Iain Howe, CPA & Associates, PLLC
Iain Howe, CPA & Associates, PLLC

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NEW SALES TAX NEXUS RULES

 

The Supreme Court recently ruled in the matter of South Dakota v. Wayfair in a case that has a huge impact for businesses that sell products online, both tangible products and intangible items such as software, SAAS, services, etc.

 

Prior to this ruling, a business in Texas could sell products online to a customer in Oklahoma and would not be required to collect and remit sales tax to Oklahoma if the Texas-based business never physically entered into Oklahoma to sell their product. This rule has changed. Now, a Texas-based business selling to a customer in another state must collect and remit sales taxes to that state even if the business did not physically enter that state. However, there are some exceptions.

 

States realize that this could put a huge burden on smaller businesses which may only have a few sales into a state other than the one in which they are physically present. Therefore, states have generally said that if you have less than $100,000 of sales into their state within the year or have less than 200 separate transactions into their state within the year, there is no requirement to collect and remit sales tax.

 

Note that each state has different thresholds. For example, Oklahoma has a threshold of $10,000 whereas Tennessee has a threshold of $500,000 which Massachusetts has a threshold of $500,000 in sales AND 100 or more transactions.

 

A good write-up can be found here:  https://blog.taxjar.com/economic-nexus-laws/ which also includes a break-down of each state’s threshold levels in addition to the dates these new threshold rules became or will become effective. There are also some good calculators available and links to each state’s specific rule and revenue departments if you are required to register your business within those states.

 

What this means for 2018 tax preparation?

 

For 2018 tax preparation, if you are a business in Texas, for example, which has historically only operated within Texas and sourced all revenues as Texas-based, but had revenues from other states, the revenue earned for 2018 will need to be broken out by state. Additionally, you may also need to track transactions by state to see if you exceed any of the state thresholds.

 

To prepare for year-end and 2018 tax filings, we strongly encourage you to have someone within your organization review the above rules and review your revenue and transaction numbers by state to determine if you have a requirement to collect sales taxes and register within those states.

 

How could this impact state income tax filings?

 

A business’s requirement to file an income tax return for any given state has historically been protected under P.L. 86-272 which states generally that if a business merely has solicitation of sales within a state but is not physically present within that state, that state cannot require that business to file an income tax return. However, some states have looked to an economic nexus standard which says that if a business receives over a certain amount of revenue from a state, or if that revenue represents a certain percentage of total company sales, the state will require the company to file an income tax return within their state. These thresholds are generally higher than the thresholds mentioned above for sales tax nexus. For example, California required sales in excess of $561,951 or 25% of total corporate sales under their economic nexus standard for 2017.

 

However, as states begin to collect sales taxes from businesses based on the lower sales tax thresholds above, their departments of revenue will have company information on file and therefore it may become more likely that those states will also challenge the business’s requirement to submit income tax returns in their state as well.

 

2018 Tax Return filings

 

We have been keeping an eye on these new rulings, the thresholds for each state, and the new rulings being announced by each state. While preparing your 2018 business tax return, we may have additional questions regarding state sales to determine if your business is in compliance with these new sales tax and income tax nexus rules. The likelihood is the questions we will be asking is did you exceed any of the sales tax thresholds in any state you sell into, whether that is the sale of tangible goods or intangible services.

 

Since these new sales tax rules have just recently been made effective by most states or will become effective as of January 1, 2019, we strongly suggest reviewing the link above to determine what the reporting thresholds are for any states that your business sells into.

 

Questions?

 

If you have questions regarding these new rules/standards or whether or not your business may have a requirement to register within a state to collect and remit sales taxes, or if you have questions about the potential for additional state income tax return filings, please contact us.

SUMMARY: FINAL TAX REFORM BILL

 

We don’t mean to take any of the fun away from you, but we went ahead and read the entire Tax Reform Bill and summarized it below. Apologies if you were intending to read it yourself – hope we don’t spoil the ending!

 

Here are the main points:

 

NEW TAX BRACKETS

 

MARRIED FILING JOINT

     
       

If taxable income is:

   

The tax is:

Not over $19,050

   

10% of taxable income

Over $19,050 but not over $77,400

   

$1,905, plus 12% of the excess over $19,050

Over $77,400 but not over $165,000

   

$8,907, plus 22% of the excess over $77,400

Over $165,000 but not over $315,000

   

$28,179, plus 24% of the excess over $165,000

Over $315,000 but not over $400,000

   

$64,179, plus 32% of the excess over $315,000

Over $400,000 but not over $600,000

   

$91,379, plus 35% of the excess over $400,000

Over $600,000

   

$161,379, plus 37% of the excess over $600,000

       

SINGLE

     
       

If taxable income is:

   

The tax is:

Not over $9,525

   

10% of taxable income

Over $9,525 but not over $38,700

   

$952.50, plus 12% of the excess over $9,525

Over $38,700 but not over $82,500

   

$4,453.50, plus 22% of the excess over $38,700

Over $82,500 but not over $157,500

   

$14,089.50, plus 24% of the excess over $82,500

Over $157,500 but not over $200,000

   

$32,089.50, plus 32% of the excess over $157,500

Over $200,000 but not over $500,000

   

$45,689.50, plus 35% of the excess over $200,000

Over $500,000

   

$150,689.50, plus 37% of the excess over $500,000

 

 

FOR INDIVIDUALS

 

