Saturday, December 30, 2017

Happy New Year!

Happy New Year everyone!  See you in 2018

Thursday, December 28, 2017

Late S Election for a corp that did not file the S election timely

Rev. Proc. 2013-30 facilitates the grant of relief to late-filing entities by consolidating numerous other revenue procedures into one revenue procedure and extending relief in certain circumstances. This procedure provides guidance for relief for late:

  • S corporation elections,
  • Electing Small Business Trust (ESBT) elections,
  • Qualified Subchapter S Trust (QSST) elections,
  • Qualified Subchapter S Subsidiary (QSub) elections, and
  • Corporate classification elections which the entity intended to take effect on the same date that the S corporation election would take effect.
Generally, the relief under the revenue procedure can be granted when the entity fails to qualify solely because it failed to file the appropriate election under Subchapter S timely with the applicable IRS Campus and all returns reported income consistently as if the election was in effect. Please note that for purposes of this guidance, the “effective date” is the date the election is intended to be effective.

In addition, the revenue procedure also increases the timeframe that allows relief, from 24 months from the due date of the election, to 3 years and 75 days of the effective date of the election. 

To assist in determining if an entity qualifies for late election relief, Rev. Proc. 2013-30 includes flow charts, as well as specific guidance for each of the five categories listed above.

If an entity does not qualify for relief under Rev. Proc. 2013-30, the entity may request relief by requesting a private letter ruling. The procedural requirements for requesting a letter ruling and the associated fees are described in Rev. Proc. 2016-1 (PDF) (or its successor).

Again, it is important to know that Rev. Proc. 2013-30 relief is only for late elections that would otherwise be valid. For example, the S election must still contain signatures from all of the shareholders. Also, if there was an invalid shareholder or the corporation was not qualified during any part of the tax year, the S election is not valid for that year. However, for certain inadvertent invalid S corporation elections or QSub elections, relief may be obtained from National Office under IRC §1362(f). 

General Relief Rules for S Corporation Elections

The following requirements must be met in order to qualify for late S corporation election relief by a corporation or entity classified as a corporation:

  • The entity intended to be classified as an S corporation, is an eligible entity, and failed to qualify as an S corporation solely because the election was not timely;
  • The entity has reasonable cause for its failure to make the election timely;
  • The entity and all shareholders reported their income consistent with an S corporation election in effect for the year the election should have been made and all subsequent years; and
  • Less than 3 years and 75 days have passed since the effective date of the election (See the Exception to the 3 Years and 75 Day Rule section below).
In addition, if the electing entity is requesting a late corporate classification election to be effective on the same date that the S corporation election was intended to be effective, the requesting entity must also meet the following additional requirements:

  • The entity is an eligible entity as defined in Treas. Reg. § 301.7701-3(a);
  • The entity failed to qualify as a corporation solely because Form 8832 was not timely filed; and
  • The entity timely filed all required federal tax returns consistent with its requested classification as an S corporation.
If the entity qualifies and files timely in accordance with Rev. Proc. 2013-30, the Campus can grant late election relief. If the entity does not qualify under the provisions of the Revenue Procedure, its only recourse is to request a private letter ruling.   

Exception to the 3 Years and 75 Days Rule

Certain entities can qualify for the exception to the 3 years and 75 day rule when:

  • The entity is a corporation (i.e., not an LLC seeking an entity classification election);
  • The entity failed to qualify as an S corporation solely because the election was not timely field;
  • The corporation and all its shareholders reported their income consistent with S corporation status for the year the S election should have been made and for every subsequent taxable year (if any);
  • At least 6 months has elapsed since the date on which the corporation filed its tax return for the first year the corporation intended to be an S corporation;
  • Neither the corporation nor any of its shareholders was notified by the IRS of any problems regarding the S corporation status within 6 months of the date on which the Form 1120S for the first year was timely filed; and
  • The completed Election form includes the statements as described in the revenue procedure.  
Although this exception exists, it is unlikely many situations will qualify since the current system is set up to notify the corporation of the problem with its filing requirement when the return rejects in processing. It could apply to a case where it did not go through normal processing.

Thursday, December 21, 2017

2017 Tax Law and 34 effects of the new tax law

It's official. Congress has ushered through the first major tax overhaul since Ronald Reagan was president.

