Tax

CARES Act Fixes TCJA Glitch on QIP, Requires Action

CARES Act Fixes TCJA Glitch on QIP, Requires Action

Congress made an error in the Tax Cuts and Jobs Act (TCJA) that limited your ability to fully expense your qualified improvement property (QIP).

The CARES Act fixed the issue retroactively to tax year 2018.

If you have such property in your prior filed 2018 or 2019 tax returns, you likely have no choice but to correct those returns. But the bright side is that the corrected law gives you options that enable you to pick the best tax result.

What Is QIP?

QIP is any improvement made by the taxpayer to the interior portion of a building that is non-residential real property (think office buildings, retail stores, and shopping centers) if you place the improvement in service after the date you place the building in service.

The CARES Act correction added the “made by the taxpayer” requirement to the definition.

QIP does not include any improvement for which the expenditure is attributable to

  • the enlargement of the building,
  • any elevator or escalator, or
  • the internal structural framework of the building.

QIP Problem

Due to a TCJA drafting error in the law, Congress made QIP 39-year property for depreciation purposes and ineligible for bonus depreciation.

Unusual twist. This drafting error did not affect expensing under Section 179. Under the TCJA, you could have elected to expense some or all of your QIP with Section 179.

But now you have to revisit your previously filed 2018 and 2019 tax returns and consider 100 percent bonus depreciation, 15-year depreciation, and Section 179 expensing.

QIP Solution

The CARES Act made QIP 15-year property and made it eligible for bonus depreciation retroactively as if Congress had included it in the TCJA when it originally became law.

This change requires you to take a one-time, lump-sum bonus depreciation deduction for the entire cost of your QIP in the tax year during which you place the QIP in service, unless you elect out.

If the QIP lump-sum deduction creates a net operating loss (NOL), you can carry back that loss to get almost immediate cash.

If you have QIP on a 2018 or 2019 tax return and think it could produce a net loss for that tax year, call me now on my direct line at xxx-xxx-xxxx. We can consider whether to start filing for a quick refund of your taxes paid in 2013 (for a 2018 carryback) or 2014 (for a 2019 carryback).

Sincerely,

THE FINANCIAL DREAM TEAM, USA

Q&A: Are PPP Loan Forgiveness Expenses Deductible?

Q&A: Are PPP Loan Forgiveness Expenses Deductible?

Question

If I obtain Paycheck Protection Program (PPP) loan forgiveness, can I still deduct the business expenses I paid with the loan forgiveness proceeds?

Answer

We have bad news—the IRS just released Notice 2020-32 telling us the answer is no. Quick

Review

As we discuss in COVID-19: New SBA Loans for Small Businesses – Maybe a Great Deal:

  • Your maximum PPP loan amount is 250 percent of your average monthly payroll expenses, up to $10 million.
  • PPP loan amounts used for payroll, mortgage interest, rent, and utility payments during the eight-week period starting with the loan origination date will be forgiven and excluded from your taxable income.

IRS Position

The IRS says the payments you make during that eight-week period to get the non-taxable loan forgiveness are non-deductible up to the aggregate amount forgiven, for two reasons:

  1. The payments are allocable to tax-exempt income, making them non-deductible.
  2. Deductions for otherwise deductible payments are non-deductible if you receive a reimbursement for those payments.

Neither the CARES Act nor the Joint Committee on Taxation’s explanation of the CARES Act addresses the deductibility issue.

Takeaways

The IRS says you can’t take a tax deduction for the business expenses you used to qualify for PPP loan forgiveness.

The key benefit of the PPP loan is that you can have the loan forgiven—essentially putting free cash in your pocket.

Your inability to deduct the expenses that created that non-taxable loan forgiveness takes away some cash due to loss of tax deductions, but you are still well ahead with the PPP loan from a cash-in-hand perspective.

This IRS position generates at least one question we’ll need to answer in the coming weeks or months: does this affect the wage amount you use to calculate your Section 199A deduction if you are over the Section 199A taxable income threshold?

COVID-19 Crisis Creates Silver Lining for Roth IRA Conversions

COVID-19 Crisis Creates Silver Lining for Roth IRA Conversions

For years, financial and tax advisors have lectured about the wonderfulness of Roth IRAs and why you should convert traditional IRAs into Roth accounts.

But, of course, you didn’t get around to it. In hindsight, maybe that was a good thing.

For many, the financial fallout from the COVID-19 crisis creates a once-in-a-lifetime opportunity to do Roth conversions at an affordable tax cost and also gain insurance against future tax rate increases.

Roth IRAs Have Two Big Tax Advantages

Let’s quickly review them.

Tax-Free Withdrawals

Unlike withdrawals from a traditional IRA, qualified Roth IRA withdrawals are federal-income-tax-free and usually state-income-tax-free, too.

What is a qualified withdrawal? In general, the tax-free qualified withdrawal is one taken after you meet both of the following requirements:

  1. 1. You had at least one Roth IRA open for over five years.
  2. 2. You reached age 59½, became disabled, or died.

