October 2017

Cryptocurrency Traders Should Consider These Two Tax Accounting Solutions

October 28, 2017 | By: Robert A. Green, CPA

Shutterstock: Cryptocurrencies

Shutterstock: Cryptocurrencies

Forbes

Smart Tax Accounting Moves For Cryptocurrency Traders

If you have multiple cryptocurrency (coin) trades, consider a trade accounting solution dedicated to coin transactions. The program should calculate taxable income and loss based on IRS rules for coin transactions. It should generate capital gains and losses reports to support Form 8949 and “other income” statements. The program needs to account for all coin transactions, including coin-to-currency trades, coin-to-coin trades, receipt of coin in a hard fork or split transaction, purchases of goods or services made with a coin, and mining revenue.

I reviewed two coin accounting solutions that fit the bill: Bitcoin.Tax and CoinTracking.Info. Both programs provide options for different outcomes and in general, stick with the default method to stay clear of potential IRS trouble. (See How Cryptocurrency Investors Can Avert IRS Attack).

Coin exchanges do not provide taxable income reports
Don’t look to your coin exchange for much help with tax reporting. They don’t keep cost-basis information and are unable to give the users online tax reports. A coin is not a “covered security” for Form 1099-B issuance, so coin investors and the IRS don’t receive a 1099-B.

Coin investors are responsible for generating their accounting and tax reports. With uncertainty on tax treatment due to lack of sufficient IRS guidance, many coin traders wind up under-reporting taxable income on coin transactions. In most cases, it may be inadvertent, but sometimes, it’s willful. Using accounting software shows an attempt to be compliant.

The IRS is pursuing coin investors
The IRS served a “John Doe” summons (the worst kind) to the most significant coin exchange, Coinbase, to obtain its customer list for investors and traders with coin transactions worth more than $20,000. The IRS calculated that less than 900 taxpayers reported capital gain or losses on coin transactions in 2015, an alarmingly small number.

With coin prices skyrocketing in 2017, the U.S. Treasury wants tax revenues — its share of the windfall profits. Perhaps this is the reason they labeled coin “intangible property” rather than currency. There wouldn’t be any taxable income or loss on the use of money.

Bitcoin.Tax
I spoke with the owner of Bitcoin.Tax (BT), Colin Mackie, who described his program to me in detail. Here’s what I learned.

“Most coin exchanges allow a download of account history as a CSV file, and then BT imports it,” he said. “BT also has an API solution that works with some coin exchanges like Coinbase and Gemini, to download directly into BT.”

Mackie said the program produces various downloads for capital gains, such as Form 8949 PDFs, 8949 attachable statement, TurboTax import, TaxACT import, and plain CSV.

“For income, it’s a summary of income and mining per coin as a CSV,” he said. “For Section 1031 like-kind exchanges, it’s a statement of the appropriate lines from the Form 8824, one row per trade.”

The BT default method is to report capital gains and losses on coin-to-coin trades like trading Bitcoin for Ethereum. I suggest our clients use this default treatment to be compliant with IRS rules. The program offers an option to defer income and loss on all coin-to-coin trades by treating those trades as Section 1031 like-kind exchanges. If you select the like-kind exchange option, the BT program delays all taxable income or loss on these trades for the entire year until the user sells the coin for currency. Mackie said some accountants requested this option, but I strongly advise our clients against it. (See Cryptocurrency Traders Risk IRS Trouble With Like-Kind Exchanges.)

Mackie recommends BT users to pay careful attention to hard fork transactions, such as when Bitcoin distributed Bitcoin Cash.

“The coin exchange shows an addition to coin balances for the hard fork distribution, but some don’t include the new coin received in trade activity,” he said. “Sometimes BT picks it up automatically. Otherwise, it requires the user to add the new coin manually. The user can enter the new coin in as income using the daily price on the fork date. But, users also have the option to enter zero for cost basis.”

Sometimes a user doesn’t get a constructive receipt of the new coin, or the new coin doesn’t have a trading price on the day received. Report it as taxable income when accepted if you can determine it’s value. (See How To Report Bitcoin Cash And Avoid IRS Trouble.) BT offers a wide selection of accounting methods, which it calls basis methods, and I am not sure all of them will pass muster with the IRS. BT offers FIFO, LIFO, average cost, and specific identification.

