Qualified Opportunity Zone Funds – UPDATE

Date March 11, 2019
Authors Cassandra Baubie, JD & Anthony Giacalone, CPA

Of the many changes that came from the Tax Cuts and Jobs Act (“The TCJA”), Qualified Opportunity Zones (“QOZ”) have been one of the most talked about provisions as the 2018 tax season progresses. As a recap, through QOZs, taxpayers may elect to temporarily defer the tax to be paid on capital gains until the 2026 tax year that are invested in a Qualified Opportunity Fund (“QOF”) within 180 days of gain recognition, the QOF must invest 90 percent of its capital in QOZ Property. Taxpayers who hold investments in a QOF for at least five years may exclude 10 percent of the original deferred gain, and investments held for more than seven years qualify for an additional five percent exclusion of their original deferred gain. In what could be the most attractive feature of the new law, after 10 years, post-acquisition appreciation is 100 percent excluded from taxable income for federal tax purposes. Many states are still evaluating how they are going to deal with the new QOZ rules.

Click here to read the full update.

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Manufacturing Monitor, Part I: New Cash Basis Options

Date February 20, 2019
Authors James Dascenzo

*This is the first in a series of articles addressing the impact of the TCJA on the Manufacturing industry.

TCJA: A Recap

The Tax Cuts and Jobs Act (TCJA) that was signed into law in December 2017 introduced changes to the Internal Revenue Code (IRC) the likes of which have not been seen since the Tax Reform Act of 1986. Many of these new or altered provisions directly affect manufacturers, and in this and subsequent articles of a series of articles, Monitoring Manufacturing: Effects of the New Tax Code, I’ll address those likely to have the most impact on our industry.

Pros & Cons of Cash Basis Accounting

One of the most beneficial additions to the IRC resulting from the TCJA is the opportunity for some manufacturers to switch to a cash basis method of accounting. Under prior law, businesses with inventories were typically required to use the accrual method, which generally requires income to be recognized when it is earned and expenses to be recognized when they are incurred.

The major pitfall to the accrual method of accounting is that it often accelerates the recognition of income and the related tax payments. That can create a cash flow problem. Under the cash basis of accounting, income is recognized when the money is received and expenses are deducted when they are paid. Improved cash flow is just one benefit associated with cash accounting; for example, the business can accelerate tax deductions by paying expenses prior to the end of its tax year.

Who is eligible?

The TCJA allows businesses with average annual gross receipts of less than $25 million – based on their previous three tax years – to adopt a cash accounting method and thereby potentially defer the recognition of income to future tax years. In addition, businesses under that $25 million threshold are no longer required to account for their cost of goods sold using inventories.

Instead, they can use a method of accounting that treats inventories as non-incidental materials and supplies or that mimics their financial accounting treatment of inventories. As such, the business can expense inventory as it is actually paid for, rather than being required to capitalize it – that is, not expense it. It is a very favorable change in that it will add to the business’s deduction for cost of goods sold. Treating inventories as non-incidental materials and supplies also exempts the business from applying Section 263A, which requires certain costs ordinarily expensed to be capitalized as part of inventory for tax purposes. Combining these opportunities could yield considerable benefits.

The TCJA expands the pool of businesses that are eligible to use the cash method of accounting. It is likely that many manufacturers previously prohibited from using the cash basis method of accounting will now be eligible. Nonetheless, it is imperative to conduct a thorough analysis of your specific circumstances.

For questions or to arrange a study of the potential opportunities for your company, contact a member of the HBK CPAs & Consultants’ Manufacturing team at (330) 758-8613.

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Parking Tax: Consequences Employers Need to Know

Date February 4, 2019
Authors James M. Rosa
Categories

Employers have provided employees with parking at the workplace for many years without a tax cost. It has been considered a non-taxable fringe benefit and rightly so. Now under recent IRS guidance in Notice 2018-99, most every employer, including tax-exempt organizations, will have tax consequences to consider related to providing employee parking.

The 2017 Tax Cuts and Jobs Act changed the law related to employee parking, but most thought this would be an issue if an employer was paying a third-party for employee parking. Under the new law, effective for parking expenses paid or incurred after December 31, 2017, a for-profit employer is not allowed to deduct expenses related to providing employee parking and tax-exempt organization employers must treat the amount paid for employee parking expenses as unrelated business taxable income (UBTI) and will pay an income tax if the amount of employee parking expenses exceeds $1,000.

