Summer Time Tax Check Up

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I frequently recommend to my clients with complicated tax situations to do a summertime checkup to see if they are paying sufficient amounts through withholding or estimated payments in order to avoid a negative surprise at tax time.  This year that activity is especially important because of the various changes made to the tax law last December.  Because tax rates dropped for virtually everyone, nearly all wage earners are having less federal withholding from their pay than last year.  However, not all taxpayers will see an overall reduction in their tax liability for 2018.  Tax rates dropped and there are some new and expanded tax credits, but some deductions also went away.  The standard deduction nearly doubled, exemption allowances were eliminated, the child credit was expanded and there is a new credit for all other dependents that don’t qualify for the child credit.

The IRS has a calculator available to help people in determining the correct number of withholding allowances to claim on their W-4 forms.  I have heard various complaints about the limitations of this IRS tool, but it works well for fairly simple situations.  If you have multiple sources of income or other factors that make it more difficult to estimate your tax liability, you probably should consult with a competent tax advisor such as an Enrolled Agent to help you with this task.  Proper tax planning can avoid that negative surprise when you file your taxes next spring.

SALT limitation in tax reform act

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Many health professionals recommend limiting our salt intake but to tax professionals, SALT limits have a different meaning.  SALT refers to State and Local Taxes which have been deductible for many taxpayers in the past but are now limited to a maximum of 10,000 dollars under the new tax reform passed last December.  There are a large number of taxpayers who won’t be affected by this limitation but for high earners especially in high tax states such as California, this could amount to a significant change to their tax liability going forward.  However, many people with 6 figure incomes end up paying the AMT (Alternative Minimum Tax) and the new tax bill grants some relief from AMT.

So, what is AMT?  The minimum tax was originally enacted in 1969 and has evolved into what is now called the Alternative Minimum Tax.  Congress was concerned that there were some high income earners who were ending up paying absolutely no income tax because they were taking advantage of so many tax breaks that they were completely eliminating their tax liability.  The AMT is a parallel tax system that eliminates most deductions and credits available for income tax purposes and calculates the tax due under AMT rules.  Then you compare the amount due under both methods and pay the higher of the two amounts.  State and local income taxes are deductible in calculating income tax but not for AMT.

Let’s demonstrate with a couple of examples:

  1. Married couple makes a little over 224,000 per year and pays roughly 12,000 in property taxes and 22,000 in state and local taxes.  For 2017 they ended up with a federal income tax liability of just over 30,000 dollars and an AMT of a little over 5,000 dollars for a total tax liability over 35,000.  For 2018 using these exact same figures the clients would owe slightly over 35,000 in income tax but no AMT.  In this case their tax liability dropped by 19 dollars.
  2. Another couple made roughly 485,000 in 2017 and had a SALT deduction of just over 64,000.  For 2018, the SALT deduction is limited to only 10,000 but they also get significant relief from AMT.  Their total federal tax liability will increase by just under 400 dollars.

As the income level rises, the benefits of the AMT reduction tend to diminish so if your income is high enough, the SALT limitation could cause a significant increase in federal tax liability.  If you have concerns about how this new change will affect your individual situation you can contact us or a competent tax professional such as an Enrolled Agent in your local area.

Trump Tax Reform – tax breaks for everyone?

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As I have written about before, although the recent tax reform bill lowers tax rates for virtually everyone, not everyone will have their overall federal income tax reduced.  That’s because the law includes some tax breaks but also eliminates some deductions.  In doing an analysis of my client base, the vast majority of clients will have a lower tax bill.  But, roughly 12% of my clients would pay more if you apply the 2018 law to their 2017 tax information.

In my client base, the largest reason for a tax increase under the new law was the elimination of the deduction for employee business expenses.  Under prior law, expenses such as union dues, supplies, continuing education and mileage expense for a temporary job could be deducted if they exceeded 2% of income.  Certain conditions had to be met to deduct the expenses and this has been a target area for IRS audits in recent years because of people claiming improper deductions.

