Tax planning to take maximum advantage of the reforms promised in the Tax Cuts and Jobs Act has been difficult because guidance on how to interpret many provisions of the legislation has not yet been issued by the IRS. Congress has yet to follow up with technical corrections to glitches in the legislation. Adding to the uncertainty is not knowing whether Congress will extend the more than 30 tax breaks that expired at the end of 2017, and the promised Tax Reform II effort has yet to get underway.
The IRS has indicated that TCJA guidance may take a year or more. In the meantime, here is what we know so far about “The Dirty Dozen,” and the questions to ask:
Individual Tax Issues
1. How to handle the new 20% deduction from qualified business income for pass-through businesses? The issues involve how “qualified business income” and “reasonable compensation” will be defined, what constitutes a “specified service business” that will have more limited access to the deduction, and how “W-2 wages” and “qualified property” will be defined. Taxpayers may want to consider changing their business entity or splitting their businesses into more than one entity to maximize the availability of the deduction.
2. There is a $10,000 annual limit on the state and local tax deduction, what about pre-payment? Many taxpayers prepaid property taxes normally due in 2018 before the end of 2017 to avoid the new limit. The IRS recently stated that 2018 property taxes can only be prepaid if they were assessed by the local jurisdiction in 2017. Several states are proposing alternatives to preserve a federal deduction, such as contributions to state charities or payroll tax deductions. The Treasury and the IRS indicated a likely attempt to restrict or prohibit such deductions. NY, CT, MD, and NJ have all brought a lawsuit against the federal Tax Reform bill claiming that its $10,000 cap on the state-local deduction is unconstitutional.
3. What about interest on home equity loans? The TCJA prohibited the deduction of interest on home equity loans after January 1, 2018, both for pre-existing and new home equity loans. BUT the IRS later clarified that taxpayers may still be able to deduct interest paid on home equity loans where the funds were used to buy, construct or improve the home, subject to the overall limit on mortgage loan indebtedness.
4. What about reducing withholding? The IRS issued new withholding tables which were not put into effect until March. Many individuals may have over withheld so it would be wise to take a look at the new IRS Withholding Calculator and Form W-4 to do a “paycheck checkup.” Verify the accuracy of your 2018 withholding, especially if a family. Revised estimated tax payments for 2018 due from many self-employed individuals, retirees and investors should be addressed.
5. Have inflation adjustments been modified? The TCJA requires a change in the calculation of many inflation-adjusted items in the Tax Code chained to the Consumer Price Index. Before Tax Reform, the IRS had issued inflation-adjusted numbers for 2018, but those have since been revised. One of the changes lowered the limitation on deductions for contributions to a health savings account (HSA), but those have since been returned to the previous higher limit. It has also been clarified that the TCJA will not affect the previously announced dollar limitations for retirement plans.
2. There is a $10,000 annual limit on the state and local tax deduction, what about pre-payment? Many taxpayers prepaid property taxes normally due in 2018 before the end of 2017 to avoid the new limit. The IRS recently stated that 2018 property taxes can only be prepaid if they were assessed by the local jurisdiction in 2017. Several states are proposing alternatives to preserve a federal deduction, such as contributions to state charities or payroll tax deductions. The Treasury and the IRS indicated a likely attempt to restrict or prohibit such deductions. NY, CT, MD, and NJ have all brought a lawsuit against the federal Tax Reform bill claiming that its $10,000 cap on the state-local deduction is unconstitutional.
3. What about interest on home equity loans? The TCJA prohibited the deduction of interest on home equity loans after January 1, 2018, both for pre-existing and new home equity loans. BUT the IRS later clarified that taxpayers may still be able to deduct interest paid on home equity loans where the funds were used to buy, construct or improve the home, subject to the overall limit on mortgage loan indebtedness.
4. What about reducing withholding? The IRS issued new withholding tables which were not put into effect until March. Many individuals may have over withheld so it would be wise to take a look at the new IRS Withholding Calculator and Form W-4 to do a “paycheck checkup.” Verify the accuracy of your 2018 withholding, especially if a family. Revised estimated tax payments for 2018 due from many self-employed individuals, retirees and investors should be addressed.
5. Have inflation adjustments been modified? The TCJA requires a change in the calculation of many inflation-adjusted items in the Tax Code chained to the Consumer Price Index. Before Tax Reform, the IRS had issued inflation-adjusted numbers for 2018, but those have since been revised. One of the changes lowered the limitation on deductions for contributions to a health savings account (HSA), but those have since been returned to the previous higher limit. It has also been clarified that the TCJA will not affect the previously announced dollar limitations for retirement plans.
