Roeser Accountancy Book Club for Business Entrepreneurs
Today, the natural question for those of us in business or the tax world is, “What does the election mean for tax policy in general, and tax reform in particular?”
The answer is somewhat mixed. To be sure, Republicans generally have supported lower taxes and the idea of tax reform, but they are not currently unified behind any particular plan or approach. In fact, there are meaningful differences among the policies being considered in the House and the Senate versus the tax plan proposed by President Trump. So it will be interesting to see how, or if, those differences will be resolved.
Here are five issues we think will be important in the coming discussion over tax reform. *
The Estate Tax
A number of factors make the estate tax an issue to watch in the coming year. Repeal of the estate tax is a feature of both the Trump and House Republican tax plans. Furthermore, it is a policy proposal that has fairly strong popular support. Third, it collects less than 1 percent of federal revenue, making it less of a deficit concern than many other tax-cutting priorities. And finally, the repeal of a tax is a relatively simple policy negotiation that could move quickly if it became a priority.
The House voted last year to repeal the estate tax, and the composition of the chamber has not changed much with Tuesday’s election. The main questions on this policy are whether any change to step-up basis would happen in an estate tax repeal, and whether it has the votes to pass the Senate. All in all, though, repeal of this tax seems like a priority that would have relatively little in its way.
Under current law, the tax code distinguishes between two major types of businesses. The first type of business is the traditional C corporation, which is taxed twice: once at the entity level at 35 percent, then again at the shareholder level when individuals pay tax on their dividends and capital gains. The second business form is known as a “pass-through” business. These businesses are not taxed at the entity level. Instead, their profits are passed immediately to their owners and are subject to the individual income tax.
The different treatment of these businesses is a challenge for tax reform. Most agree that the statutory marginal tax rate on C corporations is too high. Yet, if a tax plan only cut the corporate income tax rate, pass-through businesses would not receive a tax cut. In fact, if the corporate rate were cut in concert with base broadening, pass-through businesses could face a tax increase. As such, some plans attempt to deal with this by also cutting the ordinary income tax rate. However, cutting individual income tax rates is very expensive.
One way lawmakers have proposed to deal with this political issue is to provide pass-through business income a special, reduced rate compared to wage income. Both the House GOP tax plan and Trump’s tax plan provide a special low rate or system for pass-through businesses. Both plans have a top ordinary rate of 33 percent, but the House GOP plan caps the pass-through rate at 25 percent; Trump’s plan caps the pass-through rate at 15 percent. However, it is still unclear exactly how Trump’s tax plan would treat pass-through businesses.
While this deals with the political problem of pass-through businesses feeling left out of tax reform, there are significant policy concerns. Creating a special rate for pass-through businesses can encourage gaming. Individuals who own businesses would have an incentive to re-categorize their wage income to business income. There is no strong theoretical case that pass-through business income should be taxed at a lower rate than wage income. It would also increase the tax differential between corporate investment and pass-through investment.
It is worth noting that there is a tax reform proposal that could address this. Specifically, the corporate integration proposal from Senator Hatch (R-UT). His yet-to-be-released proposal would integrate the individual and business tax code by allowing corporations to deduct their dividends against their taxable income. It would also tax dividends at ordinary income tax rates. There are a lot of moving pieces with this plan, but the goal of this plan is make sure that all business and individual income are taxed at roughly the same marginal tax rate. If this is included in reform, lawmakers could reduce the marginal tax rate on corporate investment and make sure that pass-through and corporate income are taxed more equally.
Individual Income Tax
The Trump Plan will collapse the current seven tax brackets to three brackets. The rates and breakpoints are as shown below. Low-income Americans will have an effective income tax rate of 0. The tax brackets are similar to those in the House GOP tax blueprint.
Brackets & Rates for Married-Joint filers:
Less than $75,000: 12%
More than $75,000 but less than $225,000: 25%
More than $225,000: 33%
*Brackets for single filers are ½ of these amounts
The Trump Plan will retain the existing capital gains rate structure (maximum rate of 20 percent) with tax brackets shown above. Carried interest will be taxed as ordinary income.
