LET ME MAKE THIS PERFECTLY CLEAR

I’m back again.  I just want to take this opportunity to clarify some of the points I had intended to make in my ACCOUNTING TODAY commentary “Some Truths About the GOP Tax Law”.

Under tax law prior to the passing of the Tax Cuts and Jobs Act the 2018 personal exemption was $4,150.  For a person or couple in the 15% tax bracket this represented a reduction of tax liability of $623.  For a taxpayer in the 25% bracket this represented a reduction of tax liability of $1,038.  And so on.

For a dependent child under age 17 the Child Tax Credit, previously $1,000, is increased to $2,000.  The additional $1,000 credit is presumably to make up for the loss of the tax savings from the elimination of the personal exemption deduction.  A taxpayer with a “qualifying” child in the 15% bracket comes out ahead.  But a taxpayer in the 25% bracket does not.

The GOP Tax Act does increase the AGI threshold for claiming the Child Tax Credit – so it will be available to many more taxpayers than it was under prior law.  It is true that many married couples in the 25% tax bracket received a reduced Child Tax Credit or no credit at all under “old” law.  In these situations, the increased credit more than makes up for the loss of the dependency deduction.

But taxpayers can only claim a $500 credit for a dependent child age 17 or older, in many cases college students.  A taxpayer in the 10% bracket would have saved $415 for such a dependent under prior law, so that person benefits.   But taxpayers in all other tax brackets end up with increased net taxable income.  If we look at the new tax rates – 12% of $4,150 would be just about $500, but 22% of $4,150 is $913, and so on.  So, under the GOP Tax Act dependents under age 17 have more value than those over age 16 as well as non-child dependents such as elderly parents.

The elimination of the dependency deduction also adversely affects taxpayers who had been able to itemize in the past but will no longer itemize for 2018 through 2025 due to the increased Standard Deduction amount.  A married couple with no dependents who would have been able to claim $26,000 in itemized deductions and $8,300 in personal exemptions will be taxed on $10,300 more in net taxable income if their itemized deductions are reduced to below $24,000 by the $10,000 limit on the deduction for taxes and the elimination of miscellaneous deductions subject to the 2% of AGI exclusion.  Granted the tax rates are lower, but the increase in net taxable income can substantially reduce or eliminate the benefit of the lower rates.  A taxpayer in the 15% marginal bracket under “old” law could be in the 22% bracket under the GOP Tax Act.

And if I may add an observation on the corporate tax rate change - it appears that the new 21% corporate tax rate is a flat rate (correct me if I am wrong), and replaces the previous progressive scale.  So smaller corporations who had previously paid 15% in federal income tax on corporate profits will get a tax increase and now pay 6% more in tax.  

The bottom line is that the GOP Tax Act is not a “massive” tax cut for the middle class.  Whether or not a taxpayer will benefit from the Act, or actually pay more federal income tax, depends on their individual facts and circumstances.  As I said at the end of my AT commentary – “In reacting and responding to the changes made by the Tax Cuts and Jobs Act, one must look carefully at what the new law actually says and not rely on the “party” line that is being presented in the press.”

TAFN

THE GOP TAX ACT AND THE TAX PREPARATION INDUSTRY

The tax filing season is off to a relatively slow start, as usual.  As I receive returns in the mail I am getting them out, with only a 1-day turnaround.  So, I have some time to comment on this topic.

My fellow tax blogger Jason Dinesen has posted his thoughts on how the GOP Tax Act will affect tax preparers in “How Will the New Tax Law Affect the Preparer Industry” at DINESEN TAX TIMES.

I do agree for the most part with his comments on “What I Think Will Happen”.  Any tax law change, good, bad or indifferent, results in increased business.  So, 2017 and 2018 will see an increase in the use of paid tax preparers.  However, I agree that what follows, at least until 2025, will be a drop in basic 1040 and Schedule A clients.

However, the increased complexity of the new Section 199a deduction will most definitely increase business from self-employed taxpayers, be they Schedule C filers, partners, or owners of closely-held corporations.  This will more than make up for the loss of itemizers.  And the complexity of having 2 separate tax rate schedules for investors who benefit from the lower qualified dividend and capital gain rates will keep investors in “the fold” and perhaps add new ones.  So, tax preparers will lose clients on the lower-end of the fee schedule and gain clients on the higher-end.  And existing business clients will be paying higher fees for the increased complexity and calculations.

So, the bottom line is that the tax preparation industry in general will benefit from the new Act.  How it will affect the industry is that preparers will need to increase their continuing education and training in the area of business returns – sole proprietorships, partnerships, “regular” and sub-S corporations – and become conversant with Section 199a, and focus their practice development efforts on these self-employed taxpayers.

