Tax Planning

The Tax Reform Act of 1986 first brought about the concept of taxation on the investment and unearned income for those individuals over thirteen and under seventeen years of age.  It is commonly known as the “Kiddie Tax.”  Originally the law only covered children over fourteen, as children under that age cannot legally work.  This meant that any income of a child under fourteen was derived from dividends or interest from bonds.  More recently, the age limits were revised to include children who hadn’t reached age nineteen by the close of the tax year, and full-time students under age twenty-four whose earned income was less than half of their own support, had at least one living parent, and didn’t file a joint return.  In the original tax bill, this tax is imposed on children whose investment and unearned income was higher than the annual threshold.  Under the old law, the first $1,050 of a child’s income is tax-free and the next $1,050 is taxed at 10%.  Furthermore, any unearned income over the $2,100 was taxed at the parents’ rate if it was higher than that of the child.  Earned income, like wages from a job, were still taxed at the child’s lesser rate.  In other words, the earned income from a job and the unearned investment income up to $2,100, less the standard deduction, was taxed at the child’s rate.  This encouraged parents and grandparents to make financial gifts to minors in the form of appreciated stock, assets from taxable estates, income transfers, and inherited IRAs.

During the introduction of the new Tax Cuts and Jobs Act of 2017 little was said about the rewrite of the Kiddie Tax rules. With these changes taxpayers will need to give pause in their strategies.  Beginning in 2018 and continuing until at least through 2025, when the law sunsets, the taxable income attributable to the child’s earned income is taxed under the rates for a single individual, as before.  However, the portion of the unearned income that is subject to tax, meaning the amount over $2,100, will now be taxed at the brackets applicable to trusts and estates.  This does mean that calculating the Kiddie tax will become far simpler.  Previously, parents and children would have to combine the income from all of the children, figure the parents’ tax rates and spread the tax between everyone.  Now everyone’s earnings are separate.  But with the use of the trust and estate brackets, there will be added complication in the form of a higher tax bracket for most.  For example, the income from IRA distributions, interest and short-term gains is taxed at the rate of 37% when the estate and trust rates are applied (once it exceeds $12.500).  By contrast, the married parents would only pay that rate on the portion of their income that exceeded $600,000.  The top long-term capital gains rate of 20% kicks in at $12,700 for the child, but not until $479,000 for the parents.

Children of high earning parents may find themselves in a lower tax bracket, as high-income taxpayers could be taxed up to 39.6%.  However, families of modest means will be hit harder, where the tax bracket is well under 37%.  Additionally, the tax applies to all types of unearned income, including Social Security from survivor’s benefits, legal settlements, investment income, and inherited IRAs and 401Ks.

The new tax law changes will also affect the standard course of utilizing inherited IRAs and other investments for school funding.  For example, a college student has parents in a fairly low-income tax bracket.  The grandparents previously gifted the child stock to sell.  For this example, the child pulls out funds for college, resulting in $200,000 of capital gains.  Under last year’s taxes, the $200,000 would have been subject to his parents’ capital gains rate of 15%.  Under the new law, the same gains are subject to 20%.  Under this taxation difference, it would have been a better strategy to gift the stock to the parents and have them sell it for the lower bracket on the gains.  Additionally, because by definition, a child must provide over half of their support from earned income to qualify as financially independent, this withdrawal of funds will not remove them from the Kiddie Tax effects.  Many financial advisory firms are recommending that the safest tax strategy is to have the student borrow for college and then utilize the IRA withdrawals to pay back the loan(s) after they have turned 24. 

Parents and grandparents wishing to gift investment wealth to their descendants will have to utilize a bit more strategy.  Leaving a child a Roth IRA may present a better option, as these result in tax-free payouts that would not be subject to the Kiddie Tax.  Naming children or grandchildren as beneficiaries on a Roth IRA and rolling the investment funds from a traditional pre-tax IRA to the Roth can be a good strategy.  Traditionally, the grandparents will have a lower income tax bracket and can take the hit of the taxes on the pre-tax rollover.  Make sure that you do not leave your IRAs subject to your estate.  This will mean that the distribution to your beneficiaries will need to take place within five years and cannot be stretched over the life span of the beneficiary.  Choosing investments wisely, is also a good strategy.  With $2,100 of non-taxable and low tax rate dollars to work with, dividends from large investments can be relatively sheltered from tax.  On the other hand, a taxable merger with large capital gains could result in a much higher Kiddie Tax.  If the goal is to pay for education, funding a 529 college plan is a good way to give tax free assistance.  Furthermore, the Tax Cut and Jobs Act allows for up to $100,000 a year of 529 money per child to be used for kindergarten through twelfth grade private-school costs tax-free, provided your state allows it.  Gifts of low-basis stocks to a Uniform Transfers to Minors Act account is also still a sound strategy.  Since the parents’ return is no longer involved, UTMA simpler now.  Additionally, once UTMA held stocks are sold, the funds can be transferred into a 529 account.