The measure, which now awaits President Trump's signature, is about to shake up life for millions of Americans. It will redistribute the country's wealth. It could sway decisions about whether to buy a home, or where to send kids to school. It could even affect when unhappy couples decide to get a divorce.
As the bill becomes law, here are 34 things you need to know.

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1. This is the first significant reform of the U.S. tax code since 1986.
Reagan signed major legislation for corporations and individuals in 1986. Since then, serious tax reform has eluded Republicans, though they repeatedly called for it as the tax code became longer and more arcane.
2. Changes have been made to both individual and corporate tax rates.
Individual provisions in the new legislation technically expire by the end of 2025, though some people expect that a future Congress won't actually let them lapse. Most of the corporate provisions are permanent.
3. Tax reform will increase deficits by $1.46 trillion over the next decade.
That's the net number that's been crunched by the nonpartisan Joint Committee on Taxation. The future law's contribution to the debt will likely be even higher if individual tax cuts are re-upped in eight years.
4. There are still seven tax brackets for individuals, but the rates have changed.
Americans will continue to be placed in one of seven tax brackets based on their income. But the rates for some of these brackets have been lowered. The new rates are: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Find out where you fit here.
5. The standard deduction has essentially been doubled.
Republicans want fewer people to itemize their taxes. To achieve this, they've nearly doubled the standard deduction. For single filers, the standard deduction has increased from $6,350 to $12,000; for married couples filing jointly, it's increased from $12,700 to $24,000.
6. The personal exemption is gone.
Previously, you could claim a $4,050 personal exemption for yourself, your spouse and each of your dependents, which lowered your taxable income. No longer. For some families, the elimination of the personal exemption will reduce or negate the tax relief they get from other parts of the reform package.
7. The state and local tax deduction now has a cap.
The state and local tax deduction, or SALT, remains in place for those who itemize their taxes -- but now there's a $10,000 cap. Previously, filers could deduct an unlimited amount for state and local property taxes, plus income or sales taxes.
8. The child tax credit has been expanded.
The child tax credit has doubled to $2,000 for children under 17. It's also now available, in full, to more people. The entire credit can be claimed by single parents who make up to $200,000, and married couples who make up to $400,000.
9. There's a new tax credit for non-child dependents, like elderly parents.
Taxpayers may now claim a $500 temporary credit for non-child dependents. This can apply to a number of people adults support, such as children over age 17, elderly parents or adult children with a disability.
10. Fewer people will have to deal with the alternative minimum tax.
The alternative minimum tax, a parallel tax system that ensures people who receive a lot of tax breaks still pay some federal income taxes, remains in place for individuals. But fewer people will have to worry about calculating their tax liability under the AMT moving forward. The exemption has been raised to $70,300 for singles, and to $109,400 for married couples.
11. And the mortgage interest deduction has been lowered.
Current homeowners are in the clear. But from now on, anyone buying a new home will only be able to deduct the first $750,000 of their mortgage debt. That's down from $1 million. This is likely to affect people looking for homes in more expensive coastal regions.
12. None of this will affect your 2017 taxes.
Americans won't need to worry about these changes when they start filing their 2017 tax returns in about a month. The new laws will first be applied to 2018 taxes.
13. By the way, you can still deduct student loan interest.
The deduction for student loan interest, which is up to $2,500 per year, is safe.
14. You can still deduct medical expenses.
The deduction for medical expenses wasn't cut. In fact, it's been expanded for two years. In that time, filers can deduct medical expenses that add up to more than 7.5% of adjusted gross income. In the past, the threshold for most Americans was 10% of adjusted gross income.
15. If you're a teacher, you can still deduct classroom supplies.
The deduction for teachers who spend their own money on school supplies was left alone. Educators can continue to deduct up to $250 to offset what they spend on classroom materials.
16. The electric car tax credit lives on.
Drivers of plug-in electric vehicles can still claim a credit of up to $7,500. Just as before, the full amount is good only on the first 200,000 electric cars sold by each automaker. GM, Nissan and Tesla are expected to reach that number some time next year.
17. Home sellers who turn a profit keep their tax break.
Homeowners who sell their house for a gain will still be able to exclude up to $500,000 (or $250,000 for single filers) from capital gains, so long as they're selling their primary home and have lived there for two of the past five years.
18. 529 savings accounts can be used in new ways.