I do still think there is a market for the returns of those who cannot itemize.  I have always said I would make more money, have less GD extensions, reduce the potential for error, and experience much less agita and aggravation if I did nothing but 1040A returns all day during the tax season.  Preparers will need to be aware of pricing issues, and keep their fees for these simpler returns reasonable.

From a personal standpoint, the GOP Tax Act will not affect my 1040 practice one iota.  None of my clients will leave me to prepare their own returns due to increased simplicity.  I do not accept any new clients, period, and am actually attempting to “thin the herd” as I head toward retirement after 4 more filing seasons (once I can say I have been preparing 1040s for 50 tax seasons).  I am actually somewhat pleased that the Act will actually reduce the complexity, and potential for agita, of the returns for many of my clients (I have truly minimal business clients).   

So, what are your thoughts on the subject.  Will the GOP Tax Act help or hurt your practice?

TAFN

A LITTLE THIS-A, A LITTLE THAT-A

+ For those of you who are members of NATP, I recently got the word from Cindy Hockenberry -

“The research team is ready and able to answer any question regarding the new tax law. Questions will be billed as research questions.”

+ I submitted my questions about the deduction for interest under the GOP Tax Act and learned, despite what I had thought, that the itemized deduction for investment interest is NOT gone.  It has survived the Act.  The NATP Research Department told me -

“Investment interest will continue to be reported on Form 4952 and carried to Schedule A, line 14, part of the interest you paid section.”

+ The GOP Tax Act totally did away with the itemized deduction for home equity interest.  There is no “grandfathering” of existing home equity debt.  This makes it truly vital for all homeowners with both new and existing mortgages to keep separate track of acquisition and home equity debt going back to day one of the purchase of the property. 

After having some items confirmed by the NATP Research Department I am just about ready to “go to press” with my revised “Mortgage Interest Guide” and a special report on deducting mortgage interest under the GOP Tax Act for my clients.  Both of these include my worksheets for keeping separate track of acquisition and home equity debt and a detailed example. 

Reprint rights to both of these items will be available for fellow tax professionals to give to clients for ONLY $24.95.  Members of NATP receive a 25% discount – so the cost is only $18.70.

I will email you a pdf copy of these reports for your review if you email me t rdftaxpro@yahoo.com with SAMPLE MORTGAGE REPORTS in the “subject line”.

The reports will be delivered as a “word doc” email attachment.  The signed reprint rights agreement will be sent via postal mail.  Send your check or money order, payable to TAXES AND ACCOUNTING, INC, and your email AND postal address (and membership number if a NATP member) to –

TAXES AND ACCOUNTING, INC

MORTGAGE INTEREST GUIDES REPRINT RIGHTS

POST OFFICE BOX A

HAWLEY PA 18428 

+ The new IRC Section 199a Qualified Business Income Deduction is truly a convoluted mucking fess that adds much unnecessary complexity to the Tax Code.  Tony Nitti of FORBES.COM has tried to explain this new deduction here and here.

I have already received an email from a client asking if he should change from being an employee to an independent contractor to take advantage of this new loophole.  While this is a valid question, although one certainly cannot simply go from being an employee to being an independent contractor by just saying “make it so” and changing the method of payment, and one that needs to be answered now, I have neither the time, nor the desire, to properly “digest” this new deduction now, considering that I need to get ready for the upcoming tax filing season.

A request for my fellow tax professionals – I expect the IRS will no doubt create a detailed worksheet to make sense of the convoluted mess and properly calculate this deduction when it gets around to writing the instructions for the 2018 tax returns – much later this year.  But we need such a worksheet now.  Does anyone have, or has anyone seen or heard of, a Section 199a Deduction Worksheet that is available to download NOW, either free or at a minor charge?  If so, please email me at rdftaxpro@yahoo.com with SECTION 199a WORKSHEET in the “subject line” with the information. 

I will share the link or links to acquire such a worksheet in a subsequent post here.

TAFN

A NEW INCOME OPPORTUNITY FOR 2018

HAPPY NEW YEAR!  May 2018 be less taxing.

While the new limitations on the mortgage interest deduction in the GOP Tax Act simplifies the Tax Code, it greatly complicates recordkeeping for taxpayers and potentially for tax professionals. 

As we know, under the Act interest on home equity debt, regardless of the amount of the debt principal, is no longer deductible.  Period.  There is grandfathering of existing acquisition debt interest rules – but there is NO grandfathering of existing home equity debt. 