The 3.8 percent Obamacare tax on investment income will be repealed, as will the alternative minimum tax.
The Trump Plan will increase the standard deduction for joint filers to $30,000, from $12,600, and the standard deduction for single filers will be $15,000. The personal exemptions will be eliminated as will the head-of-household filing status.
In addition, the Trump Plan will cap itemized deductions at $200,000 for Married-Joint filers or $100,000 for Single filers.
Americans will be able to take an above-the-line deduction for children under age 13 that will be capped at state average for age of child, and for eldercare for a dependent. The exclusion will not be available to taxpayers with total income over $500,000 Married-Joint /$250,000 Single, and because of the cap on the size of the benefit, working and middle class families will see the largest percentage reduction in their taxable income.
The childcare exclusion would be provided to families who use stay-at-home parents or grandparents as well as those who use paid caregivers, and would be limited to 4 children per taxpayer. The eldercare exclusion would be capped at $5,000 per year. The cap would increase each year at the rate of inflation.
The Trump Plan would offer spending rebates for childcare expenses to certain low-income taxpayers through the Earned Income Tax Credit (EITC). The rebate would be equal to 7.65 percent of remaining eligible childcare expenses, subject to a cap of half of the payroll taxes paid by the taxpayer (based on the lower-earning parent in a two-earner household).
This rebate would be available to married joint filers earning $62,400 ($31,200 for single taxpayers) or less. Limitations on costs eligible for exclusion and the number of beneficiaries would be the same as for the basic exclusion. The ceiling would increase with inflation each year.
All taxpayers would be able to establish Dependent Care Savings Accounts (DCSAs) for the benefit of specific individuals, including unborn children. Total annual contributions to a DCSA are limited to $2,000 per year from all sources, which include the account owner (parent in the case of a minor or the person establishing elder care account), immediate family members of the account owner, and the employer of the account owner. When established for children, the funds remaining in the account when the child reaches 18 can be used for education expenses, but additional contributions could not be made.
To encourage lower-income families to establish DCSAs for their children, the government will provide a 50 percent match on parental contributions of up to $1,000 per year for these households. When parents fill out their taxes they can check a box to directly deposit any portion of their EITC into their Dependent Care Savings Account. All deposits and earnings thereon will be free from taxation, and unused balances can rollover from year to year.
Trump will enter office promising a large increase in infrastructure spending, additional military spending, and a pledge to not touch entitlements. At the same time, he will bring with him a tax plan that would reduce federal revenues by about $6 trillion over the next decade. Without adjustments, Trump’s plan would significantly increase the federal deficit, which is already projected to increase significantly under current law. According to the Committee for a Responsible Federal Budget, his complete fiscal plan would increase federal debt by $5.3 trillion over the next decade
Given this disconnect, it is likely that Trump will need to either revisit his spending priorities, his tax plan, or both. If he revisits his tax plan and wants to keep the marginal rates the way they are, he will need to find ways to reduce the cost.
Trump could reduce the cost of his tax plan if he follows the lead of the House GOP tax reform plan and takes base broadening more seriously. Overall, the House GOP plan has a significantly smaller impact on the federal budget and could be more realistically matched with spending cuts. We estimated that the House GOP plan would reduce federal revenue by $2.4 trillion over the next decade. However, when accounting for economy growth, the cost is about $200 billion (a little more if you include the elimination of the ACA-related taxes). It maintains a relatively small impact on the deficit compared to Trump’s plan by significantly broadening the individual and business tax bases. It limits itemized deductions for individuals, eliminates the net interest expense deduction for businesses, and border-adjusts the corporate income tax.
The Corporate Tax Rate
Both the Trump plan and the House GOP plan include substantial reductions in the corporate tax rate, from its current 35 percent to top rates of 15 percent and 20 percent, respectively. The current rate is the highest in the developed world. The Trump plan would be a bold step that leapfrogs the United States all the way to having one of the lowest rates in the developed world, while the House GOP plan is more modest in its reduction.
