Taxpayers have now had close to a year to evaluate the new provisions of the Tax Cuts and Jobs Act. However, they have had much less time to look at proposed regulations interpreting those provisions and are still awaiting some proposed regulations and any final regulations.
There have been suggestions that the 2019 tax filing season might be delayed due to the inability of the Internal Revenue Service to process all of the changes in time. Even with a lot of questions remaining, taxpayers should be thinking about taking steps prior to year-end to take advantage of the new provisions in the law.
Increased standard deduction and reduced itemized deductions.
With the standard deduction nearly doubling to $12,000 for single filers and $24,000 for joint filers, while a number of common itemized deductions have been reduced or eliminated, particularly the state and local tax deduction, the interest deduction, the casualty loss deduction and the miscellaneous itemized deductions over the 2-percent-of-adjusted-gross-income floor, many more taxpayers are projected to be better off with the standard deduction than the itemized deduction. Already in prior years, about two-thirds of taxpayers claimed the standard deduction. Now that percentage is expected to increase to more than three-fourths of all taxpayers. Many more taxpayers in 2018 may no longer receive a tax benefit from itemized deductions that they had received in the past.
Taxpayers must compare not only the new standard deduction to the amount of itemized deductions to which they were entitled in the past but also to the amount of itemized deductions to which they expect to be entitled in 2018 and beyond.
Taxpayers who regularly claimed itemized deductions in the past may now want to bunch those deductions into one year and claim the standard deduction in the other year. One itemized deduction that is easily bunched is charitable contributions. A taxpayer can still give annually to their favorite charities by making the donations in January and December of one year while skipping the following year or through the use of donor-advised funds, where the donation is claimed in one year while the distributions to charities can be spread over several years.
If the standard deduction is now still a better option with the level of charitable giving, taxpayers over age 70-½ can consider making the charitable contributions from an IRA, offsetting required minimum distributions that otherwise would have been required to be taken into income.
Taxpayers with line of credit interest should consider documenting the cost of home improvements that would support claiming at least a portion of that interest as qualified mortgage interest.
With respect to the $10,000 limit on the state and local tax deduction, taxpayers with real estate taxes should consider whether it is possible to allocate any real estate taxes to a business tax return. While some higher-tax states have adopted laws to help taxpayers preserve their deductions through charitable contributions to state charities or through payroll deductions, the IRS is attacking those approaches and it is not clear that such approaches will hold up.
The Tax Cuts and Jobs Act was enacted so late in 2017 that the new 2018 withholding tables were not required to be put into effect until March 2018, creating a potential over-withholding situation for some taxpayers.
While the new withholding tables adjusted for lower tax rates, the increased standard deduction, and the elimination of exemptions, those tables did not adjust for the loss of itemized deductions. This has created the potential for under-withholding in 2018 for millions of taxpayers unless they have adjusted their estimated tax payments or withholding accordingly.
Taxpayers should review their estimated tax payments and withholding as soon as possible to adjust for the new reality. While increasing estimated tax payments late in the year will provide only a benefit based on the date they were paid, increasing withholding will provide a benefit as if it had been paid throughout the year. Taxpayers facing possible under-withholding should therefore consider revising their Form W-4s for the remainder of the year to add a dollar amount to compensate for any anticipated under-withholding.
The 20 percent deduction for pass-through businesses
By this point in the year, most pass-through business owners are aware of and excited about the new 20 percent deduction available to them. However, even with proposed regulations released, there remains a lot of uncertainty about how to take maximum advantage of the deduction. Does my activity qualify as a trade or business? What is my qualified business income after considering investment income and compensation-like income? Am I a specified service trade or business or have some level of specified service trade or business income? What are the W-2 wages of the business? What is the qualified property of the business? Would I be better off aggregating businesses or breaking up businesses?
The issues can be complicated and the answers in many instances remain unclear. Pass-through business owners should be working with their trusted tax advisor to develop the best strategy to maximize the deduction. Also complicating planning is that the 20 percent deduction, like many of the individual tax provisions in the new law, expires after 2025, which must be considered in any significant restructuring.
Some taxpayers may elect to do nothing until the answers to some of these issues become clear, perhaps in final regulations or later. Other taxpayers may, however, be able to take steps for the remainder of the year, with expert advice, to increase their deduction for 2018.
The new partnership audit rules
The new partnership audit rules are effective for 2018. These require designation of a partnership representative, smaller partnerships considering electing out of the rules, or partnerships pushing out liability for audit adjustments under the new rules from the partnership to the partners. These actions should be taken as soon as possible before an IRS audit materializes, remembering that the audit rules are designed to increase the number of IRS audits of partnerships.
Child Tax Credit and Social Security numbers
The Tax Cuts and Jobs Act now requires any child for whom the new higher Child Tax Credit is claimed to have a Social Security number. For the refundable portion of the Child Tax Credit, the Social Security number must be issued to a U.S. citizen or authorize the individual to work in the U.S.
A Taxpayer Identification Number is no longer sufficient; however, it is sufficient for the new $500 credit for a qualifying dependent. The Social Security number can be issued up until the filing date for the tax return.
529 plans and ABLE accounts
Look at new options to pay elementary and secondary tuition from 529 plans and new opportunities to provide increased funding for ABLE accounts from 529 plans or the beneficiary’s income. The attractiveness of ABLE accounts still suffers, however, from the fact that the funds revert to the state on the death of the beneficiary. Special needs trusts may remain a more attractive alternative.
Do the usual
In addition to some of the special issues for 2018, taxpayers should still look at the usual year-end planning:
Review your investment portfolio to realize gains and losses before year-end. From a tax perspective, the ideal year-end situation is a $3,000 net capital loss that can be offset against more highly taxed ordinary income. However, it must always be considered whether it is better to realize capital losses to offset capital gains in 2018, taxed at a maximum rate of 20 percent, or to postpone those losses into future years when, if there are no capital gains, they might offset ordinary income that would otherwise be taxed as high as 37 percent.
