Friday, August 17, 2018

Why Is Everyone Talking About the 20% Qualified Business Income Deduction?

Streets of Barcelona, Spain PC: pixabay.com
2018 has been all about Tax Reform, you would probably have to be living in a cave in the United States if you did not hear about this. Or you could be this guy "who knew too little". A lot has already been said about the reform, today we focus on the brand new section that came out it.  

We really need to talk about the biggest change that came out with the Tax Cuts and Jobs Act of 2017: Section 199A. This section allows owners of flow through entities such as Sole Proprietorships,S Corporations  or Partnerships a deduction of 20% of the income earned by the flow-through. Ever since December 2017, the entire tax community has been abuzz with this new section and has been eagerly awaiting the Internal Revenue Service's guidelines on interpretation. 

The Internal Revenue Service dropped the proposed regs on Section 199A on August 8th, 2018, all of its 184 pages can be accessed here. Since December, a lot of different interpretations were being tossed around, everyone was hoping that the guidance would clear up the ambiguity. There is a lot still that needs to be addressed but unlike the story of the four blind men and the elephant, a solid shape is emerging out of the mist! 

Caveat: Today's post is a small introduction to this new section. There is a LOT more information to be culled from the 184 pages, my dear readers. I am hoping that you will take today's post to glean some knowledge about the new section and will talk to experts about the mechanics of qualifying for the deduction. 

Let us get some basics out of the way first: 

I. What is a pass through business?: A pass through is a business where taxes are not levied at the entity level but rather at the owner level where the income and expenses have been passed through. The owners' tax rates apply to this pass through income. Pass through entities are typically sole proprietorships, partnerships, LLC's, trusts and S corporations. Only pass through entities are eligible for the Section 199A deduction. 

II. Do all pass-through businesses qualify for the deduction?: YES any trade or business qualifies UNLESS 

One: The pass-through is a "Specified service trade or business" or SSTB. 

An SSTB is one that involves performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading and dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. In short, if the business would not run if it were not for your skill or expertise, the business is an SSTB. 

Two: The proposed regulations that came out on August 8th, 2018 made it clear that an employee or an employee who organized herself/ himself as a pass-through to be an independent contractor and did essentially the same work as before to take advantage of Section 199A would NOT qualify for the deduction. 

AND YES there are EXCEPTIONS TO THE EXCEPTION!! 

1. A pass-through that provides engineering or architecture services is not an SSTB. 

2. If the taxpayer's taxable income DOES NOT exceed $315,000 if married filing jointly or $157,500 for everyone else, the SSTB exception DOES NOT apply and one can claim the 20% deduction. 

III. What is qualified business income or QBI?: QBI is the "net income of qualified items of income, gain, deduction and loss from any qualified trade or business". 

1. Only items included in taxable income are counted. 

2. Items must be effectively connected with U.S. trade or business. 

3. Items such as capital gains and losses, dividends, interest income are excluded. 

Note #1: For the sake of simplicity, we are not going to tackle the income and deduction items in this blog. And oh boy does that get even more complicated? Fun, fun! 

IV. How do S Corps/ Partnerships handle the deduction? OR What if I have an S Corp or a partnership that is a share-holder or partner in another pass-through entity?: Well, if you are organized in such a manner, you know the entities themselves do not report income/ losses hence cannot take the deduction. The S Corporation/ Partnerships then report the shareholder's/ partner's share of QBI, W-2 wages, UBIA of qualified property among other items on the shareholders'/partners' Schedule K-1. The shareholders/ partners then take the 20% deduction on their personal returns. 

