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Proposed Regulations Issued for New Business Deduction

Posted by Admin Posted on Aug 10 2018

The Tax Cut and Jobs Act, enacted in December 2017, added Code Section 199A, which provides a  deduction for 20% of pass-through entity business income.  This provision has attracted much attention but has also raised many questions about its details. 

On August 8, the IRS issued proposed regulations, which may be relied upon until finalized.  These answer many questions about how the new deduction will work in practice.  A quick summary is as follows-

 1.  The deduction applies to qualified business income passed-through by sole proprietorships, S Corporations, and partnerships to any entity other than a C Corporation.  It also applies to qualified REIT dividends and qualified publicly traded partnership income.  It does not apply to income earned as an employee, including reasonable compensation paid to an S Corporation shareholder, or to guaranteed payments to a partner. 

2.      The deduction is limited to 20% of taxable income before the Sec. 199A deduction in excess of net capital gains.

 3.      The deduction is from adjusted gross income, not to adjusted gross income, but applies regardless of whether or not a taxpayer itemizes.  It will not affect income subject to self-employment tax or Indiana taxable income.

 4.      If the taxpayer’s taxable income before the Sec. 199A deduction is below a threshold ($315,000 for married filing joint taxpayers and $157,500 for all others), no other limitations apply.  If the taxpayer’s taxable income is in a phase-out range ($315,000-$415,000 for joint filers and $157,500-$207,500 for others), partial limitations apply.  For taxpayers above the phase-out range, the following limitations apply-

·         Income from a specified service business is not eligible for the deduction.  Specified services businesses include the fields of health, law, accounting, consulting, athletics, performing arts, and brokerage of financial products.  They do not include real estate or insurance agents or brokers.

·       The deduction is limited to the lesser of- 1) 50% of W-2 wages from the business, or 2) 25% of W-2 wages from the business, plus 2.5% of the unadjusted basis of qualified property in the business.

 

The proposed regulations provide definitions and specifics about the above provisions.  Please contact us if you would like more information.

 

 

The Tax Cut and Jobs Act Becomes Law

Posted by Admin Posted on Dec 22 2017

On December 22, 2017, the President signed into law the Tax Cut and Jobs Act, the most sweeping change to federal tax law since 1986.  Below is a summary of the Act’s more far-reaching provisions, all of which are effective January 1, 2018 unless otherwise noted.

Provisions Affecting Individuals

Area

Change

Tax brackets (married filing joint returns)

Seven brackets- 10% on taxable income up to $19,050; 12% from $19,051 to $77,400; 22% from $77,401 to $165,000; 24% from $165,001 to $315,000; 32% from $315,001 to $400,000; 35% from $400,001 to $600,000; and 37% over $600,000.

Tax brackets (single returns)

Seven brackets- 10% on taxable income up to $9,525; 12% from $9,526 to $38,700; 22% from $38,701 to $82,500; 24% from $82,501 to $157,500; 32% from $157,501 to $200,000; 35% from $200,001 $500,000; and 37% over $500,000.

Tax brackets (head of household returns)

Seven brackets- 10% on taxable income up to $13,600; 12% from $13,601 to $51,800; 22% from $51,801 to $82,500; 24% from $82,501 to $157,500; 32% from $157,501 to $200,000; 35% from $200,001 to $500,000; and 37% over $500,000.

Tax brackets (married filing separate returns)

Seven brackets- 10% on taxable income up to $9,525; 12% from $9,526 to $38,700; 22% from $38,701 to $82,500; 24% from $82,501 to $157,500; 32% from $157,501 to $200,000; 35% from $200,001 to $300,000; and 37% over $300,000.

Measure of inflation

Beginning in 2019, tax brackets will be adjusted using chained CPI-U instead of CPI-U (chained CPI generally grows at a slower rate).

Tax rates on capital gains and qualified dividend income

Retains same break-points for lower rates as current law- 15% break-point of $77,200 for joint filers, $38,600 for married filing separately, $51,700 for heads of households, and $38,600 for singles; 20% break-point of $479,000 for joint returns, $239,500 for married filing separately, $452,400 for heads of households, and $425,800 for singles.

Standard deduction

Increased to $24,000 for joint filers, $18,000 for heads of households, and $12,000 for all others.  The current additions to this deduction for being over 65 or blind (or both) were not changed ($1,300 each for married filing either joint or separate and $1,600 for singles). 