  • After you calculate gross income, you would either subtract your standard deduction amount ($6,350 in 2017 or $12,700 if married) or calculate your itemized deductions (mortgage interest, property taxes, charitable contributions, and medical expenses & miscellaneous deductions if they are above the 10% and 2% hurdles, respectively) and generally subtract your itemized deductions if they were higher than your standard deduction. From that amount, you would then subtract your personal exemptions (yourself, spouse if married, and # of dependents x $4,050). There are a few changes taking effect for 2018:
    • The standard deduction will now be almost double, at $12,000 for Single filers and $24,000 for Married Filing Joint (MFJ) filers
    • The will no longer be a personal exemption (absorbed into the higher standard deduction)
    • Itemized deductions will be limited in the following ways:
      • The deduction for property taxes on your principal residence and second home, state income taxes, personal property taxes, and sales taxes cannot exceed $10,000 (so pay property taxes before year-end 2017)
      • Mortgage interest on new mortgage loans is only deductible on up to $750,000 of mortgage debt (pre-existing mortgages are grandfathered at the $1,000,000 level, even if you refinance)
      • Home equity interest is no longer deductible unless it was a loan taken out before 12/15/17 to purchase, construct, or improve your residence and is secured by your residence.
      • Medical expenses were previously subject to a hurdle based on 10% of your adjusted gross income (only the portion above 10% was deductible); however, for 2017 and 2018, that hurdle is lowered back to 7.5%
      • Unreimbursed employee expenses, tax preparation fees for individuals, investment advisor fees, safe deposit box fees, and other items subject to the 2% miscellaneous itemized deduction hurdle are no longer deductible
      • The limit on charitable contributions is now based on 60% of your income (was previously 50%)
      • The Pease limitation is removed (meaning there is no longer a phase-out of itemized deductions based on your gross income, except as it applies to medical expenses)
    • Planning: If your standard deduction of $24,000 (if married) will exceed your itemized deductions in 2018, consider paying property taxes in December 2017 vs. January 2018, and make your planned charitable contributions before year-end 2017 instead of in 2018. You will generally be offsetting higher tax dollars in 2017 than in 2018. If you plan on giving to a charity over a number of years, consider contributing to a Donor Advised Fund before year-end 2017. You receive the deduction in 2017 for the amount contributed to the fund, but can then distribute from the fund over the next few years.
  • Alternative Minimum Tax (AMT) is a tax that is calculated in addition to your regular income tax. AMT adds back certain “preference” items such as property taxes, sales taxes, incentive stock option gain on exercise, recalculated depreciation, etc. These adjustments determine your AMT income; however, there is an AMT exemption of $54,300 ($84,500 if MFJ), so unless your preference items are high, you most likely will be able to avoid AMT. Your refigured AMT income tax is compared to your regular income tax, and if AMT is higher than regular, an AMT adjustment is added to your tax return to increase your overall tax owed. For 2018, the AMT exemption increases to $70,300 ($109,400 if MFJ). The phase-out (taxable income level at which you begin to lose the exemption) is increased to $500,000 ($1,000,000 if MFJ).
  • Child tax credits of $1,000 per child are available for dependent children under age 17 at year-end, but begin to phase-out when your income exceeds $75,000 ($110,000 if MFJ). For 2018, the child tax credit increases to $2,000 per child under 17, and the phase-out income level increases to $200,000 ($400,000 if MFJ). An additional benefit is that up to $1,400 of the credit is refundable beginning in 2018, meaning even if you owe no tax, you may still receive a refund because of the credit.
  • Alimony payments are no longer picked up in income, nor are they deductible.
  • No deduction available for personal theft or casualty losses unless the loss was incurred in relation to a federally-declared disaster.
  • If you took a distribution from a retirement plan in 2016 or 2017 because you sustained an economic loss related to a federally-declared disaster, the 10% penalty is waived.
  • Roth recharacterizations are no longer allowed. If you converted a traditional IRA to a Roth IRA, but then the value of your portfolio decreased, you had the opportunity to recharacterize your Roth IRA back to a traditional IRA. This can no longer be done. Once you convert to a Roth, you are stuck with a Roth even if the value of your portfolio later decreases.
  • Moving expenses are no longer deductible for individuals, nor is the amount excludible from income if your employer reimburses you for your moving expenses. Exception applies if you are on active military duty.
  • Section 529 plans can pay out up to $10,000 per year per student, and can be used for public, private or religious schools.
  • The Affordable Care Act penalty for not having health insurance still applies in 2018, but the penalty goes to zero for 2019 and beyond.
  • There were no changes to the rules related to excluding gain on the sale of your principal residence; therefore, as long as you live in your home for 2 of the last 5 years prior to sale, your gain of up to $250,000 on the sale ($500,000 if MFJ) is generally tax-free. (There was talk of increasing the requirement to 5 of the last 8 years prior to sale, but this provision was eliminated)
  • Student loan debt discharged due to death or disability will not be included in gross income (student loan interest is still deductible).
  • Estate and gift tax exemption increases to $11.2 million per person ($22.4M if MFJ), up from $5.49 million in 2017. (Note: sunsets after 2025, so would revert back to current levels unless extended)
  • Most of these rules are in place through 2025, then revert back to current tax law in 2026.

