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Our client portal will be unavailable from 9PM MST, April 26 until 9PM MST April 28th due to a scheduled maintenance.
Office alert – Friday March 15th, 2024.
Due to the road conditions, majority of our staff will be working remotely today.
We want you to be safe, we have a drop off at COS on 3rd floor. If you are planning to come by the Denver and Springs office please make contact with your SKR contact first.
Our client portal will be unavailable from 9PM MST, April 26 until 9PM MST April 28th due to a scheduled maintenance.
Office alert – Friday March 15th, 2024.
Due to the road conditions, majority of our staff will be working remotely today.
We want you to be safe, we have a drop off at COS on 3rd floor. If you are planning to come by the Denver and Springs office please make contact with your SKR contact first.
The Tax Cuts and Jobs Act (TCJA) imposes a limit on deductions for business interest for taxable years beginning in 2018. The limit, like other aspects of the law, has raised some questions for taxpayers. In response, the IRS has issued temporary guidance that taxpayers can rely on until it releases regulations. While the guidance provides some valuable information, it also leaves some questions unanswered.
The prior-law limit rules
Prior to the TCJA, corporations could not deduct “disqualified interest” expense if the borrower’s debt equaled more than one and a half times its equity and net interest expense exceeded 50% of its adjusted taxable income. Disqualified interest included interest paid or accrued to:
Previously, taxpayers could carry forward excess interest indefinitely. And any excess limit could be carried forward three years.
These rules were for the so-called “earnings stripping” rules. They were intended to prevent corporations from wiping out their taxable income by deducting interest payments on debt owed to certain parties.
The new-law limit
For tax years beginning after 2017, the deduction for business interest incurred by both corporate and noncorporate taxpayers is limited to the sum of:
The limit applies to all taxpayers, except those with average annual gross receipts of $25 million or less, real estate or farming businesses that elect to exempt themselves and certain regulated utilities.
The amended rules allow for the indefinite carryforward of any business interest not deducted because of the limit. Excess limit, however, cannot be carried forward.
C-corporation business interest income and expense
The IRS announced it will issue regulations clarifying that, for purposes of Section 163(j) only, all interest paid or accrued on a C corporation’s debt is business interest. All interest on debt held by a C corporation and includable in its gross income is business interest income.
In addition, the regulations will address the proper treatment of interest paid, accrued or includable in gross income by a noncorporate entity (e.g., a partnership) in which the C corporation holds an interest. And the regulations will clarify that the disallowance and carryforward of a deduction for a C corporation’s business interest expense will not affect whether and when such an expense reduces the corporation’s earnings and profits.
Treatment of consolidated groups
For groups of affiliated corporations that file a consolidated tax return, forthcoming regulations will clarify that the business interest deduction limit applies at the group level. For example, a consolidated group’s taxable income for purposes of calculating its adjusted taxable income will be its consolidated taxable income. Intercompany obligations (e.g. debt between affiliated corporations) will not count when determining the amount of the limitation.
The regulations also will address several other issues related to the application of the limit to consolidated groups. These include the allocation of the limit among group members, the treatment of disallowed interest deduction carryforwards when a member leaves the group and the treatment of a new group member’s carryforwards. The regulations are not expected to treat an affiliated group that doesn’t file a consolidated tax return as a single taxpayer for purposes of the interest expense deduction limit.
Electing to be exempt from the interest expense deduction limit
Real estate and farm businesses can elect to exempt themselves from the Section 163(j) interest expense deduction limit. At first glance, making the election may seem like a no-brainer — but the election, which is irrevocable, can backfire.
Businesses that make the election must use the alternative depreciation system (ADS) for certain property (generally, real or farm property with a recovery period of 10 years or more) used in the business, regardless of when the property was placed in service. ADS depreciation is over longer periods, so an electing taxpayer’s annual depreciation deductions are reduced if the election is made. Electing businesses also can’t claim first-year bonus depreciation. Businesses should weigh the advantage of avoiding the interest expense deduction limit by making the election against the detriment of slower depreciation deductions if the election is made.
Treatment of pre-2018 interest carryforwards
According to the temporary guidance, the IRS will issue regulations clarifying that taxpayers with interest carryforwards from the last taxable year beginning before 2018 can carry them forward as business interest to their first taxable year beginning after 2017. The regulations will clarify that this business interest that is carried forward will be subject to potential disallowance under amended Section 163(j) in the same manner as any other business interest otherwise paid or accrued in a tax year beginning after 2017.
