Tax Reform: Practical Insights

October 17, 2018 | Article

You Should Be Interested in Interest
If you finance a car, house, education or vacation, or if you borrow money for an investment, you probably pay or accrue interest for the use of the money you borrowed. The question then becomes, “is that interest deductible for tax purposes?”

In answering that question, you will find that not all interest payments are handled in the same way for tax purposes. Since almost all individual taxpayers will report taxes using the cash method, interest paid on your house, for example, is eligible for use as an itemized deduction if your loan qualifies. Interest paid on investment debt is treated the same way. If you don’t itemize, and instead use the standard deduction, then you’re out of luck on deducting those specific interest items.

Interest paid on funds that have been borrowed to finance a business or student loan are eligible for deducting, subject to limitations, when calculating your adjusted gross income. This is referred to as an “above the line” deduction. Unfortunately, interest paid when borrowing for personal items, such as a non-business car, credit card debt or a family vacation is not deductible.

In addition, interest deduction matters got a little more complicated with the passing of the Tax Cuts and Jobs Act. This act made certain rule changes that need to be considered when assessing the deductibility of interest payments, particularly those related to interest paid on a qualified personal residence or business.

To learn more about the deductibility of your interest payments, contact an Eide Bailly tax professional.

Moving Expenses: Are They Covered or Not?
Starting in tax year 2018, job-related moving expenses are no longer deductible, except for employees who are active-duty members of the Armed Forces who are moving under orders. Employers can still make reimbursements for moving expenses, but non-military employees will pay tax on the amount reimbursed.

That said, some non-military employees will be able to use the old rules on 2018 returns. The IRS has announced (Notice 2018-75) that employees can exclude from their wage income reimbursements for 2017 moving costs that they received from employers in 2018. This exclusion only applies if the employee did not deduct the expenses in 2017.

The IRS notice does not include information regarding 2017 moving expenses paid in 2018 but not reimbursed by the employer. However, there appears to be no deduction available for non-military moves.

To learn more, contact your Eide Bailly tax professional.

Don’t Let the IRS Pick Your Team
Under new IRS rules for examining partnerships, the IRS can sometimes choose which partner will represent the partnership in an audit. This rule can kick in if the partnership fails to select a representative, or if that representative doesn’t qualify to serve.

The partnership representative holds a powerful position under the new rules and has authority to bind the partnership. Since the new partnership examination rules can cause the partnership to have to pay tax, a misstep can be costly. Therefore, it’s important to make sure that partnership documents define the appropriate partnership representative, so that the partners—rather than the IRS—get to choose who will represent their financial interest.

Contact your Eide Bailly tax professional to learn how the new rules can affect your partnership, and what you can do to prepare.

Take Your Bonus and Go Shopping!
Are you looking to add an additional production line for manufacturing, open a new business or make improvements to an existing property? Now is the time, and you may get some great depreciation benefits along with it. Acquired used property is eligible for a bonus depreciation deduction. That’s right; the purchased item doesn’t need to be new in order to potentially benefit!

The Tax Cuts and Jobs Act, signed December 22, 2017, allows qualified property with a recovery period of 20 years or less to receive 100 percent bonus depreciation. In addition, the definition of property eligible for 100 percent bonus depreciation was expanded to include used qualified property acquired, if all of the following factors apply:

  • The taxpayer didn’t use the property at any time before acquiring it.
  • The taxpayer didn’t acquire the property from a related party.
  • The taxpayer didn’t acquire the property from a component member of a controlled group of corporations.
  • The taxpayer’s basis of the used property is not figured in whole or in part by reference to the adjusted basis of the property in the hands of the seller or transferor.
  • The taxpayer’s basis of the used property is not figured under the provision for deciding basis of property acquired from a decedent.

A non-residential purchased building is still depreciated over 39 years (27.5 years for residential), and comes with no bonus treatment. However, a cost segregation study is a tax savings tool that has the ability to unleash significant bonus deductions, particularly when combined with the above change regarding used qualified property. Through a cost segregation study, a portion of the building’s cost basis can be componentized to a lower recovery period and, in turn, qualify for 100 percent bonus treatment. This can equate to additional cash in hand.