 

 

FOR BUSINESSES

 

  • Beginning in 2018, for C Corporations, instead of being taxed at graduated rates on income, there is a flat 21% income tax rate (keep in mind that profits from C Corps are paid out to shareholders as dividends. Shareholders then generally pay a 15% tax rate on that dividend income, plus potentially another 3.8% net investment income tax rate, so while the rate is low within the C Corp, there is a second level of tax when the profits are paid out).
  • For S Corps and other flow-through entities, including partnerships, LLCs, sole-proprietors, and Schedule E rental activities, the tax rates are a bit more complex…actually, a LOT more complex:
    • Under new Section 199A, flow-through entities, as the name implies, flow the income through to the owners, i.e. the entity does not pay tax itself, but instead the owners pay tax at their own personal tax rates (see tables above). To level the playing field when compared to the reduction in tax rates that C Corps will now receive, the following applies to flow-through entity income for 2018 (through 2025):
      • Individuals will receive a 20% deduction on total aggregated flow-through income (“qualified business income”) from all activities to the extent their taxable income does not exceed $157,500 ($315,000 if MFJ)
      • If taxable income exceeds $157,500 ($315,000 if MFJ), the deduction is either the lesser of:
        • 20% of qualified business income; or
        • The greater of:
          • 50% of W-2 wages paid through the qualified business (special rules apply to allocate wages to partners/shareholders based on their ownership); or
          • 25% of W-2 wages paid through the qualified business + 2.5% of the unadjusted basis of qualified property (generally, buildings & equipment owned by the business)
      • Qualified business income excludes capital gains, dividends and interest.
      • Service-oriented businesses have another restriction:
        • Specified service trade or business is defined as those in the health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investment services, and other businesses earning income through services provided based on the “skill or reputation” of one or more of its employees or owners. Engineering and architecture businesses are excluded from this definition.
        • Above the $157,500 limit ($315,000 if MFJ), the 20% deduction begins to phase-out over the next $50,000 of income ($100,000 if MFJ), and is completely phased out at $207,500 ($415,000 if MFJ)
        • For specified service trades or businesses, if taxable income exceeds $207,500 ($415,000 if MFJ) at the taxpayer level, i.e. on the taxpayer’s personal tax return, then no deduction is available
      • Capital-intensive businesses with buildings or other large equipment assets will fare better under the above rules, especially if they also pay wages, since they have the ability to use the 50% of wages option, or 25% of wages + 2.5% of business assets option even if they exceed the $207,500 ($415,000 if MFJ) taxable income thresholds.
      • For other than service-oriented businesses, using the $2,500 de minimis election to immediately expense assets of $2,500 or less may no longer make sense. These businesses will want those assets to be included in their year-end fixed asset listing, and since there’s a 100% depreciation deduction available, there is no benefit to making the de minimis election.
  • There is a 100% bonus depreciation deduction! For business assets placed in service after September 27th, 2017, a full bonus depreciation deduction is available to immediately depreciate the asset. 100% depreciation is available through 2022, then is reduced to 80% for 2023, 60% for 2024, 40% for 2025, and 20% for 2026. A bonus is that the depreciation deductions also apply to used property, not just new asset purchases.
  • The Section 179 deduction (ability to immediately expense fixed assets) is increased to $1,000,000 and is available for roofs, HVAC systems, fire, alarm and security systems. Since there is a recapture on Section 179 assets which are sold though, it makes sense to use the 100% bonus depreciation instead.
  • The depreciation deduction for passenger vehicles is increased to $10,000 in the first year, and has increased limits that will apply to each subsequent year as well.
  • The 15-year depreciable life is available for “qualified improvement property” including leasehold improvements (LHIP) made to non-residential buildings even if those buildings have been in service for less than 3 years (under prior rules, LHIP on buildings in service less than 3 years would be considered 39-year lived assets, and would therefore not qualify for bonus depreciation since bonus is only available for assets with a depreciable life of 20 years or less).
  • Farming businesses can depreciate farm machinery and equipment over a 5-year property instead of a 7-year property, and are no longer subject to the 150% double-declining balance method that was specifically applicable to farm equipment.
  • The Domestic Production Activities Deduction (Section199) has been repealed and will no longer be available after 2017 (this provided for a 9% deduction for mostly manufacturing companies which paid wages, and is replaced by the Section 199A 20% deduction above).
  • The corporate Alternative Minimum Tax (AMT) has also been repealed and will no longer apply after 2017; however, prior-year AMT paid may still be eligible for a phase-in of the credit, with the remaining amount of any unused credit available in 2021. The credit is also refundable, meaning corporations can receive a refund of the credit amount even if they owe no tax.
  • Meals are still deductible at 50%, but entertainment expenses, including amounts paid in exchange for college athletic event seating rights, are no longer deductible. The new law disallows a deduction for entertainment, amusement or recreation expenses. Further, meals on the business premises or for the convenience of the employer are now subject to a 50% deduction (the same as business-client and overnight business travel meals), which full repeal of the deduction for on-site meals after 2025.
  • Employee achievement awards are no longer deductible to the extent they consist of cash, cash-equivalents, gift cards, gift coupons, gift certificates, vacations, meals, lodging, tickets to theatre or sporting events, stocks, bonds, or securities and other similar items.
  • Section 1031 exchanges allow a taxpayer to exchange one piece of property for a like-kind piece of property and defer any gain realized on the initial property. This rule still applies to real-estate property, but cannot be used for any other type of property, e.g. vehicles, personal property, etc.
  • Research and development expenses which were once immediately deductible must now be capitalized and amortized over a period of 5 years (15 years in the case of non-U.S. based research); however, the R&D credit is still available.
  • Patents, inventions, models, designs, secret formulas and processes are no longer considered capital assets; therefore, the sale of such assets will not qualify for capital gain treatment (this rule already applies to copyrights, and other intangible items such as literary, musical or artistic composition).
  • The dividends received deduction (DRD) provides a deduction for dividends received by a corporate entity from another corporate entity in which it has an ownership share. Current law provides a deduction of 70%, or 80% if the corporation owns a 20% share or more of the paying corporation. These amounts are reduced to 50% and 65%, respectively.
  • Net Operating Losses (NOLs) are limited to 80% of taxable income going forward after 2017, and they can no longer be carried back to offset income from prior years (except for farms and insurance companies other than life-insurance companies).
  • Fines & penalties are already non-deductible, but this has been expanded to include “other amounts” (currently undefined) paid or incurred to a government, governmental entity, or non-governmental entity that exercises self-regulatory powers, e.g. national security exchanges registered with the SEC, or domestic boards of trade. The denial of the deduction is for any expenses incurred for the payment of, or defense of, the violation of any law, or the investigation or inquiry by a government or entity into the potential violation of any law. The investigating government or entity receiving payment is required to issue a form similar to a Form 1099-MISC to report any payments it receives for settlements or costs reimbursed that are $600 or more (could be modified to a lower amount).
  • Payments or settlements related to sexual harassment or sexual abuse, including payment of attorney’s fees, are not deductible if the payment or settlement is subject to a non-disclosure agreement.
  • The Cash Method of accounting is now available for companies that have average 3-year gross receipts under $25,000,000. This also removes the UNICAP (Uniform Capitalization) requirements for these businesses which can simplify requirements for capitalizing non-direct costs into the assets being produced or built.
  • A credit is available to employers for providing paid family and medical leave to employees. The credit is equal to 12.5% of the employee’s regular pay but increases by 0.25% for each 1% paid above 50% of the employee’s regular pay, with a maximum credit of 25% for a maximum of 12-weeks pay. No credit is available if the FMLA pay is less than 50% of the employee’s regular pay. Further requirements are the employee must have been employed for 1 year or more, and must receive compensation of no more than 60% of the defined “highly-compensated employee” amount found in Code Section 414(q)(1)(B) – currently $120,000 (so $72,000 at 60%).
  • A work opportunity credit is still available for hiring disadvantaged employees, including long-term unemployment recipients, qualified veterans, ex-felons, designated community residents (living in Empowerment Zones or Rural Renewal Counties), vocational rehabilitation referrals, SNAP/Food Stamp recipients, supplemental security insurance recipients, or long-term family assistance recipients (see https://www.doleta.gov/business/incentives/opptax/pdf/wotc_employer_guide.pdf) for more.