Mackie says the specific identification method “uses strategies, so the user may select the lowest cost, highest cost, or closest cost, where the program finds the best match to minimize capital gains.” That sounds like too much cherry picking after year-end. I think users should use acceptable accounting methods and select them in writing before the year commences.

I suggest our clients use FIFO to stay out of harm’s way with the IRS. This program feature of greater choice of basis method naturally leads to more income deferral and that will attract more IRS attention.

All that being said, I think BT is an inexpensive accounting solution that can work well for American taxpayers, provided they stay clear of the non-compliant options to defer income. Be sure that the program captures all transactions from the coin exchange.

BT is free up to 100 transactions, and it charges $19.95 per year when users exceed 100 entries.

CoinTracking.Info
CoinTracking.Info is another accounting solution to consider. I spoke with CoinTracker founder and CEO Dario Kachel to learn more about this program. According to Kachel, CoinTracking is the only service with current and historical prices for all 4,878 coins on the market.

RG: Does CoinTracking (CT) generate a capital gains and losses report for American coin investors in compliance with U.S. tax law?

DK: Yes, it does. CoinTracking creates U.S. compliant tax reports such as Capital Gains And Losses on Form 8949, Other Income Reports, Gift and Donation Reports, Lost and Stolen Reports, and Closing Position. Reports can be exported in many formats like Excel, CSV, PDF and even in standard forms like Form 8949, Statement for the IRS, TaxACT, and TurboTax.

RG: Does CT account for all coin transactions, including coin-to-currency trades, coin-to-coin trades, receipt of coin in a hard fork or split transactions, and each time a coin investor purchases goods or services using a coin?

DK: Yes. We support all your mentioned transactions, which is necessary for a correct capital gains report. Also, we handle mined coins, income (e.g., a salary in cryptos), gifts, donations, and lost or stolen coins.

RG: On coin-to-coin trades, like trading Bitcoin for Ethereum, does CoinTracking report a capital gain on the imputed sale of Bitcoin?

DK: Yes it does. All coin-to-coin trades will be calculated based on the cost basis and the proceeds value of the cryptos at the time of the transaction converted in USD or any other FIAT currency.

RG: On coin-to-coin trades, does CT offer the user an option to use a “like-kind-exchange” to defer the capital gains income?

DK: The option for like-kind calculations on CoinTracking is already in progress, and we will release it in December 2017. But as you said, coin investors do not qualify for like-kind exchanges, and there are no other countries officially supporting like-kind calculations (that we know of at this moment).

RG: For coin forks or splits, does CT account for the receipt of the new coin and report its fair market value or initial trading price as income? Does the program report other income or capital gains income?

DK: There are two ways (for our program) to calculate forked coins. The easy way is to figure them with their fair market value. The other way is to set the cost basis of both coins on the date of the fork depending on the coin distribution. For example, the BTC/BCH split was a 90:10 split. This would mean, that all your new BCH coins would receive a cost basis of 10% of your BTC cost basis.

RG: In How To Report Bitcoin Cash And Avoid IRS Trouble, I suggest two options, too.

RG: Do you give the user the choice of accounting method after-the-fact, so they cherry pick which is best for them in a given tax year? (We frown upon that practice as pointed out in my last blog post, How Cryptocurrency Investors Can Avert IRS Attack.)

DK: Yes, users can change the accounting method as often as they like. We also provide an instant gain calculator, where users can estimate their gain/loss and tax even prior the sale of assets.

CT’s Website states that it offers the various accounting methods including FIFO, LIFO, HIFO, and LOFO.

CT is free to use for up to 200 transactions, and it charges $325 “for lifetime use,” when users exceed 200 entries. “CT also offers more imports than other providers, margin trades, lending and borrowed coins,” says Kachel.

Coin investors and traders face a minefield of IRS trouble on a wide selection of tax accounting issues. Non-compliance is rampant, and the IRS is on the case. Put your best foot forward by using one of these accounting solutions and don’t use the features that can get you into trouble like like-kind exchanges.

