Will You Need a Tax Preparer Next Year?

One of the big “selling points” (to use the term very loosely) of the new tax act was that it would make tax filing simpler for the vast majority of people.  Oh, but if that were true.

Put it this way, if you are currently paying over $500 for tax preparation you will likely still need to see a professional to ensure that you are in compliance with tax law.  Your taxes are not simpler to calculate and you are likely faced with a monstrous number of choices that some professional guidance is warranted.

As discussed previously, if you are in business for yourself and live in a high tax state, It is unlikely that you can easily file your own taxes.  I mean, except for those engineers and frustrated accountants out there who think that the real magic is in dropping numbers into boxes and creating an Excel spreadsheet to do the calculations.  That is the easy part.

You are facing a daunting array of choices and options – from filing as a C Corporation to the amount of wages you should pay.  Do you take bonus depreciation or regular?  Each decision has current and future ramifications that can benefit or hurt you.

Will you need a tax preparer?  Most likely.  Oh, not if you are a W-2 employee for a company and have a modest lifestyle.  Let’s face it, $12,000 of itemized deductions is hard to get over as a single person.  Property taxes, state taxes and mortgage interest will likely be only about $10,000 at best.  Your taxable income will be higher but your bracket will likely be lower – which is the tax reduction you were promised.

If you are a sales professional who used to have a fairly outsized unreimbursed employee expense deduction you will likely no longer need an accountant to prepare your taxes.  You may want to talk with one though to help you renegotiate your compensation package because the loss of those deductions is going to sting.  Unless you can make it work as an independent distributor of the companies products – in which case, yes, you may want to work with a tax preparer.

You will adapt to the new tax law just like tax preparers will adapt.  I doubt that 2019 will see a dramatic reduction in the number of returns filed by paid tax preparers; perhaps by 2021.  Of course, that assumes we are not whipsawed by a change in congress which decides to change the tax code again.

In the meantime, use your resources to engage the best professionals available.  If you are interested in starting a business then I suggest talking with a professional who can help you plan and grow your business profitably.  Too much of an emphasis on taxes minimizes your potential.  Trust me, there are lots of ways to use profits to improve your business but you have to make the money first.  The easiest tax planning is based on zero.  It is the absolute worst for planning your life though.

Time for the plug.  If you are looking for some solid planning feel free to contact me.  I enjoy working with small business owners who have dreams of making a ton of money and who want great advice for getting their business to the next level.  I am here to be of service to you.  Feel free to contact me anytime.

Have an awesome Tuesday.

The New Bonus Depreciation Deduction

Continuing on with my examination of the new tax act, I am going to examine the purported meat of the “jobs” portion of this act.  Beginning 9/27/17 (that’s right, assets purchased as of a very odd date at the 3nd of the third quarter) you can deduct 100% of the purchase price for certain qualifying assets.

But, this is one of those temporary tax deals.

Placed in Service before % Deductible
1/1/2023 100
1/1/2024 80
1/1/2025 60
1/1/2026 40
1/1/2027 20

It get better, I think.  the new code appears to also allow for the purchase of used property.  The code section they added says, ”

c) APPLICATION TO USED PROPERTY.—
(1) IN GENERAL.—Section 168(k)(2)(A)(ii) is amended to read
as follows:
‘‘(ii) the original use of which begins with the
taxpayer or the acquisition of which by the taxpayer
meets the requirements of clause (ii) of subparagraph
(E), and’’.
(2) ACQUISITION REQUIREMENTS.—Section 168(k)(2)(E)(ii) is
amended to read as follows:
‘‘(ii) ACQUISITION REQUIREMENTS.—An acquisition
of property meets the requirements of this clause if—
‘‘(I) such property was not used by the taxpayer
at any time prior to such acquisition, and
‘‘(II) the acquisition of such property meets
the requirements of paragraphs (2)(A), (2)(B),
(2)(C), and (3) of section 179(d).’’

To interpret legaleze, the “original use” means new property.  Under the old code, what you had to buy in order to qualify was new, under the premise that new stuff creates jobs.

The new tax law adds a new clause, “such property was not USED by the taxpayer at any time prior to such acquisition…”  Again, to interpret, whatever you buy will qualify as long as you didn’t already use it before buying it.  Think converting a leased car.  You were using it and then decide to “buy” the car.  This would not qualify as you already used it.  It doesn’t stop you, however, from buying someone else’s leased vehicle and then claiming the bonus depreciation.

Ok, I am with you, used equipment doesn’t generate jobs.  But it does allow a business the option now of spending 30-40% less by buying pre-owned and still getting the 100% write off.

What is interesting is the new tax law provides taxpayers the option to elect out of the bonus depreciation.  I will admit that under the old rules, where we had graduated corporate tax rates, I often suggested that C Corporations elect out because the item was taxed at less than 25% and we were pretty certain that the next years tax rate was going to be 35%.  But now, it is a flat 21% so there are no brackets to maximize.

The election is no doubt for Schedule C businesses and possibly pass-through entities since they are still subject to the graduated tax brackets.  I have to analyze a few scenarios to see if the election is worthwhile though.

And try to find the hidden gem that is no doubt lurking in one of the “by extension” paragraphs.  These call to the other code sections to ensure their references are updated and possibly one of these has another limit I haven’t caught yet.  Stranger things have happened.

Naturally, please don’t take this as tax planning advice and whatever you do, don’t rush out and buy stuff without talking with your tax professional.  If you like, I am happy to discuss your situation and help you decide if taking the 100% bonus depreciation is worthwhile if you are not currently working with a professional.  Feel free to contact me if you have any questions about this or any other aspect of the new tax law.

Have a great day.

