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Member of Russell Bedford International, a global network of independent professional service firms.
The Tax Cuts and Jobs Act of 2017 – with its many changes impacting the 2018 tax year and beyond – brought the Qualified Business Income deduction (sometimes called the QBI deduction or 199A deduction). This new deduction can be up to 20% of the net income of a qualified business, meaning only 80% of your QBI is taxed on the federal level. But, if you are a real estate investor you are probably wondering if this deduction will apply to you. The answer is, of course, not so simple.
Defining a Qualified Trade or Business
The biggest limitation of the QBI deduction is that it only applies to a “qualified trade or business”. There is not a lot of clarity within IRS regulations in determining what exactly is a trade or business in the real estate arena and there are many unique situations concerning real estate.
The IRS cites “key factual elements” that are relevant to whether an activity is a trade or business: (a) the type of property (commercial versus residential versus personal); (b) number of properties rented; (c) day to day involvement of the owner or agent; and (d) type of lease (triple-net versus traditional). Therefore, due to the large number of actual combinations that exist in determining whether a rental activity rises to the level of a trade or business, the IRS says bright-line definitions are impractical.
Below are a few example situations that demonstrate when real estate investments would likely or likely not pass as a qualified trade or business.
We can help you determine if your rental activity facts and circumstances can give rise to a trade or business and thus allow you to be eligible for QBI. If you are not eligible, we can develop some operational strategies which can allow you to qualify for the deduction. Please contact us today at 630-953-4900.
A lot of change has come with the 2017 Tax Reform. As we adjust to the new provisions, we’re constantly learning about ways that we can shift tax planning strategies in the future to benefit and lessen tax burdens. One way to potentially minimize your taxes is with a strategy called “bunching”.
What is “Bunching”?
The near doubling of the standard deduction amount to $12,000 for single filers and $24,000 for joint filers produced the bunching strategy. With tax bunching, you move two or three years of deductible expenses into the one year you intend to itemize. For the other years, in lieu of itemizing deductions, you can claim the new higher standard deduction.
Assess Your Bunching Option
Using the bunching strategy requires some planning. First, you need to know how close you are to the standard deduction limit by reviewing your 2017 tax return. Because of the many new limits on qualified itemized deductions, you will need to estimate how close you are to the new standard deduction thresholds. Remember to limit your state and local tax deduction to $10,000 and eliminate any miscellaneous itemized deductions.
The closer your total itemized deduction total gets to the standard deduction amount for your filing status, the more the bunching strategy makes sense.
For example, John and Mary’s new itemized deduction total is about $22,000, which includes $10,000 of state taxes paid and $12,000 of charitable deductions every year. Since their itemized deductions are less than the new $24,000 standard deduction, they are losing the benefit of their itemized deductions.
Instead, John and Mary can choose to “bunch” three years of charitable contributions into one year. Using this strategy, the couple have itemized deductions of $46,000 in year one ($10,000 of state taxes and $36,000 of charitable contributions). In years two and three, John and Mary would claim the standard deduction. Here are the deduction results:
By bunching, John and Mary are able to shift their itemized deductions to maximize the tax benefit.
If you determine that bunching is the best strategy for you, here are a few ways you can bunch your itemized deductions:
1. Review your medical and dental expenses. This is a potential bunching expense group if you project these expenses will surpass 7.5% of your income. Schedule non-emergency expenses, such as medical exams and dental cleanings, in the year you plan to clear the deduction threshold. Plan other procedures such as crowns and braces in one year instead of over many years. You can even move up health insurance premium payments.
2. Consider charitable donations as bunching options. This is the largest potential bunching area. Make all your gifts in the year you plan to surpass the standard deduction threshold. But keep an eye on the 60% of adjusted gross income (AGI) annual limit.
Alternatively, consider postponing contributions to January of the following year if you aren’t going to itemize.
3. Use mortgage interest as another bunching tool. The deduction for interest paid on new acquisition debt of up to $750,000 (or $1,000,000 if the loan was made prior to Dec. 15, 2017) is still available. Consider pre-paying the next month’s mortgage payment at the end of the year to increase the deductible interest in the year you wish to itemize.
We recommend speaking with your accountant to determine if the bunching option is best for you. Please don’t hesitate to contact Cray Kaiser with any questions.
With tuition costs rising each year, setting aside funds for college savings can be daunting. However, there are several tax options that may lessen the financial burden of college. We encourage you to review these plans with your family and your accountant to determine if one of them works for you.
Consider putting after-tax money into a Section 529 college savings account. Contributions aren’t deductible, but earnings will grow tax-free in these plans when used to pay qualifying educational expenses.