If you have questions, please contact us or another expert in coin taxation.


How Cryptocurrency Investors Can Avert IRS Attack

| By: Robert A. Green, CPA

ShutterstockCryptoCoins

Shutterstock

Forbes

Read it on Forbes.com

If you invested in cryptocurrency (coin) and spent some in 2017, it likely triggered a capital gain, loss, or other income, which you should report on your tax return. There is taxable income or loss on all coin transactions, including coin-to-currency trades, coin-to-coin trades, receipt of coin in a hard fork or split transaction, purchases of goods or services using a coin, and mining income. In this post, I show you how to capture the proper income amount on all coin transactions.

Capital gains and losses
Some coin deals naturally generate taxable income, including coin-to-currency trades and mining income. For example, Bitcoin sold for U.S. dollars is a noticeable capital gain or loss reportable on Form 8949. Or, when a coin miner receives a coin for his work, he naturally recognizes revenue based on the value of the coin he received.

Imputed income
The big problem for the IRS is that most other coin transactions are not evident for tax reporting, including coin-to-coin trades, hard fork transactions, and using a coin to purchase goods and services. The coin investor must “impute” a sales transaction to report a capital gain or loss on coin-to-coin trades and using a coin for purchases of items. Many coin investors and their accountants overlook or mishandle this reporting and underpay the IRS.

Coin is intangible property, not money
Overlooked income has to do with the fact that the IRS labeled coin “intangible property.” Coin users may call it “digital money,” but it’s not money. That’s the critical difference: Each use of money is not a taxable event. Imagine having to report a capital gain or loss every time you purchased an item or asset with cash or a credit card. That would be ridiculous.

Coin-to-currency sales are capital gains and losses
Most taxpayers comprehend that if they purchased Bitcoin in 2016 for $10,000 and sold all of it in 2017 for $30,000, they should report a capital gain of $20,000 on their 2017 tax return form 8949. If the investor held the coin position for one year or less, it’s considered a short-term capital gain taxed at ordinary tax rates (up to 39.6% for 2017). If the position was held for more than one year, the long-term capital gain rate (up to 20% for 2017) applies.

Coin-to-coin trades don’t qualify for deferral of income
Many taxpayers and preparers delay capital gains income on coin-to-coin trades by inappropriately classifying them as a Section 1031 “like-kind exchange,” where they may defer income to the replacement position’s cost basis.

I do not think coin-to-coin trades qualify for Section 1031 transactions as they fail the two primary requirements. First, Bitcoin does not qualify as like-kind property with another coin. Second, coin-to-coin trades primarily executed on exchanges are not “direct two-party exchanges” or “multi-party exchanges using a qualified intermediary.” (See Cryptocurrency Traders Risk IRS Trouble With Like-Kind Exchanges.)

Coin splits in hard forks are taxable income
Bitcoin had a hard fork in its blockchain on Aug. 1, 2017, dividing into two separate coins, Bitcoin vs. Bitcoin Cash. Each holder of a Bitcoin unit was entitled to arrange receipt of a unit of Bitcoin Cash.

Some Bitcoin holders did not gain immediate access to be able to sell Bitcoin Cash, so they may feel it’s okay to defer income on the fork transaction until they gain such access. For example, the most significant U.S.-based coin exchange, Coinbase, did not initially support Bitcoin Cash. Before the fork date, Coinbase informed its customers how to arrange receipt of Bitcoin Cash outside of Coinbase. For this reason, the IRS could argue the holder did, in fact, have “constructive receipt of income.”

A Wall Street Journal article, Bitcoin’s Civil War: What You Need to Know, stated the initial fair market value of Bitcoin Cash on Aug. 1, 2017, was $266 per unit. Taxpayers should report $266 per unit or another price that they established, as “Other Income” or as a capital gain on Form 8949. (See How To Report Bitcoin Cash And Avoid IRS Trouble.)