In the past, funds invested in 529 savings accounts wasn't taxed -- but it could only be used for college expenses. Now, up to $10,000 can be distributed annually to cover the cost of sending a child to a "public, private or religious elementary or secondary school." This change is a win for Education Secretary Betsy DeVos.
19. And tuition waivers for grad students remain tax-free.
Graduate students still won't have to pay income taxes on the tuition waiver they get from their schools. Such waivers are typically awarded to teaching and research assistants.
20. But say goodbye to the tax deduction for alimony payments.
Alimony payments, which are codified in divorce agreements and go to the ex-spouse who earns less money, are no longer deductible for the person who writes the checks. This provision will apply to couples who sign divorce or separation paperwork after December 31, 2018.
21. The deduction for moving expenses is also gone ...
There may be some exceptions for members of the military. But most people will no longer be able to deduct the cost of their U-Haul when they move for work.
22. As is the tax preparation deduction ...
Before tax reform passed, people could deduct the cost of having their taxes prepared by a professional, or the money they spent on tax prep software. That break has been eliminated.
23. ... The disaster deduction ...
Losses sustained due to a fire, storm, shipwreck or theft that aren't covered by insurance used to be deductible, assuming they exceeded 10% of adjusted gross income. But now through 2025, people can only claim that deduction if they've been affected by an official national disaster. That would make someone whose house was destroyed by a California wildfire potentially eligible for some relief, while disqualifying the victim of a random house fire.
24. ... And the reimbursement for bicycle commuters.
The tax code used to let you to knock off up to $20 from your income per month for the costs of bicycle commuting to work, assuming you weren't enrolled in a commuter benefit program. That's gone.
25. Almost everyone is now exempt from the estate tax.
Before tax reform, few estates were subject to the estate tax, which applies to the transfer of property after someone dies. Now, even fewer people have to deal with it. The amount of money exempt from the tax -- previously set at $5.49 million for individuals, and at $10.98 million for married couples -- has been doubled.
26. Adjustments for inflation will be slower.
The new legislation uses "chained CPI" to measure inflation. It's a slower measure than what was used before. Over time, that will raise more money for the federal government, but deductions, credits and exemptions will be worth less.
27. Oh, and the individual mandate on health insurance has been scrapped.
Republicans failed to repeal Obamacare earlier this year, but they managed to get rid of one of the health law's key provisions with tax reform. The elimination of the individual mandate, which penalizes people who do not have health care, goes into effect in 2019. The Congressional Budget Office has predicted that as a result, 13 million fewer people will have insurance coverage by 2027, and premiums will go up by about 10% most years.
28. You won't be able to file your tax return on a postcard.
Trump said H&R Block would go out of business after tax reform because filing taxes would become so simple. Not quite. While doubling the standard deduction will ease the process for some individuals, there's still a web of deductions and credits to work through. And for small businesses, filing could become even more complicated.
29. The corporate tax rate is coming down.
The corporate tax rate has been cut from 35% to 21% starting next year. The alternative minimum tax for corporations has been thrown out altogether. Earnings are expected to go up as a result.
30. Pass-through entities will also get a break.
The tax burden by owners, partners and shareholders of S-corporations, LLCs and partnerships -- who pay their share of the business' taxes through their individual tax returns -- has been lowered via a 20% deduction. The legislation includes a rule to ensure owners don't game the system, but tax experts remain concerned about abuse of this provision.
31. Not all CEOs think they'll use their savings to create jobs, though.
Just 14% of CEOs surveyed by Yale University said their companies plan to make large, immediate capital investments in the United States following tax reform. Capital investments, like building plants and upgrading equipment, can spur hiring.
32. Plus, the way multinational corporations are taxed is about to change.
The U.S. is switching to a territorial system of taxation, which means companies won't owe federal taxes on income they make offshore. To help the transition, companies will be required to pay a one-time, low tax rate on their existing overseas profits -- 15.5% on cash assets and 8% on non-cash assets, like equipment in which profits were invested.
33. By the way, there's a provision to rein in executive pay at nonprofits.
The legislation includes a new 21% excise tax on nonprofit employers for salaries they pay out above $1 million. That may mean some well-paid executives at nonprofits take a pay cut.
34. Businesses won't be able to write off sexual harassment settlements.
New Jersey Democratic Senator Bob Menendez's amendment born of the #MeToo moment made it all the way through. Companies can no longer deduct any settlements, payouts or attorney's fees related to sexual harassment if the payments are subject to non-disclosure agreements.
-- Thanks to CNNMoney With contributions from Jeanne Sahadi, Kathryn Vasel, Tami Luhby, Anna Bahney, Jackie Wattles, Katie Lobosco, Lydia DePillis and Matt Egan.