Let’s go through a couple of examples:

  1. Ima and Ura Builder had a combined income of a little more than 72,000.  They have 3 children all young enough to qualify for the child credit.  In 2017, they had total itemized deductions of roughly 29,000 which included 9,500 of deductible EBE. (employee business expense) If you apply 2018 law to their 2017 situation, they lose the 9,500 EBE but get an additional tax benefit from the expanded child tax credit and the overall tax rate reduction.  Their net result would come out with owing an additional $3 in income tax.
  2. Olive Operator runs heavy equipment on a construction site and earned 115,000 in wages plus some other investment income giving her a total income around 117,000.  She worked for roughly 10 months outside her tax home so her EBE including travel costs, union dues, etc was just over 14,000 and total itemized deductions were roughly 19,000.  She has no children or other dependents.  Applying the 2018 law to her case would result in the loss of EBE, but a lower overall tax rate.  She would end up with 1,950 in additional federal tax liability.

Most of my clients who were eligible to deduct EBE will still have lower taxes in 2018 but especially those with large amounts of EBE may not.  My next blog post will most likely be about the other reason Californian’s don’t like the Trump tax act which is the limitation on the SALT deduction.  We would be happy to answer your questions on how the various provisions of the tax reform bill will impact your individual circumstances.

 

 

Changes to Mortgage Interest deduction for 2018

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During the 2018 tax season one of the most common questions I got from clients had to do with  whether they will lose their mortgage interest deduction in 2018.  Many of them had heard incorrect information about what is changing and not changing in the new law.

So, what does the new law change?   For rental properties mortgage interest was and still is deductible as a rental expense.  Nothing really changed there.  For personal residences there were some changes.  Tax law defines two types of deductible interest for personal residences, acquisition indebtedness and equity indebtedness.  Under the old law, you could deduct interest on up to 1 million dollars to buy or improve up to two personal residences. (Acquisition Indebtedness)  You could also deduct interest on up to 100,000 borrowed against the equity in your residence. (Equity Indebtedness)

Under the new law, the limit for acquisition indebtedness does not change on any existing mortgage, but for new mortgages the limit for acquisition indebtedness has dropped to 750,000.  As under the old law, you can still deduct interest on up to two personal residences as long as the total acquisition debt for the two does not exceed the 750,000 limit.

Equity interest, on the other hand, is no longer deductible. It’s important to remember that what determines whether a mortgage loan is deductible under the new law is how the funds were spent and not the title of the loan.  For example: let’s say that you have a 500,000 balance on your mortgage and then you take out an equity line of credit and borrow an additional 30,000.  Let’s say you spend the 30,000 to remodel your home.  In that case the 30,000 spent would qualify as acquisition indebtedness and would be fully deductible.  If you then borrow another 30,000 on that same line of credit and take a vacation with the funds, the interest on that 30,000 is not deductible under the new law.

If you are confused about any provisions in this new law, we would be happy to answer your questions regarding how it will impact your individual situation.

 

CA wildfire victims receive special tax relief for casualty losses

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Last fall congress passed a tax bill granting special tax relief for anyone who suffered a casualty loss as a result of the devastating hurricanes that impacted the US in 2017.  In the budget deal agreed to last month, congress has finally extended those same benefits to victims of the California wildfires.

The special tax benefits have to do with being able to deduct a personal casualty loss.  Normally, to deduct a casualty loss you must itemize deductions, the loss has to exceed 10% of adjusted gross income and you then subtract a 100 deductible from the loss.  Here’s an example: let’s say your adjusted gross income is 100,000 and you sustain an economic loss from a casualty of 11,000 dollars.  You would first deduct 10% of AGI or 10,000 and then you would subtract 100 as a deductible so your loss would be 11,000 – 10,000 – 100 = 900.  This 900 would only be a deduction if you itemize deductions on Schedule A.

The special rule for deducting a casualty loss due to the wildfires is that you don’t have to deduct 10% of AGI and you can take the casualty loss whether or not you itemize deductions.  However, the 100 deductible is raised to 500.  So, if the above 11,000 loss occurred as a result of a California wildfire or the 2017 hurricanes you would now calculate the loss as follows: 11,000 – 500 = 10,500 as a deductible casualty loss.  This loss can be taken as an itemized deduction or for those who don’t itemize deductions, the deduction would be added to your standard deduction.

