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Tax-Saving Tips

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Tax-Saving Tips

Does No 1099 Mean No Deduction for You?

Imagine this: you didn’t issue Form 1099s to your contractors. Now, the IRS is auditing your tax return, and the auditor claims you lose your deductions because you didn’t issue the Form 1099s. Is this correct?

No. IRS auditors often make this claim, but they are incorrect.

There is no provision in the federal tax law that denies you a deduction for labor expenses simply because you didn’t file the required Form 1099s. But the tax court has stated that the non-filing of required Form 1099s can cast doubt on the legitimacy of the deduction claimed.

As with any deduction claimed on the tax return, you have to keep sufficient records to substantiate the deduction amount. If you had filed Form 1099s, then this would have been solid documentation to help prove the expenses to the auditor.

But since you didn’t file Form 1099s, you need to provide ironclad documentation to prove the expenses, including some or all of the following:

  • Bank statement transactions
  • Canceled checks
  • Credit card statement transactions
  • Invoices from the contractor
  • Signed agreements with the contractor
  • A signed statement from the contractor verifying the amounts received

Ultimately, to prove your deduction in a court of law, should you have to go that far, you’ll need to show by a preponderance of the evidence that you made the payments. This means that your evidence has to make it more than 50 percent likely that you did make the payments to the contractors.

Besides the extra trouble of proving the deductions, keep in mind that the cost of not filing Form 1099s surfaces a financial penalty. For the 2019 Form 1099s, the potential penalties are

  • $270 per Form 1099, or
  • $550 per Form 1099 if the IRS determines you intentionally disregarded the requirement.

As you can see, filing the 1099s avoids trouble.

IRS Issues New Bitcoin Tax Guidance

The IRS recently issued new cryptocurrency guidance and is hot on your trail if you bought and sold cryptocurrency and didn’t report it on your tax return.

Tax-saving tips

Here are the tax basics. You’ll treat cryptocurrency as property for tax purposes.

  • If you receive bitcoin in exchange for your services, then your income is the fair market value of the bitcoin received. Your basis in the bitcoin received is its fair market value at the time of receipt plus any transaction fees incurred.
  • If you receive bitcoin in exchange for your property, then your gain or loss is the fair market value of the bitcoin received less the adjusted basis of your property given up. Your basis in the bitcoin is its fair market value at the time of receipt plus any transaction fees incurred.
  • If you give bitcoin in exchange for services, then the value of the expense is the fair market value of the bitcoin given. Also, the value of the services received less the adjusted basis of the bitcoin is a gain or loss to you.
  • If you give bitcoin in exchange for someone’s property, then your gain or loss is the fair market value of the property you received less the adjusted  youbasis ofr bitcoin.

Cryptocurrency is a capital asset (provided you aren’t a trader). Therefore,

  • you pay tax on any gain at reduced rates, and
  • losses are subject to capital loss limitation rules.

Forks

In the cryptocurrency world, a fork occurs when the digital register that logs transactions of a particular cryptocurrency diverges into a new digital register. There are two types of forks:

  • one in which you don’t get cryptocurrency, and
  • one in which you get new cryptocurrency.

The IRS ruled that

  • a fork in which you don’t get cryptocurrency is not a taxable event, and
  • a fork in which you get new cryptocurrency is a taxable event and you’ll recognize ordinary income equal to the fair market value of the new cryptocurrency received.

Example. You own J, a cryptocurrency. A fork occurs and you receive three units of K, a new Cryptocur­rency. At the time of the fork, K has a value of $20 per unit. You’ll recognize $60 of ordinary income due to the fork.

Specific Identification

When selling property, you generally sell it on a first-in, first-out (FIFO) basis, unless you are eligible to use the specific identification method. You want to use the specific identification method if you can because you can select the amount of gain or loss your sale will create. With FIFO, you have no choice.

To use the specific identification method, you’ll have to either

  • document the specific unit’s unique digital identifier, such as a private key, public key, and address, or
  • keep records showing the transaction information for all units of a specific virtual currency, such as bitcoin, held in a single account, wallet, or address.

 

Tax-saving tips

This information must show

  • the date and time you acquired each unit;
  • your basis and the fair market value of each unit at the time you acquired it;
  • the date and time you sold, exchanged, or otherwise disposed of each unit;
  • the fair market value of each unit when you sold, exchanged, or disposed of it; and
  • the amount of money or the value of property received for each unit.

Divorce-Related Tax Issues for Small-Business Owners

As with all financial transactions, divorce comes with tax consequences. And those consequences have changed for tax years 2018 and later thanks to the Tax Cuts and Jobs Act (TCJA).

