Each year, millions of taxpayers claim an income tax refund. To be sure, receiving a payment from the IRS for a few thousand dollars can be a pleasant influx of cash. But it means you were essentially giving the government an interest-free loan for close to a year, which isn’t the best use of your money.
Fortunately, there’s a way to begin collecting your 2018 refund now: You can review the amounts you’re having withheld and/or what estimated tax payments you’re making, and adjust them to keep more money in your pocket during the year.
Choosing to adjust
It’s particularly important to check your withholding and/or estimated tax payments if:
Even if you haven’t encountered any major life changes during the past year, changes in the tax law may affect withholding levels, making it worthwhile to double-check your withholding or estimated tax payments.
Making a change
You can modify your withholding at any time during the year, or even more than once within a year. To do so, you simply submit a new Form W-4 to your employer. Changes typically will go into effect several weeks after the new Form W-4 is submitted. For estimated tax payments, you can make adjustments each time quarterly payments are due.
While reducing withholdings or estimated tax payments will, indeed, put more money in your pocket now, you also need to be careful that you don’t reduce them too much. If you don’t pay enough tax throughout the year on a timely basis, you could end up owing interest and penalties when you file your return, even if you pay your outstanding tax liability by the April 2019 deadline.
One timely reason to consider adjusting your withholding is the passage of the Tax Cuts and Jobs Act late last year. In fact, the IRS had to revise its withholding tables to account for the increase to the standard deduction, suspension of personal exemptions, and changes in tax rates and brackets. If you’d like help determining what your withholding or estimated tax payments should be for the rest of the year, please contact us.
In an increasingly globalized society, many people choose to open offshore accounts to deposit a portion of their wealth. When doing so, it’s important to follow the IRS’s strict foreign accounts reporting requirements. In a nutshell, if you have a financial interest in or signature authority over any foreign accounts, including bank accounts, brokerage accounts, mutual funds or trusts, you must disclose those accounts to the IRS and you may have additional reporting requirements.
To do so, your tax preparer will check the box on line 7a of Schedule B (“Interest and Ordinary Dividends”) of Form 1040 — regardless of the account value. If the total value of your foreign financial assets exceeds $50,000 ($100,000 for joint filers) at the end of the tax year or exceeds $75,000 ($150,000 for joint filers) at any time during the tax year, you must provide account details on Form 8938 (“Statement of Specified Foreign Financial Assets”) and attach it to your tax return.
Finally, if the aggregate value of your foreign accounts is $10,000 or more during the calendar year, file FinCEN (Financial Crimes Enforcement Network) Form 114 — “Report of Foreign Bank and Financial Accounts (FBAR).” The current deadline for filing the form electronically with FinCEN is April 15, 2018, with an automatic extension to October 15.
Failure to disclose an offshore account could result in substantial IRS penalties, including collecting three to six years’ worth of back taxes, interest, a 20% to 40% accuracy-related penalty and, in some cases, a 75% fraud penalty. For further information, contact us.
With the risk of being hit by hacking, malware, and other forms of cyber-crime so high, most organizations go to great lengths (and expense) to protect their networks and infrastructure.
However, one major security risk that’s being overlooked is the printer!
All too often, print falls beyond IT teams’ field of view and is left hanging in an abyss ready and waiting for hackers to take advantage.
Here are some interesting statistics: According to research that was conducted by the Ponemon Institute, 64 percent of IT managers are suspicious that their printers have been infected with some form of malware; however, just 54% of organizations include printers in their security strategy.
With organizations placing all eyes firmly on network security, the major threats that are posed by printing devices that are directly connected to these networks are all too often completely overlooked.
So, what actions can you take to reduce the risk of print-related breaches?
Monitor your print devices
Regardless of how many printers are connected to the network, keep tabs on every single one. You can make this job easier by using remote management software.
Utilize pull printing
Also known as “follow-me printing,” this security technique holds a print job on the server until the person who executed the print command is physically present at the printer and authenticates themselves using a card or code.
This reduces the risk of sensitive documents being left unattended in the print room.
Did you know that most printers and multi-function devices contain a hard drive where your print jobs and copies are stored?
In many cases, years of images and print jobs are retained on this drive, and can easily be read by hackers or criminals when the machine is removed from service.
You need to protect your documents and ensure they are always stored on secure hard drives. Consider fitting your printers with hard drive encryption functionality to prevent data from being stolen.
Include print in the overall security strategy
As printers are connected to your network, they should form an integral part of your security strategy. Ensure they are protected in the same way you would protect any other device on the network.
Follow data protection mandates
When it comes to printers, user behavior represents a critical threat. Develop a clear security policy and ensure it is followed across the organization.
By Michael Cohn
A group of Senate Democrats introduced legislation to revive tax deductions for labor union dues and unreimbursed work expenses that were eliminated by the Tax Cuts and Jobs Act.
The Tax Fairness for Workers Act, introduced last month by Sen. Bob Casey, D-Pa., and co-sponsored by Sen. Debbie Stabenow, D-Mich., Bob Menendez, D-N.J., Sheldon Whitehouse, D-R.I., and Tammy Baldwin, D-Wis., would reinstate the deduction for unreimbursed employee expenses, and make the deduction for union dues above-the-line so it would be available to everyone, not just those who itemize.
“Unions provide a path to the middle class for working people by increasing their income and the economic security of their families,” Casey said in a statement. “To this end, it’s important that we do all we can to empower workers to organize, not make it harder.”
The Tax Cuts and Jobs Act eliminated many tax deductions that have long been used by itemizers, but doubled the size of the standard deduction in the name of tax simplification. During negotiations between House and Senate Republicans in a conference committee last December, GOP lawmakers restored a number of the tax breaks that were popular with some of their constituents, but since labor unions have traditionally been associated with Democrats, the tax break for union dues wasn't one of them.
By Matt Townsend and Brandon Kochkodin
America’s companies are swimming in cash thanks to the big cut in the corporate tax rate.
The roughly 180 companies in the S&P 500 Index that have reported results saw their effective tax rate drop by 6 percent on average in the first quarter. That saved them a total of almost $13 billion in taxes, an analysis by Bloomberg shows. About a third of that went to 44 financial firms.
What companies are doing with that boatload of money is a bit muddy. Some analysis shows spending on capital expenditures is surging. That would confirm President Donald Trump’s insistence that the cut would boost investment.
But lots of cash is also still going to buybacks that have anchored the U.S. stock market’s unprecedented run since the recession. Many firms also need more dough to pay for increasing labor and transportation costs.
Here are some of the early winners of the tax law, which reduced the federal corporate rate to 21 percent from 35 percent. To measure how much money a company saved, Bloomberg applied the 2017 tax rate to this year’s first-quarter pretax income, and then compared the number to 2018 results.
Among financial firms, Bank of America Corp.’s IRS bill in the first quarter fell the most, plummeting by $709 million from a year ago. No surprise, the firm posted record profits of $6.92 billion, a 30 percent jump. The funds could help the bank open more branches and expand into states like Ohio.
Alphabet Inc., parent of Google, is embarking on a spending binge to catch up to rivals in areas including artificial intelligence and home assistants. In the first quarter, capital expenditures tripled as its tax rate was slashed almost in half to 10.8 percent. The tech giant has, so far, had the biggest dollar windfall, seeing its tax bill plummet by $1 billion.
Consumer discretionary firms, like appliance-maker Whirlpool Corp. and Harley-Davidson Inc., have seen their rates fall. The iconic motorcycle maker is in the midst of a turnaround plan aimed at reversing sagging interest from younger shoppers. In the first quarter, it saved $24 million on a tax rate that fell by 1,000 basis points. Capex rose by 18 percent. But the company remained focused on cutting costs, while also boosting buybacks and its dividend.
Many companies have already realized the tax law would be more beneficial than they figured just a few months ago. One is Texas Instruments Inc., which in January projected a 23 percent rate for this year. Last week it reduced that to 20 percent.
Among the largest drops in tax rate, Netflix Inc.’s sank to 3 percent from 20 percent. Ford Motor Co. saw its decline by two-thirds to 9 percent. AbbVie Inc., maker of top-selling drug Humira, had already projected a 9 percent adjusted rate for this year, and posted a minuscule 0.5 percent levy last quarter. The drugmaker says it plans to spend more on research and development and capital projects.
“We view the passage of U.S. tax reform as an important business driver for companies like ours,” AbbVie Chief Executive Officer Richard Gonzalez said last week in a conference call. “Tax reform is having the intended impact.”
By Greg Stohr
Overstock.com has a small but unmistakable advantage for anyone looking to buy a three-cup Cuisinart Mini Prep Plus Food Processor for shipment to Germantown, Maryland: Purchasers don’t have to pay the 6 percent sales tax they’d owe at a local store.
That sort of discrepancy is at the heart of a multibillion-dollar U.S. Supreme Court case set for argument Tuesday. States and traditional retailers are asking the court to overturn a 26-year-old ruling that exempts many internet merchants from collecting billions of dollars in sales taxes. The 1992 decision says retailers can be forced to collect the tax only if they have a physical presence in a state, such as a store or warehouse.
“That rule doesn’t make sense anymore in today’s world of e-commerce,” said Deborah White, general counsel of the Retail Litigation Center, which represents the country’s largest merchants. “A retailer today can transact a significant amount of business in a state without ever being physically present in the state.”
A ruling for the states would put new pressure on internet retailers and marketplaces that don’t always collect taxes — including Overstock.com Inc., Wayfair Inc., Newegg Inc., EBay Inc., Etsy Inc. and thousands of smaller merchants.
The case will also affect e-commerce behemoth Amazon.com Inc., though less directly. The company now charges consumers in every state that imposes a sales tax, but only when selling products that come from its own inventory. About half of Amazon’s sales involve goods owned by third-party merchants, many of which don’t collect tax.
Broader taxing power would let state and local governments collect an extra $8 billion to $23 billion a year, according to various estimates. Forty-five states have a statewide sales tax.
Retailers fighting the states say they would be hit with heavy costs of complying with rules for thousands of products in thousands of cities, counties and even airports that serve as their own taxing jurisdictions. Overstock board member Jonathan Johnson says the available tax software only partially addresses the complexity.
"When you come to Overstock, I’ve got to know 12,000-plus tax jurisdictions," Johnson said. "And the more types of products I sell, the more difficult it is to map to the software that’s out there."
Maryland is one of the jurisdictions where Overstock doesn’t collect tax, including the $2.56 that would otherwise be due on the $42.63 Cuisinart food processor. Consumers must pay sales tax on the item at both the local Macy’s department store or on Amazon, which sells the appliance out of its own stock for $39.95, plus $2.40 in tax.
Amazon, which President Donald Trump accused of underpaying taxes, isn’t involved in the Supreme Court case.
The court showdown instead involves Wayfair, Overstock and Newegg, three retailers sued by South Dakota for not charging taxes to consumers there. Although all collect taxes in other parts of the country — 25 states for Wayfair, eight for Overstock and six for Newegg — they’ve been able to skirt South Dakota because they don’t have a physical presence there.
Under a 2016 law, South Dakota requires retailers with more than $100,000 in annual sales in the state to pay a 4.5 percent tax on purchases. The state enacted the measure with the explicit goal of overturning the 1992 Supreme Court ruling, known as Quill v. North Dakota.
The Quill ruling, involving a mail-order company, centered on the Constitution’s so-called dormant commerce clause, a judge-created legal doctrine that says states can’t unduly burden interstate commerce unless authorized by Congress.
Justice John Paul Stevens wrote for the court that the physical-presence requirement, despite its "artificiality," provided a clear standard for applying the dormant commerce clause. "Such a rule firmly establishes the boundaries of legitimate state authority to impose a duty to collect sales and use taxes and reduces litigation concerning those taxes."
South Dakota and its allies say "physical presence" is an increasingly elusive concept in the era of internet storefronts and smartphone apps. The state is urging the court to let sales taxes be imposed on companies with an "economic presence" in a state — a test South Dakota says its law would pass.
“This court’s outdated physical-presence rule now causes outsized harms to state treasuries and fundamental unfairness among retailers,” South Dakota argued in court papers. The state has the backing of the Trump administration.
Although South Dakota’s tax law applies only prospectively, critics say overruling Quill could open retailers to years of retroactive liability in other states.
“I think you’re going to see a flood not only of demands for ongoing tax collection but retroactive audits,” said Andy Pincus, a Washington lawyer who filed a brief on behalf of eBay and a group of small businesses that oppose the states.
In a court filing supporting South Dakota, more than 40 states said the retroactivity concern is overblown. The Colorado-led group said most states have safeguards to prevent retroactive application, or at least require advance notice. In addition, they said, the court can write a ruling that “applies prospectively only for all retailers and taxpayers.”
The court’s decision to take up the case suggests that Quill may be on shaky ground. Three current justices — Clarence Thomas, Anthony Kennedy and Neil Gorsuch — have already expressed doubts about the precedent.
Kennedy said in 2015 that Quill had produced a “startling revenue shortfall” in many states, as well as “unfairness” to local retailers and their customers. Gorsuch, who recently marked his one-year anniversary as a justice, suggested skepticism about Quill as an appeals court judge.
And Thomas said in a 2007 case involving waste disposal that he would jettison the entire dormant commerce clause. It “has no basis in the Constitution and has proved unworkable in practice,” he wrote.
No matter what the court decides, Congress gets the final word — if lawmakers want it. Amazon and Overstock are among the companies that say they support a nationwide law addressing internet sales taxes that would relieve retailers from dealing with a patchwork of state measures.
But Congress also could have acted any time since 1992. Its inaction is why White and other opponents of the physical-presence rule say the court needs to step in.
"We have waited more than 25 years for Congress to act and they haven’t," White said.
The case is South Dakota v. Wayfair, 17-494.
By Stephen Mihm
Taxpayers who rushed to complete Form 1040 by Tuesday’s deadline can take some comfort from the fact that they’re exceedingly unlikely to get a follow-up visit from the Internal Revenue Service. Over the past 50 years, audit rates have fallen pretty steadily. Today, the average taxpayer has one chance in 200 of getting audited.
The downward trend has led to concerns that the IRS needs more funding to do its job correctly and competently. That’s true, but before Congress throws money at hiring more auditors, it should take aim at the agency’s antiquated computer system. It has helped drive audit rates to all-time lows, but it desperately needs an upgrade.
After the creation of the first permanent income tax in 1913, IRS agents would scrutinize returns by hand, laboriously poring over the numbers, checking the math, and flagging returns that looked suspect. This was insanely time-consuming. It also led to a very high audit rate. One taxpayer in 10 was subjected to a “field examination” from IRS personnel, according to one estimate from 1926.
This was possible because so few taxpayers actually filed Form 1040; most didn’t because their income fell well below the threshold. As government spending increased from the late 1930s onward, more and more Americans found themselves paying income tax. That trend only intensified in the postwar years.
And therein lay a problem: How could IRS agents possibly check so many tax returns, much less run audits on this scale? As audit rates plummeted in the late 1940s, concerns over lost revenue fueled a search for solutions. Conveniently, a means of fixing the problem appeared at that precise moment in history: the computer.
The first mainframe computers may look like dinosaurs now, but they offered a way of reviewing tax returns on a mass scale. In the late 1950s, the IRS began using computers to correlate and compare the information submitted by taxpayers on their 1040 forms with the income figures supplied by employers. In 1959, the Washington Post, capturing the mood of the moment, warned of “brain machines” that would soon audit taxpayer returns; the Wall Street Journal called them “robot revenuers.”
By the early 1960s, the IRS had amassed a staggering amount of computing power in the service of compiling, collating and auditing returns. The stars of this brave new world consisted of a number of IBM mainframe machines, many of which resided in a nondescript brick building in Martinsburg, West Virginia. This was the heart — or brain — of the new order. And it triggered serious warnings that the jig was up.
“The Martinsburg Monster is going to get us all,” Charles Seib wrote in Harper’s Weekly. “The imaginative taxpayer, who in the past has had at least as good a chance as a devotee of Russian roulette, now must fact the certainty that all the chambers are loaded and the trigger set.”
Under the new system, the data contained in paper tax returns — along with all the other forms issued by employers, brokerages and banks — would be coded onto paper punch cards by an army of clerical workers. The data would then be “read” by the computer and stored on thousands of magnetic tapes.
The Martinsburg facility’s L-shaped array of mainframe computers and tape-reel machines became something of a destination for those looking for a glimpse of the future. “So many visitors come to gawk,” explained the New York Times in 1964, “that a glass enclosure was built for them to sit in.”
Throughout the 1960s, the IRS labored to build what it called the “Individual Master File” of all taxpayers, each identified by his or her Social Security number. This database would contain all the information relevant to each taxpayer. “By 1966,” predicted Seib in Harper’s, “every tax return in the nation will be under the Monster’s cold, electronic eye.”
This proved both a blessing and a curse for the IRS. Between 1963 and 1967, the Times reported, the number of taxpayers who reported any interest income rose 45 percent; the total amount of interest and dividend income reported to the IRS rose by $2.8 billion in the same period. “The hot eyeball of the computer was the goad to virtue,” reported the paper.
At the same time, the sheer number of possible leads on underpayment of taxes threatened to overwhelm the very human staff responsible for overseeing audits. The IRS solved the problem in two ways.
First, it began using the computers to issue automated letters demanding that taxpayers correct errors. In effect, it relied on form letters to achieve what field audits had formerly accomplished. At the same time, it began using historical data to build algorithms designed to sniff out suspect returns. Such returns might not contain any errors, but because of certain red flags — an unusual deduction, a deviation from some norm — the computer could flag the return. The higher the “Dif,” or “discriminate function,” score, the more likely something fishy was taking place. Audit rates drifted downward, a trend that continues to this day.
Though the IRS has periodically upgraded its computing system, today’s system is still running the same code, which was written nearly 60 years ago. Most of it is in the Assembly programming language, which the IRS itself has described as “antiquated” and “inflexible.” Worse, the number of programmers who can understand and maintain the code behind the Individual Master File (IMF) dwindles with every passing year. According to the Government Accountability Office, the IMF and its business counterpart (the BMF) are the oldest computing systems used by the federal government. (The runner-up in this dubious contest is the software used to coordinate the nation’s nuclear weapons.)
Plans to replace the IMF with a twenty-first-century equivalent known as CADE (Customer Account Data Engine) have faltered. The transition is now well behind schedule. As a consequence, the likelihood of a catastrophic computer failure during tax season increases with every passing year. That may not pose quite the same danger as an errant missile, but the prospect of lost refund checks, unnecessary audits, and other errors suggests that the time has come to bring the IRS into the 21st century.
By Michael Cohn
The Internal Revenue Service issued a notice to corporate taxpayers to provide more information about the tax rates they will be paying as they transition to the new tax law.
The IRS noted that many U.S. corporations use a fiscal year end instead of a calendar year end for federal income tax reporting purposes. Under the recently enacted Tax Cuts and Jobs Act, a corporation with a fiscal year that includes Jan. 1, 2018 is supposed to pay federal income taxes using a blended tax rate and not the flat 21 percent tax rate under the TCJA that would generally apply to taxable years beginning after Dec. 31, 2017.
