New tax legislation provides numerous tax benefits for individuals for 2018 through 2025. But not all the changes are likely to align with your go-to tax strategy from previous years. Here are five big tax breaks that could leave you with a tax surprise come April 2019 if you haven’t adjusted your current tax plan:
State and local taxes: You may have prepaid taxes at year-end to increase your SALT deduction in previous years. Hold off this year if there’s no tax benefit. The new tax law limits the deduction for state and local taxes (SALT) to $10,000 annually. This includes any combination of property taxes AND income or sales taxes.
Entertainment expenses: You can no longer deduct 50 percent of your entertainment expenses. But there’s still some leeway. According to a new IRS ruling, you may deduct 50 percent of food and beverages paid separately from entertainment like a basketball or hockey game. Also, a business can deduct 100 percent of the cost of its holiday party.
Miscellaneous expenses: The new law eliminates deductions for miscellaneous expenses, such as out-of-pocket employee business expenses. If possible, have these expenses reimbursed by your employer’s accountable plan. Generally, the expenses are deductible by the employer and tax-free to employees.
Kiddie tax: The kiddie tax continues to apply to unearned income above $2,100 received by a dependent child under 19 or full-time student under 24. But the new law puts more teeth into this tax. The kiddie tax is now based on the tax rates for estate and trusts. This generally produces a higher tax, so plan intra-family transfers accordingly.
Home equity loans: In the past, a homeowner could deduct mortgage interest paid on the first $100,000 of home equity debt, regardless of use of the proceeds. The new law eliminates this deduction for home equity debt, unless the proceeds from the loan are used to buy, build or substantially improve your home. Fortunately, you may still deduct interest on the first $750,000 of acquisition debt. Take advantage!
Under recent tax legislation, the deduction for miscellaneous expenses has been eliminated, effective for 2018 through 2025. This wipes out any write-off for employee business expenses you pay out of your own pocket.
However, employers will often agree to authorize a plan that reimburses business expenses, like those involving travel. As a result, reimbursements you get from your employer may be tax-free to you, while the payments remain deductible by the company.
Your employer’s accountable plan
Your employer may authorize a plan that reimburses travel expenses by using an accountable plan, which helps ensure that expenses qualify for favorable tax treatment. The plan complies with tough IRS rules requiring substantiation for the date, time, place, amount and business purpose of business travel. Similarly, an accountable plan may be used to reimburse employees for the cost of tools, uniforms or other expenses.
In order for an accountable plan to qualify for tax breaks, it must meet the following requirements (and you can help):
The expenses must have a business connection. The plan may reimburse your travel expenses to a distant location on behalf of the company, but not a disguised vacation. For instance, if you go on a business trip and spend most of the time lying on the beach drinking margaritas, your expenses likely won’t be considered related to business. It may be a good idea to confirm with your employer what type of expenses qualify before you go on a business trip.
Employees must account for expenses to the employer within a reasonable time. Usually, you’ll file the paperwork with the accounting department once you return from the trip. But this process can’t drag on for months. Ask your employer how much time you have to report your business expenses.
Employees must return excess reimbursements within a reasonable time. For example, 90 days might be the max. You can avoid putting your tax breaks in jeopardy by asking your employer what the deadline is to return any excess when you first receive the reimbursements.
If the accountable plan doesn’t comply with these rules, payments won’t be deductible by your company. Even worse, you and other employees will be taxed on the reimbursements — even though you incurred the costs doing your job! Check with accounting to ensure the requirements are met.
New tax legislation eliminated the tax deferral on exchanges of like-kind exchanges of property, except for real estate. This change (generally effective in 2018) may apply to more transactions than you think. For instance, it comes into play when you trade in one business car for another.
Here’s what matters for business vehicles
Under prior law, no current tax was due on an exchange of like-kind properties, like vehicles, if certain requirements were met. You only had to pay tax on any “boot” you received (e.g., cash on a car trade-in). But now taxpayers must contend with a convoluted set of rules that could result in a taxable gain.
Let’s look at an example involving a trade-in before and after the new law:
Before the new law: You bought a truck for your business for $50,000 that has been fully depreciated. So your “basis” for computing any gain or loss is zero. If you trade in the truck for a new one costing $55,000 and give the dealer $30,000 in cash, no current tax is due on the like-kind exchange. Your adjusted basis equals your basis plus any additional amount you pay. As a result, your adjusted basis going forward is $30,000.
After the new law: Assume the same scenario above. Although you’re eligible to claim favorable depreciation deductions for the vehicle, especially in the first year of ownership, your adjusted basis under the new rules is $55,000. Therefore, you must report a $25,000 taxable gain.
There are other tax complications, but you get the basic idea.
Keep these new rules in mind when you negotiate the price of a new business vehicle and the trade-in value of your old one. Alternatively, you might sell the vehicle personally and pay the full price for a new one. Call Carl Heinemann, your Chattanooga CPA, for help determining your best approach.