The regulations also will address the treatment of pre-2018 business interest under the TCJA-created IRC Section 59A, the base erosion and anti-abuse tax. The base erosion tax applies only to businesses with average annual gross receipts of at least $500 million.
Next steps
The IRS has requested comments on the rules outlined in its interim guidance. It also expects to issue regulations providing additional guidance on issues not yet covered and requested comments on which issues those regulations should address. Comments are due by May 31, 2018.
When President Trump signed the massive federal income tax overhaul into law on December 22, 2017, much was made of nonprofits’ understandable concern that the higher standard deduction would reduce incentives for charitable giving. The concern is, of course, extremely important, but the new law also includes several other provisions that may affect nonprofits.
The Tax Cuts and Jobs Act (TCJA) has substantially lowered the corporate tax rate to 21%, a significant benefit to any nonprofits already paying unrelated business income tax, which is imposed at the corporate rate. But when it comes to calculating the income that is subject to this tax, the new law brings a significant change for nonprofits.
The TCJA requires nonprofits to compute unrelated business taxable income (UBTI) separately for each unrelated business activity and pay tax on any activity with net income. That means nonprofits cannot use a loss from one unrelated business to offset income from a different unrelated business for the same tax year.
They may, however, use one year’s losses on an unrelated business to offset profits in a different year for that business, subject to certain restrictions. For example, if your nonprofit incurred a loss in its bookstore business in 2018, it can use that loss to offset bookstore profits in 2019.
The TCJA also makes certain fringe benefits includable in UBTI. These include qualified transportation benefits (for example, transit passes), qualified parking benefits and access to any on-site athletic facility.
The TCJA also imposes a 21% excise tax on “excessive” executive compensation. The tax applies to the sum of any compensation (including most benefits) in excess of $1 million paid in the tax year to a covered employee plus certain large payments to that employee upon his or her departure from the organization (known as “excess parachute payments”).
A “covered employee” means a current or former employee reported as one of the five highest paid employees for any taxable year beginning after 2016. Licensed medical professionals are not covered employees for this tax.
But what is an “excess parachute payment?” A payment generally is considered an excess parachute payment if two conditions are met:
The excess parachute payment subject to the excise tax is the amount of the parachute payment less the base amount.
The increase in the standard deduction — it is expected to reduce the number of taxpayers who itemize and, thus, can deduct charitable contributions — is not the only change that may affect giving.
For example, the TCJA doubles the estate tax exemption to $10 million (indexed for inflation) through 2025. With fewer wealthy individuals at risk of paying this tax, fewer people may make the generous donations that have been partly motivated by a desire to shrink their taxable estates. Plus, the TCJA eliminates any deduction for donations made in exchange for the right to buy season tickets to college athletic events.
The TCJA does raise the limit on cash donation deductions from 50% of adjusted gross income to 60%. But cash donations at this level are uncommon, so the higher limit may not stimulate much additional giving.
Some nonprofits issue tax-exempt bonds to finance construction and other capital activities. These bonds typically pay lower interest rates than other bonds. But investors are willing to accept the lower rates because they are not required to pay income taxes on the interest.
The TCJA, however, repeals the tax-exempt treatment for interest paid on a bond issued to refinance another tax-exempt bond. An “advance refunding bond” is used to pay principal, interest or redemption price on a prior bond issued more than 90 days before redemption of the refinanced (refunded) bond.
Let’s say you issue tax-exempt bonds at 4% interest but later discover you can refinance the bonds at 3% interest. Under the TCJA, the interest payments on the 3% advance refunding bonds will not be tax-exempt for investors — that means you will need to pay a higher interest rate because of the new bonds not being tax-exempt as recompense for the investors’ increased tax liability.
Despite the advantage of a lower tax rate on unrelated business income, the new income tax law may reduce overall charitable giving while simultaneously increasing some nonprofits’ costs. Your CPA may help identify the potential impact of charitable giving on your nonprofit as well as chart the best course forward.
Under the pre-Act rules, you could deduct interest on up to a total of $1 million of mortgage debt used to acquire your principal residence and a second home, i.e., acquisition debt. For a married taxpayer filing separately, the limit was $500,000. You could also deduct interest on home equity debt, i.e., debt secured by the qualifying homes. Qualifying home equity debt was limited to the lesser of $100,000 ($50,000 for a married taxpayer filing separately), or the taxpayer’s equity in the home or homes (the excess of the value of the home over the acquisition debt). The funds obtained via a home equity loan did not have to be used to acquire or improve the homes. So you could use home equity debt to pay for education, travel, health care, etc.
