Tax Strategies

It used to be that the term “Section 1031 Exchange” or even “Like-Kind Exchange” was uncommon except in certain circles.  But as the idea of tax strategies have reached more and more taxpayers coupled with the housing market’s fluctuation in recent years, 1031s have become increasingly commonplace. 

So, what is a 1031 Exchange?  In its broadest terms, a 1031 Exchange is the trade of one investment property for another.  When most people think of trading one property for another, we think in terms of selling one property, paying any applicable taxes and then buying a new property in a separate transaction.  With the 1031, this is not the case.  If your transaction meets the 1031 requirements, you will have limited to no tax due at the time of the exchange.  In other words, you are changing your investment without cashing out or recognizing capital gains.  This is a good strategy for someone that wants to remain an investor but may no longer have an interest in their current property portfolio.  As there is no limit on the number of times you can perform a 1031 exchange, the investment you originally had will continue to grow tax deferred until such time as you eventually sell.  This can provide time to create a sound plan and tax strategy for paying the long-term capital gain rate at the time of sale.

One thing to note, however, is that there are special rules pertaining to depreciable property exchanges.  In order to avoid depreciation recapture, you must make sure that you are exchanging investments that retain the same structure.  For instance, if you were to exchange improved land with a building utilized in an investment activity for raw land, you will incur recapture income.  But if you were to exchange a rental property for another rental property, you would not, even though the rental has been depreciated.  There will be basis adjustments for the exchanged buildings and your tax preparer should be informed of your intent so that they can help you strategize and prepare for the outcome.  In addition to engaging your tax professional, you will also need the help of a 1031 Exchange Facilitator.   Here are some things to think about when determining if a 1031 exchange is the right path for your investments.

In years prior, 1031 Exchanges could be used for a number of different types of properties – real estate, franchises, aircraft, and equipment.  With the 2017 Tax Cuts and Jobs Act, only real estate still qualifies.  And while the exchange of corporate stock and partnership interest is not exchangeable, some Tenants in Common (TIC) structures are.  The TCJA does include a ruling that allows for the exchange of qualified personal property in 2018 if the original property was sold or the replacement property was acquired by December 31, 2017.  There are limitations on this rule and a 1031 should not be entered into without understanding the full implications of the changes made by TCJA.  1031s are also not for personal use property.  The property must be held for investment and while there are provisions that can allow you to exchange a vacation property, the loophole is much smaller and more difficult to obtain.   With that in mind, the term like-kind is not as well defined as one might think in their own mind.  You can exchange investment property (buildings, land, rentals) for other investment property.  But there are traps for the unaware.

There are a few rules you must adhere to when performing a 1031 Exchange.   The first are the timing rules.   An important factor in 1031 Exchanges is that you do not receive the cash from the sale yourself.   This will negate the 1031 treatment of the sale and create a taxable event.  Therefore, you must designate an Exchange Facilitator prior to selling your initial investment property.   The facilitator must hold the cash from the sale of the original property during the time period between the initial sale and the new purchase.  You must designate the replacement property within forty-five days of the sale of your original property in writing to the facilitator.    You can designate up to three properties and one of them must be the one that you purchase.  You can also do a reverse exchange, where the replacement property is purchased before selling the exchanged property. (Note: Reverse 1031 Exchanges are far more complicated, and it is important to know the rule before engaging in one).  The second timing rule pertains to the closing of the sale.  You must close the sale of the new property (or old property in the case of a reverse exchange) within one-hundred and eighty days of the sale of the initial property.  It is important to note that both of these time requirements run simultaneously. 

Something to consider is the value of the two properties.  If you proceed with a sale in which you receive funds after the purchase of the new property, those funds will be taxable to you.  This is known as “boot.”  Additionally, if you have a mortgage on the initial property and incur a lesser mortgage on the new property, the difference in liability is also considered boot and is taxable.

Another version of the 1031 exchange is the 1033 Exchange that relates to Eminent Domain Reinvestment.  This occurs when the investor is required to relinquish property to the government through a force conversion.  The IRS made provisions for this by creating the 1033 rules.  The timeline for the exchange is extended to two to three years from the date of the forced conversion, giving the investor time to find the new property.  Additionally, an Exchange Facilitator is not needed, and the funds can be placed in other shorter-term investments until the close of the 1033.  The 1033 allows for the new investment opportunity to hold less value than the initial property without incurring the taxable boot.

Tax-deferred exchanges are very complex, even if you are a well-seasoned investor.  Seeking the help of your tax professional and an Exchange Facilitator to go over the rules and consequences before attempting the exchange will provide for a better outcome in the long run.

