First run at the new tax law

~ C.O.R.E. Beliefs ~ Leave a comment

Just for fun, I created a quick spreadsheet to calculate individual taxes based on the new tax law – at least the parts that make sense this morning.  I will be adding to it as I go along.  The calculations are based upon the Senate version.

It is simpler, I will give congress that.  I put the spreadsheet together in about 30 minutes from scratch.  Here is something to think about though, $12,000 is a lot of property tax and mortgage interest.  And $24,000 is a heck of a hurdle for a married couple.

If your current mortgage value is under $200,000 and your property tax is less than $3,500 you will probably not get above $12,000 for the standard deduction if you are single.  If you are married you will need a mortgage above $450,000 to get close to the $24,000 limit.

A single person making $50,000 will have a 2018 tax liability of $4,370 under the Senate plan.  A single person making this amount will likely not have a mortgage above $200,000, and will therefore take the standard deduction of $12,000.

A married couple making $72,000 combined and with one child under 16 will owe taxes of $5,379, before the child tax credit.  If the tax credit is $2,000, their net tax is $3,379.

Since it is unlikely that this couple would have a mortgage above $450,000, they would also take the standard deduction.

A married couple with no children who makes $150,000 with a $450,000 mortgage will likely itemize as their property tax and interest will be above $24,000.  Their tax would be $17,430.  If they didn’t have a mortgage, their tax would be about $17,700.

The single person making $50,000 has an effective tax rate of 11.5%

The married couple making $150,000 with a mortgage has an effective tax rate of 14%

The married couple making $150,000 without a mortgage has an effective tax rate of 14.4%

A married couple making $150,000 with a mortgage and 2 children has an effective tax rate of 10.8%

Obviously, it is what is missing that matters.  Many of our clients have employment related expenses that will no longer be allowed as a miscellaneous itemized deduction.  And, from what I have read, medical expenses will no longer be taken into consideration.  We have several families with an aged parent in a care facility because they cannot be left alone.  This is $80,000 that is no longer a deduction and those gains, interest and dividends, pensions and social security will end up with a tax hit of about $10,000 or an effective tax rate of 14.6%.

I will spend some time looking at the corporate side the rest of the day and tomorrow and have some thoughts on that by the end of the weekend.

Enjoy your Saturday.

 

 

 

 

Living Trusts and QSSTs

~ C.O.R.E. Beliefs ~ Leave a comment

One of the tax projects that we are working on involves a couple where the husband passed away in 2012 who owned a successful small business.  As we go through the process of trying to make sure all the appropriate steps were taken, my research leads me to potential issues related to S Corporations, Living Trusts and QSST elections.  This is a simple thought experiment but the overall issue is likely to be a potential problem as baby boomer’s age and we find their estates have ownership of S Corporation stock.

Husband (H) was the owner of all the shares and owned the shares prior to his marriage to wife (W).  The S Corporations shares were titled to the living trust of Husband.  The shares, per the will, specified that half of the shares were to go to a marital trust and the other half directly to W.  The marital trust stated that W could not sell the shares and they would all go directly to their 4 children at the time of her death.

Husband passed away in 2012.  The problem beings when the 2012 return reports the S Corporation shares on the joint return which reported H as deceased and W as surviving spouse.  The Company’s tax preparer changes the name and tax id number to W’s on the 1120-s K-1 in accordance to W’s statements and their understanding of the living trust document.  All shares are now in W’s name and reported on her 1040 return as the preparer knew about the living trust arrangement.

This creates lots of problems.  The will stated how the assets were to be divided and from the look of it, it wasn’t handled correctly.  Possibly, the shares transferred directly to W through the living trust would be valid, but what about the shares that were supposed to be transferred to the marital trust?  If the shares are owned by the marital trust, was a Qualified Subchapter S Trust (QSST) election filed with the IRS?  Can the marital trust even qualify as a QSST because of the successor beneficiaries listed in the will?