General Rule

The general tax rule in a divorce is that you can divide up most assets, including cash, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences.

When an asset falls under the tax-free transfer rule, the ex-spouse who receives the asset takes over its existing tax basis (for tax gain/loss purposes) and its existing holding period (for short- or long-term holding period purposes).

Example. Your divorce settlement calls for your soon-to-be-ex to get 40 percent of your highly appreciated  small-business corporation stock. Thanks to the tax-free transfer rule, there’s no tax impact when you transfer the shares.

 

Your ex keeps on rolling under the same tax rules that would have applied had you continued to own the shares (carryover basis and carryover holding period). When your ex ultimately sells the shares, he or she (not you) will owe any resulting capital gains taxes.

QDRO Required

Does your business have a qualified retirement plan, such as a profit-sharing plan, 401(k) plan, or defined benefit pension plan? If so, you probably will be required to give your soon-to-be-ex a percentage of your account balance or benefits as part of the divorce property settlement.

The trick is to do this without putting yourself on the hook for income taxes on amounts that go to your ex. Here’s the drill: include a qualified domestic relations order (QDRO) in the divorce papers. The QDRO makes your ex responsible for the income taxes on retirement account money that he or she receives in the form of account withdrawals, a pension, or an annuity.

In other words, the QDRO causes the tax bill to follow the money, which is only fair.

QDRO Not Required

You don’t need a QDRO to obtain an equitable tax outcome when you are required to turn over some of your IRA money to your ex as part of a divorce property settlement. QDROs are only relevant in the context of qualified retirement plans.

Therefore, you don’t need a QDRO for your Simplified Employee Pension accounts, Savings Incentive Match Plan for Employees (SIMPLE) IRAs, traditional IRAs, and Roth IRAs. Even so, you have to

Tax-saving tips

be careful and use the magic words to avoid getting taxed on money that goes to your ex.

Magic Words

Avoid the tax problem: include magic words in the divorce papers.

You can make a tax-free transfer of all or a portion of an IRA balance to your ex only if the transfer is ordered by a divorce or separation instrument. For this purpose, the tax code narrowly defines a divorce or separation instrument as a “decree of divorce or separate maintenance or a written instrument incident to such a decree.”

TCJA Eliminates Alimony Tax Deduction

How do you counteract loss of alimony deductions?

The federal income tax deduction for alimony payments required by divorce agreements executed after 2018 was permanently eliminated by the TCJA.

If you are a higher-income individual, this TCJA post-2018 development is an expensive game-changer for you. In the pre-TCJA days, you as a higher-income individual could reap big tax savings from deducting alimony payments, but those tax savings are history.

What can you do now that those deductions have been eliminated? One thing is to transfer assets with tax liabilities to your soon-to-be-ex (such as qualified plan and IRA balances, appreciated stock and mutual fund shares, and ownership of your highly appreciated vacation home).

Disassociating yourself from tax liabilities is effectively the same as getting a deduction. In a divorce, make it your mission to try to keep ownership of assets that have no tax liabilities, such as your Roth IRA.

Stock Redemption

 

If your business is incorporated and your soon-to-be-ex is a part owner, another idea is to arrange for a stock redemption deal to buy out your ex’s shares in lieu of making nondeductible alimony payments. With proper planning, you can arrange for your ex to bear the tax consequences of the redemption.

As you can see, there’s much to consider in a divorce.

Tax Tips for the Self-Employed Age 50 and Older

 

If you are self-employed, you have much to think about as you enter your senior years, and that includes retirement savings and Medicare. Here a few thoughts that will help.

 

Keep Making Retirement Account Contributions, and Make Extra “Catch-up” Contributions Too

 

Self-employed individuals who are age 50 and older as of the applicable year-end can make additional elective deferral catch-up contributions to certain types of tax-advantaged retirement accounts.

For the 2019 tax year, you can take advantage of this opportunity if you will be 50 or older as of December 31, 2019.

  • You can make elective deferral catch-up contributions to your self-employed 401(k) plan or to a SIMPLE IRA.
  • You can also make catch-up contributions to a traditional or Roth IRA.

 

Tax-saving tips

Tax-saving tips

Catch-up contributions are above and beyond

  1. the “regular” 2019 elective deferral contribution limit of $19,000 that otherwise applies to a 401(k) plan.
  2. the “regular” 2019 elective deferral contribution limit of $13,000 that otherwise applies to a SIMPLE IRA.
  3. the “regular” 2019 contribution limit of $6,000 that otherwise applies to a traditional or Roth IRA.

How Much Can Those Catch-up Contributions Be Worth?