The House GOP plan, furthermore, contained a number of significant base broadeners in order to offset the revenue lost from lower rates. The Trump plan does not have those base broadeners, and as a result its corporate income tax raises substantially less revenue than that of the House GOP plan. If Trump decides to scale back the size of his net tax cut, he may give the House GOP’s 20 percent corporate rate, or its base broadeners, another look.
Please let us know of any questions - and we'll keep you informed as matters develop.
Bill Roeser, CPA, CFP, CVA
*Reference and Credit to: TaxFoundation.org
So you own a small business and you’re not a tax expert. That’s okay, few are. Your focus is on your business, not on tax rules and regulations. As a result, tax time can be a time of panic and stress as you scramble to get information together in order to meet deadlines and avoid penalties.
The key to minimizing tax woes is to treat taxes like any other business practice: as an ongoing process that needs attention throughout the year in order to be successful. When you begin to think this way, preparing for tax time on a continual basis will allow you to focus on what you’re passionate about: growing your business. Focus on your core competencies.
Having worked with thousands of individuals and businesses over the years, I know first-hand how difficult tax preparation time can be. What ultimately makes tax season more manageable is using technology to help automate the processes, and working with a professional. With that in mind, I’ve listed out seven tips that will help you prepare for tax season all year long.
1. Get started now – After you complete your 2016 taxes, schedule time on your calendar to establish better habits for next year and beyond. You may have promised yourself last year that you’d never again wait until the last minute to file taxes, but just like anything else, life happens and things fall through the cracks. Make the commitment to do better while the most recent tax season is fresh in your mind.
2. Ditch the shoebox – Collecting receipts in a shoebox or other container is highly inefficient and can make year-end even more stressful. Do you even know what’s in there? Can you find it? Start recording everything electronically so you’ll have an archive ready when it’s time to file next year. User a good scanner, such as the Fujitsu ScanSnap and software like Evernote or Dropbox to store your information. And, since now all your information is stored electronically…
3. Back up your electronic records – What would happen to your data in the event of a man-made or natural disaster? Backing up your records and files on a routine basis to a remote location, like in the cloud using Carbonite or Mozy, saves valuable business information. The IRS won’t forgive you because your records are missing, so be sure to have a contingency plan, just in case.
4. Work with an accountant, a CPA – An accountant can be a trusted advisor throughout the year to help you plan properly for tax season. This partnership can also provide sound business advice throughout the year, as many have not only tax expertise, but great business counsel. Build a relationship with an accountant that you trust so that you can tap into this expertise all year long.
There are too many rules to know and understand. Also, the IRS now has over 10,000 forms. Hire a CPA and let them work their magic on your tax return. They pay for themselves many times over and will not only save you money, but will keep you out of trouble. Hire a CPA professional who’s been doing it a while, ten years or more, for the best experience.
5. Use online banking – Most banks let you download all of your transactions. Go in every month and mark the transactions that are tax deductible. When next spring rolls around you’ll have a comprehensive list of tax deductible items ready to go.
6. Automate the accounting process – If you are not using an accounting solution, it’s time to consider one. There are now many online solutions available including QuickBooks, Xero, and Freshbooks. Using online accounting will eliminate the need to invest a large amount of money upfront and you’ll always have access to the latest version of the software. Your accountant can help you determine the best fit, and access by your accountant will save you time, money and frustration.
7. Don’t be late – How do you ensure you’re not late for regular meetings or appointments? You likely have them marked in your calendar and you prepare in advance. Do the same thing when it comes to filing taxes, otherwise you might face hefty penalties; ones that could be avoided with the proper planning. There are more deadlines than just April 15. Businesses must file many different types of tax returns and associated forms. Don’t dump your information on your accountants desk on April 1 – give them plenty of time to get it done in time and accept an extension if you bring your information in late.
Working with an accountant and using tools that make the process easier will not only help you handle tax time, but give your small business a competitive edge, and get you back to doing what you love.