To meet the five-year requirement, start the clock ticking on the first day of the tax year for which you make your initial contribution to any Roth account. That initial contribution can be a regular annual contribution, or it can be a contribution from converting a traditional IRA into a Roth account.

Example: Five-Year Rule.

You opened your first Roth IRA by making a regular annual contribution on April 15, 2017, for your 2016 tax year. The five-year clock started ticking on January 1, 2016 (the first day of your 2016 tax year), even though you did not actually make your initial Roth contribution until April 15, 2017.

You meet the five-year requirement on January 1, 2021. From that date forward, as long as you are age 59½ or older on the withdrawal date, you can take federal-income-tax-free Roth IRA withdrawals—including withdrawals from a new Roth IRA established with a 2020 conversion of a traditional IRA.

Exemption from RMD Rules

Unlike with the traditional IRA, you as the original owner of the Roth account don’t have to take annual required minimum distributions (RMDs) from the Roth account after reaching age 72. That’s good, because RMDs taken from a traditional IRA are taxable.

Under those rules, if your surviving spouse is the sole account beneficiary of your Roth IRA, he or she can treat the inherited account as his or her own Roth IRA. That means your surviving spouse can leave the account untouched for as long as he or she lives.

If a non-spouse beneficiary inherits your Roth IRA, he or she can leave it untouched for at least 10 years. As long as an inherited Roth account is kept open, it can keep earning tax-free income and gains. Nice!

Silver Lining for Roth Conversions

A Roth conversion is treated as a taxable distribution from your traditional IRA, because you’re deemed to receive a payout from the traditional account with the money then going into the new Roth account.

So, doing a conversion will trigger a bigger federal income tax bill for the conversion year, and maybe a bigger state income tax bill, too. That said, right now might be the best time ever to convert a traditional IRA into a Roth IRA. Here are three reasons why.

1. Current tax rates are low thanks to the TCJA.

Today’s federal income tax rates might be the lowest you’ll see for the rest of your life.

Thanks to the Tax Cuts and Jobs Act (TCJA), rates for 2018-2025 were reduced. The top rate was reduced from 39.6 percent in 2017 to 37 percent for 2018-2025.

But the rates that were in effect before the TCJA are scheduled to come back into play for 2026 and beyond.

And rates could get jacked up much sooner than 2026, depending on politics and the need to recover some of the trillions of dollars the federal government is dishing out in response to the COVID-19 pandemic.

Believing that rates will only go back to the 2017 levels in the aftermath of the COVID-19 mess might be way too optimistic.

2. Your tax rate this year might be lower due to your COVID-19 fallout.

You won’t be alone if your 2020 income takes a hit from the COVID-19 crisis.

If that happens, your marginal federal income tax rate for this year might be lower than what you expected just a short time ago—maybe way lower. A lower marginal rate translates into a lower tax bill if you convert your traditional IRA into a Roth account this year.

But watch out if you convert a traditional IRA with a large balance—say, several hundred thousand dollars or more. Such a conversion would trigger lots of extra taxable income, and you could wind up paying federal income tax at rates of 32, 35, and 37 percent on a big chunk of that extra income.

3. A lower IRA balance due to the stock market decline means a lower conversion tax bill.

Just a short time ago, the U.S. stock market averages were at all-time highs.

Then the COVID-19 crisis happened, and the averages dropped big-time.

Depending on how the money in your traditional IRA was invested, your account might have taken a substantial hit. Nobody likes seeing their IRA balance go south, but a lower balance means a lower tax bill when (if) you convert your traditional IRA into a Roth account.

When the investments in your Roth account recover, you can eventually withdraw the increased account value in the form of federal-income-tax-free qualified Roth IRA withdrawals. If you leave your Roth IRA to your heirs, they can do the same thing.

In contrast, if you keep your account in traditional IRA status, any account value recovery and increase will be treated as high-taxed ordinary income when it is eventually withdrawn.

As mentioned earlier, the current maximum federal income tax rate is “only” 37 percent. What will it be five years from now? 39.6 percent? 45 percent? 50 percent? 55 percent? Nobody knows, but we would bet it won’t be lower than 37 percent.      

The Bottom Line

If you do a Roth conversion this year, you will be taxed at today’s “low” rates on the extra income triggered by the conversion.

On the (far bigger) upside, you avoid the potential for higher future tax rates (maybe much higher) on all the post-conversion recovery and future income and gains that will accumulate in your new Roth account.

That’s because qualified Roth withdrawals taken after age 59½ are totally federal-income-tax-free, as long as you’ve had at least one Roth account open for more than five years when withdrawals are taken.

If you leave your Roth IRA to an heir, he or she can take tax-free qualified withdrawals from the inherited account—as long as at least one of your Roth IRAs has been open for more than five years when withdrawals are taken.

If you want my help thinking this through or executing on the Roth conversion, I’m here to help. Call me on my direct line at 408-778-9651.

Sincerely,

The Financial Dream Team, USA

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