 

The timing of the Tax Reform Bill is unfortunate as it passed a week before the end of the year, which does not provide a lot of time for planning before 2018 begins; however, if you have any questions or would like to schedule an appointment or call to discuss, please feel free to contact us. As time permits during our “Busy Season,” we will try our best to work in 2018 tax planning along with the preparation of your 2017 tax returns.

 

Best Wishes for a Happy, Healthy and Prosperous 2018!

 


Regards,

 

Iain Howe & David Romero

(your friendly neighborhood CPAs!)

BUSINESS PERSONAL PROPERTY RENDITIONS

 

As a reminder, your Texas Business Personal Property(BPP) Rendition is due April 15th and is based on business personal property on-hand as of January 1, 2018.

 

If you have any obsolete property or equipment, it is best to sell,  dispose of, or donate the asset prior to year-end so that it will not be on your January 1st property list. Doing so will reduce the value of assets that your BPP tax is assessed on.

 

This also applies to inventory, and is the same reason a lot of car dealers will provide year-end incentives to sell cars so that they are not sitting on their car lots and taxable on January 1st.

TAX REFORM - THE GOOD, THE BAD AND THE UGLY

 

On November 2nd, the House Ways and Means Committee released its draft of tax reform measures. While the draft must still go through a mark-up process, and then must be approved by the House and Senate, the latter of which is expected to have their own version, this draft provides a good indication of the basic framework.

In order to pass the bill through budget reconciliation (a process allowing passage with just a simple majority), the bill cannot add more than $1.5 trillion to the deficit. The bill is therefore drafted to ensure there are revenue raising measures through disallowance of deductions and credits to offset a majority of the “good” tax reform changes, such as lower corporate tax rates, increased child care credits, etc.

Below is a list of the good, the bad and the ugly based on the current November 2nd draft:

 

THE GOOD

  • Corporate tax rates would be reduced from 35% to 20% effective as of January 1, 2018

  • Equipment that businesses purchase after September 27, 2017 would qualify for 100% expensing through December 31, 2022. Note that this will allow for 2017 year-end planning as the 100% expensing is effective as of 9/27/2017.

  • Alternative Minimum Tax (AMT) would be repealed at both the business and individual levels (50% of any remaining carryover credits could be used in 2019, 2020 and 2021, and any remaining credit can be fully utilized in 2022)

  • The 30% residential energy credit is extended through tax year 2021, although it is reduced to 26% in 2020 and 22% in 2021.

  • U.S. corporations owning foreign corporations can now receive a 100% dividends-received-deduction (previously 70%) for dividends paid by the foreign corporation.

  • Repatriation of foreign earnings currently offshore can be brought back into the U.S. at a 12% tax rate (or 5% for property other than cash), offset by foreign taxes paid and/or foreign credit carryovers. Can be paid over 8 years, if elected.

  • A 25% rate may be available to certain individuals who are partners or shareholders in partnerships or S Corps (flow-through entities). Generally, this is applicable to passive activities, i.e. activities in which the partner or shareholder does not actively participate; however, partners or shareholders who actively participate will by default have 30% of earnings subject to the lower 25% rate, with the election for a higher amount to be subject to 25% if the capital investments in their business are higher than 30%. Certain service businesses (involving health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage services) may not be eligible unless their businesses involve a lot of capital assets, e.g. MRI machines, buildings, and other capital assets.

  • A more-than-50% sale or exchange of a partnership interest normally results in a technical termination of the partnership. This technical termination would be repealed, so a partnership would continue under its current form vs. “terminating” and reforming.