Contact your Eide Bailly professional or Mark Rogers for information on claiming bonus depreciation. We can also provide a free assessment on capturing bonus depreciation through a cost segregation assessment, and advise on fixed asset opportunities available to you in the new tax reform environment.

Divorce: Tax Consideration
As a result of the 2017 tax reform, married couples who decide to file for divorce need to consider the timing of their final divorce settlements.

Prior to 2019, if a divorce or legal separation is created by a court action and calls for payment of alimony, the divorce/separation will generate both a deduction from gross taxable income for the paying spouse and taxable income for the recipient spouse. This structure, which has been available for more than 70 years but will soon be changing, generates tax planning opportunities based on the tax brackets of the paying and recipient spouse. However, under this structure there is also the potential that no alimony will be paid, depending on the financial facts presented in the divorce or legal separation.

The 2017 tax reform legislation has changed the above structure for alimony. For a divorce or legal separation that comes into existence after 2018, the alimony deduction option for the paying spouse goes away, as does the taxability to the recipient spouse. There also is a special rule in the new legislation that could be very important for existing pre-2019 divorces or legal separations. Existing pre-2019 agreements can be legally modified so that the new rules related to alimony will not apply, unless the new alimony rules are expressly provided for in the modified agreement. This is an important feature that will provide an opportunity to change existing pre-2019 agreements for changes in financial conditions of the divorced parties. This feature could also impact parties dealing with a pre-nuptial agreement with stated conditions, which could possibly change because of the new alimony rules. If these agreements are not reviewed and left unmodified, undesired consequences will likely result.

While divorce settlements can be difficult, knowing the rules related to alimony makes it easier for the spouses to find common ground. Contact your Eide Bailly tax professional to learn more.

Partnerships can pay tax—Really!
Because of the very low examination rate of partnerships by the IRS, which is said to be the result of complications created when chasing adjustments through the partners separate tax returns, the IRS requested and Congress approved an overhaul of the rules covering IRS partnership examinations.

Under the new rules, beginning with 2018 partnership returns, the IRS can collect tax directly from the partnership, rather than the partners, depending on decisions the partnership makes. If this action is allowed, the IRS will collect tax at the top individual and corporate rates for any understatement of taxable income – even for an allocation of partnership income or loss made to the wrong K-1.

We expect the IRS will ramp up partnership audit activity utilizing this new exam tool, which will make it important for partnerships to review their agreements prior to the IRS knocking on their door.

The partnership has important options and decisions to be made when it comes to dealing with IRS examinations. Failure to be prepared and take action can foreclose those options for the partnership, which can cause the IRS examination procedures to default to potentially the most expensive option.

Find out more from your Eide Bailly tax professional.

I scream, you scream - should we incorporate?
The 2017 tax reform legislation reduced the federal corporation tax rate from 35 percent to 21 percent. But a lot of small businesses operate as partnerships or S corporations, which means their earnings are frequently taxed at the individual tax rate; the new legislation only reduced the individual rate to 37 percent, which is 16 percent higher than the corporate rate.

So, based on the above every business should be incorporated, right?

Not so fast.

After thinking about the large tax rate reduction provided to corporations, Congress decided that small business partnerships, S corporations and sole proprietors needed a tax reduction too, so they designed the 20 percent qualified business income deduction. This deduction doesn’t cover every business type, and there are taxable income limitations on the new deduction that will apply, but if available, the deduction more than levels the playing field with corporations when it comes to tax rates. 

However, there is still the potential of double taxation with a corporation that needs to be considered. For a shareholder to actually use the income earned in a corporation, a taxable dividend must be paid out of the corporation. When you add that second tax on the dividend, the combined tax rate for useable corporate earnings doesn’t seem as appealing.  Then, when you add on state corporate taxes the rate seems even less attractive.