Corporations can figure their federal income tax for fiscal years that include Jan. 1, 2018, by first calculating their tax for the entire taxable year by employing the tax rates in effect prior to the tax code overhaul and then calculating their tax with the new 21 percent rate, subsequently proportioning each tax amount based on the number of days in the taxable year when the different rates were in effect. The sum of the two amounts is the corporation’s federal income tax for the fiscal year.
The IRS noted the blended rate applies to all fiscal year corporations whose fiscal year includes Jan. 1, 2018. Fiscal-year corporations that have already filed their federal income taxes that don’t reflect the blended rate may want to consider filing an amended return, according to the IRS.
On Monday, the IRS issued Notice 2018-38, which provides guidance on the changes made by the Tax Cuts and Jobs Act to federal income tax rates for corporations to the alternative minimum tax for corporations for corporations whose taxable year begins before Jan. 1, 2018, and ends after Dec. 31, 2017.
The IRS also pointed out the federal sequester law remains in effect for the 2018 federal fiscal year, and corporations need to be aware of how it could affect their tax credits and refunds. The IRS has posted information about the effect of sequestration on the alternative minimum tax for corporations. Revised forms and instructions for corporate tax filers are available here.
The tax rules related to meals and entertainment have changed, and left some uncertainty in the gap between the old law and the new.
Before the Tax Cuts and Jobs Act, the deduction allowed for entertainment expenses was limited to 50 percent of the amount otherwise deductible. Under the TCJA, the deduction for entertainment is completely repealed. Prior to the act, a 50 percent deduction was allowed for expenses related to business meals that were not lavish or extravagant. The confusion results from the issue of whether such business meals fall under the entertainment umbrella, or are still deductible.
“It now raises the question of what is an entertainment expense,” said Nathan Smith, director at the National Tax Office at Top 10 Firm CBIZ MHM. “Taxpayers have to be certain as to what falls under that category. It made no difference before, since there was a 50 percent deduction either way. Now, if it’s entertainment, it’s totally nondeductible.”
Until the IRS comes out with guidance in the area, the confusion will remain, according to Smith: “Some would argue that taking a client out for a meal clearly falls under entertainment. You could make a strong case for that by looking at the legislative notes for prior legislation, which suggest that meals are entertainment. On the other hand, the committee reports for the current law passed last December indicate they did not intend to change prior-law treatment for business meals. But the actual law that’s on the books doesn’t say this.”
“The consensus is that business meals are not caught under the entertainment umbrella and remain 50 percent deductible, which is what the committee report indicated, but it’s not the law,” he continued. “Nothing in the code says that meals are only entertainment and can be nothing else. The 50 percent deduction for business meals will likely remain, but we just don’t know for sure.”
A printout of the Tax Cuts and Jobs Act, alongside a stack of income tax regulations.Bloomberg News
“It will be some time before we see guidance on this,” said Meredith Kowal, senior manager of R&D tax credit services at Top 100 Firm Aprio.
“It comes down to intent – are you really entertaining customers or are you having a business discussion to solve an issue,” she explained. “Documentation is increasingly important this year, as it will provide more opportunity to deduct items now considered ‘gray area’ due to the vague rules.”
“The IRS will provide more guidance in the coming months,” she said. “What it will come down to is whether there is a business purpose, and what is the business purpose? What people don’t realize is that extravagant entertainment – such as a luxury suite at a ballgame – has always been disallowed. The luxury suite portion was disallowed in the past but the regular ticket price was deductible.”
And contrary to common misconceptions, internal expenses such as holiday parties, and team-building outings that boost employee morale are still fully deductible, Kowal indicated. “And sponsorships are often included in the same contract as a suite or box,” she said. “While the suite or box is no longer deductible, the sponsorship is still deductible.”
“My interpretation now, without more clarification, is that a meal is a meal, and entertainment is entertainment,” said Emily Matthews, principal at Boston-based Edelstein & Co. “So if you’re going to a game, the tickets are not deductible, but if you go to dinner beforehand and talk about business, that’s trickier. Arguably the meal would be 50 percent deductible, but there is some clarity to be had there.”
“Clearly the idea is to cut back on entertainment side, but to allow for the business meal to take place,” said Roger Harris, president of Padgett Business Services. “Make sure that while you’re eating you’re discussing business matters. If the conversation is boring and you feel like falling asleep, it’s probably deductible.”
In 2017, the IRS received more than 152 million tax returns from individuals, married couples, and businesses. And these numbers are predicted to increase for 2018. With so many people filing, you’d think it’s highly unlikely to get audited. However, you should think again. Since the IRS began allowing e-filing, many people have been filing taxes themselves, which means they’re more likely to make mistakes.
This is one important reason why the IRS set up a filter system to pay specific attention to certain parts of your tax return and flag them if they seem suspicious or potentially inaccurate. You’ll have a much better chance of avoiding an audit if you keep these 10 IRS audit triggers in mind when you file your taxes.
1: Out-of-proportion Income
The IRS has extensive information about what the median average wage for your job should be. If your income figures are out of proportion to how much other people in the same industry are making, this is one of the most common IRS audit triggers, and the IRS will want to know more. To help avoid this audit: be honest with how much you really make and how you make it. Otherwise, you’ll be on the IRS’ radar every time you file a tax return from now on.
2: Self-employment Deductions
Being self-employed, you have the luxury of working at home in your pajamas if you want. However, you could also be audited faster than others because you may claim deductions and business expenses that are not related to your self-employment. To help avoid this audit: keep personal expenses and business deductions separate, report all taxable income correctly, and file the correct tax forms to claim legitimate deductions. A free, comprehensive tax organizer can be of great help here.
3: Tip and Cash Earners
It is admittedly more difficult to keep track of tips and cash payments than checks or direct deposits. The IRS knows this and holds these types of earners to a higher standard. The IRS audits professions more frequently that accept cash and tips, such as restaurants and wait staff. To help avoid this audit: report all your income, not just what you think is traceable via credit card receipts or checks. If you trigger this type of audit, an IRS agent will ask specific questions that will tell them if you’re underreporting your cash income. Answer truthfully and keep accurate, detailed accounting records.
4: Home Office Deductions
The IRS has very stringent guidelines on what qualifies as a home office, so the home office deduction is a definite red flag on your tax return. For this deduction to be legitimate, there must be a room separate from the rest of the house that cannot be used for other reasons. (It can’t be your living room, for example.) Sometimes people try to include their entire home for the deduction, which is a major no-no. To help avoid this audit: have a separate room for your home office used exclusively for business purposes and not for other activities. Read IRS publication 587 to ensure you qualify for a home office deduction.
5: Business Losses for the Self-employed/Business Owners
When you’re self-employed or a sole proprietor, business losses are common for the first one or two years. However, if you’re still claiming losses after being in business for five or more years, the IRS will question if you own a real business or if you’re just writing off a hobby to get more deductions. To help avoid this audit: document all your business expenses to prove you did indeed lose money.
6: Making $200,000 or More a Year
The more you make, the more likely the IRS will audit you. They know taxpayers will likely make more mistakes or be tempted to underreport their income on tricky tax returns when they’re in higher income brackets. Also, the IRS gets a larger payoff when auditing these higher-income returns. To help avoid this audit: report all income and keep documentation to prove it. Also, use the correct tax forms and fill in all relevant fields.
7: Not Reporting All Taxable Income
Misplacing a decimal point or adding an extra number is a simple mistake, but it can throw off all your income figures. If your tax returns don’t match the W-2 form or 1099 form submitted by your employer, the IRS is much more likely to audit you. To help avoid this audit: if an error occurs on your W-2 or 1099, have the employer send the IRS the correct information.
8: Taking Higher-than-average Deductions
Most taxpayers should claim as many deductions as possible to get a bigger tax refund or owe less taxes. If you can claim the deduction and have the documents to back it up, then put it on the return. However, if the deductions are too large in comparison to the amount earned — for example, claiming $17,000 in expenses but only reporting $23,000 in gross income — you’re likely to trigger an audit. To help avoid this audit: don’t take a deduction you can’t prove.
9: Claiming EITC Tax Credits
The Earned Income Tax Credit (EITC) is a subsidy given to low-income working families. If you receive this tax credit but make more than the eligibility requirements, you may be audited. The IRS has cracked down on this credit specifically, so anyone claiming the EITC will have to wait until after February 15 to receive any part of their tax return. This delay allows the IRS to confirm income levels with W-2 forms before issuing the refund. To help avoid this audit: take the credit only if you qualify as a low-income family or low-income individual.
10: Large Charitable Deductions
Since giving to charities is a worthy endeavor, our tax laws reward it. But if your charitable deductions seem unusually large in comparison to your income, the IRS may come knocking on your door. To help avoid this audit: if you donated more than $250 last year, keep all related documentation and receipts on file. If you made donations of $500 or more, be sure to file form 8283.
On April 11, I testified before the congressional Joint Economic Committee on whether the Tax Cuts and Jobs Act (TCJA) will help "Unleash America’s Economic Potential.” I find that Congress is conducting an interesting experiment by enacting a major economic stimulus at a time of full-employment.
To evaluate the new law, consider the four basic tenets of good tax policy:
In the real world, all these goals involve tradeoffs. But keeping these aims in mind makes it possible to evaluate changes in tax levels on some objective basis.
How does the TCJA measure up against these goals?
How will the law affect economic growth and jobs? Conventional analysis suggests these effects are likely to be modest because:
The Tax Policy Center, the Penn Wharton Budget Model, and the Congressional Joint Committee on Taxation (and the Congressional Budget Office) all come to a similar conclusion: The economic effects of the TCJA are positive in the short run but will dissipate over subsequent years.
Impact on Fiscal Position of the US
Over the last 60 years or so, federal receipts have tended to fluctuate in a range of 15-20 percent of Gross Domestic Product (GDP). Tax legislation, economic booms, and economic downturns have all occurred over this timeframe, but receipts as a share of the economy have stayed in this relatively narrow range. During this period, the federal budget was balanced just twice.
The most recent period was in the late 1990s/early 2000s, when federal receipts were right around 20 percent of GDP. Given demographic trends—retiring baby boomers, relatively low birth rates, and longer life spans—we should expect that revenue will have to at least reach those levels in the future to bring the federal budget into balance. But the TCJA goes in the opposite direction and reduces revenue as a share of the economy.
Thus, the TCJA is part of a large fiscal experiment. It provides a big fiscal stimulus when the economy is near full employment and it creates a number of investment incentives at a time when companies have been accumulating cash, indicating they have seen limited opportunities for profitable investments. But, proponents of the Act say that the law will lead to increased US investment that will in turn increase the productivity of US workers and increase wages.
It is too early to tell if all these linked relationships will occur. The outcomes are still months and years away, given investment planning horizons.
So the jury is out on the effects of the Tax Cuts and Jobs Act, but given the structure of the Act, with numerous parts scheduled to increase, phase-in, or phase-out, Congress will have many opportunities to evaluate the Act and make any necessary changes.
Low-income Americans see little benefit from tax law
By Michael Cohn
Low-income people aren’t being helped much by the new tax law, according to a new survey by a website catering to pawnshop customers.
PawnGuru surveyed 1,280 users and found that of the respondents who work, although they are overwhelmingly low-income, 80 percent have not received a raise since February, while 50 percent have not gotten a raise since last year. Of those who got a raise, a 55 percent majority received an additional $50 or less per month, which amounts to about 25 cents an hour.
Low-income Americans were only barely aware of the new tax law. While nearly nine-tenths of the respondents claimed to read or watch the news, and half were aware of the new tax law, only one-third knew any details of the legislation. Of those who were comfortable replying to this question, only 30 percent saw a representative of the GOP defend the law.
“While 88 percent of the population in the sample claimed to read or watch the news, only 51 percent were aware of the new tax law, and only 35 percent reported any details,” said PawnGuru co-founder Jordan Birnholtz. “About a third of the people were uncomfortable replying to the question when we asked, ‘Did you ever see a representative of the GOP defend the law?’ Only 30 percent said that they have, which was surprising to us.”
PawnGuru is a startup that allows people to post items they want to sell, buy or get a loan on from a pawnshop. It’s aimed at unbanked and underbanked users. Over 30 percent of PawnGuru’s users are unemployed, and the rest are largely low-income. Although half the respondents to the survey are either unemployed or make less than $20,000 a year, only 35 percent said they are on SNAP or Medicaid.
“The tax law isn’t helping workers,” said Birnholtz. “Workers are barely aware of the law, and it’s really hard for people who need help to get it.”
He isn’t sure what the impact the new tax reform law will have on the midterm elections in the fall. “These are folks who don’t feel any allegiance to the GOP or any sense of gratitude,” said Birnholtz. “It’s not clear to me what extent Democrats will capitalize on their lack of satisfaction or lack of knowledge about the tax law. This is a population that is likeliest to vote when they are the subject of frequent contact by their friends and by their community to remind them to vote.”
However, Republican lawmakers are pointing to some signs of success. The House Ways and Means Committee held a hearing Wednesday at a hearing on how tax reform was growing the economy and jobs. Ways and Means Committee chairman Kevin Brady, R-Texas, who was one of the main architects of the new law, cited some positive data from the Congressional Budget Office.
"In August of 2016, CBO projected that GDP growth would slow to 2.1 percent by the end of 2018,” he said. “Our families and workers deserved better than that slow growth status quo. And now, thanks in large part to the Tax Cuts and Jobs Act, the economic outlook for America has dramatically improved. Already in the first quarter of 2018 we are seeing actual growth of 2.9 percent. And CBO projects that this will accelerate to 3.3 percent by the end of 2018. Before the Tax Cuts and Jobs Act, CBO projected investment would grow to 4.4 percent in the first quarter of 2018 — after tax reform, CBO revised its projection to 5.6 percent for that same quarter. And the data now shows that investment actually grew 6.1 percent in the first quarter of 2018 — even higher than CBO’s revised projection. Looking forward, CBO has also estimated that the Tax Cuts and Jobs Act will create 900,000 jobs, raise wages by $1.2 trillion, and boost investment by $600 billion.”
Brady added that consumer confidence has risen to its highest level since 2000. “The National Federation of Independent Business April 2018 survey shows small business confidence in the economy is near all-time highs,” he said. “In addition, the percentage of small businesses that reported seeing profit growth is the highest in the 45-year history of the survey.”
However, Rep. Richard Neal, D-Mass., the ranking Democrat on the Ways and Means Committee, disputed the success of the new tax law. "Mr. Chairman, when you began the process of tax reform, Democrats were very clear in reminding you that trickle-down economics simply does not work," he said. "If you didn’t believe us then, I hope you’ll believe us now. Since passage of the tax law, we have all watched as record stock buybacks have lined the pockets of the elite, as companies stated publicly that their tax cut is funding the offshoring of American jobs. One American corporation even went as far as admitting openly that your tax law gave them the money to lay off more than 5,000 U.S. workers. That’s 5,000 families whose lives will be upended by your irresponsible law."
Pelosi plans to revisit Trump tax cuts if she becomes Speaker
By Erik Wasson
House Minority Leader Nancy Pelosi said that if Democrats take control of the House in November and she’s elected as their leader, she will seek to revise the GOP’s tax cut bill to reverse its estimated $1.9 trillion increase to federal budget deficits.
“The tax bill is a dark cloud over our children’s future,” the California Democrat said Thursday at the Peterson Foundation Fiscal Summit in Washington. “We want to revisit in a way that puts the middle class first and reduces the debt.”
Pelosi said she would seek to negotiate a bipartisan extension of the tax bill’s middle-class tax cuts for individuals, which expire in 2026. The new tax bill would be one that “promotes growth, generates jobs and reduces the deficit,” she said.
Republicans have been highlighting the tax cuts signed by President Donald Trump in December as polls show Democrats have a chance of taking the House and perhaps the Senate in November’s elections. But the issue may be of limited value to the GOP. An April NBC News/Wall Street Journal poll showed that 27 percent of Americans said the cuts were a good idea, a decline from 30 percent in January.
Pelosi didn’t say whether she would seek to raise the corporate rate — which was cut to 21 percent from 35 percent — and didn’t specify other tax breaks she would seek to end. The GOP tax law gave an array of temporary tax breaks to other types of businesses and to individuals — including rate cuts that will tend to favor the highest earners.
Pelosi promised to follow pay-as-you-go procedures for any new spending, though she didn’t specify how she would fund the infrastructure and education proposals in the Democrats’ election-year platform.
“Wouldn’t it have been better if we had spent over a trillion dollars on infrastructure” instead of “tax breaks for the wealthy?” she said.
The U.S. budget deficit is projected to rise above $1 trillion per year in 2020 and remain at that level, according to the nonpartisan Congressional Budget Office.
IRS warns about new twist on banking tax scam
By Michael Cohn
The Internal Revenue Service issued a warning Thursday about a new variation on a scam involving requests by criminals who pretend to be working for the IRS asking for bank information from international taxpayers and non-resident aliens.
The crooks mail or fax a letter to unsuspecting victims asking them to fill out a copy of a Form W-8BEN, “Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting,” and saying they need to fax it back to the criminals who are impersonating IRS employees. The letter acknowledges the recipient is exempt from withholding or reporting income tax but insists they need to authenticate their information with the IRS.
The Form W-8BEN is a legitimate U.S. tax exemption document related to the Foreign Account Tax Compliance Act, also known as FATCA. But the IRS noted it can only be submitted through a withholding agent. In the past, scammers have targeted nonresidents of the U.S. using the form as a way to elicit personal details such as passport numbers and PIN codes. The legitimate IRS Form W-8BEN doesn’t ask for any of that information. The bogus letter or fax also refers to a Form W9095, which doesn’t exist, the IRS pointed out, adding that the agency doesn’t require recertification of foreign status.
A missing $10,000 check and how it led to a new bank feed solution
It all started in 2012, when financial analyst Maurice Berdugo decided to do his own taxes.
Berdugo had claimed $10,000 in healthcare costs. Two years later, his accountant informed him that the IRS was requesting a copy of the check he had written for that amount. Berdugo confidently logged in his Bank of America account online, but quickly found that the image of that check was no longer available. He called the bank up, and staff informed him the bank only stores check images for one year.
Well, the IRS’ window for audit is three years, and Berdugo had a problem.
After multiple phone calls with Bank of America, Berdugo had to send a formal letter — yes, on paper — to get an image of his old check. He knew there was an opportunity here.
“I talked to a lot of accountants, and this was a problem,” Berdugo said. “They said just getting copies of checks is a big pain, and every accountant said they have one or two clients that make it very difficult to gain access to their bank feed.”
While many online accounting software platforms do offer bank feed integration, those feeds typically populate numerical data into the software. Check images don’t transfer over. So Berdugo recruited an accountant as his business partner, Chris Ragain, CPA, and together they created LedgerSync.
LedgerSync gives real-time connection to client’s bank and credit card accounts, and stores them indefinitely. The software uses optical character recognition (OCR), provided by AutoEntry, to read checks and statements populating the numerical data into the user’s accounting software.