Good question. You might dismiss catch-up contributions as relatively inconsequential unless we can prove otherwise. Fair enough. Here’s your proof:

401(k) catch-up contributions. Say you turned 50 during 2019 and contributed on January 1, 2019, an extra $6,000 for this year to your self-employed 401(k) account and then did the same for the following 15 years, up to age 65. Here’s how much extra you could accumulate in your 401(k) account by the end of the year you reach age 65, assuming the indicated annual rates of return below:

Tax-saving tips

Is There an Upper Age Limit for Regular and Catch-up Contributions?

Another good question.

While you must begin taking annual required minimum distributions (RMDs) from a 401(k), SIMPLE IRA, or traditional IRA account after reaching age 70 1/2, you can continue to contribute to your 401(k), SIMPLE IRA, or Roth IRA account after reaching that age, as long as you have self-employment income (subject to the income limit for annual Roth contribution eligibility).

But you may not contribute to a traditional IRA after reaching age 70 1/2.

Claim a Self-Employed Health Insurance Deduction for Medicare and Long-Term Care Insurance Premiums

If you are self-employed as a sole proprietor, an LLC member treated as a sole proprietor for tax purposes, a partner, an LLC member treated as a partner for tax purposes, or an S corporation shareholder-employee, you can generally claim an above-the-line deduction for health insurance premiums, including Medicare health insurance premiums, paid for you or your spouse.

Key point. You don’t need to itemize deductions to get the tax-saving benefit from this above-the-line self-employed health insurance deduction.

Medicare Part A Premiums

 

Tax-saving tips

Medicare Part A coverage is commonly called Medicare hospital insurance. It covers inpatient hospital care, skilled nursing facility care, and some home health care services.

You don’t have to pay premiums for Part A coverage if you paid Medicare taxes for 40 or more quarters during your working years. That’s because you’re considered to have paid your Part A premiums via Medicare taxes on wages and/or self-employment income.

But some individuals did not pay Medicare taxes for enough months while working and must pay premiums for Part A coverage.

  • If you paid Medicare taxes for 30-39 quarters, the 2019 Part A premium is $240 per month ($2,880 if premiums are paid for the full year).
  • If you paid Medicare taxes for less than 30 quarters, the 2019 Part A premium is $437 ($5,244 for the full year).
  • Your spouse is charged the same Part A premiums if he or she paid Medicare taxes for less than 40 quarters while working.

 

Medicare Part B Premiums

Medicare Part B coverage is commonly called Medicare medical insurance or Original Medicare. Part B mainly covers doctors and outpatient services, and Medicare-eligible individuals must pay monthly premiums for this benefit.

Your monthly premium for the current year depends on your modified adjusted gross income (MAGI) as reported on Form 1040 for two years earlier. For example, your 2019 premiums depend on your 2017 MAGI.

MAGI is defined as “regular” AGI from your Form 1040 plus any tax-exempt interest income.

Base premiums. For 2019, most folks pay the base premium of $135.60 per month ($1,627 for the full year).

Surcharges for Higher-Income Individuals. Higher-income individuals must pay surcharges in addition to the base premium for Part B coverage.

For 2019, the Part B surcharges depend on the MAGI amount from your 2017 Form 1040. Surcharges apply to unmarried individuals with 2017 MAGI in excess of $85,000 and married individuals who filed joint 2017 returns with MAGI in excess of $170,000.

Including the surcharges (which go up as 2017 MAGI goes up), the 2019 Part B monthly premiums for each covered person can be $189.60 ($2,275 for the full year), $270.90 ($3,251 for the full year), $352.20 ($4,226 for the full year), $433.40 ($5,201 for the full year), or $460.50 ($5,526 for the full year).

The maximum $460.50 monthly premium applies to unmarried individuals with 2017 MAGI in excess of $500,000 and married individuals who filed 2017 joint returns with MAGI in excess of $750,000.

Medicare Part D Premiums

Medicare Part D is private prescription drug coverage. Premiums vary depending on the plan you select. Higher-income individuals must pay a surcharge in addition to the base premium.

Surcharges for higher-income individuals. For 2019, the Part D surcharges depend on your 2017 MAGI, and they go up using the same scale as the Part B surcharges.

The 2019 monthly surcharge amounts for each covered person can be $12.40, $31.90, $51.40, $70.90, or $77.40. The maximum $77.40 surcharge applies to unmarried individuals with 2017 MAGI in excess of $500,000 and married individuals who filed 2017 joint returns with MAGI in excess of $750,000.

Tax-saving tips

Medigap Supplemental Coverage Premiums

Medicare Parts A and B do not pay for all health care services and supplies. Coverage gaps include copayments, coinsurance, and deductibles.

You can buy a so-called Medigap policy, which is private supplemental insurance that’s intended to cover some or all of the gaps. Premiums vary depending on the plan you select.