Still, the new 21 percent corporate rate beats the old 35 percent, and some businesses, depending on their requirements, may use earnings to build the business value and allow stockholders to skip dividends. This would also allow stockholders to skip the second layer of tax payment that would be required until the business is sold. Only then would the prior earnings be taxed at capital gains tax rates rather than ordinary income tax rates.

Here’s the takeaway point: while rates are an important feature in tax planning, they are only a piece to the tax planning puzzle. which will at times cause everyone to scream a little.

To learn more, contact your Eide Bailly tax professional.

The “Pass-Through” Deduction Doesn’t Require a Pass-Through
The “Qualified Business Income” deduction, a new tax break for certain businesses, allows qualifying individuals and trusts to potentially deduct up to 20 percent of their net business income from taxable income.

Recent tax reform legislation reduced the top corporation tax rate from 35 percent to 21 percent. That corporate reduction prompted “pass-through” businesses to lobby for their own tax break. The QBI deduction was the result, which prompted many taxpayers to refer to it as the “Pass-Through Deduction

Unfortunately, that nickname has led many taxpayers to believe the QBI deduction is only available if the income is earned by a “pass-through entity,” such as an S corporation, partnership or LLC. But, that’s wrong. While there are limitations related to business type and amounts earned, most business income reported on a Schedule C, Schedule E or Schedule F is potentially eligible for the deduction; it doesn’t need to arise in a pass-through entity nor be reported on a Form K-1.

There may be a lot of good business reasons to use a pass-through entity, but being eligible to benefit from a QBI deduction (or the “Pass-Through Deduction” for some) isn’t necessarily one of them. Contact your Eide Bailly tax professional to find out what you really need to know and do in order to qualify for this valuable deduction.

Tax Reform Benefits Gig Economy, Too
Many participants in the "gig economy" can look forward to good news when they file their 2018 taxes, thanks to tax reform.

A “gig,” long used to identify the work of freelancers such as musicians and others working in a similar environment, has evolved to include taxpayers who make a living, or maybe just some extra cash, working for themselves in "sharing economy" businesses such as Uber or Lyft. These taxpayers do their work as Form 1099 independent contractors, rather than as W-2 employees.

The Tax Cuts and Jobs Act, through the qualified business income deduction, provides the opportunity for many in the gig economy to exclude 20 percent of their net gig income from tax.

There are limits to this tax deduction benefit, including the exclusion of certain service type businesses that could match some of the gig economy services. However, if a taxpayer with gig net income has a taxable income level below the phaseout amounts, even an excluded service type will qualify for the 20 percent deduction benefit. The phaseout starts at $157,500 of taxable income for single filers and $315,000 for joint filers, and completely phases out at $207,500 of taxable income for single filers and $415,000 for joint filers. After those levels, while the benefit opportunity still exists, it’s probably difficult for a gig-styled business to qualify. But, it would seem, these limits are generous enough to help a lot of gig economy workers.

Gotta gig? Contact your Eide Bailly tax professional to learn more about reducing your taxes to increase your cash flow.

Take Me Out to The Ball Game — Nondeductible!

Tell me it’s not so, Joe. A customer entertainment event, like a trip to the ballpark to discuss business in a relaxed environment, is a long and storied business tradition. The ballpark’s still open, but the tickets to events that are considered customer entertainment are no longer deductible beginning in 2018. Recent tax reform legislation eliminated the deduction for business entertainment expense.

What is “entertainment?” IRS Publication 463 gives a good summary:

Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation. Examples include entertaining guests at nightclubs; at social, athletic, and sporting clubs; at theaters; at sporting events; on yachts; or on hunting, fishing, vacation, and similar trips.

Although new law guidance questions remain to be answered by the Internal Revenue Service, it’s important to understand and plan for deductions that are no longer available in relation to meals and entertainment. Perhaps the real focus, however, should be on a change of operational activities rather than just on the loss of deduction. Implementing such a change can effectively maintain client relationships and service expectations while still enabling some part of that cost to be deductible.

Contact your Eide Bailly professional to learn more about the new meal and entertainment expensing rules; we can outline how they could affect your client relationship activities and provide ideas on how to deal with the changes.

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