Fiscal year for for-profit filers for tax returns filed for years ending in 2018 should consider the amount of employee parking expenses paid or incurred after 12/31/2017. Tax-exempt filers for years ending in 2018 should consider the amount of parking expenses paid or incurred after 12/31/2017 as unrelated business income.

There are two notable exceptions to the disallowance rule. The first is if the parking benefit is included in the taxable wages of the employees. The second is if that parking is primarily for the general public and not primarily for employees.

There is an ongoing effort to repeal this tax provision, but passage of repeal faces a number of political hurdles.

What is considered parking expenses?
Parking expenses are not just what is paid to a third party for parking spaces, but expenses an employer incurs for a parking lot owned by an employer or leased by an employer. Parking expenses included a portion of rent or lease payments allocated to parking if not broken out separately, repairs, real estate taxes, insurance among other expenses.

Other expenses related to parking are also to be considered, but depreciation of any costs related to the parking lot or facility is not to be considered.

After identifying all parking expenses, an allocation of those expenses to employee parking must be determined. Typically, an employer will designate parking spaces for visitors and certain others that effect the determination of the amount that is not deductible or is to be considered UBTI by a tax-exempt organization. Additionally, reserved spaces for employees have expenses allocated in a manner different than general parking for employees. Lastly, if parking is primarily used by the general public, rather than employees, then these rules do not apply at all.

The IRS also issued Notice 2018-100, which provides for a waiver of penalties, in certain circumstances, for the failure by tax-exempt employers to make quarterly estimated income tax payments otherwise required to be made on or before December 17, 2018. The penalty relief is available only to tax-exempt employers that were not previously required to file Form 990-T and that underpaid their estimated income tax due to the parking expenses being included in UBTI.

This penalty relief applies only in case of underpayment of quarterly estimates. Tax-exempt employers that fail to timely file Form 990-T or that fail to pay taxes by the original due date are not eligible for the relief. To claim the waiver, the tax-exempt organization must write ‘Notice 2018-100’ on the top of its Form 990-T.

Employer who pays a third party for parking spots.
If an employer pays a third party an amount so that its employees may park at the third party’s parking lot or garage, the disallowance generally is calculated as the employer’s total annual cost of employee parking paid to the third party. However, if the amount the taxpayer pays to a third party for an employee’s parking exceeds a monthly limitation, which for 2018 is $260 per employee, that excess amount must be treated by the taxpayer as compensation and wages to the employee.

Employer who owns or leases all or a portion of a parking lot or facility.
Until further guidance is issued, if a taxpayer owns or leases all or a portion of one or more parking lots or facilities where its employees park, the deduction disallowance and UBTI amount may be calculated using any reasonable method.

Using the “value” of employee parking, rather than an allocation of actual parking expenses, to determine expenses allocable to employee parking in a parking lot or facility owned or leased by the taxpayer is not considered a reasonable method. The IRS guidance provides the following four step methodology that is deemed to be a reasonable method.

  1. Calculate the disallowance for reserved employee spots.
  2. Determine the primary use of the remaining spots (for the general public (over 50 percent) or for employees).
  3. Calculate the allowance for reserved nonemployee spots.
  4. Determine the remaining use and allocable expenses.

Please contact us about your specific situation so we can assist you to comply with these requirements. We have developed an approach to determine what a reasonable approach to allocate expenses to employee parking. We will keep you informed of possible changes to this parking tax.

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Decoding the 2018 Tax Form Makeover

Date December 21, 2018
Authors Sarah N. Gaymon

The passage of the Tax Cuts and Jobs Act (TCJA) resulted in a complete makeover of the forms used to prepare individual income tax returns. Apparently “filing on a post card” is possible; for some, the new Individual Income Tax Return will indeed be as simple and straightforward as filling out a two-sided post card-sized form. For many others, however, the new form will be accompanied by one or more of six new schedules.

The first page of the new form is informational. It lists the taxpayer’s filing status, name, address, social security number and dependents. It also includes a signature area for the taxpayers and the tax preparer.