Maximize contributions to 401(k) plans and 529 plans. Take required minimum distributions if the taxpayer reached age 70-½ prior to 2018.
If taxpayers have exercised incentive stock options during 2018, consider selling the stock before year-end if the values have significantly declined since the exercise date. Otherwise, the taxpayer could be hit with a large Alternative Minimum Tax that it might be difficult to pay.
The TCJA did include a provision permitting non-highly-compensated employees to make an election to defer tax on stock options for up to five years.
The many changes in the Tax Cuts and Jobs Act have created a number of planning opportunities for 2018 tax returns. There remain a number of outstanding issues for which guidance is still being sought from the IRS, and the IRS will continue to issue additional guidance between now and year-end.
Tax advisors and their clients should monitor these developments as they occur and take actions before year-end that will prove helpful in taking full advantage of the provisions of the new law.
Source: accountingtoday.com Written by: M. Luscombe
The new revenue recognition standard doesn’t only affect publicly traded corporations and large privately held companies. It could have an impact on small businesses, particularly if they hope to obtain bank loans next year.
Some small businesses may find that because of the standard that takes effect for private companies next year, they will need to recognize revenue later than before. That means they could need larger loans than previously planned or they could fall short on loan repayments. While some financial institutions might be willing to amend the terms of a loan to increase lending limits or adjust payments, others might not be as flexible. For many small businesses, falling short on cash because of inadequate loans could have major consequences for growth, including the ability to pay their suppliers, as well as offer performance-based incentives such as bonuses and hire new employees.
“Private companies are starting to realize is it’s not business as usual,” said Mark Davis, national managing partner of Deloitte Private Enterprises. “When you’re dealing with a bank or a lender, whether it’s a commercial bank or a private lender, they’re in the business of looking to invest their dollars through a loan. They generally have confidence in what they’re receiving, and they build that level of integrity and confidence by their interactions with the company. The standard is very complicated, and one of the things that we recommend to our clients that either have a loan or plan to get a loan is that the banks are going to be looking for a level of confidence and comfort in what they’re getting from the company. They want to see that things are under control. They want to see that they have this standard understood, and they can explain to the bank or the lender what the impacts would be, whether that be on the current loan that they have or on a potential loan that they would look to get.”
Davis believes banks are going to want to know how their small business clients are implementing the revenue recognition standard.
“I think the bank will certainly have an interest in understanding how a company is dealing with it, whether they have it under control, whether they’ve evaluated it, whether they’ve hired somebody to do it for them,” he said. “If you’re looking to obtain a loan, I think that would be part of the conversation. They’re relying on what you give them from the financial statements. Many loans have financial covenants. That’s where the nuances of the standard can have an impact. The issue of covenants and whether you’re in compliance with them currently and will remain in compliance with them after the new standard is a big issue if you have a loan today. If you’re looking to enter into a new loan with somebody, it’s the same thing — how will those covenants be impacted by the new standard?”
Many banks will soon be dealing with another new accounting standard on current expected credit losses, also known as the CECL standard, but the revenue recognition standard is more likely to have an impact on small businesses that rely on bank loans. While small businesses like a mom-and-pop corner grocery probably won’t have to worry much about accounting standards, startup businesses in the technology industry could be facing some concerns.
“I think the standard affects companies more in certain industries than others, and certain businesses than others, like technology or media companies or companies that have long-term contracts or long-term construction contracts,” said Davis. “They’ll be affected whether they’re public or private. We’ve seen in the retail consumer business space much less of an impact in that space, but it really depends on the industry. Each industry has different issues that are affected by the standard. It really has less to do with public vs. private, big vs. small, and I think that’s why private companies have tended to wait to deal with it, because they’re of the view that it probably applies to public companies and may not affect them, when it reality it has nothing to do with public or private. It has more to do with the type of company.”
Startup companies that hope to go public eventually will need to be sure they can secure funding and their revenue recognition accounting is in order.
“If you look at a technology company that hypothetically is an emerging company looking to go public in a couple of years, and they do, say, software as service, hypothetically it could have an impact,” said Davis. “Let’s say they were recording revenue ratably over a period of time, over the life of the contract. Now they might have a different outcome. Let’s say someone had a $10 million two-year contract with a customer, and they were recording that revenue ratably over a two-year period. In each year they would have $5 million of revenue reflected in their financial statements. Let’s say they had covenants that were tied to that. Let’s say they had a revenue covenant in their debt agreement, and let’s say they had an EBITDA [earnings before interest, taxes, depreciation and amortization] covenant, both tied to that expectation of revenue being earned evenly. Now all of a sudden for whatever reason, let’s say a majority of that number doesn’t get recorded until that contract ends, so they may not achieve the revenue target and they may not achieve the EBITDA target, and they would have to go back to the bank in early ’19 to say, ‘We may not make our covenant.’ I would say a significant percentage of the time, a bank would say, ‘Yeah, we expected that. Let’s take a look at it and we’ll adjust the covenant and it won’t be a problem.’”
Deloitte advises clients to be aware of the potential things that could go wrong with loans and debt covenants for small businesses.
“I tell clients that banks go through changes. They go through oversight changes, they go through leadership changes, they go in and out of different industries at different times, and they also look at a company when they get a chance to look,” said Davis. “Let’s say your business isn’t doing as well today as it was when you first got the loan. Or they say, ‘We’re not interested in that space any longer. We’re going to go in a different direction.’ All of a sudden, getting that covenant waived could get more complicated, and you might not get that covenant waived. We’ve been alerting our clients to that issue and why it’s become so important, regardless of whether it’s public or private.”
The new standard could also have an impact on whether companies can provide bonuses to employees and hire new workers.
