There are so many wonderful things about spring. Flowers are starting to bloom, the grass is green, and (hopefully) Chicago is done with snow! But as accountants, we sometimes look at spring with unease. We’ve worked hard all fall and winter to help our clients prepare for April 15th, but how will our collective efforts pan out? While the work of tax season is fresh in our minds, we wanted to share our insights into the lessons learned during the 2018 tax season (Cray Kaiser’s 47^th tax season).

Tax Withholding Tables

Last January, the IRS adjusted the federal tax withholding tables to reflect the reduced tax rates that would apply during the 2018 tax season. As a result, many employees enjoyed higher paychecks, at the sake of reduced federal tax withholding. The problem was that the tables were too generous in reducing federal tax withholding. The tables didn’t take into account other changes in the law, including the loss of tax deductions by higher income individuals. As a result, many taxpayers faced significant, unexpected tax bills.

If you fell into the camp of being disappointed with the tax results, let us know. We can plan beyond the basic tax table to advise not only the appropriate federal tax withholding rate, but also other tax minimization ideas.

Qualified Business Income (QBI)

The 20% deduction for Qualified Business Income (QBI) was one of the most discussed topics this year. It was not until the summer of 2018 that we received more clarity on “specified service” businesses. There are still uncertainties in the law, which we hope will be ironed out via additional guidance. That said, many of our clients took advantage of the new deduction and the advance planning surrounding maximizing the QBI was effective.

On the flip side, we saw a significant delay in tax reporting from partnerships and S corporations that hold businesses that may generate QBI. Hedge funds in particular will face extremely challenging reporting requirements for the QBI. We expect that some K1’s will arrive even later in the summer of 2019.

Decrease in Individuals Claiming Itemized Deductions

Effective for the 2018 tax season, the standard deduction was increased ($12,000 single and $24,000 married filing jointly). Given the $10,000 limit on the income and real estate deduction, as well as the elimination of miscellaneous itemized deductions, many taxpayers’ standard deduction was higher than allowable itemized deductions. Taxpayers that found themselves in this situation would likely anticipate that the standard deduction will probably be more beneficial in the near term. Those taxpayers should consider steps to better plan controllable tax deductions in order to maximize the benefit of the deduction.

Increase in Notices

At the time of this writing, a mere week after April 15th, our clients have already started receiving tax notices from both the IRS, and more so from the Illinois Department of Revenue. Our advice: Don’t panic! Most of these notices are showing disallowed deductions or credits, but that doesn’t mean the notice is correct. The revenue agencies are simply asking for more information. If you receive any such notice, forward it to your tax advisor. They will be able to provide the information necessary to rectify an apparent underpayment with the information supporting the tax position.

Theft Identity Protection PIN

Sadly, there continues to be an uptick in fraud and scams, and tax returns are no exception. As an added protection, the IRS has in recent years provided an Identity Protection (IP) PIN to affected taxpayers. The PIN is a six-digit number assigned to eligible taxpayers that helps prevent the misuse of their Social Security Number on fraudulent federal income tax returns. Taxpayers with a PIN must use the PIN on their tax returns in order for the IRS to accept the tax filing.

Recently, the program opened up to taxpayers here in Illinois. We believe that requesting an IP PIN is yet another tool to help you protect your identity. Please contact us if you’d like to learn more.

While it’s easy to bask in the glow of another tax season behind us, we believe it’s important to continually learn. When a rainy spring day arrives and you want to look ahead to 2019 taxes, give us a call at 630-953-4900. We are happy to walk through the nuances of your tax return in order to plan effectively for next year.

Identity theft is a real threat, but it is often downplayed because not everyone has witnessed or experienced it firsthand. Having a false sense of security can leave you exposed, especially during tax season. Here are some tips to keep your identity safe from tax scams and scammers:

1. Be naturally suspicious. Understand that there are people out there trying to get your information, and others willing to pay for it. With that in mind, be suspicious of anyone asking for personal information – especially your Social Security number (SSN). Even when a known vendor asks for your SSN, ask what they will be using it for and refuse most requests unless you deem it necessary.