Many people wait until year-end to make substantial gifts.  With the complications added by the Tax Cuts and Jobs Act, now is a good time to start the process of determining the best possible ways in which to pass along your wealth. The best advice is to seek the aid of a tax professional to run numbers and find the best way to achieve your goals.

The Tax Cuts and Jobs Act (TCJA) tax reform and transfer pricing questions have become hot topics. However, as publications such as Tax Notes have observed, there is no single simple answer that applies across the board and fits all companies. While companies based in the U.S. are cheering on the new 21 percent corporate tax rate (a substantial relief from the 35 percent rate), local businesses may not have a firm grasp on how changes to transfer pricing could affect theme. (Keep in mind: these changes will affect 2018 corporate tax return filings, but not 2017.) A guiding principle that should be remembered: the effects of changes to transfer pricing guidelines will not impact every small business the same way. The effects must be considered on a case-by-case basis with each client. There are layers of factors that must be considered at the same time when attempting to model these transfer pricing issues.

Note: The following is a brief, generalized overview. It does not constitute comprehensive or actionable advice. It is imperitive that you consult with your own legal and tax professionals before engaging in a definitive strategy for tackling the issues of transfer pricing raised by the TCJA.

Transfer Pricing for Small Businesses

The issue of transfer pricing isn’t confined to multi-entity companies with operations overseas. The rules of transfer pricing also apply to local businesses who work with entities across state lines. Small businesses confined to domestic operations should aim to keep their transfer prices in an “arm’s length” (or ALP, which means Arm’s Length Principle) to market costs so that no one entity in the company is out of balance in their financial health with the other entities. Effective transfer pricing should be modeled to keep every component of the company in the same shape as the other component no matter where their operations are located.

Small companies with cross-border entities should take into account the cross-border prices incurred on services, royalties, loans, and other components such as inventory. If you do not adjust your transfer pricing to account for the new US federal tax rate, for example, the benefits may not be spreading equally across to cross-border entities, and the overall financial health of the company may become out of balance.

In addition, small businesses with cross-border entities should also look at tranfer pricing modeling to ensure they’re in compliance on both sides of the border. They should be diligent in preparing unique policy documentation for each country in question, and the documentation should be articulating and defending their transfer pricing decisions in each context.

Make the Effort to Review Your Transfer Pricing Approach

This last point may seem obvious but it is a common problem. Companies often rely on old transfer pricing models that haven’t been updated for a lengthy period of time. It is even more imperitive to review your transfer pricing model now that the TCJA is coming down the pike for 2018 corporate tax filings.

No Cookie Cutter Answers

The nature of transfer pricing means there is not a cookie cutter answer that applies to all small businesses all of the time. The simple fact is difficult to zero in on a single across-the-board, uniform impact of how TCJA will affect transfer pricing models for companies. As mentioned previously, it could easily be different for each small business and their unique situations and company goals.

Tax planning will become more important than ever now that the TCJA has completely transformed the tax code landscape. There are significant implications for tax planning on every level, from individuals to businesses.

The following highlights provide a bird’s-eye-view of what tax planning considerations could be made in 2018 and beyond.

For business owners

Biz Journal takes note of several items that businesses should consider for tax planning. In particular, sole proprietorships and owners of pass-through businesses (partnerships, LLCs taxed as partnerships, and S corporations) enjoy a new tax deduction equal to 20 percent of qualified business income from a qualified U.S. business. (This deduction is also available to individuals, trusts, and estates and expires for taxable years beginning after Dec. 31, 2025.)

However, there are several limitations to consider that will impact whether your business can take the deduction: 

• Qualified business income includes the ordinary income and deductions of a trade or business, but excludes most investment type income such as dividends and interest. Guaranteed payments to partners and reasonable compensation paid to S corporation shareholders or income generated from the business of being an employee are not included. The definition of qualified business excludes “specified service trades or businesses” including, health, law, accounting and financial services, and performing arts.
• Qualified business income is capped at an amount that exceeds either (i) 50 percent of W-2 wages paid by the qualified business or (ii) 25 percent of W-2 wages paid plus 2.5 percent of the unadjusted basis of qualified depreciable property used in the qualified business. Guaranteed payments to partners are not included, although W-2 wages paid to S corporation shareholders may be included.
• Limits on the qualified business income deduction do not apply if taxable income falls beneath $157,000 (315,000 for married taxpayers filing a joint return - MFJ).

For individuals

As the Money Guy notes in a recent report, there are certain steps that individuals will want to consider for tax planning as well, including the following:

Defer or Accelerate Income

• While TCJA still features seven tax brackets, they are slightly modified from the existing tax law. If you find yourself in a higher tax bracket next year due to the adjustments, consider deferring or accelerating your income if you’re able to control it like someone who self-employed or earns a commission.
• As an example, a married couple filing jointly earning $100,000 a year would find themselves in the 25 percent tax bracket in 2017, but in the 22 percent tax bracket in 2018. Therefore, if you were in a position to defer income until after the New Year you could take advantage of your lower tax rate.

529 Plans

The Money Guy notes that under TCJA, they are even more attractive because you can now use a 529 plan toward private K through 12 education expenses, not just college.