Before the Tax Cuts and Jobs Act of 2017 bill was passed, buying a home was a big incentive to taxpayers looking to reduce their annual taxes.  While some states do have a benefit calculation on rental costs, and home office users can add rental costs to their expenses, for most taxpayers the tax breaks received on the real estate taxes and mortgage interest you pay through homeownership were far more beneficial than renting.  In addition, building equity in your home for possible use later was a nice added bonus.  With the changes put in place by the TCJA, taxpayers are starting to wonder if homeownership is a valuable as it once was.

For many taxpayers, the first thing they think of when looking at the “rent versus buy” scenario is that renting means that each dollar you spend in rent goes to someone else, while buying a house is a great investment.  This is the old “why pay a landlord when you could be building your own equity” adage.  While this is a common thought, there are quite a few costs associated with homeownership that do not increase equity.  Nor are they deductible.  Funds spent towards mortgage interest, real estate taxes, and in some cases homeowner’s and other insurances are items that can potentially have additional benefit in annual tax breaks.  But they aren’t helping you build equity.  Additionally, the fees paid through the mortgage, Association dues or fees, landscaping, repairs and maintenance items, some utilities, and the like are expenses that your landlord would incur on your behalf as a renter and are not of added advantage to you.  So, while at first blush, the mortgage payment may be lower than your monthly rent, it’s just the beginning of the costs of homeownership.  The associated costs of homeownership can run up to an additional fifty percent of your mortgage payment per month.

Home equity is built when the home’s market value outweighs its mortgage value.  In other words, the equity is the amount of the home that you “own.”  If you borrowed money to purchase your home, your lender also has an interest in your home.  While the lender doesn’t “own” your home, the home is securing the loan and can be subject to a lien.  That value cannot be added to your equity.  One way to build equity in your home is to continue to pay down the mortgage, thereby increasing the amount of the home that you own free and clear.  In addition, you may be the beneficiary of increased equity if the housing market in your area takes an up-swing.  And if you add any large improvements to your home that increase the sales value, this will also create added equity.  Capital improvements made to the property will also help you reduce the potential capital gains at the time of sale.

Equity in your home can be used for a variety of things.  Most people look at it as a way of having a savings they can draw on in times of need.  And while a home equity line of credit (HELOC) or a home equity loan can be used to payoff current expenses, it is money better spent if put towards long-term investments.  The equity in your home can also be used to pass on wealth to your heirs, fund your retirement, or purchase your next home.

But how did TCJA change the conversation?  The first tax break that people think of is the deductible interest associated with the mortgage payments.  This is because, in most cases, your interest is the largest of the deductible portions of your homeownership annual costs.  Interest of this nature is deductible as part of your Itemized Deductions.  According to 2016 filing data, roughly thirty percent of taxpayers itemized, and only three out of every four taxpayers who itemized took this deduction.  That means that approximately twenty-one percent of tax filers claimed this deduction.  With the near doubling of the standard deduction by TCJA, the incentive to itemized is greatly reduced.  The Tax Policy Center estimates that a mere four percent of taxpayers will itemize in 2018 and beyond.

Traditionally, taxpayers with larger mortgages received bigger tax breaks.  Under TCJA, those with a new home purchase made between December 14, 2017 and 2026, can deduct the interest on up to $750,000 in mortgage debt used to purchase or improve the home.  This is down from the previous amount of up to $1 million.  Additionally, you can no longer deduct the interest on a home equity loan.  Prior to TCJA, you could deduct the interest on these types of loans up to $100,000.  Also gone with TCJA is the ability to deduct mortgage interest from a second home.  Previously, taxpayers could deduct interest on both their primary residence as well as a secondary residence or vacation home, as long as the combined mortgages were under the $1 million cap.  Again, this applies to new purchases made.

The second tax benefit that homeownership brought was the deductibility of real estate taxes.  Historically, taxpayers were allowed to take the full value of the cost of their property taxes on their federal return.  Again, however, these are deductible using itemized deductions.  As mentioned previously, the number of taxpayers who will be claiming the itemized deduction will greatly decrease in the coming years.  For those that will be claiming real estate taxes, the TCJA reform capped the state and local tax deduction at $10,000.  For many taxpayers, $10,000 does not come close to covering the costs of their combined property and income tax bills. 

There is some good news in the mix.  The capital gains rules are staying the same.  Initially, there was talk of changing the rules to increase the ownership and use requirements from two out of the last five years to five of the last eight, but it did not make the final version of the bill.  This means that taxpayers are still eligible for the $250,000 exclusion for single filers and $500,000 for joint, provided you meet the residency qualifications.  And while the tax deductions may have been reduced, an unintentional benefit may be that housing prices may begin to reduce, and buyers may come out ahead.

While alternative education paths are on the rise, a traditional education track is still the most readily available to most high school graduating classes.  However, college, professional, and graduate schools are more costly than ever.  The cost of higher education surged more than five hundred percent since 1985.  In fact, higher education costs more than four times the amount it did thirty years ago.  Financial challenges are one of the largest qualifiers for non-completion of higher education.  Those lacking a financial cushion and even those with financial assistance, can easily find themselves underwater with the growing requirements and unexpected costs of higher education.  Many of these students find themselves caught between rising costs of completing their education and the jobs available to them if they do not. 

