What Happened at the End of 2017?

The federal tax overhaul passed, and there were other major developments as well.  Please see the below, with content by RIA Checkpoint with occasional commentary from me.
Major tax reform. On December 22, President Trump signed into law the “Tax Cuts and Jobs Act” (P.L. 115-97), a sweeping tax reform law that will entirely change the tax landscape.
This comprehensive tax overhaul dramatically changes the rules governing the taxation of individual taxpayers for tax years beginning before 2026, providing new income tax rates and brackets, increasing the standard deduction, suspending personal deductions, increasing the child tax credit, limiting the state and local tax deduction, and temporarily reducing the medical expense threshold, among many other changes. The legislation also provides a new deduction for non-corporate taxpayers with qualified business income from pass-throughs.
For businesses, the legislation permanently reduces the corporate tax rate to 21%, repeals the corporate alternative minimum tax, imposes new limits on business interest deductions, and makes a number of changes involving expensing and depreciation. The legislation also makes significant changes to the tax treatment of foreign income and taxpayers, including the exemption from U.S. tax for certain foreign income and the deemed repatriation of off-shore income.
[Our Department of Taxation just submitted “conformity bills” to our Legislature that would pick up most of the federal changes for Hawaii purposes.  Reference:  Senate Bill 2821House Bill 2394.]
Regulations issued for electing out of new partnership audit rules. The IRS has issued final regulations on the election out of the centralized partnership audit regime rules, which are generally effective for tax years beginning after Dec. 31, 2017. Under the new audit regime, any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership tax year (and any partner’s distributive share thereof) generally is determined, and any tax attributable thereto is assessed and collected, at the partnership level. The applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to any such item or share is also be determined at the partnership level. However, new regulations provide guidance on how eligible partnerships that are required to furnish 100 or fewer Schedules K-1 (Partner’s Share of Income, Deductions, Credits, etc.) may elect out of this new regime.
 
Safe harbor methods for nonbusiness casualty losses. The IRS provided safe harbor methods that individual taxpayers may use in determining the amount of their casualty and theft losses for their personal-use residential real property and personal belongings. Taxpayers often have difficulty determining the amount of their losses under the IRS regulations. In order to provide certainty to both taxpayers and the IRS, the safe harbor methods provide easier ways for individuals to measure the decrease in the fair market value of their personal-use residential real property following a casualty and to determine the pre-casualty or theft fair market value of personal belongings. In addition, the IRS provided a safe harbor under which individuals may use one or more cost indexes to determine the amount of loss to their homes as a result of Hurricane and Tropical Storm Harvey, Hurricane Irma and Hurricane Maria.
Deductions denied for house rented to daughter. The Ninth Circuit determined that married taxpayers weren’t entitled to claim business deductions with regard to their second house that they rented to their daughter at below-market rates. During 2008 through 2010, the taxpayers reported rental income from daughter ($24,000 for 2008, $24,000 for 2009, and $6,000 for the first three months of 2010) and claimed deductions relating to the property for, among other things, mortgage interest, taxes, insurance, and depreciation. Overall, they claimed net losses for each year of $134,360, $84,600, and $107,820. The Court determined that the daughter’s use of the house was, in effect, personal use by her parents for purposes of Code Sec. 280A(d)(1)’s limit on deductions with respect to a dwelling unit used for personal purposes. Because she didn’t pay fair market rent, they didn’t qualify for an exception to the general rule in Code Sec. 280A(e) disallowing deductions in excess of rental income. [Seriously.  What were these taxpayers thinking?]
 
 
Standard mileage rates increase for 2018.  The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) increased by 1¢ to 54.5¢ per mile for business travel after 2017. This rate can also be used by employers to provide tax-free reimbursements to employees who supply their own autos for business use, under an accountable plan, and to value personal use of certain low-cost employer-provided vehicles. The rate for using a car to get medical care increased by 1¢ to 18¢ per mile.
Taxpayer was liable for million dollar FBAR penalty. The Ninth Circuit found that a taxpayer wilfully failed to file a Report of Foreign Bank and Foreign Accounts (FBAR) where IRS assessed a penalty of approximately $1.2 million penalty against the taxpayer for failing to disclose her financial interests in an overseas account. The Court rejected a variety of the taxpayer’s arguments, ranging from the contention that the imposition of the penalty violated the U.S. Constitution’s excessive fines, due process, and ex post facto clauses, to assertions that it was barred by statute of limitations or treaty provisions. [IRS 1, Weaselly Taxpayer 0.]