Dear Clients and Friends of the Firm:
As the end of the year approaches, it is a good time to think of planning moves that will help lower your tax bill for this year and possibly the next. Factors that compound the planning challenge this year include political and economic uncertainty, and Congress's all too familiar failure to act on a number of important tax breaks that will expire at the end of 2016.
Some of these expiring tax breaks will likely be extended, but perhaps not all, and as in the past, Congress may not decide the fate of these tax breaks until the very end of 2016 (or later). For individuals, these breaks include: the exclusion of income on the discharge of indebtedness on a principal residence, the treatment of mortgage insurance premiums as deductible qualified residence interest, the 7.5% of adjusted gross income floor beneath medical expense deductions for taxpayers age 65 or older, and the deduction for qualified tuition and related expenses. There is also a host of expiring energy provisions, including among them: the nonbusiness energy property credit, the residential energy property credit, the qualified fuel cell motor vehicle credit, the alternative fuel vehicle refueling property credit, the credit for 2-wheeled plug-in electric vehicles, the new energy efficient homes credit, and the hybrid solar lighting system property credit. Higher-income earners have unique concerns to address when mapping out year-end plans. They must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax.
The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer's approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI.
The 0.9% additional Medicare tax also may require year-end actions. It applies to individuals for whom the sum of their wages received with respect to employment and their self-employment income is in excess of an unindexed threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case). Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of the employee's filing status or other income. Self-employed persons must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward the end of the year to cover the tax. For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don't exceed $200,000.
We have compiled a checklist of additional actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you (or a family member) will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:
Year-End Tax Planning Moves for Individuals
• Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.
• Postpone income until 2017 and accelerate deductions into 2016 to lower your 2016 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2016 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2016.
For example, this may be the case where a person's marginal tax rate is much lower this year than it will be next year or where lower income in 2017 will result in a higher 2017 tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit.
• If you believe a Roth IRA is better than a traditional IRA and you are eligible to convert a traditional IRS to a Roth IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA. Keep in mind, however, that such a conversion will increase your AGI for 2016.
• If you converted assets in a traditional IRA to a Roth IRA earlier in the year and the assets in the Roth IRA account declined in value, you could wind up paying a higher tax than is necessary if you leave things as is. You can back out of the transaction by recharacterizing the conversion-that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.
• It may be advantageous to try to arrange with your employer to defer, until early 2017, a bonus that may be coming your way.
• Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2016 deductions even if you don't pay your credit card bill until after the end of the year.
• If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2016 if you won't be subject to alternative minimum tax (AMT) in 2016.
• Take an eligible rollover distribution from a qualified retirement plan before the end of 2016 if you are facing a penalty for underpayment of estimated tax and having your employer increase your withholding is unavailable or won't sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2016. You can then timely roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2016, but the withheld tax will be applied pro rata over the full 2016 tax year to reduce previous underpayments of estimated tax.
• Estimate the effect of any year-end planning moves on the AMT for 2016, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state and local property taxes on your residence, state income taxes, miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses of a taxpayer who is at least age 65 or whose spouse is at least 65 as of the close of the tax year, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. If you are subject to the AMT for 2016, or suspect you might be, these types of deductions should not be accelerated.
• You may be able to save taxes this year and next by applying a bunching strategy to "miscellaneous" itemized deductions, medical expenses and other itemized deductions.
• For 2016, the "floor" beneath medical expense deductions for those age 65 or older is 7.5% of adjusted gross income (AGI). Unless Congress changes the rules, this floor will rise to 10% of AGI next year. Taxpayers age 65 or older who can claim itemized deductions this year, but won't be able to next year because of the higher floor, should consider accelerating discretionary or elective medical procedures or expenses (e.g., dental implants or expensive eyewear).
• You may want to pay contested taxes before the end of the year, so as to be able to deduct them this year while continuing to contest them next year.
