tax deduction

Business owners can claim a qualified business income deduction

Eligible taxpayers may now deduct up to 20 percent of certain business income from domestic businesses operated as sole proprietorships or through partnerships, S corporations, trusts, and estates.  The deduction may also be claimed on certain dividends.  Eligible taxpayers can claim the deduction for the first time on the 2018 federal income tax return they file in 2019. This provision is the result of tax reform legislation passed in December 2017.

Here are some things business owners should know about this deduction:

  • The deduction applies to qualified:
    – Business income 
    – Real estate investment trust dividends
    – Publicly traded partnership income

  • Qualified business income is the net amount of qualified items of income, gain, deduction and loss connected to a qualified U.S. trade or business. Only items included in taxable income are counted.

  • The deduction is available to eligible taxpayers, whether they itemize their deductions on Schedule A or take the standard deduction.

  • The deduction is generally equal to the lesser of these two amounts: 
    – Twenty percent of qualified business income plus 20 percent of qualified real estate investment trust dividends and qualified publicly traded partnership income.
    – Twenty percent of taxable income computed before the qualified business income deduction minus net capital gains.

  • For taxpayers with taxable income computed before the qualified business income deduction that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers, the deduction may be subject to additional limitations or exceptions. These are based on the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid by the qualified trade or business, and the unadjusted basis immediately after acquisition of qualified property held by the trade or business.

  • Income earned through a C corporation or by providing services as an employee is not eligible for the deduction.

  • Taxpayers may rely on the rules in the proposed regulations until final regulations appear in the Federal Register.

At Zhong & Sanchez, we provide high-quality tax and financial reporting services to privately-held entities and small business owners. Our expertise ranges from income tax filing and accounting services to international compliance and financial analysis. Located in the Silicon Valley, you can reach us at 510-458-4451 or schedule your first consultation today at https://calendly.com/zhongsanchez

More Information
REG-107892-18, Qualified Business Income Deduction 
Notice 2018-64, Methods for Calculating W-2 Wages for Purposes of Section 199A
FAQs

Source: IRS

Tax Reform and U.S. Expats: The Good, the Bad and the Same

Source: CPA Practice Advisor

Here’s what we know. The new tax reform bill called, Tax Cuts and Jobs Act (TCJA), is the first time in 30 years that the tax code has been fully transformed. While it is expected to ease tax filings and processing for Americans, the same can’t be said for American Expats. These are US Citizens who live abroad (whether for personal or professional reasons), and who are also required to file with the IRS annually. For years, this group of tax-paying Americans have raised concerns about changes they would like made but unfortunately, for the most part, their voices were ignored. Below is a look inside the new tax reform bill for US Expats:

What hasn’t changed:

The Foreign Information Reporting Requirements Expats are required to submit, in addition to their tax returns, are largely unchanged. The Foreign Bank Account Report, AKA FBAR or FinCen 114, the FATCA requirements - Form 8938, Form 5471 (Report of Certain Foreign Corporations), Form 3520 (Report of Foreign Trusts), and the Net Investment Income Tax, are still here and unchanged. This means that many Expats will continue having trouble banking abroad and face onerous penalties if they fail to file.

The two most important tax code provisions for Expats, the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit have also not been substantially changed. Expats can use the FEIE to exclude over $100,000 in earned income, from their US taxes each year and can use the FTC to reduce their US taxes dollar for dollar by the amount they have paid to a foreign government. This allows individuals to try to avoid double taxation and this has been largely unchanged in the Tax Cuts and Jobs Act. However, the way the FEIE will increase going forward has been changed, which brings us to what has changed.

What’s New:

The new tax reform changes the way inflation is calculated and will affect a number of tax-related issues. Inflation calculations had previously been calculated using the “regular consumer price index,” but going forward the IRS will use the “chained consumer price index.” The end result is a lower rate of inflation will be used to calculate the increase to the FEIE, which will increase taxes over time.

Modifications were made in tax brackets, exemptions, and deductions. Tax brackets are now larger, meaning you may now be in a lower bracket than you were previously, and the standard deduction has been nearly doubled. For those considering a move to or from the US, two new issues should be considered: 1) the moving deduction has been completely eliminated; 2) the individual mandate, as part of the Affordable Care Act has been eliminated. Unfortunately, the Net Investment Income Tax was not eliminated and will still impact Expats.

The corporate tax has been the most talked about change. This tax reform bill has transitioned the US to a territorial system of corporate taxation. Before, the US operated using worldwide taxation, meaning that corporations had to pay taxes on the income they earned abroad. This change will affect Expats who own corporations outside of the US, because they will face a one-time deemed repatriation tax of 15.5% of any previously untaxed overseas profits as the US transitions to a more territorial system for corporations instead of a worldwide system.

