2017 Tax Bill Approval Details

Now that it has been signed into law as of last Friday, we thought that we should give you a summary of the final changes, and things that you can do before year end. Having it signed the Friday before Christmas weekend means that we can’t get this out to you until Tuesday when our office is open again. So it isn’t giving you a lot of time to act on our recommendations, but that was thanks to the late passage of the bill.

 The major changes that affect our clients are the following:

The Limitation on #SALT deductions and property taxes to $10,000

The elimination of deductions for employee business expenses

The elimination of the deductibility of investment management fees and tax preparation fees for non-business clients

An increase in the standard deduction

The elimination of the deduction for personal exemptions

An increase in the child tax credits

The elimination of the deduction for alimony for divorce agreements finalized after 2018.

Lower corporate #tax rates for C Corporations

A new deduction of 20% of business profits from certain businesses

State and local income taxes and property taxes

We have lost the full deduction for state and local income and property taxes. In the future, the maximum that we can deduct for those taxes is $10,000 in total. That is why if possible, we want you to prepay and 2017 state and local tax that you owe before year end. The same is true for property taxes that are assessed. The IRS does not allow you to deduct any property taxes that have not been assessed yet. So check with your county or locality to see which taxes are assessed for you to determine how much you can pay and deduct before year-end.

For those of you who are subject to alternative minimum tax (AMT) in 2017, you will not get any tax benefit prepaying these taxes. If you are not sure if you are subject to #AMT, you can check with us. Even if you are subject to AMT, there is no harm paying your last state tax estimate by year-end just in case. If your typical state, local and property taxes are over $10,000, you lose nothing paying that last estimate early

If your income is higher than last year, and you think that you will owe taxes to the state or city, please let us know how much your income has increased, and we will give you an estimate of what to pay. When you can afford to pay more, we are estimating high. This is the year that it might be better to over-estimate.

 We have had people asking if they can pre-pay 2018 state tax. You can’t. They wrote that into the new law.

Employee Business Expenses

 For people paid as employees on W-2 forms (and that includes freelancers paid on W-2’s), starting in 2018, you can no longer deduct employee business expenses. So Union dues, agent fees, professional publications, continuing education, unreimbursed entertainment and travel, just to name a few, are no longer deductible after this year.

 We have had a lot of queries already from clients who are freelancers on whether it pays to incorporate so that they can maintain these deductions, and our answer is a solid, it depends. If you have a lot of out of pocket unreimbursed expenses it may indeed be better to incorporate. For those without a lot of out of pocket expenses, the cost may outweigh the benefits. We will need to determine what is best based on your individual circumstances. Clearly we can’t, nor do we need to, decide this by 12/31. Please contact us if this is something that you think might apply to you, and we can figure it out.

 Again, if you are not subject to AMT, please try to pre-pay whatever expenses like this that you have before year-end.

Investment Management Fees and Tax Preparation Fees

All investment expenses including management fees, and tax preparation fees for non-business filers are no longer deductible as of 2018. So if you choose to, you can prepay these types of fees as well by year-end.

 Higher Standard Deductions

 The standard deduction has been increased to $12,000 for single taxpayers, $18,000 for unmarried head of household taxpayers, and $24,000 for married taxpayers filing jointly. For many of our clients, that may mean that they will no longer be itemizing personal deductions. It will be possible to preserve itemizing deductions in some years by bunching up deductions into alternate years. This will work by doing multiple years of charitable donations in one year, or bunching up out of pocket medical expenses that exceed 7.5% of your income.

 You can contribute multiple years of donations to charities by opening something called a donor advised fund. They have these funds at Schwab or Fidelity or Vanguard or elsewhere. You can donate either cash or appreciated stock, if you have any. Giving appreciated stock to charity is a great tax savings technique because you get a full deduction for the stock donation, and you do not need to pay tax on the capital gain as long as you have owned the stock for at least a year. You get the donation deduction in the year that you put the money in the donor advised fund, but you can give the money from the fund to the charities that you support in subsequent years.