Personal exemptions

Reduced to zero.

Income from pass-through businesses (S Corps, LLC’s, partnerships, and sole proprietorships)

Allows a deduction from taxable income for 20% of qualified domestic income from S Corps, partnerships, and sole proprietorships.  For all entities except sole proprietorships, the deduction is limited to the greater of 1) 50% of W-2 wages of the business, or 2) 25% of W-2 wages of the business plus 2.5% of the cost of property used in the business.  However, this limitation does not apply to owners with taxable income below certain limits (for joint filers $315,000 to $415,000, and for all other filers $157,500 to $207,500). 

The deduction is phased-out for owners of specified service businesses (health, law, accounting, and consulting) or of businesses involved in investment-type activities if the owner’s taxable income exceeds certain amounts.  For joint filers, the deduction is phased-out for owners with taxable income from $315,000 to $415,000, and for all other filers with taxable income from $157,500 to $207,500. 

Child tax credits

Increased to $2,000 per child up to age 18, with refundable portion capped at $1,400, but is phased-out if adjusted gross income is income over $400,000 for joint filers or $200,000 for all others.  Also adds a new $500 credit for certain non-child dependents.

Deduction for state

and local taxes

  • Limited to an aggregate of $10,000 for property taxes and either income or sales taxes. 
  • Deduction in 2017 for pre-payment of 2018 taxes is prohibited.

 

Deduction for mortgage interest

  • Deduction for interest on home equity indebtedness eliminated.
  • Deduction for interest on acquisition-mortgage interest for first and second homes limited to underlying indebtedness of $750,000.  This limit does not apply to acquisition indebtedness outstanding at December 14, 2017.    
  • The current $1 million/$500,000 debt limit continues to apply for taxpayers who re-finance existing qualified mortgage indebtedness incurred before January 1, 2018 as long as the refinanced debt does not exceed the prior debt. 

Deductions for medical expenses

Reduces current threshold to deduct medical expenses from 10% of adjusted gross income to 7.5% for 2017 and 2018.

Phase-out of itemized deductions for high-income taxpayers

Repealed.

Other itemized deductions

Repeals deductions for-

  • Casualty losses unless attributable to a federally declared disaster.
  • All miscellaneous itemized deductions subject to 2% of adjusted gross income limitation (includes tax preparation fees, investment expenses, employee business expenses).

 

Charitable contributions

  • Deduction limit increased to 60% of adjusted gross income.
  • No payments to colleges and universities in exchange for the right to purchase sporting event tickets will qualify as charitable contributions. 

 

Moving expenses

Eliminates exclusion of moving expense reimbursements from income and the deduction from gross income for moving expenses.

Alternative Minimum Tax

Retained, but with increased exemptions ($109,400 joint, $70,300 singles, $54,700 married filing separately) and exemption phase-out limits ($1 million for joint returns, $500,000 for all others).

Alimony

  • For agreements executed after December 31, 2018, alimony will no longer be deductible by the payer or taxable to the recipient. 
  • Also applies to modifications executed after December 31, 2018 if the modification expressly provides that the new tax law applies.

 

Section 529 (College Savings) Plans

Allows tax-free withdrawals for up to $10,000 in expenses for elementary and secondary schooling and for home schooling. 

ACA Individual Mandate

Penalty reduced to zero beginning in 2019.

Recharacterization of IRA contributions

The rule that allows a contribution to one type of IRA to be recharacterized as a contribution to the other type of IRA does not apply to a conversion contribution to a Roth IRA.  Thus, a recharacterization can’t be used to unwind a Roth conversion.

 

Provisions Affecting Estates and Trusts

Area

Change

Lifetime exclusion

Doubles lifetime exclusion through 2025.  The exclusion (which is adjusted annually for inflation) in 2018 is expected to be approximately $11.2 million ($22.4 for a married couple). 

Income tax brackets

Four brackets- 10% on taxable income up to $2,550; 24% from $2,551 to $9,150; 35% from $9,151 to $12,500; and 37% over $12,500.

Tax rates on capital gains and qualified dividend income

Retains same break-points for lower rates as in current law- 15% break-point of $2,600, and 20% break-point of $12,700.