Not every hard fork coin transaction should be treated the same. A very successful coin trader told me it would be more equitable to value new coin received in hard fork transactions with zero cost basis. He pointed out that hard forks are uncontrollable, contentious and they frequently happen, that their initial fair market value varies significantly across coin exchanges, the new coin may not even trade for several days, and that each new coin acts differently with the original coin. For these reasons, he said it’s nearly impossible to establish a balanced formula and value for reporting income on the new coin. Even Bitcoin Cash had a wide-ranging initial trading price on exchanges. (See Blockchain Orphaned Blocks.)

On Oct. 24, 2017, Bitcoin had another hard fork, splitting off Bitcoin Gold. There are more than 4,000 coins; many were created in hard fork transactions.

Example: Purchasing goods and services with coin
On Jan. 1, 2017, Joe bought 100 Bitcoins at a price of $998 each, for a total cost basis of $99,800. On June 1, 2017, when the price of a Bitcoin unit was $2,452, Joe used one Bitcoin to purchase a new computer for an invoice price of $2,452.

Without realizing it, Joe triggered a reportable short-term capital gain on his 2017 Form 8949. The sales proceeds are $2,452, representing the fair market value of the one bitcoin he used to purchase the computer. His cost basis for that one Bitcoin unit used is $998, so his net short-term capital gain is $1,454. If Joe uses the computer in his business, he will deduct $2,452 as an expense.

The IRS is taking action against coin exchanges and investors
The IRS was late in recognizing a coin “tax gap,” and it recently commenced an aggressive campaign to catch coin investors with under-reported income.

The IRS successfully served a John Doe summons (the roughest kind) on Coinbase, and we are awaiting the results of its investigation. You should respect the tax rules for all types of coin transactions to avoid an IRS exam, which could lead to an assessment of back taxes, interest expenses, and penalties. Accuracy-related penalties include a negligence penalty of 20% and a substantial understatement penalty of 20% if you understate your income by 10% or more.

In March 2014, the IRS issued long-awaited guidance (IRS Notice 2014-21) declaring coin “intangible property” and addressing some other tax questions. But, many issues remain uncertain including whether coin-to-coin trades may qualify for a Section 1031 like-kind exchange, how and when to report hard fork coin transactions, how and when to select permissible accounting methods, whether wash sale losses on securities apply to coin, and more.

We cannot hold tax return filings waiting for new IRS guidance, which may not come at all.  Our position is that coin traders cannot use Section 1031 on coin-to-coin trades executed on coin exchanges. Hard fork income is often taxable income when the new coin is received. Section 1091 wash sale loss rules and Section 475 MTM do not apply to coin because it’s not a security. Coin traders should select a permissible accounting method in advance of the year or contemporaneously with the trade — not after the fact.

In my next post, Coin Traders Should Consider These Two Tax Accounting Solutions, I discuss coin accounting solutions and review two leading programs.

If you have questions, please contact us or another expert in coin taxation.

Darren Neuschwander, CPA contributed to this blog post. 

 


How Businesses Can Save Taxes For 2017 Before Year-End

October 16, 2017 | By: Robert A. Green, CPA

shutterstockTaxPlanning

The tax reform framework favors businesses by drastically cutting tax rates on corporations from 35% to 20% and pass-through entities from 39.6% to 25%. Pass-through entities (PTEs) include sole proprietorships, S-Corps, LLCs taxed as partnerships, general partnerships, and limited partnerships. These entities pass income and loss to the owner’s tax return. It’s wise for businesses to consider deferring income to take advantage of lower business tax rates in 2018 and accelerate business expenses to 2017. Even if Congress fails to pass tax reform, you’ll benefit from the time value of money.

Based on the tax reform framework, it’s uncertain if a trading business would be eligible for the lower PTE rate. There are nuances to consider for a trading business eligible for trader tax status (TTS) vs. a non-trading business. Officer compensation and employee benefit deductions work differently for S-Corps, partnerships, and C-Corps.

Officer compensation for a TTS trading business
I recommend an S-Corp structure for a TTS business to unlock employee benefit deductions including health insurance and retirement plans. You need to execute 2017 officer compensation with these deductions included before year-end, so don’t miss the boat!

