized deductions subject to the 2% floor are suspended through 2025. --Medical expenses: The Act reduces the threshold for deducting medical expenses to 7.5% of adjusted gross income for both the regular tax and AMT calculations for 2017 and 2018, and returns the threshold to 10% of AGI in 2019.

  9. The Tax Cuts and Jobs Act of 2017 The individual AMT was not repealed...The Act temporarily increases the AMT exemptions through 2025 to $109,400 for joint filers ($70,300 for singles and $54,700 for MFS) and raises the exemption phase-out levels to $1,000,000 for joint filers and $500,000 for others!

  10. 2017 Definitions of “Rich” Income Earners • Super Rich: $418,400 Single and $470,700 MFJ TIs ...Highest brackets (39.6% Ordinary Income and 20% for LTCG/Qualifying Dividends) • Medium Rich: $261,500 Single and $313,800 MFJ AGIs …Phase-out begins of personal exemptions and itemized deductions • Poor Rich: $200,000 Single and $250,000 MFJ AGIs …additional 3.8% Medicare Surtax on Net Investment Income • Social Security Wage Base is $127,200 for 2017.

  11. 2018 Definitions of “Rich” Income Earners • Super Rich: $500,000 Single and $600,000 MFJ TIs ...Highest brackets (37% Ordinary Income and 20% for LTCG/Qualifying Dividends) • Suspension of personal exemptions and phase-out of itemized deductions suspended for 2018 through 2025! • Poor Rich: $200,000 Single and $250,000 MFJ AGIs …additional 3.8% Medicare Surtax on Net Investment Income • Social Security Wage Base increased from $127,200 to $128,400 for 2018

  12. 2013 Health Care Reform Changes • .9% Medicare Tax on Compensation and/or Self Employment Income in excess of $200,000 for individuals, and $250,000 for married couples filing jointly. • 3.8% Medicare Tax on Investment Income; applies to the lesser of: net investment income, or the excess of modified adjusted gross income (AGI) over the threshold amount ($200,000 for single individuals or heads of households; $250,000 for married couples filing jointly; and $125,000 for married couples filing separately). • Higher Threshold for Medical Expense Deductions (was 10%...now 7.5% for 2017 and 2018 under new Act!) • $2,650 Cap on Health Care FSA Contributions for 2018 (was $2,600 for 2017)

  13. Health Care Alert: the Combined Impact of a Broader Medicare Tax Base! Example: Cliff and Julia are married and have a 2017 modified AGI of $650,000, including $500,000 in wages, investment income of $50,000, and the sale of their principal residence for a $600,000 gain in 2017 (only $100,000 is taxable due to the Sec. 121 exclusion). Result - An additional tax of $7,950: (i) the “Additional Medicare Tax on Wage Earners” of .9% of $250,000 or $2,250, plus (ii) the “Unearned Income Medicare Contributions Tax” of 3.8% of $150,000 or $5,700.

  14. Filing Status Marriage Penalty Relief? • JGTRRA of 2003 originally provided relief for 2003 and 2004 ONLY!* • Increased Basic Standard To 2X Basic Standard Deduction for Singles • Increased Size of 15% Tax Bracket for MFJs to 2X the width of the 15% Tax Bracket for “Single” Filer (Parity now applies thru 35% tax bracket) • *The American Taxpayer Relief Act permanently extended the JGTRRA of 2003’s “doubling of the Standard Deduction” and 15% Tax Bracket. What is the impact of the Tax Cuts and Jobs Act?

  15. Exemption Standard Deduction Amounts Amount Year MFJ HH S MFS $4,050 2017 $12,700 $9,350 $6,350 $6,350 0 2018 24,000 18,000 12,000 12,000 *Additional Standard Deduction for individuals elderly or blind has been retained under 2017’s Tax Cuts and Jobs Act… Exemption vs. Standard Deduction Exemption Basic support should not be taxed Standard Deduction To simplify tax administration

  16. Additional Standard Deductionsfor Elderly or Blind Elderly or Blind Married Unmarried 2017 1,250 1,550 2018 1,300 1,600

  17. Filing Status Has Marriage Penalty Relief Improved? • Example: John and Mary, a power couple earning $450,000 each and having individual Taxable Incomes of $443,650 in 2017 and $438,000 in 2018 (AGI less Standard Deduction – no exemption in 2017 nor 2018) are contemplating marriage. • Single v. MFJ in 2018: Single: $128,989.50 each ($257,979 combined) or MFJ: $263,499 for a marriage penalty of only $5,520! (Occurs at 37% tax bracket!) • For 2017…the marriage penalty was $33,593.10 on $887,300 ($900,000 less a Standard Deduction of $12,700 or $296,601.60 less $263,008.50 if Single)! • This excludes any Medicare surtaxes…both on earned income and investment income ($200,000 S v. $250,000 MFJ)!