Medicare Advantage Premiums

You can get your Medicare benefits from the government through Part A and Part B coverage or through a so-called Medicare Advantage plan offered by a private insurance company. Medicare Advantage plans are sometimes called Medicare Part C.

Medicare pays the Medicare Advantage insurance company to cover Medicare Part A and Part B benefits. The insurance company then pays your claims. Your Medicare Advantage plan may also include prescription drug coverage (like Medicare Part D), and it may cover dental and vision care expenses that are not covered by Medicare Part B.

When you enroll in a Medicare Advantage plan, you continue to pay Medicare Part A and B premiums to the government. You may pay a separate additional monthly premium to the insurance company for the Medicare Advantage plan, but some Medicare Advantage plans do not charge any additional premium. The additional premium, if any, depends on the plan that you select.

Key point. Medigap policies do not work with Medicare Advantage plans. So if you join a Medicare Advantage plan, you should drop any Medigap coverage.

Premiums for Qualified Long-Term Care Insurance

These premiums also count as medical expenses for purposes of the above-the-line self-employed health insurance premium deduction, subject to the age-based limits shown below. For each covered person, count the lesser of premiums paid in 2019 or the applicable age-based limit.

Your age as of December 31, 2019, determines your maximum self-employed health insurance tax deduction for your long-term care insurance as follows:

  • $790—ages 41-50
  • $1,580—ages 51-60
  • $4,220—ages 61-70
  • $5,270—over age 70

Does a cash overdraft kill tax deductions?

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Does a cash overdraft kill tax deductions?

Here is a hypothetical (although common) scenario:

I have a cash-basis calendar-year client who on December 31, 2018, wrote and mailed $5,000 in checks for 2018 expenses. With this activity, his books showed a $9,000 negative cash book balance.

His December 31, 2018, bank statement shows a positive balance of $15,000.

Outstanding checks totaling $24,000 make up the difference.

The client has $50,000 available in a line of credit that he could have borrowed, but did not. His bank account does not have automatic overdraft protection.  

What answers would you give to the following questions:

  1. Can he claim the deduction for the $5,000 of checks he wrote on December 31 and the others that were written when his books showed negative cash?
  2. What are the deciding factors such as the line of credit and overdraft protection?
  3. If overdraft-paid expenses are deductible, how do I show the result on the balance sheet in the S corporation tax return? Negative cash as asset, overdraft as liability, or increase the line of credit?
  4. If he can’t deduct $5,000 or, say, even $9,000, do I increase the book cash to show a zero balance and reduce expenses by $5,000?

Here’s how this works:

  1. If the checks are honored, the monies are deductible.
  2. If the checks are not paid because of insufficient funds, the courts have disallowed the expenses.

In the S corporation balance sheet, use zero for cash and report the overdraft in the current liabilities section and title it “cash overdraft” or “checks written in excess of cash balance.” 

There’s no room for this title on the 1120S tax return balance sheet, so label it in a statement attached to the return.

As with many tax compliance issues, the important thing to keep in mind is to properly report the transactions to avoid unnecessary IRS scrutiny.

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Copyright © 2019. www.jsanchezcpa.com/blog

 

 

Tax Cuts and Jobs Act Employers

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Tax Cuts and Jobs Act Employers

The Tax Cuts and Jobs Act is the biggest federal tax law change in over 30 years. Below are some significant changes affecting employers. Note: Except where noted, the changes are effective for tax years 2018– 2025.

Certain Fringe Benefits Modified

Prior Law. Generally, a deduction has been allowed for an activity (or facility used in connection with the activity) considered to be entertainment, amusement, or recreation that was directly related to the active conduct of an employer’s business when the expense was included in an employee’s gross income as taxable wages, or otherwise excludable as a fringe benefit.
For example, the cost of employer-provided qualified transportation fringe benefits, such as parking, transit passes, and vanpool benefits was deductible by the employer and excluded from the employee’s W-2 wages.
Another example applies to meals furnished to an employee for the convenience of the employer that are provided on the employer’s business premises. Such costs are deductible by the employer and excluded from the employee’s W-2 income.

Entertainment Expense Deduction
The new law provides that no deduction is allowed with respect to:
• An activity generally considered to be entertainment, amusement or recreation,
• Membership dues with respect to any club organized for business, pleasure, recreation or other social purposes, or
• A facility or portion thereof used in connection with any of the above items.
The new law does not apply to certain exceptions including expenses for recreational, social, or similar activities

primarily for the benefit of employees (other than highlycompensated employees).
Food and beverage expenses related to entertainment may be deductible if the entertainment (e.g. ticket to an event) and the food and beverage expenses are either paid for separately or separately stated on the invoice for the entertainment.