• You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
• Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year you reach age 70-½. That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Although RMDs must begin no later than April 1 following the year in which the IRA owner attains age 70-½, the first distribution calendar year is the year in which the IRA owner attains age 70-½. Thus, if you turn age 70-½ in 2016, you can delay the first required distribution to 2017, but if you do, you will have to take a double distribution in 2017-the amount required for 2016 plus the amount required for 2017. Think twice before delaying 2016 distributions to 2017, as bunching income into 2017 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2017 if you will be in a substantially lower bracket that year.
• Increase the amount you set aside for next year in your employer's health flexible spending account (FSA) if you set aside too little for this year.
• If you become eligible in or before December of 2016 to make health savings account (HSA)contributions, you can make a full year's worth of deductible HSA contributions for 2016.
• If you are thinking of installing energy saving improvements to your home, such as certain high-efficiency insulation materials, do so before the close of 2016. You may qualify for a "nonbusiness energy property credit" that won't be available after this year, unless Congress reinstates it.
• Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and/or estate taxes. The exclusion applies to gifts of up to $14,000 made in 2016 and 2017 to each of an unlimited number of individuals. You can't carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
Year-End Tax-Planning Moves for Businesses & Business Owners
• Businesses should consider making expenditures that qualify for the business property expensing option. For tax years beginning in 2016, the expensing limit is $500,000 and the investment ceiling limit is $2,010,000. Expensing is generally available for most depreciable property (other than buildings), off-the-shelf computer software, and qualified real property-qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. The generous dollar ceilings that apply this year mean that many small and medium sized businesses that make purchases before the end of 2016 will be able to currently deduct most if not all their outlays for machinery and equipment. What's more, the expensing deduction is not prorated for the time that the asset is in service during the year. This opens up significant year-end planning opportunities.
• Businesses also should consider making expenditures that qualify for 50% bonus first year depreciation if bought and placed in service this year. The bonus depreciation deduction is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the full 50% first-year bonus write-off is available even if qualifying assets are in service for only a few days in 2016.
• Businesses may be able to take advantage of the "de minimis safe harbor election" (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs don't have to be capitalized under the Code Sec. 263A uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit of property can't exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA's report). If there's no AFS, the cost of a unit of property can't exceed $2,500. Where the UNICAP rules aren't an issue, purchase such qualifying items before the end of 2016.
• A corporation should consider accelerating income from 2017 to 2016 if it will be in a higher bracket next year. Conversely, it should consider deferring income until 2017 if it will be in a higher bracket this year.
• A corporation should consider deferring income until next year if doing so will preserve the corporation's qualification for the small corporation AMT exemption for 2016. (Note that there is never a reason to accelerate income for purposes of the small corporation AMT exemption because if a corporation doesn't qualify for the exemption for any given tax year, it will not qualify for the exemption for any later tax year.)
• A corporation (other than a "large" corporation) that anticipates a small net operating loss (NOL) for 2016 (and substantial net income in 2017) may find it worthwhile to accelerate just enough of its 2017 income (or to defer just enough of its 2016 deductions) to create a small amount of net income for 2016. This will permit the corporation to base its 2017 estimated tax installments on the relatively small amount of income shown on its 2016 return, rather than having to pay estimated taxes based on 100% of its much larger 2017 taxable income.
• If your business qualifies for the domestic production activities deduction (DPAD) for its 2016 tax year, consider whether the 50%-of-W-2 wages limitation on that deduction applies. If it does, consider ways to increase 2016 W-2 income, e.g., by bonuses to owner-shareholders whose compensation is allocable to domestic production gross receipts. Note that the limitation applies to amounts paid with respect to employment in calendar year 2016, even if the business has a fiscal year.
• To reduce 2016 taxable income, consider deferring a debt-cancellation event until 2017.
• To reduce 2016 taxable income, consider disposing of a passive activity in 2016 if doing so will allow you to deduct suspended passive activity losses.
• If you own an interest in a partnership or S corporation, consider whether you need to increase your basis by loaning amounts to the company or making additional investments in the entity so you can deduct a loss from it for this year. These are just some of the year-end steps that can be taken to save taxes.
Your Team at Roeser Accountancy