  18. The Tax Cuts and Jobs Act of 2017 Some Observations on Business Changes for 2018… --Corporate Tax Rates are now significantly below Individual Tax Rates (21% vs. 37%) --Single Tax Rate is 21%, including Personal Service Corporations...no progression of rates! --An all inclusive corporate tax rate with corporate dividends or capital gains is slightly lower than maximum individual tax rate. --Pass-Thru Effective Rate for Qualifying Business Income is now lower than normal ordinary individual income rates for salary and portfolio income (29.6% vs. 37%)

  19. The Tax Cuts and Jobs Act of 2017 Key C-Corporation Business Changes for 2018… --35% top corporate rate reduced to 21% --Dividends Received Deduction of 80% (20% or more owned) and 70% (<20% owned) reduced to 65% and 50% --Corporate AMT repealed --NOLs limited to 80% of taxable income. Unlimited carryforward, but no carryback for losses originating after December 31, 2017 (except for farmers). --Eliminates Domestic Production Activities Deduction, Non-Real Property Like-Kind Exchanges, and Entertainment Deduction (Meals @ 50%)

  20. The Act’s Impact on Entertainment Expenses (1/1/18) • The new law eliminates the deduction for entertainment expenses, including activities such as taking a client or a prospect to sporting events, the theater, movies, concerts, and amusement parks. The Act also eliminates deductions for expenses incurred for entertainment facilities (for example, a stadium suite or skybox) and for amounts paid for membership in any club organized for business, pleasure, recreation, or social purposes. The deduction for meals purchased during entertainment activities is also eliminated.

  21. The Act’s Impact on Meals (1/1/18) • Meals with clients, customers, or prospects at an entertainment activity (for example, meals at a sporting event): Nondeductible Originally (50% Deductible if purchased or stated separately – IRS Update as 10/18) • Meals with clients, customers, or prospects with substantial business discussions: 50% Deductible • Meals with clients, customers, or prospects without substantial business discussions: Nondeductible • On-premise meals provided for the convenience of the employer (such as lunch or dinner provided to employees while working): 50% Deductible • Meals in office during meetings and meals while traveling on business: 50% Deductible • Holiday party or similar social events for employees: 100% deductible

  22. The Tax Cuts and Jobs Act of 2017 Example: 2017 Tax C-Corporation and Shareholder The Smith Corporation has $100 of Taxable Income and pays tax at 35% or $35, leaving $65 to be distributed as a dividend to its sole shareholder. The tax rate applicable to the dividend is 20% with a corresponding tax of $13 on the shareholder’s individual tax return. In addition, the shareholder incurs a 3.8% Medicare Surtax on the $65 dividend of $2.47. Total Taxes paid: $50.47 (for an all inclusive federal tax rate of 50.47% in 2017) *Assumption: highest applicable tax rates used.

  23. The Tax Cuts and Jobs Act of 2017 Example: 2018 Tax C-Corporation and Shareholder The Smith Corporation has $100 of Taxable Income and pays tax at 21% or $21, leaving $79 to be distributed as a dividend to its sole shareholder. The tax rate applicable to the dividend is 20% with a corresponding tax of $15.80 on the shareholder’s individual tax return. In addition, the shareholder incurs a 3.8% Medicare Surtax on the $79 dividend of $3. Total Taxes paid: $39.80 (for an all inclusive federal tax rate of 39.80% in 2018) *Assumption: highest applicable tax rates used.

  24. The Tax Cuts and Jobs Act of 2017 Example: 2018 Tax C-Corporation and Shareholder Planning: The Smith Corporation can decide to defer or perpetually postpone the declaration of the dividend by reinvesting the cash in the business, reducing total current tax liability to $21 (the sole shareholder can simply leave the shares in his/her estate avoiding both the capital gains and Medicare taxes). --Both the capital gains rate of 20% and Medicare Surtax rate of 3.8% can be reduced and/or avoided if recipients are in lower tax brackets.

  25. The Tax Cuts and Jobs Act of 2017 Key Business Changes for 2018… Depreciation Changes: --100% Bonus depreciation (was 50%) for property placed in service after September 27, 2017, and before January 1, 2023 for both new and used business property (only applied to “new property” prior to the Act). Can create NOL! --Vehicle depreciation: The Act increases the annual caps as follows: Year 1) $10,000 (from $3,160); Year 2) $16,000 (from $5,100); Year 3) $9,600 (from $3,050); and for subsequent years $5,760 (from $1,875) until recovered. These amounts are indexed for inflation after 2018. --Section 179 expensing increased to $1 million (up from $500,000 prior to indexing) with the phase-out beginning at $2.5 million (up from $2 million prior to indexing).