Other Considerations for Individuals

Biz Journals also points out that income tax rates are temporarily reduced in the TCJA, with the highest rate at 37 percent. The TCJA also brings other significant changes, including the following:

• Ties the kiddie tax to trust tax rates and brackets.
• Increases AMT exemptions, with adjustments for inflation (not applicable to trusts and estates).
• Increases standard deduction to $12,000 ($24,000 MFJ).
• Increases child credit to $2,000 per qualifying child ($1,400 is refundable), and a $500 nonrefundable credit for qualifying dependents.
• Increases limit on cash contributions to public charity deductions to 60 percent of AGI.
• Eliminates deductions for investment fees, mortgage debt, and other miscellaneous itemized deductions.
• Limits total itemized deduction for state and local income and property taxes to $10,000.
• Limits deduction for mortgage debt interest to $750,000 for indebtedness incurred after Dec. 14, 2017. Previous mortgage debt incurred is grandfathered in and limited to $1 million.
• Excludes personal property from section 1031 like-kind exchanges.
• Eliminates deductions for alimony and excludes inclusion of alimony payments in income for divorce settlements after Dec. 31, 2018.
• Expands section 529 plans to include K-12 education expenses but limits use to $10,000 per year per beneficiary.

For estate planning

Biz Journals also explains that estate, gift, and generation-skipping transfer taxes have increased lifetime exemptions to $11,180,000 per individual with annual adjustments for inflation. This increased threshold expires Dec. 31, 2025.

As you look into the details of your tax planning for 2018 and beyond, keep in mind that this article only highlights some key points of this topic. It does not constitute comprehensive or actionable advice of any sort. It is imperitive that you consult with your own legal and tax professionals before engaging in a definite tax planning strategy.

With such sweeping changes coming in with that Tax Cuts and Jobs Act (TCJA), there has been a fair amount of confusion with how certain deductions are handled. In particular, there are frequent questions about how entertainment and client meal expenses are handled.

Before TCJA, companies for the most part could deduct 50 percent of these expenses for business-related meal and entertainment purposes. In addition, if the meal was provided by the employer on the employer’s property it was 100 percent deductible.

Not so anymore.

Under the new law, any entertainment expenses incurred or purchased after Dec. 31, 2017 are not deductible. Meals provided by the employer (i.e. food and beverages provided on-site or provided through a cafeteria operated by the company) on the employer’s property are reduced to a 50 percent deduction.

The following summaries by Tax Connections provide the fine print details of how these changes will work:

• Disallowance of Deduction for all Entertainment, Amusement, and Recreation Expenses. Prior to TCJA, entertainment, amusement, and recreation expenses could be deducted (subject to certain restrictions) to the extent the taxpayer could “establish that the item was directly related to, or in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that such an item was associated with, the active conduct of the taxpayer’s trade or business.” TCJA §13304(a) fully repealed the deductibility of these items, regardless of any proximate business purpose.
• Disallowance of Deduction for Entertainment Tickets, Skyboxes, etc. Prior §274(l) placed further restrictions on the deductibility of entertainment tickets and box suites.  274(l) was fully repealed by TCJA due to the blanket, 100% disallowance of these types of expenses.
• De Minimis Fringe Eating Facilities Now Subject to 50% Disallowance. Prior §274(n)(2)(B) provided that expenses for food and beverage that were excluded from gross income of the recipient under §132(e) were not subject to the general 50% meals and entertainment disallowance under §274(n)(1).  This provision was repealed by TCJA, thereby making such expenses now subject to the general 50% limitation.
• No Deduction for Meals Provided for Convenience of Employer after 12/31/2025. Effective January 1, 2026, new §274(o) provides that no deduction is allowed for any expense for a de minimis fringe eating facility (§132(e)) or any meal provided for the convenience of the employer (under §119(a)).

There are some exceptions to these disallowances that Tax Connections notes, and they’re worth considering. For example, in order for meals expense to be deductible, it must first pass muster as ‘ordinary and necessary’ under §162 or §212. In addition, the expense must be directly related to or associated with the business or have a business purpose. If the meal is for goodwill or to make a client view your company favorably, rather than having a direct business purpose, such as a sales pitch, the expense will not be deductible.

In general, for all meals expenses, proper documentation that provides an explanation of the business purpose for each event should be retained. With that in mind, the following items are generally 100% deductible:

• Recreational activities and/or facilities furnished primarily for the benefit of employees for recreational, social, or similar activities. An example of this would be a holiday party for your office or taking your employees to a sporting event. However, this exception does not apply if the purpose of the event is primarily for the benefit of officers, highly compensated employees, or shareholders.
• Lodging and facilities charges (excluding meals) for business meetings or business travel, such as hotel rooms and conference facilities.
• Any expenses that are treated as compensation to the recipient (i.e., an employee per diem meal allowance).