 

Provisions Affecting Businesses

Area

Change

Corporate tax rate

Flat 21%

Corporate Alternative Minimum Tax

Repealed

Section 179 expensing

  • For property placed in service after December 31, 2017, up to $1 million may be expensed, reduced by acquisitions in excess of $2.5 million.
  • Expands eligible real property to include roofs, HVAC, and fire protection and security systems

Bonus deprecation

  • Increased to 100% for qualifying property placed in service from September 28, 2017 through December 31, 2022.
  • Both new and used property will now qualify.

 

“Luxury” automobile depreciation limits

Increased to $10,000 for year 1, $16,000 for year 2, $9,600 for year 3, and $5,760 for each year thereafter.

Real property depreciation

  • For qualified leasehold improvement property, qualified restaurant property, qualified retail improvement property, and qualified improvement property-
  • The separate definitions are eliminated and the requirements that such improvements be made subject to a lease, are placed in service more than three years after the building was first place in service, or made to restaurant property are eliminated.
  • Such property will be depreciable over 15 years using the straight-line method and a half-year convention
  • The AMT live for such property will be 20 years.
  • For residential property, the AMT life will be 30 years.

 

Business interest deduction

Deduction for net interest expense limited to 30% of adjusted taxable income (taxable income before interest expense or depreciation and amortization expense), with any excess carried forward indefinitely.  Does not apply to businesses with average annual gross receipts in the prior three years under $25MM or to businesses with inventory financed under floor plans.

Net operating loss deduction

  • Carrybacks disallowed, but carryforwards allowed indefinitely.
  • Deduction limited to 80% of pre-NOL taxable income.

 

Domestic Activities Production Deduction

Repealed for non-corporate taxpayers for years beginning after December 31, 2017 and for C corporations for years beginning after December 31, 2018.

Like-kind exchanges

Limited to real property

Entertainment expenses

  • No deduction for entertainment or club dues.
  • 50% deduction for food and beverages retained.

Deduction for local lobbying expenses

Eliminated.

Credit for employer-paid family and medical leave

Adds a tax credit of 12.5% of the amount of wages paid to employees on family or medical leave, if those wages are at least 50% of the wages normally paid to the employee.  The credit is increased by .25% (but not above 25%) for each percentage point by which the rate of payment exceeds 50%.

Accounting methods

  • Permits cash-basis of accounting if average annual gross receipts in the prior three years under $25MM.
  • Can treat inventory as non-incidental materials and supplies if average annual gross receipts in the prior three years under $25MM.
  • Exempts taxpayers with average annual gross receipts in the prior three years under $25MM from the Sec. 263A (UNICAP rules) that require capitalization of certain costs into inventory.
  • Exempts contractors from having to use the percentage-of-completion method if average annual gross receipts in the prior three years under $25MM.

 

Partnership technical terminations

Repealed.

 

Provisions Affecting Exempt Organizations

Excess tax on excess executive compensation

Imposes the corporate tax (21%) on compensation in excess of $1 million paid to any of an organization’s top five highest paid employees.

Excise tax on endowments

Imposes a 1.4% excise tax on the net investment income of private colleges and universities with at least 500 tuition-paying students and an endowment of at least $500,000 per student.

Unrelated business taxable income (UBTI) and losses

Losses from an unrelated business activity may not offset the unrelated business income from another activity.

 

What are the major take-aways from this bill?

With the large increase in the standard deduction and the limitation on deducting state and local income and property taxes, far fewer individuals will itemize in future years.  Individuals whose mortgage interest, state and local taxes (up to the $10,000 limit) and charitable donations are close to the new standard deduction may want to alternate years in making charitable donations, giving two years’ of donations in one year so as to exceed the standard deduction in one year and then making no donations the next year and using the standard deduction.

 

  1. Individuals who expect to itemize in 2017 will likely benefit by making their fourth quarter state estimated tax payments and any possible property tax payments by December 31, especially if their state and local tax deduction will exceed $10,000 in future years. 

 

  1. Individuals who expect to itemize in 2017 and incur significant miscellaneous itemized deductions (investment fees, portfolio expenses, tax preparation fees, employee business expenses) will likely benefit by accelerating payment for such items by December 31 as these will no longer be deductible in the future.

 

  1. Individuals with income from pass-through entities will want to study those rules carefully to determine if they will benefit from the 20% deduction and to defer as much income into 2018, or accelerate as many expenses into 2017, from such entities as possible.

 

  1. Businesses will want to evaluate their form of tax entity in light of the lower C corporation income tax rates and the 20% deduction for pass-through income.