2. File your tax return as soon as possible. A popular tax scam is to file a fake tax return and deposit the refund into the thief’s account, all before you get the chance to file your own return. You close the door on scammers once your tax return is filed with the IRS so consider completing your return sooner rather than later.

3. Shred your documents. Get in the habit of shredding all paperwork before it’s thrown out to keep personal information from falling into the wrong hands. If you don’t own a shredder, contact your bank or other local community services as they often offer free shredding services on specific days.

4. Keep your Social Security card safe. Only carry your Social Security card with you when it’s needed for a specific purpose. Your wallet or purse is not a good permanent spot for your card. Any criminal would have a treasure trove of personal data if it were to get lost or stolen along with your driver’s license and credit cards.

5. Periodically check your credit reports. The three major collection agencies (Experian, Equifax and TransUnion) are legally required to provide you with a free credit report each year. Take advantage of this service and review the reports. Correct any errors and use this report to monitor your accounts for any potential identity theft.

The bottom line: be smart when handling your personal information. Don’t get caught off guard by identity theft, especially by being careless. If you think you are a victim of a tax scam, alert the IRS right away and go to identitytheft.gov for more information. If you have any additional questions about tax scams, please contact us.

The updated mileage rates for travel for 2019 have been confirmed by the IRS. The standard business mileage rate is increasing by 3.5 cents to 58 cents per mile. The medical and moving mileage rates are also increasing by 2 cents to 20 cents per mile. Charitable mileage rates remain unchanged at 14 cents per mile. Please see the chart below for quick reference:

It is important to properly document your mileage in order to receive full credit for your miles driven. As always, should you have any questions or concerns please contact Cray Kaiser at 630-953-4900.

“Wayfair” is the new buzzword in sales tax reporting, and for good reason. You have likely heard that the Supreme Court’s decision in South Dakota v. Wayfair, Inc. has resulted in businesses being required to collect and remit sales tax to certain states in which they have no physical presence. Have you wondered how this change affects your requirements for income tax filing?

Does This Change Income Tax Nexus?

While the Wayfair decision did not directly impact income tax nexus, the removal of a physical presence requirement for sales tax nexus may encourage more states to enact a sales factor indicator for income tax nexus. In fact, states such as Alabama, California, Colorado, Connecticut, Michigan, New York, and Tennessee already have bright-line tests in place, which consider a business with certain levels of property, payroll or sales in the state to have income tax nexus. Other states, such as Ohio and Washington have enacted gross receipts taxes, which come into play once a business reaches a certain level of activity in the state.

It’s important to note that the Wayfair decision does not overrule P.L. 86-272, which allows businesses to send representatives into a state to solicit orders for personal property without being subject to a tax based on net income. However, a state may still impose a tax not based upon income, such as a minimum tax or a net worth tax.

What Does This Mean for My Business?

States are continually enacting changes related to nexus and various types of taxes. As your business becomes active in other states, it’s more important than ever to discuss potential income tax exposure with your CPA. Here are some steps you can take to protect your business:

• Regularly watch your sales levels in all states – both dollar amount and number of transactions.
• If your business employs workers in other states, even if just for solicitation of sales, be aware of the level of payroll in each state.
• Be aware of each state’s requirements. The landscape of nexus is constantly changing as more and more states enact legislation.
• Inform your CPA immediately when you notice changes in your level of business in other states.

Cray Kaiser is available to help you navigate through these ever-changing requirements, and to consider potential exposure to income tax reporting as a result. If you are unsure of the requirements of states you sell into, please contact us to discuss.

One of the interesting items coming out of the Tax Cut and Jobs Act of 2017 (TCJA) was the inclusion of specified tax breaks for taxpayers investing in low-income communities. Known as Opportunity Zones, the idea is to encourage long-term investments in low-income communities nationwide through property (real estate or equipment) or business operations.