  26. The Tax Cuts and Jobs Act of 2017 Key Pass-Thru Business Changes for 2018… --Historically, owners of partnerships, S corporations, and sole proprietorships paid tax at individual tax rates…as high as 39.6% --The Act provides a 20% deduction for qualified business income (QBI) from a partnership, S corporation, or sole proprietorship. Generally, the deduction is on the lesser of: • the “combined QBI” of the taxpayer, or • 20% of the excess, if any, of the taxpayer’s taxable income for the year over net capital gains. (Sec. 199A(a), Act Sec. 11011) The 20% deduction combined with the new top ordinary rate of 37% results in a top rate of 29.6 % for such income in the absence of other limitations (80% times 37% = 29.6%).

  27. The Tax Cuts and Jobs Act of 2017 Key Pass-Thru Business Changes for 2018… --QBI is generally defined as the net amount of “qualified items of income, gain, deduction, and loss” relating to any trade or business of the taxpayer. (Sec.199A(c)(1) --The “combined QBI amount” means, for any tax year, an amount equal to: (i) the deductible amount for each qualified trade or business of the taxpayer (defined as 20% of the taxpayer’s QBI subject to the W-2 wage limitation; see below); plus (ii) 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income of the taxpayer for the tax year. (Sec. 199A(b)) NOL carryforwards reduce the “combined QBI amount”

  28. The Tax Cuts and Jobs Act of 2017 Key Pass-Thru Business Changes for 2018… If taxable income exceeds $415,000 MFJ or $207,500 for others, the deduction cannot exceed the greater of: (1) 50% of the W-2 wages with respect to the qualified trade or business; or (2) the sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all ‘‘qualified property.’’ --Item 2 appears to benefit individuals owning businesses with large real estate holdings but having few actual employees. --The 20% deduction is NOT allowed in computing AGI (nor reducing self-employment income), but rather as a deduction reducing taxable income. (Sec. 62(a))

  29. The Tax Cuts and Jobs Act of 2017 Key Pass-Thru Business Changes for 2018… --Caveat: The 20% deduction does NOT apply to specified service businesses, such as lawyers, doctors, accountants, and consultants, and trades or businesses that involve the performance of services that consist of investment-type activities, but excludes engineering and architecture. --However, the deduction will apply to taxpayers with taxable income below $315,000 for MFJ and $157,500 for others. The deduction for service businesses is phased out over the next $100,000 of taxable income for MFJ ($50,000 for others). (Sec. 199A(d)). Thus, for 2018, the limit fully applies to married taxpayers with taxable income over $415,000 and others with taxable income over $207,500. --The deduction does not apply to an employee (and includes S-Corp S/H compensation and a Partner’s guaranteed payment)

  30. The Tax Cuts and Jobs Act of 2017 Key Pass-Thru Business Changes for 2018… Sec. 1202(e)(3)(A) defines a specified service business “as any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees” (or owners). What does this mean? Proposed Regulations on August 8, 2018 provided clarity…

  31. The Tax Cuts and Jobs Act of 2017 Proposed § 1.199A-5: • What does “REPUTATION OR SKILL” mean? – “(1) receiving income for endorsing products or services, including an individual’s distributive share of income or distributions from a relevant pass-thru entity or RPE for which the individual provides endorsement services; – (2) licensing or receiving income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity, including an individual’s distributive share of income or distributions from an RPE to which an individual contributes the rights to use the individual’s image; or – (3) receiving appearance fees or income (including fees or income to reality performers performing as themselves on television, social media, or other forums, radio, television, and other media hosts, and video game players).”

  32. The Tax Cuts and Jobs Act of 2017 A Thought: Key Pass-Thru Business Changes for 2018… For joint filers with taxable income below $315,000 (and $157,500 for others), the 20% deduction will apply. Many lawyers, doctors, accountants, and consultants have taxable income under $315,000… For two married lawyers, doctors, accountants, and consultants each earning $150,000, the total deduction will be $60,000…resulting in an income tax savings of about $15,000! …The following QBI Deduction example formats were adopted in part from Keebler & Associates, LLP

  33. The Tax Cuts and Jobs Act of 2017 Example 1: Sole Proprietorship-Below Phase-Out Range Talene, single and a sole proprietor owns a bagel shop in Delaware County. The shop nets $100,000 in 2018. Talene has $22,000 of other income and will take the standard deduction of $12,000 in 2018. Net Business Income: $100,000 Other Income 22,000 AGI $122,000 Less: Standard Deduction -12,000 Taxable Income $110,000 QBI Deduction: $20,000 (lesser of 20% of net business income or 20% of taxable income)