 

  1. Businesses will want to evaluate their tax accounting policies to see if they qualify for the more liberalized rules for entities with average annual gross receipts under $25 million. 

Indiana Department of Revenue Issues Updated Sales Tax Rules for Construction Contractors

Posted by Admin Posted on Nov 29 2017

In November 2017, the Department issued Information Bulletin #60 to reflect statutory changes made in response to the 2014 Lowe's case that had invalidated Indiana's rules for time-and-material contracts.  Those changes re-instated the pre-Lowe's rule that sales tax must be charged on the marked-up material price on T&M contracts, not on the cost of those materials.  The Bulletin provides updated guidance for both T&M and lump-sum contracts, as well as the treatment of materials purchased for tax-exempt jobs and off-site fabrication of materials.  All contractors should review the Bulletin (attached below) to make sure their procedures are compliant, especially since sales and use tax audits of contractors is common.  Please let us know if you have any questions about it.  

Information Bulletin #60

 

New Accounting Standard Clarifies Accounting for Contributions

Posted by Admin Posted on Aug 07 2017

In June 2018, FASB issued Accounting Standards Update 2018-08, "Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made."  The standard is effective for years beginning after December 15, 2018, but may be early adopted.   

The new standard focuses on two topics - 1) determining whether transactions are contributions or exchange transactions, and 2) determining whether contributions are conditional or unconditional.  Both topics affect when and how revenue from transactions are recognized. 

Currently there is much diversity in practice in how certain transactions - particularly with government entities - is recognized, and one of the purposes of the proposal is to bring uniformity in recording such transactions.  The standard will likely result in more governmental grants and contracts being treated as contributions rather than exchange transactions.  The standard also provides a framework to evaluate whether a contribution is conditional or unconditional.  Included in the standard are several illustrative examples that should prove useful in implementing the new provisions.    

Indiana Changes County Tax Rules and Increases Tax on Nonresidents

Posted by Admin Posted on Sept 29 2016

Effective January 1, 2017, Indiana will impose county taxes on nonresidents whose principal place of employment or business is in a taxing Indiana county at the same rate as imposed on residents.  In addition, all county income taxes (county adjusted gross income tax, county option tax and county economic development income taxes) will be combined into one combined local income tax.

Most Indiana counties impose one or more income taxes on individuals who are residents of the county, and on nonresidents whose principal place of employment or business is in the county, as of January 1.  Currently, the tax rate  imposed on nonresidents is less than the rate imposed on nonresidents.  However, as of January 1, 2017, nonresidents will be taxed at the higher resident rate.  Consequently, employers will need to change county tax withholdings on nonresidents beginning January 1, 2017.  

New Accounting Standard will Affect All Nonprofits Beginning in 2018

Posted by Admin Posted on Aug 23 2016

Earlier this week, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No, 2016-14, Presentation of Financial Statements of Not-for-Profit Entities.  As expected, the ASU makes significant changes to the not-for-profit financial reporting model that has been in effect since 1993.  However FASB deferred the issue of an operating measure until a later update.

Effective Date

The ASU is effective for years beginning after December 15, 2017 (i.e., 2018), with early application permitted.  Changes are to be applied on a retrospective basis, but certain provisions are not required to be implemented for the prior year comparative statements.

Main Provisions

The main provisions of the update are as follows-

1) Balances and activities will be reported by two net classes – net assets without donor restrictions, and net assets with donor restrictions.  Current reporting uses three net asset classes – unrestricted, temporarily restricted, and permanently restricted.

2) In the statement of cash flows, operating cash flows may continue to be presented using either the indirect or the direct method (the draft of the update would have eliminated the indirect method).  The requirement to reconcile the change in net assets to operating cash flows has been eliminated.

3) All NFP’s must report expenses by both natural classification (e.g., salaries, rent, etc.) and functional classification in one location, either in the statement of activities, a separate statement of functional expenses, or in the notes.  Previously, only voluntary health and welfare organizations were required to do this.

4) Investment income is to be reported net of external and (if applicable) internal investment expenses, and the netted expenses no longer need be disclosed.

