How to improve upon last year's tax reform

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.

Source: Accountingtoday.com via Bloomberg News

Corporate America ‘in limbo’ as IRS punts on foreign tax issue

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.

‘Taxpayer Friendly’

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.

Repatriation Refunds

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.

— With assistance from Isabel Gottlieb

Source: Bloomberg News Via:Accountingtoday.com 

Small businesses need major tax help

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

IRS will allow contributions to state and local tax credit programs as deductible business expenses

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.

Source: Accountingtoday.com Written by: M. Cohn

Hold everything: What clients need to know about new withholding rules

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.”

Many under-withhold

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

Finding the opportunity in the opportunity zones

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

What does the Supreme Court ruling on online sales tax mean for small business owners?

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