This option is best for parents and grandparents who want to save for their kids’ school tuition and other related expenses while still receiving a tax break.
The Coverdell Education Savings Account is a flexible account in which you can choose from a wide variety of investments to meet your individual needs.
This option is best for students who have education expense costs and want additional investment options for education savings.
If you’re looking for a savings option that goes beyond education, a custodial account may work well for you. With Uniform Transfers to Minors Act (UTMA) and Uniform Gift to Minors (UGMA) custodial accounts, you can generally invest in a wider variety of options versus a Section 529 plan.
This option is best for parents who give financial gifts to their kids and don’t mind handing over control of the accounts when they are 18 or older.
If you’d like to discuss these college saving options, please contact Cray Kaiser at 630-953-4900.
Many of us dream of owning a second home, but a second property can be much more than your vacation destination. In addition to a getaway for your own use, renting out your second home is a great way to offset its expense and earn extra income. But just like other types of income, the IRS expects its share of tax if your property and its use fits their definition of a “vacation rental home.” Here are some ways to determine whether your second home qualifies as a vacation rental, what needs to be reported, and what you can deduct.
Vacation homes are unique because they’re somewhere in between a rental and a personal use property. Since they’re so different, the IRS has defined several special rules for the income you earn from a vacation home, as well as what type of property qualifies as a vacation home. The property doesn’t have to fit the strict definition of a ‘home,’ since the IRS classifies a vacation home as anything that has a sleeping place, toilet, and cooking facilities. If you rent any kind of property that fits their description, from a home to a houseboat to an RV, the IRS will tax the income you earn.
The rules around how a second property is used are more complicated. According to the IRS, the amount of time that your property is used for personal use will determine whether you need to report the income and what expenses you can deduct. Here are the general guidelines:
Renting your second property can be lucrative, but don’t forget that you’ll still likely need to report the income you earn from renting your property on your taxes. We can guide you through the rules and ensure that you’re getting the best tax breaks and deductions. If you have questions about renting your second home, please don’t hesitate to contact Cray Kaiser at 630-953-4900.
On June 21, 2018 the U.S. Supreme Court held that states can assert nexus for sales and use tax purposes without requiring a seller’s physical presence in the state. While you may have heard about the Wayfair case in the news, have you thought about what this may mean for your business?
Prior to the Wayfair case, mail, phone, or internet retailers of tangible goods used the Quill case for protection from the burden of collecting sales tax. According to Quill, the protection from sales tax burdens was possible because these retailers did not have a physical presence in the form of an office, storefront, warehouse, or merely having an employee solicit the sale of goods in that state. Therefore, without stepping foot in a given state, sales in that state could be made without charging sales tax. That meant it was up to the purchaser to pay use tax on the sale.
With the Wayfair case, everything changes. Here’s what happened:
Justice Anthony Kennedy, who wrote the decision, reasoned that modern e-commerce no longer aligns with the Quill case. Essentially, the Quill case is outdated with the large amount of commerce that is conducted via the internet. The Wayfair decision essentially overturns the Quill case and physical presence is no longer a requirement for states to assert sales tax collection requirements.
The Wayfair case will now allow all states to set their own laws in connection with interstate online sales. In fact, 31 states already have some form of laws in place. Effective October 1, 2018, retailers making sales of tangible personal property to Illinois purchasers will have to collect sales tax once Illinois sales reach $100,000 in outside sales or 200 transactions.
It is thought that the $100,000 in sales or over 200 transactions as determined in South Dakota may be the standard to determine economic sales tax nexus in other states. As noted above, this is the new standard for Illinois. If you are a retailer exceeding these numbers in states in which you don’t have physical presence, you may now have a sales tax collection and filing requirement moving forward. Congress may decide to move ahead with legislation on this issue to provide a national standard for online sales and use tax collection. We will keep you informed of future changes.
Cray Kaiser is here to help. Please contact us if you have any questions or would like guidance on a specific state’s current stance on sales tax nexus.
As your business grows, you may find yourself hiring employees out of state. While the growth associated with having an employee in another state is great, keeping up with the payroll compliance in each state can feel like trudging through murky waters. States have varying requirements related to withholding income tax and paying unemployment tax. Additionally, states have increased their tax compliance efforts over the years making it even more necessary that employers be aware of their responsibilities. So, if you have an out-of-state employee, here’s what you need to consider:
Generally, you are required to withhold income tax and pay unemployment tax in the state in which the employee physically works. Makes sense, right? But it’s not always so straightforward. If your employee travels into several states, you need to be familiar with each state’s requirements. Some states require withholding from the first day an employee works in the state while other states have thresholds (minimum numbers of days or minimum amount earned) that determine when withholding is required.
