Wednesday, October 31, 2018

Net Operating Loss under Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act (TCJA) brings significant changes to the tax code and offers new challenges for tax advisors. Those same challenges offer a number of benefits for taxpayers, especially business filers. However, it is best to temper a client’s expectations, as not every change introduced by the TCJA will benefit them.
Net Operating Losses (NOLs) are one of the changes that many may be disappointed to learn lessens a powerful benefit from the prior tax code. Let’s take a closer look at the changes that will have the greatest impact on tax planning for any client with a current or anticipated net operating loss for the upcoming tax year.

Change in NOL Calculation

Starting with tax years beginning after Dec. 31, 2017, IRC Sec. 172 limits NOLs by the changing how they are calculated.
IRC Sec. 172 (a)(1) and (2) state the current year NOL is: “…an amount equal to the lesser of the aggregate of …[Net Operating Loss] carryovers to such a year, plus …[NOL] carrybacks to such a year, or 80% of taxable income….”
NOLs are now less beneficial going forward, and for the current year, it would be best to advise any clients anticipating a net operating loss of this change soon to avoid any surprises at filing time.
On the other hand, a current-year deduction will now be more valuable for the same client than in years past; this offers a good planning opportunity for any tax advisor.
Also of note, this change will make it necessary to separately track any prior NOL a client has from any NOLs generated for future tax years. While many practitioners likely have already done so, this change will increase advisors’ bookkeeping responsibilities and can’t be overlooked.

Elimination of Two-Year Carryback

Another significant change is the elimination of the two-year carryback for NOLs, with exceptions for farming losses and non-life insurance companies. IRC Sec. 172 (b)(1)(A) states: “…except as otherwise provided … a net operating loss for any taxable year … shall not be a net operating loss carryback for any taxable year preceding the taxable year of such a loss, and shall be a net operating loss carryover to each taxable year following the taxable year of the loss.”
In other words, the TCJA has eliminated the carryback. For any clients depending on a carryback to provide a refund, it will be critical to advise them that this strategy is disallowed going forward. Note that the IRC makes no mention of the 20-year carryforward limitation, and does offset part of the loss of the two-year carryback.
Corporation XYZ, a calendar-year tax-filer, has an NOL of $45,490 in 2018. It has no other carryovers. XYZ’s only choice is to carry the NOL forward. In 2019, XYZ Corporation has taxable income of $50,000. XYZ's 2019 NOL deduction is limited to $40,000 ($50,000 × 80%). The remaining $5,490 is not deducted, but can be carried forward indefinitely.

Changes to Farming Losses and QBI Deduction

These are not the only changes to NOLs. Two of the most prominent involve farming losses and the new qualified business income (QBI) deduction introduce by IRC Sec. 199A.
Both IRC Sec. 172 (b)(1)(B) and (C) follow on from paragraph (A) and state that the losses of both farms and insurance companies (with the exception of life-insurance companies) may still utilize the two-year carryback to the extent of taxable income attributable to those activities. Both of these activity types are also limited to a carryforward of 20 years for any NOLs generated.
For non-corporate taxpayers, the 20 percent deduction of qualified business income deduction introduced by 199A is disallowed by IRC Sec. 172(d)(8) with regard to the calculation of any net operating losses.
The TCJA introduced many changes to the IRC, and while Sec. 172 is a small part, the changes mentioned above should serve to prepare tax advisors for just one part of what may be a challenging tax season.

Thanks to Mike D’Avolio, CPA, JD, is a senior tax analyst with Intuit ProConnect for this inforamtion.  ProConnect link is at:                     (Thanks to Noelle Fauver with InseevInteractive for the Link)

Thursday, October 18, 2018

Trump Tax Law for 2018

Personal Exemption and Phase-Out

Gone.  Previously the 2018 personal exemption rate was slated to me $4,150 but the new tax bill has removed this exemption entirely.

2018 Standard Deduction

The standard deduction is jumping A LOT this year.  Here are the standard deductions by tax filing status:
  • Married Filing Jointly/Surviving Spouse: $24,000
  • Heads of Households: $18,000
  • Single: $12,000
  • Married Filing Separately: $12,000

2018 Tax Brackets

So how much will you pay in taxes for 2018? Here’s how the tax rate is applied for the year. Remember, the income listed here is your taxable income–not your gross income.