V. What Is Section 199A Deduction?: 

A. If the taxpayer's taxable income is below $315,000 for married filing jointly or $157,500 for all others, we do not worry if the trade or business is an SSTB and the deduction is the LESSOR of: 


  •       20% of the taxpayer's QBI PLUS 20% of the his/ her's qualified real estate investment trust and qualified publicly traded partnership income

  •     20% of the taxpayer's income MINUS net capital gains
B. If the taxpayer's taxable income is between $315,000 and $415,000 for married filing jointly or between $157,500 and $207,500 for all others, the deduction is LIMITED based on: 

  • Whether the business is an SSTB
  • Whether W-2 wages are paid by the business
  • Unadjusted Basis immediately after acquisition (UBIA) of certain property used by the business
C. If the taxpayer's taxable income is above $415,000 for married filing jointly or above $207,500 for all others, the deduction is NOT AVAILABLE if the trade or business is an SSTB. 

D. If the taxpayer's taxable income is above $415,000 for married filing jointly or above $207,500 for all others, and if the trade or business IS NOT an SSTB, the deduction is limited by:

  • The amount of W-2 wages paid by the trade or business
  • Unadjusted Basis immediately after acquisition (UBIA) of certain property used by the business
Note #2: The numbers $157,500, $315,000, $207,500 and $415,000 are for 2018 alone. The subsequent years' numbers will be adjusted for inflation. 

VI. What if taxpayer owns multiple pass-through entities?: 

  • The QBI is calculated on each pass-through entity.  
  • The taxpayer's taxable income is calculated.  
  • Non-SSTB QBI can still be deducted as per above explanation in Question #V, Part D without regard to taxpayer's income. 
  • Experts seem to interpret this as all non-SSTB QBI can be aggregated. 
  • I am not sure if taxpayer's income is below the limits, can SSTB QBI be aggregated as well. 
Well, if your eyes have not glazed over yet- you are either a hard working tax geek like me or really interested to know if you can bag a 20% deduction on your pass-through income. This journey definitely is not for the faint-hearted! There are many, many planning opportunities that you, my dear reader may be eligible for. Grab that phone and call your favorite tax professional to get more information. 

Glossary: SSTB-Specified Service Trade or Business; QBI- Qualified Business Income; UBIA-Unadjusted Basis Immediately After Acquisition; REIT-Real Estate Investment Trust; PTP-Publicly Traded Partnership



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    Consult with a Circular 230 tax professional for your unique needs and make sure your questions are answered. Please read my disclaimer here. If you have any questions regarding this issue or other tax matters, all of my contact information is on my website www.mntaxbiz.com.  






    Tuesday, July 31, 2018

    Interesting Cases: Courts Hold FBAR Penalties Cannot Exceed Reg Cap

    Mars, the Red Planet. Pic Courtesy; www.pixabay.com

    I believe the planet Mars is at its closest to us since 2003, it will not be not be this close to us again until 2035. I have been trying to locate Mars every night this past weekend but the skies have been cloudy unfortunately. This event is called "opposition" when the Sun and Mars are on either side of our planet Earth. 

    Most US citizens with foreign bank accounts and the US government are in similar opposition (cheesy analogy, I know) most of the time. Maintaining and reporting of these accounts are time consuming and arduous. If you are regular readers of my blog, you know the requirements to file and declare your foreign bank accounts. If you need a brief refresher, please read this post

    The penalties for non-disclosure of your foreign bank accounts are significant. Civil penalties for non-willful violation are up to $10,000 per violation and willful violation can range up to greater of $100,000 or 50% of the account balance at the time of violation. 

    These penalties are after a law change that happened in 2004 which increased the maximum penalties for willful failures. Before the law change, the maximum penalty that could be assessed was $100,000. These regs have now been renumbered and amended to index for inflation. (31 C.F.R 1010.820(g))

    There were 2 Court cases, one in May 2018 {U.S. v. Colliot, (DC TX 05/16/2018) 121 AFTR 2d 2018-775} and another recently in July 2018 {Waldhan, (DC CO 07/18/2018) 122 AFTR 2d 2018-5060} where the Court held that the INternal Revenue Service lacks the authority to impose a penalty in excess of $100,000 as prescribed by 31 C.F.R. 1010.820. 

    In each of the cases, the taxpayers had failed to file or filed inaccurate FBARs for tax years before 2010. The IRS had imposed total penalties in excess of $100,000 in each case. 

