Tax

As the end of year approaches, taxpayers should be reminded that business expense deduction for meals and entertainment have changed due to tax law changes in the Tax Cuts and Jobs Act (TCJA). Until proposed regulations clarifying when business meal expenses are deductible and what constitutes entertainment are in effect, taxpayers should rely on transitional guidance that was recently issued by the IRS.

Prior to 2018, a business could deduct up to 50 percent of entertainment expenses directly related to the active conduct of a trade or business or, if incurred immediately before or after a bona fide business discussion, associated with the active conduct of a trade or business. However, the 2017 TCJA eliminated the deduction for any expenses related to activities generally considered entertainment, amusement or recreation.

Taxpayers may continue to deduct 50 percent of the cost of business meals if the taxpayer (or an employee of the taxpayer) is present and the food or beverages are not considered lavish or extravagant. The meals may be provided to a current or potential business customer, client, consultant or similar business contact.

Please note that food and beverages that are provided during entertainment events will not be considered entertainment if purchased separately from the event.

• By Leon Clinton
• November 19, 2018

Thanks to tax reform legislation passed in December 2017, eligible taxpayers may now deduct up to 20 percent of certain business income from qualified domestic businesses, as well as certain dividends. Eligible taxpayers can claim the deduction for the first time on the 2018 federal income tax return they file in 2019.

Note: Although the final regulations have not yet been published in the Federal Register, taxpayers who wish to become familiar with the rules may review the proposed regulations issued by visiting the IRS website or calling the office.

The Qualified Business Income Deduction (QBID) often referred to as the 20 percent deduction for pass-through entities, is officially known as the Section 199A deduction after Section 199A of the Internal Revenue Code.

Here are six key facts about the qualified business income deduction:

1. The deduction applies to qualified business income from a qualified business (i.e. pass-through entities) such as:

• a sole proprietorship
• S-corporation
• Partnership
• LLC treated as a sole proprietorship or partnership for tax purposes
• Non-corporate taxpayers such as trusts and estates
• REITs
• Publicly traded partnerships

2. Qualified business income is the net amount of qualified items of income, gain, deduction, and loss connected to a qualified U.S. trade or business. Only items included in taxable income are counted. Qualified business income does not include income from performing services as an employee. Capital gains and losses, shareholders wages, certain dividends, and interest income are excluded as well.

3. The deduction is available to eligible taxpayers, whether they itemize their deductions on Schedule A or take the standard deduction.

The deduction can be taken in addition to the standard or itemized deductions and is subject to limitations based on the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid with respect to the qualified trade or business, and the unadjusted basis of qualified property held by the trade or business.

4. The deduction is generally equal to the lesser of these two amounts:

• Twenty percent of qualified business income plus 20 percent of qualified real estate investment trust dividends and qualified publicly traded partnership income.
• Twenty percent of taxable income computed before the qualified business income deduction minus net capital gains.

5. For taxpayers with taxable income computed before the qualified business income deduction that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers, the deduction may be subject to additional limitations or exceptions. These are based on the type of trade or business (see below), the taxpayer’s taxable income, the amount of W-2 wages paid by the qualified trade or business, and the unadjusted basis immediately after acquisition of qualified property held by the trade or business.

6. Income earned through a C corporation is not eligible for the deduction.

7. Qualified Trade or Business. A qualified trade or business is any trade or business except one involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. This exclusion only applies, however, if a taxpayer’s taxable income exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers.

While relatively straightforward for most businesses, those with more complicated tax structures or multiple businesses or trades, consulting a tax professional is advised. As always, don’t hesitate to call if you have any questions.

• By Leon Clinton
• November 16, 2018

Lending money to a cash-strapped friend or family member is a noble and generous offer that just might make a difference. But before you hand over the cash, you need to plan ahead to avoid tax complications for yourself down the road.

Take a look at this example: Let’s say you decide to loan $5,000 to your daughter who’s been out of work for over a year and is having difficulty keeping up with the mortgage payments on her condo. While you may be tempted to charge an interest rate of zero percent, you should resist the temptation.

Here’s why:

When you make an interest-free loan to someone, you will be subject to “below-market interest rules.” IRS rules state that you need to calculate imaginary interest payments from the borrower. These imaginary interest payments are then payable to you, and you will need to pay taxes on these interest payments when you file a tax return. To complicate matters further, if the imaginary interest payments exceed $15,000 for the year, there may be adverse gift and estate tax consequences.

Exception: The IRS lets you ignore the rules for small loans ($10,000 or less), as long as the aggregate loan amounts to a single borrower are less than $10,000, and the borrower doesn’t use the loan proceeds to buy or carry income-producing assets.

As was mentioned above, if you don’t charge any interest, or charge interest that is below market rate (more on this below), then the IRS might consider your loan a gift, especially if there is no formal documentation (i.e., written agreement with payment schedule), and you go to make a nonbusiness bad debt deduction if the borrower defaults on the loan–or the IRS decides to audit you and decides your loan is really a gift.

Formal documentation generally refers to a written promissory note that includes the interest rate, a repayment schedule showing dates and amounts for all principal and interest, and security or collateral for the loan, such as a residence (see below). Make sure that all parties sign the note so that it’s legally binding.

As long as you charge an interest rate that is at least equal to the applicable federal rate (AFR) approved by the Internal Revenue Service, you can avoid tax complications and unfavorable tax consequences.

AFRs for term loans, that is, loans with a defined repayment schedule, are updated monthly by the IRS and published in the IRS Bulletin. AFRs are based on the bond market, which changes frequently. For term loans, use the AFR published in the same month that you make the loan. The AFR is a fixed rate for the duration of the loan.

Any interest income that you make from the term loan is included on your Form 1040. In general, the borrower, who in this example is your daughter, cannot deduct interest paid, but there is one exception: if the loan is secured by her home, then the interest can be deducted as qualified residence interest–as long as the promissory note for the loan was secured by the residence.

If you have any questions about the tax implications of loaning a friend or family member money, please contact the office.

• By Leon Clinton
• November 14, 2018