Many students assume that financial aid will aid those with scarce means achieve their education. But financial aid policies are often limited and do not fully cover the cost of attending classes.  Information regarding the cost of attending the institution usually comes from the institution itself.  These costs generally list tuition and fees, along with the estimate for books, supplies, transportation, room and board, and a few other expenses.  Federal law dictates that a college must include tuition and fees, books and supplies, transportation and living costs in their publicized costs.  Financial aid cannot exceed the school’s publicized costs, even if they are artificially low.

Up to fifty percent of students do not live on campus or with family, and their cost of living expenses vary due to distance to the school.  These varied costs, and off-campus costs, are not included in the figures provided by the school.  Schools do not often take into consideration the geographic cost of living adjustments and poverty thresholds in their specific communities or across the nation.

Due to the fact that college severely limits the time available to the student to obtain and/or be available for work, they often have to rely on their own means to fund their education.  More than one-third of the states have capped tuition in the past few years, but this has not reduced the cost of attending college.  This is because the cost of living has continued to rise, while financial aid has remained the same.  Financial aid is most beneficial in the first year, therefore making the cost of continuing their education past year one a considerably larger investment.  For some students, grants and scholarships can be resources that help in reducing their cost.  Eligibility for grants are often need-based upon the family’s financial strength.  However, the determination of that strength tend to be taken from few types of information.  The biggest forms of family debt, mortgages, auto loans, student loans and credit cards, are not included in these assessments.  Often times divorced or remarried families can be greatly affected when applying for financial aid or grants because the absent parent or step-parent’s income is included even if it cannot be accessed by the student.  Additionally, low, moderate, and even middle class income families also have the benefit of the student’s ability to work and assist with household expenses prior to the student going to college.  Once fully enrolled, the family often loses this income source, but the financial assistance assessment is not recalculated.

Grants and FAFSA must be applied for and renewed every year, even if the student makes no changes in their circumstances.  Grants and FASFA often have a requirement for both grade point average and pace progress.  One out of four students surveyed were unaware that the needed to meet academic requirements in order to maintain their grants or FAFSA status.  Additionally, students miss the fact that these must be renewed.  In the last year, up to twenty percent of FAFSA students failed to renew.  Students must also maintain full time enrollment.  This means carrying a full load of classes, thereby reducing the ability to work and possibly the ability to add a tutoring session on a subject of struggle.

To avoid the restrictions and limitations of FAFSA and grants, some students turn to loans in order to continue to afford their education.  But these can come at the price of having to pay these funds back.  In fact, twenty percent or more of the annual income of these students leaving college is borrowed to pay for one year of college.  Many students try to balance their education and work in order to begin paying back a loan prior to graduation.  This taxation of their time can bring study time to a halt and make finishing school harder.  This means that some students choose a college or degree program solely based upon what they can afford to pay back upon completion.

While financial resources may be scarce, here are some ways things to keep in mind:

• Look into the true cost of attending college.  Use the information provided by the schools, but be sure to add in cost of living, reduced availability of work, tutors and other non-disclosed choices.
• Look at shared housing and food options.  Some of the largest expenses after tuition and fees is the cost of living.  Be sure that your financial aid package correctly accounts for your living situation.
• Make sure to calculate in your Expected Family Contribution, including changes made from the student no longer being part of the equation.  Make sure you understand the workload requirements, as well as GPA and pace requirements of any grants, scholarships and financial aid methods.  If you must have a work-study competent, be sure to secure that job immediately.
• Make sure to research all loan avenues and determine what government funding versus private funding looks like in the long run.
• If working alongside education is a must, be sure to calculate in travel to and from work, wardrobe requirements, meals, hours, job stability, and study impact.
• Research any and all social benefit programs you may qualify for.

Many high schools and colleges have resources for assisting in finding out what your options are.  Be sure to reach out to them during the application process.

With the change in the season and the return of fall, many people begin the act of making their homes less cluttered, and we will all begin to get donation requests in the mail.  As the weather cools, we tend to turn an eye towards end of year tax moves as well.  The Tax Cuts and Jobs Act of 2017 brought about many changes in how businesses and individuals are going to operate starting for 2018 onward.  With the deviations to the itemized deductions that we are all so used to, rethinking your charitable giving is a must.