“Cash is driven by the payment schedule in the contract, so you could potentially be getting the cash all throughout the contract, but with revenue recognition you don’t get to record it in the same manner,” said Davis. “If you go back to the example I gave you, maybe now half of the revenue would have to be deferred and recorded when the contract ends. So you’ve got the cash. It’s not a cash flow problem. It’s not a cash issue. It’s a financial statement, and it’s a reflection of the strength of the business from an income statement standpoint. So could it affect bonuses? Yes.”
The revenue recognition standard is a complex one for many small businesses to handle, and many of them will be turning to their accountants for help. “Another thing we’ve told people as to why this standard is more complicated than others is it’s a very far-reaching standard,” said Davis. “It goes outside of finance. It could touch human resources. It could touch your sales force. If your sales force is used to getting bonuses based on revenue earnings, and if now they have to wait two years to get their commission, a salesperson could be upset about that. There are so many facets that get impacted because lots of these things are tied to the financial statements: revenue or EBITDA. Bonuses could change. It’s really the timing of these things, the timing of when a bonus would occur. It could change. It’s not that the person will never get it. It’s that they may not get it the way they’ve been used to getting it. That gets people upset. Generally they don’t necessarily understand.”
Tax reform’s dizzying array of changes seemed to confuse preparers, lawmakers and the IRS alike. But amid all the new laws, which one stands out to clients?
As with the Tax Cuts and Jobs Act itself, answers can vary widely.
“Many are concerned with the non-deductibility of unreimbursed employee business expenses, along with other expenses that were subject to the 2 percent [AGI rule],” said Chris Hardy, an Enrolled Agent at Georgia-based Paramount Tax and Accounting.
“For individuals, it’s the lack of exemptions and particularly how that will affect taxpayers such as college students whom parents would normally claim but [who] still need to file their own return,” said EA Laurie Ziegler at Sass Accounting in Saukville, Wisconsin.
Burbank, California, CPA Brian Stoner finds clients chiefly concerned about two things. First, SALT limitations: “In California, almost every homeowner has way, way over $10,000 in real estate, state income taxes and personal property taxes,” he said.
And second, personal exemptions: “Especially if they have two or three dependents,” Stoner said, “but many will qualify for the Child Tax Credit because of a much higher income limitation or family credit on a lot of the dependents – so I have some good news for them.”
Client professions key
Many of Stoner’s clients are also in entertainment, paid by some of the large entertainment payroll companies. “Some are going to lose $30,000 to $60,000 in itemized [deductions] because unreimbursed employee business expenses are no longer deductible, plus financial advisor and tax preparation fees are also not deductible,” he said. “Many entertainment clients are looking into forming corporations as production companies to continue to deduct many of these expenses.
New York EA Phyllis Jo Kubey likewise has many clients in the performing arts. “While they’re freelancers, because of union contracts with many venues they’re treated as employees for some work, receiving a W-2, and as independent contractors, receiving a 1099-Misc for other work,” Kubey said. “Since they’re doing the same thing, they’re tremendously confused about what’s an employee business expense – no longer deductible under TCJA – and what’s a business expense related to their [self-employed] income [that is] deductible under TCJA.”
Another wrinkle: Some clients think that they can deduct nothing anymore. “I have to keep reminding them what is and isn’t deductible for 2018,” Kubey said. “My clients are also confused, even with detailed explanations and 2018 tax projection worksheets I’ve provided, about whether they’ll still itemize deductions.” In New York City, where real estate carrying costs are dizzying, “even with the SALT limitation many will still itemize their deductions on what used to be Schedule A,” Kubey said.
Another major confusion for clients remains one pivotal detail of reform’s pass-through income deduction. “Lots of clients have expressed concern and confusion with the new 199A deduction,” said Jake Alexander, an EA and owner of Alexander Financial in Largo, Florida. “There’s been a lot of confusion for them establishing who qualifies for it, what it means if they do and how it will affect them.”
“Certainly for my small businesses, it’s 199A,” Ziegler added. “There are so many questions about how it works and who it includes, especially in light of the exclusion for certain professions.”
Recently proposed regs do attempt to narrow the scope of service businesses ineligible for the deduction. “Ineligible consulting business” has been limited to businesses that provide advice and counsel, for example. Experts say tricky areas remain when an activity rises to the level of a trade or business, and possibly banking when banks provide multiple services beyond lending and paying interest on deposits.
John Dundon, an EA and president of Taxpayer Advocacy Services in Englewood, Colorado, sees the most questions over the definition of a “specified service, trade or business,” which is key to the new pass-through income deduction. “The proposed regulations are less than fully clear, and many industries are not addressed or incompletely addressed,” he said. “As an example, the practice of law is deemed to be an SSTB, but what if all the lawyer did was trust administration, work that does not require a law degree? Is that lawyer performing duties [that are] an SSTB? Many think not.”
Post-reform, no matter their questions, “clients will need a lot of hand-holding from their tax pros as we go into the 2019 filing season for 2018 returns,” Kubey said.
The Internal Revenue Service released guidance Wednesday on the business expense deduction for meals and entertainment in the wake of the Tax Cuts and Jobs Act, which was supposed to eliminate deductions for expenses pertaining to activities generally considered entertainment, amusement or recreation.
The IRS said taxpayers can still deduct 50 percent of the cost of business meals if the taxpayer (or an employee of the business) is present at the meal, and the food or beverages aren’t considered to be “lavish or extravagant.” The meals can involve a current or potential business customer, client, consultant or a similar business contact. Food and beverages provided during entertainment events won’t be considered entertainment if they’re bought separately from the event.
Before 2018, a business was able to deduct up to 50 percent of entertainment expenses directly related to the active conduct of a trade or business or, if they’re incurred immediately before or after a bona fide business discussion, associated with the active conduct of a trade or business. That changed, however, with the passage of the tax code overhaul last December.