  • Code Section 179 deductions would increase from the current $500,000 to $5 million. The threshold for phase-out would also increase from $2 million to $20 million. Therefore, a business that puts less than $20 million in fixed assets in service during the year can fully expense up to $5 million worth of assets under Section 179. Qualifying assets would include energy-efficient heating and air-conditioning property.

  • Currently, C corporations with more than $5 million of average gross receipts (and partnerships with C Corp partners) cannot use the cash method of accounting. This level would be increased to $25 million, which should allow more companies to use the less-complex cash method. This would also allow those companies to account for inventories as nonincidental material and supplies, as well as exempting those companies from the Section 263A UNICAP rules.

  • The current 20% capital gains rate and qualified dividends rate will stay in place.

  • Tax brackets drop from 7 to 4 (12%, 25%, 35%, and 39.6%). While the 39.6% rate stays, it will be effective for income over $1 million vs. the current $480,050.

  • The higher 35% tax bracket will apply to taxable income over $200,000 for Single filers, but at $260,000 for Married Filing Joint filers.

  • The standard deduction will be almost doubled, but personal exemptions will be repealed.

  • The limit for charitable contributions is increased to 60% of adjusted gross income vs. 50% under current law.

  • The Pease limitation would be repealed (this phased out the amount of itemized deductions allowed as income increased above $313,800 for MFJ or $261,500 for Single).

  • The child tax credit is increased from $1,000 to $1,600 with a $300 credit available to dependents who are not qualified children. Both are subject to phase-out based on income.

  • The transfer of wealth exemption and generation-skipping transfer tax exemption are both increased from $5.6 million to $10 million for transfers after 2017.

  • Estate tax would be repealed for decedents dying after 2023, as would the generation-skipping transfer tax.

  • Gift transfers would also receive the increased $10 million exemption, and the rate on gifts above this amount would drop from 40% to 35%.

  • Property received from a decedent would continue to receive a step-up in basis to fair market value at date of death.

  • There is no limitation on the amount an individual is able to contribute to retirement accounts, as had been previously rumored.

  • In-service distributions from defined benefit plans can begin at age 59 ½ vs. the current 62.

 

THE BAD

  • Corporations will only be able to deduct interest expense to the extent they have interest income; however, this would only be applicable to businesses with revenues in excess of $25 million, and whose interest expense exceeds 50% of its adjusted taxable income.

  • Net Operating Losses (NOLs) can no longer be carried back. While the carryforward period for NOLs would be indefinite, a company can only use NOLs to offset up to 90% of taxable income. NOLs would be increased by an interest factor.

  • Like-kind exchanges (§1031) can only be used for real property (real-estate and land) going forward. It will no longer apply to other assets, e.g. selling a vehicle and purchasing another vehicle while deferring any gain on the sale of the first vehicle.

  • Employer-provided child care credit will be repealed.

  • Certain unused business credits cannot be carried back or forward.

  • The Americans with Disabilities Act (ADA) credit will be repealed (allowed businesses to receive a credit for the cost of providing access to disabled individuals).

  • The tip credit available to employers is now based on the higher current minimum wage which may limit the number of businesses that qualify for the credit if they pay less than minimum wage to their tipped employees.

  • The 3.8% net investment income tax and 0.9% hospital insurance tax is expected to stay in place.

  • Married individual taxpayers with more than $1.2 million of taxable income ($1 million if Single) will begin to lose the benefit of the 12% tax bracket at a rate of $6 for every $100 above the threshold. Essentially, the 12% bracket is recalculated at 39.6% as income begins to exceed the thresholds above.

  • Personal exemptions ($4,050 per individual/dependent) will be repealed, but the standard deduction will almost double.

  • Limitation on mortgage interest will be at $500,000 vs. the current $1 million; and the additional $100,000 of home equity will be repealed. This will only apply to new loans taken out after Nov. 2, 2017. Refinancing would not be considered a new loan.

  • Medical and dental expenses, state and local taxes, casualty losses, tax preparation fees, moving expenses, and unreimbursed employee expenses would no longer qualify as itemized deductions. The property tax deduction would be limited to $10,000.

  • The exclusion of gain on the sale of a principle residence will begin to phase-out by $1 for every dollar the taxpayer’s adjusted gross income (AGI) exceeds $500,000 ($250,000 for Single). The requirement is increased to 5 of the 8 years prior to sale vs. the current 2 of the last 5, and the exclusion is only allowed once every 5 years (meant to take away the benefit for “flippers.”)

  • Adoption credit is repealed.

  • Increased standard deduction for the elderly is repealed.

  • Deferred compensation would be taxable as soon as it is no longer subject to a requirement to provide future service. Stock options would also be subject to tax once no longer subject to vesting conditions.

  • Highly-compensated individuals who are employees of publicly-traded companies can no longer exclude the value of commissions or performance-based compensation, including stock options, when calculating compensation for purposes of Section 162(m). This section generally limits the deduction for companies to $1 million per year for certain highly-paid employees. A 20% excise tax would be assessed for any compensation over $1 million for employees of tax-exempt organizations.

  • Roth IRA recharacterizations would be eliminated, as well as the ability for taxpayers to recharacterize a traditional IRA to a Roth IRA. This means no more “backdoor” Roth IRA contributions.

  • The exclusion for housing provided by an employer would be limited to $50,000 ($25,000 for a married individual filing a joint return), phased out for individuals considered highly compensated ($120K for 2017).

  • Employee achievement awards would now be taxable to the employee.

  • Moving expense reimbursements paid by an employer would not be deductible by the employer.