The second page of the new form contains the information used to compute the tax due for the year; it has been significantly simplified from prior year forms. If additional information needs to be reported, the TCJA has provided the following schedules to be used:

  • Schedule 1 should be included in any tax return where the taxpayer receives income from capital gains (reported on Schedule D), ordinary gains (reported on Form 4797), business income (reported on Schedule C), rental and pass through income (reported on Schedule E), or any other type of income typically referred to as “Other Income.” This form will also report any adjustments to income, such as the deductible part of self-employment tax (reported on Schedule SE), the self-employed health insurance deduction, the deduction for contributions to an IRA and the student loan interest deduction.
  • Schedule 2 will be included in any tax return where the taxpayer is subject to the Alternative Minimum Tax (reported on Form 6251) or needs to make an excess advance premium tax credit repayment.
  • Schedule 3 will be used to claim nonrefundable credits such as the foreign tax credit (reported on Form 1116), any residential energy credits, general business credits or child and dependent care expenses.
  • Schedule 4 will be used to compute other taxes such as self-employment taxes (reported on Form SE), additional taxes on IRAs, net investment income taxes (reported on Form 8960), household employment taxes (reported on Schedule H) and any Section 965 taxes due.
  • Schedule 5 will be used to report any estimated tax payments as well as any payments made with an extension. This schedule will also be used to claim any refundable credits that the taxpayer is entitled to other than the earned income credit, such as the American opportunity credit or the additional child tax credit.
  • Schedule 6 should be included for any taxpayers who have a foreign address or wish to designate a third- party designee to discuss their return with the IRS.

In addition to these new schedules, taxpayers should be prepared to fill out many of the standard, familiar forms and schedules when completing 2018 returns.

Taxes can be complex, and it is important to understand how these changes might affect filings. The examples included in this article are not all-inclusive and not intended as a substitute for the value and knowledge of consulting with a tax specialist. Please contact a member of the HBK Tax Advisory Group with your questions and concerns. We’re here to help.

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Opportunity Zone Investing Yields Tax Saving Opportunities

Date December 17, 2018
Authors Anthony Giacalone, CPA

A provision of the Tax Cuts and Jobs Act (TCJA) of 2018 allows investors to defer taxes on capital gains by investing them in properties and businesses in Qualified Opportunity Zones (QOZs). The purpose is to encourage investment that will revitalize low-income areas. Essentially QOZs allow investors to take capital assets that have appreciated, monetize them, and defer the gain for up to seven years, or through 2026.

A typical investor might be a client selling a stock that has amassed substantial capital gains over time. A QOZ unties the binds that keep that individual from selling by allowing him or her to re-invest the gains tax-deferred in a Qualified Opportunity Fund (QOF).

Qualified Opportunity Zones are designated by state governors and currently all 50 states have designated zones in their respective jurisdictions. Florida’s governor Rick Scott added its name to that list as of April 19, 2018 with his recommendations for zones in 427 communities across every county in the sunshine state. As in the case of TCJA, and most new tax legislation, subsequent regulations will be required to address some unresolved issues, but all QOFs do provide federal capital gains tax benefits. Here’s how it works:

QOFs chart

If a client sells an investment that generates a capital gain before December 31, 2026, and re-invests the gain in a QOF within 180 days, the benefits are:
– Deferred taxes on the initial gain until December 31, 2026
– Elimination after five years of a portion of the deferred gain
– Elimination of more of the gain after 7 years
– Elimination of post-rollover appreciation after 10 years

The following guidelines must be considered for qualified, preferential tax treatment under a QOF:

  • To qualify as a QOF, the corporation or partnership must have 90 percent of its assets invested in QOZ properties or businesses.
  • A QOF investor can be any taxpaying entity: individual, partnership, S corporation, trust.
  • An “unrelated person” is an entity in which the investor does not have an ownership stake of more than 20 percent. The rule would keep the investor from selling the original investment to himself, or an entity in which the investor holds a substantial stake, such as in a current partnership, for example.
  • The provision applies only to capital gains, including 1231 and 1250 gains, but not gains taxed as ordinary income.