Section 274 of the tax code now generally disallows a deduction for expenses with respect to entertainment, amusement or recreation after passage of the new tax law. However, the Tax Cuts and Jobs Act doesn’t specifically address the deductibility of expenses for business meals.
The Treasury Department and the IRS plan to publish proposed regulations that will clarify exactly when business meal expenses are deductible and what constitutes entertainment. Until those proposed regulations take effect, taxpayers can rely on guidance in Notice 2018-76, which the IRS issued Wednesday in conjunction with the announcement.
Although the White House now acknowledges that Republicans will not be able to pass a second round of tax cuts before the midterm elections, House Speaker Paul Ryan has promised a vote on so-called Tax Reform 2.0 before then. But even if the politics are unsettled, the policy shouldn’t be.
Whether Tax Reform 2.0 is the first salvo in a protracted battle over tax policy or just an election-year gambit, this is a debate that cannot be avoided. New legislation will have to be passed to make many aspects of last year’s Tax Cuts and Jobs Act permanent. (The sunset provision, under which many features of the law change or expire in several years, was a gimmick designed to lower its impact on the budget deficit.)
The Tax Cuts and Jobs Act contained three essential elements, two of which substantially strengthened the U.S. Tax Code and should be made permanent under any reform. The third one did not and should not.
The first two elements are the changes to the corporate and individual tax codes. America’s corporate tax rate is now commensurate with those of America’s economic peers, making the U.S. more competitive globally, and a change in the expensing of capital purchases will encourage investment. The individual code, meanwhile, has been simplified, and an increase in the standard deduction is essentially a tax cut for millions of Americans.
Together these two elements give U.S. businesses and taxpayers stronger incentives to save and invest. If made permanent, the Tax Foundation estimated last year, they could increase the total amount of capital invested in the U.S. economy by 12 percent.
The third element is the creation of a major new loophole in the form of large deductions for what are known as pass-through entities. These are essentially business structures, such as limited-liability corporations, that allow the owners to avoid paying corporate taxes and instead have their corporate profits added to their individual tax liability.
This kind of structure makes sense for sole proprietorships and other small businesses. Increasingly, however, driven in part by the U.S.’s relatively high corporate tax rate, it had been used by midsized and large businesses. Part of the rationale for lowering the corporate rate was to remove some incentive to form pass-through entities.
Unfortunately, the Tax Cut and Jobs Act also created a whole new incentive to classify a business this way. Under the law, an individual can claim a 20 percent tax deduction for any income classified as business income. That means high earners such as celebrities, financial professionals and surgeons have an incentive to form LLCs and claim this deduction, even when their services more closely resemble those of an employee rather than an entrepreneur.
It’s not as if members of Congress couldn’t have seen this coming. When Kansas included a similar loophole in its tax reform in 2012, it saw a 20 percent increase in the number of pass-through entities. This led to a $300 million decline in revenue, and Kansas officials essentially rescinded their tax reform in 2017.
Lowering marginal tax rates and encouraging investment are worthwhile goals. But the creation of a large pass-through deduction undermines those efforts, creating a tax loophole that is largely unavailable to middle-class taxpayers. It narrows the tax base, reduces long-term revenue projections and undermines the efficiency gains from the reform if the individual tax code.
As members of Congress consider tax reform — regardless of whether they actually vote on it — they should keep these larger goals in mind: reduce complexity and encourage economic growth. The pass-through deduction does neither.
U.S. companies anxiously awaiting guidance on how hard they’ll be hit by a new foreign levy in the tax overhaul will have to stay tuned for at least another two months.
The Internal Revenue Service proposed regulations on Thursday spanning 157 pages that provide some details on which assets are subject to the tax on GILTI, or global intangible low-tax income, and how to calculate it. But one of the most pressing questions — to what extent multinational companies can use foreign tax credits and business expenses to offset the levy — remained unanswered.
“It’s a very big deal that the FTC and expense allocation issues have been left out,” said Andrew Silverman, a Bloomberg Intelligence analyst who focuses on tax policy. The regulations are “not a great answer for companies who are essentially left in limbo.”
The rules provide a starting point for how to calculate what they owe, but without the additional information companies still won’t be able to get to a level of comfort to complete tax returns and file documents with the Securities and Exchange Commission, Silverman said.
Corporations don’t want to underestimate their GILTI liability because they could be hit with a penalty if they pay too little in their quarterly tax installments to the IRS. The deadline for two portions has already passed and the next payment is due Sept. 15. Treasury officials said during a call with reporters Thursday that the additional guidance will be coming in about 60 days.
The Republican tax overhaul slashed the corporate rate to 21 percent from 35 percent, and shifted the U.S. to a system of taxing its companies on their domestic profits only. Those changes required guardrails — like the tax on GILTI — to ensure multinationals pay at least something on their future overseas profits.
The piecemeal guidance process, and the lack of understanding about the ultimate amount of tax that will be paid until all the parts are finalized, underscore the complexity of the tax law’s international provisions.
Tax advisers have been modeling the effects of the new law for their multinational clients, but because many of the new provisions are interconnected, and implementation may be governed by old tax regulations still on the books, they’re only able to estimate the amount of tax due.
That’s been a frustration for many publicly traded companies and their investors, who are anxious to understand how the new tax law affects them.
Companies are hesitant to record a tax hit for GILTI that they don’t think they should pay, so they’re waiting for the clarification in the regulations, said Brent Felten, managing director of international tax at accounting firm Crowe.
Still, Thursday’s regulations signal some good news could be ahead for multinationals. The rules indicate that companies can “gross up” their foreign income by the amount of foreign tax paid, a move that would result in a lower GILTI bill, said Mitch Thompson, a tax partner at Squire Patton Boggs.
“It’s taxpayer friendly,” Thompson said.