2018 Year-End Planning Tips

Now that the federal tax overhaul has passed, you might want to talk with your tax advisor about doing a few things before year-end (not much time left).

Prepay State Taxes.

Under Trump Tax, individuals only may deduct $10,000 of state and local taxes per year.  For us in Hawaii, that includes state income tax and real property tax.

If you pay more than that in a year, consider paying some taxes in 2017 so they can be deducted under 2017 rules.  Take, for example, the estimated income tax payment due on January 20th.  If you as an individual can pay it by the end of the year, then it can be deducted in 2017 when you might be able to get a bigger benefit from it.

By the way, this won’t work for 2018 taxes that you pay in 2017.

Prepay Miscellaneous Itemized Deductions.

Many of the miscellaneous itemized deductions — the ones that need to be over 2% of adjusted gross income to count — are going away next year.  If you have some of these, you may want to consider prepaying them this year to get a 2017 benefit.

Some of these deductions include:

  • Tax return preparation fees
  • Investment advisory fees
  • Safe deposit box fees
  • Unreimbursed employee business expenses such as job travel, union dues, job education

Charitable Contributions.

Charitable contributions are made by many people, especially in Hawaii.  It’s one of the most popular itemized deductions.  The number of people who itemize is expected to fall sharply because the standard deduction is going up in a big way.  If you think you’ll stop itemizing, you might want to consider making your 2018 contributions by Dec. 31 so you would be able to deduct what you give to charity.

The move makes tax sense only for people who believe they will have enough deductions to itemize on their 2017 return but not when they file 2018 taxes.  So this is not for everyone.

Mortgage Interest.

Mortgage interest will be deductible in 2018, but there will be new limits on the deduction.  Under the new law, you can deduct interest on no more than $750,000 in mortgage debt, down from the current $1.1 million limit.  People who already own homes, or who had a binding written contract to buy one before the law went into effect, still get the higher limit.

As with the charitable contribution deduction, it may make sense to prepay mortgage interest — the payment due at the end of December but that won’t be late if paid in early January, for example.  Prepayment makes tax sense only for people who believe they will have enough deductions to itemize on their 2017 return but not on the 2018 return.

Defer Income Into 2018.

Because tax rates will be lower in 2018, it might make sense for people who can do so to defer some billings into 2018.  Self-employed individuals, for example, who aren’t in a rush to get their cash in the door might send out some year-end billings into 2018.  Generally, individuals are on the cash basis, meaning that their income is considered to be earned not in the year they billing was sent out, but in the year that the payment was received.  Many larger businesses, in contrast, are on the accrual basis, meaning that their income is considered earned when billed.

 

2017 3Q Federal Developments

The following is a summary of important tax developments that have occurred in the past three months courtesy of Thompson Reuters’ Checkpoint.

President Trump and key lawmakers reveal tax reform plan. The Trump Administration and select members of Congress have released a “unified framework” for tax reform. The document provides more detail than a number of other tax reform documents that have emerged from the Administration over the past few months, but it still leaves many specifics to be worked out by the tax-writing committees (i.e., the House Ways and Means Committee and the Senate Finance Committee).

Plan provisions affecting individuals would:

  • Increase the standard deduction to $24,000 for married taxpayers filing jointly, and $12,000 for single filers;
  • Eliminate the personal exemption and the additional standard deductions for older/blind taxpayers;
  • Reduce the number of tax brackets from seven to three: 12%, 25%, and 35%;
  • Increase the child tax credit;
  • Repeal the individual alternative minimum tax;
  • Largely eliminate itemized deductions, but retain the home mortgage interest and charitable contribution deductions; and
  • Repeal both the estate tax and the generation-skipping transfer tax.

Plan provisions affecting businesses would:

  • Provide a maximum 25% tax rate for “small” and family-owned businesses conducted as sole proprietorships, partnerships and S corporations;
  • Reduce the corporate tax rate to 20% (down from the current top rate of 35%);
  • Provide full expensing for five years;
  • Partially limit the deduction for net interest expense incurred by C corporations;
  • Repeal most deductions and credits, but retain the research and low-income housing credits;
  • Modernize special tax rules that apply to certain industries and sectors;
  • Provide a 100% exemption for dividends from foreign subsidiaries; and
  • To protect the U.S. tax base, tax the foreign profits of U.S. multinational corporations at a reduced rate and on a global basis.