If the QSST is considered invalid or isn’t made, then the S election is terminated.  Without a valid S election, the income is no longer passed to the shareholders.  Income is first taxed at the corporate level and then the dividends – the S Corporation distributions – are taxed to the shareholder at time of receipt.

The tax consequences can be significant.  Let’s say that the Company made $1.0 Million in taxable income as an S Corporation.  It distributes all $1.0 Million to the shareholders.  The shareholders, W in this case, would pay about $390,000 in tax.  Without a valid S election, the Corporation ends up being taxed on that $1.0 Million, which costs about $350,000 and then W is taxed on the $1.0 Million in dividends, which costs her personally about $200,000.

$550,000 in taxes compared to $390,000.  And worse, the Company owed the tax but it may have distributed all its available cash, leaving W to wonder how she is going to pay the tax bill.  And if she used the remaining $610,000 to pay her living expenses, she can’t even loan the money back to the Company to pay its tax bill.

And remember, this is for the last 5 years, so almost $800,000 in additional taxes could be owed.

If you own S Corporation stock and have it titled to your living trust, you may want to talk with your estate planning attorney or CPA to make sure instructions are available to make sure something like this doesn’t happen.  Make sure your will aligns with your living trust and takes into consideration the fact that some assets have special rules about transfers to trusts.  And if you need the name of a practicing attorney or accountant who specializes in trusts and estates in Oregon or Washington, let me know and I will send you a few contacts you can discuss your concerns with.  Proper planning will make sure your wishes are carried out well and your beneficiaries receive what you planned for them.

Have a great weekend.

Clarity

~ C.O.R.E. Beliefs ~ Leave a comment

Where to start.

Depending on which talking head you prefer, the republican control of the legislative, executive and possible the courts will either ruin our great country or propel it into an amazing future.  Just like when the democrats had control, your favorite pundit predicted the death of our great country or the beginning of a new era.

The truth, and clarity, always lies in the middle.

These are trying times for all of us, especially those of us who are not ideological purists.  I personally remain unmoved by the arguments put forth by either side in the current handwringing or jubilant flag waiving of the non-centrist.  But this is a time to take stock and carefully start preparing for things to unravel.

On tax reform.

The real problem is, when the legislative and executive branches change hands, as they inevitably will, do you think that these so-called tax reforms will stand? Will we keep a 20% tax on corporate earnings?  Probably not.  Will we keep the unnecessarily complex “pass-through” tax law?  Probably not. Will individual tax brackets go back to more progressive?  Most likely.

Within 10 years.

When I first started in public accounting a partner took me along to a lunch with a long-time client.  He harvested walnuts.  The most striking thing he said at this lunch was that the crops he is harvesting today comes from trees planted 15 or more years ago.  It takes that long to produce mature enough nuts to take to market.

Consider that.  Someone had to be willing to invest day 1 knowing that there would be no pay back for 15 years.  Believe it or not, that is what strong companies do, they plant, the tend, and then they harvest.  What they need is things to remain somewhat consistent and predictable.  But if tax laws are changing every few years, planning become impossible.  Businesses get whiplash and planning goes out the window.

On our current executive.

He is what we elected.  If you don’t like it, then think about how to address the problem.  But I will be honest, more people voting against him in 2020 in the states of California and New York will not get him voted out of office.  If he really bothers you, then you will need to move you, your family, and the 10,000 close friends you have to the mid-west.  The Elector College matters and yes, sometimes it gives us terrible results, but I think that is why it was put in place.

On jobs and economic growth.

Several years ago I read a paper on the correlation between economic growth and the increase to the labor pool.  Historically, countries tend to grow at the same pace as the participants in the labor force grows, otherwise, countries end up in either inflationary or recessionary cycles.  I believe that our labor force participation rate is growing about 2% a year.  This is the net of new entrants, retirees, immigration and emigration.  Cut immigration and the economy will grow at 1.5%.