Charitable contributions are gifts given to qualified non-profits by either individuals or businesses.  This can include money, physical items, and/or investments.  In order to be qualified, a non-profit must have a religious, educational, literary, charitable or scientific purpose and have 501(c)(3) status from the IRS.  The IRS provides a tool that helps you determine if the charity is a qualified charity.  Fair market value is used to determine the amount of the gift.  Often it is assumed that gift of time and labor can also be deducted.  This is not in fact true.  This is because the value of your time versus someone else’s is arbitrary and the Internal Revenue Service does not deal in vague terms.  What you can deduct from your volunteered time and labor are the costs that directly relate to those endeavors, including auto costs or mileage, other transportation and supplies.  You must have a receipt for all of your claimed deductions.  Additionally, you can only deduct the amount of the donation that exceeds the fair market value of the benefit received if you get something in exchange for the donation.  For example, if you donate at a local auction for a charity and receive sports tickets in exchange for the donation, you may only deduct the amount of the donation over and above the face value of the tickets.

Contrary to popular belief, the TCJA did not tax away the deduction for charitable contributions.  What it did do was nearly double the standard deduction for most taxpayers, rising the rate from $6,500 for single filers and $13,000 for joint to $12,000 and $24,000 respectively.  This increase thereby made the standard deduction more preferable over the itemized deductions in many cases.  And while not everyone that makes donations to charity does so in order to gain the deduction, it is an added benefit.  Many studies have been done indicating that contributions will drastically lower in the coming years to nearly a forty percent reduction.  Non-profits are hoping that people will still recognize the needs that are addressed by each of their given charities and will continue to give.  If giving is in your future, there are ways that may give you back the tax advantage of clearing the threshold and making itemized deductions a possibility.

One strategy is called bunching and the idea behind it is that instead of spreading your giving out from year to year, you give a larger amount in a single year.  For example, instead of giving $4,000 two years in a row, you can give $8,000 in a single year.  Of course, another option is to give a large amount every year that, in combination with your other itemized deductions, carries you over the threshold.

Another method is that you can give appreciated investments, such as stock shares, that allows you to deduct the full market value without having to pay capital gains on the appreciation, within certain limits.  If you are concerned about the value of your portfolio, you can take the cash that you would have donated to charity and use it to purchase identical investments to the ones donated. One can also still donate stocks to a donor advised fund and the charity will receive a check in lieu of the stocks.  This is beneficial if the charity does not accept stocks.

Additionally, retirees ages seventy-and-a-half and older can transfer funds up to $10,000 from their IRA to a qualifying charity.  This qualified charitable distribution is better than a straight deduction of cash because the income is never reported as taxable income and the gift counts towards your required minimum distribution.  The tax benefit to the individual is the same regardless of whether or not they itemize, and the charity gains the benefit of the donation.

A final method is to make a charitable bequest and beneficiary designation to a charity of your choice in your estate planning.  You can leave a specific amount to the intended charity, designate a percentage of the total estate or sales of assets within the estate, or name the charity as a full or partial beneficiary of the estate, life insurance, investment accounts, bank accounts or any other account that contains a beneficiary transfer policy. 

Many people have focused their attention on the federal changes in itemized deductions and its effect on charitable giving.  But let’s turn our attention to state level giving.  In many states, the state level has increased.  For example, in the state of California, those paying the highest level tax rate of 13.3 percent, would be able to claim up to $47.63 in reduced state and federal taxes on a one-hundred dollar deduction.  That amount is now worth up to $50.30.  This is because, under the new law, the deduction for state taxes is capped at ten-thousand dollars.  So, for many taxpayers the reduction in state taxes due to the charitable gift will now make now difference in their federal amount or taxes.

There are many different factors that go into tax strategy decisions.  You may determine that taking the standard deduction is the best tax benefit for you, and still give to an organization.  Or you may find yourself on the edge of making the itemized deduction a better benefit, and donations for charitable organizations may tip you over that edge.  Whatever your case may end up being, keeping charities and charitable giving strategies in mind is always a benefit.

By now, most people have heard the term HSA or Health Savings Account.  But what is it?  A Health Savings Account combines a high deductible health insurance plan with a tax savings account. It operates somewhat like a Flexible Spending Account.  An FSA allows for pretax income to be redirected into an employer-sponsored plan with limitations placed upon it by the employer, but not exceeding $2,600, and does not require a high-deductible health plan to be attached to it.  This plan reimburses you for qualified medical expenses.  The main drawback to an FSA is that it requires that you utilize the funds in the given calendar year.  You are not allowed to carry over the excess into the next year, with limited exceptions.

An HSA also allows you to contribute pre-tax income to an employer-sponsored plan or make an after-tax dollars deductible contribution to an HSA that you set up yourself.  Unlike an FSA, there is no limit to the amount that can be carried over to another year.  You are also the owner of the account, which can generate interest or be invested, much like an IRA.  HSAs do not carry a phaseout limitation, and so are available to high-earners and low-earners alike.  HSA users must carry a high-deductible health plan.  For many self-employed individuals, small business owners, and employees, the deductible threshold won’t be a problem.  It is also okay if the insurance plan doesn’t impose deductibles for preventative care, such as annual checkups.  An individual cannot be eligible for Medicare benefits, even if they are not utilizing them, or be claimed as a dependent on another person’s tax return.