There are third party extensions that offer such deep bank feed integration capabilities, such as HubDoc, which Berdugo says is LedgerSync’s closest competitor. But unlike HubDoc, LedgerSync is focused just on perfecting banks feed integration, and doesn’t foray into areas like document management.
One of the most distinguishing features of LedgerSync is that it currently integrates with 850 banks. Berdugo uses technology to go “right in the front door” of bank feeds, so doesn’t have to wait for agreements from banks to integrate. This is significant, as the native bank feeds available within Xero and QuickBooks are limited to certain banks with which the software companies have agreements.
To create the solution, Berdugo and Ragain hired a team of software developers through regular job sites like Indeed. The developers are located remotely — mostly in Canada, which Berdugo said has helped keep costs down.
Technology is now Berdugo's full time gig, and he has taken on the role of CEO for LedgerSync, having bought his partner Ragain out early on.
“The plan now is to integrate with QuickBooks Online, Xero, and possibly expand into building a small business accounting solution, because we already have the data,” Berdugo said. “A lot of our accountants are telling us, ‘look, you’ve got all data’ — all most businesses need is profit and loss statements. That’s all they care about —
Corporate America is investing, but tax cuts aren’t top reason
By Shobhana Chandra
Corporate America is stepping up its investment plans this year, but the main reason may come as a surprise. An improved business outlook — rather than the Trump administration’s tax cuts — is driving companies’ decisions.
About a third of purchasing and supply executives say they’ve recently boosted their capital spending plans for the next 12 months, according to the Institute for Supply Management’s latest semi-annual forecast, released Monday. Within the share that said they’re ramping up their investment plans, the recent tax overhaul was cited as the reason by just 14.4 percent of respondents at factories and 18.6 percent at service providers.
The “general business outlook” was the primary catalyst — cited by 69 percent in manufacturing and 58 percent in services, according to ISM. The survey didn’t elaborate on what the general business outlook included.
Republicans have said the new tax law’s slashing of the corporate rate and a provision that allows companies to fully write off their capital expenditures right away will lead to increased investment, more job creation and faster economic growth. President Donald Trump highlighted the expensing measure during a small-business tax roundtable in Florida last month, saying it would have a bigger impact than almost anything else in the bill.
“Nobody thought they’d ever see that,” Trump said. “And that’s had a huge impact.”
Before Trump signed the tax law, 5.8 percent of respondents in manufacturing and 4.3 percent of those in services said tax changes were the reason for increasing capital spending plans over the next 12 months, according to a December ISM report. At that time, firms were awaiting final details on corporate changes.
Tax reform law may give freelancers a boost
By Michael Cohn
The 20 percent pass-through deduction in the new tax law could provide a major benefit for freelancers and gig economy workers, but there are also some important caveats for the self-employed.
“Getting a 20 percent reduction off your business income for individuals who are either sole proprietors, or if they are self-incorporated and have business income that is below the threshold of the specified service of $157,500, or $315,000 if they’re married, is going to be quite an incentive for people to want to be independent contractors and freelancers,” said MBO Partners CEO Gene Zaino, whose firm provides technology for self-employed professionals.
Today there are over 40 million independent workers in the U.S., according to MBO’s research, and the number has been growing as more companies rely on contractors rather than employees. Many workers are affiliating themselves with gig economy apps like Uber, Lyft, TaskRabbit, Handy and others to earn extra money. The Tax Cuts and Jobs Act offers some incentives for the self-employed.
“It’s a pretty significant part of our economy, and it’s been growing quite fast,” said Zaino. “It’s actually growing five times faster than traditional employment. We think the new tax law and the benefit to the small business and independent sole proprietor is only going to be further motivation to accelerate the shift in the workforce from full time to having more and more people launch their own independent career.”
But there’s a great deal of risk to going freelance, particularly the loss of employer-provided health insurance and other employee benefits like a 401(k).
“That remains probably the single biggest job lock: benefits,” said Zaino. “But what’s happening is many independent workers are either covered through a spousal program, or there’s a lot of baby boomers who are pre-retirement or they have COBRA or are getting onto the Medicare program. They generally have other ways of getting health benefits.”
In January, the Department of Labor proposed to expand access to Small Business Health Plans, also known as “association health plans,” which don’t provide the full range of benefits required under the Affordable Care Act for plans offered by the state-run health insurance exchanges. Sole proprietors would be able to join the Small Business Health Plans. The proposal came not long after Congress eliminated the Affordable Care Act’s individual mandate requiring people to buy health insurance when it passed the Tax Cuts and Jobs Act last December.
“We think there’s going to be some dramatic innovation in that area that’s also going to have better health benefits available through the private exchanges, through the private insurance companies, now that the individual mandate is no longer in place,” said Zaino. “In other words, people can buy health insurance now that isn’t ACA compliant for their own individual purpose, and there’s not a penalty for doing that. I think you’ll see insurance companies also looking at products that could be attractive to this independent worker community. But that still is a big problem. What we see in our world today is most of these people have insurance through their spouse or through some other avenue.”
The Tax Cuts and Jobs Act includes a 20 percent deduction for pass-through businesses such as sole proprietorships and partnerships, but there are limits, particularly when it comes to professional services firms such as accounting firms and law firms.
“Our understanding is that everyone would get it up until the threshold of $157,500,” said Zaino. “Once you break past that threshold, there are ‘specified services,’ which is basically just about every service industry other than architects and engineers that won’t be entitled to it any longer. But for the independent freelancer, $157,500 in pass-through profit is quite attractive for a one-person company, and certainly if they’re married, it can be up to $315,000. We think it’s going to be absolutely an accelerator for that segment of the market.”
Many of the self-employed have little understanding of the new tax law, which is probably true of most taxpayers. A recent survey by the National Association for the Self-Employed found that 83 percent of small business owners didn’t have a complete understanding of the impact the new tax reform law would have on their business (see Small businesses unprepared for tax reform). Over 90 percent of the 389 respondents felt the government did not adequately prepare them for the new tax system. More than half, 55 percent, said they had spent zero on outside professional assistance to prepare for the new tax law.
A separate survey by Intuit found 36 percent of self-employed workers admit they don't pay taxes, and nearly one in 10 self-employed workers don’t know about the recent tax reform. More than a fourth of self-employed workers think the tax reform will cause them to pay more in taxes, and 14 percent of self-employed workers are currently behind on their taxes.
Despite the dramatic changes in the tax code in recent months, the IRS is likely to still keep a close watch on employee versus independent contractor classification and misclassification issues.
“The law has not changed in terms of what is an employee and what is an independent contractor,” Zaino pointed out. “There are rules about that, regarding the level of control that your client has over the work that you do, and your real ability to have profit or loss and have entrepreneurial opportunity, what’s the nature of the arrangement, and are you really set up as a business. If you’re going to become an independent contractor, you have to really understand what that means. You have to set yourself up properly and know that you are taking on risk. You have to get your own benefits and your own business insurance. You have to market yourself and hold yourself out to be a true business.”
One thing companies should not do is pressure their employees to become independent contractors.
“I do believe you’re going to see people and companies push the envelope to probably convert employees into independent contractors, which is illegal, and that’s going to cause a lot of conflict,” said Zaino. “One of the biggest issues is to raise awareness and give people a better understanding of the difference between an employee and an independent contractor. Companies that are going to be using these people are at risk of potentially misclassifying the worker as their employee, and they should really understand those rules. For the actual freelancers and contractors who want to take advantage of this tax deduction, they should make sure they really understand how to set themselves up properly to be a qualified independent contractor. If they’re set up properly, I think there’s a great opportunity for them. But this is not a matter of just calling yourself an independent contractor and getting a 20 percent benefit.”
5 tax reform twists businesses need to know more about
The Treasury Department has been directed to remove two existing regulations for every new one it issues going forward. While these moves are intended to reduce the volume of regulations and to clarify the new law, tax and regulatory executives at businesses of varied sizes are still looking for clarification across many key areas, particularly when it comes to the ramifications of the Tax Cuts and Jobs Act.
While the size, entity type and geographic footprint of a business yields many company-specific questions and tax scenarios, what is known about the implementation of the new tax law today does permit the identification of some broad areas of observation and discussion. Here are several specific examples:
When the Tax Cuts and Jobs Act became law, most of the discussion centered on individual and domestic business tax reform changes. However, several of the international tax provisions in this law may have a significant impact on taxpayers. A new category of income, “global intangible low-taxed income,” or GILTI, will require businesses to recognize a percentage of previously deferred foreign earnings via a minimum tax on a controlled foreign corporation’s income, offset by a 10 percent reduction roughly equal to the adjusted tax basis of the CFC’s depreciable tangible personal property. While conformity laws are expected in some states, not all states may conform to the federal GILTI provisions.
To prepare, taxpayers should analyze their existing foreign structures to ensure they have appropriate expense allocations and add GILTI implications into their tax rate forecasts and provisions. Similarly, as some of the offsets of this provision are only available to C corporations, taxpayers should examine their overall tax position to determine which alternative tax strategies could be required to mitigate the GILTI impact.
2. Section 162(m)
This section of the Tax Code prohibits publicly held corporations from deducting more than $1 million per year in compensation paid to each of certain covered employees. With an eye toward reining in performance-based compensation exceptions, the proposed revisions to this section stem from public outcry in the late 2000s over exorbitant executive bonus structures. Questions remain as to what might be grandfathered in from previous law and what might not. “There was always an exception for performance-based compensation,” said Ronnie Brown, vice president of tax at National Vision Inc., who teaches at Georgia State University’s J. Mack Robinson College of Business. “Those rules have been tightened a bit. Companies may look at their compensation structures more and make sure they look at the 162(m) regime.”
3. Transition taxes
To offset potential revenue from transitioning to a quasi-territorial tax regime, a one-time deferred income inclusion on previously deferred and untaxed income will be subject to a mandatory transition tax in the United States at either an 8 percent tax rate for illiquid assets or a 15.5 percent tax rate for earnings attributable to liquid assets measured at Nov. 2, 2017, or Dec. 31, 2017, whichever is higher. New sourcing rules also change where activities are considered taxed. The law changes the current worldwide taxation system (with some deferrals) to a participation exemption (via a dividend received deduction) with current taxation of some types of income. This tax will affect U.S. persons who own 10 percent of the vote or value of a specified foreign corporation. Therefore, this provision could impact not just U.S. corporations owning foreign subsidiaries, but also foreign private equity funds and their U.S. owners.
The relatively low rates of the transition tax are designed to facilitate the return of the estimated $2.5 trillion in accumulated foreign earnings – earnings that, under the higher tax rates of the prior tax law, were largely left tax-deferred in foreign subsidiaries. Early trends indicate that the law is achieving its desired impact. However, some companies may still not be able to bring this money back to the United States due to the working capital needs in their foreign operations, as well as withholding tax at the local level.
4. Section 163(j)
The deductibility of net business interest expense generally will be limited to 30 percent of adjusted taxable income. Moreover, there is no grandfather provision for loans made prior to the enactment of the law, so interest on these prior loans will also be subject to this new limitation. This may result in less borrowing by businesses with a corresponding turn to equity transactions, as not only will the interest deduction be limited but the deduction itself is not as valuable now that the corporate tax rate has been reduced to 21 percent. Additionally, the law does not address whether a consolidated group is treated as a single taxpayer in the calculation of this deduction, which requires further clarification.
5. Conformity laws
For companies operating across numerous states, new federal regulations present challenges if states do not conform with the federal provisions. The state income tax implications of the new legislation vary widely depending on states’ automatic or fixed conformity to the Internal Revenue Code and based on states’ appetite for amending their tax laws after the law’s enactment. Generally, however, the tax reform will have the effect of increasing most businesses’ effective state income tax rate due to the broadened federal income tax base without a corresponding reduction in the state tax rate. For example, Georgia recently enacted HB 918, which resulted in GILTI income being subject to tax despite Georgia’s historical stance of not subjecting foreign dividend income to taxation.
Shortly after taking office last January, the Trump administration set in motion a process requiring the Treasury to identify and reduce tax regulatory burdens. The Treasury has responded by proposing the removal of hundreds of burdensome or obsolete regulations. Under the requirement to remove two old regulations for every new one, the Treasury now can issue regulations to answer the many questions and provide the clarity that corporations will need as they plan for and comply with the provisions of the most significant tax legislation in the last 30 years.
IRS expands access to info on tax-exempt groups
By Michael Cohn
The Internal Revenue Service unveiled an online tool Monday to provide easier access to public information about tax-exempt organizations.
The new Tax Exempt Organization Search replaces EO Select Check, a tool that’s been available since 2012 but had more limited features. EO Select Check mainly offered information on whether an organization was tax-exempt or not, and whether its status had been revoked, but TEOS provides much more information.
The new tool provides images of newly filed Forms 990 available for the first time. TEOS also includes two other significant improvements. Users can find more kinds of information than previously available through EO Select Check. On top of that, the search process has been simplified, enabling users to search across multiple data files for information with one query.
TEOS also works better than EO Select Check on mobile devices, so users can search for information via smartphone or tablet. They can also see images of an organization’s information returns and IRS determination letters. That includes:
TEOS also provides access to all the information that used to be available on EO Select Check. That includes whether an organization is eligible to receive tax-deductible contributions, has had its tax-exempt status revoked because it failed to file required forms or notices for three consecutive years and, for a small organization, whether it filed a Form 990-N (e-Postcard) annual electronic notice with the IRS.
“This new tool provides taxpayers an easy way to get information about charitable organizations,” said Acting IRS Commissioner David Kautter in a statement. “Tax-exempt organizations play a critical role in our nation, and this will provide greater insight for people considering donations.”
Publicly available data from e-filed Forms 990 will continue to be available in a machine-readable format through Amazon Web Services.
Only a third of companies are ready for new tax law so they’re hiring tax pros
By Michael Cohn
Just 32 percent of companies said they are very ready for the demands of the Tax Cuts and Jobs Act, according to a new survey of CFOs, while 68 percent indicated they are somewhat prepared or not at all ready for the changes.
The survey, by the recruitment firm Robert Half Finance & Accounting, found companies are using a variety of strategies to deal with the new tax law, including hiring tax experts and other staff. Twenty-one percent of the more than 2,000 CFOs polled said their companies are hiring full-time staff to prepare to meet the new requirements, while 33 percent are bringing in subject matter experts. Meanwhile 42 percent of them are doing extra training, and 34 percent are upgrading their financial systems.
“The changes to the tax laws are going to impact just about every organization, both public and private, irrespective of size, industry and location,” said Robert Half Finance & Accounting executive director Steve Saah. “A lot of them are really behind the curve in terms of what they need to do to prepare for it.”
That’s one reason why many companies are adding more tax and accounting employees to their staff, doing extra training for those who already work there, and upgrading their accounting and tax software. “They’re just making sure that they have the right staff in place, that they’re getting everyone on their current staff and organization trained properly to account for the new tax changes,” said Saah. “They’re looking at their financial systems and making determinations as to whether their existing systems are adequate, whether they need to upgrade that system or maybe even implement a new system. A lot of them are looking to potentially bring in subject matter experts. They may not have that talent on their existing staff. There’s a lot of looming changes that are coming, and organizations really have to take all of that into consideration to make sure that they can properly account for them.”
Companies not only need tax experts to handle the usual tax season chores, but they also need experts to help them plan around the best strategies to deal with tax reform.
“Especially on the consulting side of our business, I think we are seeing an increase in the demand for tax professionals, both from the perspective of hiring full-time staff as well as bringing in subject matter experts or consultants who have an expertise in this area in preparation for the consequences of the new laws,” said Saah.
Robert Half found that the top four U.S. markets hiring full-time staff to handle tax reform are in the San Francisco Bay Area, San Diego, St. Louis and Cleveland. Four cities appeared to be the least prepared, according to the CFOs surveyed there: Minneapolis, Des Moines, Cleveland and St. Louis. The top industries planning to hire full-time staff include finance, insurance and real estate (32 percent), and business services (28 percent). Larger companies with 1,000 employees or more appear to be slightly more prepared than smaller companies with between 20 and 249 employees.
“There were cities such as Minneapolis, Des Moines, Cleveland, St. Louis and San Francisco that generally CFOs said that they were somewhat unprepared for the new tax laws,” said Saah. “We definitely saw an increase in hiring in San Francisco, San Diego, St. Louis and Cleveland. Then, from an industry perspective, we also saw some pretty big demands in industries that were planning to hire full-time staff within the finance, real estate, insurance and business services industries.”
While both domestic and multinational companies are affected by the tax code overhaul, some of the most complicated new provisions involved international taxation.
“While the laws are going to impact just about every organization irrespective of whether it’s a publicly traded company or a privately held one, it’s fair to say that it’s probably going to have a little bit more of an impact on larger, publicly traded global organizations,” said Saah.
Tax and accounting aren’t the only sectors that have seen hiring increases as the economy continues to expand after the 2008-2009 recession. Last Friday, the U.S. Bureau of Labor Statistics reported that employers added 164,000 jobs in April, and the unemployment rate dropped two-tenths of a percentage point to 3.9 percent after six months of being at 4.1 percent. The 3.9 percent is the lowest level of unemployment in 18 years. Job gains occurred in professional and business services, along with other sectors.
“At the end of the day, there’s a huge demand for a specialized skill set like tax professionals,” said Saah. “That demand far exceeds the supply that’s out there.”
Companies will need to do more hiring of tax professionals to get ready for the overhauled tax code, but finding the necessary talent is going to be a challenge in itself.
“The organizations that are proactive about this, either looking to hire additional staff, bringing in subject matter experts or consultants, and really just getting ahead of the curve, those are the ones that are probably going to be well prepared for all the changes that are about to hit them,” said Saah. “A little over 90 percent of the CFOs, at least the ones that we surveyed, were facing challenges in finding those skilled professionals. That goes right in line with supply, demand and unemployment rates.”
Buffett’s accounting ‘nightmare’ fuels first loss since 2009
By Katherine Chiglinsky
Warren Buffett has warned about the “nightmare” tied to new accounting-rule changes. Now it’s beginning.
The rules, which require Berkshire to report unrealized gains or losses in equity investments in net income, helped fuel a $1.14 billion loss at Buffett’s Berkshire Hathaway Inc. in the first quarter, the Omaha, Nebraska-based company said Saturday in a statement. That marked the company’s first net loss since 2009.
The “requirement will produce some truly wild and capricious swings in our GAAP bottom line,” Buffett said in his annual letter to shareholders released in February. The accounting change “will severely distort Berkshire’s net income figures and very often mislead commentators and investors.”
Warren Buffett at Berkshire Hathaway's annual shareholders meetingDaniel Acker/Bloomberg
Buffett has said operating results are a better barometer of company performance, in part because Berkshire’s more than $170 billion stock portfolio can fluctuate from quarter to quarter. Operating profit, which doesn’t include those changes, jumped 49 percent to $5.29 billion during the first quarter as insurance underwriting swung to a profit after a difficult 2017.
A 16 percent jump in revenue at auto insurer Geico helped the company turn an underwriting profit, according to a regulatory filing. Geico was helped by rate increases that pushed premiums higher. The railroad business also posted a gain in profit due to increased revenues per car as fuel prices rose.