Transportation Benefits
The new law disallows a deduction for expenses associated with providing any qualified transportation fringe benefit to employees of the taxpayer, and except as necessary for ensuring the safety of an employee, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment.

Meals
Employers may still generally deduct 50% of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel). The new law expands this 50% limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer (such as an in-house cafeteria).

Bicycle Commuting Reimbursement
Prior Law. Qualified bicycle commuting reimbursements of up to $20 per month were excludible from an employee’s gross income.
New Law. The bicycle commuting reimbursement exclusion is repealed. Any reimbursements are taxable to the employee.

Tax-savings tips

Tax Cuts and Jobs Act Employers

Employee Achievement Awards
Prior Law. Generally, an employer’s deduction for the cost of an employee achievement award was limited and excludible from an employee’s gross income (and for employment tax purposes). An employee achievement award is an item of tangible personal property given to an employee in recognition of either length of service or safety achievement and presented as part of a meaningful presentation.
New Law. The new law clarifies items that may not be deductible as achievement awards. Tangible personal property shall not include cash, cash equivalents, gift cards, gift coupons or gift certificates (other than arrangements conferring only the right to select and receive tangible personal property from a limited array of items pre-selected or pre-approved by the employer), or vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items.

Other Deductions Modified

Sexual Harassment or Sexual Abuse Settlements
A taxpayer generally is allowed a deduction for ordinary and necessary expenses paid or incurred in carrying on any trade or business. However, certain exceptions apply. No deduction is allowed for:
• Any charitable contribution or gift that would be allowable as a deduction were it not for the percentage limitations, the dollar limitations, or the requirements as to the time of payment,
• Any illegal bribe, illegal kickback, or other illegal payment,
• Certain lobbying and political expenditures,
• Any fine or similar penalty paid to a government for the violation of any law,
• Two-thirds of treble damage payments under the antitrust laws,
• Certain foreign advertising expenses,
• Certain amounts paid or incurred by a corporation in connection with the reacquisition of its stock or of the stock of any related person, or

• Certain applicable employee remuneration.

The new law adds the following to the list of non-deductible expenses:
• No deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.

New Credit

Credit for Paid Family and Medical Leave
The new law allows eligible employers to claim a general business credit equal to 12.5% of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave if the rate of payment under the program is at least 50% of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%. The maximum amount of family and medical leave that may be taken into account with respect to any employee for any tax year is 12 weeks.
An eligible employer is one who has in place a written policy that allows all qualifying full-time employees not less than two weeks of annual paid family and medical leave, and who allows all less-than-full-time qualifying employees a commensurate amount of leave on a pro rata basis. For purposes of this requirement, leave paid for by a state or local government is not taken into account.
A qualifying employee means any employee who has been employed by the employer for one year or more, and who for the preceding year, had compensation not in excess of 60% of the compensation threshold for highly compensated employees ($125,000 for 2019 × 60% = $75,000).
If an employer provides paid leave as vacation leave, personal leave, or other medical or sick leave, this paid leave would not be considered to be family and medical leave. The credit does not apply to wages paid in tax years beginning after 2019.

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Copyright © 2019 Tax Materials, Inc.
All Rights Reserved

Tax Cuts and Jobs Act Excess Business Loss and Net Operating Loss (NOL)

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Tax Cuts and Jobs Act Excess Business Loss and Net Operating Loss (NOL)

The Tax Cuts and Jobs Act is the biggest federal tax law change in over 30 years. Below are significant changes affecting excess business losses and net operating losses (NOLs) for noncorporate taxpayers. Note: Except where noted, the changes are effective for tax years 2018–2025.

Excess Business Loss Limitation

Your overall business losses may be limited as you cannot deduct an excess business loss in the current year. An excess business loss is the amount by which your total deductions from all of your trades or businesses are more than your gross income or gains from all of your trades or businesses, plus a threshold amount. For 2019, the threshold amount is $255,000 ($510,000 if Married Filing Jointly). Any disallowed excess business loss is treated as a net operating loss (NOL) carryforward, subject to the NOL rules. See How to Use an NOL, later.

Example: George has $500,000 of gross income and $800,000 of deductions from his retail furniture business. His excess business loss is $45,000 [$800,000 – ($500,000 + $255,000)]. George must treat his excess business loss of $45,000 as an NOL carryforward to 2020.

Pass-Through Entities
For pass-through entities (partnerships and S corporations), the excess loss limit applies at the partner and shareholder level. Each partner’s or shareholder’s share of the items of income, gain, deduction, or loss of the partnership or S corporation is taken into account by the partner or shareholder in applying the excess business loss limitation.