4) The following enhanced disclosures will be required-

  • Provide the amounts and purposes of governing board designations and appropriations that result in self-imposed limits on the use of resources without donor restrictions.
  • Provide the composition of net assets with donor restrictions and how those restrictions affect the use of resources.
  • Provide qualitative information about how the NFP manages its liquid resources to meet cash needs for general expenditure in the next year.
  • Provide quantitative information about the availability of financial assets to meet cash needs for general expenditure in the next year.  Availability of a financial asset may be affected by 1) its nature, 2) external limits imposed by donors, grantors, and laws, and 3) internal limits imposed by the governing board.
  • Information on methods used to allocate costs among program and support functions.
  • Provide information about “underwater” endowment funds, including 1) the NFP’s policy and related actions concerning appropriation from underwater funds, 2) the aggregate fair value of such funds, 3) the aggregate original gift amounts, and 4) the aggregate amount such funds are underwater for net assets with donor restrictions.

Conclusion

The ASU will bring some welcome uniformity to not-for-profit reporting.  Some provisions will simplify financial statements, but others will add complexity, particularly in disclosures. 

The complete ASU (270 pages) contains useful implementation examples.  It is available for download at http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176156316498#2016

Please let us know if you have any questions about how this pertains to your organization.

 

New Accounting Standard for Recognizing Credit Losses

Posted by Admin Posted on June 22 2016

In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2016-13 , Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.  Beginning in 2021, credit losses will be recognized using an "expected loss" model (i.e. losses are recorded based on the full amount of expected losses), rather than the current "incurred loss" model (i.e., losses are not recorded until it is probable that a loss has been incurred).  Under this more conservative model, credit losses will be recognized earlier than they were previously.

The standard will apply to all entities with financial assets, such as trade receivables and loans. Thus, expected credit losses will be measured based on past experience and current and reasonably supportable forecasted conditions.  Though many of the loss estimation techniques currently being applied will continue to be permitted, the inputs to those techniques will change to reflect the full amount of expected losses. 

The new standard is not effective until calendar 2021 for non-public entities, with early implementation allowed in 2019.

IRS Announces 2018 Standard Mileage Rates

Posted by Admin Posted on May 05 2016

The IRS has announced that in 2018 the optional standard mileage rates will be as follows: the rate for business travel will increase slightly to 54.5¢ per mile, the rate for medical care and moving will increase to 17¢ per mile, and the the rate for charitable driving remains fixed by statute at 14¢.

These standard mileage rates replace separate deductions for lease payments (or depreciation if the car is owned), maintenance, repairs, tires, gas, oil, insurance and license and registration fees. Taxpayers may, however, still claim separate deductions for parking fees and tolls connected to business driving.

Employers that require employees to supply their own vehicles may reimburse them at a rate that doesn't exceed the standard business rate for employment-connected business mileage, whether the vehicles are owned or leased.  The reimbursement is treated as a tax-free accountable-plan reimbursement if the employee substantiates the time, place, business purpose, and mileage of each trip.

 

 

New Accounting Standard to Have Big Effect on Lessee Balance Sheets Beginning in 2020

Posted by Admin Posted on May 02 2016

The main change in the new standard is that lessees must recognize, in their balance sheets, leased assets and lease liabilities for operating leases.  Currently, lessees do not record either assets or liabilities for operating leases.

The new standard covers all entities – both for-profit and nonprofit - that issue financial statements in accordance with U.S.. generally accepted accounting principles (GAAP).

For non-public entities, the standard takes effect in years beginning after December 15, 2019 (i.e., calendar 2020), with early application permitted. It will apply to all leases in effect as of the beginning of the earliest comparative period presented; in other words, if 2019 comparative statements are included with 2020 statements, leases in effect at January 1, 2019 will be covered.

 For lessees-

  • At the start of a lease, lessees must record both an asset and a liability for the net present value of future lease payments. The asset will be amortized to expense, and lease payments will reduce the liability, over the lease term. How that is done depends on whether the lease is an operating or a finance lease.
  • The biggest effect to lessees will be on their balance sheets. The new standard will gross-up lessee’s assets and liabilities for leases, which will change financial statement ratios and may affect compliance with loan covenants.

 

For lessors-

  • Unless a lease is sales-type or financing lease, lease income is simply recognized when earned, and there is no grossing-up of assets and liabilities.

 

Depending on the number and value of leases, the new standard could have a large effect on lessee balance sheets by increasing both assets and liabilities. This, in turn will affect certain balance sheet ratios, particularly the current ratio and the debt-equity ratio. Since many loan agreement contain covenants that specify minimum current ratios and maximum debt-equity ratios, lessees may want to discuss the effects of the new standard with their lenders before it goes into effect and make appropriate adjustments to affected covenants.