Berkshire’s cash pile fell to $109 billion at the end of March from the record $116 billion at year-end, the first decline in two years. Buffett has said that deploying that cash into new, large acquisitions is key to increasing earnings over time. The first quarter’s drop was driven in part by spending more than $12 billion on more Apple Inc. shares.
The company reported the value of Apple its stake at $40.7 billion as of March 31, a jump from $28.2 billion at the end of 2017. Buffett said in a CNBC interview that aired Friday that his company bought an additional 75 million shares of the technology company in the first quarter.
Berkshire said the fair value of its investment in Kraft Heinz Co. dropped by more than $5 billion to $20.3 billion in the quarter, as shares slipped almost 20 percent. All my
Berkshire shareholders are gathering in Omaha for the company’s annual meeting Saturday, where Buffett and his business partner Charles Munger discuss everything from the economy to investing tips and even the pair’s wagers on certain companies.
During the weekend, Buffett also showcases the businesses that Berkshire owns, including Geico and BNSF Railway Co. Berkshire’s railroad, utilities and energy businesses reported a 31 percent increase in profit during the first quarter.
Here’s some other takeaways from Berkshire’s earnings release:
• Book value, a measure of assets minus liabilities, declined to $211,184 a share from $211,750 per Class A share at the end of 2017.
• Underwriting at the insurance businesses generated a gain of $407 million in the first quarter, compared to a loss of $267 million during the same period a year earlier.
• Investment income at those operations rose 11 percent to $1.01 billion.
— With assistance from Hannah Levitt, Sonali Basak and Noah Buhayar
How criminals steal $37B a year from America’s elderly
By Nick Leiber
Marjorie Jones trusted the man who called to tell her she’d won a sweepstakes prize, saying she could collect the winnings once she paid the taxes and fees. After she wired the first payment, he and other callers kept adding conditions to convince her to send more money.
As the scheme progressed, Jones, who was legally blind and lived alone in a two-story house in Moss Bluff, Louisiana, depleted her savings, took out a reverse mortgage and cashed in a life insurance policy. She didn’t tell her family, not even the sister who lived next door. Scammers often push victims to keep promised winnings a secret, says an investigator who helped unravel this sinister effort to exploit an 82-year-old woman.
Her family didn’t realize something was wrong until she started asking to borrow money, a first for a woman they admired for her financial independence. But by then it was too late, says Angela Stancik, one of Jones’s granddaughters. Jones had lost all of her life savings—hundreds of thousands of dollars.
About one week after calling Stancik at the family business in Ganado, Texas, to borrow $6,000, Jones committed suicide.
That was May 4, 2010. When family members went to her home, they found a caller-ID filled with numbers they didn’t recognize and three bags of wire transfer receipts in her closet. Jones had $69 left in her bank account.
Some 5 million older Americans are financially exploited every year by scammers like the ones who targeted Jones. The elderly are also suffering at the hands of greedy, desperate or drug addicted relatives and friends, among others. The total number of victims is increasing as baby boomers retire and their ability to manage trillions of dollars in personal assets diminishes. One financial services firm estimates seniors lose as much as $36.5 billion a year. But assessments like that are “grossly underestimated,” according to a 2016 study by New York State’s Office of Children and Family Services. For every case reported to authorities, as many as 44 are not. The study found losses in New York alone could be as high as $1.5 billion.
The U.S. Centers for Disease Control and Prevention drew attention to elder exploitation as a public health problem in a 2016 report, citing groundbreaking research two decades earlier by Mark Lachs. Now co-chief of the Division of Geriatrics and Palliative Medicine at Weill Cornell Medicine and New York-Presbyterian Hospital, Lachs says elder abuse victims—including those who suffer financial exploitation—die at a rate three times faster than those who haven’t been abused. It’s a “public health crisis,” he warns.
“I knew these crimes were killing people,” says Elizabeth Loewy, who directed the elder abuse unit at the Manhattan District Attorney’s Office. As her exploitation cases steadily rose to hundreds per year, she says, “so many family members told me, ‘I can’t prove it, but this killed him.’”
“How could you do that to older people who could not protect themselves?”
Bente Kongsore, a retired accountant in Creswell, Oregon, says her parents’ mental and physical decline accelerated after an assistant manager at a local bank, Susan Paiz, befriended the octogenarians and subsequently stole $100,000 from them in 2014. To hide the theft, Paiz pretended Kongsore’s father, who had been diagnosed with Alzheimer’s at age 85, gave her the money. The lie soured the last two years the couple had together, as Kongsore’s father questioned himself and his wife questioned him. “It was a total violation of the type of feelings we would want to share with each other at the end of their lives,” Kongsore says.
By 2016, her mother had become bedridden, eventually dying in June of that year. Kongsore’s father died in December 2017, just weeks before Paiz was sentenced to 10 months in jail. Paiz was caught and convicted thanks to a dogged detective in Bellevue and the King County prosecutor’s office in Seattle, which had established an elder abuse unit in 2001. When Kongsore saw Paiz in the courtroom, she says she thought to herself, “How could you do that to older people who could not protect themselves?”
Adding insult to injury, the bank where Paiz worked, Union Bank in Bellevue, didn’t return the money until Kongsore scanned and emailed a bank investigator an incriminating letter Paiz wrote her parents, Kongsore says. She adds that the bank still hasn’t formally apologized. Union Bank didn’t immediately respond to requests for comment. Paiz couldn’t be immediately reached.
Financial exploitation is “a huge problem in the sense that it’s so profoundly destructive,” says Page Ulrey, a senior deputy prosecutor who became the Seattle unit’s first member. The bulk of her cases are financial, involving victims who rarely get their money back. “They’re usually emotionally devastated as a result of having been betrayed,” she says.
In many cases, it may appear the victim gave consent, but it’s often based on manipulation or deception. Like Kongsore’s father, victims often “have some level of cognitive impairment, which makes it really difficult for them to figure out the truth of what’s going on,” Ulrey says.
As a result, many of her cases hinge on showing incapacity. “Obviously, you have the right to give your money to who you want, even if your family disapproves,” Ulrey says. But when you suffer from dementia, you may no longer have the ability to judge whether another person has your best interests at heart, or to understand the consequences of your decisions.
If an evaluation shows a victim lacks capacity to make financial decisions, “we potentially have a stronger criminal case,” she says.
But capacity assessment by adult protective services investigators and police is uneven across the country. “Law enforcement doesn’t have good tools to assess capacity,” Ulrey says, adding that most jurisdictions lack people who can conduct thorough evaluations.
In 2015, Weill Cornell’s Lachs coined the term “Age-Associated Financial Vulnerability,” or AAFV, to sound the alarm. He defined it as a “pattern of imprudent financial decision-making that begins at a late age and puts older adults at risk for material losses that could decimate their quality of life.” Financial judgment can start to falter before normal cognition does, Lachs says, regardless of whether the person was savvy with money when they were younger. In other words, it can happen even when the person seems normal.
Despite the severity of the problem, the federal government’s response has been frustrating, according to practitioners and public officials. Joe Snyder, who served as director of older adult protective services at the Philadelphia Corporation for Aging, says he’s doubtful necessary funding will arrive in his lifetime. Before he retired, he oversaw 27 investigators with limited resources handling about 3,500 cases a year. Snyder says it was like using water pistols to fight a forest fire.
The Elder Justice Act, the first comprehensive legislation to address abuse of senior citizens, was enacted in 2010 but remained unfunded until 2015—when it was allocated only $4 million. “Dollars appropriated since then have, in Congressional terms, been dribbling,” says Marie-Therese Connolly, a former Justice Department attorney who championed the law, working with the Senate Special Committee on Aging. Originally, the allocation was to be closer to $1 billion, she says.
“Financial exploitation causes large economic losses for businesses, families, elders and government programs, and increases reliance on federal health care programs,” warned a 2014 elder justice report Connolly helped prepare.
Three years later, a Congressional Record Service report bemoaned a lack of progress. “As a result of this limited federal funding, the federal government has not substantially developed and expanded its role in addressing the prevention, detection, and treatment of elder abuse.”
“It's a fundamentally reactive system,” says Connolly. “The big story is the dearth, the complete nonexistence, the shameful scandalous absence of any credible prevention or intervention research.”
Some progress, however, is being made. In February, the Justice Department announced “the largest coordinated sweep of elder fraud cases in history,” charging more than 250 defendants with schemes that caused 1 million mostly elderly Americans to lose more than $500 million. The alleged perpetrators include people who targeted Marjorie Jones, according to one investigator.
The dragnet, which lasted one year, is part of an ongoing effort “to detect and infiltrate these criminal organizations that are trying to exploit the elderly,” says Antoinette Bacon, a career prosecutor who serves as the DOJ’s national elder justice coordinator. Her position was created through the Elder Justice Prevention and Prosecution Act, a law signed by President Donald Trump in October meant to improve coordination among federal, state and local agencies.
States have been stepping up as well. Thirty-nine of them and the District of Columbia addressed financial exploitation of the elderly in last year’s legislative sessions, according to the National Conference of State Legislatures. More than half enacted legislation or adopted resolutions. Still, Snyder worries the federal block grant many states rely on to pay for services that protect seniors could be cut dramatically under Trump. “If that goes away, programs will be crushed overnight.”
The financial industry says it’s doing more, too. On Feb. 5, the Financial Industry Regulatory Authority, an industry body, put into effect “the first uniform, national standards to protect senior investors.” It now requires members to try to obtain a trusted contact’s information so they can discuss account activity. It also permits firms to place temporary holds on disbursements if exploitation is suspected. Loewy, who left her job as a prosecutor in 2014 to join EverSafe, a startup that makes software to monitor suspicious account activity, is underwhelmed by the industry projects.
“They may say they’re focused on it, but they aren’t really doing much more than training employees,” she says. “Exploiters know what they’re doing. They take amounts under $10,000 that they know won’t get picked up by fraud and risk folks at banks. And they steal across institutions over time.”
The dirty little secret about elder exploitation is that almost 60 percent of cases involve a perpetrator who is a family member, according to a 2014 study by Lachs and others, an especially fraught situation where victims are often unwilling, or unable, to seek justice. Such manipulation sometimes involves force or the threat of force, says Daniel Reingold, chief executive officer of RiverSpring Health, a nonprofit that provides care to about 18,000 seniors in the New York City area. In 2005, he helped establish the first elder abuse shelter in the country.
While many families don’t intervene when they suspect a family member is abusing an elderly relative, Philip Marshall did, in a famous example of elder exploitation. “I was a family member who acted,” says Marshall. “And that’s huge. Because people don’t act. They say ‘we don’t want dirty laundry out there.’”
Marshall wanted his grandmother, famed socialite Brooke Astor, to enjoy her final years at her country home, as she had wished. When his father, Anthony Marshall, wouldn’t let her, Philip sought guardianship, setting off a legal battle. As the fight progressed, Philip says he discovered that his grandmother, who had been diagnosed with Alzheimer’s, was enduring various forms of neglect. It was “all in an effort by my father to gain her money,” he alleges.
The dispute culminated in his father’s conviction and prison sentence in 2009 for siphoning off millions of dollars from Astor. At first, says Philip, “Our goal was just to stop my grandmother’s isolation and manipulation. We didn’t really care about money.” A separate legal proceeding over the neglect allegations was eventually resolved. Last year, Philip quit his job as a professor to become a full-time advocate in the fight against elder abuse. He gives talks to government officials and financial institutions and spends hours speaking with strangers dealing with exploitation. “So many times, it’s family,” he says. “I don’t think people realize that.”
On a rainy April afternoon at the Harry and Jeanette Weinberg Center for Elder Justice, the shelter Reingold helped start in the Bronx, there are countless versions of Astor’s story unfolding daily, albeit for smaller sums. More than 70 percent of the center’s clients are victims of financial abuse, with most also suffering from emotional and physical abuse as well.
“It’s often a slow and steady and unrelenting experience,” says Joy Solomon, a former New York prosecutor and director of the center. She says her team is seeing an increase in seniors showing up in housing court—because they’re being evicted. “A lot have been financially exploited and they don’t even know what’s happening until they get that notice.” Losing housing usually accelerates mental and physical decline, she says.
Unless we figure out how to protect the assets of senior citizens from this epidemic, Solomon says, “we’re going to come to a place where we’re seeing a lot of homeless elderly people on the street.”
The big winners in Trump’s tax cuts include his loudest critics
By Ben Steverman
In a surprise plot twist, President Donald Trump’s new tax law is delivering many of its juiciest benefits to his most vocal critics in Hollywood.
The tax overhaul doles out windfalls to the producers and film financiers who control the entertainment industry. It slashes tax rates, especially on overseas profits that are the lifeblood of Hollywood, and changes accounting rules in a way that could attract more investment dollars to show business. With clever tax planning, A-list celebrities and directors could also benefit, especially by using a special break intended for business owners.
“It is going to be very encouraging for people who risk money making movies,” said Michael R. Morris, a tax lawyer at Valensi Rose PLC in Los Angeles, and a former Internal Revenue Service trial attorney.
Trump has said middle-class Americans will be the biggest beneficiaries under the GOP’s $1.5 trillion tax cut. But in Hollywood, the opposite is playing out. It’s the struggling performers and behind-the-scenes workers who could get squeezed by the tax law.
Sandra Karas, an actor and tax attorney, has been touring the country for the Actors’ Equity union to warn members about one very expensive change for working- and middle-class performers—the elimination of deductions for work-related expenses such as union dues, lessons, publicity, travel to auditions and payments to agents who line up jobs.
Those write-offs have been crucial for actors who are often considered employees for their gigs, even if they’re temporary. Top earners in Hollywood are almost always independent contractors or owners of pass-through entities; both will still be able to deduct those expenses.
“The money is moving up to the top, and it’s not going to go back down to the little guy anytime soon,” Karas said.
Hollywood’s hostility to Trump was apparent during the 2016 election, when the entertainment industry made $85 million in political donations and sent 84 percent of individual candidate donations to Democrats—the highest level since at least 1990—according to the Center for Responsive Politics. This year, some of the industry’s biggest names, including Steven Spielberg, George Lucas and Jeffrey Katzenberg, are bankrolling Democrats in competitive Senate campaigns.
Still, those donations don’t mean the industry’s lobbying groups were absent in Washington as GOP lawmakers were crafting the bill, which passed in December without a single Democratic vote. The big studios such as Walt Disney Co., Viacom Inc., Warner Bros. Entertainment Inc. and NBCUniversal Inc. will benefit from the new corporate tax rate of 21 percent. Most of the studios’ owners, including Disney and Comcast Corp., previously paid effective tax rates above 30 percent.
But beyond that, one of their main lobbyists, the Motion Picture Association of America, successfully pushed for the entertainment industry to immediately write off the costs of large U.S.-made film and TV projects. An earlier iteration of the House tax bill wouldn’t have allowed entertainment projects to be included in the new expanded write-off provision.
Under the old tax regime, producers could deduct the costs of large projects only gradually over the many years that they typically bring in revenue. In the final version of the tax bill, total production costs, which can exceed $100 million for big-budget blockbusters, can be deducted as soon as a new product is released to the public. The benefit is set to phase out starting in 2023.
“That is going to be a tremendous boon for TV and film-production companies, because they have so much money tied up in those projects,” said Mitchell Freedman, a CPA and wealth manager.
A quicker tax write-off may also make it easier for Hollywood to attract outside investors, said Benson Berro, a partner at KPMG, especially since there’s booming demand from streaming services like Netflix and Amazon.
Treasury Secretary Steven Mnuchin, who helped oversee the tax revamp, is familiar with these sorts of co-financing deals. A former investment banker, he helped produce dozens of films, including The Lego Movie and Mad Max: Fury Road. Mnuchin said he divested his stakes in Hollywood last year, but hasn’t disclosed whom he sold them to. A Treasury spokeswoman didn’t respond to a request for comment.
Another addition to the tax bill introduced by the Senate allows owners of U.S. content to pay an ultra-low tax rate, about 13 percent, on foreign income. The provision—designed to encourage companies to bring offshore profits and intellectual property back to the U.S.—is a triumph for an industry that licenses its products worldwide. Film and TV were responsible for $16.5 billion in exports in 2016, according to the MPAA.
“Studios just got a big windfall,” said Schuyler Moore, a partner at law firm Greenberg Glusker. By combining lower rates, immediate expensing and the “astounding” new rate on foreign derived intangible income, Moore said, “they’re not going to be paying taxes for a long time.”
On the individual side, the most lucrative break for many Hollywood luminaries could be a new 20 percent deduction for so-called pass-through businesses, whose income is taxed on owners’ personal returns. Hollywood’s biggest stars generally set up loan-out corporations, which loan out their services to film, TV and theatrical productions. The loan-out can be structured as LLCs or S corporations, both of which can qualify for the new break.
Taking the full 20 percent deduction would effectively lower their top federal tax rate to less than 30 percent—but first they need to qualify.
Congress intentionally excluded high-income owners of service businesses from the “performing arts” and other fields from the break. Entertainers, along with thousands of other businesses across the country, are waiting for IRS guidance to define exactly what a service business is.
“I can guarantee you that we’ll find some nice loopholes,” said Mitchell R. Miller, a tax attorney based in Beverly Hills, California.
Performing on stage or in front of the camera might not get the pass-through deduction, but actors could still get the break on income from merchandising, licensing and side projects such as cookbooks, vineyards, and perfume and clothing lines. Or big-name actors might bargain for ownership stakes in projects, giving them a slice of the tax benefits enjoyed by studios and investors.
A producer and director, meanwhile, might sign a contract to deliver the product of a film or TV show—rather than their artistic services. “It may change how contracts are written,” said Stephen Landsman, a CPA and tax partner at Squar Milner.
One drawback for the Hollywood elite in the tax law: Many are likely to get hit by the $10,000 limit on deductions for state and local taxes. And moving from a high-tax state such as California may not be the easy answer. State tax collectors can be aggressive about disputing those who claim they’ve changed residency—especially when they have strong professional links to their former locations.
The typical performers don’t have to worry about the $10,000 deduction cap. And they typically don’t make enough money to justify setting up a loan-out corporation: consistent annual earnings of at least $100,000. The estimated 43,500 actors in the U.S. earn a median wage of $17.49 per hour—and few work full-time.
Todd Cerveris and his wife are New York-based actors who sometimes spend half of the year on the road performing. They expect to pay as much as $7,000 more in taxes this year because of lost deductions.
“It effectively becomes a tax for trying to be an actor,” Cerveris said in an interview from Cincinnati, where he was working on the premiere of a new play. “I’m not trying to make a killing, but I am trying to make a living, and that’s getting harder and harder.”
Court To Consider Taxation Of Bobbleheads And Other Sports Promotions
By Kelly Phillips Erb , FORBES STAFF
MIAMI, FL - SEPTEMBER 14: The Bobble Head Museum at Marlins Park is shown during a game between the Miami Marlins and the Cincinnati Reds on September 14, 2012 in Miami, Florida. (Photo by Jason Arnold/Getty Images)
Does free really mean free? That's a question that the Ohio Supreme Court will attempt to settle next month when it hears a dispute between the Cincinnati Reds and Ohio's tax department. The case focuses on the taxation of promotion items, including the fan favorite bobblehead dolls.