I have seen examples of very high-income people who have no mortgage deductions who will not be itemizing under the new rules. So if you are married, and you typically donate $10,000 a year to charity, and use the $10,000 maximum SALT deductions, you will have $20,000 a year in deductions, so the standard deduction of $24,000 is higher than your itemized deduction. If you were to put $50,000 into a donor advised fund before 12/31, you get the deduction for the full $50,000 this year. If you are in the top tax bracket, you would save around $20,000 in tax this year on your federal return, and you can possibly save some state tax as well. If you continued to give $10,000 a year for the next five years, you will not have any tax savings in that example. Once the money runs out after five years, you can then contribute again, and in the year you contribute, you will have enough deductions to itemize again.

Personal Exemptions and Child Tax Credits

They have eliminated personal exemptions, and instead have increased the child tax credit to $2,000 for a child up to age 17. There will be a $500 credit for dependents other than children aged 17 and under. There is really nothing that you can do before year end to change anything related to this.

Alimony

For anyone contemplating divorce or in the middle of divorce negotiations, the rules are changing for any divorce agreements finalized after 12/31/18. This change does not affect existing divorce agreements. For agreements finalized in 2019 and later, alimony is not deductible for the payer, and is not taxable for the payee. While this may sound good for the payee. We don’t believe this is good for either side.

Typically the person paying the alimony is in a higher tax bracket than the recipient. So the tax savings of the payer tends to be great than the tax owed by the recipient. With the loss of the deductibility, it is very possible that the payer will be expected to pay less alimony because they have a higher cost. We believe that this will negatively impact the income of the poorer spouse who needs the higher funds to live on.

Lower Corporate Tax Rates for C-Corporations

We have had a lot of people reach out to us to see if they should become C-Corporations with the new low 21% federal corporate tax rate. The answer for most small businesses is no.

If you are in a place like NYC, there is double taxation on federal, state, and city level, so even when you calculate the federal corporate rate after deducting the corporate state and city taxes, you would pay 35% in overall corporate tax. You would have $65 left of each hundred dollars earned to pay dividends, and then if you were in the bracket that taxes dividends at 15%, you would pay another 25% in personal taxes including your NY taxes or a total of $16,. So your effective tax rate on $100 is 51%. You also need to deal with payroll tax preparation because the owner must be paid as an employee. If we take it further and look at people in the 0% tax rate, that would mean that their federal tax rate is only 15%, and if that is true, why would they want to pay a corporate rate of 21%. It would be a very rare case where a small business owner would want to be a C-Corp in New York. Perhaps for a state with no tax, it may be better, but I am not convinced.

New Business Profit Deduction for Certain Businesses

 There is a new 20% deduction of business profit for non service businesses, and for service businesses where your income is under $ 315,000 in total for a couple who are married filing jointly, or under $157,500 for an individual taxpayer. This deduction is allowed for any form of business entity, S-Corporation, LLC, Partnership, or sole-proprietorship. Here is a definition from Forbes magazine of how they defined a service business:

Specified service trade or business. A specified service trade or business is any business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.” I like to think of it this way: if the success of your business depends on you and not on something that you sell, you’re pretty much included (except for engineering and architecture services, which were specifically excluded). The definition also includes a business where the performance of services consists of investing and investment management trading, or dealing in securities, partnership interests, or commodities.

 Now there are some fairly complicated calculations based on the type of business, how much is paid in wages, how much capital is invested, and what the overall income is of the taxpayer. Right now the most important takeaway is that you do not need to be a corporation to take advantage of the reduced taxable income. For those of our clients with businesses, we will be reviewing files over the next month to see who qualifies, and how it affects each of our clients. Nothing must be done by year-end to make this work. We will have a little time to put this together.

As with any major new legislation, there are a lot of unknowns. We will do our best to digest these changes, and pass information on to you, as it is available. Please reach out to your accountant with questions.