Under the TCJA, starting in 2018, the limit on qualifying acquisition debt is reduced to $750,000 ($375,000 for a married taxpayer filing separately). However, for acquisition debt incurred before Dec. 15, 2017, the higher pre-Act limit applies. The higher pre-Act limit also applies to debt arising from refinancing pre-Dec. 15, 2017 acquisition debt, to the extent the debt resulting from the refinancing does not exceed the original debt amount. This means you can refinance up to $1 million of pre-Dec. 15, 2017 acquisition debt in the future and not be subject to the reduced limitation.
And, importantly, starting in 2018, there is no longer a deduction for interest on home equity debt. This applies regardless of when the home equity debt was incurred. Accordingly, if you are considering incurring home equity debt in the future, you should take this factor into consideration. And if you currently have outstanding home equity debt, be prepared to lose the interest deduction for it, starting in 2018. (You will still be able to deduct it on your 2017 tax return, filed in 2018.)
Lastly, both of these changes last for eight years, through 2025. In 2026, the pre-Act rules come back into effect. So beginning in 2026, interest on home equity loans will be deductible again, and the limit on qualifying acquisition debt will be raised back to $1 million ($500,000 for married separate filers).
Before the Tax Cuts and Jobs Act, a second tax system called the alternative minimum tax (AMT) applied to both corporate and noncorporate taxpayers. The AMT was designed to reduce a taxpayer’s ability to avoid taxes by using certain deductions and other tax benefit items. The taxpayer’s tax liability for the year was equal to the sum of (i) the regular tax liability, plus (ii) the AMT liability for the year.
A corporation’s tentative minimum tax equalled 20% of the corporation’s “alternative minimum taxable income” (AMTI) in excess of a $40,000 exemption amount, minus the corporation’s AMT foreign tax credit. AMTI was figured by subtracting various AMT adjustments and adding back AMT preferences. The $40,000 exemption amount gradually phased out at a rate of 25% of AMTI above $150,000. “Small” corporations-those whose average annual gross receipts for the prior three years didn’t exceed $7.5 million ($5 million for startups)-were exempt from the AMT. A taxpayer’s net operating loss (NOL) deduction, generally, couldn’t reduce a taxpayer’s AMTI by more than 90% of the AMTI (determined without regard to the NOL deduction). Very complex rules applied to the deductibility of minimum tax credits (MTCs). All-in-all, the AMT was a very complicated system that added greatly to corporate tax compliance chores.
Corporate AMT repeal
The Tax Cuts and Jobs Act repealed the AMT on corporations. Conforming changes also simplified dozens of other tax code sections that were related to the corporate AMT. The TCJA also allows corporations to offset regular tax liability by any minimum tax credit they may have for any tax year. And, a corporation’s MTC is refundable for any tax year beginning after 2017 and before 2022 in an amount equal to 50% (100% for tax years beginning in 2021) of the excess MTC for the tax year, over the amount of the credit allowable for the year against regular tax liability. Thus, the full amount of the corporation’s MTC will be allowed in tax years beginning before 2022.
The Tax Cuts and Jobs Act (TCJA) should provide a substantial tax benefit to individuals with “qualified business income” from a partnership, S corporation, LLC or sole proprietorship. This income is sometimes referred to as “pass-through” income. The deduction is 20% of your “qualified business income (QBI)” from a partnership, S corporation, or sole proprietorship, defined as the net amount of items of income, gain, deduction, and loss with respect to your trade or business.
The business must be conducted within the U.S. to qualify, and specified investment-related items are not included, e.g., capital gains or losses, dividends, and interest income (unless the interest is properly allocable to the business). The trade or business of being an employee does not qualify. Also, QBI does not include reasonable compensation received from an S corporation, or a guaranteed payment received from a partnership for services provided to a partnership’s business.
The deduction is taken “below the line,” i.e., it reduces your taxable income but not your adjusted gross income. It is available regardless of whether you itemize deductions or take the standard deduction. The deduction cannot exceed 20% of the excess of your taxable income over net capital gain. Current QBI losses will be carried forward to offset future QBI income years.
For taxpayers with taxable income above $157,500 ($315,000 for joint filers), an exclusion from QBI of income from “specified service” trades or businesses is phased in. These are trades or businesses involving the performance of services in the fields of health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners. Here’s how the phase-in works: If your taxable income is at least $50,000 above the threshold, i.e., $207,500 ($157,500 + $50,000), all of the net income from the specified service trade or business is excluded from QBI. (Joint filers would use an amount $100,000 above the $315,000 threshold, or $415,000.)