    The taxpayers argued that the assessments were improper because the IRS' authority was limited by 31 C.F.R. 1010.820(g). 

    The Courts after delving on the differences in the penalty caps in the statute and the regs, said that the Secretary limited the penalties that the IRS could impose to $100,000 in exercise of statutory discretion. They said that it cannot be assumed that the Secretary could have simply overlooked these differences (between the statute and the regs) for 14 years. Therefore the Secretary elected to continue to limit IRS' authority to impose penalties to $100,000 as specified in 31 C.F.R. 1010.820 even though penalties are avialable under 31 U.S.C. 5321(a)(5)(C)

    The Court concluded that "although IRS believes that it is empowered by 31 U.S.C. 5321 to act, it is not. It is empowered by the Secretary who has discretion to determine what penalties are imposed. 1010.820 remains in effect until amended or repealed."

    Note: The Supreme Court, on the other hand, has recently declined to hear a Ninth Circuit decision upholding a more than $1 million FBAR penalty based on a $2.4 million unreported account.

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    Consult with a tax professional for your unique needs and make sure your questions are answered. Please read my disclaimer here. If you have any more questions regarding this or other tax matters, all of my contact information is on my website, www.mntaxbiz.com.   




    Wednesday, June 6, 2018

    Cryptocurrency: The Saga Continues!


    PC: pixabay.com Plitvice Lakes, Croatia
    Cryptocurrency discussions are every where these days cropping up like the ubiquitous dandelions. There is a lot of information out there and it can be quite over-whelming to say the least. Some of the information is downright inaccurate and one needs to be careful about the sources that dish it out. We talked about Cryptocurrency briefly in our blog-post here. Not much has changed since then. 

    What has changed however is that an increasing number of tax professionals are asking the Internal Revenue Service for guidance surrounding taxation of Cryptocurrency. In fact the American Institute of Certified Public Accountants {AICPA} recently wrote to the Internal Revenue Service recommending that the IRS address certain issues with Cryptocurrency by way of guidance or FAQ's. 

    Some of the major recommended areas the AICPA asked for comments/ guidance from the Internal Revenue Service on were: Expenses of obtaining the currency; Acceptable valuation and documentation; Computations for gains and losses; Virtual currency events, and held and used by dealers; Treatment under Sections 1031 and 453; Holding Virtual currency in Retirement Accounts; Foreign Reporting Requirements. 

    One of the recommended topics that I personally thought was most relevant was that the Cryptocurrency Miners/ Users be allowed to make a De Minimis Election for cryptocurrency transactions. At this time every payment in Cryptocurrency is deemed a sale of the currency and hence each of those events needs to be kept track of and reported as a Capital Gain/ Loss on the tax return. Tracking these transactions can be onerous, hence the recommendation for a de minimis exclusion. 

    If cryptocurrencies are traded on exchanges located outside the United States and if accounts are held within these exchanges, there is currently no guidance whether the FATCA regulations apply and if these balances in the exchanges have to be reported on an FBAR. 

    A Like-Kind-Exchange via Section 1031 has been effectively removed for Cryptocurrencies by the Tax Reform Act. After Tax Year 2017, this will no longer be available as a tax strategy for cryptocurrencies.

    The loss of this deduction may not help those who had exchanged one type of cryptocurrency for another within an exchange.  

    This past tax season was an eye-opener for me to see how many younger clients came to their appointments with questions regarding cryptocurrency or that they had bought and sold some of it for a neat profit. I will tell you what I told them, be wary, stay informed and make sure you take your tax professional into confidence. 

    If this is the first time you are reading up on cryptocurrency and most/ all of the above seemed like Greek to you, first of all let me welcome you to the "Fourth Industrial Revolution" and then provide you with a link to a really good write up on Mining of Cryptocurrency here

    Bibliography: AICPA Comment Letter Dated May 30th, 2018; Notice 2014-21

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    As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxbiz.com.  



    Tuesday, May 29, 2018

    A Death Knell On the Offshore Voluntary Disclosure Program? What To Expect?