Here are the facts. The Cincinnati Reds are a major league baseball team, and they rely on revenue from, among other things, ticket sales to games. Like other sports teams, the Reds use promotional items, like bobbleheads, jerseys, t-shirts, wall posters, and baseball cards, to woo fans to their games. This can be especially true during a season, like one that begins 7-24, where play alone may not be enough to drive in the crowds (sorry, Reds fans). None of that is in dispute.
Here's where things get tricky. The Reds don't charge their fans separately for these promotional items. They are essentially "free" with the purchase of a ticket to the game. No, those quotation marks aren't a mistake: Whether the promotional items are free or "free" (wink, wink) is the issue at stake in the litigation.
The Tax Commissioner of Ohio agrees that the promotional items have value but maintains that they are free to fans. That means, the Commissioner claims, that they are subject to use tax which the Reds must pay since the Reds use the items to boost ticket sales. The Reds argue that the promotional items are not free to fans but are instead included in the cost of the ticket.
Why does the distinction matter? Sales tax. Under Ohio state law (and in most states), there is a resale exemption available to parties who resale an item to a consumer. Let's use a candy bar as an example. When you buy a candy bar from, say, Target, you (as the consumer) pay the sales tax. You don't pay the state the sales tax directly. Rather, you pay the sales tax at the store and the store remits the tax to the proper authorities. Target doesn't pay additional sales tax for the candy bar after your purchase, and it doesn't pay when it initially receives the candy bar from the manufacturer or distributor. That's because Target is not intended to be the end user of that candy bar which makes it exempt from sales tax. Got it?
The Reds argue that they, like Target, are just passing an item along to the end user. Their promotional items, they argue, are intended to "induce ticket sales by supplementing the value for tickets to games which may not be as highly desired." That means, they claim, that the ticket price includes the cost of the promotional item, making the club a reseller of the item and not a taxable user. And, the Reds claim, under state law, no separate price needs to be stated for an item to qualify for the resale exemption.
The Commissioner agrees that the Reds do not separately state the cost of the items from the ticket price, and they note that ticket prices do not fluctuate based on the nature of the promotional item (and let's face it, a tea towel doesn't have the same value as a bobblehead). That, the Commissioner argues, supports the idea that the items are free to fans - but taxable to the Reds. Citing R.C. 5741.01, the Commissioner claims that an item is subject to tax when a person "gives or otherwise distributes it, without charge, to recipients in this state." Further, the Commissioner argues, Ohio courts have long supported the idea that promotional items are taxable.
But let's assume for a moment that the Reds are right and the team really did qualify for a resale exemption. The idea of the resale exemption is to exempt the reseller from paying sales tax because the tax will be collected from the end user. It's basically legislative maneuvering to avoid a double tax on the same item.
That's not what happens here, according to the Commissioner. Here, the promotional items would never be subject to sales tax if the Reds claimed the exemption because Reds' tickets are not taxed (their admission fees are not taxable sales under Ohio law). If the Reds don't pay sales tax on the promotional items when they receive them, the items would not be taxed to the end user, the fans, as part of subsequent ticket sales.
Of course, lots of teams offer promotional items to attract fans to games, and it shouldn't come as a surprise to learn that this issue has been litigated before. The Milwaukee Brewers argued a similar case in front of the Supreme Court of Wisconsin and lost (Wisconsin Dept. of Rev. v. Milwaukee Brewers, 111 Wis.2d 571, 577 (1983)). Ditto for the Minnesota Twins (Minnesota Twins Partnership v. Commissioner of Revenue, 587 N.W.2d 287 (Minn. 1998))
But what about the Kansas City Royals? The Missouri Supreme Court ruled a little differently in that case (Kansas City Royals v. Director of Revenue, 32 S.W.3d 560, 562 (Mo. 2000) (en banc)). The Court found that "[a]lthough the promotional items are ostensibly given away, the cost of purchasing those items is factored into the price charged for each ticket of admission to a Royals game." The Commissioner, however, argues that those facts are distinguishable. Unlike Reds' tickets, Royals' tickets are taxable. To tax the promotional items to the Royals and then again to the fans is double taxation and the resale exemption is intended to avoid that very problem. Under Ohio law, the Commissioner claims, there is no such issue with double taxation because tickets are not taxed in the first place.
Finally, even if it made sense to have a resale exemption on promotional items, the Commissioner argues that such an exemption doesn't currently exist. The court isn't the place to change that, the Commissioner argues, writing in a court filing, "If the Reds wish such promotional items to be exempt, they should ask the General Assembly for an exemption."
So far, the Reds have not been able to sway legal opinion to their side. Last year, the Ohio Board of Tax Appeals ruled against the team claiming they have "not provided this board with competent and probative evidence in support of the position that it does not owe the assessed tax." The team appealed to the Ohio Supreme Court. Now, oral arguments in the case will begin on June 13, 2018. The case is 2017-0854: The Cincinnati Reds, LLC v. Joseph W. Testa, Tax Commissioner of Ohio. Emails to attorneys for the State and the Reds were not immediately returned.
Tax Strategy: States respond to the SALT deduction limit
State tax revenues will be impacted in many ways by the federal Tax Cuts and Jobs Act. States vary greatly in the way that their state tax systems coordinate with the federal tax system. Some tie in to federal adjusted gross income. Others tie into taxable income. Some couple to particular provisions of federal law that have been changed by the TCJA. Some offer a state tax deduction for federal income taxes paid. States are looking at a variety of approaches to adjust their state tax systems for the impact of the TCJA.
One of the changes made by the TCJA has been to restrict the deduction for state and local taxes to $10,000 per year. This change will likely have the greatest impact on states with relatively high tax rates and also relatively high-income citizens. Many of these states have been exploring responses to this change — states such as California, Connecticut, Illinois, Maryland, Nebraska, New Jersey, New York, Virginia and Washington.
The primary responses being discussed range from creating an alternative contribution to a state charitable fund or funds to preserve the tax deduction as a charitable contribution, creating a payroll tax deduction for all employees to preserve the tax deduction as a payroll tax, or even suing the federal government for penalizing high-tax states.
In crafting any response to the restriction, it is important to look at who will be impacted by the change. Even before the TCJA was enacted, around two-thirds of taxpayers claimed the standard deduction and had no benefit from the state and local tax deduction. However, in some states the percentage of taxpayers claiming the deduction was much higher, with several states exceeding 40 percent of taxpayers claiming it. In a number of states the average state and local tax deduction claimed has also exceeded $10,000. In 2015, the average state and local tax deduction overall of all taxpayers claiming the deduction with adjusted gross incomes of $100,000 or greater exceeded $10,000.
Of the one-third of taxpayers that have claimed the itemized deduction in the past, it is estimated that half of those will not claim it in the future. This is due to a combination of the increased standard deduction and the reduction in certain of the itemized deductions. To the extent that the itemized deductions claimed in the past did not exceed the new standard deduction, those taxpayers also would not be harmed by the new state and local tax limit. To the extent that the standard deduction is now more attractive because of the reduced itemized deductions, those taxpayers can still be viewed as potentially impacted to some extent by the restriction on the state and local deduction.
Even those taxpayers that, in the past, were eligible for the state and local tax deduction could have faced other hurdles to claiming it. The state and local tax deduction was a preference item totally or partially disallowed if subject to the Alternative Minimum Tax. Also, the Pease phase-out of itemized deductions may have also partially restricted the state and local tax deduction to which a taxpayer may have been entitled.
The net result is that the state and local tax deduction primarily benefited wealthier taxpayers in higher-income states. It is not clear how influential the state and local tax deduction is to these taxpayers in motivating their activities or affecting their possible future actions. Some of the proposed state responses to the restriction of the deduction would primarily be targeted at these wealthier taxpayers; other responses would apply more generally.
A charitable contribution
Over half a dozen states, with California leading the way, are looking at an optional charitable contribution to one or more state charities performing a government function and providing a state income tax credit equal to the charitable contribution. A number of states already offer tax credits for a number of charitable funds with the apparent blessing of the Internal Revenue Service.
Still, there are some concerns with the approach. In general, charitable contributions are supposed to come with charitable intent and no personal benefit to get the charitable deduction. If Congress or the IRS perceived this as an abuse, the deductions could be disallowed and might even be disallowed for existing state tax credits for charities. There is also some concern that too much tax money could be directed to certain programs, exceeding their needs and leaving other responsibilities of state government short of funds. Addressing such issues could add a lot of complexity to these proposals.
By replacing a disallowed itemized deduction with an itemized deduction that is still allowed, a charitable contribution deduction would tend to benefit the same people who had benefited from the state and local tax deduction, i.e., wealthier taxpayers. These proposals could therefore be viewed as tax proposals primarily to benefit the wealthy.
A payroll tax deduction
New York is taking the lead in looking at an expanded payroll tax deduction for employers. The concept is that the payroll tax would be tied to compensation adjustments such that employees after tax would be in the same position that they were before. This could be structured to offset the revenue loss to state taxpayers from the loss of the state and local tax deduction but spread the benefit to a larger group of taxpayers.
This proposal appears to come with a number of complexities that might make it difficult to ensure that the employees are left in the same position that they were in before. Commentators have pointed out issues such as the difficulty in adjusting minimum wages or negotiated wages. It is also possible that, due to the loss of anticipated federal revenue, Congress could also step in to try to curtail this deduction.
New York has also joined with several nearby states to challenge the loss of the deduction in court as being a discriminatory act by Congress. While the state and local tax deduction has been a part of the Tax Code from the beginning, its form has varied, with personal property taxes disallowed and, for a time, state sales taxes disallowed as a deduction. With this precedent, most commentators do not seem to be giving the states much chance of success in this effort.
The state and local tax provision of the TCJA is already set to expire after 2025. Republicans in Congress would like to make it permanent, but that appears unlikely to happen before the mid-term elections this fall. If the Democrats take control of the House, they could try to overturn the loss of the deduction, perhaps paid for with an increase in the top individual tax rate.
They might not be successful in that effort at least until after the 2020 elections, but they could at least stop Republican efforts to make the loss of the deduction permanent.
It will be important for tax practitioners to monitor closely state actions taken this year in response to the TCJA. States may take actions that will require corresponding responses from taxpayers during the year to take maximum advantage of those tax changes, with implications for their federal tax liability on their 2018 tax returns. The responses to the state and local tax deduction are just one of the more active and interesting areas of activity for states this year that are worth monitoring.
IRS sets new 5-year strategic plan
By Michael Cohn
The Internal Revenue Service has a new five-year strategic plan for improving taxpayer service and tax administration.
The Fiscal Year 2018-2022 IRS Strategic Plan will provide a roadmap to guide IRS programs and operations, while trying to meet the ever-changing needs of taxpayers and tax professionals.
“Providing service to taxpayers is a vital part of the IRS mission, and the new Strategic Plan lays out a vision of ways to help improve our tax system,” said IRS Acting Commissioner David Kautter in a statement. “The plan is part of an ongoing effort by the IRS to work with the tax community and find ways to improve our work for taxpayers and for the nation.”
The IRS developed the strategic plan based on feedback from outside partners in addition to IRS employees. It emphasizes six goals to improve customer service:
• Empower and enable all taxpayers to meet their tax obligations: For taxpayers to understand and meet their filing, reporting and payment obligations, the IRS plans to continue to add and improve its tools and other support services.
• Protect the integrity of the tax system by encouraging compliance through administering and enforcing the tax code: As part of the IRS’s efforts to close the tax gap, the agency intends to try new approaches to understand, detect and resolve potential tax noncompliance.
• Collaborate with outside partners proactively to improve tax administration: The IRS will work with partners to enhance service and outreach to taxpayers, improve collaboration and share best practices.
• Cultivate a well-equipped, diverse, flexible and engaged workforce: The IRS hopes to build a work culture that prizes innovation, embraces different perspectives and celebrates diversity.
• Advance data access, usability and analytics to aid decision-making and improve operational outcomes:The IRS intends to continue to use data to drive decisions and make the most effective use of resources.
• Drive increased agility, efficiency, effectiveness and security in IRS operations: Modern IT systems and technology are necessary for beefing up customer service and enforcement capabilities. Strong data systems are crucial for protecting taxpayer data from various threats.
As the agency works on these improvements, the IRS plans to enforce the tax code fairly and safeguard taxpayer rights. It noted that under the Taxpayer Bill of Rights, every taxpayer has a set of fundamental rights they should be know about when communicating with the IRS.
FBAR ruling may limit penalties
A recent district court decision may require rethinking tax strategies on assets held abroad.
The case, which was decided on May 16, 2018, struck down an Foreign Bank Account Reporting penalty in excess of $100,000, despite the authorization of higher penalties provided by the statute, 31 U.S. Code 5321(a)(5)(C). While the regulation pertaining to the statute sets a maximum penalty of $100,000, the statute has been amended to allow a greater penalty.
The FBAR requirement is a product of the Bank Secrecy Act of 1970, but the section that requires filing of FinCEN Form 114 (formerly known as Treasury Form 90-22.1) has only been seriously enforced in the past decade. The provision applies to a person having an interest in or signature or other authority over a bank, securities or other financial account in a foreign country if the aggregate value of the accounts is greater than $10,000 at any time during the year. Penalties for failure to file may run as high as $100,000 per account, or 50 percent of the account value per year. While there is a reasonable-cause exception for non-willful violations, the penalty for willful violations can be staggering. In 2013, Ty Warner, the inventor of Beanie Babies, paid more than $53 million in FBAR penalties.
In U.S. v. Colliot, the judge granted the taxpayer’s motion for summary judgment on the basis that the regulation’s maximum penalty of $100,000 was valid despite the government’s argument that the regulation was overridden by the change in the statute in 2004.
“Under the government view, an individual could have two accounts, each with $1 million, and the penalty could be 50 percent of each account per year,” said Larry Kemm, of counsel at Carlton Fields, who argued the case for the taxpayer. “But this decision would limit the penalties to $100,000 for each account.”
The two sides in the case – the government and the taxpayer – have 30 days from the decision on May 16 to submit a brief as to whether the case should be dismissed in its entirety, Kemm noted: “The government will argue that the case should not be dismissed but that the amount of penalties should be adjusted in line with the regulation. If the judge dismisses the case in its entirety, the government will not be able to come back and reassess the penalty.”
The Offshore Voluntary Disclosure Program, set to wind down in September 2018, has offered taxpayers a way out of the draconian penalties, by hitting them with a one-time penalty of 27.5 percent of the balance in the overseas account, and no criminal prosecution.
However, with this court ruling, taxpayers currently considering going the OVDP route may want to reconsider, according to Kemm.
“The penalty charged in OVDP may very well far exceed the amount the regs would indicate as appropriate,” he said.
“I’m surprised because I haven’t seen this analysis before,” said Jon Barooshian, partner at Bowditch & Dewey. “The challenges in most of these cases are constitutionally based – on the ‘Excessive Fines’ clause. We now have a judge saying ‘Hey, you never amended the reg.’ The IRS and FinCIN [Financial Crimes Enforcement Network of the U.S. Treasury] created this, and it didn’t change when the statute was amended.”
“If you’re a taxpayer who has money overseas which you haven’t disclosed, you might think twice,” he said.“
“When it comes time to write a check, some may think it’s not worth it because the penalty is capped at $100,000, but there are holes in that strategy,” he said. “There’s nothing to stop the government from changing the regulation, and the government can pursue criminal charges as well.”
“The burden of proof on the IRS for willful failure to file in a civil trial is not a whole lot less than in a criminal trial,” he added. “They’re looking at the same evidence. The main difference is that a criminal trial requires a unanimous verdict. The average juror wouldn’t be able to discern the difference between ‘clear and convincing’ evidence, or evidence ‘beyond a reasonable doubt.’”
N.J. warns IRS against banning property taxes as charitable gift
By Elise Young
New Jersey Attorney General Gurbir Grewal warned the Internal Revenue Service that he will fight any challenge to a law that preserves state and local property-tax deductions.
Grewal’s letter to acting Commissioner David Kautter was in response to an IRS notice issued Wednesday that said taxpayers must adhere to federal law when filing. New Jersey Governor Phil Murphy on May 4 signed legislation to allow local governments to establish non-profit funds that will accept property-tax payments as a workaround to President Donald Trump’s $10,000 cap on deductions. New York Governor Andrew Cuomo signed a similar law last month.
Though the IRS hasn’t expressly banned the practice, Grewal said the notice signaled an intent to do so. New Jersey has the nation’s highest property-tax bills, averaging $8,690 last year.
“I ask you to think twice before going down that misguided road,” Grewal wrote. In all, he said, 33 states have 100 programs allowing people to receive tax credits for donations to governments and non-profits. “The IRS should not play politics. Should the IRS and Treasury Department continue down this path, New Jersey will have no choice but to challenge the new rule in court.”
Sarah Allen, an IRS spokeswoman, said by telephone that the agency had no immediate comment.
States struggle with nexus questions
The variation in states’ use of economic presence in determining nexus for sales tax is one of the key takeaways from the 2018 Bloomberg Tax Survey of State Tax Departments. With the Supreme Court’s decision in South Dakota v. Wayfair in the offing, 16 states indicated that they have economic presence nexus standards for sales tax — despite the fact that they are currently disallowed under the court’s 1992 ruling in Quill v. North Dakota, which established that a physical presence test be met before states can require remote sellers to collect sales tax on sales into the state. While the Quill decision addressed only sales tax nexus, it left open the question of nexus for corporate income tax.
Nexus is the minimum amount of contact between a taxpayer and a state allowing the state to tax a business on its activities (income tax nexus) or require it to collect and remit sales tax (sales tax nexus). The requirement arises from two clauses in the Constitution: the Commerce Clause and the Due Process Clause. The Commerce Clause prohibits a state from unduly burdening interstate commerce, and the Due Process Clause requires a minimum connection between a state and the entity it seeks to tax.
In addition to questions on nexus, Bloomberg Tax asked questions of senior tax officials in each state on the tax treatment of pass-through entities and intangible holding companies, conformity to federal tax reform, methods of sourcing income, sales tax refund actions, requirements for reporting federal changes, enforcement, and collection policies. The survey also addressed the states’ general apportionment formula and sourcing method, and pass-through entity level nexus. “State variances in taxation create complexity and risk for businesses, which is magnified in today’s economy,” said Bloomberg Tax editorial director George Farrah.
“As the survey reveals, states continue to struggle in dealing with taxation of cloud computing and digital goods,” observed Richard Cram, director of the Multistate Tax Commission’s National Nexus Program.
Sales tax issues
“This year, two of the biggest topics discussed were about tax reform and the Wayfair sales tax nexus issue,” explained Chreasea Dickerson, tax law editor for Bloomberg Tax, who helped oversee the survey. “Sixteen states indicated that their policy was based on economic nexus, while five states said that they have an economic nexus that is not currently being enforced due to pending litigation or an effective date in the future.”
“This year we also asked about notice and reporting requirements,” she said. “Eleven states indicated that they require in-state retailers to report in-state sales to the Department of Revenue, and seven states said that they require out-of-state retailers to notify customers of their use-tax obligation.”