In addition, the following would be examples of expenses subject to the 50% limitation §274(n):

• Food and beverages provided for employees on the employer’s business premises, such as in a cafeteria.
• Meals provided at a shareholder or employee business meeting.
• Meals for officers or employees traveling for business purposes.
• Meals provided during business meetings held with clients. However, in order for the expense to qualify as a business expense, a business purpose for the meeting must be documented, and the taxpayer or an officer, owner, or employee of the taxpayer must be present for the meal. There is also a “reasonableness” test associated with this limitation and the expense should not be considered “lavish or extravagant.”

This article only highlights some key points of this topic and does not constitute comprehensive or actionable advice of any sort. It is imperitive that you consult with your own legal and tax professionals before strategizing your business expenses and tax deductions.

If you’ve formed certain habits related to how you handle meals, entertainment, transportation, and parking as it relates to your business and taxes, the time to change those habits has come.

As this report notes, tax reform law commonly referred to as H.R. 1 Tax Cuts and Jobs Act of 2017 has changed the deductibility of certain meals, entertainment and transportation expenses. Before 2018, a taxpayer could deduct 50 percent of business meals and entertainment and 100 percent of meals provided through an in-house cafeteria or meals provided for the convenience of the employer (i.e., also known as a de minimis fringe benefit).

Not so anymore.

Under the new law, effective January 1, 2018, entertainment is no longer deductible and meals provided through an in-house cafeteria or for the convenience of the employer are subject to the 50 percent limitation.

And for tax years after 2025, meals provided through in-house cafeteria or for the convenience of the employer will not be deductible at all (unless Congress makes changes before 2025 when certain provisions change or expire). No change was made to the rule allowing a 50 percent deduction for business meals and a 100 percent deduction for expenses incurred for recreational, social, or similar activities (including facilities, but not club dues) primarily for the benefit of employees (other than employees who are highly compensated employees).

As Tax Connections notes, prior to TCJA, entertainment, amusement, and recreation expenses could be deducted (subject to certain restrictions) to the extent the taxpayer could “establish that the item was directly related to, or in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that such an item was associated with, the active conduct of the taxpayer’s trade or business.”

TCJA §13304(a) fully repealed the deductibility of these items, regardless of any proximate business purpose.

No More Free Parking

As discussed in a blog by attorneys Durham Jones & Pinegar things have also really changed when it comes to the deductibility of automobile parking.

Effective January 1, 2018, the Act eliminates the tax deduction benefit that has long been available to employers that subsidize their employees’ transit and parking expenses. For years employers could provide or pay for parking or transit passes (worth up to $255 a month to employees in 2017) as a tax-free benefit to help pay for their employees’ commuting expenses, and then deduct those costs from their business taxable income.

Under the Tax Cuts and Jobs Act (the Act) employers can still provide parking or transit passes to employees, but the employer will no longer get to deduct the costs of that benefit. Any arrangement where the employer pays for employee parking, no matter how structured, will mean a non-deductible expense for the employer.

Parking is employer-provided if:

• It is on property that the employer either owns or leases,
• The employer pays someone else (such as their landlord or a parking lot/garage owner) for the parking, or
• The employer reimburses the employee for parking expenses.

According to the Durham Jones & Pinegar blog, employers who wish to avoid the loss of the tax deduction or the after-tax imposition of the parking cost on their employees will need to create a method to continue providing tax-deductible parking to employees. Refer to Pinegar for relevant examples and workarounds.

In conclusion, the information recited in this blog is solely intended to emphasize from a different angle information presented elsewhere. This information is not intended to be used by the reader for any purpose other than general information. We forewarn the reader against making any form of business decision based solely on the blog we have created as these articles serve as snippets and brief overviews of broad, complex situations. Prior to making any business decision, first seek advice from a suitable professional such as a licensed legal or accounting professional. 

After a lengthy process, Congress and the President did what they had to do in late December 2017 to put into law one of the most significant pieces of legislation in decades: the Tax Cuts and Jobs Act (TCJA). The Act put into place a number of provisions that will affect Not for Profit Organizations. Note the following areas of tax impact that the provisions of the TCJA  brought in relation to Not For Profit Organizations, as noted in Yeo Yeo:

• Changes the computation of unrelated business taxable income (UBIT) if an organization has more than one unrelated trade or business. It’s possible that more nonprofits will have to pay UBIT. As Nolo explains:

Subject to numerous exceptions and emptions, tax-exempt nonprofits that operate businesses unrelated to their charitable mission must pay an unrelated business income tax (UBIT) on their net unrelated business income. Under prior law, a nonprofit that operated multiple unrelated businesses could deduct the losses from one business from the profits from another to determine the amount of net unrelated business income subject to UBIT. The TCJA does not allow this. Starting in 2018, each unrelated business must determine its net income without regard to losses from other unrelated businesses. As a result, it’s likely that more nonprofits will have to pay UBIT.