Married Filing Jointly and Surviving Spouses

Taxable Income Taxes
Up to $19,050 10% of taxable income
Over $19,050 but not over $77,400 $1,905 plus 12% of excess over $19,050
Over $77,400 but not over $165,000 $8,907 plus 22% of the excess over $77,400
Over $165,000 but not over $315,000 $28,179 plus 24% of the excess over $165,000
Over $315,000 but not over $400,000 $64,179 plus 32% of the excess over $315,000
Over $400,000 but not over $600,000 $91,379 plus 35% of the excess over $400,000
Over $600,000 $161,379 plus 37% of the excess over $600,000

Heads of Households

Taxable Income Taxes
Up to $13,600 10% of taxable income
Over $13,600 but not over $51,800 $1,360 plus 12% of excess over $13,600
Over $51,800 but not over $82,500 $5,944 plus 22% of the excess over $51,800
Over $82,500 but not over $157,500 $12,698 plus 24% of the excess over $82,500
Over $157,500 but not over $200,000 $30,698 plus 32% of the excess over $157,500
Over $200,000 but not over $500,000 $44,298 plus 35% of the excess over $200,000
Over $500,000 $149,298 plus 37% of the excess over $500,000

Unmarried Individuals (other than Surviving Spouses and Heads of Households:

Taxable Income Taxes
Up to $9,525 10% of taxable income
Over $9,525 but not over $38,700 $952.50 plus 12% of excess over $9,525
Over $38,700 but not over $82,500 $4,453.50 plus 22% of the excess over $38,700
Over $82,500 but not over $157,500 $14,089.50 plus 24% of the excess over $82,500
Over $157,500 but not over $200,000 $32,089.50 plus 32% of the excess over $157,500
Over $200,000 but not over $500,000 $45,689.50 plus 35% of the excess over $200,000
Over $500,000 $150,689.50 plus 37% of the excess over $500,000

Married Individuals Filing Separately:

Taxable Income Taxes
Up to $9,525 10% of taxable income
Over $9,525 but not over $38,700 $952.50 plus 12% of excess over $9,525
Over $38,700 but not over $82,500 $4,453.50 plus 22% of the excess over $38,700
Over $82,500 but not over $157,500 $14,089.50 plus 24% of the excess over $82,500
Over $157,500 but not over $200,000 $32,089.50 plus 32% of the excess over $157,500
Over $200,000 but not over $300,000 $45,689.50 plus 35% of the excess over $200,000
Over $300,000 $80,689.50 plus 37% of the excess over $300,000

Gift Tax examined

The gift tax is a tax on the transfer of money or property to another person while getting nothing (or less than full value) in return.

Now, there are a lot of things to worry about in life, but the gift tax probably isn’t one of them.

Why? Because the IRS generally doesn’t care about what you give away to other people unless that giving exceeds some lofty amounts. And even if it does, it might mean you just have to fill out some paperwork.

Two things keep the IRS’ hands out of most people’s candy dish: the $15,000 annual exclusion and the $11.2 million lifetime exclusion (in 2018). Stay below those and you can be generous under the radar. Go above, and you’ll have to fill out a gift tax form when filing returns — but you still might avoid having to pay any gift tax.

How the annual gift tax exclusion works

  • You can give up to $15,000 to someone in a year and generally not have to deal with the IRS about it
  • If you give more than $15,000 in cash or assets (for example, stocks, land, a new car) in a year to any one person, you need to file a gift tax return. That doesn’t mean you have to pay a gift tax. It just means you need to file IRS Form 709 to disclose the gift.
  • The annual exclusion is per recipient; it isn’t the sum total of all your gifts. That means, for example, that you can give $15,000 to your cousin, another $15,000 to a friend, another $15,000 to the neighbor, and so on all in the same year without having to file a gift tax return.
  • The annual exclusion also is per person, which means that if you’re married, you and your spouse could give away a combined $30,000 a year to whomever without having to file a gift tax return
  • Gifts between spouses are unlimited and generally don’t trigger a gift tax return. Gifts to nonprofits are charitable donations, not gifts (read about how that works).
  • The person receiving the gift usually doesn’t need to report the gift