Where Are the Opportunity Zones?
Over the last few months, the Department of the Treasury has worked with governors to designate qualified Opportunity Zones in each state. Investing in these specific areas will have tax advantages. For example, in Illinois, there are 1,305 tracts, 327 of which (25%) have been designated for Opportunity Zones. A list of the Opportunity Zones can be found here.

What Are the Tax Benefits of Opportunity Zones?
The crux of the program is to allow investors an option to reinvest their realized capital gains into opportunity funds and provide a deferral of at least a portion of the tax on the realized gain. A qualified reinvestment is primarily invested in qualified Opportunity Zones that retain their designation for at least 10 years. In order to qualify for deferral, the reinvestment into an Opportunity Zone must occur within 180 days from the date of the original sale.

For example, a capital gain that was reinvested in an Opportunity Zone and held greater than 5 years in the Opportunity Zone, 10% of the original gain will be excluded from taxes. If held in an Opportunity Zone greater than 7 years, another 5% (for total of 15%) will be excluded. In addition, if the reinvestment in an Opportunity Zone is held greater than 10 years, then not only is the original taxable capital gain reduced by 15%, but any gains from the Opportunity Zone will be excluded from capital gain tax.

For investors, this could be a great time to review any large capital gain tax exposure in order to assess whether the Opportunity Zone deferral is a good investment option given the potential to defer gains.  In addition to the deferral of the original gain, the appreciation from the Opportunity Zone investment would not be subject to capital gains when disposed after 10 years. Because there are pending regulations and other requirements that need to be met in order to for Opportunity Zone designation, please contact us for more information.

The new Qualified Business Income (QBI) deduction is an income tax game changer for owners of flow through entities. But there are many rules and nuances to getting the most out of the deduction.  Whether your business is a Specified Service Trade or Business (SSTB), pays employee wages, has qualified property, or generates taxable income over certain thresholds can create many opportunities or obstacles for maximizing the deduction. Here is how non-SSTB owners with small employee workforces can determine the minimum amount of wages to be paid in order to maximize the QBI deduction. 

The 2/7 Rule 

Remember, once your taxable income exceeds $364,200 (married couples filing jointly) or $182,100 (single filers) a wage limitation is phased in. Once the threshold is breached the calculation for QBI deduction is limited to the lesser of 20% of income or 50% of wages. Therefore, the amount of wages you pay yourself or your employees can become a major factor in the QBI deduction generated. The 2/7 rule can help you determine how to adjust your wages in order to maximize your QBI deduction. 
 
Note that there is an additional computation considering company assets, but that calculation is beyond the scope of this article and will not be considered in the following examples.   

Example 1  
ABC, Inc. is an S-Corp with a net taxable income of $1,000,000 before wages paid for the 2023 tax year. ABC is not an SSTB and has one owner and one employee, John Smith. John takes a modest salary from his company of only $50,000. The QBI Deduction before taking into consideration the wage limitation would be $190,000 (net income of $950,000 x 20%). However, because the company generates income that will put John over the taxable income thresholds, his QBI deduction is now limited to $25,000 (50% of $50,000).   

So what should John have paid himself to maximize the QBI deduction? That’s where the 2/7 rule comes into play. Wages paid should equal 2/7 of business income. Therefore, John should pay himself a wage of $285,714 ($1,000,000*2/7). That means his net Income would be $714,286 – 20% of the net income is $142,857 which would be the same as 50% of the $285,714 of wages. The 2/7 rule generated an additional QBI deduction of $117,857. This would equate to tax savings of $43,607 ($117,857 x the 37% tax bracket).   

Example 2 
What if you are a small business owner that has more employees than just yourself? In that case you would take into consideration the employees’ wages along with yours.