 

THE UGLY

  • Contributions made to corporations normally qualify for non-recognition under various Code sections; however, going forward, contributions of money and property could be included in the gross income of the company. This would apply to partnerships as well as corporations. It is generally meant to avoid the ability for governmental entities to fund a company and have the company treat that funding as a capital contribution vs. income, but could have farther reaching implications.

  • The domestic production activities deduction will be repealed. This generally provided a deduction to businesses which paid wages and which manufactured or produced/developed their goods within the U.S.

  • The deduction for entertainment expenses would be repealed. Normally, meals and entertainment expenses are deductible at 50%, so if you entertained a business client by taking him or her to a meal then to a baseball game, only the meal will be a deductible item going forward. No deduction would be allowed for entertainment, amusement or recreation activities, facilities, or membership dues, including on-site gyms.

  • Income from the sale of patents, inventions, models or designs, or secret formulas and processes would no longer qualify as capital assets. Gain from the sale of these assets would therefore be taxable under the higher ordinary tax rates.

  • The credit for new plug-in electric vehicles would be repealed.

  • Payments made by a U.S. corporation to a related foreign corporation that are deductible, includible in cost of goods sold, or includible in the basis of depreciable or amortizable assets are subject to a 20% excise tax, unless the foreign corporation elects to treat the payments as income effectively connected with the conduct of a U.S. trade or business. An exception applies for intercompany services that the U.S. company elects to pay for at cost (i.e. no markup).

 

Planning considerations should include paying property taxes before year-end 2017 (if not in AMT) instead of waiting until January, purchasing large items before year-end 2017 to take advantage of the 100% expensing, generally deferring income to 2018 and pulling expenses into 2017 if tax rates are to drop in 2018, and moving before year-end if you would otherwise qualify to deduct moving expenses.

 

CAUTION: Each taxpayer’s situation is different, and the items above are a general outline of a bill that must still be marked up and approved by both the House and Senate (with the Senate expected to draft its own version). That said, the items above are meant as a general guideline of what the current administration is looking at when considering tax reform.

The President has asked for a final bill to be on his desk by Christmas Day, which ultimately does not provide a lot of time for 2017 year-end planning. The purpose of this outline is to provide you with information to consider now as the process of tax reform runs through its various stages.

If you have questions about how this may impact your particular tax situation, or if you would like us to analyze how these various changes could impact you, please contact us and we will be happy to do so.

ELECTION - TAX IMPACT

Well, after a harrowing evening, it appears the outcome is a Trump presidency. What does that potentially mean for taxes?

 

Based upon Trump’s tax policy (which could change, of course; however, with Republicans retaining control over the House and Senate, passage of any changes may be easier), here are some things to consider:

  • Tax brackets on income would decrease from 7 to 3. Trump’s proposal is that ordinary income would be taxed at 12% up to $37,500, 25% up to $112,500, and 33% above $112,500 for a Single taxpayer. Married filing joint taxpayers would be at the same tax rates on double the income, e.g. 12% up to $75,000, 25% up to $225,000, and 33% above $225,000.
  • Capital gains would be taxed at 0%, 15% or 20% depending on whether you are in the 12%, 25% or 33% ordinary income brackets, respectively.
  • Obamacare would be abolished, as would the additional 3.8% net investment income tax and presumably the additional 0.9% hospital insurance tax on wages.
  • For estates with under $10 million of assets, there would be no estate tax. Estates above $10 million would be taxed on the appreciation of assets, but only when the beneficiary sells those assets. (Some joke, perhaps a wee bit morbidly, that the next 4 years would be a good period in which to die!)
  • Corporations would see their tax rates reduced from 35% to 15%, although a number of business deductions may be eliminated to compensate for the reduced tax rate.
  • Businesses could fully expense asset purchases, meaning no more depreciation calculations! Businesses that choose to fully expense assets would not be permitted to deduct interest expense on loans however.
  • Pass-through entities such as partnerships and S corporations could elect to be taxed at 15% at the entity level, meaning goodbye to flow-through income being taxed at your individual tax rate on your personal tax return. Pulling income (“dividends”) out of the partnership or S corporation would most likely be taxed as dividends however, similar to the current practice for distributions from C corporations. Interestingly, this may encourage a number of taxpayers to set up their own entities and contract with their employers vs. being treated as employees in order to benefit from the lower 15% tax rate vs. the higher 33% ordinary income rate.
  • Itemized deductions would be capped at $100,000 for a Single taxpayer or $200,000 for a Married-Filing-Joint taxpayer. The Standard deduction would increase to $15,000 for Single taxpayers, or $30,000 if filing Married-Filing-Joint. Personal exemptions would be eliminated which may hurt larger families. Head-of-Household status would also be eliminated.

While nothing is likely to change for the 2016 tax filing year, there will be plenty of planning opportunities ahead as the likelihood of the above tax policies passing into law becomes more discernible.

 

We will be keeping an ever-present eye on these changes, but if you have an interest in attending an event to receive a rundown of these policies and what to expect, please let us know. A number of financial advisory firms will host webinars and meetings to discuss these potential changes and what it could mean for your bottom line.

 

As these tax policy changes become more certain, we will do our best to keep you apprised.

Tax Savings

New IRS Expensing Limit - $2,500!

 

On Nov. 24th, IRS in Notice 2015-82 increased the threshold for deducting business expenses from $200 (or $500 if you made the de minimis election) to $2,500!

 

This is great news for small businesses! Now, instead of capitalizing and depreciating purchases in excess of $200 or $500, they can immediately be expensed.

 

While IRS indicated the rule change is effective for 2016 tax returns, they also indicated they would not challenge taxpayers who used the new limit for 2015.