To achieve deferral or potentially eliminate the tax on a QOF investment, the investor must commit the capital gain to an investment in a QOF within 180 days of the sale of the original investment. Then:

  • After five years of holding the investment in the QOF, the basis is increased by 10 percent of the initial deferred gain, thereby permanently excluding from income that 10 percent.
  • After 7 years, the basis in the investment is increased by another 5 percent of the deferred gain, thereby permanently excluding that amount from taxable income.
  • After 10 years of holding the QOF investment, the investor can elect to have the basis equal its fair market value when the investment is sold. Because the originally deferred gain will be taxed December 31, 2026, with a corresponding adjustment in basis, the rule has the effect of excluding from tax all post-rollover appreciation.

Even if an investment is not made in time to capitalize on the seven or five-year basis-point increases, there are still advantages to investing in a QOF. Invested capital gains are still eligible for deferral until December 31, 2026. As well, the investor remains eligible for the 10-year rule allowing all post-rollover appreciation to be permanently excluded from being taxed.

One of the requirements for qualification as a QOZ business is that less than 5 percent of the average of the aggregate unadjusted bases of property held by the entity must be attributable to nonqualified financial property (NQFP). Under Section 1397C(e), the definition of NQFP does not include reasonable amounts of working capital held in cash, cash equivalents, or debt instruments with a term of 18 months or less. If documented adequately, capital can be used for expenses, effectively maintaining the investment as a QOF at less than the prescribed 90 percent threshold.

Another round of regulations from the Treasury Department for QOFs is expected by the end of the year. Among the issues that need to be addressed is the requirement that at least half of all receipts from a QOZ business come from their zone of location. That might make sense for a single grocery store or apartment building, but not necessarily for a manufacturer selling its products throughout the country. The sales might be dispersed but the income, jobs and other benefits are clearly local.

Other questions hoping to be answered by the next round of regulations include:

  • What are the federal tax benefits relative to the income generated from this investment?
  • The QOFs will likely own a portfolio of businesses in the zone, but what are the benefits to the operating entities?

We will closely monitor future announcements from the U.S. Treasury Department on this topic and provide updates as soon as they are available. For questions, please contact Anthony Giacalone at agiacalone@hbkcpa.com.

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IRS Issues New Guidance on the Deductibility of Business Meals

Date October 4, 2018
Authors Ben DiGirolamo

UPDATE: PLEASE NOTE THAT THE IRS ISSUED CHANGES TO THIS RULING. PLEASE SEE THE NEW ARTICLE DATED OCTOBER 2, 2020 FOR DETAILS ON THE UPDATES.

When the Tax Cuts and Jobs Act (TCJA) was issued, we noted that there were several areas of the new law that needed clarification. One of those addressed the deductibility of expenses for meals and entertainment. While the TCJA clearly denied deductions for entertainment, the treatment of the cost of meals associated with entertainment was not as well defined.

Now the IRS has issued Notice 2018-76 (The Notice) indicating that taxpayers will be allowed to deduct half the cost of meals, but only if they meet the following requirements:

  1. The expense is an ordinary and necessary expense under §162(a) that is paid or incurred during the taxable year in carrying on any trade or business;
  2. The expense is not lavish or extravagant for the circumstances;
  3. The taxpayer, or an employee of the taxpayer, is present when the food or beverages are purchased;
  4. The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
  5. In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bill, invoice, or receipt. The entertainment disallowance rule may not be circumvented by inflating the amount charged for food and beverages.

The Notice provides the following three examples regarding meals associated with entertainment:

Example 1. Taxpayer A invites B, a business contact, to a baseball game. A purchases tickets for A and B to attend the game. While at the game, A buys hot dogs and drinks for A and B. The baseball game is entertainment, and the cost of the game tickets is a nondeductible entertainment expense. The cost of the hot dogs and drinks, which are purchased separately from the game tickets, is not an entertainment expense. Therefore, A may deduct 50 percent of the expenses associated with the hot dogs and drinks purchased at the game.

Example 2. Taxpayer C invites D, a business contact, to a basketball game. C purchases tickets for C and D to attend the game in a suite, where they have access to food and beverages. The cost of the basketball game tickets, as stated on the invoice, includes the food and beverages. The basketball game is entertainment, and the cost of the game tickets is a nondeductible entertainment expense. The cost of the food and beverages, which are not purchased separately from the game tickets, is not stated separately on the invoice. Thus, the cost of the food and beverages also is an entertainment nondeductible entertainment expense. Therefore, C may not deduct any of the expenses associated with the basketball game.