    Picture Courtesy: www.pixabay.com, Italy. 
    Hello everyone, I am back! The 2018 Tax Season was definitely one for the books, a series of challenges with Tax Reform and retroactive changes affecting 2017 taxes; and trying the impossible-tax planning for 2018 without guidance from the Internal Revenue Service! Guidance has been trickling in since but most of us are still waiting! 

    In the midst of all the chaos that was, the Internal Revenue Service put an end to the Offshore Voluntary Disclosure Program or OVDP for short, via IR-2018-52. If you remember, the OVDP was first introduced in 2009, then there were more modified versions put forth in 2011, 2012 and 2014. I wrote in detail about the OVDP in 2013, we can go back and look at it here

    Closure of the OVDP in 2018: The 2014 OVDP is going to close effective September 28th, 2018. If you would like to take part in the OVDP program, your submission should be received or post-marked by September 28th, 2018 and must be complete. The submissions may not be partial/ incomplete/ or serve as place-holders. 

    The Internal Revenue Service replies "No" in answer to the question, "Does the closing of the 2014 OVDP signal a change in IRS priorities towards offshore tax noncompliance?" A growing network of inter-governmental agreements with many countries, automatic compliance by financial companies under FATCA or the Foreign Account and Tax Compliance Act, the DOJ's Swiss Bank program etc has ensured that it is getting more and more difficult to evade taxation by stashing money off-shore. 

    The Streamlined Filing Compliance Procedures will continue to remain open after September 28th, 2018. Those who can declare under penalties of perjury that their conduct was non-willful can participate in the Streamlined Filing Procedure. This procedure is available to both citizens living within the USA and abroad although the filing thresholds may vary.

    All other Delinquent FBAR Filing Procedures are still available to eligible taxpayers even after September 28th, 2018. More about this process is in my blog post here

    If you have undeclared foreign bank accounts and will qualify to be a candidate, you still have time (around four months from the time this article is published) to contact a tax professional with the expertise to help you through the program. 

    If you would like to give your feed-back or have suggestions about a future voluntary disclosure program to the Internal Revenue Service, I believe their email address is lbi.practice.unit.public.feedback@irs.gov. Make sure your subject line reads “Suggestion for voluntary disclosure practice after OVDP closes.”

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    As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxbiz.com

    Thursday, February 8, 2018

    The TCJA: Changes For American Expats OR Not?

    Tokyo, Japan
    Many American citizens who live outside the US have for years raised concerns about the United States' Citizen-Based-Taxation System. They may have been hopeful when tax reform was being proposed but have been disappointed that their concerns have been ignored. 

    The new tax reform bill, Tax Cuts and Jobs Act called TCJA (pronounced tick-jah) has brought about massive changes in the way individuals are going to be taxed but not much has changed for American Expats. 

    As most of my readers know, if you are a US Citizen, you are required to file a US tax return annually. The information needed to be filed along with your tax return via Form 8938, Form 3520, Form 5471, Form 8865 remains in place. So does the requirement to file Form 114 AKA the FBAR. Not only does non-compliance with these rules and regulations come with stiff penalties, they also make banking in the countries of residence burdensome for expats. Most foreign banks do not want US citizens for customers as they have to comply with FATCA requirements. 

    The Net Investment Income Tax has also remained in place, therefore high earning expats with passive income may find themselves subject to this tax.  

    On the good side, the Foreign Earned Income Exclusion {FEIE} and the Foreign Tax Credit {FTC} have not been repealed. If you want to read in detail about what this is, my post is here and also here. An expat can exclude up to $104,100. And for those who go over the limit, they can take the tax paid in the country of residence as a credit. The United States has tax treaties with many countries so most expats can avoid double taxation. 

    New Points To Look Out For under TCJA:

    There has been a major shake-up in the tax brackets, deductions and exemptions. The Standard Deduction has increased substantially. You may now find yourself in a lower tax bracket than you were in earlier. 

    If you are planning to move in to the United States, the Moving Expense deduction is no longer available for moves made after January 1st, 2017. 