 

SALT Limitation Issues

I went into the ITS offices yesterday.  We had a meeting with a client and also it gave me a chance to catch up with the other John.  He attended a tax update workshop last week and we wanted the chance to compare notes.  One thing that caused us a good deal of chuckling is the state and locate tax (SALT) limitation and how it is going to be applied.

Lets say you live in a state that taxes income – say like Oregon.  You make $100,000 a year as an engineer.  You live in a modest home priced at $500,000.

  • Your Oregon income tax withheld is $10,000
  • Your Property tax is $6,500
  • Total SALT is $16,500, capped at $10,000

Oh, but wait.  Your actual Oregon income tax is $9,000 when you finally get to filing the return.

So, lets start with the easy question:

Which part of the $10,000 SALT deduction is the actual deduction?

Why does it matter?  Well, lets start with the fact that you reached the $10,000 limit with your income tax withheld.  If the rule states that you first apply the SALT to income tax and then property tax, your $1,000 overpayment would be taxable income in the next year.  Recovery of a deduction rules.

But if the property tax is deduction first, then you only used $3,500 of your income tax to reach the cap.  So, did you really have a $1,000 overpayment?  Do you still need to recapture that overpayment in the next year?  The state of Oregon is still going to issue the 1099.

Oh wait, how about we pro-rate?  $10,000/$16,500 is (hold on had to dig out the calculator) 60.1%.  So does this mean that you only report 60.1% of the refund as taxable income next year?

Yes, in case you are curious, it seems that the code rewrite is somewhat silent on this trivial matter.  Which means we have to await a ruling from our friends at the IRS.

The same IRS that is getting its budget slashed again for 2018.

Speaking of the IRS, I think the rush to prepay property taxes has been overblown.  There are several problems with all the handwringing but not least of which is, the IRS doesn’t know what your property tax bill is.  This is one of the few items of deductibility where a form is not sent to the IRS.

So, this is going to be an audit issue.  It will most likely start by some enterprising young IRS employee programming an algorithm to look for property tax deductions that are more than 50% higher than the amount deducted in the prior year.  Sounds simple enough.

Nope.  I remember doing some basic research on this wayyyy back in college and there is no such thing as a simple command for the IRS database.  Problem number 1.

Problem number 2.  Assuming they deal with #1 they will send out a ton of notices to people who bought their first home in 2016 and who only deducted a fraction of the property tax.  Knowing the IRS, it will not be a pleasant little letter asking for a reasonable explanation of the deduction and, please disregard if you feel you received this notice in error.  Nooo, it will be a CP2000 notice of deficiency.  Awesome.

Problem number 3.  All these people who got all these notices will send a response back to the IRS.  The IRS computer system cannot read and respond, only a human.  Did I mention that the IRS is getting their budget cut again?  Where are they going to get all these highly trained tax experts who can review a client document and respond effectively?

Look, don’t take this as advice.  Lord knows I don’t want anyone thinking that they can rely upon my little missive to get them out of tax trouble.  But the truth is, anyone who prepaid their taxes is probably safe.  Make sure you have a copy of the check and the payment receipt.  DON’T MAKE IT UP!  If you didn’t prepay it then don’t think you can claim the deduction but if you did, I don’t see the IRS going out of its way to deny the deduction.  It is, after all, a one time deal and frankly…

They need to put their very limited resources into writing the rules to help poor taxpayers figure out how the SALT limitation is going to actually work.  Oh, and rules for every other piece of code section that got put into this major rewrite. The SALT issue is not the worst unknown lurking in this, unfortunately.

Have a great day.  As always, if you would like to discuss this or any other issue feel free to contact me.  And if you are looking for some great tax advice and planning, let me know and let me see what me or my network of great accountants can do for you.

How to Use Your Tax Windfall

One of the most important things to be thinking about, even as a small business, is how to use the cash from paying less taxes.  Oh sorry, this assumes you are a C Corporation.  S Corporations are probably out of luck on the tax savings side – but that will be tomorrow’s blog.

First, keep in mind that from a banking perspective, your company won’t change.  That is because bank’s typically measure you according to EBITDA – or Earnings Before Interest, Taxes, Depreciation and Amortization.  If you have bank covenants with any time of earnings ratio it is based on this, not net profit after tax.

This being said, you should have additional cash flow.  Assuming you are profitable.

An example might help.  Lets say your business has EBITDA of $1,000,000.  From this:

  • Interest on your bank loan is $100,000
  • Depreciation and amortization is $100,000
  • Earnings before taxes is $800,000

Under old law, your tax would have been about $240,000.

Under the new tax law your tax will be $168,000, or a savings of about $72,000.

Honestly, the one thing you may want to avoid is increasing an expense by paying out a bonus, increasing wages, etc.  Paying out that $72K will reduce your EBITDA which could cause a covenant violation.

You also probably can’t issue a dividend to the shareholders because there is another covenant prohibiting such a move.  The bank wants its money first – which is only fair.

So what should you do?  Keeping idle cash around seems foolish, especially if you have a line of credit or term debt.

Ah yes, the debt.

Small businesses should seriously consider using the free cash flow from the reduced income tax rates to pay down debt. I would recommend freeing up the Line of Credit first and then start paying down the term debt.

The sooner you get that debt down the sooner you can start paying dividends – which as my blog yesterday pointed out, might be a better choice than taking payment as wages.  You will need to work with your accounting professional to ensure that this is the most effective way of getting money out to you but it may work out best that way.

Make sure you are on top of your loan covenants before you make big decisions on how to spend the tax savings which start this year.  And, everything else being equal, paying down bank debt will improve your ratios – anything else you do might impair them.

Have a great day.  If you are looking for an accounting and tax advisor who can help you navigate these times, feel free to contact me for a free consultation.