If your employee works in one state but lives in a neighboring state, he or she may have to file tax returns in both states. However, if the two states have entered into a reciprocal agreement, the employee would only need to file in the resident state.
Some states have formed reciprocal agreements, which exempt employees from paying income tax on wages earned within the state if the employee lives in a bordering state. That means that wages are only taxed by the employee’s resident state. This simplifies compliance for the employee, who would otherwise be required to file income tax returns both in the resident state and the state in which the wages were earned.
When an employee has a reciprocal exemption, the employer withholds income tax in the employee’s resident state but generally pays unemployment tax to the state in which the wages were earned. For example, consider an employee working in Illinois but living in Michigan. The employer would report the wages as Michigan wages on the payroll withholding reports, but the wages would be reported as Illinois wages for Illinois unemployment tax reports.
Payroll taxes are an obvious consideration when you have employees working in other states. You will also need to consider other workforce requirements of each state, including:
Additionally, be sure your workers’ compensation policy includes all employees, even those working remotely. In the case of remote workers, be sure to inform your workers’ compensation company of the employees’ duties, work area and work hours.
Asking yourself these questions is the first step in being compliant with the states and also providing the best possible state withholding for your employees. Cray Kaiser is available to assist you when these issues come into play. Please contact us anytime at 630-953-4900.
Marriage, like every major milestone, brings a multitude of changes. If you’re recently married or engaged, you may not be thinking too much about your taxes yet. But many newly married couples are surprised to discover how marriage impacts their tax situation. After marriage, a couple’s tax liability can go up or down compared to when they were single.
The so-called “marriage penalty” typically occurs when two people with similar incomes marry, which raises their tax liability. To further complicate matters, the Tax Cuts and Jobs Act has brought additional changes to the tax implications of marriage. Whether you’re soon to be married, newly married, or have been married for a long time, we recommend reviewing the new changes to the tax code that may affect how marriage impacts your tax returns.
Prior to the tax reform, couples in the middle to high income tax brackets faced a tax penalty. Now, that penalty only applies to very high-income earners because the income tax brackets are exactly double those for individual filers.
Unfortunately, that doesn’t mean that the marriage penalty has completely disappeared. Rather, the penalty has been shifted to itemized deductions. If you take the standard deduction you won’t see an impact. But starting this year, taxpayers who itemize their deductions can deduct up to $10,000 in state and local taxes. However, that limit is the same whether you file as an individual or as a married couple, so married couples effectively have that deduction cut in half.
Each individual’s situation is different, but here are the general implications under the new guidelines:
Even though the Tax Cuts and Jobs Act has created new tax liability challenges for married couples, there are also new opportunities. You can read our overview of the impact of tax reform here. Please call Cray Kaiser today at 630-953-4900 if you have any questions.
When it is set up and maintained properly, QuickBooks can be an incredibly helpful and powerful tool for business owners and managers. The software can provide up-to-date financial statements and cash flow data and create general efficiencies in your accounting. However, too often we see that QuickBooks is either underutilized or simply a burden to our clients.
With tax season behind us, we thought it would be helpful to share a few challenges that we encountered with our QuickBooks clients this year. These challenges added additional barriers and complications during tax season. By being proactive and taking action now, you can help make next tax season much easier to navigate.
The most common QuickBooks issues included:
1. Unorganized Chart of Accounts: Your financial statements are the framework that gives insight into your organization’s financial health. The financial statements are born from your Chart of Accounts. It’s easy to think more detail is better, but that’s not always the case. Having too many and/or an unorganized Chart of Accounts can hinder the amount of information provided by the financial statements.
For example, when analyzing financial statements, you often want to perform trend analysis (looking for increases, decreases or baseline for certain items). This can be extremely difficult if there are too many accounts. When this occurs, there is an increased chance of the same account appearing multiple times as a subaccount. Thus, creating confusion for those performing the data entry, resulting in errors in the financial statement reporting.
There are a number of different solutions to resolve this problem:
a. Use subaccounts when necessary to the financial reporting.
b. Merge accounts when you find too many accounts which are similar.
c. Mark the account inactive when you no longer need to use the account.
2. Disorderly Items List: QuickBooks defines the product(s) you sell as “items”. Over time, it’s easy to add inventory anywhere into the system and forget to keep amounts updated. This can sometimes create negative inventory amounts on your balance sheet. Here are a few quick steps to clean up your Items List:
a. Mark any items you no longer sell as inactive.
b. Ensure each item is correctly labeled inventory, non-inventory, etc.
c. Double-check the item exists with your physical inventory.
d. Make sure you keep the costs for each item updated.
e. Assign each item correctly with the proper revenue and cost accounts to ensure accuracy in your financial reporting.