Passive Activity Loss Rules
The excess business loss limit is applied after the passive loss rules. Under the passive activity rules, losses and expenses attributable to passive activities may only be deducted from passive activities. Generally, passive activities are those in which a taxpayer may own an interest in the business, but does not materially participate. Some activities are considered passive by default, such as rental activities.

Net Operating Loss (NOL)

A net operating loss (NOL) generally means the amount by which a taxpayer’s business deductions exceed gross income.
An individual, estate, or trust may have an NOL if deductions for the year exceed income. NOLs are caused
by losses from the following:
• Trade or businesses (Schedules C and F losses, or Schedule K-1 losses from partnerships or S corporations),
• Casualty and theft losses (whether personal or business), and
• Rental property (Schedule E).

Individual NOL
An individual may have an NOL if adjusted gross income (AGI) minus the standard deduction or itemized deductions is a negative amount, and the negative amount is due to business deductions exceeding business income.

Estate or Trust NOL
An estate or trust may have an NOL if the taxable income line on Form 1041, U.S. Income Tax Return for Estates and Trusts, is a negative amount, and the negative amount is due to business deductions exceeding business income.

Tax-savings tips

Tax Cuts and Jobs Act Excess Business Loss and Net Operating Loss (NOL)

How to Use an NOL
Once the NOL has been calculated for the tax year, the NOL deduction is limited to 80% of taxable income and may not be carried back to any previous year. The remaining NOL is carried forward to the following year. If not used up in that year, it continues to be carried forward until it is used up. For farming loss NOLs, the default rule is to carry the NOL back two years, but an  election may be made to waive the carryback period.

NOL Carryback and Carryforward
Default rule. The NOL deduction is limited to 80% of taxable income (taxable income for the year in which it is carried to, determined without regard to the NOL deduction), which means an NOL cannot completely zero out taxable income. This 80% limitation does not apply to a property and casualty insurance company.
Note: When computing a taxpayer’s NOL, the 20% qualified business income deduction is not taken into account.
Carryback. The option to carry back an NOL is disallowed for most taxpayers. Exceptions apply to certain farming losses and NOLs of nonlife insurance companies.
Exception: Farming loss. A farming loss is the smaller of the NOL for the tax year or the NOL computed considering only farming income and deductions, and has a 2-year carryback. An election may be made to waive the carryback period.
Note: NOLs arising in tax year 2019 are limited by the excess business loss limitation rule, so the NOL carryback will not exceed $255,000 ($510,000 for joint returns).
Exception: Property and casualty

insurance companies. Applies to insurance companies other than a life insurance company, and an NOL has a 2-year carryback period. An election may be made to waive the carryback period.

Carryforward. In general, an NOL carryforward is adjusted to take into account the 80% of taxable income limitation and may be carried forward indefinitely (until used up).
Exception: Property and casualty insurance companies. An NOL carryforward is limited to 20 years and the 80% limitation does not apply.

Where to report the NOL in a carryback or carryforward year. The NOL deduction is listed as a negative number as Other Income on Form 1040, with a statement attached that shows how the NOL deduction was computed. If more than one NOL is deducted in the same year, the statement must cover each NOL.

How to Calculate an NOL Carryforward
The NOL that is more than 80% of taxable income for the year is an NOL carryforward. Certain modifications must be made to taxable income to determine how much NOL will be used up in that year and how much may be carried over to the next tax year. The carryforward is the excess of the NOL deduction over modified taxable income for the carryback or carryforward year. If the NOL deduction includes more than one NOL, apply the NOLs against modified taxable income in the same order they were incurred, starting with the earliest.
Additionally, if an NOL consists of both a farming loss and a non-farming loss, the losses should be treated separately and the farming loss is treated as a separate NOL and taken into account only after the non-farming NOL is applied

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Copyright © 2019 Tax Materials, Inc.
All Rights Reserved

Tax Cuts and Jobs Act Qualified Business Income Deduction

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Tax Cuts and Jobs Act Qualified Business Income Deduction

The Tax Cuts and Jobs Act is the biggest federal tax law change in over 30 years. Below is a significant change affecting qualified business income from a partnership, S corporation, LLC, or sole proprietorship. Note: Except where noted, the change is effective for tax years 2018–2025.