Many states are holding back on the issue of sales tax nexus and reporting requirements pending the outcome of the Supreme Court decision in Wayfair, she suggested.
One state that went ahead and jumped the gun is Georgia, which passed an economic nexus standard in early May. The legislation requires online retailers that make at least $250,000 or 200 sales a year in Georgia to either collect and remit sales taxes on purchases, or send “tax due” notices each year to customers who spend at least $500 on their sites.
“Some states are using use-tax notification requirements to strong arm out-of-state taxpayers into registering for sales tax purposes,” suggested Stephen Bradshaw, a senior manager at Atlanta-based Top 100 Firm Bennett Thrasher. “The tax notification reporting requirements are burdensome, and penalties for noncompliance are high,” he said.
The majority of states indicated that merely attending a trade show or attending a seminar was not enough to create sales tax nexus. However, a majority also said that holding at least two one-day seminars was sufficient to create nexus.
Regarding e-commerce, or click-through nexus, states are taking a closer look at whether arrangements with affiliates utilizing internet tools have the potential to create nexus, according to the survey.
Eighteen states said that using an internet link or entering into a linking arrangement with a third party in the state is sufficient to create nexus for sales under $10,000. The number of states imposing nexus increases to 26 when the relationship results in more than $10,000 in sales, the survey noted.
Overall, a majority of states said that selling remote access to digital products would not create nexus, the survey found. This year, nine states said that selling remote access to canned software would create sales tax nexus. When the software is considered to be “custom” software, only four states indicated that remote sales would create nexus.
“However, states almost unanimously agreed that nexus is created when a representative visits the state in order to customize canned software,” the survey reported.
Selling a digital version of a tangible magazine or newspaper would not create nexus in the majority of states.
The survey also asked states about “cookie” nexus, according to Dickerson. Cookie nexus would impose nexus on an out-of-state retailer if the retailer requires visitors to its website to download cookies. “Only two states indicated that requiring visitors to download internet cookies onto electronic devices would create nexus,” she said.
Two other states said that it depends, while 31 states said “No” to cookie nexus.
Eighteen states, one fewer than in 2017, indicated that entering the state solely for the purposes of providing disaster relief was enough to create sales tax nexus.
The survey breaks down income tax nexus into three categories: states that follow a physical presence standard based on the presence of employees or property within their borders; states that follow an economic presence test based on sales into their state; and states that have constructed a factor presence nexus standard based on taxpayers exceeding a specified threshold of physical or economic presence in the state.
“This year, an additional state indicated they have factor presence nexus,” Dickerson said. “Last year, 13 states indicated they had factor presence nexus, while this year 14 said they had factor presence nexus.”
“Any trend is toward broadening the state’s authority to get more revenue,” she explained.
The income tax side
“Most of the activity on the income tax side was related to tax reform over the last six months,” Dickerson said. “One aspect of tax reform has been enhanced expensing provisions. Because most states operate on a one- or two-year budget, 100 percent expect an impact in Year One on how much tax revenue they collect. Many states also have a balanced budget requirement, meaning they can’t run a deficit, so they’re doing a lot of analysis into figuring out whether they will conform to tax-reform provisions.”
“A large portion of this year’s survey was about sourcing,” said Dickerson. “This year we asked states about their general sourcing method used to source receipts from sales. As we expected, most indicated they follow a market-based sourcing approach. However, a few states indicated their sourcing method varies depending on the types of receipts. For example, sales of services would differ from the sales of intangibles.”
Market-based sourcing looks to the state where a service is received, rather than the state where the provider is located. In recent years, there has been some movement away from cost-of-performance sourcing to market-based sourcing. Specifically, 19 states indicated that they use market-based sourcing, nine states reported that they use cost-of-performance sourcing, and four states said that they use a sourcing method other than either cost-of-performance or market-based.
“There was not a lot of movement from cost-of-performance to market-based sourcing this year,” Dickerson said.
States plan for a post-Wayfair world
On the heels of the Supreme Court hearing in Wayfair v. South Dakota, but before any decision has been made public, Georgia Gov. Nathan Deal got a jump on the court by quietly signing legislation aimed at making sure that Georgians who buy goods from online retailers will pay sales taxes on what they purchase, beginning January 1, 2019.
“A lot of states are holding off on taking any action, just to see what happens with Wayfair,” observed Chreasea Dickerson, tax law editor for Bloomberg Tax, who helped oversee the just-released Bloomberg Tax’s 18th Annual Survey of State Tax Departments.
“Surprisingly, 16 states indicated that their sales tax nexus policy was based on economic nexus, despite the fact that it contradicts Quill. In addition, six states indicated that they have an economic nexus that is not currently being enforced due to an effective date in the future, or pending litigation,” she said.
Georgia’s bill requires online retailers who make at least $250,000 or 200 sales a year in Georgia to either collect and remit to the state sales taxes on purchases, or send “tax due” notices each year to customers spending at least $500 on their sites. Its passage will generate an extra $500 to $600 million a year to local and state governments, according to proponents of the bill.
“Georgia is getting in line with everyone else,” said Tim Howe, a partner at Atlanta CPA firm Smith & Howard. “If the Supreme Court decides for South Dakota, Georgia wants to have its legislation in place so it’s ready to rock. They don’t want to wait until the next legislative session next spring to go through the process.”
“Everyone believes that ecommerce is the current basis, and the future, of retail,” he said. “You just don’t see brick and mortar stores popping up – that has either flatlined, or is in decline,” said Howe. “But it’s a gamble that SCOTUS will decide in favor of South Dakota. Everyone in the tax practitioner world knows that this is the appropriate way to go. Without it, states are losing hundreds of millions of dollars.”
Somehow, either the Supreme Court or Congress will have to define a threshold of what constitutes a small business, according to Howe.
“There has to be a threshold below which a seller doesn’t have to file,” he said. “They need to come to a conclusion as to who is going to have to comply with remote seller laws. It can’t vary from a $100,000 threshold to a $500,000 threshold state by state. There needs to be a standard threshold.”
“They can’t just focus on attorneys – they need to add CPAs to the mix,” he said. “Get us in a room for five minutes and we can whiteboard out what this should look like. Right now, practitioners – the ones responsible for compliance -- don’t have a strong enough voice.”
“States are using the use tax notification reporting requirements, and their associated penalties, to strong arm out-of-state taxpayers into registering for sales tax purposes,” said Stephen Bradshaw, a senior manager at Top 100 Firm Bennett Thrasher. “Use tax notification reporting requirements are burdensome, and penalties for noncompliance are high.”
“For example, I have a mid-market online retailer client with about $20 million of revenue that had 3,500 transactions to Georgia customers in 2017,” he said. “If they were ignorant of Georgia’s new law, which is very possible without a CPA or counsel, or if they decided on constitutional grounds to not register for sales tax purposes with Georgia and not comply with Georgia’s use tax notification rules, they could be faced with as much as a $90,000 penalty based on their 3,500 transactions for the use tax notification penalties alone. If this client was ignorant of other states’ notification rules, as is often the case, and if they were noncompliant for multiple years, the accumulated penalties could easily exceed $500,000.”
“So even if Quill [the 1992 Supreme Court decision that requires a physical presence in the state before a state can impose sales tax collection requirement on a remote seller] is upheld, it is likely that states will use reporting requirements to force sellers into collecting the sales tax,” he added.
Prenups might be in jeopardy as tax law kills alimony break
By Ben Steverman
President Donald Trump’s tax overhaul could wreak havoc on prenuptial agreements across the country — and maybe even his own.
Prenups often contain provisions about how much a partner would pay in alimony, also known as spousal support. The agreements can be thrown out if judges deem them unfair, signed too quickly or signed under duress. Now the tax revamp offers another avenue for challenges because courts will likely have to consider how the law has changed since the contracts were created. Starting in 2019, payers will no longer be able to deduct their alimony payments.
For divorcees in the top tax bracket, the change could mean they effectively pay double in post-tax costs compared to what they had previously agreed to in their prenups.
“We made a deal, and now Congress messed it up,” said Linda Ravdin, a partner at law firm Pasternak & Fidis, who’s written reference books about premarital agreements.
Divorce lawyers are in an awkward position and weighing whether to alert happily married clients with decades-old prenups of the change. Ravdin said she was concerned that an unexpected letter or call from a divorce attorney could be unwelcome. Instead, she put the information in an emailed client newsletter.
The obvious fix for married couples is to amend their agreements, but that’s almost always a bad idea, said Christopher Melcher of Walzer Melcher who specializes in the divorces of ultra-wealthy Californians.
“It’s doubtful that anyone would want to mess with that thing” if they’re happily married, Melcher said. “It would open up a huge can of worms.”
While Trump told New York Magazine in 2006 that his prenup with Melania Trump made his marriage stronger despite being a “hard, painful, ugly tool,” he didn’t disclose any details of the agreement. A White House spokeswoman didn’t respond to a request for comment.
There aren’t hard numbers, but it’s fair to say that prenups have become more popular in recent years as younger Americans delay marriage, and the divorce rate has skyrocketed for people over 50 who often use prenups if they remarry. More than 60 percent of divorce attorneys said they had seen a rise in the number of clients seeking prenups in the previous three years, while just 1 percent reported a drop, according to a 2016 survey by the American Academy of Matrimonial Lawyers.
Some prenups may specify that in the event of divorce, one spouse is owed, say, $10,000 a month for half the length of time the couple was married. Other agreements set alimony based on a formula, such as a percentage of the payer’s income. Child support is often calculated in tandem with alimony. If agreements aren’t amended to factor in the tax changes, it will be up to divorce attorneys to settle — or judges to decide — whether the amounts or formulas still stand for couples who divorce starting next year.
Even if both parties agree to an adjustment in alimony, they’ll need to agree on exactly how much to cut the payers’ obligations. Divorcing couples could end up hiring rival accountants as expert witnesses to sway judges.
“No one knows the outcome of that kind of dispute,” Ravdin said. “When you go to court, it’s like rolling the dice.”
For those in the top income-tax bracket — the likeliest to have a prenup — being able to deduct the payout from taxable income had been a big saving because every dollar in alimony reduces the payer’s taxable income by the same amount. Top earners in high-tax areas like California and New York City can face marginal tax rates close to 50 percent. Without the deduction, a spouse who agreed to write a $10,000 check each month could be on the hook for what is effectively almost $20,000 in pre-tax income.
“Folks already don’t like paying alimony, so doubling the effective cost would be painful,” said Chris Chen, a financial planner who specializes in divorce-related matters at Insight Financial Strategists.
Republican lawmakers said they eliminated the alimony deduction to end what they called a “divorce subsidy” under the old law. The change, which raises an estimated $6.9 billion over the next decade, doesn’t affect divorces and separation agreements finalized before the end of 2018. Starting next year, the newly divorced won’t be able to deduct alimony payments, but recipients will get the money tax-free (previously, the payments had to be reported as part of their taxable income).
Ultimately, the change could hurt alimony recipients. Payers could plead with judges to revise their obligations given the new law — a valid legal argument given that many prenups specifically mention that the payments are intended be deductible. Those potentially reduced payments are likely to overpower the benefit recipients get from being able to receive the payments tax-free because they tend to be in lower tax brackets than the payers.
Divorce attorneys have already been warning that killing the alimony deduction could make splitting up more acrimonious.
Alimony deductibility “eases the pain of making the support payment,” Melcher said. “When that goes away, it makes it harder. There is less money to spread around.”
Focus on the facts before you claim this valuable retirement income benefit.
Getting your arms around Social Security can be pretty complicated. Misinformation, partially informed opinions, and complex benefits formulas can easily lead one down an incorrect—and costly—path.
Before you make your decision about claiming this valuable benefit, let's clear up 5 of the most common myths and misperceptions about Social Security that could undermine your ability to generate the income you’ll need in retirement to live the life you want.
Many people are adamant that Social Security benefits must begin at age 62. This is a myth: 62 is the earliest age you can claim your benefit, but it's not the only age.
Your base benefit is calculated based on your "full retirement age," or FRA. Your date of birth determines your FRA. Your base benefit is calculated by the Social Security Administration based on your average indexed monthly earnings during the 35 years in which you earned the most (only the years that you paid Social Security taxes).
Tip: You'll find your FRA at Social Security's website, SSA.govOpens in a new window, or on a paper statement mailed to you by the Social Security Administration. For those born between 1943 and 1954, your FRA is 66. Those born later have an FRA of 66 (plus some months) or an FRA of age 67.
If you claim any time before your FRA, you lock in a permanent reduction in monthly income. Claiming at 62 translates to a reduced monthly income of 25% to 30%, depending on your FRA. That means you may receive a lot less monthly retirement income, every year, for potentially several decades. You might think you are not going to live a long life, but many people do: For people age 65 today, 25% of men will live until 93; 25% of women will live to 96.1 A key consideration for when you claim Social Security is maximizing your income for a retirement that could last longer than 30 years.
Wait until age 70 and lock in a "bonus":
Many believe there is a "bump up" or "added income" once they reach their full retirement age. They've heard they can claim early at 62, then when they reach 66 or older, their checks will increase to the amount that corresponds to their full retirement age benefit. That's a big misperception.
There is no bumping up of income once you've claimed your Social Security retirement benefit. However, anyone receiving a benefit can voluntarily "suspend" that benefit after they reach FRA and resume it as late as age 70. If they do, the annual benefit will increase by 8% until age 70. After that, you get an annual cost of living adjustment, but no increase in your base benefit, which will start automatically the month you reach age 70 unless you specify otherwise.
In general, you can cancel your Social Security claim if you do so within the first 12 months of receiving benefits.2 You must repay the full amount you've received, and the full amount a current spouse or family member received based on your benefit. Then, you are eligible to claim again at a later date and will receive a larger monthly payment. Each individual can only cancel a claim once in their lifetime.
Case Study: Lower-income spouses may get a "top up" or "auxiliary" benefit.
There is, however, one case where you could get a "top up" benefit at FRA, but you still need to wait until your FRA to claim your Social Security benefit. In this hypothetical example, Sally earned less during her career than her husband Brad. Her FRA benefit is $700 per month; his is $2,000. As a spouse, she's entitled to 50% of Brad's benefit if she claims at her FRA. She would receive a "top up" of $300 to bring her benefit up to the $1,000 (half of Brad's benefit) to which she is entitled. Social Security will calculate her options and pay out the higher benefit to which she is entitled.
In a recent survey,3 Fidelity asked more than 1,000 people if an ex-spouse could influence their Social Security benefits—52% of them said yes, this is true.
The real answer: False.
There are a lot of things an ex-spouse might do to complicate your life, but Social Security is off limits. Your ex has no influence over your benefits. If you have an ex-spouse, you may be entitled to spousal benefits as if you had remained married. If you were married for 10 consecutive years and have not remarried, you are entitled to either your own benefit—or 50% of your ex's Social Security benefit, whichever is higher—once you reach your FRA.
If you wish to claim on your ex-spouse's benefit, you simply make an appointment with your local SSA office and bring documents that prove the marriage and divorce. They will calculate your benefit options, and when you submit your claim, you’ll receive the higher benefit.
Tip: There's no need to discuss this with your ex-spouse, and your claim does not reduce or affect your ex's benefit in any way. It's your benefit, even if you've been divorced for many years. And, it may be larger than your own individual benefit. Read Viewpoints on Fidelity.com: Unraveling Social Security rules for ex-spouses.
How your Social Security benefit is calculated can seem mysterious. However, it’s important to know a few essential facts to aid your claiming strategy. You can use the tools on SSA.govOpens in a new window to do the calculations.
Read Viewpoints on Fidelity.com: Social Security tips for working retirees.
Although 70% of the respondents from our survey3 thought they might not get back all the money they put in, many will. Everyone’s situation is different. Simply put, if you live a long time, you may collect more than you contributed to the system.
Due to the complexity of claiming strategies and number of variables involved, the Social Security Administration no longer offers a break-even calculator on its website. Social Security is designed to provide a safety net of income for the retired, the disabled, and survivors of deceased insured workers. The contributions you and your employers make during your working years provide:
While the government does not have a specific account set aside just for you with your FICA contributions (the taxes for Social Security and Medicare paid by you and your employer), one of the most powerful features of Social Security is that it provides an inflation-protected guaranteed income stream in retirement, ensuring against the risk you will outlive your savings. Even if you live to 100 or more, you continue to receive income every month. And, if you predecease your spouse, they also receives survivor benefits until his or her death.
Let's look at a hypothetical case of an American worker, Steve, who reaches his FRA in 2018. He's retiring in December and will begin collecting his Social Security benefit in January, 2019 at his FRA. In Steve's case, if he lives past age 76½ he will receive a larger benefit than he contributed to the system. There is no standard break-even point, but let's look at Steve's situation in more detail.
First year of work
Gross annual income in 1974
Gross annual income in 2018
Steve's OASDI* taxes paid
Employer's total OASDI contribution
Steve's total OASDI contribution
Steve's estimated benefit at FRA
$2,678 per month
*Old Age Survivor Disability Insurance
If Steve lives until age
Total Social Security benefits (not COLA-adjusted, rounded to nearest $1,000)
Percentage of Steve's total OASDI contribution
For illustrative purposes only. OASDI contribution: Old Age Survivor Disability Insurance, a 6.2% payroll tax, which is part of overall FICA employee payroll withholdings. Hypothetical case assumes a final year of wages in 2018 to be $110,000. Using the Social Security calculator built by Fidelity, a rough estimate of benefits was calculated at FRA in today’s dollars. For an estimate using your personal earnings history, go to SSA.gov.
For many, Social Security benefits are the foundation of their income in retirement. Social Security benefits provide guaranteed income that will last as long as you live. Know your numbers, do the math, and develop a plan for a claiming strategy that supports your overall retirement income strategy.
Reports of Excel's death are greatly exaggerated
Recently, the CEO of a prominent enterprise software company wrote that auditors should consider including spreadsheets in their disclosure of “critical audit matters” (CAMs) as they begin to comply with the new auditing standards adopted last year by the Public Company Accounting Oversight Board.
The argument is that “impenetrable spreadsheets” represent an error-prone, manual accounting process that don’t provide enough visibility into how they support the financial statements. Therefore, they are especially challenging to audit, and may rise to the level of a CAM. The recommended solution? Ditch the spreadsheets for proprietary software that promises to automate your reconciliations and calculate journal entries for you.
We’ve heard similar arguments before. In the fall, an article in the Wall Street Journal stirred up a tempest with the headline “Stop Using Excel, Finance Chiefs Tell Staffs” and stories about finance teams that had ostensibly dropped Excel entirely in favor of enterprise performance management (EPM) software to eliminate errors and manual processes. One accountant in particular rose up to defend the noble spreadsheet, posting on Twitter that developers could have his Excel after they’ve “ripped it from my cold, dead hands.”
This debate is all a bit of a red herring. Realistically, no one is getting rid of their Excel licenses, and every one of these solutions that promises to replace Excel has an “Export to Excel” button. Excel is powerful and endlessly customizable. There will always be something you can’t do in your ERP or EPM and you’ll want to do in a spreadsheet.