Example 3. Assume the same facts as in Example 2, except that the invoice for the basketball game tickets separately states the cost of the food and beverages. As in Example 2, the basketball game is entertainment, and the cost of the game tickets, other than the cost of the food and beverages, is nondeductible. However, the cost of the food and beverages, which is stated separately on the invoice for the game tickets, is not an entertainment expense. Therefore, C may deduct 50 percent of the expenses associated with the food and beverages provided at the game.

As with most broad legislation, sections of the new tax law can be confusing. What’s clear is that your returns for 2018 will have to comply with all provisions of the law as interpreted by the IRS. If you have questions or concerns about the new law and how it might affect you, please contact your HBK tax advisor.

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Investing in Qualified Opportunity Funds: The IRS Download

Date August 30, 2018
Categories

The Tax Cuts and Jobs Act (“TCJA”) created an investment vehicle for taxpayers through use of Qualified Opportunity Funds (“QO Fund”), which allows investors to:
• Defer capital gains
• Potentially reduce the amount of gain recognized through a basis adjustment if holding requirements are met
• Potentially permanently exclude the gain on appreciation for interests in a QO Fund

These provisions are set forth in new Internal Revenue Code Sections §1400Z-1 and §1400Z-2, and are intended to provide incentives for taxpayers to invest in low-income areas or “zones.” For additional reference, please see the IRS FAQs link. The following provides an analysis and examples of howthe QO Funds could work.

ANALYSIS
Designation of a QO Zone:
Under the Tax Cuts and Jobs Act, a state’s chief executive officer (generally a governor or the mayor of the District of Columbia) can designate certain census tracts that are low-income communities as Qualified Opportunity Zones. The state’s CEO had 90 days (plus another 30 days under an extension) after December 22, 2017, to nominate a tract by notifying the IRS in writing of the nomination. The IRS had 30 days (plus another 30 days under an extension) to certify the nomination and designate the tract as a QO Zone. Thus, designations had to occur before June 21, 2018, and those that were designated will remain in effect for 10 calendar years. Census tracts in Puerto Rico that are low-income communities are considered certified and designated as QO Zones effective on December 22, 2017.

LIST OF DESIGNATED QUALIFIED OPPORTUNITY ZONES PROVIDED VIA IRS WEBSITE
The spreadsheet located at https://www.cdfifund.gov/Pages/OpportunityZones.aspx was updated June 14,2018, to reflect the final QO Zone designations for all states.

What are QO Funds:
A QO Fund is an investment vehicle organized as a corporation or a partnership for investing in a QO Zone. A QO Fund cannot invest in another QO Fund, and each QO Fund has to hold at least 90% of its assets in QO Zone property (i.e., any QO Zone stock, any QO Zone partnership interest, and any QO Zone business property). A QO Zone property has to meet many requirements, including that substantially all of the entity’s business property is used in a QO Zone. A penalty will apply to the QO Fund if it fails to meet the 90% requirement.

Temporary gain deferral election:
If a taxpayer invests gains from the sale or exchange of property (i.e. stocks, bonds, etc.) with an unrelated person in a QO Fund within the 180-day period beginning on the date of the sale or exchange, the taxpayer can elect to defer the gain from the sale or exchange. This election will be made on the taxpayer’s 2018 tax return (filed in 2019) as directed by the Treasury. Recognition of deferred gain:

The taxpayer defers the gain until the later of the date:
• On which the QO Fund is sold or exchanged, or
• December 31, 2026

At that time, the taxpayer includes the lesser of:
• Amount of gain deferred or,
• Fair market value (FMV) of the QO Fund minus the taxpayer’s basis in the interest.

Basis in the investment:
A taxpayer’s basis in the investment is zero unless any of the following increases apply:
• 10 percent of the deferred gain if the investment is held for five years
• Five percent of the deferred gain if the investment is held for seven years
• Any deferred gain recognized at the end of the deferral period

Permanent gain exclusion election:
Taxpayers are permitted to make an election that would allow for the exclusion of any post-acquisition capital gains on an investment in a QO Fund if the investment in the QO Fund has been held for 10 years.