Another important point to remember about casualty losses is that there must be an actual economic loss.  In other words, if you were reimbursed for your loss fully by insurance, you have not sustained an economic loss.  There are a couple of other tax breaks associated with casualty losses that occur in any federally declared disaster area.  For any questions on how to deal with this situation, you can contact us or a competent tax professional such as an Enrolled Agent in your area.

Budget deal changes tax law for 2017 returns being prepared now

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This morning President Trump signed into law a new budget deal that ends the very brief government shutdown.  It contains some good news for taxpayers, but a logistical nightmare for the IRS and for tax preparers.  Some tax breaks that expired at the end of 2016 have now been reinstated retroactively for 2017.  These include a deduction for mortgage insurance premiums for certain taxpayers, an exclusion from cancellation of debt income for homeowners, some expired energy related credits are returning and various other provisions.  I will post updates as they become available, but for now here’s a summary of the tax changes that affect 2017.

Now for the nightmare.  There is no place on the current 2017 tax forms to take advantage of these tax savings, which means in the middle of tax season, IRS will have to redesign various tax forms, all tax software will have to be reprogrammed for the changes and then there is the issue of how much time tax preparers have to learn the new changes and let their clients know about them.  Anyone who has already filed but is eligible for one of these retroactive benefits can file an amended return to take advantage of the additional tax savings.  We are available to help with this or any other tax related concerns you may have.

Myths about the new tax bill

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There has been a great deal of talk in the media and elsewhere about the new tax overhaul signed by President Trump in late December.  This has included a great deal of misinformation about what the bill actually contains.  Many experts tried to analyze what they thought the bill would contain prior to passage, and others were simply misinformed or mistaken.  Here are some of the common misconceptions I have either heard from clients or seen in the media.

  1. This bill increases taxes on the middle class – The vast majority of middle class taxpayers will get a tax break from this bill.  One good analysis I read showed that the average middle class taxpayer would see a decrease in tax of 8 – 10%.  In reviewing scenarios from my client base, this appears pretty accurate.  The bill has new lower tax rates for virtually everyone but it also eliminates some tax deductions.  It is possible for a middle class taxpayer to have an increased tax by losing more in deductions than they gain from the lower tax rates, but the vast majority of the middle class will pay less tax because of this bill.
  2. Your taxes will be so simple they can be filed on a post card – First off, most taxpayers efile their returns and don’t use any paper.  As for the claim that this bill simplifies taxes, well that depends.  Currently around 35% of taxpayers itemize deductions on Schedule A.  This bill nearly doubles the standard deduction and eliminates or limits other itemized deductions so many taxpayers who have itemized deductions in the past will not be itemizing under the new tax law.  So for those taxpayers there will be one less schedule to file with their taxes.  There are many other changes in this bill which will create new and complex tax planning opportunities, especially for business taxpayers.
  3. Mortgage interest is no longer deductible on my second home or on rental property – Both of those are false.  Elimination of the mortgage deduction was proposed for 2nd homes, but it didn’t make it into the final bill.  There was never any proposal to disallow mortgage interest for rental properties. (even though some of my clients called me on this one)
  4. Businesses will no longer be allowed to deduct any expenses for doing business.  Instead there will be a flat tax on gross receipts – This was never a part of the bill although I did hear this as a proposal before either bill passed the house or senate.  I heard a similar rumor regarding the disallowance of all expenses on rental property.
  5. Charitable contributions are no longer deductible – This is another false one but I heard it from multiple sources.  This bill does eliminate the deduction for certain miscellaneous itemized deductions though.  Under prior law these deductions were allowed if they exceeded 2% of your adjusted gross income.  This includes deductions such as employee business expenses, investment advisory fees, and tax preparation fees.

This bill makes numerous changes to our tax laws.  I will be blogging in the future about some of those changes that most affect my clients.  My advice would be to not rely on anything you hear in the media but contact a competent tax professional such as an Enrolled Agent to discuss any concerns you have regarding the new tax bill.