For US Expats, the new tax bill is pretty much the same tax bill with disappointments and frustrations for the nearly 9 million Americans living away from the United States. And, those who own small businesses abroad may actually find their situation is worse under the TCJA than under the old system! We at Zhong and Sanchez will help you sort through TCJA and advise on your international exposure under TCJA. We are dedicated to provide high-quality tax and financial reporting services to privately-held entities and small business owners. Our expertise ranges from income tax filing and accounting services to international compliance and financial analysis. Located in the Silicon Valley, you can reach us at 510-458-4451 or schedule your first free consultation today at https://calendly.com/zhongsanchez

5 Ways the New Tax Law Affects Paying for College

The final version of the GOP tax bill that passed last month rewrites the tax code in many ways, eliminating deductions and adding new benefits. Some of these new provisions affect those paying for college.

After public outcry on several provisions proposed in the House's tax bill, the Senate version that passed last month left many tax credits related to higher education untouched.

The new tax bill keeps the deduction for student loan interest. Additionally, the tuition waivers that graduate students receive will stay tax free, and other tax credits – such as the Lifetime Learning Credit and the American Opportunity Tax Credit – remain unscathed.

"A lot of things didn’t change that we were worried about changing – the taxation of the tuition waiver, the taxation of employer tuition assistance. We worried about that happening, but it didn’t end up happening," says Shannon Vasconcelos, director of college finance at College Coach, an admissions consulting firm.

But a few key changes will affect families and students who are financing higher education. Here are five new tax codes that may change a family's finances.

1. Deductions for interest on home equity loans and lines of credit are eliminated. Under the new tax legislation, the ability to deduct interest on home equity loans is suspended from 2018 to 2025.

"This one is a real big one that is a bummer for families," says Vasconcelos. "For a lot of families, it's the best interest rate – it's better than a lot of the education loan rates. A lot of families do tap their home equity to pay for college, so losing the deduction is going to cost them fairly significant money."

The new restrictive mortgage rules that cap interest on new loans to $750,000 will also "prevent many middle-income taxpayers from using home-equity loans in the future to fund college tuition, while generating tax-deductible interest," says Blake Christian, a CPA at Holthouse, Carlin, Van Trigt, a Southern California accounting firm.

2. Families can use 529 plans to pay for K-12 education. Families can now use qualified education expenses in a tax-advantaged 529 savings account to pay for elementary or secondary school tuition. The new tax code allows taxpayers to pay up to $10,000 per student per year in K-12 tuition.

But college experts caution some families against using this new flexibility with 529 accounts. Sean Moore, founder of SMART College Funding, worries that parents who redirect these funds to cover private school education may use the money too quickly and come up short for college.

Christian from HCVT says this benefit will largely help families with a high net worth.

3. Colleges and universities will pay a new excise tax on endowments. A new excise tax levies a 1.4 percent on a private educational institution's endowments that amount to more than $500,000 per student.

The new provision affects scores of private universities with large endowments, such as Harvard University in Massachusetts, the University of Notre Dame in Indiana and Stanford University in California, to name a few.

"It's going to cost these colleges money. How much is going to be passed on to students and parents – we don't know yet. The colleges are just now figuring out how to deal with this new tax," says Vasconcelos from College Coach.

4. Student loans discharged for death or disability are now tax-exempt. The new tax code makes death and disability discharges of federal and private education loans tax-free.

Previously, the debt cancellation would be added as income on to the taxpayer's bill. Now the cancellation of the student debt is tax-free. But the new tax code only applies to discharges that occur during 2018 to 2025.

"It's great for those families who suffer from those devastating effects. But the reality is the people that it helps are hopefully very small," says Moore from SMART College Funding.

5. Alimony for recipients is no longer taxable. College consulting experts say this provision should make it easier for custodial parents to qualify for need-based aid when filling out the Free Application for Federal Student Aid, commonly known as the FAFSA. For the most part, the FAFSA for college-bound students relies on parental information, such as tax records.

"Without alimony showing up on their tax returns, divorced custodial parents should be eligible for financial aid," says Joe Orsolini, president of College Aid Planners, a consulting organization in Illinois that helps families navigate paying for college. "This change will make is easier for them to qualify."

Even with this provision, the FAFSA uses tax records from the prior prior year – so there is a time gap to when this new tax code would benefit a custodial parent. But Orsolini says this should benefit these parents "unless the Department of Education catches on to this and changes the FAFSA."

Source: https://www.usnews.com/education

Phantom stock: Termination of right to buy or sell, treatment of asset and basis

In Hurford Investments No. 2, Ltd., No. 23017-11 (Tax Ct. 4/17/17) (order), the Tax Court considered whether the redemption of phantom stock was treated as a sale of a capital asset and what the tax basis in the redeemed phantom stock was.