The GILTI levy effectively sets a 10.5 percent rate to apply to a company’s “excess” profits earned overseas through some of its foreign subsidiaries.
GILTI was intended to prod American technology and pharmaceutical companies into holding their valuable intellectual properties in the U.S. Currently, many hold their patents in subsidiaries in Ireland or other low-tax countries. The tax is intended to apply only in cases where a company’s cumulative overseas tax bill is below 13.125 percent, or 16.4 percent after 2025.
However, tax lawyers and accountants say quirks in the way the tax is calculated mean it will likely hit other companies, such as big banks with offshore operations, even when they already pay effective foreign tax rates above the threshold.
Bank lobbyists have urged the Treasury to come up with a fix that would lessen the pain from GILTI, saying an adjustment is needed to make the tax consistent with the intent of Republican lawmakers who wrote the legislation.
Pass-through entities such as partnerships and limited liability companies could fare even worse than corporations under the GILTI tax, but they won’t want to restructure their business without knowing how the foreign tax credit guidance will work, said David Shapiro, a partner at the law firm Saul Ewing Arnstein & Lehr.
That could create a rush of companies looking to reform as corporations after the regulations come out and before the end of 2018, Shapiro said.
Even after all of the GILTI questions are answered, companies will still be trying to figure out how they fare under the new international tax regime.
Treasury officials have said they plan to issue proposed regulations later this year on the other two major international provisions in the tax overhaul — a tax break encouraging companies to export U.S.-made goods, known as the foreign derived intangible income deduction, and the base-erosion and anti-abuse tax on payments corporations make to foreign subsidiaries.
The need to pay estimated taxes before receiving guidance has already caused headaches for some corporations that overpaid their repatriation taxes on profits accrued offshore since 1986. Some companies had overpaid to avoid penalties and were hoping for a refund. Instead, the IRS said in August it wouldn’t send the excess funds back and would apply them to a future installment of the repatriation tax bill.
“The more guidance you get from IRS and Treasury, the better, and the sooner you get it the better,” said Joe Calianno, a tax partner and international technical tax practice leader in BDO’s Washington office.
Despite the widespread belief that small businesses are a target for IRS audits, nearly a third of small-business owners think they overpay their taxes, according to a survey by B2B research firm Clutch of over 300 small-business owners and managers.
“If they think they’re paying too much, they’re questioning the accuracy of their tax return,” said Roger Harris, president of Padgett Business Services. “They’re somehow missing a deduction, or there are parts of the code they just don’t know about. If a business owner did their own accounting and bought a piece of equipment in October 2017, what’s the chance they knew the rules for the new 100 percent bonus depreciation?”
The small businesses in the survey listed unforeseen expenses (35 percent) as their top financial challenge, followed by the mixing of business and personal finances (23 percent) and the inability to receive payments on time (21 percent). Clerical errors in financial records, and outdated financial records, were both listed by 11 percent of respondents.
The majority of small businesses in the survey said they use the accrual method for tracking finances, although the smallest businesses, with fewer than 10 employees, were more likely to use the cash basis method.
“Actually, use of the cash method versus the accrual method has nothing to do with number of employees but with revenue,” said Harris. “In fact, the Tax Cuts and Jobs Act increased the ability to use the cash method for businesses with up to $25 million in annual revenue. Cash accounting is available to many businesses, and many small businesses prefer it because it’s simpler. They like taxable income to track as closely as possible to their checkbooks. In fact, most of our clients would be happy with a simple profit and loss financial statement: Money in minus money out equals money left, or what some of them call ‘my money.’”
“But the accrual method creates expenses that sometimes aren’t yet paid and sometimes defers costs that are already paid, and defers them into the future,” he continued. “In that case, taxable income can vary dramatically from using the cash method.”
“The cash method is easier for everyone to understand,” he said. “Money in is income, money out is expense, and what’s left is your money, which is what you pay taxes on.”
Most use a hybrid method — accrual for income because they have inventories, and cash for expenses, according to Harris.
“If I asked what method of accounting they use, most small-business owners would just stare at me,” Harris said. “But if I explained it to them and they made a pick, most would choose cash. I would be stunned if I asked a small-business owner without giving a choice, and anyone said ‘accrual.’ Most of them wouldn’t even know the term. If you go to the coffee shop in your building and ask the owner what method they use, they won’t know what you’re talking about.”
“In a classroom or to an accountant, the accrual method is favored,” said Harris. “But in the eyes of most owners, if they don’t have the money it’s not income, and if they haven’t paid money, it’s not an expense.”
Surprisingly, the survey found that more than a quarter — 27 percent — of small-business owners and managers said they do not have a separate bank account for their business. Naturally, established businesses are more likely to have separate bank accounts than start-ups. Nearly 80 percent of small-business owners of five years or more said they have separate accounts, compared to 68 percent of small-business owners of two years or less.
Source: accountingtoday.com Written by: R. Russell
The Internal Revenue Service and the Treasury Department said Wednesday that payments under state or local tax credit programs may be deductible as business expenses, permitting a workaround for businesses to the $10,000 limit on state and local tax deductions in the Tax Cuts and Jobs Act.
However, the IRS and Treasury are still not giving individual taxpayers the ability to make charitable contributions to state-run funds as a way to circumvent the limits on the SALT deduction in the new tax law. Last month, they issued proposed regulations aimed at stopping blue states like New York, New Jersey and Connecticut that have authorized such funds, and other high-tax states that have been considering them (see IRS moves to block New York, New Jersey plans to bypass SALT deduction cap). But they left open the possibility of allowing business taxpayers to use them (see IRS short-circuits SALT deduction charitable workarounds to new tax law, but leaves others open for now). Connecticut started such a program earlier this year, and New York is considering one (see Some high-tax states aim to provide businesses workaround for SALT limits).