Eligible individuals can make a tax-deductible contribution of $3,450 for individual plans, $6,900 for a family plan, and those over fifty-five years of age can add an additional $1,000.  The contribution for any particular tax year can be made as late as April 15th of the following year.  Since the deduction goes on the front of the federal individual tax return, Form 1040, it is not limited by the ability to take itemized deductions.  It does not count against self-employment tax bills, however.  Any employer contribution is made with pretax dollars.  This means that it is exempt from federal income, Social Security, Medicare and unemployment taxes.  It cannot be taken as a deduction on the personal return.

HSAs can be set up at any bank, insurance company or IRS deemed institution.  It must be for the exclusive use of paying the medical bills of the plan’s beneficiary, spouse and dependents (if a family plan).  Health insurance premiums do not qualify.

When you think of tax-advantaged investment vehicles, most people think of 401(k) plans, retirement accounts, and 529 plans.  The thought on HSAs is that it is usually just a form of health plan assistance.  Many taxpayers are unaware of the triple tax benefit of an HSA:  pre-tax contributions, tax-free earnings and tax-free withdrawals.  The HSA allows the account owner to pay for current and future health care expenses with either pre-tax dollars or tax-deductible dollars.  Even if the contribution is made by the employer, the money within it belongs to the account owner.  The interest earned on an HSA is tax-free.  And you may withdraw the funds tax-free for use to pay qualified medical expenses.

When they are discussed, HSAs are primarily thought of as a tax shelter.  They are also a good vehicle for putting aside money.  With the rising cost of health care plans, more and more companies are shifting health care costs away from the employer and onto the worker.  With this shift, more and more individuals are becoming eligible for an HSA.  If a taxpayer can contribute the maximum amount annually to an HSA, and have very little health costs during the year, it can very easily become a savings vehicle.  Tax strategists suggest that when health costs do arise, utilizing your current income to pay off the expense instead of the HSA allows it to grow tax-free, while getting the benefit of the current deduction.  Additionally, as we age, health expense costs increase, and having access to an HSA after retirement can be extremely beneficial.

In having the HSA act as a savings account, it ends up working very similarly to a Roth IRA.  Both have after-tax contributions, tax-free earning and no required minimum distributions after age seventy and one-half.  For this reason, one tax strategy that is utilized in funding an HSA is with a transfer from an IRA.  A taxpayer can make a tax-free rollover from an IRA to an HSA once in their lifetime.  The rollover contribution is limited to the maximum allowable contribution for the year, minus any amount already contributed.   There is a penalty on distributions not for medical purposes of twenty percent before age 65, and no penalty after.  To be tax-free, the distributions must be for qualified medical purposes regardless of age.  In the future, if the taxpayer determines that the HSA is no longer needed, they can transfer the money to their retirement accounts, tax free.

In summary, an HSA can be a great choice for taxpayers wishing to reduce their upfront health care costs, with the added benefit of saving for the future.  With HSAs coupling with high-deductible health plans, the monthly premiums are generally lower than with low deductible plans.  HSAs also allow you to pay for medical items with pre-tax dollars that other insurance options often don’t cover, or make a contribution with post-tax dollars and the taxpayer receives a tax deduction on their return.  The unused funds can be carried over from year to year, making the HSA a viable savings account.  As with everything, HSAs aren’t for everyone.  If a high-deductible plan seems risky, or you know that you will have significant health care expenses in the near future, a lower deductible plan may be better for you.  If you are in a lower income bracket or paying no taxes at all, there is little advantage to stocking away thousands of dollars.  Once you reach age 65 and qualify for Medicare, it is possible that your HSA withdrawals will become taxable.  Transaction fees associated with the account may also need to be taken into consideration.  Take a look at your plan options and associated costs, compare health savings accounts to flexible spending accounts, and see what works best for you.

The Tax Cuts and Jobs Act (TCJA), signed by President Trump in Dec. 2017, has significant implications for how businesses will assess the choice of entity. Prior to reform, partnerships were a very common choice of entity, but with the new provisions in TCJA, the C corporation has become an appealing option once again (but with some caveats).

The assessment by the National Law Review provides details on these signficant developments in choice of entity. In general it makes a helpful point: the entity choice will continue to involve a number of considerations, such as the makeup of the investor base, capitalization structure, borrowing requirements, likelihood of distributing earnings, state tax environment, compensation and benefit considerations, participation of owners in the business, presence of foreign operations, and sale or exit strategies.