When elections cannot be made:
Taxpayers are not permitted to make either election if there is already an election in effect with respect to the same sale or exchange. Additionally, a taxpayer cannot make a temporary deferral election with respect to any sale or exchange after December 31, 2026.

Taxpayers who made the temporary deferral election have to recognize any deferred gain on December 31, 2026 (unless a sale or exchange causes the period to end before December 31, 2026). The end of the deferral period, -December 31, 2026 will occur before any taxpayer could have held their investment for ten years, the permanent exclusion election will not protect a taxpayer from recognizing any deferred gain. Thus, if the taxpayer holds their investment for 10 years, the permanent exclusion election presumably will only exclude the gain in excess of the deferred gain (that has already been recognized). The following flow chart illustrates an example scenario and timeline of how the deferral opportunity works.

Deferral Opportunity Graphic

For access to the related FAQs, please read the full article here.

For more information, please contact a member of the Tax Advisory Group.

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Tax Reform 2.0: What Will It Mean for Businesses and Families?

Date July 26, 2018
Authors Amy L. Dalen
Categories

As taxpayers have struggled to understand the effect that the Tax Cuts & Jobs Act of 2017 (TCJA) will have on their 2018 taxes, Congress and the Treasury Department have been busy working behind the scenes to draft the framework for a new tax cut package and proposed regulations that will hopefully provide some clarity to an increasingly complex tax system.

Framework for a New Tax Cut Package

On July 24th, the House Ways and Means Committee Chairman, Kevin Brady (R-Texas) released the framework of a new tax cut package – labeled Tax Reform 2.0 – that gives some insight into additional tax law changes that may be coming in the near future. The following is addressed in the framework:

Making the TCJA Tax Cuts Permanent

In order to pass tax legislation at the end of 2017, the Republican-lead House and Senate had to rely on a special legislative process known as budget reconciliation. Legislation passed through this process is not subject to filibuster (meaning that the minority party cannot block the legislation), and it only requires a simple majority vote to pass. The trade-off to using this process is that any legislation passed under budget reconciliation cannot increase the deficit after 10 years. This means that most of the provisions of the TCJA are set to expire after 2025.

The Republicans used budget reconciliation to pass tax reform quickly, and now they are on a continuous campaign to try to make the changes permanent. The framework argues that permanency will provide “certainty for our families, workers, and Main Street small businesses while unleashing even more economic growth in America for the long run.” This seems rather unlikely since the Democrats, in general, do not appear to support making the cuts permanent.

Promoting Family Savings

Problems with the social security system have lead to an increased focus on other methods of promoting savings across the country. The framework focuses on the following savings accounts:

1. Retirement savings – the framework indicates that Tax Reform 2.0 will help small businesses provide retirement plans for their workers, and will help employees participate in those plans. In addition, the framework indicates that changes will be made to allow families to use their retirement accounts to pay for the costs of welcoming a new child – whether by birth or adoption – into the family.

2. Universal Savings Account (USA) – the framework introduces a new savings account that it claims will be a “fully flexible savings tool for families.”

3. 529 Education Accounts – the framework indicates that these types of accounts will be expanded to pay for apprenticeship fees to learn a trade, homeschooling costs, and to help pay off student debt.

Spurring New Business Innovation

With the United States no longer in Bloomberg’s list of top 10 most innovative countries in the world, Congress is looking for ways to increase innovation across the country. The framework indicates that Tax Reform 2.0 will introduce expanded benefits to help new businesses write off more of their initial start-up costs, and to remove barriers that may inhibit growth.

Brady hopes to move forward with a committee vote on draft legislation this coming September, though the actual legislation may change significantly as members of Congress continue to lobby for their own ideas. The November midterm elections may also have an impact on the final legislation that is put up for a vote.

Proposed Regulations

As Congress continues to focus on new legislation, the Treasury Department has been focused on providing guidance for various provisions of the TCJA. One area of the new tax law that needs clarification is the new 20% pass-through deduction. Proposed Regulations were originally slated to be released in June, but that date has been pushed back.