Background

Gary Hurford owned "phantom stock" in Hunt Oil Co. The phantom stock was a form of deferred compensation that Hunt Oil paid to its employees; a share of phantom stock was valued at approximately the share price of Hunt Oil's common stock and would be adjusted for its increase or decrease in value at the end of each calendar year.

Under the terms of the phantom stock agreement, after Hurford's death, which was considered a "qualified termination of service," a five-yearcountdown was started. During this time Hunt Oil would continue to pay out dividends and adjust the stock for any growth or decline in value. At the end of the fifth year Hunt Oil would automatically redeem the stock; both parties had the right to liquidate the account at any time.

When Gary Hurford died in 1999, Thelma Hurford, his wife, inherited the phantom stock. Thelma decided to transfer the phantom stock into Hurford Investments No. 2 Ltd. (HI-2) in 2000, one of three limited partnerships Thelma's attorney formed as part of her estate plan after Thelma was diagnosed with cancer. On March 22, 2000, Hunt Oil formally recognized HI-2 as the holder of this stock. At the time of the transfer, the value of the stock was $6,411,000, and the receipt was reported on HI-2's Form 1065, U.S. Return of Partnership Income, as a short-term gain.

Thelma died in 2001, and the value of the stock on the date of her death was $9,639,588. In 2004, the five-year period that began on Gary's death was up, and Hunt Oil exercised its right to terminate the phantom stock. In 2006, Hunt Oil distributed $12,985,603 to HI-2. The IRS argued that the difference between the $12,985,603 distribution and $6,411,000 should be treated as ordinary income (deferred compensation) and argued that HI-2 should be considered an invalid partnership for federal income tax purposes since there was no transfer of phantom stock until after Thelma died. HI-2 and the estate argued the phantom stock should be treated as a long-term capital asset in HI-2's hands, which would also establish HI-2'svalidity as a holder and recognize it for income tax purposes.

Is phantom stock a capital asset?

In Thelma Hurford's hands, the termination of phantom stock generated ordinary income (deferred compensation), but it is pertinent to note that the character of property may change depending on who holds it, e.g., a laptop is inventory for a retailer but a capital asset for most buyers. "Capital asset" has a broad definition under Sec. 1221, which defines the term as all property that is not specifically excluded in a list of exceptions. The types of property excepted from Sec. 1221 are (1) stock in trade; (2) depreciable property used in a trade or business; (3) a copyright or other similar item; (4) an account or note receivable acquired in the ordinary course of business; (5) a U.S. government publication; (6) a commodities derivative financial instrument; (7) a hedging transaction; or (8) supplies used or consumed in the ordinary course of business.

Because HI-2's interest in the phantom stock does not fit into one of the exceptions listed in Sec. 1221, the Tax Court found that it was a capital asset. This designation makes more sense when one thinks about the nature of the asset. HI-2acquired an asset that had its value linked to the stock value of Hunt Oil, and HI-2 had no influence over the underlying Hunt Oil common stock, holding it in the hope that it would appreciate. According to the Tax Court, this distinguishing characteristic is enough to conclude that the phantom stock was a capital asset.

Does Hunt Oil's redeeming the phantom stock constitute a sale?

Under Sec. 1234A(1), the gain or loss attributable to the cancellation, lapse, expiration, or other termination of a right or obligation for property that is a capital asset in the taxpayer's hands is treated as a gain or loss from the sale of a capital asset. HI-2 argued and the Tax Court agreed that when Hunt Oil liquidated the phantom stock and distributed the proceeds to HI-2, it ended HI-2's right to sell the phantom stock. Thus, under Sec. 1234A, there was a termination of a right to buy or sell a capital asset, and HI-2 was entitled to capital gain treatment.

What is the basis of the stock?

The IRS argued the basis of the stock should be $6,411,000, which was HI-2's original interest in the phantom stock upon Gary Hurford's death; the difference between the value at termination of $12,986,603 and $6,411,000 would be the long-term gain. HI-2 argued that the basis in stock should be stepped-up to the value of $9,639,588 as of Thelma's death. Because the phantom stock was included in Thelma's estate, the Tax Court found that HI-2 was entitled to a step-up in basis under Secs. 1014(a) and 1014(b)(9). The court noted that Sec. 1014(c) specifically excludes from step-up in basis "property which constitutes a right to receive an item of income in respect of a decedent under section 691." However, it concluded that Sec. 1014(c) did not apply because the phantom stock had been converted into a capital asset in HI-2'shands and as such was no longer an item of income in respect of a decedent.