Additionally, for taxpayers with taxable income more than the thresholds ($157,000/$315,000), the deduction is limited by either wages paid or wages paid plus a capital element. Here’s how it works: If your taxable income is at least $50,000 above the threshold, i.e., $207,500 ($157,500 + $50,000), your deduction for QBI cannot exceed the greater of (1) 50% of taxpayer’s allocable share of the W-2 wages paid with respect to the qualified trade or business, or (2) the sum of 25% of such wages plus 2.5% of the unadjusted basis immediately after acquisition of tangible depreciable property used in the business (including real estate). So if your QBI were $100,000, leading to a deduction of $20,000 (20% of $100,000), but the greater of (1) or (2) above were only $16,000, your deduction would be limited to $16,000, i.e., it would be reduced by $4,000.
Other limitations may apply in certain circumstances, e.g., for taxpayers with qualified cooperative dividends, qualified real estate investment trust (REIT) dividends, or income from publicly traded partnerships.
The complexities surrounding this substantial new deduction can be formidable, especially if your taxable income exceeds the threshold discussed above.
The Tax Cuts and Jobs Act makes changes to the general business credit by adding a new component credit for paid family and medical leave, and changing two current component credits, i.e., the rehabilitation credit and the orphan drug credit.
First, the Act introduces a new component credit for paid family and medical leave, i.e. the paid family and medical leave credit, which is available to eligible employers for wages paid to qualifying employees on family and medical leave. The credit is available as long as the amount paid to employees on leave is at least 50% of their normal wages and the leave payments are made in employer tax years beginning in 2018 and 2019. That is, under the Act, the new credit is temporary and won’t be available for employer tax years beginning in 2020 or later unless Congress extends it further.
For leave payments of 50% of normal wage payments, the credit amount is 12.5% of wages paid on leave. If the leave payment is more than 50% of normal wages, then the credit is raised by .25% for each 1% by which the rate is more than 50% of normal wages. So, if the leave payment rate is 100% of the normal rate, i.e. is equal to the normal rate, then the credit is raised to 25% of the on leave payment rate. The maximum leave allowed for any employee for any tax year is 12 weeks.
Eligible employers are those with a written policy in place allowing (1) qualifying full-time employees at least two weeks of paid family and medical leave a year, and (2) less than full-time employees a pro-rated amount of leave. On that note, qualifying employees are those who have (1) been employed by the employer for one year or more, and (2) who, in the preceding year, had compensation not above 60% of the compensation threshold for highly compensated employees. Paid leave provided as vacation leave, personal leave, or other medical or sick leave is not considered family and medical leave.
Second, the Act changes the rehabilitation credit for qualified rehabilitation expenditures paid or incurred starting in 2018, by eliminating the 10% credit for expenditures for qualified rehabilitation buildings placed in service before 1936, and retaining the 20% credit for expenditures for certified historic structures, but reducing its value by requiring taxpayers to take the credit ratably over five years starting with the date the structure is placed in service. Formerly, a taxpayer could take the entire credit in the year the structure was placed in service. The Act also provides for a transition rule for buildings owned or leased at all times on and after Jan. 1, 2018.
Third, the Act also makes significant changes to another component credit of the general business credit, i.e., the orphan drug credit for clinical testing expenses for certain drugs for rare diseases or conditions. For clinical testing expense amounts paid or incurred in tax years beginning in 2018, the former 50% credit is cut in half to 25%. Taxpayers that claim the full credit have to reduce the amount of any otherwise allowable deduction for the expenses regardless of limitations under the general business credit. Similarly, taxpayers that capitalize, rather than deduct, their expenses have to reduce the amount charged to a capital account. The credit has been reduced and now equals 25 percent of qualifying clinical testing expenses. However, the Act gives taxpayers the option of taking a reduced orphan drug credit that if elected allows taxpayers to avoid reducing otherwise allowable deductions or charges to their capital account. The election for the reduced credit for any tax year must be made on a tax return no later than the time for filing the return for that year (including extensions) and in a manner prescribed by IRS. Once the reduced credit election is made, it is irrevocable.
A 529 plan distribution is tax-free if it is used to pay “qualified higher education expenses” of the beneficiary (student). Before the TCJA made these changes, tuition for elementary or secondary schools wasn’t a “qualified higher education expense,” so students/529 beneficiaries who had to pay such tuition couldn’t receive tax-free 529 plan distributions.