Monday, December 18, 2017

January 31 deadlines

Early Due Dates for W-2, W-3 and Form 1099-MISC
Employers face a January 31, 2018, due date for filing 2017 Forms W-2 and W-3 with the Social Security Administration. This date applies to both electronic and paper filers.
Form 1099-MISC is due to the IRS and individuals by January 31 when reporting non-employee compensation payments in box 7.
Penalties for failure to file correct information returns or furnish correct payee statements have increased and are now subject to inflationary adjustments. These increased penalties are effective for information returns required to be filed after December 31, 2015.

Form 1098-T Reporting Changes and Limited Penalty Relief for 2017 Returns
Eligible educational institutions are required to report the total amount of payments received for qualified tuition and related expenses from all sources during the calendar year on Form 1098-T, Tuition Statement.
Announcement 2016-42 provides relief from penalties under Section 6721 and 6722 to 2017 Forms 1098-T. The IRS will not impose penalties on eligible education institutions that report the aggregate amount billed (instead of amount received) for qualified tuition and related expenses on 2017 Form 1098-T.  

Thursday, December 14, 2017

Standard Mileage Rates for 2018

Standard Mileage Rates for 2018 Up from Rates for 2017 
WASHINGTON ― The Internal Revenue Service today issued the 2018 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.
Beginning on Jan. 1, 2018, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:
  • 54.5 cents for every mile of business travel driven, up 1 cent from the rate for 2017.
  • 18 cents per mile driven for medical or moving purposes, up 1 cent from the rate for 2017.
  • 14 cents per mile driven in service of charitable organizations.
The business mileage rate and the medical and moving expense rates each increased 1 cent per mile from the rates for 2017. The charitable rate is set by statute and remains unchanged.
The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs.
Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.
A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle. In addition, the business standard mileage rate cannot be used for more than four vehicles used simultaneously.  These and other requirements are described in Rev. Proc. 2010-51.
Notice 2018-03, posted today on, contains the standard mileage rates, the amount a taxpayer must use in calculating reductions to basis for depreciation taken under the business standard mileage rate, and the maximum standard automobile cost that a taxpayer may use in computing the allowance under a fixed and variable rate plan. 

Wednesday, December 13, 2017

Getting ready to file taxes in the new year

Resources on Help Taxpayers Get Ready to File Taxes
With the tax filing season right around the corner, the IRS encourages taxpayers to visit for tax tools and resources. Taxpayers can resolve nearly every tax issue on the IRS website. provides many self-service tools and features, including these six:

Thursday, December 07, 2017

IRS Phone numbers

Internal Revenue Service Phone Numbers
800-829-1040 For individual and joint filers who need procedural or tax law information and/ or  help to file their 1040-type IRS Tax Help Line for individual returns (including Individuals| Schedules C and E); and, general account information  for Form 1040 Filers. Automated Self-Service Interactive Applications are also offered on this line.
800-829-4933 For Small Businesses, Corporations, Partnerships and Trusts who need information and/or help related to their Business Returns or Business and Specialty (BMF) Accounts. Services cover  Tax Line [new]Employer Identification Numbers (EINs), 94x returns, 1041, 1065, 1120S, Excise Returns, Estate and Gift Returns, as well as issues related to Federal tax deposits.
800-829-1954 For 1040-type Individual and Joint Filers who need to check the status of their current year refund. Automated Refund Self-Service Interactive Refund Hotline [new] Applications are offered on this line NOTE: The "Where's my refund?" automated self- service feature is also available 24/7 at to obtain refund status information.
800-829-3676 For individuals, businesses and tax practitioners who need Forms and Publications IRS tax forms, instructions and related materials and tax publications.
877-777-4778 For taxpayers, whose tax problems have not been resolved through normal channels. Taxpayer Advocate Service (TAS) provides a National Taxpayer independent system to assure Advocate's Help Line that tax problems are promptly and fairly handled. TAS operates independently of any other IRS office and reports directly to Congress through the National Taxpayer Advocate.
800-829-4059 For hearing impaired taxpayers who need tax law and/or procedural information Telephone Device for relating to filing their the Deaf (TDD) returns or who need information and/or assistance relating to their accounts.
888-912-1227 For citizens who want to provide ideas and suggestions on how to improve IRS services Taxpayer Advocacy Panel or who want to make recommendations for improvement of IRS systems and procedures.
800-555-4477 For taxpayers who want to pay business or individual taxes through electronic funds or Electronic Federal Tax transfer. The EFTPS Toll-Free 800-945-8400 Payment System (EFTPS) numbers can provide callers Hotline with EFTPS enrollment forms, instructions and customer assistance.
877-829-5500 For taxpayers who need tax information or assistance relating to Tax Exempt or Tax Exempt - Government| Government Entities, Tax Entity (TEGE) Help Line, Exempt Bonds, Employer /Employee Pension Plans or Indian Tribal Agreements
800-829-4477 For individuals who need to check the status of their current year refund or who want to use the Tele-Tax System want to listen to recorded tax information. Available 24 hours a day, seven days a week.
888-796-1074 For individual filers who want a extension to File to submit an Extension to File Tele-File System for a 1040-series return via telephone.
State of California Phone Numbers
The State of California is not as friendly as the IRS. Here is the number they give you;
Get recorded answers, in English and Spanish, to common questions about California taxes and Homeowner and Renter Assistance 24 hours a day, seven days a week. Call:
  • (800) 338-0505 or (916) 845-6600 - use touch-tone telephone

