Tax

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

While similar to FSAs (Flexible Savings Plans) in that both allow pre-tax contributions, Health Savings Accounts or HSAs offer taxpayers several additional tax benefits such as contributions that roll over from year to year (i.e., no “use it or lose it”), tax-free interest on earnings, and when used for qualified medical expenses, tax-free distributions.

What is a Health Savings Account?

A Health Savings Account is a type of savings account that allows you to set aside money pre-tax to pay for qualified medical expenses. Contributions that you make to a Health Savings Account (HSA) are used to pay current or future medical expenses (including after you’ve retired) of the account owner, his or her spouse, and any qualified dependent.

Caution: Medical expenses that are reimbursable by insurance or other sources and do not qualify for the medical expense deduction on a federal income tax return are not eligible.

Caution: Insurance premiums for taxpayers younger than age 65 are generally not considered qualified medical expenses unless the premiums are for health care continuation coverage (such as coverage under COBRA), health care coverage while receiving unemployment compensation under federal or state law.

You cannot be covered by other health insurance with the exception of insurance for accidents, disability, dental care, vision care, or long-term care and you cannot be claimed as a dependent on someone else’s tax return. Spouses cannot open joint HSAs. Each spouse who is an eligible individual who wants an HSA must open a separate HSA.

An HSA can be opened through your bank or another financial institution. Contributions to an HSA must be made in cash. Contributions of stock or property are not allowed. As an employee may be able to elect to have money set aside and deposited directly into an HSA account; however, if this option is not offered by your employer, then you must wait until filing a tax return to claim the HSA contributions as a deduction.

High Deductible Health Plans.

A Health Savings Account can only be used if you have a High Deductible Health Plan (HDHP). Typically, high-deductible health plans have lower monthly premiums than plans with lower deductibles, but you pay more health care costs yourself before the insurance company starts to pay its share (your deductible).

A high-deductible plan can be combined with a health savings account, allowing you to pay for certain medical expenses with tax-free money that you have set aside. By using the pre-tax funds in your HSA to pay for qualified medical expenses before you reach your deductible and other out-of-pocket costs such as copayments, you reduce your overall health care costs.

Calendar year 2018. For calendar year 2018, a qualifying HDHP must have a deductible of at least $1,350 for self-only coverage or $2,700 for family coverage. Annual out-of-pocket expenses (e.g., deductibles, copayments, and coinsurance) of the beneficiary are limited to $6,650 for self-only coverage and $13,300 for family coverage. This limit doesn’t apply to deductibles and expenses for out-of-network services if the plan uses a network of providers. Instead, only deductibles and out-of-pocket expenses for services within the network should be used to figure whether the limit applies.

Last month rule. Under the last-month rule, you are considered to be an eligible individual for the entire year if you are an eligible individual on the first day of the last month of your tax year (December 1 for most taxpayers).

You can make contributions to your HSA for 2018 until April 15, 2019. Your employer can make contributions to your HSA between January 1, 2019, and April 15, 2019, that are allocated to 2018. The contribution will be reported on your 2019 Form W-2.

Summary of HSA Tax Advantages

• Tax deductible. You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don’t itemize your deductions on Schedule A (Form 1040).
• Pre-tax dollars. Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income.
• Tax-free interest on earnings. Contributions remain in your account until you use them and are rolled over year after year. Any interest or other earnings on the assets in the account are tax-free. Furthermore, an HSA is “portable” and stays with you if you change employers or leave the workforce.
• Tax-free distributions. Distributions may be tax-free if you pay qualified medical expenses.
• Additional contributions for older workers. Employees, aged 55 years and older are able to save an additional $1,000 per year.
• Tax-free after retirement. Distributions are tax-free at age 65 when used for qualified medical expenses including amounts used to pay Medicare Part B and Part D premiums, and long-term care insurance policy premiums. However, you cannot use money in an HSA to pay for supplemental insurance (e.g., Medigap) premiums.

If you have any questions about HSAs, help is just a phone call away.

• By Leon Clinton
• November 11, 2018