The TCJA provides that qualified higher education expenses now include expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school. Thus, tax-free distributions from 529 plans can now be received by beneficiaries who pay these expenses, effective for distributions from 529 plans after 2017.
There is a limit to how much of a distribution can be taken from a 529 plan for these expenses. The amount of cash distributions from all 529 plans per single beneficiary during any tax year can’t, when combined, include more than $10,000 for elementary school and secondary school tuition incurred during the tax year.
Before Tax Rerfom changes were effective, individuals were permitted to claim the following types of taxes as itemized deductions, even if they were not business related:
Taxpayers could elect to deduct state and local general sales taxes in lieu of the itemized deduction for state and local income taxes.
New SALT Deduction Limits
For tax years 2018 through 2025, new tax reform laws limit deductions for taxes paid by individual taxpayers in the following ways:
Current rules
Under the current rules, an individual who pays alimony may deduct an amount equal to the alimony or separate maintenance payments paid during the year as an “above-the-line” deduction. (An “above-the-line” deduction, i.e., a deduction that a taxpayer need not itemize deductions to claim, is more valuable for the taxpayer than an itemized deduction.)
Under current rules, alimony and separate maintenance payments are taxable to the recipient spouse (includible in that spouse’s gross income).
TCJA rules
Under the TCJA rules, there is no deduction for alimony for the payer. Furthermore, alimony is not gross income to the recipient. So for divorces and legal separations that are executed (i.e., that come into legal existence due to a court order) after 2018, the alimony-paying spouse won’t be able to deduct the payments, and the alimony-receiving spouse does not include them in gross income or pay federal income tax on them.
TCJA rules don’t apply to existing divorces and separations. It’s important to emphasize that the current rules continue to apply to already-existing divorces and separations, as well as divorces and separations that are executed before 2019.
Some taxpayers may want the TCJA rules to apply to their existing divorce or separation. Under a special rule, if taxpayers have an existing (pre-2019) divorce or separation decree, and they have that agreement legally modified, then the new rules don’t apply to that modified decree, unless the modification expressly provides that the TCJA rules are to apply. There may be situations where applying the TCJA rules voluntarily is beneficial for the taxpayers, such as a change in the income levels of the alimony payer or the alimony recipient.
Under pre-Act law, the child tax credit was $1,000 per qualifying child, but it was reduced for married couples filing jointly by $50 for every $1,000 (or part of a $1,000) by which their adjusted gross income (AGI) exceeded $110,000. (The threshold was $55,000 for married couples filing separately, and $75,000 for unmarried taxpayers.) To the extent the $1,000-per-child credit exceeded your tax liability, it resulted in a refund up to 15% of your earned income (e.g., wages, or net self-employment income) above $3,000. For taxpayers with three or more qualifying children, the excess of the taxpayer’s social security taxes for the year over the taxpayer’s earned income credit for the year was refundable. In all cases the refund was limited to $1,000 per qualifying child.
Starting in 2018, the TCJA doubles the child tax credit to $2,000 per qualifying child under 17. It also allows a new $500 credit (per dependent) for any of your dependents who are not qualifying children under 17. There is no age limit for the $500 credit, but the tax tests for dependency must be met. Under the Act, the refundable portion of the credit is increased to a maximum of $1,400 per qualifying child. In addition, the earned threshold is decreased to $2,500 (from $3,000 under pre-Act law), which has the potential to result in a larger refund. The $500 credit for dependents other than qualifying children is nonrefundable.
The Act also substantially increases the “phase-out” thresholds for the credit. Starting in 2018, the total credit amount allowed to a married couple filing jointly is reduced by $50 for every $1,000 (or part of a $1,000) by which their AGI exceeds $400,000 (up from the pre-Act threshold of $110,000). The threshold is $200,000 for all other taxpayers. So, if you were previously prohibited from taking the credit because your AGI was too high, you may now be eligible to claim the credit.
In order to claim the credit for a qualifying child, you must include that child’s Social Security number (SSN) on your tax return. Under pre-Act law you could also use an individual taxpayer identification number (ITIN) or adoption taxpayer identification number (ATIN). If a qualifying child does not have an SSN, you will not be able to claim the $2,000 credit, but you can claim the $500 credit for that child using an ITIN or an ATIN. The SSN requirement does not apply for non-qualifying-child dependents, but you must provide an ITIN or ATIN for each dependent for whom you are claiming a $500 credit.
The changes made by the Act should make these credits more valuable and more widely available to many taxpayers.