I do believe in the original House version of the bill all existing mortgage debt was “grandfathered” – including home equity debt.  While I can understand, and agree with, the philosophy of limiting deductible mortgage interest to acquisition debt, for practicality sake I wish that existing home equity debt had been included in the grandfathering.

Going forward, it will not be a big problem for new home purchases made after December 15, 2017.  Taxpayers need to keep track of only acquisition debt on these mortgages – and perhaps new regulations for reporting information on Form 1098 may take care of this to a degree.  But taxpayers with existing mortgage debt incurred before December 16, 2017 will definitely need to separately track acquisition and home equity debt going back to day one! 

Taxpayers have always been required to keep separate track of acquisition and home equity debt, but, if my clients are any indication, I expect that few actually did - due to the allowance of a deduction for interest on up to $100,000 of home equity debt.  And how many of us have actually been doing this for our clients on an ongoing basis?   

I also expect that with the new law, clients will expect us as their tax preparer to keep track of their debt at least going forward.  And many will also want us to create separate schedules of acquisition and home equity debt for their existing mortgage loans so the proper amount of interest can be claimed. 

This is an opportunity for us to generate post tax-season income this year – when preparing an applicable client’s 2017 return we can explain the new mortgage rules and offer to generate separate historical debt schedules after the filing season, and a brief period of recuperation, for, of course, an additional hourly fee.   

I hope, and expect, that the existing rules and regulations for who can deduct mortgage interest - when it comes to situations like multiple owners making unequal individual payments and “equity ownership” - will remain in effect under the new Act, as well as the current rules and regulations for determining what is home equity debt. 

Currently any additional closing costs of a refinanced mortgage that are added to the principal of the new loan is considered home equity debt.  For example - clients purchased a home in 2011.  They have had only one mortgage, from the original purchase, and no home equity debt.  They refinanced the original mortgage in 2015 to get a better rate.  The principal balance on the original mortgage was $197,374.  The principal balance of the refinanced mortgage was $200,000.  They did not take any money “out”, and paid a little over $1,000 at the closing.  The difference is the closing costs for title insurance, inspections, fees, etc. etc.  These clients have acquisition debt of $197,374 and home equity debt of $2,626.    

And, also currently, if you have refinanced mortgage debt that combined both previous acquisition debt and home equity debt., the home equity debt is considered to be paid down first.  A client refinanced a mortgage to combine the purchase mortgage balance of $197,374 and the balance in a home equity line of credit of $90,000.  During a year he paid down $6,000 of the refinanced loan principal.  The $281,374 remaining principal is considered to be $197,374 of acquisition debt and $84,000 of home equity debt.

Finally, I hope, and expect, that taxpayers will still be able to elect to treat home equity debt secured by a personal residence as not being secured by the residence – so the interest on the debt is treated as deductible business interest on Schedule C or a deductible rental expense on Schedule E instead of home equity interest.  Unfortunately, investment interest is, at least I think (can anyone verify?), no longer deductible on Schedule A.

I will be rewriting my Mortgage Interest Guide, which includes worksheets for keeping track of mortgage debt and a detailed example of how to use them, to reflect the new rules for 2018 and beyond, and will be offering reprint rights of this guide to fellow tax pros.  I will also be creating a special report to give to my clients with existing mortgages, which will also include the worksheets and example, that will explain the new rules and remind them of their responsibility to keep separate track of acquisition and home equity debt.  Reprint rights to this report will also be available.  I will let you know here when they are available.

So, we should prepare for additional work, and a new opportunity for increased income, for clients with mortgage debt.

Any thoughts or comments?

TAFN

PLENTY OF QUESTIONS

Implementation of The Tax Cuts and Jobs Act changes to tax law certainly raises a multitude of questions for tax professionals.

(1) As I previously discussed in “A Nightmare on Tax Street”, will the Form 1098 form to report mortgage interest be revised and will additional recordkeeping requirements be placed on bank and mortgage companies? 

Will existing IRS regulations on acquisition debt and home equity debt – treatment of closing costs of refinancing included in principle, application of payments of principle on consolidated mortgages, etc. - remain, or will new ones be written?

(2) What about the revised dreaded Alternative Minimum Tax (AMT)?  The exemptions and exemption phase-out ranges have been changed, but I have read of no change to the “preferences”, other than because miscellaneous expenses subject to the 2% of AGI threshold are no longer deductible on Schedule A this will no longer be a preference. 