Tuesday, December 05, 2017

Trump's tax overhaul and the congressional effect

While the GOP's vision of tax reform is largely uniform between the House and Senate bills, there are some significant differences that will need to be ironed out. Here are a just a few of the items that will have to be reconciled:
Individual Tax Rates4 brackets, top rate of 39.6%7 brackets, top rate of 38.5%
Child Tax Credit$1,600$2,000
Medical Expense DeductionEliminatedPreserved
Alimony DeductionEliminatedPreserved
Education IncentivesEliminatedPreserved
Alternative Minimum TaxEliminatedPreserved, but with larger exemption
Length of all Individual ChangesPermanentExpire at the end of 2025
Individual Insurance MandatePreservedEliminated
Estate TaxRepealed in 2023Preserved, but with a doubled
Corporate Tax Rate                     20% immediately
                  20% in 2019
Perhaps the most dramatic disparity, however, can be found in the way the respective bills treat the income of owners of S corporations and partnerships, so-called "flow through entities."
Taxation of Flow-Through Entities, In General 
As a general rule, S corporations and partnerships (think: an LLC) do not pay tax at the business level. Instead, the income of the business is chopped up and allocated among its owners, who report the income and pay the corresponding tax on their individual returns at ordinary tax rates, which under current law rise as high as 39.6%.
To the contrary, so-called C corporations do pay tax at the business level, at a top rate of 35% under current law. C corporations are, quite famously, subject to "double taxation," because after the corporation pays tax on its income when it's earned, the shareholders will pay tax on the same income a second time when it is distributed to the shareholders as a dividend (at at top rate of 23.8%).
The foundation of both the House and Senate tax proposals has been to reduce the corporate tax from 35% to 20%. But you can't do that without changing the treatment of pass-through businesses; after all, if you reduce the corporate rate to 20% but leave the income of S corporations and partnerships subject to tax at a top rate of 39.6% (or 38.5% in the case of the Senate bill), then the advantage previously afforded to flow-through entities relative to C corporations would be largely eliminated.
As a result, both the House and Senate bills attempt to confer a benefit on the owners of S corporations and partnerships in hopes of preserving the advantage they enjoy over C corporations. The two proposals address the issue in dramatically different ways, and based on an initial reading of the proposed legislation, a certain class of taxpayers could have a LOT at stake as Congress tried to determine which plan to adopt.
Who should be concerned? Owners of rental property who produce income, because the two proposals differ greatly in the way they treat so-called "passive income." But before we can understand the difference, we've got to get a handle on who would be impacted.
So what is passive income? To answer the question, we've got to go back in time 31 years...
Pre-1986: Tax Shelters For Everyone!
Prior to the Tax Reform Act of 1986, tax shelters were readily available to anyone with disposable income and the patience to be a landlord. Consider the following example:
In 1985, A, a doctor, expects to earn wages of $300,000. On January 1, 1985, in hopes of sheltering his wage income, A purchases a home as a rental property and rents the home at fair market value. The rental is low-maintenance, and A is rarely required to visit the property other than to collect the occasional check. By virtue of large depreciation deductions, the rental generates a sizeable net loss, which A uses to partially offset his wage income, significantly lowering his tax bill. It is a win-win situation for A; he generates losses largely through non-cash depreciation deductions, while all the while, the rental home is appreciating in value.
Post-1986: No Rental Losses for Anyone!
The Tax Reform Act of 1986 put an end to such shelters, however, with the enactment of Section 469. Effective for tax years beginning after December 31, 1986, a taxpayer’s loss from a “passive activity” can only be used to offset income from a “passive activity.” A passive activity is defined in part as:
  1. Any trade or business of the taxpayer in which the taxpayer does not “materially participate,” and
  2. Any rental activity of the taxpayer regardless of the taxpayer’s level of participation.
As a result of the treatment of all rental activities as passive activities, the doctor’s loss in the previous example from his rental home would be treated as a passive loss. And because the doctor’s wages are not treated as passive income, the rental loss could no longer be used to offset the doctor’s wage income.