Disaster tax relief legislation. On September 29, President Trump signed into law the “Disaster Tax Relief and Airport and Airway Extension Act of 2017” (P.L. 115-63). The Act provides temporary tax relief to victims of Hurricanes Harvey, Irma, and Maria. Relief for individuals includes, among other things, loosened restrictions for claiming personal casualty losses, tax-favored withdrawals from retirement plans, and the option of using current or prior year’s income for purposes of claiming the earned income and child tax credits. Businesses that qualify for relief may claim a new “employee retention tax credit” of 40% of up to $6,000 of “qualified wages” paid by employers affected by Hurricanes Harvey, Irma, and Maria (for a maximum credit of $2,400 per employee). In addition to the new law, IRS has granted specific administrative hurricane relief, for example, extending various deadlines, encouraging leave-based donation programs for hurricane victims, and allowing retirement plans to make hardship distributions.

Treasury to roll up myRA program. On July 28, the Treasury Department announced that it would begin winding down the myRA (my Retirement Account) program—a type of government-administered Roth IRA initially offered by Treasury beginning in 2014. Noting that demand for and investment in the myRA program had been extremely low, Treasury stated that it would phase out the program over the following months. The myRA program would no longer accept new enrollments, but existing accounts were to remain open and accessible, so that individuals could continue to manage their accounts until further notice. Individuals could make deposits, and their accounts would continue to earn interest. Funds in myRA accounts remained in an investment issued by the Treasury Department.

Simplified per-diem increase for post-Sept. 30, 2017 travel. An employer may pay a per-diem amount to an employee on business-travel status instead of reimbursing actual substantiated expenses for away-from-home lodging, meal and incidental expenses (M&E). If the rate paid doesn’t exceed the IRS-approved maximums, and the employee provides simplified substantiation, the reimbursement isn’t subject to income- or payroll-tax withholding and isn’t reported on the employee’s Form W-2. Instead of using actual per-diems, employers may use a simplified “high-low” per-diem, under which there is one uniform per-diem rate for all “high-cost” areas within the continental U.S. (CONUS), and another per-diem rate for all other areas within CONUS. The IRS released the “high-low” simplified per-diem rates for post-Sept. 30, 2017, travel. Under the optional high-low method for post-Sept. 30, 2017 travel, the high-cost-area per diem is $284 (up from $282), consisting of $216 for lodging and $68 for M&IE. The per-diem for all other localities is $191 (up from $189), consisting of $134 for lodging and $57 for M&IE.

Honest mistake no excuse for incorrectly claimed advance premium tax credit. In what appears to be the first case of its kind—although others are likely to follow—the Tax Court ruled that taxpayers who didn’t qualify for the premium tax credit under the Affordable Care Act (Obamacare) because their modified adjusted gross income exceeded 400% of the federal poverty level had to repay all the advance premium tax credit paid on their behalf to their insurer. A sympathetic Tax Court noted that while their state health insurance Marketplace may have incorrectly informed the taxpayers that they were eligible for the credit for 2014, the Court’s hands were tied by the Code and regs. The simple fact was that the taxpayers’ income exceeded eligible levels and that they had to repay the advance premium tax credit payments.

Safe harbor for financially distressed homeowners extended. The IRS has extended through 2021 guidance on the tax consequences of programs that involve payments made to or on behalf of financially distressed homeowners, including a safe harbor method for computing a homeowner’s deduction for payments made on a home mortgage. For tax years 2010 through 2021, an eligible homeowner (i.e., one who meets the requirements of Code Sec. 163 (dealing with deducting interest) and Code Sec. 164 (dealing with deducting taxes), and participates in a State program in which the program payments could be used to pay interest on the home mortgage) may deduct the lesser of:

  1. The sum of all payments on the home mortgage that the homeowner actually makes during a tax year to the mortgage servicer or the State housing finance agency; or
  2. The sum of amounts shown on Form 1098, Mortgage Interest Statement, for mortgage interest received, real property taxes, and, if deductible for the tax year, mortgage insurance premiums.