W-2 wages should include health insurance premiums for 2% or more owners, which means the trader/owner and spouse if both provide services. (Attribution rules apply.) The health insurance premium component is not subject to payroll taxes. The S-Corp owner takes an AGI deduction for health insurance premiums on the individual tax return.

Some traders use a dual entity structure: A trading partnership and separate management company organized as a C-Corp or S-Corp. The management company should execute year-end payroll and health insurance deductions. A C-Corp management company may deduct health insurance premiums and health reimbursement accounts directly on the corporate tax return and don’t include it in payroll like the S-Corp. The trading partnership should pay administration fees to the management company before year-end.

Officer compensation for a non-trading business
The IRS requires S-Corps with underlying earned income (i.e., investment advisory fees or consulting fees) to have “reasonable compensation.” Current industry practice is 25% to 50% of net income before officer compensation. The IRS does not require a trading S-Corp to have reasonable compensation because it has underlying unearned income. However, the IRS does look for officer compensation on all S-Corp tax returns.

An LLC with earned income filing a partnership return or general partnership should use “guaranteed payments” for officer compensation. A partnership tax return with underlying earned income may arrange health insurance and retirement plan deductions in a similar manner to S-Corps. The IRS does not permit an investment company, not eligible for TTS, to have guaranteed payments and employee benefit deductions.

If the S-Corp, TTS or non-trading business, is profitable, consider a Solo 401(k) retirement plan contribution. Execute the 100% deductible elective deferral portion through officer compensation in payroll. This wage component is subject to payroll taxes.

Establish a high-deductible retirement plan
Eligible trading businesses and other businesses should consider a Solo 401(k) retirement plan. For 2017, S-Corp officer wages of $144,000 unlock the maximum $54,000 contribution/deduction or $60,000 if age 50 or older with the $6,000 catch-up provision. The 100%-deductible elective deferral up to $18,000, or $24,000 with the catch-up provision, provides the greatest income tax savings vs. payroll tax costs. You can set wages to cover the elective deferral amount, which limits payroll taxes. The 25%-deductible profit-sharing plan up to $36,000 is good if you have sufficient cash flow to invest in tax-free compounded growth within the plan.

Businesses that achieve consistently high income can arrange a $100,000+ contribution/deduction with a defined-benefit plan (DBP) if the owners are close to age 50. Business owners should work with an actuary on complex DBP calculations.

Solo 401(k) and defined benefit plans must be established before year-end, but you can do most of the funding in the new year. Setting up a DBP can take several weeks, so get started by early December.

Continue qualification for trader tax status
Traders should maintain eligibility for TTS as long as possible, whether as a sole proprietor, S-Corp, or partnership. If you formed a trading S-Corp mid-year 2017, it helps deflect potential IRS challenges if you continue into 2018.

Convert a 2017 wash sale loss into a 2018 ordinary loss
If you have wash sale loss deferrals at year-end on trading positions in your account, claim sole proprietor TTS for 2017 and 2018 if possible. A Section 475 election for 2018 will convert the wash sale loss deferral on TTS positions into an ordinary loss on Jan. 1, 2018. That’s much better than a capital loss in 2018.

The IRS said it might change the effective date of a Section 475 MTM election to “freeze and mark” the day it’s elected, rather than taking effect retroactively on Jan. 1. The IRS also said it might change the character of Section 481(a) adjustment (required for a Section 475 election) to capital gains and losses, rather than ordinary income or loss.

Accounting methods
Businesses may select an accounting method for recognizing the timing of revenues and expenses. Most small businesses choose the cash method, which reports revenues when collected and expenses when paid. It’s a more straightforward accounting system, providing flexibility in tax planning. Companies with inventory may or must use the accrual method, which records revenue when earned and expenses when incurred. Cash method taxpayers can defer gross revenues and accelerate expenses more easily than accrual method taxpayers.

Employees should talk to their employers about deferring their bonus to 2018. If you own a small business, consider postponing completion of client engagements and invoice them in 2018. Cash method taxpayers can hold off on collection efforts until 2018.

Be aware of the “constructive receipt of income” rules: If you receive income for services, you have to report it. (You cannot put a check in a drawer and report it later!) If a customer attempts to pay you for services and you decline receipt, it may be constructive receipt of income.