 

Contact me if you would like more information about this change and what it means to your business.

 

More at https://www.irs.gov/uac/Newsroom/For-Small-Businesses-IRS-Raises-Tangible-Property-Expensing-Threshold-to-$2,500-Simplifies-Filing-and-Recordkeeping

Entity Structures

To S Corp, or not to S Corp - that is the question!

 
So, you're a single-member LLC filing on Schedule C on your personal tax return. Should you covert to an S Corp? Well, it depends.
 
The downside of filing on Schedule C is that ALL of your net income is subject to both income tax as well as self-employment tax; however, it is much simpler to prepare as you only need to report income and expenses, and no separate tax return is required.
 
If your net income (after expenses) exceeds say $70,000 then it may make sense to look at electing S Corp status. With an S Corp, only the wages you pay yourself are subject to employment taxes with the remaining profit able to be withdrawn as shareholder distributions; however, wages paid must be "reasonable."
 
The benefit is the tax savings on employment taxes; however, the downside is it requires a separate corporate tax return along with payroll reporting. The break-even point is generally where the additional time/cost of preparing payroll and the corporate tax return equals the payroll tax savings, and hovers somewhere around the $70K NET income mark.
 
Contact me if you would like to discuss which option is best for you.

Driving for Uber - Do the numbers work? 

 

A CPA’s Perspective

With all the hype about Uber coming to town, I was curious to see what it was all about.  Reading the articles and Facebook posts online, it sounded like a pretty good proposition – drive your car whenever you want for as much or as little time as you want, and get paid weekly!  What a great way to make extra cash on the weekends, in between college classes, or to save up for that new item you have wanted to buy.  But, although the cash coming into your bank account is great to see, what are the real costs?  And once these other costs are factored into the equation, is it still worth it to drive for Uber?  Let’s take a closer look…

What is Uber?

Uber is an application designed to allow smart phone users to jump online using the Uber app and hail a ride from an Uber driver in their area.  The app shows the location of the nearest Uber driver to the requesting rider and then sends out a “ping” to the driver giving him or her 15 seconds to accept the fare.  If the driver does not accept the fare, it pings the next closest driver.  Once a driver accepts the fare, he or she drives to the user’s location.  The requesting rider is able to see the Uber driver on the map and follow the driver’s progress as the driver heads to the rider’s location.  The Uber driver then drives the rider to the desired location; however, unlike taxi cabs, the entire transaction is completely cashless!  The charge for the ride (including tip, which the rider can preset) is charged to the rider’s credit card which the rider sets up beforehand.  No tip is required so no cash ever changes hands.

Who is my Uber driver?

Before someone can partner with Uber to be a driver (offering rideshare), Uber requests a significant amount of information.  They, of course, want to see your driver’s license, proof of insurance, and registration, but they also run background checks going back seven years including a federal, state and county background check, driving record check, social security trace, and sex offender registry screening.  You must also have a reliable car that is above a certain model year.  I understand that the actual model year requirement can change by city.

A rating system?

One of the neat things about the Uber experience is you get to rate your driver.  After completing the ride, you can rate your driver from 1 to 5 stars based on the service you received.  Similarly, drivers can rate their passengers using the same rating system.  If a passenger has a bad experience and rates their driver low (below a 3, I believe), the passenger will never have that Uber driver pick them up again.  Even if the driver is the closest to them, the Uber app will ping the next available driver.  If Uber drivers’ ratings fall below a certain level, they become in jeopardy of losing their right to be an Uber driver.  This provides drivers with an incentive to make sure you have a pleasant experience.

 

Costs of being an Uber driver.

As mentioned above, while the cash going into your bank account once a week is nice to see, there are a number of costs associated with driving for Uber that should be taken into consideration to determine if this is a worthwhile venture.  An obvious cost is the price of gas – as you drive around the town from location to location, you can easily go through a full tank a day or more.  In addition, this adds a number of miles to your car’s odometer which can quickly begin to reduce the resale value of your car.  And then, of course, there are taxes which are due on the income you receive.  Let’s take them one-by-one:

Gas Cost

Depending on the cost of gas in your area, and the type of gas your car uses (regular versus supreme), this could be one of your largest expenses.  Smart drivers will begin to learn where the best places are to go for gas fill-ups by perhaps using apps such as Gas Buddy.  There are also ways of keeping gas costs to a minimum, e.g. making sure your tires are correctly inflated, getting rid of excess weight in your car, etc.  I had heard someone mention the best time to fill up is first thing in the morning when the outside air is coolest since the gas (liquid) is more compact the colder it is.  As the daytime temperatures begin to heat up, the gas liquid begins to expand, the theory being you receive less gas if you fill up when it is hot outside.  I have no idea if there is any truth to this, but it seems to make a little bit of sense!

Mileage

As any car dealer will tell you, a car with fewer miles on it will typically net you a higher resale value than one with many miles on the odometer.  An 8-hour shift driving around town can easily put 200 to 300 miles on your car, perhaps more.  Along with the increased mileage comes the need for additional maintenance and repairs – perhaps you will be stopping for oil changes more often, or may begin to notice performance issues as you deal with city stop-start driving all day.  Thankfully the IRS allows for a standard mileage deduction to compensate for the cost of these additional expenses.  It is therefore imperative that you keep track of your business miles traveled so you can support your mileage deduction at year-end.  The deduction for 2014 is 56 cents for every mile traveled for business purposes; however, the IRS will want to see proof, so estimating your mileage in most cases will not cut it.  Without proof, the IRS can deny the entire deduction!