(The deduction for mortgage insurance premiums under Code Sec. 163(h)(3)(E) expired at the end of 2016, but it is one of those tax provisions that have been repeatedly extended in the past.)

The IRS also extended penalty relief related to information reporting for mortgage servicers and state housing finance agencies.

Judge Blocks New Rules for Overtime Wages

On November 22, just days away from a December 1, 2016 effective date for new overtime regulations, a federal judge issued a nationwide injunction, bringing the process to a halt.

A federal judge in Texas on Tuesday blocked new Department of Labor rules that would have expanded the number of workers eligible for overtime pay.

U.S. District Judge Amos Mazzant of the Eastern District of Texas granted a preliminary injunction in combined lawsuits filed by 21 states and business groups. The rule would have allowed workers earning up to $47,476 a year to be eligible for time-and-a-half overtime pay after working 40 hours a week.

Currently, nonexempt employees making less than $23,660 are eligible for overtime pay.  The salary threshold was last updated in 2004.

Mazzant said the U.S. Department of Labor didn’t have statutory authority to set a salary threshold or to automatically update the amount.

Liberal groups were swift to denounce Mazzant’s decision. “This is an extreme and unsupportable decision and is a clear overreach by the court,” said Ross Eisenbrey, vice president of the left-leaning Economic Policy Institute, who helped the Labor Department develop the regulation. Eisenbrey called it “a disappointment to millions of workers who are forced to work long hours with no extra compensation” and “a blow to those Americans who care deeply about raising wages and lessening inequality.”

But the U.S. Chamber of Commerce was jubilant. “We are very pleased that the court agreed with our arguments,” said Randy Johnson, the Chamber’s senior vice president of labor, immigration and employee benefits. The rule, he said, “would have caused many disruptions in how work gets done” and “reduced workplace flexibility, remote electronic access to work, and opportunities for career advancement.”

New W-2 and 1099-MISC Filing Deadlines

This year marks a particularly important year for filers, as the deadline for submitting Form W-2 to the SSA and Form 1099-MISC to the IRS has changed significantly.

Due to changes in the law wrought by the Protecting Americans from Tax Hikes (PATH) Act, beginning in 2017 (for the 2016 reporting year), filers must send W-2 and 1099-MISC recipient copies and submit to the SSA/IRS by January 31, regardless of method (paper or e-file).

Historically, filers were required to provide W-2 and 1099-MISC forms to recipients by January 31; however, they were not required to submit the forms to the SSA/IRS until February 28 (paper) or March 31 (e-file).

The new filing deadline, as it relates to Form 1099-MISC, only affects filers reporting nonemployee compensation payments in box 7. Although the overwhelming majority of 1099-MISC filers will report information in box 7, there is bound to be some confusion.

Also, the IRS eliminated the automatic 30-day extension of time to file W-2 forms. Previously, filers could obtain an automatic 30-day extension by submitting Form 8809 to the IRS on or before January 31. Filers could also request an additional 30-day extension, pushing their e-file deadline to the end of May. A single 30-day extension still can be applied for on Form 8809, but it is no longer automatic.

For Individuals: 10 Year-End Tax Planning Tips

This year’s collection of 10 year-end tax planning tips come from accounting firm Grant Thornton and the website accountingtoday.com, with occasional editorial commentary by me. Most of the tips are familiar, but there are a few new ones.

1. Accelerate Deductions and Defer Income

It sometimes makes sense to accelerate deductions and defer income. There are plenty of income items and expenses you may be able to control. Consider deferring bonuses, consulting income or self-employment income. On the deduction side, you may be able to accelerate state and local income taxes, interest payments and real estate taxes.

2. Bunch Itemized Deductions

Many expenses can be deducted only if they exceed a certain percentage of your adjusted gross income (AGI). Bunching itemized deductible expenses into one year can help you exceed these AGI floors. Consider scheduling your costly non-urgent medical procedures in a single year to exceed the 10 percent AGI floor for medical expenses (7.5 percent for taxpayers age 65 and older). This may mean moving a procedure into this year or postponing it until next year. To exceed the 2 percent AGI floor for miscellaneous expenses, bunch professional fees like legal advice and tax planning, as well as unreimbursed business expenses such as travel and vehicle costs.