Qualified Business Income (QBI) Deduction

An individual taxpayer generally may deduct 20% of qualified business income from a partnership, S corporation, LLC, or sole proprietorship. In the case of a partnership or S corporation, the deduction applies at the partner or shareholder level. The business must be conducted within the United States. Special rules apply to specified agricultural or horticultural cooperatives.
The QBI deduction reduces taxable income, not adjusted gross income (AGI), so the QBI deduction does not affect limitations based on AGI. Also, it does not reduce selfemployment income (or self-employment tax). The deduction is available to both non-itemizers and itemizers.
A limitation based on Form W-2 wages and capital of the business is phased in when the taxpayer’s taxable income (computed without regard to the deduction) exceeds a threshold amount.
When a taxpayer’s taxable income exceeds the top of the threshold amount phase-in range, the QBI deduction is disallowed with respect to specified service trades or businesses.

Threshold Amount

Qualified business income is subject to

limitations for individuals with taxable income exceeding the threshold amount. Taxpayers above the threshold amount must apply a limitation, which reduces the QBI deduction. A taxpayer under the threshold amount does not apply any limitation.

Form W-2 Wages/Property Limitation

If taxable income is at least $50,000 above the threshold ($100,000 for MFJ), the 20% qualified business income deduction cannot exceed the Form W-2 wages/qualifying property limit.
The Form W-2 wages/qualifying property limit is the greater of:
• 50% of the Form W-2 wages paid by the business, or
• The sum of 25% of the Form W-2 wages paid by the business, plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property of the business.

Example: Mike operates a sole proprietorship that makes beef jerky. His qualified business income for 2019 was $180,000 and his taxable income is $225,000. The business bought a new high-tech dehydrator for $100,000 and placed the dehydrator in service in 2019. Mike has one employee and paid total wages of $20,000 for the year.

Tax Cuts and Jobs Act Qualified Business Income Deduction

Mike’s business income deduction is $10,000, which is the lesser of:
• 20% of his business income ($36,000), or
• W-2 wages/property limit ($10,000), which is the greater of:
– 50% of W-2 wages ($20,000 × 50% = $10,000), or
– Sum of 25% of W-2 wages ($5,000) plus 2.5% of the basis of the dehydrator ($100,000 × 2.5% = $2,500), which equals $7,500.

Qualified Trade or Business

A qualified trade or business means any trade or business other than a specified service trade or business, and other than the trade or business of being an employee. However, the specified service trade or business exclusion from the definition of a qualified trade or business is phased-in for taxpayers that exceed the threshold amount. It does not apply to taxpayers below the threshold amount.

Specified service trade or business. A specified service trade or business means any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, 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, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities.
The law specifically excludes engineering and architecture services from the definition of a specified service trade or business.
If taxable income is at least $50,000 above the threshold ($207,500), all of the net income from a specified service trade or business is excluded from qualified business income.
If taxable income is between $157,500 and $207,500, the amount excluded is

computed by determining a percentage that reflects the excess of taxable income over $157,500 ($315,000 MFJ) in a fraction over $50,000 ($100,000 MFJ).

Example: June is an attorney with taxable income of $178,200. Her qualified business income is $150,000. Her business is a specified service business and her taxable income is over the threshold amount ($160,700), therefore her qualified business income deduction is limited. Her phase-in reduction is computed:
$178,200 – $160,700 = $17,500/$50,000 = 35%
Qualified business income of $150,000 is reduced by $62,370 ($178,200 × 35%) which equals $87,630.
June’s qualified business deduction is $17,526 ($87,630 × 20%).

Qualified Business Income

Qualified business income is determined separately for each qualified trade or business of the taxpayer. Qualified business income means the net amount of qualified items of income, gain, deduction, and loss with respect to a domestic qualified trade or business of the taxpayer. It also includes gain from the sale of a partnership interest to the extent the gain is treated as gain from a sale of property other than a capital asset.
Qualified business income does not include:
• Specified investment-related items of income, deductions, or loss (dividends, interest, long-term capital gains and losses, annuities).
• Any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer.
• A reasonable amount of guaranteed payments for services rendered by a partner.
• Wage income.
If the net amount of qualified business income from all qualified trades or businesses during the taxable year is a loss, it is carried forward. Any deduction allowed in a subsequent year is reduced (but not below zero) by 20% of any carryover qualified business loss.

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Tax Cuts and Jobs Act Corporations

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Tax Cuts and Jobs Act Corporations

The Tax Cuts and Jobs Act is the biggest federal tax law change in over 30 years. Below are some significant changes affecting corporations. Note: Except where noted, the changes are effective for tax years 2018–2025.

Corporation Tax Rates

Changes have been made to the corporation tax rates, which under prior law contained several graduated tax brackets. For tax years beginning after 2017:
• All taxable income of a C corporation is taxed at a flat tax rate of 21%.
• There is no longer a separate tax rate for a personal service corporation (PSC). Previously, a PSC paid a flat 35% tax rate on all taxable income.
• There is no longer a separate maximum tax rate on net long-term capital gains. All corporation income is taxed at 21%.
• The allowable deduction for dividends received from other taxable domestic corporations has been reduced from 70% to 50% of the dividends received, and for a 20% owned corporation the percentage has been reduced from 80% to 65%. Shareholders of surrogate foreign corporation are not eligible for the reduced rate on dividends.