  34. The Tax Cuts and Jobs Act of 2017 Example 2: Sole Proprietorship-Above Phase-Out Range Talene, single and a sole proprietor owns several bagel shops in Delaware County. The shop nets $500,000 in 2018. Talene has $22,000 of other income and has $30,000 in itemized deductions ($10,000 SALT and $20,000 to Charity). In addition, the business has $125,000 of W-2 wages & $100,000 of assets (unadjusted basis). Net Business Income: $500,000 Other Income 22,000 AGI $522,000 Less: Schedule A -30,000 Taxable Income $492,000 QBI Deduction: $62,500 - Lesser of: 20% of net business income ($100,000)or 20% of TI($98,400), NOT to exceed the greater of 50% W-2 wages ($62,500) or 25% W-2 wages plus 2.5% assets ($33,750)

  35. The Tax Cuts and Jobs Act of 2017 Example 3: S-Corp Shareholder in a Service Business (Below Phase-Out Range) Alex, married and a 25% owner of the ABCD law firm has $100,000 of pass-thru income in 2018. Alex and his wife have $40,000 of other income and expect to take the standard deduction ($24,000) in 2018. Net Business Income: $100,000 Other Income 40,000 AGI $140,000 Less: Standard Deduction -24,000 Taxable Income $116,000 QBI Deduction: $20,000 (lesser of 20% of net business income or 20% of taxable income)

  36. The Tax Cuts and Jobs Act of 2017 Example 4: S-Corp Shareholder in a Service Business (Above Phase-Out Range) Alex, married and a 25% owner of the ABCD law firm has $600,000 of pass-thru income in 2018. Alex and his wife have $50,000 of other income and expect to take the standard deduction ($24,000) in 2018. Net Business Income: $600,000 Other Income 50,000 AGI $650,000 Less: Standard Deduction -24,000 Taxable Income $626,000 QBI Deduction: ZERO (Completely phased-out because Alex is in a service business and his net income is above the phase-out range for married taxpayers)

  37. The Tax Cuts and Jobs Act of 2017 Example 5: Partner in a Real Estate Partnership (Below Phase-Out Range) Johnny, single and a 40% partner in Reel-S-Tate, LP (rental r/e ptrshp) has $125,000 of pass-thru net business income in 2018. Johnny has $18,000 of other income and will take the standard deduction of $12,000 in 2018. Net Business Income: $125,000 Other Income 18,000 AGI $143,000 Less: Standard Deduction -12,000 Taxable Income $131,000 QBI Deduction: $25,000 (lesser of 20% of net business income or 20% of taxable income)

  38. The Tax Cuts and Jobs Act of 2017 Example 6: Partner in a R/E Ptrshp-Above Phase-Out Range Johnny, single and a 40% partner in Reel-S-Tate, LP (rental r/e ptrshp) has $725,000 of pass-thru net business income in 2018. Johnny has $38,000 of other income and will claim itemized deductions of $60,000 ($10,000 SALT and $50,000 in Charity) in 2018. In Addition, Reel-S-Tate, LP has $120,000 of W-2 wages and $4,000,000 of assets (unadjusted cost basis). Net business income $725,000 Other income 38,000 Adjusted gross income $763,000 Less: Schedule A 60,000 Taxable income $703,000 QBI Deduction: $130,000 - Lesser of: 20% of net business income ($145,000)or 20% of TI ($140,600), NOT to exceed the greater of 50% W-2 wages ($60,000) or 25% W-2 wages plus 2.5% assets ($130,000)

  39. The Tax Cuts and Jobs Act of 2017 “Not So Straight Forward Example” Thomas is single and has taxable income of $187,500 in 2018 of which $150,000 is attributable to his SMLLC CPA practice after incurring employee wages of $100,000. Thomas’s practice has $80,000 in depreciable property. Thomas is in the 60% phase-out range ($187,500 is $30,000 above the $50,000 phase-out range …$157,500 to $207,500). Therefore, only 40% is available. Step One: 20% of $187,500 taxable income or $37,500.

  40. The Tax Cuts and Jobs Act of 2017 “Not So Straight Forward Example” Step Two: For QBI, Thomas only considers $60,000 ($150,000 times 40%). In determining includible W-2 wages, only $40,000 is relevant ($100,000 times 40%). The alternative test involving tangible personal property will not provide a better result (i.e., 25% of W-2 wages plus 2.5% of basis or $12,000). The calculation is completed by taking the lesser of 20% of $60,000 or 50% of $40,000, resulting in a potential deduction of $12,000. Step Two shows a $12,000 deduction which is less than Step One’s $37,500. Therefore, the QBI Deduction is $12,000 for 2018. This example is based on the Senate Committee Report after adjusting for changes made by the Conference Committee.

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