Fast Forward to 2018
As the example involving the doctor illustrates, historically, we've been primarily concerned with whether an activity is passive when the activity produces losses, because those passive losses can only be used to offset passive income. Come January 1, 2018, however, taxpayers with passive income -- which as explained above, generally includes ALL RENTAL INCOME -- could suddenly have a lot at stake, depending on whether the House or Senate bill governing pass-through income triumphs in reconciliation.
To understand the impact, let's walk through a simply case study:
A owns 11 commercial properties together with another party, B. Each property is held in a separate LLC. In addition, A and B have formed a management company to oversee the 11 rental properties. Assume the following:
  1. A works 700 hours during the year, all in the management company. As a result, he will not qualify as a "real estate professional" (more on that here), and all rental income will thus be passive.
  2. The 11 commercial properties produce a total of $2 million of annual rental income to A. The LLCs the properties are housed in pay no wages or guaranteed payments.
The management company employs three people -- a controller, an accountant, and an administrative assistant -- who are paid annual wages totaling $200,000.
  • The management company breaks even each year, recognizing neither taxable income nor loss.
  • Treatment of A under the House Bill 
    The House version of HR 1 attempts to provide a benefit to the owners of S corporations and partnerships by providing that all "qualified business income" is eligible for a preferential top rate of 25%. That way, even with the C corporation rate coming down to 20%, owners of flow-through entities would retain their tax advantage by virtue of a top rate of 25%.
    While there are no shortage of ways to fail to qualify for that preferential rate, the proposed law makes one thing very clear: "qualified business income" includes all passive income. As a result, the $2 million of income A receives from his 11 commercial properties will be taxed at a top rate of 25%, so that A will pay a total tax bill of $500,000 (ignoring the lower graduated rates and the 3.8% net investment income tax that applies to all passive income above a threshold). Not a bad deal, when you consider that under current law, the income would be taxed at a top rate of 39.6% and produce a tax bill of nearly $800,000. Thus, if the House bill becomes law, A would save nearly $300,000 in tax, relative to current law.
    Treatment of A under the Senate Bill 
    Things would look drastically different for A, however, should the Senate's provision governing pass-through entities win out. The Senate proposal eschews a top tax rate in favor of a deduction; the owner of the pass-through entity would be entitled to deduct 23% of the income allocated to him or her from the business.
    But there's a catch. OK, to be fair, there's many a catch under these rules, but the one we're focused on right now is this: the owner of a pass-through business may only claim the 23% deduction up to a limit, equal to 50% of the W-2 wages (or partnership guaranteed payments) paid out by the business.
    [Two notes on this deduction: the wage limitation does not apply if the business owner's income is less than $250,000 (if single, $500,000 if married). In addition, owners of "personal service businesses" -- i.e., accounting, law and consulting firms, among others -- are not eligible for the 23% deduction unless income of the owner is less than $250,000 (if single, $500,000 if married.)]
    The purpose of the limitation is to attempt to prevent an owner of a business from forgoing compensation for services in favor of additional flow-through income that will be eligible for the new
    deduction. Let's leave A for a moment and consider this scenario:
    Assume X is the sole owner and employee of an S corporation. He provides significant services. The S corporation earns $1,000,000 annually. If X withdraws the $1,000,000 as a salary to compensate him for his services, the wages are taxed at ordinary rates as high as 38.5% under the Senate proposal, generating a tax of $385,000.
    Alternatively, to take advantage of the deduction offered by the Senate proposal, X could simply leave the $1,00,000 of income in the S corporation, to be taxed to X as "flow-through income." Barring a safeguard measure, X would be entitled to a 23% deduction against the income, reducing his taxable income to $770,000 and his tax bill from $385,000 to $296,450, a significant savings.
