Make Taxes Great Now!

Whether or not you’re a tax practitioner, it’s critical this tax-preparation season to meet with your clients and prospects. Given the magnitude of the tax-reform legislation President Trump signed into law on December 22, it’s “always a good time to ask questions and broach the subject of life planning, and if you’re not out there having the conversations now, somebody else is,” says Raymond Haller, a CPA and tax partner at accounting and consulting firm Grassi & Co., in Jericho, N.Y., on Long Island.

Start the chat by urging clients with high medical bills last year to scrounge for health-care receipts. The new law lowers the threshold for deducting medical expenses for all taxpayers from 10% of adjusted gross income to 7.5%.

Inform business owners that bonus depreciation was enhanced retroactively by the legislation. Business property that was both acquired and placed in service last year after September 27 can be completely written off, according to Mildred Carter, a tax analyst at Wolters Kluwer Tax & Accounting, a New York-based tax-software organization. The property can be new or used; in the past, only new property qualified.

Talk About 2018

By now, advisors and many clients know that income tax rates are generally coming down in 2018. Moreover, as the accompanying chart reveals, it will take quite a bit more income than before for individuals to pay the maximum ordinary rate, which is now 37% (it was 39.6% before). Carter points out that the top capital-gains bracket no longer coincides with the top ordinary bracket, although the maximum rate on cap gains remains 20% (plus the 3.8% net investment income tax, which the legislation kept intact—sorry).

While the aforementioned change to the medical-expense deduction applies to 2017 and 2018, and the repeal of the individual shared responsibility payment for failing to carry minimum essential health insurance is permanent starting in 2019, many of the legislation’s changes to the taxation of individuals are effective from 2018 through 2025.

During this eight-year period, itemizing may be out of reach for many clients. The hurdle to itemize is rising—the standard deduction for 2018 is $24,000 for a couple filing jointly and $12,000 for single filers—at the same time that some deductions are being curtailed and others are completely canned.

To surmount the standard deduction and benefit from itemizing, generous clients might consider bunching their charitable contributions into a single year. Making larger donations every other year, instead of giving a smaller amount annually, may permit itemizing in alternating years, says Robert Keebler, a CPA and partner at Keebler & Associates in Green Bay, Wis. It helps that deductions for cash contributions to public charities and certain private foundations are allowed for up to 60% of the taxpayer’s adjusted gross income from now through 2025, whereas the figure was only 50% under the law before.

Further fueling this charitable strategy is the repeal of the Pease limitation through 2025. Historically it reduced total itemized deductions for big earners. “Its elimination is helpful for clients who make large charitable contributions in a year they have high income,” says Miami CPA John Anzivino, a principal at Kaufman Rossin.

The well-publicized $10,000 cap on property tax plus state and local taxes, likewise effective for 2018 through 2025, is causing some folks to plan anew. CPA Al Zdenek, the chief executive officer of Traust Sollus Wealth Management in Manhattan, says, “Here in the New York metro area, some clients whose deductions for these taxes are now severely limited are considering accelerating plans to move to Florida, which doesn’t have a state income tax. Californians might accelerate a move to Nevada for the same reason.”

Anyone mulling a residence purchase needs to know that only the interest on $750,000 of new home-acquisition debt is deductible through 2025. “Financing the purchase of a home needs to be discussed with clients,” Zdenek says.

All the miscellaneous itemized deductions subject to the 2% of adjusted gross income floor have been terminated through 2025. This includes unreimbursed employee business expenses, tax-preparation costs and—yikes!—investment-management fees. Regarding the latter, some clients are “questioning why they’re spending tens of thousands on investment-management fees if the fees are no longer deductible. They’re wondering whether they should just go to a Vanguard,” says CPA/PFS John R. Lieberman, managing director at Perelson Weiner LLP in Manhattan.

Also nixed for the eight-year period are itemized deductions for personal casualty losses (unless attributable to a federally declared disaster) and interest on home-equity debt, along with personal exemptions and the above-the-line deduction for moving expenses.

Another new rule of note: For divorce or separation instruments executed after December 31, 2018, alimony payments won’t be deductible and alimony received won’t be taxed.

Changes For Businesses

For 2018, the maximum deduction under Section 179 for business-property purchases rises to $1 million and doesn’t begin phasing out until more than $2.5 million of equipment has been bought. In addition, the deduction is now available for the following improvements to nonresidential buildings: heating, ventilation and air conditioning, a roof, security systems and fire protection and alarm systems.

Yet even bigger news for businesses is the free fall in tax rates. C corporations pay 21% starting this year, a change not scheduled to expire.

Meanwhile, the profits of pass-through businesses (S corporations, limited liability companies, partnerships and sole proprietorships), which are taxed to the owners, could be subject to a maximum marginal rate of 29.6%, down from 39.6%, courtesy of a new deduction for up to 20% of the business’s profits. This deduction is only available through 2025, but in the meantime Kaufman Rossin’s Anzivino expects it will slash one of his client’s taxes by $250,000 annually.

However, there are hoops to jump through to deduct the full 20%. Limitations phase in when the client’s taxable income is above $315,000 for joint filers ($157,500 for single filers), according to Keebler. In the worst case, when the owner’s taxable income reaches $415,000 for couples ($207,500 for single taxpayers), no deduction is allowed for income from specified service businesses, a category that includes investment management along with law, accounting, consulting and medicine but not engineering or architecture.

To avoid this issue, consider splitting up a business into its constituent parts. For example, one of Lieberman’s high-income clients has a company that does both manufacturing and consulting. So that the client can deduct the profits of the manufacturing arm, it’s going to be spun off into a pass-through entity by itself. With the new law, “advisors need a better understanding of their clients’ businesses,” Lieberman says.

Big Decision

Many clients will want to know which is better for them, a C corporation, bearing in mind that its profits are taxed first at the 21% corporate rate and then again to the owners when they take out the earnings as dividends, or a pass-through business with its potential 20%-of-profits deduction and no double taxation.

Owners who plan to sell their companies soon, or who take out the earnings each year, may fare better with a pass-through to avoid double taxation, says Haller, the Long Island CPA.

On the other hand, owners seeking to reinvest their enterprise’s profits may find a C corp more attractive, although they need to be serious about reinvesting, i.e., ramping up inventory, making capital expenditures and strategic acquisitions, and so forth, says Haller. Otherwise, the corporation could get slapped with the nefarious accumulated earnings tax on profits retained beyond the reasonable needs of the business, he warns.

But for the right owner, a C corp could be a home run. Tom Wheelwright, a CPA and founder of Tax-Free Wealth CPAs in Tempe, Ariz., has a client in expansion mode who plans to switch from a pass-through to a C corporation. “He’s looking at writing off all the equipment for the expansion as bonus depreciation, taking a Section 179 deduction for improvements, and paying 21% on whatever’s left as profit. This is a business with millions of dollars of net income, but it will not owe much tax in the foreseeable future,” Wheelwright says.

Given the presumed permanence of the 21% corporate rate and the temporary life of the deduction for part of a pass-through business’s profits, as well as a decrease in bonus depreciation after 2022 and other changes and considerations beyond the scope of this article, “Tax advisors will have to run numbers for several years forward to help clients make good decisions,” Wheelwright says. “It’s going to take some pretty good analysis.”