The IRS said Wednesday that business taxpayers who make business-related payments to charities or government entities for which the taxpayers receive state or local tax credits can generally deduct the payments as business expenses, but it has to qualify as an ordinary and necessary business expense. In response to inquiries from taxpayers, the IRS clarified that the general deductibility rule is unaffected by the recent notice of proposed rulemaking concerning the availability of a charitable contribution deduction for contributions pursuant to such programs.
“The business expense deduction is available to any business taxpayer, regardless of whether it is doing business as a sole proprietor, partnership or corporation, as long as the payment qualifies as an ordinary and necessary business expense,” said the IRS. “Therefore, businesses generally can still deduct business-related payments in full as a business expense on their federal income tax return.”
The Treasury issued similar reassurance on Wednesday.
“The IRS clarification makes clear that the longstanding rule allowing businesses to deduct payments to charities as business expenses remains unchanged under the Tax Cuts and Jobs Act,” said Treasury Secretary Steven T. Mnuchin in a statement. “The recent proposed rule concerning the cap on state and local tax deductions has no impact on federal tax benefits for business-related donations to school choice programs.”
The clarification won't affect corporations, which aren't subject to the $10,000 limit on state and local tax deductions in the new tax law, but it would apply to pass-through entities such as partnerships.
Some clients, it now seems certain, will feel one of the Tax Cuts and Jobs Act’s most significant changes for 2018 in the spring of 2019: sticker shock on their tax bill or refund. And it also seems certain that preparers can do only so much warning.
“Taxpayers have not looked at their withholding for 2018. I’ve promoted them doing a tax check-up [but] many are going to be upset at the end of the year when they don't get a bigger refund or actually owe,” said Marilyn Meredith at Michigan-based Meredith Tax Service.
“I won’t tell them ‘I told you so,’ even though I should,” said Morris Armstrong, an Enrolled Agent and registered investment advisor at Armstrong Financial Strategies in Cheshire, Connecticut. “Through normal communications, it’s been suggested that they do a tax checkup on their pay stubs and no one really wants to do it, even for free. They don’t want to take the time. I’m hoping that April showers are avoided when they see their results.”
“We’ve been telling clients to check their withholdings but I seriously doubt people will,” said Patrick O’Hara, an EA in Poughkeepsie, N.Y. “It’s human nature to want more in your check but there will be more disappointment when they end up owing.”
The office of Kerry Freeman, an EA at Freeman Income Tax Service in Anthem, Arizona, called every client for a mid-year review of withholdings; only about 15 percent took advantage of this service. “I’ve found that many clients really don’t understand how withholding affects the tax return and are shocked with either the balance due or the refund,” Freeman said. “We feel that most of our clients have not checked their withholdings for 2018 … We sense that many of our clients have been lead to believe the new tax law would be favorable to their overall tax situation but in reality may face a quite different situation,” said Gail Rosen, a CPA and shareholder with Wilkin & Guttenplan in Martinsville, N.J. “This, coupled with the withholding tables reducing tax withheld, should have them concerned. We’ve made a concerted effort to contact clients whose reduced withholding we project will not meet their actual tax liability for 2018.”
More than one in five taxpayers will under-withhold their taxes in 2018 under changes mandated by the TCJA , according to a recent report from the federal Government Accountability Office -- though the number of under-withheld taxpayers under the new law is only three percentage points higher than the GAO estimate of what it would have been under previous law (18 percent).
Some clientele seem more susceptible to problems with withholding. “I work in a high Earned Income Tax Credit neighborhood, and I believe most of my clients are expecting a bigger refund this year with no changes to their withholding,” said Rick Reynolds, an EA in Utica, N.Y. “I’m worried about my middle-class clients who have no children. Many of them are used to filing a Schedule A. With the new tax laws they may not have enough deductions. Couple that with them losing their exemptions and their refund will go down or amount due up. In that case,” he said, “I’d definitely tell them to adjust their W-4s at work – assuming they can figure out the new and complicated W-4.”
“Don’t know what I will tell them next time, especially if the new W-4 remains as it is in the last draft,” added Paul Knapp of Exact Income Tax Service, in Santa Fe, Texas.
“Many people always complain about the tax breaks that the wealthy have,” Armstrong said, “but I find that the higher-income people simply pay more attention to their tax situation – better records and compliance.”
‘Only one client’
The IRS has launched an awareness campaign urging all taxpayers to check withholding to head off a higher tax bill or penalty in 2019, reminding taxpayers that reform increased the standard deduction, removed personal exemptions, limited or cut other deductions, and changed rates and brackets.
Preparers have also tried awareness programs. “Our office discussed withholding with every client during this past tax season,” said Marilyn Heller Ayers, a CPA in Brick, N.J. “We used our software to take a look at how the new laws would affect their bottom line. In addition, we asked every client to contact us over the summer with updated paystubs so we can review their withholding and make sure they’re not caught off guard when we file their 2018 return. I think we are in good shape.”
“When I did clients’ 2017 return, I discussed the new withholding guidelines. In July, I sent letters to all of my clients … re-explaining that the withholdings for 2018 are significantly less and offered to do a withholding check free of charge,” said Kathy Hawboldt of Hawboldt’s Tax Service, in Louisville Kentucky. “Only one client has taken me up on the offer. When I do taxes for 2018, I’ll explain to clients that any surprises were expected and that’s why I sent the letter. I’ll also re-explain what I already told them.”
Laurie Ziegler, an EA at Sass Accounting in Saukville, Wisc., reviewed the withholding for any interested clients as part of completing 2017 taxes. “Through both our website and electronic newsletter we continue to encourage clients to have us do a projection,” she said.
“As part of my 2017 tax presentation, I printed a projected federal tax worksheet for 2018 showing the differences for them under the new tax laws,” said preparer Eric Hansen in Omaha, Neb. “Tried to be proactive.”