On July 25th, a draft of the proposed regulations were delivered to the Office of Management and Budget’s Office of Information and Regulatory Affairs. Since the regulations are listed as “economically significant,” they qualify for an expedited 10-day review. Hopefully this means that we will see the proposed regulations soon.

At HBK, we strive to keep you informed of major developments and changes to the tax code. These changes may have a significant impact on current business operations and year-end planning. We encourage you to reach out to your CPA to see what impact these developments may have on your tax situation.

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An Individual Taxpayer’s Guide to Tax Reform

Date July 10, 2018
Authors Kaitlyn M. Cook, CPA, CFE
Categories

The 2018 Tax Cuts and Jobs Act, the first major tax overhaul in over three decades, will impact different households in different ways. Two of the most talked about changes brought about by tax reform involve the increase in the standard deduction and the elimination of the personal exemption. While these changes are independently significant, viewing them together will help you understand their overall effects.

Standard Deduction Increase
Most notably, the 2018 tax reform law increases the standard deduction to $12,000, $18,000, and $24,000 for “single,” “head-of-household” and “married filing jointly” filers, respectively. This is great news for taxpayers who claimed the standard deduction in years past. The almost doubling of the 2017 standard deduction will decrease their taxable incomes by $5,650, $8,650 or $11,300, depending on their filing status.

However, taxpayers itemizing deductions in excess of the new threshold amounts will not be able to capitalize on the increases. The large pool of Americans itemizing deductions that are greater than the prior standard deduction but less than the new standard deduction may in fact be negatively impacted – and the negative effects tie directly to the elimination of the personal exemption.

An End to Exemptions
Prior to 2018, tax filers could decrease their taxable income by $4,050 for each dependent. The Tax Cuts and Jobs Act eliminates that personal exemption deduction. The change will affect certain households substantially, while others will not be affected. Consider the following examples:

  • John is a single man with no dependents who has been claiming the standard deduction. For 2018, he will see an increase in his standard deduction of $5,650 and a decrease in his personal exemption of $4,050. In total, these changes will net him a $1,600 decrease in taxable income.

    John is positively affected by these two tax reform changes.

  • Jack and Mary file “married filing jointly” and have two dependents. In years past, they have itemized deductions at $20,000. For 2018, Jack and Mary once again have $20,000 in deductions, which does not meet the requirement for itemizing. Therefore, they will have to take the new standard deduction of $24,000. But they will lose $16,200 in personal exemptions: a net $12,200 increase in taxable income.

    Jack and Mary are negatively affected by these two tax reform changes.

Use the following charts to determine, based on your 2017 deductions, how the first two changes of the tax reform could affect your household for the 2018 tax year*.

Single 1 exemption 2 or more exemptions
STANDARD Positive effect Negative effect
Married Filing Joint 2 exemptions 3 or more exemptions
STANDARD Positive effect Negative effect
Married Filing Joint 2 exemptions 3 or more exemptions
Itemized over $15,900 Negative effect Negative effect
Married Filing Joint 2 exemptions 3 or more exemptions
Itemized between $12,700 and $15,900 Positive effect Negative effect
Single 1 exemption 2 or more exemptions
Itemized over $7,950 Negative effect Negative effect
Single 1 exemption 2 or more exemptions
Itemized between $6,350 and $7,950 Positive effect Negative effect

*Figures are based solely on the standard deduction and exemption changes and do not take other tax reform changes into account.

Recommendations
If you have itemized in years past, but will now benefit from the standard deduction, there are some things to consider:

  1. Reconsider your reason for charitable donations:
    Everyone loves a cheerful giver, but if you have been donating to charitable organizations just to get a tax benefit, you may want to reconsider.
  2. Unreimbursed employee expenses:
    If you have unreimbursed job travel, union dues or job expense costs, consider asking your employer to reimburse these costs. While you may have accumulated these costs in the past for a tax benefit, you will not receive the benefit in 2018 if you take the standard deduction. Additionally, the Tax Cuts and Jobs Act eliminates miscellaneous itemized deductions, subject to a “2 percent floor.” (You can deduct certain expenses – unreimbursed job expenses, investment expenses, tax preparation fees, etc. – that exceed 2 percent of your adjusted gross income.) This may lead taxpayers with significant miscellaneous expenses who have previously itemized deductions to take the standard deduction in 2018.
  3. No need to prepay:
    In an effort to increase itemized deductions, you may have prepaid real estate taxes in years past. Under the standard deduction, there would be no incentive to prepay those items in 2018.