Tax filing season kicks off in a few weeks. What records should you assemble? Due to recent tax law changes, you may not need all the records you’ve kept before. Here are several key areas to focus on:
Personal information: You still must provide your Social Security number (SSN), and SSNs for your spouse and dependents.
Employment information: Have all Forms W-2 for you and your spouse. A self-employed person must report income from Forms 1099-MISC and Forms K-1, plus information for calculating the new deduction on qualified business income (QBI).
Child expenses: Provide information for claiming the increased Child Tax Credit (CTC) and Child and Dependent Care Credit. This may include details for a dependent care provider.
Investments: Include all information on various Forms 1099 for capital gains and losses (including cost/basis information), dividends and interest. Fortunately, this can often be scanned electronically.
Retirement plans/IRAs: Report contributions to plans and IRAs, the value of accounts and distributions received on Forms 1099-R.
Rental properties: This requires records of income received and expenses paid in 2018, including amounts, dates and places.
State and local taxes (SALT): Recent legislation limits annual SALT deductions to $10,000 for 2018-2025, but itemizers still need relevant records of SALT payments.
Charitable donations: If you itemize, you generally need records for both monetary gifts and donations of property, plus appraisals for property valued above $5,000.
Mortgage interest: Itemizers must have Forms 1098 for mortgage interest on acquisition debts that remain deductible.
Medical expenses: Collect records and receipts for medical expenses that may push you above the “floor” of 7.5 percent of adjusted gross income (AGI) for 2018.
Education expenses: Provide information required for claiming higher education credits, including Forms 1098-T.
Under the new legislation, you may not need records this year for miscellaneous expenses, many casualty and theft losses, moving expenses and home equity debts. Call Carl Heinemann, your Chattanooga CPA, if you have tax record questions about your particular situation.
Whether you’re a seasoned investor or new to the game, you’ll want to make a conscious effort to avoid these three common investment mistakes:
Relying on emotions. According to Essentia Analytics, behavioral scientists have studied biases that shown to drive investment choices. For example, you might fall into anchoring bias. That’s the irrational decision to hold on to something — a stock, a car, a piece of information — just because you already own it. Or there’s recency bias, which involves the tendency to lean more heavily on recent investment performance when considering future returns. This type of bias can unduly impact investment decisions as people approach retirement.
One idea to skirt such emotional hazards may be to place investment contributions on autopilot and readjust portfolios annually to align with long-term goals.
Taking or avoiding risk. You might pack your investment portfolio with individual stocks that have performed well in recent years. Unfortunately, if stock in one of these companies takes a dive, your retirement account may never recover. On the other hand, if you’re too averse to risk, inflation may eat up the purchasing power of your money as it languishes in low-interest accounts. To avoid such pitfalls, many people consider investing in a few well-diversified low-cost mutual funds to allow money to grow without undue risk.
Not investing at all. If you live only for today and don’t save enough for retirement, you’ll likely struggle to meet expenses later. The good news: Because of compounding returns, the earlier you start saving, the less you may need to save. And if your employer provides matching contributions to your retirement account, take full advantage.
Franchise opportunities abound. A solid franchise company can offer a proven business model, staff training, advertising expertise and many other benefits for jumpstarting a business. But whether you’re selling fast food or repairing cars, it makes sense to identify and scrutinize potential risks before you sign a contract. Here’s what to look out for:
Unrealistic forecasts. The company may have highlighted only successful franchisees in booming markets in its sales pitch. Average income can be deceptive, explaining little about how individual franchisees have performed. Rosy predictions based on historical data don’t always pan out. Obtain market research for the areas you’ve staked out, and talk to other franchisees to identify a realistic timeframe for breaking even.
Unexpected costs. Advertising, initial inventory, legal costs, training, ongoing royalty fees — these expenses and many others can tank a business early on. Identify every potential outlay and build a reserve to cover costs while waiting for revenues to grow. When it comes to expenses, guess high.
Unusually high turnover. The Federal Trade Commission requires franchise companies to provide potential buyers with a Franchise Disclosure Document (FDD). Among other important details, the FDD provides contact information for current franchisees and others who have opted out of the franchise system. Talk to these folks about their experiences, both positive and negative. If the franchise company has been buying a significant number of properties from unit owners, take note. Storm clouds may be brewing.
Unfulfilled promises. Franchise companies may pledge the moon, but deliver something entirely different. For example, you may expect the company to use your advertising fees to promote your local outlet. Instead, the company may pump those dollars into unrelated national advertising.
Franchise companies can help you build a successful business. But don’t forget to analyze the details before signing up. Call Carl Heinemann, your Chattanooga CPA, for assistance.
Business taxes involve a lot of paperwork, and those papers typically contain a lot of personal financial information. Are you taking steps to make sure your records are secure? Here are a few tips to help:
Secure sensitive employee materials. As an employer, you’re required to collect Social Security numbers and other identification, such as copies of drivers’ licenses. Keep this sensitive information secure by restricting physical access to printed or copied documents, using passwords on your accounting software, and creating a unique identifier for employee IDs.
Some states require that you safeguard the information obtained from job seekers, such as shredding applications after a certain period of time.