Taxes

At year-end, assuming Uber has paid you $600 or more, you will receive a Form 1099-MISC.  This form will report the gross revenues that Uber has paid you, which will typically be reported on Schedule C of your personal tax return.  From this number you can then begin deducting your expenses.  Interestingly, some people believe if you make less than $600 then you do not need to report it – this is not true.  If you make less than $600 this just means the person paying you does not need to issue you a Form 1099-MISC; however, you must still report the revenue you earned.  From the total gross revenue number you can deduct your mileage and any other “ordinary and necessary” business expenses required to earn the revenue.  Note that the standard mileage deduction includes a component for gas, maintenance, tires, depreciation, and other costs so if you use the standard mileage rate, you cannot also separately deduct gas and other expenses as this would be double-dipping.  As Uber requires your car to be clean and well maintained, if you typically drive your car around town with 3 inches of dirt on it and only incur the cost of car washes because it is required for your job, then your car washes can be deducted as an ordinary and necessary business expense.  A tip is to look for carwash places that offer unlimited carwashes for a set price per month.  If you purchase a Garmin to get around town while operating your business then this is deductible too.  Tolls you pay can be deducted; however, Uber advises you to invoice the rider as part of the fare.  Don’t make the mistake of NOT deducting your tolls when you file your tax return however.  If the charge for tolls is included in your fare, and your fare is included in the gross revenue reported on your Form 1099-MISC, you will want to include your toll expense on your tax return to offset that portion of the fare included in gross revenue.

Federal taxes will be assessed on the income you earn.  This could eat up a quarter of your gross revenues right off the bat depending on which tax bracket you are in.  On top of that, since the income is considered self-employment income, there are also payroll taxes due.  Since being self-employed you are both the employee and the employer, you are responsible for paying in the full 15.3% (7.65% for the employer’s portion and 7.65% for the employee’s portion).  Since the employer’s portion is a business expense, you receive a bit of a break for paying this expense when figuring your income tax.

Insurance

A big doozie is insurance.  I would hazard to guess that a majority of Uber drivers do not have an insurance policy that covers them for using their car for business.  Thankfully, according to Uber’s website, Uber has a supplemental $1,000,000 insurance policy which should cover any damage by an Uber driver to another person’s property if the driver’s own insurance will not cover it; however, if the driver’s insurance company learns the driver has been using their car to operate a business, and the driver’s insurance policy prohibits this type of use of their vehicle, the driver’s insurance policy may not cover damage done to their own vehicle.  If you plan to drive for Uber, it may be wise to check with your insurance agent to be sure you have adequate coverage and also check with Uber to determine what type of insurance coverage they provide you as a driver.

Uber’s 20% cut!

You didn’t think Uber was going to provide their technology for free, did you?  Off each fare, Uber takes a 20% cut as their commission for providing you with access to their technology.  This can take a big bite out of your earnings.

So, is it worth it?

To test out the actual earnings and costs involved, I signed up to be an Uber driver (UberX) and did some driving around Austin, Texas.  On the weekend of the X-Games, I drove 97 miles on Saturday and earned passenger fares of $128.88.  From this amount, I paid 20% to Uber ($25.77) and spent approximately 17 cents per mile on gas ($16.49).  The IRS rate of 56 cents per mile factors in gas, maintenance, repairs, and depreciation, so let’s use that instead for simplicity (97 x 56 cents = $54.32).  At the end of the day, my $128.88 fare is reduced by $25.77 in commissions and $54.32 in gas/depreciation/maintenance costs = $48.79 of gross profit.  This amount is subject to both federal and self-employment tax at approximately 40% combined leaving me with 60% of $48.79 at the end of the day, or $29.27.  The scary part is the amount deposited into my bank account is $103.11 ($128.88 less $25.77 commissions) which seems okay for a day’s work.  It is not until tax time that you may realize the $103.11 is really only $29.27 after factoring in taxes and other costs.

Be sure you are putting some of your earnings aside to cover taxes – say 30-40%.  If you do not, you will have a BIG surprise when you file your tax return at year-end!

While the Uber experience is still new to Austin, Uber has some great incentives for ensuring drivers make at least a minimum amount per hour as a way to spur interest in driving for Uber.  For example, current promotions will guarantee that if you only take a couple of rides in an hour and only have say $20 in fares, Uber will chip in another $20 if the guarantee is $40/hour for that day and time.  Not bad!  A drive around down this past weekend (375 miles of driving both Saturday and Sunday) netted $406.12 in fares but another $195.86 in Uber’s guarantee match for a total of $601.98.  The total time driving was around 14 hours, 7 hours each day, so before taxes (after subtracting commissions of $102.02 and the 56 cents per mile gas/maintenance/depreciation cost of $210 and $10 for a car wash), this nets to around $20 per hour.  However, this is with the hourly guarantee match which may not always be available.  Had it not been for the additional $195.86, the hourly rate would have been closer to a dismal $6 per hour.  Factoring in estimated federal and self-employment taxes, take-home pay was around $172.49 for 14 hours worth of driving, including the hourly guarantee amount, so around $12 per hour net.  Without the guarantee, the net take-home for 14 hours worth of driving after all taxes and expenses are factored in would have been around $52.

So, is it worth it?  You decide.

 

Iain Howe is a CPA practicing in public accounting with the Austin-based CPA firm Iain Howe, CPA & Associates, PLLC.  He can be reached at Iain@IainHoweCPAs.com or at (512) 695-1231.

Disclaimer required by the IRS Rules of Practice: Any statements regarding federal taxes contained in this communication were not written or intended to be used, and cannot be used, by any person or entity as a basis for avoiding federal tax penalties.

 

 

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