3. Make Up a Tax Shortfall with Increased Withholding

Don’t forget that taxes are due throughout the year. Check your withholding and estimated tax payments now while you have time to fix a problem. If you’re in danger of an underpayment penalty, try to make up the shortfall by increasing withholding on your salary or bonuses. A bigger estimated tax payment can leave you exposed to penalties for previous quarters, while withholding is considered to have been paid ratably throughout the year.

[Editor’s Note: Estimated tax problems can be created not only when times are good, but also when times are tough. Example: Mr. X has a job and also receives some investment income, and is paying some estimated tax. Mr. X gets laid off, and starts a new job at 80% of his old salary three months later. Because Mr. X’s estimated tax was calculated on the withholding tax amount for his old job assuming he would be employed for the whole year and his new job doesn’t withhold as much, Mr. X might wind up the year underwithheld. The moral of the story is to update your tax estimates while there is still time in the year to fix any problems. Here, the fix can be made by having Mr. X’s new employer withhold more.]

4. Leverage Retirement Account Tax Savings

It’s not too late to increase contributions to a retirement account. Traditional retirement accounts like a 401(k) or individual retirement accounts (IRAs) still offer some of the best tax savings. Contributions reduce taxable income at the time that you make them, and you don’t pay taxes until you take the money out at retirement. The 2016 contribution limits are $18,000 for a 401(k) and $5,500 for an IRA (not including catch-up contributions for those 50 years of age and older).

5. Reconsider a Roth IRA Rollover

It has become very popular in recent years to convert a traditional IRA into a Roth IRA. This type of rollover allows you to pay tax on the conversion in exchange for no taxes in the future (if withdrawals are made properly). If you converted your account this year, reexamine the rollover. If the value went down, you have until your extended filing deadline to reverse the conversion. That way, you may be able to perform a conversion later and pay less tax.

[Editor’s Note: You don’t get a do-over at the voting booth, but you can get one here.]

6. Get Your Charitable House in Order

If you plan on giving to charity before the end of the year, remember that a cash contribution must be documented to be deductible. If you claim a charitable deduction of more than $500 in donated property, you must attach Form 8283. If you are claiming a deduction of $250 or more for a car donation, you will need a contemporaneous written acknowledgement from the charity that includes a description of the car. Remember, you cannot deduct donations to individuals, social clubs, political groups or foreign organizations.

7. Give Directly from an IRA

Congress finally made permanent a provision that allow taxpayers 70½ and older to make tax-free charitable distributions from IRAs. Using your IRA distributions for charitable giving could save you more than taking a charitable deduction on a normal gift. That’s because these IRA distributions for charitable giving won’t be included in income at all, lowering your AGI. You’ll see the difference in many AGI-based computations where the below-the-line deduction for charitable giving doesn’t have any effect. Even better, the distribution to charity will still count toward the satisfaction of your minimum required distribution for the year.

8. Zero Out AMT

Some high-income taxpayers must pay the alternative minimum tax (AMT) because the AMT removes key deductions. The silver lining is that the top AMT tax rate is only 28 percent. So you can “zero out” the AMT by accelerating income into the AMT year until the tax you calculate for regular tax and AMT are the same. Although you will have paid tax sooner, you will have paid at an effective tax rate less than the top regular tax rate of 39.6 percent. But be careful, this can backfire if you are in the AMT phase-out range or the additional income affects other tax benefits.

[Editor’s Note: AMT should be a concern for anyone making a decent amount of money in Hawaii, because our tax rate is high and the state tax deduction (for federal purposes) is a tax preference item. For state income tax purposes, we have no AMT but the deduction for state income tax is disallowed for taxpayers whose AGI is too high.]

9. Don’t Squander Your Gift Tax Exclusion

You can give up to $14,000 to as many people as you wish in 2016, free of gift or estate tax. You get a new annual gift tax exclusion every year, so don’t let it go to waste. You and your spouse can use your exemptions together to give up to $28,000 per beneficiary.

[Editor’s Note: At the state level, Hawaii has no gift tax but it does have an estate tax.]

10. Leverage Historically Low Interest Rates

Many estate and gift tax strategies hinge on the ability of assets to appreciate faster than the interest rates prescribed by the IRS. An appreciating market and historically low rates create the perfect atmosphere for estate planning. The past several years presented a historically favorable time, and the low rates won’t last forever.