Let’s use the same facts as example 1 except this time ABC, Inc. has employee wages of $200,000 outside of John Smith’s wages. Business income would be $800,000 before John’s wage to himself. Using the 2/7 rule, John would only need to pay himself $85,714 ($285,714-$200,000) to maximize his QBI deduction.   

Additional Considerations 

• You might be worried about the additional payroll taxes incurred with higher wages, but the 20% QBI tax benefit outweighs the 15.3% combined payroll tax. Plus, the spread increases once the social security wage base ($16,200 for 2023) is met. Afterward you would only be left with Medicare tax of 2.9% to 3.8%, leaving a spread of nearly 17%.   

• S corporations also have a requirement to pay “reasonable compensation” to owner employees.  The determination of “reasonable compensation” should be based on what a reasonable salary would be for an employee performing similar work, not a variable based on QBI considerations.  Therefore, if ABC, Inc. already pays its non-owner employees more than the amount required to meet the QBI wage threshold, that doesn’t mean John doesn’t have to take a salary. It’s important not to forget the requirements of an S-corp.  

With the fourth quarter coming to a close, it is crucial to discuss your expected income and wages with your tax advisors to make sure you are getting the most out of your potential QBI deduction. Please contact Cray Kaiser if you’d like to discuss the QBI deduction and fourth quarter planning. 

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.

1. If an investor owned a single property and it was leased under a triple-net lease with an unrelated party, it would likely NOT qualify as a trade or business. In a triple-net lease, the tenant pays the owner rent and the tenant is also responsible for the real estate taxes, repairs and maintenance of the property. The investor activity is generally limited to the collection of rent. Upon audit it would be difficult to prove these rental activities constitute a trade or business.
2. If in the above situation the triple-net lease was associated with a qualified trade or business with at least 50% common ownership, the rental property would not be excluded from the QBI deduction as this would be a trade or business under the new rules. If the income comes from multiple tenants, one being a related party and one being unrelated, only the portion attributable to the related party will be considered to be an active trade or business.
3. If a real estate investor was a retired individual who owned and rented five residential properties and regularly maintained the properties, collected rents, paid bills and found tenants, there likely would be a strong argument that this would constitute a trade or business. This individual should keep a log of their daily activities relating to the rental properties should they need to later prove their participation under audit.

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.

Section 529 Plan

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.

• Plan funds can be used for college tuition, room and board, computers and related equipment.
• Unused fund earnings are subject to income tax.
• There are no contribution phaseout limits. However, the account owner’s contributions plus other gifts totaling more than $15,000 in 2018 for one student may be subject to gift taxes.
• Section 529 plans can also be used for up to $10,000 in tuition expenses for elementary and secondary public, private and religious school.

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.

Coverdell Education Savings Account (ESA)

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.

• Funds in this account can be withdrawn tax-free if used for qualified education expenses such as tuition, room and board, books, tutoring and more.
• If the funds are not spent by the time the beneficiary is 30, the unspent money must be withdrawn (subject to income tax and a 10% penalty) or rolled over into another family member’s education savings account.
• The maximum annual contribution per beneficiary is $2,000.
• Unlike 529 plans, Coverdell ESA contributions begin phasing out for parents with an adjusted gross income (AGI) of $190,000 (single filers with an AGI of $95,000).
• A Coverdell ESA can also be used for elementary and secondary school expenses.

This option is best for students who have education expense costs and want additional investment options for education savings.

Custodial Account

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.

• The funds are considered property of your child.
• The tax advantage in these accounts comes into play for unearned income up to $2,100 per year, which are taxed at the child’s (usually lower) tax rate.
• The annual investment earnings over $2,100 will be taxed at trust and estate rates.  This is new for the 2018 tax year.
• There are usually no annual contribution limits, but contributions of more than $15,000 may be subject to gift tax rules.
• The biggest potential disadvantage is that you gift the funds irrevocably to the child. At a certain age, your child controls the account and could spend the funds on something besides college.

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.