Although the decision is always complex and never exactly cut and dry, the NLR’s report looks at several major impacts on choice of entity, including the following highlights:

• C corporations are now subject to a flat corporate income tax rate of 21%, down from a maximum rate of 35% under prior law. The corporate alternative minimum tax has also been repealed, which simplifies tax reporting for many corporations. Although the state income tax deduction has been severely limited for individuals as discussed below, the deduction has been preserved for corporations. Dividends paid by domestic C corporations are still subject to the maximum 20% qualified dividend rate that applied under prior law.
• Following tax reform, C corporations are now subject to a maximum effective federal tax rate of 39.8%, assuming that all net income is distributed to shareholders and that the 3.8% net investment income tax applies to all dividends paid.

Business Law Today notes that C corporations have become much more attractive from the standpoint of annual income taxes than S corporations, partnerships, or sole proprietorships (collectively, pass-throughs):

• As noted above, C corporations now have a flat, 21-percent federal income tax rate. Even personal service corporations use the new low rate. This contrasts with the top federal income-tax bracket of 37 percent for pass-through income, which may be reduced to 29.6 percent by way of a 20-percent deduction for qualified business income—if and to the extent that one’s pass-through qualifies for the deduction.
• Partners and sole proprietors in lower income-tax brackets face 15.3-percent self-employment tax, and those in the highest brackets may pay 3.8-percent self-employment tax or net investment income tax.
• S corporation owners who work in the business must report compensation income to the extent of the lesser of cash they receive or “reasonable compensation,” and in 2017 the IRS explained to its agents how to keep taxpayers out of tax court when the IRS reclassifies distributions as compensation. Any amounts classified as wages are not eligible for the 20-percent deduction.

There are caveats to the attractiveness of the C corporation. Although C corporation tax rates are lower, this is tempered by the taxation of distributions as dividends. A shareholder in the top bracket pays 23.8-percent federal income tax on qualified dividends, considering net investment income tax. Add state income tax, and the double taxation involved in declaring dividends each year can make C corporations unattractive, as noted by Business Law Today.

This only touches the tip of the iceberg, but the bottom-line from Business Law Today is this: a C corporation will likely produce superior annual income tax results, but only if the company reinvests a large portion of its income.

These points provide only a brief survey of a vast and complicated topic. The reader is encouraged to study the reports linked above in detail. In addition, this article does not constitute advice of any sort. It is imperitive that you consult with your own legal and tax professionals before making any move as many of the complicated factors mentioned in the topics above can vary on a case-by-case basis for businesses.

With the holidays fast approaching, many people are looking for ways to combine their desire to help the causes they believe in along with their desire to save on taxes. For the charitably inclined, there are strategic ways of giving that can accomplish both goals. The following strategies, as noted by Fidelity, are for your consideration and can help you make the most of your charitable giving this year.

Generally, if you itemize your deductions, making charitable contributions can decrease your tax bill, and with higher tax rates for high‐income earners, there is an increased tax benefit for charitable contributions. However, if Congress passes a tax reform bill this year, it could include a proposal to increase the standard deduction. That could mean fewer people will qualify for itemized deductions such as charitable gifts.

The following five points will help you form a successful strategy toward these objectives:

1. Give Appreciated Securities, Rather Than Cash

Most publicly traded securities with unrealized long‐term gains (meaning they were purchased more than a year ago and have increased in value) may be donated to a public charity, without the need to sell them first. When the donation is made, the donor can claim the fair market value as an itemized deduction on their federal tax return—up to 30% of the donor’s adjusted gross income (AGI).  

2. Consider Establishing A Donor-Advised Fund.

A donor-advised fund (DAF) is a program of a public charity that allows donors to make contributions to the charity, become eligible to take an immediate tax deduction, and then make recommendations on their own timetable for distributing the funds to qualified charitable organizations. Establishing a DAF can be a particularly useful strategy at year‐end because it allows you to make a gift and take the tax deduction immediately but doesn't require you to decide on the charities to support with grant recommendations. 

3. Consider Using A Charitable Donation To Offset The Tax Costs of Converting A Traditional IRA To A Roth IRA.

Roth accounts may make sense if you believe your current tax rate is lower than it will be in the years you’ll make withdrawals; however, there are many other factors that must be evaluated to determine what makes sense in your individual situation.

4. Consider Donating Complex Assets

Donors may also contribute complex assets—such as private company stock, restricted stock, real estate, alternative investments, or other long-term appreciated property—directly to charity. The process for making this type of donation requires more time and effort than donating cash or publicly traded securities, but it has distinct advantages. 

5. Consider A Qualified Charitable Distribution (QCD) From An IRA

The qualified charitable distribution (QCD) option emerged after Hurricane Katrina in 2005 and was made permanent by Congress in 2015. If you are at least age 70½, have an IRA, and plan to donate to charity this year, another consideration may be to make a QCD from your IRA. This action can satisfy charitable goals and allows funds to be withdrawn from an IRA without any tax consequences. A QCD can also be appealing because it can be used to satisfy your required minimum distribution (RMD).