There are also plenty of tasks today still better done in a spreadsheet than in a proprietary database: Reconciliations that support the monthly financial close, for instance. The argument that spreadsheets become too complex to audit properly is false, as any good auditor will tell you. Rather, it’s proprietary software that creates extra work for auditors.
Excel is essentially an open standard for accountants. All accountants know how it works and anyone can look under the hood to figure out what's going on in a particular spreadsheet. Since all the formulas are exposed, it’s easy for a third party who didn’t create the spreadsheet to audit the formulas and assumptions in a well-designed workbook. You can't easily do that with a database. In all likelihood, the auditors of a company using a specialized application for their reconciliations will have to export the data into Excel anyway and recalculate in order to validate the outputs.
But what about errors? Supposedly, ditching spreadsheets for our reconciliations and analysis will prevent costly errors. We’ve been told for years by anti-Excel developers that spreadsheets are full of them.
I’m happy to tell you, it’s a myth. A myth that began with a University of Hawaii study in 1998 that suggested that as many as 97 percent of spreadsheets contain “serious material errors.” As with many studies, it went on to be cited by anyone who wanted to convince accountants that spreadsheets are too risky. But as any accountant who works with spreadsheets on a regular basis will tell you, that 97 percent is an absurd statistic that must have been the result of a limited or flawed sample size.
When it comes to reconciliation workpapers, as long as they’re constructed according to best practices, there’s not much chance for error. Most reconciliations are simple, and roll forward from month to month with just a few changes.
That’s why we don’t need a specialized application to manage these workpapers. It just ends up creating more work for the accounting staff. This is the problem when non-accountants try to make software for accountants — they take something simple and make it complicated because they don’t understand how accountants work.
A spreadsheet is like a very sharp knife. In the right hands, it can slice and dice like no other. And, as with any powerful tool, it can also be dangerous. But that doesn’t mean that we should take away all the knives and replace them with a food processor. There’s a time and a place for both.
And in the world of accounting, sometimes we need spreadsheets, and sometimes we need a specialized application. We need both. And whatever new apps we implement ought to add on to the functionality that’s built up over decades within Excel rather than trying to replace it entirely.
The spreadsheet is here to stay.
Supreme Court says EY and other employers can bar worker class actions
By Greg Stohr
A divided U.S. Supreme Court ruled that employers, including Ernst & Young, can force workers to use individual arbitration instead of class-action lawsuits to press legal claims. The decision potentially limits the rights of tens of millions of employees.
The justices, voting 5-4 along ideological lines, said for the first time Monday that a 1925 federal law lets employers enforce arbitration agreements signed by workers, even if they bar group claims. The majority rejected contentions that a separate law guarantees workers the right to join forces in pressing claims.
The high court ruling is a victory for three companies involved in the fight. The group includes the accounting firm Ernst & Young LLP, which was fighting allegations that it misclassified thousands of employees to make them ineligible for overtime pay.
The court was also considering an appeal from Epic Systems Corp., a health-care software company that was sued by Jacob Lewis, an employee who says the company misclassified him and other technical writers so that they wouldn’t be eligible for overtime pay.
The third case involved a Murphy USA unit fighting allegations that it underpaid four employees at its gas station in Calera, Alabama. The National Labor Relations Board had concluded the company engaged in an unfair labor practice by refusing to let the workers pursue their claims together.
The ruling builds on previous Supreme Court decisions that let companies channel disputes with consumers and other businesses into arbitration. The latest decision applies directly to wage-and-hour claims, and its reasoning might let employers avoid class action job-discrimination suits as well.
“The policy may be debatable but the law is clear: Congress has instructed that arbitration agreements like those before us must be enforced as written,” Justice Neil Gorsuch wrote for the majority.
Arbitration supporters say that forum is cheaper and more efficient than traditional litigation. Critics say companies are trying to strip individuals of important rights, including the ability to band together on claims that as a practical matter are too small to press individually.
Justices Ruth Bader Ginsburg, Stephen Breyer, Sonia Sotomayor and Elena Kagan dissented. Ginsburg called the ruling “egregiously wrong.”
“The inevitable result of today’s decision will be the underenforcement of federal and state statutes designed to advance the well-being of vulnerable workers,” Ginsburg wrote.
Ginsburg called on Congress to pass legislation to override the court’s decision. Ginsburg successfully issued a similar call a decade ago, urging Congress to bolster the rights of women to press equal-pay lawsuits.
The ruling shows the impact of the 14-month battle over the seat left vacant when Justice Antonin Scalia died unexpectedly in 2016. President Donald Trump filled the opening with Gorsuch last year after Senate Republicans blocked a vote in 2016 on then-President Barack Obama’s nominee, Merrick Garland.
Chief Justice John Roberts and Justices Clarence Thomas, Anthony Kennedy and Samuel Alito — all Republican appointees and members of the court’s conservative wing — joined Gorsuch in the majority.
About 25 million employees have signed arbitration accords that bar group claims, a lawyer for the workers in the case told the court.
The workers said the National Labor Relations Act guarantees them the right to press claims as a group, either in arbitration or in court. The 1935 law protects “concerted activities” by workers, without explicitly mentioning lawsuits.
The majority said that language wasn’t specific enough to overcome a separate law, the 1925 Federal Arbitration Act, which says arbitration agreements must be enforced like any other contract.
That provision “focuses on the right to organize unions and bargain collectively,” Gorsuch wrote. “It may permit unions to bargain to prohibit arbitration. But it does not express approval or disapproval of arbitration. It does not mention class or collective action procedures. It does not even hint at a wish to displace the Arbitration Act.”
Ginsburg sought to limit the impact of the ruling, saying its logic shouldn’t prevent workers from banding together to press broad discrimination claims under the 1964 Civil Rights Act.
“It would be grossly exorbitant to read the FAA to devastate Title VII of the Civil Rights Act of 1964 and other laws enacted to eliminate, root and branch, class-based employment discrimination,” she wrote.
Although the Trump administration backed the employers, the National Labor Relations Board took the side of the workers during arguments in October. At the time, the board’s general counsel was a Democratic appointee.
Chamber of Commerce
The ruling drew cheers from business advocates, who said it will reduce costly litigation.
“Today’s decision is a victory for everyone but lawyers,” said Andrew Pincus, a Washington lawyer who filed a brief for the U.S. Chamber of Commerce. “Employees and businesses will continue to have access to a quick, less expensive, and fair system for resolving claims.”
Some civil rights advocates suggested the ruling will undermine class action discrimination lawsuits, even though the court didn’t directly address that issue.
“The Supreme Court has taken away a powerful tool for women to fight discrimination at work,” said Fatima Goss Graves, president of the National Women’s Law Center. “Instead of banding together with coworkers to push back against sexual harassment, pay discrimination, pregnancy discrimination, racial discrimination, wage theft and more, employees may now be forced behind closed doors into an individual, costly — and often secret — arbitration process.”
Still, the impact on civil rights claims is likely to be a subject of future court fights. Raymond Audain, senior counsel at the NAACP Legal Defense and Educational Fund, said that “we agree with Justice Ginsburg that the decision does not apply to discrimination claims.”
The cases are Epic Systems v. Lewis, 16-285; Ernst & Young v. Morris, 16-300; and NLRB v. Murphy Oil USA, 16-307.
Biggest rollback of bank rules since Dodd-Frank clears house
By Elizabeth Dexheimer
The U.S. House has approved a sweeping overhaul of bank regulations, sending to President Donald Trump a bill that will give him a chance to make good on his vow to "do a big number" on the Dodd-Frank Act.
Lawmakers voted 258-to-159 Tuesday to advance a measure that is the product of years of financial-industry lobbying to soften post-crisis rules and sensitive negotiations on Capitol Hill to attract bipartisan support needed to get it through the narrowly divided Senate.
The legislation would be the most significant overhaul of banking oversight to become law since Dodd-Frank was enacted in 2010 and may represent Congress’s last shot at dialing back financial regulation before midterm elections in November.
House leaders agreed to vote on the compromise bill that Senate Republicans negotiated with moderate Democrats in exchange for a promise that a broader set of House-passed rollbacks will get a vote later this year. Senate Democrats who backed the plan sponsored by Banking Committee Chairman Mike Crapo, an Idaho Republican, have said they will oppose further changes.
“This is a moment years in the making," Crapo said in a statement after the bill’s passing. “This step toward right-sizing regulation will allow local banks and credit unions to focus more on lending, in turn propelling economic growth and creating jobs."
Moderate Democrats’ support for the bill has sparked fights with progressives including Senator Elizabeth Warren of Massachusetts, who say the bill is a gift to bank lobbyists.
“The bill would raise the asset threshold at which banks would be subject to enhanced supervision by regulators, weaken stress tests and capital requirements for big banks, undermine critical mortgage protections, and exempt 85 percent of depository institutions from reporting important Home Mortgage Disclosure Act data,” Representative Maxine Waters of California, the top Democrat on the House Financial Services Committee, said in a statement before the vote. “I’m all for helping community banks and credit unions but this bill goes way beyond that and includes massive giveaways to Wall Street.”
The legislation gives smaller banks relief from post-crisis rules that they’ve decried as burdensome and costly. It raises to $250 billion in assets from $50 billion the threshold for banks to face stricter Federal Reserve oversight as systemically important financial institutions. That would free companies such as American Express Co. and SunTrust Banks Inc. from higher compliance costs associated with being considered too big to fail.
It could also spark a wave of dealmaking among regional firms that have been reluctant to cross that $50 billion threshold.
“This gives us the ability to do more deals and bigger deals,” said Joe Ficalora, chief executive officer of New York Community Bancorp Inc., which has $49.6 billion in assets. “There are many opportunities, and we’ve just been waiting for the timing to be right."
Even if the bill is signed into law, the Federal Reserve will ultimately determine how much relief regional firms get — and how soon. While losing the SIFI label frees them from some stricter oversight and annual stress tests mandated by Dodd-Frank, banks with more than $50 billion in assets are still subject to other rules including the Fed’s annual Comprehensive Capital Analysis and Review.
If the Fed does decide to make changes in response to the legislation, the process that could take months, even a year, according to Jared Seiberg, an analyst at Cowen Inc.
There are fewer gains in the legislation for Wall Street banks and investment firms, which will have to rely on regulators appointed by Trump to dial back hated constraints such as the Volcker Rule ban on proprietary trading.
Among the bill’s biggest losers are large regional banks such as Capital One Financial Corp. and PNC Financial Services Group Inc., which would keep their SIFI designations. Wall Street banks like Citigroup Inc. and JPMorgan Chase & Co. also lost out on getting relief on some capital requirements they lobbied to include.
The legislation lets big banks include municipal bonds in required stockpiles of assets that could be sold to provide funding in a crisis. That’s a modification JPMorgan and Citigroup have sought for years.
Custody banks such as State Street Corp. and Bank of New York Mellon Corp., which specialize in safeguarding assets as opposed to traditional commercial banking, are likely to see relief from some capital requirements. The bill frees small banks from the Volcker Rule and makes a technical fix that would let some investment firms like BlackRock continue trading with some funds.
House Financial Services Committee Chairman Jeb Hensarling and Senate Majority Leader Mitch McConnell have agreed to consider additional financial deregulation measures later this year. Hensarling, who is leaving Congress at the end of 2018, has identified more than two dozen House-passed measures that he would like to see considered. But there’s no sign that Senate Democrats — whose votes are needed for passage — will get on board.
Hedge fund managers shift billions over carried interest concern
By Lynnley Browning and Miles Weiss
Late last year, some hedge fund managers raced to protect their personal fortunes from being carved up by the Republican tax law.
David Tepper, who runs Appaloosa Management and may soon own the Carolina Panthers, and Ross Margolies, founder of Stelliam Investment Management, were among the managers who took action, according to regulatory filings and people familiar with their moves. They collectively shifted billions of dollars before Jan. 1, when a provision took effect requiring a longer holding period to qualify for the tax break on carried interest profits.
Their concern? That the vague language of the new rule makes it possible that profits that had already been paid to them, taxed and reinvested back into the fund would be lumped in with other untaxed carried interest — and all subject to the new three-year holding period. So they rushed to separate out those distributed gains.
“The whole statute is an epic screw up and so poorly done,” said Michael Spiro, who chairs the tax group at Finn Dixon & Herling. “Nobody thought through these various policy decisions.”
Spiro said he thinks the lack of clarity in the law spurred dozens of hedge fund managers to split their taxed and untaxed profits up to avoid having it all potentially taxed at a higher rate.
Under the old tax regime, carried interest profits had to be held for one year to be eligible for a rate of just 23.8 percent, instead of facing ordinary income tax rates — which now top out at 37 percent.
It’s a complicated benefit enjoyed by few, but President Donald Trump turned carried interest into a battle cry during his populist presidential campaign. He’s called some hedge fund managers “paper pushers” who are “getting away with murder,” since they often pay tax rates that are so much lower than employees who face ordinary income tax rates. Money managers have argued that treating carried interest as long-term capital gains is sound tax policy that encourages entrepreneurial risk taking.
Most activist and long-short equity funds, which tend to hold onto investments for more than one but less than three years, “did something” to protect at least part of their carried interest profits because they stood to lose the most under the new law, said Jeffrey Chazen, a tax partner at EisnerAmper. Those that didn’t may pay more tax, he said.
Carried interest is typically 20 percent of a fund’s profits paid to money managers and makes up the bulk of their compensation — when the funds are profitable. The payouts accumulated by managers over the years generally consist of realized gains that have been reinvested in the fund, unrealized gains that exist as paper profits and the right to a share of future profits. The profits are located in what’s called a general partner’s capital account, which may also include additional money kicked in by the manager.
The legislation says capital contributions — meaning money or assets put in by the manager — are exempt from the three-year holding period, but it’s unclear whether profits that have been reinvested in the fund can be considered a capital contribution.
Senate Finance Committee Chairman Orrin Hatch is continuing to meet with members, taxpayers and other stakeholders to address any concerns with the new law and examine potential technical corrections, should be they be needed, said Julia Lawless, a spokeswoman for the panel.
In a Jan. 18 note, KPMG said that it was “difficult to determine” the exact effect of the law’s carve out for capital contributions.
In early December, Tepper along with other Appaloosa insiders created a new fund called Azteca Partners LLC that they have full ownership of, filings show. The purpose was to put the realized gains in a separate vehicle, according to a person familiar with the manager’s thinking who asked not to be named because the matter is private.
Tepper’s ownership of one of the Appaloosa funds — Appaloosa Investment LP I — declined to zero from 80 percent by the end of December, and its assets dropped to $2.1 billion as of Dec. 31, from $9.3 billion a year earlier, as he shifted the realized gains out. Azteca had $9.6 billion as of Dec. 31.
A spokesman for Appaloosa declined to comment.
Margolies took a similar approach and also shifted some of his realized gains into a new entity, according to a person familiar with the move who asked not to be named because the matter is private.
A spokesman for Stelliam declined to comment.
David Logan, the financial services industry tax practice leader at accounting firm CohnReznick, said he worked with clients to divvy up carried interest profits last year, but declined to name them.
Some managers may have pursued a more aggressive move to exempt a portion of their unrealized, untaxed gains from the three-year requirement. The strategy involved shifting those gains out of the general partner’s account, sometimes into a new entity, theoretically recasting them as a capital contribution from a limited partner.
A Feb. 21 presentation from Morgan, Lewis & Bockius advised managers to consider preserving unrealized gains by having the funds distribute underlying securities or financial instruments to the manager, who would recontribute them to the fund. The move would effectively render the manager a limited partner with an exempt capital contribution. “It depends on the taxpayer’s risk tolerance,” said Jason Traue, a Morgan Lewis tax lawyer. He added that moving realized gains was a safer approach because unlike unrealized gains, they’ve already been taxed.
“The changes to the taxation of carried interests is a huge development for the taxation of hedge fund managers,” wrote Kleinberg, Kaplan, Wolff & Cohen PC, a boutique law firm that works with hedge fund clients, in a note on Dec. 21 — the day before Trump signed the tax bill. The firm highlighted how the new law could cause the investment returns on money in the general partner’s entity to be subject to the three-year holding period.
A “minimum action” to take would be converting part of the GP interest in the fund to an LP interest, according to KKWC. It didn’t specify whether it was referring to shifting the realized gains or untaxed gains out of the GP interest. Jeffrey Bortnick, a partner at KKWC, declined to comment.
Maneuvers involving carried interest would have been relatively easy to do, Spiro said, given that many fund agreements allow for the automatic re-designation of partnership interests and sales of securities. And the moves generally didn’t affect a fund’s trading strategy.
Setting a three-year holding period was supposed to save the federal government $1.1 billion over a decade, but workarounds to avoid the three-year holding period could chip away at that number.
Rafael Kariyev, a tax partner at Debevoise & Plimpton, warns that “any structure designed to avoid the carried interest provision is likely to be attacked by the IRS in regulations or other guidance.”
Marisol Garibay, a Treasury spokeswoman, didn’t respond to requests for comment about IRS guidance on carried interest profits.
The agency has already said it will close a carried interest loophole after Bloomberg News reported that hedge funds were rushing to take advantage of a potential workaround for the new three-year holding period by setting up thousands of limited liability companies for managers entitled to the payouts.
“People will be creative in trying to structure around the three-year holding period, but folks will need to be mindful,” said David Sussman, a lawyer who chairs the private investment funds practice at Duane Morris.
Recent conversations with prospective clients:
Prospect: I started a side business doing “XYZ” (one time it was raising shrimp — in Iowa! — while other times it’s been things such as collecting old coins) and I’m hoping I can get all the tax writeoffs for it. I made no money and spent about $10,000. Can I deduct that?
Me: Did you run it as a business? Were you trying to turn a profit? If so, then you probably could write off the loss. But this sounds an awful lot like a hobby, and if that’s the case you wouldn’t be able to write off the loss.
Prospect: (blank stare, often followed by some comment about how their neighbor or their brother-in-law wrote off a huge loss from THEIR Iowa-based shrimp operation. Then the prospect leaves and I don’t hear from them again.)
Prospect: I live on an acreage and have a few goats. I sold one goat for $300 and spent about $8,000 on supplies and feed and other things for the goats. I’m hoping I can deduct that this year and going forward.
Me: Looking at your tax return, you and your spouse make a combined income of $100,000 working full-time jobs in the city. Are your goats really a business?
Prospect: I don’t know, I just want to take advantage of tax writeoffs like everyone else does.
Me: Are you trying to turn a profit? Do you have a business plan? It’s not a huge deal to show a $7,700 loss in year one if there will be profits in future years. But with something like “raising a couple of goats,” it would be hard to argue this is a real business.
Prospect: (blank stare, followed by a comment about how their brother-in-law always writes off huge losses from the three chickens he owns. They leave and I never hear from them again.)
I always get sideways looks from people when I say this: turning a profit is not a bad thing.
Yes, you’ll have to pay tax on that profit, and that stinks. And yes, of course you should deduct everything you possibly can.
But when you show losses in a business venture, that means you spent more money than you brought in. When that happens for a year or two, that’s no big deal and is in fact normal for businesses just getting started.