3. Unreconciled Bank and/or Credit Card Accounts: Reconciling your bank and credit card accounts every month is very important. Why? Because it serves as a control to ensure that all cash and credit card transactions are accounted for properly. Performing this function monthly helps you identify problems before they get out of hand. Here are a few steps to take when reconciling your accounts:
a. Review uncleared transactions.
b. Make sure the transaction hit the right account.
c. Check to see if there are any duplicate entries.
4. Incorrectly Applying Deposits to Invoices: When customer balances appear on your accounts receivable aging as a ‘negative balance’, unless the customer has an overpaid balance, this is usually a pretty good indicator that something is wrong. In most cases, this is the result of invoices being applied incorrectly. Every time you get paid by a customer, you should be able to receive that payment against an open invoice. Take a second look to make sure this is happening in your QuickBooks account.
5. Not Applying Payments to a Vendor Bill: Sometimes vendors who have been paid still show amounts due on the AP Aging reports. This creates a situation where a company’s liabilities are being overstated. To correct this, you may need to void or delete the bill that has already been paid. We recommend contacting your accountant before deleting any entries as they may be linked to other transactions.
6. Misusing the Undeposited Funds Account: Are you receiving payments from customers but your cash account isn’t increasing on your financial reports? It’s likely that you’re using Undeposited Funds incorrectly. Undeposited Funds is an internal current asset account created by QuickBooks to hold funds until you are ready to deposit them in the system. When you receive a customer payment, open the deposit module, batch checks together that you’re taking to the bank, and record them as one single deposit in the software.
7. Forgetting to Lock a Closed Period: When you close out a month (or any period), make sure to lock it so that no one can go back and change the amounts that were used to file tax returns and financial statements. Please note that all entries should be made in the current period.
Following these few steps will allow management to make decisions using timely and reliable financial information. By taking the opportunity to implement these strategies now, next tax season will be less stressful and provide management greater opportunities throughout the rest of 2018. Our QuickBooks Pro Advisors team can provide you support in any of the above areas. Please contact Cray Kaiser today for more information on how you can maximize QuickBooks.
Since the recent signing into law of the Tax Cuts and Jobs Act on December 22, 2017, the CK team has received many inquiries about its effect on future tax burdens. According to a recent survey from HubSpot, 88.5% of small businesses don’t understand the full impact of the tax bill. It’s apparent that business owners are seeking more clarity. As your trusted business advisors, we hear you loud and clear. To help you get through this transition, we will be posting our latest insights into the effects of the new law. You can subscribe here to receive our weekly email updates.
This week we are examining a provision in the new law that could cause a tax increase – the new limitation on business interest.
What is an electing real property trade or business?
A real property trade or business is “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.” The IRS will allow these real property businesses to elect out of the interest deduction limitation via an annual irrevocable election. The cost for doing so? The real property business must apply ADS depreciation rather than the usual MACRS methods, which means longer depreciable lives and limitations on bonus depreciation.
Adjusted taxable income generally means the business’ taxable income without regard to:
Any business interest not deductible due to these limitations will carry forward to the following tax year.
We expect these provisions will impact our clients with multiple entities and large amounts of financed capital expenditures the most. Given that interest rates are expected to rise, this valuable interest deduction will need to be looked at in terms of how companies decide to finance and capitalize their operations.
Keep in mind that these rules apply for tax years beginning after December 31, 2017. If you have questions in the interim, please call us at 630-953-4900.
It’s not fun to think about, but there’s no way to be completely immune from the possibility of an IRS audit. But if thinking about it isn’t pleasant, going through an audit can be even worse. If you do get audited, you’ll have a better chance of an easy audit experience if you start planning for it now. Since we’re in tax season, it’s wise to prepare for a potential audit while your tax information for the previous year is at hand. Here’s how to prepare for an IRS audit:
Use your current tax return to guide you in gathering all the components of your tax return and putting them together in one file. That way, if the state or federal tax authorities decide to review your return, you’ll have the right documents readily available.
It’s a good idea to organize your documents by year, as well as income and expense type. Including a summary of transactions for each year as a quick guide for yourself and the auditors will also be helpful.
You can anticipate by looking over anything that could potentially trigger an audit. Anything that looks out of the ordinary like foreign bank accounts, large tax losses, or significant business tax deductions are all flags for auditors. It’s best to have explanations for those items in advance. It’s an auditor’s job to ask tough questions, so be prepared!
Audits aren’t known for being enjoyable, but there are ways you can make them stress free by being proactive. If you do get audited, Cray Kaiser is here to help you through the entire process. Please don’t hesitate to contact us if you have questions on how to prepare for an IRS audit or how to avoid an audit.