• Increases UBIT by the amount of certain fringe expenses for which a deduction is disallowed.
• Imposes a 21% excise tax on compensation of over $1 million for the five highest paid employees.
• Imposes a 1.4% excise tax on net investment income of private colleges.
• Modifies the rules for charitable contributions:
  • Repeals the special rule in Code Sec. 170(l) that provides a charitable deduction for the amount paid for the right to purchase tickets for athletic events;
  • Repeals the Code Sec. 170(f)(8)(D), effectively ensuring that donee organizations will not be allowed or required to report details of donations of $250 or more
  • Increases the 50% limitation under Code Sec. 170(b) for cash contributions to public charities and certain private foundations to 60%;

Will the TCJA Dampen Charitable Giving or Stimulate It?

One point of view, usually the side that is broadly opposed to the TCJA, makes the case the TCJA will hurt charitable giving because, among other things, it provides to taxpayers such a huge increase for standard deductions. PJ News sums this point of criticism up as follows:

The Act roughly doubles the standard deduction for individuals ($12,000 for individuals and $24,000 for joint filers) and generally lowers individual income tax rates across the board. The Act also places an annual limitation on the state and local tax deduction at $10,000 (for both individual and joint filers). These income tax changes are scheduled to remain in effect through 2025. Doubling the standard deduction makes it much more likely that fewer people will itemize their deductions. Because a taxpayer must itemize deductions in order to obtain any income tax benefit by making a charitable contribution, a taxpayer not itemizing deductions receives no tax benefit from such a contribution. Capping the state and local tax deduction also makes it more likely that the standard deduction will be used. Even for those who will still itemize, the lower income tax rates reduces the value of the charitable deduction because with lower tax rates, less taxes are saved by taking a charitable deduction than before the Act.

An opposing point of view from the Washington Examiner makes the case that the tax cuts will actually stimulate charitable giving as income and financial resources increase as a result of the tax cuts:

The thrust of the Left’s argument is that allowing Americans to keep more of their money makes them stingier, and high taxes are needed to force Americans to take advantage of charitable tax write-offs.

It’s ironic that anyone in the nonprofit sector, which is built entirely on the generosity of individuals and corporations, can argue that higher taxes encourage charity – or that charity needs to be legislated.

This argument has no basis in economic reality, either. According to Giving USA, which tracks charitable donations, philanthropy has grown rapidly since it bottomed out during the Great Recession. Giving rose to a new high of $390 billion in 2017 largely thanks to individuals, whose giving increased nearly four percent in 2016. Giving USA also notes that donations grew substantially in 2014 and 2015 likely due to two factors: “The country’s overall economic environment continuing its path to recovery after recessionary times, and household finances seeming to stabilize.”

No matter which “side” you take, whether you agree with PJ News or the Washington Examiner, here are five steps nonprofits should take now to tackle tax reform:

1. Assess impact. Tax professionals will likely need to review the law to measure their organization’s specific circumstances against it to assess the impact of each provision, as well as the holistic effect on their bottom line.
2. Assemble a team. While the heaviest burden may fall on accountants, companies and their finance teams will have an important role to play to gather all the necessary data.
3. Dig into the data. Assessing the impact of tax reform requires a substantial amount of data to be readily available. Nonprofits need to move from modeling the impact of tax reform to focus on data collection and computations as soon as possible.
4. Establish priorities.  Focus on the areas that could have the greatest impact on your organization.
5. Initiate tax reform conversations with your tax advisor.  Tax reform of this magnitude is the biggest change we’ve seen in a generation, and will require intense focus to understand not only how the changes apply at a federal level, but also how to navigate the ripple effect this is likely to have on state taxation as well.

Most articles about the passage of the Tax Cuts and Jobs Act in December buzz about the resulting income tax consequences for individuals and businesses.

But what about the intersection of the TCJA and estate planning?

In a report by Stefi Gascon Hafen, published by AccountingToday, she comes to some interesting conclusions about the TCJA’s significant impact on estate planning.

Under the Act, the estate, gift and generation-skipping transfer taxes remain in effect with double the unified federal gift and estate tax exemption and the GST tax exemption (from $5 million to $10 million). These amounts are indexed for inflation. For 2018, the gift and estate tax exempt amounts and GST tax exempt amount is expected to equal $11.18 million ($22.36 for married couples). However, the increased exemption sunsets in 2026.

The Act left portability unchanged. If a spouse dies without exhausting his or her lifetime gift and estate tax exemption, so long as the decedent’s executor makes the proper election on an estate tax return, the unused exemption is credited or “ported” to the surviving spouse for use during life or at death. Thus, for some married couples, an “all to the other” approach with a portability election may be preferable.

Portability might seem like the right choice for married couples. But that’s not always the case as Hafen notes:

• Blended family or other intended beneficiaries: For blended families, the traditional “QTIP” trust or bypass trust may still be a better strategy to ensure that the children of the first-to-die are remainder beneficiaries at the second death.
• Creditor issues: The “all to the other” approach provides that the assets of the first-to-die will be allocated to the survivor. Because the survivor has full control over the assets, the survivor’s creditors can also reach the assets. If there is concern about creditors, a QTIP trust or bypass trust may be ideal.
• Dynasty planning: Because portability does not apply to the GST tax exemption, the GST tax exemption of the first-to-die is lost with “all to the other.”
• High appreciation potential: While the “all to the other” approach provides a step-up in basis at the death of each spouse, there are instances where removing the assets and all future appreciation out of the second-to-die’s estate produces the best results, in which case a bypass trust should be used.
• Clawback: It is not clear what will happen if an estate elects portability and the exemption subsequently decreases at the death of the second spouse. The IRS may attempt to clawback the unused exemption of the first-to-die spouse over the lower exemption amount applicable at the death of the second-to-die spouse.