    The Affordable Care Act mandate has been eliminated. 

    The big and most onerous change that US Expats will find is with their ownership in foreign corporations. Under the TCJA, U.S. shareholders owning at least 10% of a foreign subsidiary may end up paying a one-time "expatriation tax" on profits earned abroad that have not been taxed previouslySome US shareholders will have this change impact their 2017 tax returns. 

    This is a very short and simplistic analysis of the tax change for owners of foreign corporations among other aspects affecting expats. Please consult your tax professional if this applies to you and get guidance. 

    Most tax professionals are working with and trying to understand the new law. We await more guidance from the Internal Revenue Service. As always look out for more coming through this space from me. 

    Bibliography: Tax Reform and Jobs Act


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    As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxbiz.com





    Sunday, December 24, 2017

    Tax Reform Changes How You Itemize

    St. Nicholas Church, Old Town, Prague
    The media is abuzz with Tax Reform news, here to allay your confusion regarding the cut to some deductions and tax rates is my latest blog post. 

    The tax rates change has been the most publicized but there are many deductions on the chopping block that will drastically change how you prepare your taxes and/ or your bottom line. 

    Most taxpayers who itemized on Schedule A had substantial medical expenses (deductible over 10% of their AGI), state & local income taxes, real & personal property taxes, home mortgage interest, home equity loan interest, charitable contributions, and other miscellaneous deductions over 2% of their AGI. If the total of such itemized deductions went over the standard deduction based on your filing status below*, one would itemize. 

    *The standard deduction rates for filing your 2017 tax returns are as follows: 

                         Filing Status                                         Standard Deduction Allowed
                            Single                                                           $6,350
      Married Filing Jointly & Surviving Spouse                            $12,700
                Married Filing Separately                                           $6,350
                    Head of Household                                                $9,350

    The personal exemption amount, a deduction available for yourself, spouse and your dependents for 2017 is $4,050 each.

    If you did not have enough expenses to file the Schedule A, then your total deduction was the standard deduction plus the $4,050 times the number of dependents you claimed including yourself on your tax return. 

    What Has Changed After Tax Reform?: 

    1. The standard deductions rates are now as follows:

                       Filing Status                                         Standard Deduction Allowed
                            Single                                                           $12,000
      Married Filing Jointly & Surviving Spouse                              $24,000
                Married Filing Separately                                           $12,000
                    Head of Household                                                $18,000

    The personal exemption amounts are no longer available. 

    2. Medical & Dental Expenses: 

    Going line-by-line on Schedule A, the first deduction for medical & dental expense is in place for 2017 & 2018 with a threshold of 7.5% of your AGI(adjusted gross income). This threshold is lower now than the 10% of your AGI that had been in place for 2016. 

    Since this provision is retroactive, it affects your current tax return if you have had high medical bills for 2017. 

    3. State & Local Taxes {SALT}: 

    State, local sales taxes, income taxes and property taxes remain in place under the tax reform package. However, the deduction is capped at $10,000 (discussed below). Foreign real property taxes cannot be deducted under the new provision. 

    What Are SALT Caps?:

    The deduction for SALT remains, however there is a $10,000 cap on this deduction. This means that the total of state & local sales, income taxes, and property taxes cannot exceed $10,000 ($5,000 for those filing married separately). If these taxes including foreign real property taxes are being deducted on a Schedule C, Schedule E or Schedule F, then there is no cap on the total. 

    Also, amounts paid in advance in 2017 for state or local income tax imposed for 2018 will be treated as paid in 2018. There is no restriction on property taxes under this rule.

    4. Home Mortgage Interest: 

    Home Mortgage or "acquired indebtedness" has been defined under the new law as "indebtedness that is incurred in acquiring, constructing, or substantially improving a qualified residence of the taxpayer and which secures the residence".  Please note that a home equity indebtedness is not considered acquisition indebtedness. 

    Hence any home equity interest deductions that were available to you on your residence or vacation home is not available any more. 