This is a huge problem, and not just for meeting the projections in the tax bill.  Japan is a fascinating example of this.

Social security needs a certain minimum number of working adults paying into the system in order for it to receive sufficient funds to pay out claims for retirees.  If I remember my numbers, back in the 1930’s there were 8 working people for every retiree drawing social security.  Today I believe that number is about 3:1.  Again, if the ranks of retirees are growing faster than the ranks of new entrants to the labor market, we have to face the reality that this ratio could drop to 1.5:1.

Oh, and consider that wages are not growing.  That means that social security taxes, which are only on wages, is not growing.

Getting clarity is not hard.  It does, however, require a little effort to look beyond your belief system and ask hard questions.  The most effective answers always lie in the middle.  Let’s see if we can’t start having that conversation there instead of always arguing from the fringes.

Have a great day.

 

On Growth and Taxes

~ C.O.R.E. Beliefs ~ Leave a comment

Happy Monday.  From what I see, the tax debate begins in earnest this week, barring someone going horribly off-message.  I give that a 30% chance.

One of the more perplexing points about reducing US Corporate taxes is the belief that lower taxes will lead to job creation.  I am afraid the logic isn’t there.

There are two big pots of money in a corporation – money to run the business and money to return to shareholders.  Money to run the business is before tax, return to shareholders is after tax.  This is generally structured as a dividend.

The logic is, if we reduce the amount of money available after tax, businesses will reinvest.  Or, if we reduce the amount of tax on money returned to shareholders, the business will reinvest.  It is an invalid conclusion.

It is my understanding that corporations are facing another great year of profits.  That means their revenues exceeded costs.  Those costs include labor, or the hiring of workers to produce the goods and services which generate the revenues.

If a corporation already has all the employees it needs and is profitable, how is reducing taxes going to incentivize a corporation to hire more?  The answer is, it won’t.  Companies hire employees to fulfill demand.  Thus, if you want to increase employment, increase demand.  That is a market issue, not a tax issue.  The only employment opportunities coming from this tax bill are for tax lawyers and accountants, for which I am truly thankful.

If more money is returned to me as a shareholder, I MIGHT consider reinvesting.  More likely, I will attempt to diversify my holdings and invest in another opportunity – provided it can generate a reasonable rate of return. But that investment will likely be in the stock market, not in a start-up or small business so new job creation will probably not occur.

The corporate tax system needs to be redesigned, I don’t think anyone with the basic premise.  But the real issue is, do we want to spend $3.0 TRILLION? Once we decide on that, the next issue is how to collect $3.0 TRILLION in taxes without creating whole new cottage industries designed to thwart the collection cycle?

Fundamentally there are two things to consider from my perspective.  Corporations do not pay taxes – consumers pay taxes.  And, redistribution should be between today’s taxpayers, not between generations.  That is, no deficits.

So what to do about this?

First, don’t buy the argument that tax cuts focused on the top 1-5% of income producers will increase jobs.  Demand increases jobs.  Unfortunately, the wealthy can already spend on discretionary items; it is really the middle class and poor echelons that have a desire to spend which actually drives demand.  There is nothing in this tax cut for them.

Second, accept the premise that the corporate tax system needs to be reformed.  It was designed in an age where we were a net producer economy and that is no longer the case.  How we get to true corporate tax reform should probably take a little longer than 3 months though.

Third, question why we have to shift our tax burden to the next two (or more) generations.  Deficit spending is simply asking future generations to pay for our spending habits today.  I personally am not convinced that deficit spending is warranted even in recessions but most economists believe it works so that is probably the only time it may be justified.  I haven’t heard about the US being in a recession at the moment.

Finally, write, call or visit your local congressional delegation.  I know that a lot of these issues are complex and we are only given sound bites to work with, but if it doesn’t feel right, say something.  You don’t need to be a hyper-partisan, you just need an informed opinion.  Remember, this is about our tax structure and how we get where we want to go.  But if you want to spend, be ready to pay the bill.