Another tricky situation noted by Hafen: Many family trusts (especially those drafted before portability) use tax formulas to fund a bypass trust. Such formulas were likely drafted when the exemption amount was much lower. (It was $1.5 million in 2005!) With the increased exemption, the formula could serve to overfund the bypass trust.

New Opportunities to Transfer Wealth

As Accounting Today observes, for those who exhausted their exemption up to the 2017 $5.49 million limit, they now have another $5.69 million (or $11.38 million for a married couple) to use. However, given the sunset provision, this opportunity may only be available until 2026.

Income Tax Becomes King

In 2017, of the 2.7 million estates, only 5,190 are expected to owe federal estate tax. With the increased exemption, some predict this number to drop to 2,000.

On the other hand, while the top federal individual income tax rate is 37 percent and the top capital gains rate is 20 percent, the 3.8 percent net investment income tax remains in effect.

Thus, high net worth individuals may prefer to engage in strategies that both reduce their total income tax and transfer wealth to their descendants with as little transfer tax as possible. Some techniques include:

• Shifting income: Gift high income-producing assets to a trust that distributes taxable income to a beneficiary in a lower tax bracket.
• Charitable giving: The Act increased the charitable contribution limit to 60% of adjusted gross income.
• Delaying capital gains taxation
• Selling instead of gifting
• Exploit basis step-up: Cause low-basis assets to be included in a decedent’s nontaxable estate, receiving a step-up in basis and reducing capital gains tax at a subsequent sale.

Of course, Hafen’s conclusions are for general information purposes only. It is not intended to be used in place of advice received from a suitable professional advisor such as an attorney with an expertise in estates and trusts.

The bottom-line: new rules governing estates and trusts could generate unexpected consequences.

A recent interview style Q and A session appeared in Accounting Today featuring the expertise of author Iralma Pozo. In this series of questions, Pozo tackles some important aspects of the most significant change to the U.S. tax code since 1986. With such historic changes underway, it’s critical that you understand how the Tax Cuts and Job Act will affect cash flow issues for clients.

What’s particularly insightful is Pozo’s advice regarding parents and what they need to know about 529 plans. Her observations about developing a new strategy for charitable deductions and nonprofit organizations are also highlights:

With so many changes and factors, where do advisors start?

Legal and accounting firms, bar and state accounting associations, continuing education providers and publishers have been busy providing articles, webinars and training. In any planning, cash management and cash flow must be taken into account, to ensure there is enough money to cover ongoing expenses and operations and to fund any additional expenses taxpayers chose to incur in order to take advantage of tax changes. Looking at the bottom line is not enough in times of change; one must also make sure on a monthly basis that basic necessities are met and the lights stay on. Additionally, advisors will have to take into account which changes are permanent, temporary and due to increase or decrease between now and 2025.

How will the states react to tax reform?

In the past, many states piggybacked on the federal tax regulations. Some states such as New York have already announced plans for changes in the state tax laws. Any additional differences will have to be taken into consideration when preparing estimated tax payment calculations and projections. With some states increasing the minimum wage and providing paid family leave, there will be a lot of changes.

How will the alternative minimum tax enter the equation?

The AMT has to be taken into account in planning for individuals and corporations. The individual phase-out threshold has increased to $1 million. For individuals who prepaid real estate taxes for 2018 that were already assessed in 2017, the AMT exemptions from 2017 may yield less or no tax savings.

What are some things that advisors should discuss with parents?

Parents will benefit from the $400 increase in the refundable child tax credit. The standard deduction was increased and personal exemptions were eliminated. This change may be confusing to some parents. Parents will be able to use 529 plans to send children to elementary school.

Advisors can help families leverage caps on real estate and tax deductions with education expenses. Some parents purchase homes in counties they can barely afford in order to send their children to schools in better school districts. Some of these parents will no longer benefit from the tax savings they were accustomed to when they were able to deduct their real estate and state taxes. Advisors can help parents determine how contributions to educational savings accounts can lower their taxable income and save them money on taxes.

How can advisors help clients with retirement-related issues?

Advisors will have to help clients access their current and future earnings and tax expectations, to ensure a Roth IRA conversion is best for them. Roth IRA conversions will no longer be reversible.

How can advisors help clients with real estate investment issues?

With the caps on deduction of property and real estate taxes, mortgage interest, business interest expenses, advisors can help clients figure out what the best structure is for real estate investments. Some clients who have previously shied away from partnerships may find such entity structures more favorable or feasible.

How will entrepreneurial business owners make out with tax reform?