In conclusion, we highly recommend that you engage the services of a qualified professional before attempting to undertake any of these giving strategies. You should consult your legal, tax, or financial adviser. However, properly employed, each of the strategies represents a tax‐advantaged way for you to give more to your favorite charities.

President-elect Donald Trump has taken the “bull by the horns,” so to speak, and proposed a sweeping tax reform plan that will diminish what goes to the US Treasury in the form of tax revenues in the hopes of stimulating the economy. It should be worth emphasizing that the Trump tax plan is merely a proposal at the time of this writing, and Congress must still approve any final proposal that Trump and his cabinet create once Trump is sworn into office.

What follows is a brief discussion surrounding some of the more significant elements to the Trump plan.

Individual Tax Cuts

Trump has proposed cutting the tax brackets to three: 12%, 25%, and 33%. He would also eliminate Obamacare’s 3.8% net investment income tax. As a result, the top rate would be 33%, with the top rate on capital gains and dividends a firm 20%.

In addition, Trump’s tax plans call for slashing itemized deductions. Under Trump’s plan, personal exemptions are eliminated. High earners already do not deduct personal exemptions due to the phase out, so this should have little impact.

More consequential, though, is that itemized deductions would be capped at $200,000 for married couples, as noted by Forbes.

Business Tax Cuts

Businesses are supposed to be in for big tax cuts. Corporations currently pay 35%. President-elect Trump would cut it to 15%, but he would also eliminate most business deductions. Instead of depreciation over many years, Trump would allow up-front deductions, but forget deducting interest on debt, he has suggested.

LLCs, partnerships and S corporations would have changes too. Trump has suggested that the owners of these entities should pay the same 15% rate as corporations. Astoundingly, that could mean someone taxed at 39.6% or even 43.4% on flow-through business income could see their tax rate slashed to 15%! Of all the proposed tax changes, this one—if it happens—may be the most momentous.

Pass-Through Taxation in the Trump Plan

An excellent summary found on TaxFoundation.org notes how one particular policy question that has received quite a bit of attention is the tax rate on individual income derived from pass-through businesses such as LLCs, partnerships, and Sub-S Corps. Tax Foundation makes the following points:

1. Pass-throughs are businesses that pay their taxes through the individual income tax code rather than through the corporate code.
Under current law, such businesses distribute all of their earnings to their owners every year, and such earnings immediately appear only on the owners’ tax returns. They are taxed at ordinary individual income tax rates.
2. In contrast, traditional C corporations can retain earnings without distributing them immediately to any particular shareholder.
This allows shareholders to defer, but not permanently avoid, personal income tax liability on the gain in wealth that is tied up in the corporation. A substantial tax drawback to C corporations, though, is that they have to pay two layers of tax: an entity level tax on retained profits, and the personal income taxes for the shareholders who receive the profits when they are disbursed
3. However, there are multiple interpretations of the plan because the plan is not finalized.

The topic can be confusing because there are multiple interpretations of the way that pass-through businesses would be taxed under the Trump plan.

As Tax Foundation notes, one particular tax rate--the individual income tax rate on pass-through business income--is not clearly specified in the current plan:

Assuming that the individual income tax rate on pass-through business income is the same as the rates on other individual income, the Trump tax plan would reduce federal tax revenue by $4.4 trillion over the next decade. But if the tax rate on this income is instead intended to be the same as the tax rate on corporate business income, the plan would then reduce federal revenue by $5.9 trillion.

Currently, the clearest understand of the current plan is as follows:

• Pass-throughs are not eligible for a single 15 percent tax rate on the individual income that their owners report.
• At best, they may be allowed to adopt some kind of tax status similar to that of C-corporations, either on a temporary or permanent basis.

Conclusion

Trump’s plan means big tax cuts, mostly for individual and corporate income. It will cut down the cost of capital as well as the marginal tax rate on labor. The plan will change incentives to work and invest, and, in the long run--as the Tax Foundation explains:

• The U. S. economy would increase
• Wages would be boosted
• Full-time equivalent jobs would increase

In summary, it would boost after-tax incomes for every income group, but also decrease revenue to the United States Treasury.

If you’re an investor who is looking to sell property, IRC Sec 1031 has good news for you: you can defer any and all capital gains by reinvesting the proceeds of your sale into new property. As IRC Section 1031 (a)(1) states:

No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment….1031 exchanges allow investors to defer capital gain taxes as well as facilitate significant portfolio growth and increased return on investment.

Of course, to take full advantage of the benefits available, it’s critical that you have a thorough understanding of Section 1031 code and the mechanics involved in the exchange.

The IRS breaks it down as follows:

• Whenever you sell business or investment property and you have a gain, you generally have to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange.

• Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free.

• The exchange can include like-kind property exclusively or it can include like-kind property along with cash, liabilities and property that are not like-kind.

• If you receive cash, relief from debt, or property that is not like-kind, however, you may trigger some taxable gain in the year of the exchange.

