It is hard to believe that we are nearly halfway through 2018, but we hope that all of you are enjoying your summer! Many of you have asked about the 2018 Tax Reform which is the most extensive re-write of the Internal Revenue Code since 1986! Our staff at Proactive Accounting & Tax Services has been working diligently to analyze and familiarize ourselves with the final tax bill changes, however, much of the information available is still very unclear. In fact, the American Institute of CPAs has requested that the IRS release further explanation and guidance in most areas, especially regarding the 20% Business Deduction (Code Section 199A Deduction) and Meals and Entertainment deductibility. Unfortunately, the IRS has yet to release a response to this request.
In this article, we will attempt to highlight areas of the tax reform that may affect our clients and provide some guidance and expectations.
Tax Bracket Changes – Personal Filing Form 1040
The final bill kept the seven-bracket structure and mostly lowered the rates as compared to prior years. Remember that just because your tax bracket is, say 24%, your effective tax rate may be different. Your taxes are not calculated by simply taking your 24% tax rate by your total income, but rather it is tiered on different dollar levels of your income, which is also similar to prior years.
|Tax Rate||Single||Married Filing Jointly||Head of Household||Married Filing Separately|
|37%||Over $500,000||Over $600,000||Over $500,000||Over $300,000|
To assist in determining the correct amount withheld on your W-2 income if applicable, we recommend using the “Withholding Calculator”. The calculator results depend on the accuracy of information entered and should be used again when circumstances change (change of employment, new child, marriage, etc).
The “Withholding Calculator” can be found at https://apps.irs.gov/app/withholdingcalculator/
The higher standard deduction, which nearly doubled from prior years, appears to be a movement in simplifying this area of the personal Form 1040 return. The personal exemption has been eliminated. For example, a single filer would have been entitled to a $6,500 standard deduction and a $4,150 personal exemption in 2017, for a total of $10,650 in income exclusions. Under the new tax plan, the taxpayer would receive a $12,000 standard deduction. See the chart below for a comparison of current tax law to prior.
|Tax Filing Status||Previous Standard Deduction in 2017||New Standard Deduction in 2018|
|Married Filing Jointly||$13,000||$24,000|
|Married Filing Separately||$6,500||$12,000|
|Head of household||$9,350||$18,000|
INCREASE TO CHILD TAX CREDIT
While exemptions are eliminated, the offset for this change in the tax reform is the increase to the Child Tax Credit which doubles ($2,000 v prior $1,000) and is available for qualified children under the age of 17. It also increases the portion of the credit that is refundable to $1,400.
EDUCATION TAX BREAKS
The tax reform bill did not alter the Lifetime Learning Credit and Student Loan Interest Deduction, but it does expand the use of funds from 529 College Savings Plans to include levels of education other than college (such as grades K-12, tutoring, private schools, etc).
MORTGAGE INTEREST DEDUCTION
The mortgage interest deduction can only be taken on mortgage debt of up to $750,000 and only applies to mortgages taken after December 15, 2017. Pre-existing mortgages are grandfathered into the tax changes. Interest on home equity debt can be deducted, however, the debt must have been incurred to buy, build or substantially improve the taxpayer’s home that secures the loan.
SALT, which stands for “state and local taxes” is not eliminated, however, it is limited in your itemized deductions at $10,000. For instance, if your W-2 withheld state taxes for $3,000, local taxes for $1,200 and you paid in 2018 real estate taxes of $9,000 then your maximum itemized deduction is $10,000 even though the total paid for “state and local taxes” was $13,200 ($3,000 + $1,200 + $9,000).
Much of the current tax law was written to simplify areas that can be considered grey and complex. This includes eliminating the following deductions:
- Casualty and theft losses (except those attributable to a federally declared disaster)
- Unreimbursed employee expenses
- Tax preparation expenses and investment-related expenses
- Other miscellaneous deductions previously subject to the 2% AGI cap
- Moving expenses (except active duty military)
PIECE OF MIND
Itemizing may not be worthwhile for many taxpayers, even those who have been itemizing for years. For example, if a married couple has mortgage interest of $8,000, makes $4,000 in charitable contributions and pays $5,000 for state and local taxes equaling $17,000. When compared to the prior standard deduction of $13,000, it makes sense to itemize, however with the new standard deduction at $24,000, it is not justified to itemize.
It is important to note that most of these changes to the individual taxes are temporary and are set to expire after the 2025 tax year.
LONG-TERM CAPITAL GAINS / QUALIFIED DIVIDENDS TAXES
Long-Term Capital Gains / Qualified Dividends tax structure which applies to stock sales and sales of other appreciated assets has not changed significantly. Short Term Capital Gains (held for 12 months or less) are still taxed as ordinary income but taxed at the new income tax rates.
The three Long-Term Capital Gains thresholds are included below.
|Long-Term Capital Gains Rate||Single Taxpayers||Married Filing Jointly||Head of Household||Married Filing Separately|
|0%||Up to $38,600||Up to $77,200||Up to $51,700||Up to $38,600|
|20%||Over $425,800||Over $479,000||Over $452,400||Over $239,500|
The business tax implications of the tax reform are ambiguous and are the area of most concern to the AICPA, which is why they have requested further clarification from the IRS.
MEALS & ENTERTAINMENT: Our interpretation and stance at this point, without further definition from the IRS or Congress, is that business meals with clients, prospects and referral sources are NOT deductible starting for tax year 2018. We also believe that documentation of a substantial and bona fide business discussion will be important as any additional guidance from the IRS released in the future will likely signify that the “directly related” test be met for the 50% deduction to be allowed.
All entertainment including admission fees, tickets, food and beverages are 0% deductible unless they are…
- Expenses treated as compensation
- Reimbursed expenses
- Recreational, etc., expenses for employees
- Items available to public
- Entertainment sold to customers
- Expenses includible in income of persons who are not employees
PIECE OF MIND: It is imperative to structure your records and supporting documentation for these types of expenses to fall within the new reform guidelines to avoid missing deductions and/or taking deductions that are not allowed within the tax law as of 2018. Please refer to the additional attachment of examples which provide some clarity regarding the changes. Once the IRS or Congress releases further guidance, we will certainly do the same.
20% BUSINESS DEDUCTION: The 20% Business Deduction, officially titled Code Section 199A Deduction, is similar to the Domestic Activities Deduction, which was repealed in the 2018 Tax Reform. Basically, non-corporate taxpayers may deduct up to 20% of domestic qualified business income from a Partnership, S Corporation or Sole Proprietorship (pass through entities that give owners K-1s). This deduction is limited to wages paid or on wages paid plus a capital element and is phased out for taxpayers with taxable income above the outline thresholds (married filing jointly $315,000; all others types of filers$157,500).
Businesses involved in the performance of services in the fields of accounting, actuarial science, athletics, brokerage services, consulting, financial services, health, law, or performing arts cannot use the 20% Business Deduction unless the individual taxpayer’s income is less than the threshold provided above. K-1 reporting when processing the business returns of Partnerships and S Corporations will be more involved due to the need for information that will be entered into the personal return to calculate the deduction which is very different than prior year filings.
PIECE OF MIND: There are 3 important pieces to draw from our research
- There is more to come from the IRS and/or Congress with regards to defining certain types of industries and the form to calculate the credit.
- While we have all been calling it the 20% Business Deduction, it is not as simple as multiplying your K-1 income by 20% as there are 2 tiers of limitations.
- If you are a pass-through business owner who earns below the threshold, you get full access to the deduction regardless of your business’ industry. Above the thresholds, the deduction phases out.