    There is also a limit on acquisition debt post December 15th, 2017 of $750,000 ($375,000 for married filing separate status). Before December 15th, 2017 limits stand at $1,000,000. 

    5. Charitable Contributions: 

    There is not much change on this one. The major change here is that payments made to a college athletic board in exchange for tickets in a stadium are no longer deductible. 

    6. Casualty & Theft Losses: 

    Only losses incurred in federal disaster areas are deductible, other than that this deduction is repealed for years 2018 to 2025. 

    7. Job Expenses & Miscellaneous Deductions Subject to 2% of AGI: 

    All miscellaneous deductions that were subject to the 2% of the AGI limit will now be repealed until 2025. These are unreimbursed job/ employee expenses including travel & mileage and the home office deduction.  

    8. Limit On Itemized Deductions: 

    For all it is worth, there is no limit on itemized deductions for years 2018 to 2025. 

    If you would like to check how you will fare under the new tax provisions, here are the new tax rates from the bill: 






       


    The Internal Revenue Service has to issue regulations in order for all the above changes to be implemented and that will come out sometime in 2018. The above information is complicated to say the least, now would be a good time for you to talk to an Enrolled Agent to see how the changes affect you and make decisions based on their expert advice. 


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    As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxbiz.com



    Tuesday, November 14, 2017

    When Can A Non-Resident Spouse Be Treated As A Resident


    PIC Courtesy: pixabay.com Arc De Triomphe, Paris, France


    As the tax reform debate rages on currently, I do not see much in the proposals changing for US citizens living abroad. As this story unfolds, I think it is a good thing that US citizens/ resident aliens living abroad are not affected. We shall wait and watch. For all the latest news-stay tuned! 

    As it happens many times for those US citizens who have moved abroad and married someone who is a citizen of their resident country, when times comes to file a tax return, they have to use the "Married Filing Separately" or the "Head of Household" filing status. Both of these may not be as advantageous as the "Married Filing Jointly" filing status tax-wise. 

    This can also apply for those who have just become US citizens/ residents at the end of the year but the spouse has not yet/ chosen not to become a US resident/ citizen at the same time. 

    One can get around this by making an election to treat the non-resident/ non-US citizen spouse as a resident/ US citizen, file jointly and perhaps reduce one's tax burden.

    If this election is made, the following rules will apply: 


    • For all years the election remains in effect, the couple is treated as residents for federal tax purposes. The election is effective for the entire tax year, both for purposes of the federal tax return & taxes to be withheld from wages. 
    • The couple must file a joint tax return for the year/s the election remains in effect. 
    • The couple must report their "world-wide income" on their US tax return. 
    • Generally, tax treaty benefits cannot be claimed. Details of the savings clause of treaties must be examined in detail. 

    How is the Election to be made:


    The election is made by attaching a statement to the joint tax return, signed by both the spouses in the first tax year in which this applies. The statement should have the following information: 

    1. A declaration that one spouse is a resident alien/ US citizen and the other spouse is a non-resident alien on the last day of the tax year. And that they chose to be both treated as resident aliens/ US citizens for the entire tax year. 

    2. The name, address and identification number for each spouse. 

    Other Notable Points: 


    • The election can be made on an amended tax return or on an originally filed tax return. If amending a tax return to make such an election, it should be filed with the Internal Revenue Service within 3 years of originally filing or 2 years from the date the tax was paid, whichever is later. 
    • The non-resident spouse needs to have a Social Security number or a Tax Identification number in order to be able to make the election. 
    • The election will be suspended for any later tax year if one of the couple is not a US citizen or resident alien at any time during a later tax year. 
    • The election is ended if it is revoked by either spouse; death of either spouse; the couple get legally separated; or have inadequate records to prove they are married. 
    • If one of the spouses is a resident of American Samoa or Puerto Rico, they can be treated as a resident without having to make an election. 
    If the above situation applies to you and you would like to make such an election to claim a non-resident spouse as a resident & file a joint return, please contact us. 


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    As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxbiz.com.