'Appreciation' is a hallmark of a capital asset

According to the Tax Court, the phantom stock was a capital asset in HI-2's hands as determined by Sec. 1221; it was treated as long-term capital gain when Hunt Oil terminated the program and liquidated the phantom stock account. The partnership could not affect the value of the stock in any way and could only hope for the phantom stock value to appreciate; this characteristic was enough to classify the stock as a capital asset. Per Sec. 1234(A), it was also determined that Hunt Oil's liquidation of the stock was a termination of HI-2's right to sell the phantom stock and constituted a sale of an asset. Lastly, the partnership had basis in the phantom stock equal to its fair market value as of Thelma's death. The fair market value of $9,639,588 was included in Thelma's estate, and under Sec. 1014(b)(9), that was the partnership's basis in the stock.

Source: https://www.thetaxadviser.com/

Senate tax reform bill contains more changes

The Senate Finance Committee on Thursday evening approved its version of the Tax Cuts and Jobs Act, sending the bill to the full Senate for debate and a vote. The committee had spent the week amending the bill, and the final version includes some changes beyond those included in the chairman’s mark released on Tuesday. 

The Senate is expected to take up the bill after it returns from its Thanksgiving recess.

Here are notable changes in the final version approved by the Senate Finance Committee.

Individuals

Free File program: The Senate bill would codify and make permanent the IRS’s Free File program.

Whistleblower awards: The Senate bill would provide an above-the-line deduction for attorneys’ fees and court costs paid in connection with any action involving claims under a state false claims act, the SEC whistleblower program, and the Commodity Futures Trading Commission whistleblower program.

The bill would also modify Sec. 7623 to expand the definition of collected proceeds eligible for whistleblower awards.

Carried interests: The Senate bill would impose a three-year holding period requirement before certain partnership interests transferred in connection with the performance of services would qualify for long-term capital gain treatment.

Businesses

Excessive compensation: Sec. 162(m) limits the deductibility of compensation paid to certain covered employees of publicly traded corporations. Current law defines a covered employee as the chief executive officer and the four most highly compensated officers (other than the CEO). The Senate bill would revise the definition of a covered employee under Sec. 162(m) to include both the principal executive officer and the principal financial officer and would reduce the number of other officers included to the three most highly compensated officers for the tax year. The bill would also require that if an individual is a covered employee for any tax year (after 2016), that individual will remain a covered employee for all future years. The bill would also remove current exceptions for commissions and performance-based compensation.

The bill includes a transition rule, so that the proposed changes would not apply to any remuneration under a written binding contract that was in effect on Nov. 2, 2017, and that was not later modified in any material respect.

Dividends paid: Under the Senate bill, corporations that pay dividends would be required to report the total amount of dividends paid during the tax year and the first 2½ months of the succeeding year, effective for tax years beginning after 2018. Corporations would not be allowed to deduct dividends paid when computing taxable income.

Dividends received: The Senate bill would also reduce the current 70% dividends-received deduction to 50% and the 80% dividends-received deduction to 65%.

Net operating losses: The Senate bill would limit the net operating loss deduction to 80% of taxable income (as determined without regard to the deduction). Net operating losses would be allowed to be carried forward indefinitely, but not carried back (except for certain farming losses). This change would apply to tax years beginning after 2022.

Orphan drug credit: The Senate bill would reduce the current Sec. 45C 50% orphan drug credit to 27.5% and would institute reporting requirements similar to the required for the Sec. 48C qualifying advanced energy project credit and the Sec. 48D qualifying therapeutic discovery project credit.

Employer-provided meals: The Senate bill would disallow an employer’s deduction for expenses associated with meals provided for the convenience of the employer on the employer’s business premises, or provided on or near the employer’s business premises through an employer-operated facility that meets certain requirements. However, the final version of the bill delays this change until tax years starting after 2025.

Amortization of research and experimental expenditures: The Senate bill would require specified research or experimental expenditures to be capitalized and amortized over a five-year period, effective for amounts paid or incurred in tax years beginning after 2025. Specified research and experimental expenditures attributable to research conducted outside the United States would be amortized over a 15-year period. The bill would also institute a new reporting requirement, for tax years beginning after 2024.

Exempt organizations

Excise tax on private college investments: Under current law, private colleges and universities are generally treated as public charities rather than private foundations, and thus they are not subject to the Sec. 4940 private foundation excise tax on net investment income. However, the Senate bill would impose a 1.4% excise tax on net investment income of private colleges and universities that have at least 500 students and aggregate assets of at least $250,000 per student. The assets-per-student threshold will be determined by including amounts held by related organizations, but only to assets held by the related organization for the education institution and to investment income that relates to assets held for the institution

Source: https://www.journalofaccountancy.com/