Business owners should be open with their advisors on what their strategic plan for the year is, how much they plan to grow and what their operating budget includes. Discussions should include which entity type is most beneficial, how the business owner can receive compensation and benefits to save taxes, and how much money the business owner needs to cover basic operations and living expenses on a monthly basis.

How can advisors help pass-through entities that are service providers?

Advisors can assist high-earning service-providing businesses set up compensation and benefits that can reduce income and increase tax savings, yet provide future benefits to business owners.

How will tax reform affect nonprofit organizations?

With the increased standard deduction, some people will no longer be able to itemize, and will no longer see a tax savings from making charitable donations. 

Executive compensation changes will particularly be something nonprofits will have to address. With potentially decreasing donations, stakeholders would prefer to see more money going to causes and programs as opposed to executive pay. Endowments will be affected by tax reform as well, with a new excise tax of 1.4 percent on the net investment income of applicable educational institutions. Investment and other advisors will have to work with educational institutions that have large endowments to ensure the organizations strategize about what to spend and what to save for the future. 

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It’s clear that the TCJA will have far-reaching effects for years to come. For this reason, we recommend that you plan on extensive meetings with your advisors (legal and accounting) to obtain help with navigating through “the jungle” of new tax rules that reform has left us.

You will likely need to spend plenty of extra time with your legal and accounting/taxation advisors this year.

In last month’s newsletter we presented some general facets of the Tax Cuts and Jobs Act (TCJA). In this article, we will explore some portions of the new bill in greater detail.

In general, the law cuts corporate tax rates permanently and individual tax rates temporarily. It permanently removes the individual mandate, a key provision of the Affordable Care Act, and it changes other policies in dramatic ways, such as the SALT deduction (which will be explained in more detail below).

It should be noted that the impact from the TCJA is not expected to occur until the 2018 (not 2017!) tax filing.

How the Tax Cuts and Jobs Act impacts U.S. Tax Returns

The following items which are now presented with accompanying detail were deferred from discussion last month. Other items not presented yet should be presented in following months assuming they are of sufficient materiality and general interest.

A report by Investopedia notes the following changes that will take place as a result of the new tax bill:

Income Tax Rates

The law retains the current structure of seven individual income tax brackets, but in most cases it lowers the rates: the top rate falls from 39.6% to 37%, while the 33% bracket falls to 32%, the 28% bracket to 24%, the 25% bracket to 22%, and the 15% bracket to 12%. The lowest bracket remains at 10%, and the 35% bracket is also unchanged. The income bands that the new rates apply to are lower, compared to 2018 brackets under current law, for the five highest brackets.

Standard Deduction

The law raises the standard deduction to $24,000 for married couples filing jointly in 2018 (from $13,000 under current law), to $12,000 for single filers (from $6,500), and to $18,000 for heads of household (from $9,550). These changes expire after 2025. The additional standard deduction, which the House bill would have repealed, will not be affected. Beginning in 2019, the inflation gauge used to index the standard deduction will change in a way that is likely to accelerate bracket creep (see below).

Personal Exemption

The law suspends the personal exemption, which is currently set at $4,150 in 2018, through 2025.

Inflation Gauge

The law changes the measure of inflation used for tax indexing. The Internal Revenue Service (IRS) currently uses the consumer price index for all urban consumers (CPI-U), which will be replaced with the chain-weighted CPI-U. The latter takes account of changes consumers make to their spending habits in response to price shifts, so it is considered to be more rigorous than standard CPI. It also tends to rise more slowly than standard CPI, so substituting it will likely accelerate bracket creep. The value of the standard deduction and other inflation-linked elements of the tax code will also erode over time, gradually pushing up tax burdens. The change is not set to expire.

Family Credits and Deductions

The law temporarily raises the child tax credit to $2,000, with the first $1,400 refundable, and creates a non-refundable $500 credit for non-child dependents. The child credit can only be claimed if the taxpayer provides the child's Social Security number. (This requirement does not apply to the $500 credit.) Qualifying children must be younger than 17. The child credit begins to phaseout when adjusted gross income exceeds $400,000 (for married couples filing jointly, not indexed to inflation). Under current law, phaseout begins at $110,000. These changes expire in 2025.

Head of Household

Trump's revised campaign plan, released in 2016, would have scrapped the head of household filing status, potentially raising taxes on 5.8 million single-parent households, according to an estimate by the Tax Policy Center (TPC). But the final version of the law that Congress passed and Trump signed leaves the head of household filing status in place.

Itemized Deductions

Mortgage Interest Deduction

The law limits the application of the mortgage interest deduction for married couples filing jointly to $750,000 worth of debt, down from $1,000,000 under current law, but up from $500,000 under the House bill. Mortgages taken out before Dec. 15 are still subject to the current cap. The change expires after 2025.

State and Local Tax Deduction

The law caps the deduction for state and local taxes at $10,000 through 2025. The SALT deduction disproportionately benefits high earners, who are more likely to itemize, and taxpayers in Democratic states. A number of Republican members of Congress representing high-tax states opposed attempts to eliminate the deduction, as the Senate bill would have done.