In the “old” AMT personal exemptions were a tax preference, and not deductible in calculating Alternative Minimum Taxable Income.  And the Child Tax Credit is allowed as a credit against AMT.  We will no longer have a personal exemption deduction – this deduction is replaced by an increased Child Tax Credit and a new “non-child” dependent credit.  Will the enhanced and new credit be allowed in full as a credit against AMT?

(3) How will the new Schedule A report the specific components of real estate taxes and state and local income or sales taxes that make up the $10,000 maximum if this maximum is applied?  This information will be important in determining if any portion of state tax refunds are includable in taxable income in the subsequent year. 

I would think the first line in the tax section of Schedule A would be to identify real estate taxes paid, up to the $10, 000 maximum.  A second line would report either state and local income taxes or state and local sales taxes allowed (with a box check like on the current Schedule A), up to the combined maximum, if the property taxes paid are less than $10,000. 

(4) We know that the 20% deduction of “pass-through” business income will not be deducted directly on Schedules C or E or as an “adjustment to income” to reduce AGI, but will be deducted from AGI to determine net taxable income.  But will this deduction also be applied in determining “net earnings from self-employment” subject to the self-employment tax.

And the list goes on.

With a law written and passed in such a hurry there will be lots of issues that will need to be addressed, many in additional “Technical Corrections” legislation.

TAFN

IS A PUZZLEMENT

As you all know by now, in the wee hours of Saturday morning the Senate approved its version of the “Tax Cuts and Jobs Act” by a vote of 51 to 49.  The Republicans were actually able to finally pass a bill in both the House and the Senate, despite the handicap of having arrogant idiot Donald T Rump in the White House!

FYI - see my post on "Making One Bill Out of Two" at TWTP.

This bill is not as good as the Republicans claim it is, and not as disastrous as the Democrats insist it is.  There is both good and bad in both the House and Senate versions of the bill.  

What is bad with ANY legislation at ANY time is rushing it through without proper intelligent review, research and discussion merely so the idiot in the White House, and the Republican Party, can claim a legislative victory (Trump really doesn’t give a rodent’s hind quarters what is actually in the bill – he just wants Congress to pass ANY bill so he looks good).  The “Affordable Care Act”, aka Obamacare, was similarly rushed through, with nobody actually reading in full the actual bill, to get an early victory for Obama – and, while like the tax reform bill it was based on a good concept, the actual legislation that passed was a mucking fess.

It is obvious that, despite what Trump tweeted in self-congratulation, the tax cuts for working families and the middle class in the bill is certainly not MASSIVE.  And let’s be perfectly clear - self-absorbed Trump truly gets a MASSIVE tax cut in this bill.

I look forward to seeing the final legislation that the conference committee will come up with.

One thing that has always confused me in both versions is the need to reduce the maximum tax rate on “pass-through” business income, which includes income reported by a sole proprietor on Schedule C.

Am I not seeing something?

Under current law corporations pay a maximum of 35% on corporate income, and when this income is passed to shareholders as dividends they pay a maximum of 20% in income tax and 3.8% in NIIT on the dividends. So, the income of a “C” corporation CAN be taxed at a maximum federal rate of 58.8%.

Pass-through business income is currently taxed at the business owners’ individual tax rate. It is not subject to NIIT. So, under current law the maximum federal tax on, for example, “S” corporation income is 39.6%. When you consider the phase-out of items affected by AGI the actual effective maximum rate may be a bit higher – but nowhere near 58.8% The purpose of pass-through treatment is to avoid the double-taxation of corporate income.

Partnership and sole proprietor income is also subject to the self-employment tax, but the W-2 salaries of corporate owners is subject to FICA tax. So this is not included in the above comparison.

So why does there need to be a reduction to the federal tax rate of pass-through business income?

All pass-through entities are not equal.  Owners of sub-S corporations must be paid a W-2 salary, taxed as a W-2 salary; the amount that is passed through on the K-1 is in full the equivalent of corporate dividends.  The “pass-through” income of sole proprietors and general partners is a combination of wage-equivalents and dividend-equivalents, but is currently taxed in full at ordinary income rates and subject in full to the self-employment tax.  And the deductions for health insurance and pension contributions for the self-employed sole proprietor and general partner do not reduce net earnings subject to the self-employment tax; they are treated as adjustments to income on the Form 1040.  These items are not subject to FICA tax for a corporate owner-employee.  It is the in the application of the self-employment tax that inequities exist. 

If nothing else, the pass-through rate changes add additional and unnecessary complexity to the mucking fess that is the Internal Revenue Code, and more unnecessary work and agita for us at tax time.

I would very much like to hear from fellow tax professionals on this issue.  You can send a comment to this blog or email me at rdftaxpro@yahoo.com.

TAFN