Protect important numbers. Truncate Social Security numbers on the paper copy of Forms 1099 that you send to your vendors. Instead of displaying the full nine digits, replace the first five numbers with asterisks or Xs.
Encryption is key. When sending data to your accountant for tax return or payroll preparation, be sure to use encrypted email or upload files to a secure digital storage service site.
Keeping accounting information from falling into the wrong hands is a growing concern for many businesses. Give Carl Heinemann, your Chattanooga CPA, a call if you have questions.
Health savings accounts (HSAs) have been around a long time, and little has changed since they were first introduced in 2003. They offer tax benefits, many of which you can benefit from if you know how. Here’s a refresher on how HSAs work:
An HSA has two parts. These parts include a high-deductible health insurance policy and a savings account. The idea is simple: You buy a health plan with a high deductible, and you deposit cash into a savings or investment account to pay the policy deductible and other qualified out-of-pocket medical expenses.
Contributions are tax-deductible. The tax benefit comes from the way the savings account part of the HSA works, which is similar to a traditional individual retirement account. For example, you can claim a federal income tax deduction for contributions to your HSA, and the deduction is above the line, meaning you can benefit without having to itemize.
Contribution amounts change. For 2018, the maximum tax-deductible contribution is $3,450 when the insurance plan covers only you, or $6,900 when you purchase an insurance plan for your family. When you’re age 55 or older, you can contribute (and deduct) an extra $1,000.
There are rules around withdrawals. Interest, dividends or other growth in the account is tax-free as long as you use withdrawals for qualified medical expenses. But what happens if you use the money for other purposes? The withdrawals are included in income, taxed at your regular rate, and subject to a 20-percent penalty. If you are 65 or older, you can withdraw money from your account for any reason without paying a penalty.
Keep in mind that other rules apply, including the opportunity to fund an HSA with a tax-free rollover from your individual retirement account.
Call Carl Heinemann, your Chattanooga CPA, if you have questions about how you can make the most tax-savvy choices with your HSA.
Are you up to your ears in tax debt or at odds with the IRS over your tax liability? You may have more payment options than you think.
Offer in compromise (OIC)
Essentially, an OIC is an agreement with the IRS to settle your tax liability for less than the full amount owed. Usually, the IRS won’t accept an OIC unless the amount you offer is equal to or greater than the “reasonable collection potential” (RCP) from assets you own – including real estate, autos, bank accounts and future earnings.
The IRS may accept an OIC for one of three reasons:
There is doubt as to the tax liability
There is doubt that the full amount owed can be collected
The compromise is based on effective tax administration (In other words, requiring full payment would create an economic hardship or otherwise be inequitable)
The application fee for an OIC is generally $186, although there are certain exceptions.
You may end up deciding to apply for an installment agreement instead if you can’t pay the full amount of tax you owe within the OIC payment parameters. An installment agreement allows you to make a series of monthly payments over time. The IRS offers various options for making these payments, including:
Direct debit from your bank account
Payroll deduction from your employer
Payment by the Electronic Federal Tax Payment System (EFTPS)
Payment by credit card
Payment via check or money order
Payment with cash at a retail partner
The user fee for installment agreements varies, depending on the type of payment, but the maximum fee is $225. Interest and possibly penalties will also be added to the amount owed.
Which option is better? It depends on your personal situation. Call Carl Heinemann, your Chattanooga CPA, to discuss what option is right for you.
One type of retirement plan that often fits the needs of small business owners is the Simplified Employee Pension (SEP). Typically, accounts are set up as SEP IRAs, much like traditional IRAs.
What to know about SEPs
As the name implies, it’s relatively simple to establish and operate a SEP plan. Unlike some other qualified plans – including 401(k)s – you don’t have to file annual reports with the IRS. Here are some other key aspects of SEPs:
The contribution limit is generous. For 2018, the maximum deductible contribution is generally equal to the lesser of 25 percent of compensation (20 percent of earned income of a self-employed individual) or $55,000. In comparison, the annual contribution limit for a traditional IRA is only $5,500 ($6,500 if you’re age 50 or older).
Employers make contributions. A potential downside for employers is that you generally have to make contributions on behalf of all full-time employees who are 21 and older and have worked for the business at least three of the last five years. Part-time employees are included if each earns more than $600 in 2018.
Contributions are discretionary. For instance, you can boost them in good years, cut them or even skip them in bad years, as long as you contribute the same percentage of compensation for all participants. This gives small business owners flexibility.
RMDs are necessary. As with other qualified plans, you must begin taking required minimum distributions (RMDs) after you reach 70 1/2. And, if you make withdrawals prior to 59 1/2, you could be hit with a 10 percent penalty tax on top of the regular income tax (unless a special exception applies).
Of course, you have other options. The qualified SIMPLE plan is similar to the SEP, but offers a lower contribution limit. For 2018, the limit is $12,500 ($15,500 if you’re 50 or older). Finally, you have until your tax return due date, plus extensions, to set up and fund a SEP for the tax year.
Call Carl Heinemann, your Chattanooga CPA, for assistance in setting up a SEP.