“Clients depending on me for payroll services have had their withholdings systematically adjusted. Those that do not have been accordingly advised,” said John Dundon, an EA and president of Taxpayer Advocacy Services in Englewood, Colorado. “Most follow through and have made adjustments, many have not. Those [finding] themselves surprised will be advised to engage my payroll services going forward.”
“A few clients have called and asked about their withholdings and how it will affect their 2018 tax returns. I asked them if they want me to do an estimate based on the projected income, withholding and deductions, and come up with a refund or balance due,” said preparer Andrew Piernock at Piernock Accounting and Tax Services, in Philadelphia. “Most of them, their refunds are much lower than 2017. I explain to them to change their W-4 and take out additional withholding. I definitely,” he added, “charge for this service.”
Source: accountingtoday.com Written by: J. Stimpson
Opportunity zones could be the single biggest tax break in decades, but the topic is not yet well known to many CPAs, and that lack of knowledge could end up costing your clients millions.
The Tax Cuts and Jobs Act, passed by Congress in the final days of 2017, introduced transformative changes to key areas of the Tax Code, many of which garnered a great deal of attention in the media and the professional accounting community. The TCJA also created the lesser known IRC Sections 1400Z-1 and 1400Z-2, which could have an enormous impact both on your clients’ tax liability and on economically distressed communities throughout all 50 states of the U.S. The new Opportunity Zone program, which consists of Opportunity Zones and Opportunity Funds, has the power to accomplish this. At a high level, the goal of opportunity zones is to promote investment of the estimated $6.1 trillion in unrealized gains held privately in the U.S. into the development of low-income communities across the country in exchange for federal tax advantages only available through the new Opportunity Zone legislation.
What are Opportunity Zones and Opportunity Funds?
As outlined in Section 1400Z-1, Opportunity Zones are census tracts generally composed of economically distressed communities. The census tracts are nominated by state governors and the mayor of the District of Columbia and certified by the Department of the Treasury. Up to 25 percent of census tracts in each state and the District of Columbia that meet the qualification requirements defined in Code Section 45D(e) are eligible. Areas certified as qualified opportunity zones retain their designation for 10 years, and to date, there are more than 8,700 qualified opportunity zones in the US. Code Section 1400Z-2 goes on to define opportunity funds as investment vehicles that aim to invest at least 90 percent of their capital into “qualified opportunity zone property,” which is defined as qualified opportunity zone stock, partnership interest, or business property located in designated census tracts. Investors have 180 days to roll a capital gain into a qualified opportunity fund in order to realize several important tax benefits:
A temporary tax deferral for capital gains reinvested in an opportunity fund. The deferred gain must be recognized on the earlier of the date on which the opportunity zone investment is sold or Dec. 31, 2026.
A step-up in basis for capital gains reinvested in an opportunity fund. The basis of the original investment is increased by 10 percent if the investment in the qualified opportunity zone fund is held by the taxpayer for at least five years. It is increased by an additional 5 percent if held for at least seven years, thus excluding up to 15 percent of the original gain from taxation.
A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in a qualified opportunity zone fund, if the investment is held for at least 10 years. This exclusion applies to the gains accrued from an investment in an opportunity fund, and not the original gains invested into an opportunity fund.
To see exactly how much more an investor can save, compare a $100,000 capital gain rolled into a traditional stock portfolio versus an opportunity fund both earning a 7 percent annual return. After ten years, net of taxes, the total return on the stock portfolio would be 32 percent. Meanwhile, the net, after-tax return on the opportunity fund investment would be 73 percent. On an after tax basis, opportunity funds could mean a two times higher return on investment as compared to a traditional stock portfolio. As you can imagine, such potential return premiums are attracting interest throughout the investor community.
While there are still some unanswered questions on opportunity zones, the rules and processes are designed to be straightforward with minimal friction. Opportunity funds not only provide exceptional tax benefits, but also hold the promise to be simpler, lower maintenance, and less expensive than alternative tax incentives like tax credit programs and 1031 exchanges. The provision is more of a tax election, rather than a tax program, and that should ease the burden on investors.
The unique appeal of opportunity funds
It is important to note that opportunity funds are not just for real estate clients. Gains from the sale of stock, a company and even cryptocurrency can be rolled into an opportunity fund. Did your client sell their business this year? Are they currently working through estate planning? Are they attempting to finally exit a 1031 exchange and get access to principal after years of exchanging? This tax legislation could be a cornerstone of a client’s tax planning strategy.
It is critical that CPAs know about and understand the benefits of opportunity zones, as clients will undoubtedly begin turning to their CPAs with questions as this legislation begins to receive more attention. More importantly, some of your most eligible clients might not be aware of the benefits of this legislation. Due to the time-sensitive nature of this tax incentive, you can be proactive in talking to your clients about the potential benefits of this entirely new and emerging tax advantage.
Source: accountingtoday.com Written by: G. Agarwal
The Supreme Court ruled in June that states have the authority to require businesses to collect online sales tax on purchases even if the business does not have a physical presence in the state. Previously, businesses were only required to collect sales tax in states where they operate physically. Though some major online retailers like Amazon were already collecting sales tax nationwide, the decision has implications for small to midsized businesses that must adapt to remain compliant.
It’s not all bad news for business owners. While small businesses with an e-commerce presence may now be looking at a significant incremental compliance obligation, smaller brick-and-mortar operations who have always been required to collect sales tax are hailing the decision as providing long-overdue competitive equity. There are also some upsides for online retailers:
• You have some time. It takes time for states to react to such rulings and make the necessary changes to enable the collection of a new tax. While some states have been readying their processes in anticipation of the ruling, most will have work to do before enacting any major changes. In the meantime, it’s wise to get in front of this by locating the tools you need going forward.
• Some states already have enacted, or will likely enact, thresholds above which the tax will be triggered. Thus, if your activity in a particular locale is below an ordained dollar or transaction level, you may be exempt.