Business Tax Issues
6. What constitutes business interest eligible for deductions? Tax Reform put new limits on the deduction of business interest, in particular a limit of 30% of adjusted gross income. How will the limit be applied to pass-through entities and consolidated groups? The IRS clarified that all corporate debt is considered to be business interest rather than investment interest, and that interest payments on debt of members of a consolidated group would be allocated at the consolidated group level. Still waiting for regulations to be issued.
7. Impact on expensing of business assets? 100% bonus depreciation on both new and used qualified property and an expanded Code Sec. 179 deduction for smaller businesses has been made available. However, we are concerned that a legislative oversight may have limited the deduction of qualified leasehold property. There has also been confusion as to how the expensing provisions apply in a partnership context and how to address built-in gains and losses. Some states are looking at not allowing full expensing for state income tax purposes.
8. When are certain items recognized for financial accounting purposes? The TCJA requires greater conformity under the tax laws as to when items are recognized for financial accounting purposes and the handling of advance payments. We are advising clients to rely on pre-TCJA law until guidance is issued.
9. When will blended corporate tax rates apply? A corporation with a fiscal year that includes January 1, 2018, will pay a blended corporate tax rate, not just the new 21% corporate tax rate. The IRS did provide guidance on how to calculate corporate taxes using the two rate regimes.
10. What is the carried interest holding period? Tax Reform imposed a 3 year holding period for long-term capital gain treatment for carried interest but provides an exception for “corporations.” Some tax experts predict the IRS intends to issue regulations to the effect that “corporation” for this purpose does not include S corporations.
11. Are fines and penalties still deductible? Unfortunately, the categories of fines and penalties that do not qualify as a business deductions have been expanded. Proposed regulations will be issued shortly. TCJA provided additional time to file an administrative claim or to bring a civil suit for a wrongful levy or seizure.
12. How have international tax provisions changed? Multinational corporations have already had to deal with the obligation to pay a tax on un-repatriated foreign earnings. The tax is calculated for the 2017 tax year but can be spread over an eight-year period. In early June the IRS provided some additional penalty and filing relief. The IRS addressed avoidance issues like electing a November end to the fiscal year to try to defer the transition tax. It also addressed reduced deferred earnings and profits, reduced foreign cash and paid foreign tax credits, as well as estimated tax requirements.
7. Impact on expensing of business assets? 100% bonus depreciation on both new and used qualified property and an expanded Code Sec. 179 deduction for smaller businesses has been made available. However, we are concerned that a legislative oversight may have limited the deduction of qualified leasehold property. There has also been confusion as to how the expensing provisions apply in a partnership context and how to address built-in gains and losses. Some states are looking at not allowing full expensing for state income tax purposes.
8. When are certain items recognized for financial accounting purposes? The TCJA requires greater conformity under the tax laws as to when items are recognized for financial accounting purposes and the handling of advance payments. We are advising clients to rely on pre-TCJA law until guidance is issued.
9. When will blended corporate tax rates apply? A corporation with a fiscal year that includes January 1, 2018, will pay a blended corporate tax rate, not just the new 21% corporate tax rate. The IRS did provide guidance on how to calculate corporate taxes using the two rate regimes.
10. What is the carried interest holding period? Tax Reform imposed a 3 year holding period for long-term capital gain treatment for carried interest but provides an exception for “corporations.” Some tax experts predict the IRS intends to issue regulations to the effect that “corporation” for this purpose does not include S corporations.
11. Are fines and penalties still deductible? Unfortunately, the categories of fines and penalties that do not qualify as a business deductions have been expanded. Proposed regulations will be issued shortly. TCJA provided additional time to file an administrative claim or to bring a civil suit for a wrongful levy or seizure.
12. How have international tax provisions changed? Multinational corporations have already had to deal with the obligation to pay a tax on un-repatriated foreign earnings. The tax is calculated for the 2017 tax year but can be spread over an eight-year period. In early June the IRS provided some additional penalty and filing relief. The IRS addressed avoidance issues like electing a November end to the fiscal year to try to defer the transition tax. It also addressed reduced deferred earnings and profits, reduced foreign cash and paid foreign tax credits, as well as estimated tax requirements.
In summary – It is not unusual that such a major piece of tax legislation would be accompanied by a lot of questions and uncertainty. There is a need for clarification and guidance on many issues, this is just the tip of the iceberg!
Contact Us: Both business and individual tax clients should not make any drastic changes before checking with their Fuoco Group tax professionals. We anticipate that additional Tax Reform guidance will eventually be released, but where the IRS is concerned we do not expect that guidance to be rapidly forthcoming. Also keep in mind that Congress will have to tackle several technical correction issues and this time there will need to be cooperation on both sides of the aisle! Be sure to keep up with our newsletters and tax alerts to stay informed.