But if the losses continue beyond the startup phase, that’s a problem. Even if it’s a side business.
Let’s go back to our “goat” example above. Let’s just presume that this is a real business and not a hobby. The taxpayer is spending thousands of dollars on their goats. Yeah, they get a tax writeoff. But let’s look at it from a cash-flow standpoint.
Tax savings on $7,700: 7,700 * .22 = 1,694*
Net cash outflow on the goats: $7,700 – 1,694 = $6,006
(*-For this example, let’s presume that the taxpayer is in the 22% tax bracket in 2018.)
On the surface, this sounds like a great thing for the client. They save almost $1,700 on their tax bill!
YEAH, TAKE THAT, STUPID GOVERNMENT!!!!!
But hold on. This taxpayer hasn’t really “saved” anything …. They spent $7,700 to save $1,700 in taxes — BUT THEY ARE STILL IN THE HOLE A NET OF $6,000 OF NEGATIVE CASH FLOW.
Let’s forget about the IRS and the “hobby loss rules” for a minute here, and let’s just say that this scenario plays out year after year, which seems to be what a lot of people WANT. (Ignoring the IRS/audit implications lets us focus just on the cash flow issue.)
This client is throwing away $6,000 per year in their goat “business.” Yes they “save” $1,700 per year on their tax liability and I suppose that makes them feel better that the government is not getting that money from them.
But the $6,000 net cash outflow is a real cost that the client has to absorb. Think of the things they could do with that $6,000.
I do want to add: spending $6,000 a year of net cash outflow on goats might be worthwhile for the client because they enjoy raising goats and it brings them a sense of satisfaction that they wouldn’t have from, say, putting $6,000 into a retirement account. That’s a fair enough counterpoint.
But this gets back to something I always tell my clients: don’t spend money on something just because you might get a tax deduction, because the savings are not dollar-for-dollar — you’re still netting out in the hole.
If you’re spending money on something because your business needs whatever it is that you’re buying, then great, take the deduction.
Otherwise, you’re tossing money around trying to chase tax deductions.
At first blush, the answer to the question posed in the title of this post would seem to be yes. Unfortunately, the answer is actually “no.”
As I’ve written about before, charitable contributions must be substantiated. If you give less than $250 at any one time, you can substantiate the donation in any reasonable method, such as showing a canceled check. You don’t necessarily need a receipt from the organization.
So let’s say you toss $20 into the collection plate at your church each Sunday. Each of those donations individually is less than $20, so the relaxed substantiation rules apply.
HOWEVER … if you’re audited, you still have to be able to prove the donation. You don’t need a receipt from the church because each individual gift is less than $250, but you still need a paper trail to document the donation.
As the “PPC 1040 Desk Reference Guide” says:
Charitable cash handouts—such as cash placed on church collection plates—will not result in any deductions unless the donor obtains a qualifying receipt or written communication.
(From Key Issue 26C: Substantiating Contributions, PPC’s 1040 Deskbook)
So unless you can get the church to give you a receipt for the cash you toss into the collection plate, you’re out of luck in taking the deduction.
10 Tax Moves To Make Before Summer Begins
Kelly Phillips Erb , FORBES STAFF
As the warmer weather finally makes an appearance, many of us are dreaming about summer: lazy days spent by the pool, at the shore or just sprawling in the grass (although, honestly, those of us with kids know that this never actually happens). With a more relaxed schedule, summer can be a great time to catch up on your to-do list, including tax moves to save before year-end. Here are 10 tax moves to make now:
1. Take a good look at retirement accounts. If the thought of lounging around this summer has you thinking about early retirement, now is the time to do a check on your retirement savings. Contributions to a traditional IRA are immediately tax-deductible, while contributions to a Roth IRA are tax-favored at retirement. Additionally, the more money that you can sock away into your 401(k) or other retirement savings plan, the better, since most contributions are made with pre-tax money. That goes for self-employed persons, too: SEP IRAs and solo 401(k) plans allow for long-term savings and immediate tax benefits.
2. Shore up health care accounts. With healthcare costs on the rise, now is an excellent time to do a quick check on your health care accounts, including your healthcare flexible spending account (FSA) and your health savings account (HSA). FSAs are set up by an employer as a benefit plan, often in connection with a high deductible or high co-pay health insurance plan. They can be funded by you, your employer, or both; the most common arrangement involves voluntary contributions to a plan taken out of your paycheck with additional contributions made by your employer on your behalf. With an HSA, you can contribute pre-tax dollars directly from your paycheck - even without an employer contribution. And unlike the FSA, the HSA is not a use it or lose it account, so the funds roll over at the end of the year (there's no penalty or guesswork involved).
(For 2018 HSA limits, click here.)
3. Double-check your withholding. Mid-year is a great time for a withholding checkup. The Tax Cuts and Jobs Act, which was signed into law in 2017, ushered in many changes with most taking effect for individual taxpayers in the 2018 tax year. In addition to the loss of personal exemptions and the doubling of the standard deduction, significant changes to itemized deductions could affect your tax bill. It's best to make sure you're on track now so that you don't end up with a nasty surprise at tax time.
(For more information on what to look for in your checkup, click here. To learn how to use the IRS withholding calculator, click here. And if you need to adjust your form W-4, click here. To see what 2018 rates look like under tax reform, click here.)
4. Prepare for your side hustle. If you're not the toes in the sand type, summer can be a great time to pick up a little bit of extra cash with a side gig. But more cash can also mean more tax consequences. Before you get started with your side hustle this summer, make sure that you're on track to be successful. Keep good records of both income and expenses, including pro-rating costs when applicable, so that you don't pay more in tax than you have to. Also, be ready to pay estimated taxes if necessary (see below) so that you don't get hit with a big tax bill next year.
(For more on what you need to know about taxes and your side hustle, click here.)
5. Pay your estimated tax. Depending on your finances, you may need to make estimated payments. Estimated tax is generally payable by self-employed and freelance taxpayers, as well as other taxpayers not subject to withholding like landlords, S corporation shareholders, partners in a partnership or taxpayers with significant investments. If you don't have withholding on those payments and you expect to owe more than $1,000 at tax time, you'll want to make estimated payments. To make estimated payments, you’ll use federal form 1040ES, Estimated Tax for Individuals(downloads as a pdf). Estimated taxes are due each quarter: if you skip a payment or pay late, you may be subject to a penalty.
(For more on estimated taxes for 2018, click here.)
6. Consider bundling your charitable gifts. As you're putting out the patio furniture this summer, don't forget about charitable donations, and don't overlook non-cash gifts like household goods and furnishings. You can typically take a deduction for the fair market value of non-cash gifts: fair market value is generally the price that a willing buyer would pay to a willing seller (depending on the amount, appraisals might be necessary). With the doubling of the standard deduction in 2018, fewer taxpayers will have an incentive to itemize and claim the charitable deduction. That $1,000 that you donate each year might not make as much of an impact on your taxes now. However, instead of giving $1,000 for each of five years, consider giving $5,000 now. Also, by combining your cash gifts with your non-cash gifts, you're driving those values up even more and maximizing the chances that you'll benefit on the tax side.
(For more on charitable giving, click here.)
7. Pay tuition bills now. I know: School is just getting out, and you don't even want to think about next semester. But, it will be here before you know it and if you start paying now, you'll be on track to have your bills before the end of the year. That means that you'll be able to take advantage of educational tax breaks, like the American Opportunity Credit (AOC) and Lifetime Learning Credit (LLC), in 2018. Currently, an eligible student may qualify for the AOC, which provides a credit of up to $2,500 per year (40% of which is refundable) for qualified tuition and related expenses for each of the first four years of college (or certain other degree programs), while an eligible taxpayer may qualify for the LLC, which provides a credit of up to $2,000 per return.
(For more on the AOC and LLC, click here.)
8. Go to the doctor. A trip to the doctor might not sound like a fun way to start your summer break, but it might be a good idea for tax purposes. The good news is that medical and dental expenses survived tax reform and for 2018, the floor is back in play at 7.5% of your adjusted gross income (AGI). So, let's say your AGI is $40,000 and your medical expenses were $5,000. You can claim $2,000 as a deduction: $5,000 in expenses less the floor (7.5% x $40,000 = $3,000). Sounds good, right? The bad news is that, as with charitable giving, the doubling of the standard deduction in 2018, means that fewer taxpayers will have an incentive to itemize. But by bundling - meaning grouping your deductions together - you can take advantage of them in the year that it makes the best tax sense. So if you know that you have a big medical expense coming in 2018, why not get those visits to the dentist, eye doctor and general practitioner in now? That way, when you're adding up those medical visits - you already know that you'll be stopping by for sunburns, poison ivy and occasional summer cold this season - you can maximize your tax benefit.
(For more on what Schedule A might look like in 2018, click here.)
9. Consider dumping your house. It's been a long, cold winter for many taxpayers. In some areas of the country - like my corner of Pennsylvania - residents worried that we might never see the sun. If you spent the past winter swearing that you were going to move somewhere different after the thaw, why not do it? New caps on home mortgage interest and property taxes under tax reform may make it more appealing than ever to take the plunge and move to your favorite vacation spot or permanent retirement home. Under the new law, the amount that you may claim on Schedule A for all state and local sales, income, and property taxes together may not exceed $10,000 ($5,000 for married taxpayers filing separately). Downsizing never looked so good.
(For more on SALT deductions and a second home, click here.)
10. Consult with your tax professional - or hire one. Your tax professional isn't exactly sitting around the office twiddling his or her thumbs about now. There are still returns to be done, accountings to be filed, and petitions to prepare. Trust me: There is plenty to do. But thankfully, this time of year isn't quite as busy as it was a few months ago, which makes it a great time to touch base with your tax professional. Setting up a meeting to discuss how things look now and whether you should engage in any additional planning is a good idea. Just don't wait too long to make an appointment, since the busy season will be here soon enough. Remember, your tax pro cannot turn back time any more than Cher can.
Tax reform discussions rarely touch on the many inequities and basic “unfairness” in the US Tax Code.
Here are three examples of “unfairness” that still remain in the US Tax Code. They were not addressed in the GOP Tax Act but should be in future tax reform legislation. I have posted separately about these in the past – but here they are together in one post.
As an aside, many of the inequities in the pre-TCJA code involved or were made worse by the dreaded Alternative Minimum Tax. But the Act makes the AMT no longer an issue in most cases.
(1) Taxation of Social Security and Railroad Retirement Benefits
As I am often telling clients each filing season, because of the way Social Security and Railroad Retirement benefits are taxed it is very possible that for every additional $1.00 of income you pay tax on $1.85. So, income that falls within the new 22% bracket can be effectively taxed at 40.7% - almost 4% above the current top tax rate.
Social Security and Railroad Retirement benefits are taxed based on the extent of your other taxable income and tax-exempt interest. You could pay tax on up to 50% or 85% of the gross benefits. So, an additional $100 of dividends, or interest or capital gains or W-2 income can cause an additional $85 of your benefits to be taxed, so the $100 increase causes your AGI to increase by $185.
Because taxable Social Security and Railroad Retirement benefits increase AGI, increases could also reduce tax deductions and credits that are affected by AGI – increasing the effective tax rate of the increase.
As a side bit of unfairness, because increased SS or RR benefits increase AGI, the increase can potentially result in some qualified dividends and long-term capital gains, which have caused the increase in taxable SS or RR, being effectively taxed at more than the “advertised” 0% or 15% rate.
The Solution – tax Social Security benefits the same as any other pension with “after-tax” employee contributions, using the “Simplified Method”. The taxable portion of the benefit would be calculated by SSA and reported as such on the SSA-1099 and RRB-1099, similar to the way partially taxable pension income is reported on the Form 1099-R. Or perhaps treat Social Security and Railroad Retirement like a “ROTH” investment, as employee contributions are not deductible, and do not tax benefits at all. These benefits were not taxed at all until 1984.
(2) Taxation of Gambling Winnings
Gross gambling winnings, reported on Form W-2G, are generally reported in full as income on Line 21 of Page 1 of the Form 1040, increasing AGI, while gambling losses, to the extent of reported winnings, are deductible as an Itemized Deduction. So, it is possible for a taxpayer to pay additional federal income tax on net gambling losses.
John Q Taxpayer buys $10 in state lottery tickets each and every week. One week he hits for $500. He has no other gambling activity for the year. He must report the $500 win in full as taxable income and, if he receives Social Security, potentially increase taxable SS benefits by $425. So, his AGI could increase by $945. If he is unable to itemize due to the increased Standard Deduction he does not get a tax benefit for his losses. So, if he is in the 22% bracket he would pay from $110 up to $204 in federal income tax on $20 in gambling losses.
If the $500 win does cause his taxable SS benefits to increase by $425 but he can itemize and deduct $500 in losses on Schedule A he is still paying $94 in income tax in the 22% bracket. And if he can deduct medical expenses the net taxable income is increased by $69 because the additional income reduces the allowable medical deduction.
Thankfully Tax Court decisions and IRS regulation revisions have corrected this problem for some casino gambling – but not for all gambling situations.
I have no problem with limiting the deduction for gambling losses to gambling winnings – just with where and how the losses are deducted.
The Solution – obviously, report only net gambling winnings, after deducting losses, but not less than 0, as income on Page 1 of Form 1040, as is done on the NJ-1040.
(3) The Marriage Tax Penalty
The Marriage Penalty manifests itself in many ways in the US Tax Code. The result is that two married individuals, each with their own separate sources of income (i.e. W-2 or pension income), pay more income tax by filing as a married couple then by filing two separate returns as unmarried Single taxpayers merely living together.
Filing as Married Filing Separately does not always remove or reduce the Marriage Penalty. Some deductions are “per return” and not “per spouse”. And many tax benefits allowed on a Single return are reduced or just plain not allowed on a Married Filing Separate return – such as the Credit for Child and Dependent Care Expenses, the Earned Income Credit, the Credit for the Elderly or Disabled, or the HOPE or Lifetime Learning Education Credit. A couple filing separately can pay more tax than if they filed a joint return.
The maximum amount of combined income or sales and property taxes that can be deducted on Schedule A is $10,000 – but only $5,000 if Married Filing Separate. Two unmarried individuals living together can each deduct $10,000, for a total of $20,000. If the 22% bracket applies, the marriage tax penalty for this item alone is up to $2,200.
A married couple can deduct up to $3,000 in net capital losses per year – but only $1,500 if Married Filing Separate. Two unmarried individuals each with capital losses for the year, or carried forward, in excess of $3,000 can each deduct $3,000, for a total of $6,000. You do the math.
There is also a Marriage Tax Benefit – for households with only one earning spouse. Because of the doubling of many tax benefits on a joint return the couple pays less tax than the earning spouse would pay on a Single return (if one spouse has no taxable income and was not married there is no need to file a return and the Standard Deduction is not claimed if filing as single – but twice the Standard Deduction is allowed on a joint return reporting the same total income; granted the earning taxpayer could claim the non-earning taxpayer as a dependent on the one Single return and possibly get additional tax benefits – but not as much as Married Filing Joint).
In my opinion there should be neither a tax penalty or tax benefit for marriage.
The solution – allow a two-income married couple to file separately as if they were each filing a Single return, with all the benefits and the same tax table and rate schedule as a Single filer. I deal with this in more detail in “The Tax Code Must Be Destroyed”. This at least does away with the marriage penalty. I am not quite sure how to remove the marriage benefit, or if it actually should be removed.
There are many other inequities in the current US Tax Code.
But you’re right
Here are two more inequities in the US Tax Code, which have been made worse by the GOP Tax Act.
(1) Many employers have established an “accountable” plan for reimbursing employees for expenses. If an employee incurs a legitimate job-related out-of-pocket expense he/she submits proof of payment to the employer and is reimbursed. However, others, especially outside commission salesmen, are not reimbursed for the expenses incurred to generate sales. The employer pays the employee a draw and a commission based on sales volume. The employee is expected to “eat” his out of pocket expenses, which could be extensive in terms of business miles, meals and promotional expenses.
In the case of the reimbursed employee, his net salary is, in effect, all “in-pocket”. In the case of the unreimbursed employee his net “in pocket” is his net salary less his unreimbursed expenses. The salary of the unreimbursed employee is usually higher due to the “unreimbursementness”. And there are employers without an accountable plan who simply provide their employees with a flat monthly “expense allowance”, or as was the case with municipal police officers and fire fighters an annual “uniform allowance”, without any documentation requirement. This expense or uniform allowance is included in the gross taxable wages of the employee.
Prior to the GOP Tax Act unreimbursed employee business expenses were allowed as a Miscellaneous Expense deduction on Schedule A, subject to the 2% of AGI limitation. So, there was some relief. But you had to itemize to be able to deduct expenses and had to reduce expenses by 2% of AGI, so the benefit was limited. As Miscellaneous Expenses subject to the 2% of AGI exclusion were not deductible in calculating the dreaded Alternative Minimum Tax (AMT) many taxpayers lost the benefit of this deduction. And as the gross wages before deducting any employee business expenses were included in AMT, a multitude of deductions and credits could be reduced, increasing the taxpayer’s effective tax.
And to add insult to injury, the increased amount of wages paid to unreimbursed employees, and the flat expense or uniform allowance included in gross taxable wages, are also subject to FICA tax.
Under the new law employee business expenses are no longer deductible.
So, both before and after the GOP Tax Act, employees who were not reimbursed for their legitimate out of pocket expenses via an accountable plan are effectively paying more tax on their net “in pocket” income than employees who were reimbursed.
FYI – back when I started out in “the business”, in the early 1970s, outside salesmen could deduct their unreimbursed expenses “above the line” (remember – the “line” is Adjusted Gross Income) as an adjustment to income.
(2) Similarly, if a person receives a taxable legal award or settlement the gross amount of the award or settlement is reported as income on Page 1 of the Form 1040 – not the amount received by the beneficiary after legal fees are deducted. If the award or settlement is from a claim of unlawful discrimination the legal fees are deducted “above the line” as an adjustment to income – so their Adjusted Gross Income includes only the amount they actually receive “in pocket” from the settlement.
In all other cases the legal fees are, like employee business expenses, deducted as a Miscellaneous Expense on Schedule A, subject to the 2% of AGI exclusion. Here the AGI includes the gross award or settlement, so the 2% exclusion is inflated.
And, also like with employee business expenses, since Miscellaneous Expenses subject to the 2% of AGI exclusion are not deductible in calculating the dreaded AMT, the taxpayer, in most cases, is taxed on the full amount of the award or settlement.
Under the GOP Tax Act, the legal fees paid on taxable awards and settlements not related to unlawful discrimination are no longer deductible.
A taxpayer gets an award of $100,000. His “contingent” legal fee is 1/3, or $33,333. So, the taxpayer is only “in pocket” $66,667. If in the new 24% bracket the taxpayer will pay $24,000 in federal income tax on net income of $66,667 – which is an effective 36% tax.
Disclaimer: This article is for general information purposes only, and is not intended to provide professional tax, legal, or financial advice. To determine how this or other information in this newsletter might apply to your specific situation, contact us for more details and counsel.
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