    The Senate proposal prevents such an abuse, however, by limiting X's deduction to 50% of the wages paid by the S corporation. In the second scenario, because X takes no wages in an attempt to abuse the system, X runs afoul of the "50% of W-2 wages" limitation, and the Senate bill allows for no deduction. Thus, X's flow-through income would remain $1,000,000 and his tax bill $385,000, just as it was when he withdrew the full $1,000,000 as wages.
    With that understood, let's go back to A, our well-to-do landlord. He has total rental income of $2,000,000, but his entities combine to pay out only $200,000 in W-2 wages; thus, the limitation looms large. Even worse, it appears the Senate bill looks at the wage limit on a business-by-business basis; as a result, because A's only business that pays wages is the management company -- which has no net income -- he would not be entitled to a deduction against that income. He would also not be entitled to a 23% deduction against the $2,000,000 of rental income, because those separate LLCs pay neither wages nor guaranteed payments.
    In summary, it appears that under the Senate bill, A would recognize $2,000,000 of passive rental income with no offsetting deduction, with the income taxed at the Senate's top rate of 38.5%, resulting in a tax bill of $770,000. If you're scoring at home -- or even if you're all alone -- that would represent an increase of $270,000 over the's $500,000 bill A had under the House version of HR 1.
    Putting it all Together 
    Could this be an accident? Or does the House bill purposefully cater to owners of rental properties by offering a no-questions-asked top rate of 25%, with the Senate bill doing just the opposite, making it nearly impossible for a rental owner to get the benefit of the 23% deduction by virtue of the fact that rental properties rarely pay wages or guaranteed payments?
    The answer? Who knows. This process has been so rushed on both sides, it is completely reasonable to suspect that this is simply an oversight, and the two chambers will give the issue the careful consideration it deserves in the weeks to come. And if the President has anything to say about it -- well, let's just remember that he stands to save a fortune should the House bill win out, as it would give him a 25% rate on all of his passive rental income.
    The treatment of a passive rental property owners is not the only hole that needs to be plugged in the treatment of flow-through entities, however. There is also potential for abuse under the Senate bill in the opposite scenario: an active owner of an S corporations or partnership that pays significant wages to non-owner employees.
    Follow along:
    Jerry X is the sole owner of America's Team, a once-proud NFL franchise that has slowly devolved into a glorified three-ring circus. Shoot, that's too obvious...let's call him Mr. Jones, instead. Yeah, that'll do it...
    Anyway, Mr. Jones is a VERY hands on owner. The team is housed in an S corporation, and generates $20,000,000 of income for Jones annually, after deducting $60,000,000 in salaries to players and team personnel. Traditionally, Jones has paid himself a salary of $10,000,000 and withdrawn the remaining $10,000,000 as a distribution.
    Assume the Senate bill and its 23% deduction triumphs and becomes law. If Mr. Jones does nothing different in 2018, his $10,000,000 salary will be taxed at ordinary rates of 38.5%, resulting in a tax liability of $3,850,000. Then, Mr. Jones will be entitled to a deduction of 23% against the $10,000,000 of flow-through income, leaving him with $7,700,000 of income and a tax bill of nearly $3,000,000 ($7,700,000 * 38.5%). Thus, total tax at the individual level would be $6,850,000. The deduction is allowed in full because the amount ($2,300,000) does not come close to hitting the limit of 50% of wages paid by the business ($30,000,000, or 50% of $60,000,000).
    But what prevents Mr. Jones from saving himself a bundle of tax by skipping the salary in 2018 and taking the full $20,000,000 out as earnings and distributions? He would still be entitled to a deduction of 23% against the $20,000,000 of income -- or $4,600,000-- because again, that amount would not run afoul of the "50% of W-2 wages" limitation.
    As a result, by virtue of the large salaries Mr. Jones pays to non-owners, he could convert salary taxed at ordinary rates into flow-through income eligible for a 23% deduction.
    This column, of course, is just scratching the surface in identifying problems with this last-minute legislation. It's been said before, but when you try to construct tax reform that is three decades in the making in the span of just four weeks, there will be some confusion. Some drafting orders. Some big, gaping loopholes just begging to be exploited.
    Thanks to Tony Nitti working with Forbes to put this information together!