How the lifetime gift tax exclusion works

  • On top of the $15,000 annual exclusion, you get a $11.2 million lifetime exclusion. And because it’s per person, married couples can exclude double that in lifetime gifts. That comes in handy when you’re giving away more than $15,000.
  • “Think about buckets or cups,” says Christopher Picciurro, a certified public accountant and co-founder of accounting and advisory firm Integrated Financial Group in Michigan. Any excess “spills over” into the lifetime exclusion bucket.
  • For example, if you give your brother $50,000 this year, you’ll use up your $15,000 annual exclusion. The bad news is that you’ll need to file a gift tax return, but the good news is that you probably won’t pay a gift tax. Why? Because the extra $35,000 ($50,000 – $15,000) simply counts against your $11.2 million lifetime exclusion. Next year, if you give your brother another $50,000, the same thing happens: you use up your $15,000 annual exclusion and whittle away another $35,000 of your lifetime exclusion.
  • “What the gift tax return does is it keeps track of that lifetime exemption,” says Julie Malekhedayat, a CPA and principal at accounting and advisory firm Abbott, Stringham and Lynch in San Jose, California. “So if you don’t gift anything during your life, then you have your whole lifetime exemption to use against your estate when you die.”

The IRS generally doesn’t care about what you give away to other people unless that giving exceeds some lofty amounts. And even if it does, it might mean you just have to fill out some paperwork.

What is the gift tax rate?

If you’re lucky enough and generous enough to use up your exclusions, you may indeed have to pay the gift tax. The rates range from 18% to 40%, and the giver generally pays the tax. There are, of course, exceptions and special rules for calculating the tax, so see the instructions to IRS Form 709 for all the details.

What can trigger a gift tax return

Caring is sharing, but some situations often inadvertently trigger the need to file a gift tax return, pros say.

Spoiling the grandkids with college money

  • Picciurro explains it like this. “Let’s say Grandma and Grandpa say, ‘We don’t really like your husband and we don’t really like you, but we really like our grandkids. So we’re going to give $60,000 and we’re going to put it in a 529 plan for them so their college is paid for.’ Well, Grandma and Grandpa just triggered the gift tax exclusion because it’s over [$15,000].”
  • A special rule allows gift givers to spread one-time gifts across five years’ worth of gift tax returns to preserve their lifetime gift exclusion.

Springing for vacations, cars or other stuff

  • If you fork out $40,000 for Junior’s wedding, or just pay for the crazy-expensive honeymoon, get ready to do some paperwork. “Those kinds of things are actually gifts that people normally wouldn’t even think about,” Malekhedayat warns.
  • If you’re paying tuition or medical bills, paying the school or hospital directly can help avoid the gift tax return requirement (see the instructions to IRS Form 709 for details).

Laid-back loans

Lending money to friends and family is usually a bad idea, and the IRS can make it even worse. It considers interest-free loans as gifts, Malekhedayat says. “Or if you give them a loan and later decide they don’t need to repay the loan to you, that’s also making gifts,” she warns.

Elbowing in on a non-spouse bank account

“Let’s say you live by Grandma, so for convenience, we’re going to put you on Grandma’s bank account. Guess what just happened?” Picciurro says. “If you’re put as a joint [owner] on a bank account with somebody and you have the right to take the money out at any time, essentially Grandma is giving you a gift.”
Thanks to Tina Orem for this timely information.

When can you use Stepped-up Basis?

Every long-term investor needs to know about the stepped-up basis loophole (also sometimes called the stepped-up cost basis loophole). It's a tax benefit Congress gives families who aren't rich enough to be subject to the estate tax but who diligently built wealth by acquiring stocks, real estate investments, or other property (such as construction equipment) throughout their lifetime and want to pass those assets on to their children, grandchildren, nieces, nephews, or other heirs after death. 