Other considerations
Child Tax Credit Changes
As noted earlier, taxpayers with multiple dependents are most negatively affected by the personal exemption elimination. To offset this disadvantage, the new law increases the child tax credit from $1,000 to $2,000. The Tax Cuts and Jobs Act also created a $500 credit that can be taken for any non-child dependent. A dependent must be under the age of 17 to be considered a “child” for child tax credit purposes. The income phase out for this credit does not start until $200,000 of taxable income for single taxpayers and $400,000 for married taxpayers filing jointly. Additionally, parents can receive up to $1,400 as a refund if the credit is larger than their federal income tax liability.

It is important to remember that while the standard deduction and exemption changes affect taxable income, the child tax credit decreases, dollar for dollar, the tax that you owe.

Other Itemized Deduction Limitations
If you are trying to determine whether you will be itemizing or taking the standard deduction for 2018, you will want to consider two additional Tax Cuts and Job Act changes.

  1. State and Local Tax Cap: Under the tax reform, taxpayers can only deduct $10,000 in state and local income.
  2. Mortgage Interest Deduction: If you purchased a home after December 16, 2017, you can only deduct the interest on up to $375,000 (single) or $750,000 (married filing jointly) of mortgage debt. Additionally, most interest deductions on home equity debt have been eliminated.

Staying informed and making appropriate decisions during the tax year will help prepare you for tax time next spring. While it is beneficial to stay in the know, you don’t have to do it alone. An HBK tax advisor is ready to help guide you along the way with a personalized tax projection.

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Under the New Tax Act: Can Dealers Eliminate Their Related Finance Companies?

Date June 11, 2018
Authors
Categories

We are receiving a number of questions from dealers who have heard that the Tax Cuts and Jobs Act of 2017 (The Act) contains changes to tax law which will result in “Buy Here Pay Here” or BHPH dealers no longer needing to use a related finance company (RFC). The Act, the most comprehensive tax legislation since the Reagan era, is very complicated and we expect a significant number of regulations implementing the new law to be issued in the coming months and years.

One of the items contained in The Act is an expansion of the use of the cash method of accounting for businesses. Taxpayers using the cash method of accounting recognize income when cash is received and deduct expenses when paid. In general, the accrual method recognizes revenue when it is earned and expenses as incurred regardless of when payment for those items are received or paid.

Under prior law, there have been limitations on using the cash method of accounting. One of these limitations impacts taxpayers who maintain inventories. Generally, taxpayers with inventories are required to use the accrual method of accounting. Since dealers typically maintain inventories, they are not permitted to use the cash method. This results in dealers being required to recognize all of their sales revenue as income, forcing them to pay income taxes long before the customer has paid for the vehicle. Using an often-overlooked section of the tax code, dealers created RFCs to help alleviate the tax impact of this issue. The use of an RFC, because of the discounts taken, permits dealers to spread the recognition of taxable income over the life of the loan; thereby, more closely matching the tax burden to the cash flow. If dealers could use the cash method, the creation of the RFC would have been unnecessary.

The Act has expanded the use of the cash method so that businesses with gross receipts of less than $25 million dollars may be able to file for an election to use the cash method. This sounds like good news for many BHPH dealers, right? Not necessarily.

The current tax rules relating to the use of the cash method contain a snag for BHPH dealers that they may not have considered. These rules create “cash equivalency.” Under this definition, a dealer who receives an unconditional, assignable promise to pay from the customer, must recognize this as a cash equivalent; therefore, making the entire sale, once again, subject to income tax. The courts and the IRS have both reinforced this cash equivalency theory.

The Bottom Line: The expansion of the use of the cash method under the Act may not solve BHPH dealers’ problems. Accordingly, BHPH dealers must continue the use of RFCs until the IRS issues guidance changing the current rules or dealers risk seeing a significant increase in their tax bills. Contact Rex Collins with any questions you may have about the Tax Act and how it may impact your business.

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