• The Streamlined Sales and Use Tax Agreement. Twenty-four states currently participate in this agreement, which in addition to standardizing some of the supporting tax calculation and submission protocols also provides for free sales tax compliance software for retailers under certain circumstances.Though the Supreme Court’s decision has been made, there are areas that small online retailers will still need to keep an eye on:
• Retroactivity: Some states may be tempted to look to collect these taxes not only going forward, but retroactively.
• Federal standardization: Policy makers grasp how challenging it will be to stay on top of the multitude of state and local sales tax rules. As such, the Supreme Court ruling may prompt Congress to finally enact a standardized federal policy — though this may be politically unlikely for now.
• Potential impact on general business taxes: Some states don’t levy income taxes on businesses without a brick-and-mortar location within their borders. This decision may spur these states to reconsider that stance given the opportunity for incremental revenue.
Though some effects of this ruling are unknown at this time, business owners can take steps to prepare. Assess the impact, evaluating where your main out-of-state sales come from. This will give you a sense of where you may want to focus your compliance attention.
Source, www.accountingtoday.com Written by: M. Trabold
Accounting professionals, as the stewards of financial information, have a unique opportunity to take the lead in adopting the new lease guidance and implementing lease accounting software. Approaching the adoption methodically, which includes collecting data, making policy decisions, and applying operational realities, accountants play a distinct role in developing the processes and implementing the systems that guide an organization into the future. In doing so, accountants can help companies capture the benefits of enhanced, centralized processes, improved lease management and increased data visibility that ultimately lead to cost savings and more accurate financial data and disclosures.
One of the keys to realizing these benefits is for accountants to embrace technology as part of the implementation process. Unlike cumbersome and error-prone spreadsheets, lease accounting software that is effectively implemented will allow accountants to efficiently analyze vast amounts of asset data and make informed decisions. Empowered by the centralized data from the lease accounting software, accounting professionals are positioned to add valuable insights on lease spend, advise on both operational and financial decisions and provide more in-depth and accurate financial analysis.
Selecting and implementing lease accounting software
Lease accounting software, when judiciously selected, enables accountants to help their organizations capitalize on streamlined data. At the highest level, the most appropriate solution will come from a financially stable vendor with lease experience and be SOC 1 compliant. When evaluating software options, understanding your company’s business requirements is critical. Specific items to consider include the lease portfolio characteristics, international reporting requirements and foreign currency translation needs. To cement the selection process, users need to be able to easily input data, navigate the modules, and produce disclosure reporting.
Beyond ensuring that a solution meets your company’s requirements, a system should be easy to implement. Employing a lease accounting system requires organizations, specifically accountants, to coordinate cross-departmental teams that will assess the current state and inform the development of future state processes around procurement, month-end close journal entries and asset management. Leading the implementation presents a strong opportunity for accountants to move beyond the numbers and partner with upstream functions that often do not understand how their processes impact financial information.
Enhanced, centralized processes
Creating more efficient, centralized processes to not only collect information but to accurately input data into a system will pay dividends. On the front end, by working with procurement and operations, accounting can implement processes that ensure compliance with the new standard. This approach paves the way for accountants to be the Center of Excellence and subject matter experts for advising both operational and financial decisions. For example, as part of a monthly or quarterly process, accountants can utilize a lease system to provide more timely and accurate analysis of lease spend, ultimately leading to cost savings and an improved bottom line.
Additionally, the new guidance has a significant impact to the financial statements and disclosures, requiring accountants to thoughtfully strengthen internal controls and improve reporting processes. For instance, lease information that previously resided only in the footnotes is now presented as a liability that will be subject to increased scrutiny from internal and external stakeholders. Through heightened attention and robust processes around lease terms and details of lease transactions, accountants can make certain the financial statements under the new guidance are accurate.
Improved lease management
Lease accounting software and centralized lease management allows accountants to monitor and make educated decisions on lease events. Typical events include amendments to add or remove assets, altering length of term and middle- or end-of-term options such as terminations or renewals. Specifically, with lease accounting software, companies can produce standardized and customized reports to assist in presenting actionable information. A common benefit to these operational reports are their assistance to inform decisions on whether to renew or end a lease agreement prior to the lease end date, ultimately reducing unwanted month-to-month lease expenses which may have previously gone unnoticed.
More complete and accessible lease data will position accountants to assist their companies with proactively managing assets. To illustrate, lease versus buy decisions may oftentimes be uninformed because of the lack of data and decentralized lease management, resulting in inefficiencies and overspending. The centralized monitoring of lease events will help inform lease versus buy strategies that produce efficiencies and cost savings related to common challenges like evergreen leases, vendor management for similar leases and end-of-term options such as lease extensions.
Increased data visibility
Cross-departmental collaboration and an effective lease accounting software implementation will lead to a more cohesive and efficient data flow. This improved workflow creates on-demand access into lease data and knowledge sharing between previously disconnected areas of an organization like purchasing, real estate, IT and accounting. Currently, accountants are often delayed in receiving information that could impact timely journal entries. In the case of leases, communication about a new contract may not occur until after the month closes, resulting in catch-up entries and the risk of misstatements in financial reporting. With a new lease accounting solution and efficient workflow, accounting groups will have visibility into upcoming and recently transacted agreements to influence management with concrete financial analysis on lease spend.
As accountants take leadership roles in the adoption of the new guidance and the system selection and implementation processes, companies will realize value from enhanced, centralized processes, more robust management of leases and more in-depth visibility to lease data. These improvements provide accountants with the opportunity to provide their companies with analysis and insights on critical capital-asset procurement and spending. Ultimately, successful adoption of the lease guidance will yield cross-departmental collaboration and efficiencies, more cost-effective lease decisions, and increased accuracy in financial reporting.
Source: accountingtoday.com Written by: Bill Maloney