Other Itemized Deductions

The law leaves the charitable contributions deduction intact, with minor alterations (if a donation is made in exchange for seats at college athletic events, it cannot be deducted, for example). The student loan interest deduction is not affected (see "Student Loans and Tuition" below). Medical expenses in excess of 7.5% of adjusted gross income are deductible for all taxpayers – not just those aged 65 or older – in 2017 and 2018; the threshold then reverts to 10%, as under current law.

The law does, however, suspend a number of miscellaneous itemized deductions through 2025, including the deductions for moving expenses, except for active duty military personnel; home office expenses; laboratory breakage fees; licensing and regulatory fees; union dues; professional society dues; business bad debts; work clothes that are not suitable for everyday use; and many others. The moving expenses deduction is also suspended. Alimony payments will not longer be deductible after 2019; this change is permanent.

Alternative Minimum Tax

The law temporarily raises the exemption amount and exemption phaseout threshold for the alternative minimum tax (AMT), a device intended to curb tax avoidance among high earners by making them estimate their liability twice and pay the higher amount. For married couples filing jointly, the exemption rises to $109,400 and phaseout increases to $1,000,000; both amounts are indexed to inflation. The provision expires after 2025.

Student Loans and Tuition

The House bill would have repealed the deduction for student loan interest expenses and the exclusion from gross income and wages of qualified tuition reductions. The law leaves these breaks intact. The conference bill would also have extended the use of 529 plans to K-12 private school tuition, but that provision was struck down by the Senate parliamentarian as ineligible to be passed through reconciliation.

Pease

The law repeals the Pease limitation on itemized deductions. This provision does not cap itemized deductions, but gradually reduces their value when adjusted gross income exceeds a certain threshold ($266,700 for single filers in 2018); the reduction is limited to 80% of the deductions' combined value.

In conclusion, it should be evident that the TCJA touches many aspects
of the individual taxpayers’ life. Next month we will present relevant TCJA aspects of Estate Tax and Business Taxes.

President Trump signed the "Tax Cuts and Jobs Act" into law on Dec. 22, as noted and summerized from a report by Investopedia. The Senate passed the bill on Dec. 20 by a party-line vote of 51 to 48. The House passed the bill later in the day by a vote of 224 to 201. No House Democrats supported the bill, and 12 Republicans voted no, most of them representing California, New York and New Jersey. (Taxpayers who itemize and rely on the state and local tax deduction in these high-tax states will have their state and local tax deductions capped at $10,000 or $5,000 if Married Filing Separate). Generally speaking, some are concerned that this overhaul is forecasted to raise the federal deficit by a significant amount, while others say the tax cuts will significantly boost the economy and produce growth across many industries.

The law cuts corporate tax rates permanently and individual tax rates temporarily until 2025 when those individual rates would expire if they’re not renewed. The law permanently removes the individual mandate, a key provision of the Affordable Care Act.

It should be noted that the impact from the TCJA is not expected to occur until the 2018 (not 2017) tax filing.

There is a significant amount of material as it relates to the Tax Cuts and Jobs Act” (“TCJA”), and this article can only provide a brief sketch.

How the Tax Cuts and Jobs Act impacts U.S. Tax Returns

Note the following points that are affected by the TCJA and will be discussed in future newsletter articles.

1. Tax brackets are changed and tax rates are reduced for most taxpayers, some quite significantly. For example, in the old tax brackets a Married Filing Jointly taxpayer who made between about $38,000 and $92,000 fell in the 25 percent tax rate. With the new brackets, most taxpayers in that range (up to around $77k) would slide down to the 12 percent tax rate. See this snapshot of the new brackets and rates for details.
2. Personal and dependent exemptions are eliminated.
3. Child tax credit increased through 2025.
4. New credit for non-child dependents available through 2025.
5. Standard deduction is doubled through 2025. (For example, Married Filing Jointly had a standard deduction of $12,000 previously. Now it is $24,000.)

Many itemized deductions eliminated, limited or modified:

6. Fully Eliminated

a. Miscellaneous Itemized Deductions

b. Personal Casualty and Theft Losses

7. Limited

a. State and Local Income Taxes

b. Home Mortgage Interest

8. Modified

a. Charitable Contributions

b. Gambling Losses

c. Medical Expenses

Many “Above-the-line” deductions eliminated, limited or modified:

9. Fully Eliminated

a. Alimony

b. Tuition and Fees

c. Domestic Production Activities Deduction (DPAD)

10. Most education benefits remain the same, others modified. For example, the tax bill modifies this rule governing the discharge of student loans by including discharges on account of death or disability, so that such discharges are also excluded from taxable income.

11. Health care penalty eliminated.

12. Self-employed taxpayers may claim a new deduction for qualified business income.

13. Taxpayers may benefit by adjusting withholding and estimated taxes.

In conclusion, with such sweeping changes, it would be advisable that the taxpayer start meeting with their tax professional to undertake a planning process that centers on the taxability of their 2018 tax year.