Maximize tangible property expenses (TPE)
Businesses can expense new tangible property items up to $2,500 per item, a great way to defer income. Purchase and begin using TPE items before year-end. Arrange separate invoices for each item not exceeding $2,500 and be sure to make the de minimis safe harbor election with your tax return filing.

Section 179 (100%) depreciation
For equipment, furniture and fixtures above the tangible property threshold ($2,500), use Section 179 depreciation allowing 100% depreciation expense in the first year. The Protecting Americans From Tax Hikes (PATH) Act of 2015 made permanent generous Section 179 limits. The 2017 limit is $510,000 on new and used equipment including off-the-shelf computer software. Buildings do not qualify for this deduction. The IRS limits the use of Section 179 depreciation by requiring income to offset the deduction. Look to business trading gains, other business income or wages, from either spouse, if filing jointly.

Additions and improvements to office
Consider an addition or improvements to your home office like constructing more space, replacing windows, walls, and flooring. Depreciate residential real property over 39 years on a straight-line basis. If you rent or own an outside office, depreciation rules are more attractive. PATH created “qualified improvement property” — a new class of nonresidential real property, excluding additions like increasing square footage. Use 50% bonus depreciation on qualified improvement property placed in service in 2017. PATH extended bonus depreciation through 2019.

Home office expenses
“Use or lose” an S-Corp accountable plan before year-end for reimbursing business expenses paid individually, including home office expenses. LLC Operating Agreements and partnership agreements may provide that partners should deduct home office expenses as “unreimbursed partnership expenses” (UPE) on their individual tax returns.

Capitalize expenses for a new business
If you plan to become eligible for TTS or another type of business in early 2018, consider capitalizing late-year 2017 purchases for business expense deductions in 2018. I suggest this strategy for Section 195 start-up costs including training and mentors, Section 248 organization costs for a new entity, and internal-use software including automated trading systems. Otherwise, you might not get any tax deduction for these items in 2017. (Learn more about these deductions in my blog post Top 10 Tax Deductions For Active Traders.)

Maximize net operating losses
If you have an NOL generated in 2017, try to enhance it as much as possible and consider the two-year NOL carryback option — an excellent way to achieve quick tax refunds. Earlier tax blueprints discussed repealing NOL carrybacks and retaining the 20-year NOL carry forward.

Avoid passive-activity losses on pass-through entities
Consider selling some passive loss activities to convert suspended tax losses carried over from prior years into realized losses in the current year. Alternatively, you could spend more time on the business to meet material participation requirements, which generate non-passive losses. Passive-activity entity income or loss is part of net investment income (NII) for calculating the 3.8% net investment tax, which applies to upper-income taxpayers (modified AGI of $200,000 single, $250,000 married, and not indexed for inflation).

Shifting income to family members with gifts and wages
The 2017 annual gift tax exclusion is $14,000 per person, per donor. The current tax reform framework repeals the federal estate tax starting in 2018, so the “unified credit” against the estate tax may become moot. The unified credit is reduced by annual gift amounts made over the gift tax exclusion. Twenty states currently have estate or inheritance taxes.

Shifting income to family members can be a smart strategy. Be aware of the “kiddie tax” rules, which limit the benefit of moving too much investment income to young children, including qualifying young-adult children.

Paying wages for teenage and adult children is an efficient way to avoid the kiddie tax rules, which apply to unearned income. According to IRS.gov, “Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to social security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child.” Also, you will save federal and state unemployment insurance and state workmen’s compensation on children under age 21.

Manage debt cancellation income (DCI) properly
DCI is excludable from gross income providing the debtor is insolvent or filed for bankruptcy. If you are not insolvent or bankrupt, try to defer DCI taxable income to 2018.

Stay tuned for tax reform developments
Wait for final tax legislation expected in November 2017 to see how the anti-abuse measures work on preventing wealthy business owners from recharacterizing their individual (personal) income as business income to qualify for lower PTE rates up to 25% vs. the top ordinary rate of 35%. Will tax reform allow a trading company, perhaps with Section 475 ordinary income, to use the lower business tax rate of 25% on pass-through entities? Will employee benefit plan deductions for health insurance and retirement plans continue? (Stay tuned on our blog and see How Tax Reform Framework Impacts Traders And Investors.)