To accomplish a Section 1031 exchange, as the IRS also notes, there must be an exchange of properties, and there are different types of exchanges:

• The simplest type of Section 1031 exchange is a simultaneous swap of one property for another.

• Deferred exchanges are more complex but allow flexibility. They allow you to dispose of property and subsequently acquire one or more other like-kind replacement properties.

• A reverse exchange is somewhat more complex than a deferred exchange.  It involves the acquisition of replacement property through an exchange accommodation titleholder, with whom it is parked for no more than 180 days. During this parking period the taxpayer disposes of its relinquished property to close the exchange.

To qualify for Section 1031, the IRS also has a wide array of requirements:

• Both the relinquished property you sell and the replacement property you buy must meet certain requirements.

• Both properties must be held for use in a trade or business or for investment.

• Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment.

• Both properties must be similar enough to qualify as "like-kind."  Like-kind property is property of the same nature, character or class. Quality or grade does not matter. Most real estate will be like-kind to other real estate.

• While a like-kind exchange does not have to be a simultaneous swap of properties, you must meet two time limits or the entire gain will be taxable. The first limit is that you have 45 days from the date you sell the relinquished property to identify potential replacement properties. The second limit is that the replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier.

The IRS page on the guidelines offers more details. The foregoing high-level summary concerning the application of IRC Sec. 1031 should get the message across to not try to do this yourself without help from your attorney or other advisor. To say that the rules are complex is an understatement of biblical proportions!   

 Image courtesy of Erin Smith @ flickr

With the amount of taxes the IRS already collects from taxpayers—as well as the ever-increasing cost of living self-employed—tax payers can ill afford to overlook claiming as many deductions as the IRS makes available. The income and expense situation of self-employed taxpayers are widely recognized as fertile hunting grounds for a wide variety of deductions. This article will highlight a number of potentially significant deductions available to the self-employed taxpayer as well as some of the most commonly over-looked deductions by the self-employed.

1. Home Office Deduction, as explained by the IRS: If you use part of your home for business, you may be able to deduct expenses for the business use of your home. The IRS provides two methods for calculating this deduction, the “Simplified” approach and the “Regular” approach. The difference between the two approaches is that the Regular approach requires the taxpayer to determine the actual home office expenses. This approach could result in a higher deduction at the expense of more extensive record keeping.

   Regardless of the method chosen, the basic requirements for your home to qualify as a deduction are:

   • Regular and Exclusive of your home for conducting business, and

   • You must show that you use your home as your principal place of business.

Investopedia recommends these additional deductions for the self-employed:

1. Internet and Phone: Regardless of whether you claim the home office deduction, you can deduct your business phone, fax and Internet expenses. The key is to only deduct the expenses directly related to your business.

2. Health Insurance Premiums: If you are self-employed, pay for your own health insurance premiums, and were not eligible to participate in a plan through your spouse's employer, you can deduct all of your health, dental and qualified long-term care insurance premiums.

3. Meals: A meal is a tax-deductible business expense when you are traveling for business or entertaining a client. The meal cannot be lavish or extravagant under the circumstances.

4. Entertainment: The IRS has numerous restrictions on claiming the business entertainment tax deduction. For starters, you must conduct business with the person you are entertaining during, immediately before or immediately after the event. If your entertainment expense meets all the tests, it’s still only 50% deductible.

And according to ZipBooks.com:

1. Educational expenses: If you go to seminars, take web-based classes, pay professional dues or subscribe to business publications, you can deduct all of those expenses.

2. Vehicle: If you use your personal vehicle for business purposes, you can deduct a standard mileage charge that is currently 54 cents per mile. Be sure to keep extremely detailed and accurate records. If you have a vehicle that you use exclusively for business, you can depreciate it over its useful life, which will possibly provide a much greater deduction.

3. Purchase/depreciation of computer and other office equipment: Depending on the price of the things you purchase, you may be able to write them off completely in the year that you put them into service with your company, or you may have to depreciate the cost over the item's useful life.

4. Retirement plan(s): Even though you do not have the opportunity to participate in an employer's 401(k) plan, there are several ways you can set aside money tax-free for your own retirement. Every dollar that you put into one of these plans comes off your taxable income, and you can put a very large amount into some of these plans.

The IRS does tend to target self-employed and small business owners at a greater rate than ordinary job-holding individuals. This is because there is far more room for “fudging” numbers when you are self-employed than when you receive a paycheck. The legal advice site, Nolo.com, offers the following two rules for the self-employed:

1. Claim all of your income.

2. Don't claim expenses for which you didn't actually pay.

To these two rules can be added a third: Keep amazingly accurate records. One way to do this is to use an accounting app designed for small businesses. In addition, a smartphone-based app ensures that you always have the ability to note and detail your expenses, no matter where you are.