What is the stepped-up basis loophole? Under present tax law in the United States, when you die, the qualified stocks, real estate, and other capital assets that you leave to your heirs get their original cost basis wiped out entirely. That means your heirs can value that property at its fair-market value on the date they inherited the asset. 

Managed correctly, the stepped-up basis loophole is a close second to the twin combination of a Roth 401(k) and a Roth IRA in terms of amassing money in the most tax-efficient way for generations of your family. Under certain circumstances, it can even be preferable to an inherited IRA.

A Real-World Example

Imagine that, like one out of five families in the United States, you earn a minimum of $8,333 per month. You live below your means and don't have debt. Let's assume you financed the purchase of your home, but your mortgage payments are modest because you're conservative with your money. You plan on paying that off before you retire, though, so it doesn't cause you to lose sleep at night.

You decide that you're going to save 10 percent of your starting pretax income in a regular brokerage account or through direct stock purchase plans and their closely related sibling, DRIPs. You invest in a basket of stocks that compounds at average rates of return. (For the sake of simplicity, let's assume you only bought non-dividend-paying stocks, but the underlying concept is the same regardless.) You keep this up for 35 years. You never increase your annual savings by inflation, so it represents a smaller and smaller burden on your cash flow as time passes and the dollar loses purchasing power.

Over the years, you put aside $350,000 out of your own pocket. You end up with $2,710,244 sitting in your brokerage account. This represents an unrealized gain of $2,360,244.

If you sell the stock, you're going to have to pay federal capital gains taxes, as well as state and local taxes. Under a worst-case scenario (e.g., you live in Southern California or New York City), you'd be lucky to end up with $1,896,706, of which $350,000 represented your original principal and $1,546,706 represented your nominal after-tax profit before inflation adjustment. You then gift that money to your heirs in your will or through a trust fund. If your heirs turn around and invest the money in an asset that earns a 10 percent rate of return, they might enjoy a $189,671 annual increase in personal net worth.

If, instead, you qualify to take advantage of the stepped-up basis loophole without triggering the estate tax, you could pass the entire $2,710,244 to your heirs without the federal, state, or local governments getting any of it. All you have to do is leave the appreciated shares of stock, real estate property, or other capital assets to your heirs. When you die, the fair market value will be appraised (in the case of stock, this is often easy, as it is the market quotation) and the heirs get to act like that price—the inherited price—is their cost basis.

This stepped-up basis loophole gives your heirs two superior alternatives:

  1. If they hold onto the stock or real estate and it continues to produce average rates of return, they're earning it on the higher asset level of $2,710,244, not the lower $1,896,706. This means they'd enjoy an increase in wealth of $271,024 per year, not $189,671. That's an extra $81,353 or 42.89 percent per year. Meanwhile, the $813,538 in additional equity sitting on their balance sheet can lower their cost of borrowing elsewhere or serve as collateral if they want to fund a new acquisition or development.

  1. If they sell the stock, real estate, or another asset upon receiving it, they can pocket the entire $2,710,244. That is an extra $813,538 in real, liquid cash that would be available for your heirs.

Giving Stock or Property as a Gift While You're Still Alive

What happens if you want to give your heirs shares of appreciated stock or other property during your lifetime? They won't get to take advantage of the stepped-up basis loophole. Rather, they'll inherit your cost basis as if they had been the original purchaser on the same terms, at the same price, and on the same date that you did. For that reason, it's almost always a better idea to give cash or freshly purchased shares instead (where the market value and cost basis are comparable), and keep the appreciated stock until death.

One major exception to this rule is as follows: If you are going to go over the estate tax limits and you don't have a lot of cash on hand, you can use the annual gift tax limit exclusions to give appreciated stock, real estate, or assets to your heirs. That approach will help you lower the size of your estate and save on the taxes that you'd otherwise owe. If you make sure the final appreciated property is below the estate tax limits, then the rest of it gets inherited with the stepped-up basis loophole.

Be sure to consult with a qualified tax specialist before taking these steps to ensure that you're doing it all correctly.
Thanks to Joshua Kennon for pulling this together.