Alternative Minimum Tax (AMT)

Prior Law. AMT was imposed on a C corporation to the extent the corporation’s tentative minimum tax exceeded its regular tax. This tentative minimum tax was computed at the rate of 20% on alternative minimum taxable income (AMTI) in excess of a $40,000 exemption amount that phased out. A corporation with average gross receipts of less than $7.5 million for the prior three tax years was exempt from the corporate AMT.

The $7.5 million threshold was reduced to $5 million for the corporation’s first three-taxable year period.
If a corporation was subject to AMT in any year, the amount of AMT was allowed as an AMT credit in any subsequent tax year to the extent the taxpayer’s regular tax liability exceeded its tentative minimum tax in the subsequent year. Corporations were allowed to claim a limited amount of AMT credits in lieu of bonus depreciation.
New Law. Effective for tax years after 2017, the AMT for corporations is repealed.
AMT credits are allowed to offset the regular tax liability for any tax year. In addition, the AMT credit is refundable for any tax year 2018 through 2020 in an amount equal to 50% of the excess of the minimum tax credit for the tax year over the amount of the credit allowable for the year against regular tax liability. For tax year 2021, the 50% refundable amount is increased to 100%. So, the full amount of any minimum tax credit remaining will be allowed in full for a tax year beginning in 2021.

Accounting Methods

Prior Law. Under the general rule, the accrual method of accounting was required for purchases and sales if it was necessary to keep an inventory in order to clearly reflect income. An exception applied if average annual gross receipts were $1 million or less and the cash method was allowed even if inventories were kept. However, a deduction for inventory costs was not allowed until the inventory item was sold or paid for, whichever was later. If average annual gross receipts were $10 million or less, service type industries could use the cash method even if inventories were kept.

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Tax Cuts and Jobs Act Corporations

Farming C corporations and farming partnerships with C corporation partners (except family farming C corporations) were required to use the accrual method if average annual gross receipts were over $1 million. Family farming C corporations and family farming partnerships with C corporation partners were not required to use the accrual method until average annual gross receipts exceeded $25 million.

New Law. Effective beginning in 2018, the new law expands the number of taxpayers that may use the cash
method of accounting.
The cash method of accounting may be used by taxpayers, other than tax shelters, that satisfy the gross receipts test (average annual gross receipts that do not exceed a threshold amout for the three prior tax-year period), regardless of whether the purchase, production, or sale of merchandise is an income-producing factor. The threshold amount is indexed for inflation for tax years beginning after 2018.
For taxable years beginning in 2019, a corporation or partnership meets the gross receipts test if the average annual gross receipts of the entity for the three prior tax-year period do not exceed $26 million.
The new law retains the exceptions from the required use of the accrual method for qualified personal service corporations (PSCs) and taxpayers other than C corporations. PSCs, partnerships without C corporation partners, S corporations, and other pass-through entities are allowed to use the cash method without regard to whether they meet the gross receipts test, as long as the use of such method clearly reflects income. C corporations, in contrast, that do not meet the gross receipts test are required to use the accrual method.

S Corporation Conversion to C Corporation

IRC section 481 prescribes the rules in computing taxable income when a different accounting method was used in a prior year. For example, if an S corporation that was permitted to use the cash method of accounting converts to a C corporation that is required to use the accrual method of accounting, the conversion would result in a change of accounting method which could trigger the IRC section 481 rules.
In computing taxable income for the year of change, an adjustment is made to prevent items of income or expense from being duplicated or omitted. The year of change is the tax year for which the taxable income of the taxpayer is computed under a different method than the prior year.

Prior Law. Net adjustments that decreased taxable income generally were taken into account entirely in the year of change, and net adjustments that increased taxable income generally were taken into account ratably during the four-taxable-year period beginning with the year of change.

New Law. Effective December 22, 2017, any IRC section 481(a) adjustment of an eligible terminated S corporation attributable to the revocation of its S corporation election (i.e., a change from the cash method to an accrual method) is taken into account ratably during the six-taxable-year period beginning with the year of change. An eligible terminated S corporation is any C corporation which:
• Is an S corporation on December 21, 2017,
• During the 2-year period beginning on December 22, 2017, revokes its S corporation election under IRC section 1362(a), and
• All of the owners on the date the S corporation election is revoked are the same owners (and in identical proportions) as the owners on December 22, 2017.

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