See my last blog post How Individuals Can Save Taxes For 2017 Before Year-End.

If you have any questions on tax planning, contact your tax advisor for help. I’m encouraging our clients to sign up for our tax compliance service soon to begin year-end tax planning before Dec. 5, 2017.

Attend our Webinar or watch the recording after: How To Save Taxes For 2017 Before Year-End.


How Individuals Can Save Taxes For 2017 Before Year-End

October 14, 2017 | By: Robert A. Green, CPA

shutterstockSaveTaxes

Forbes

How Individuals Can Save On 2017 Taxes Before The End Of The Year.

October through December is an excellent time to consider year-end tax planning moves to save taxes for 2017. Once tax season gets underway in Q1 2018, it’s too late for these smart ideas.

As tax reform advances through Congress, it’s safe to assume your tax rates may be lower in 2018 and some of your expenses will likely be repealed to pay for tax rate cuts. It’s probably wise to use the time-honored strategy of deferring income and accelerating payments to deduct them while you can. Even if Congress fails to pass tax reform, you’ll benefit from the time value of money.

Repealing most itemized deductions
In exchange for lowering corporate tax rates, the tax reform framework repeals most itemized deductions for individuals starting in 2018. The two notable exceptions are deductions for mortgage interest expenses and charitable contributions. Tax reform compensates for middle-income folks by doubling the standard deduction. You should try to pay all 2017 expenditures before year-end to get the deduction while you can and reduce 2017 income.

The tax reform framework repeals “miscellaneous itemized deductions,” which include investment expenses, tax compliance fees and unreimbursed employee business expenses deducted on Form 2106. You should try to pay service providers for 2017 services by year-end. Traders who are eligible for trader tax status (TTS) have business expense treatment, bypassing miscellaneous itemized deductions.

Investment advisory fees, including management fees and incentive fees, are investment expenses, which face repeal in 2018. Brokerage commissions are not investment expenses. Transaction costs are adjustments to proceeds and cost basis, reflected in capital gains and losses. The current framework was silent about earlier blueprints to repeal carried-interest tax breaks for hedge fund managers. I expect these changes would impact the investment management industry, which may consider changes to business models to achieve better tax efficiency.

Employees should submit expenses to employers for reimbursement before year-end since accountable plans have “use it or lose it” rules. Under current law, miscellaneous itemized deductions are deductible above a 2% AGI threshold, and they are not deductible for AMT. If your employer doesn’t have an accountable plan, encourage them to consider one for 2017 and 2018.

Accelerate state and local tax deductions
The current tax reform framework repeals itemized deductions for state and local taxes including income, real estate, property and sales and use taxes. States without an individual income tax, including Texas, Florida, and Washington, have real estate and sales and use taxes. For 2017, you can elect to claim sales and use taxes as an itemized deduction instead of state income taxes. If you are thinking about buying an expensive item that is subject to sales and use tax, consider purchasing it before year-end. Accountants are looking into ways for a business to treat some state and local taxes as a business expense.

The tax reform framework repeals state and local tax deductions and AMT starting in 2018, so your best chance at a deduction might be to pay state and local taxes due by Dec. 31, 2017. This is a change from previous tax years when individuals may have postponed state and local taxes to avoid AMT. Be sure to check the latest developments on tax reform before you make this decision close to Dec. 31 since there is blowback on the repeal of state and local taxes, and I expect there could be changes.

Casualty loss deductions
The tax reform framework repeals the casualty loss itemized deduction for 2018, so try to complete your claims to support a 2017 tax deduction. The 2017 disaster tax relief bill for Hurricanes Harvey, Irma and Maria victims exempts qualified disaster-related personal casualty losses from the 10% AGI threshold. Victims don’t have to itemize; they can add this casualty loss to their standard deduction, and that part is deductible for AMT. (Hopefully, Congress applies this same relief to victims of the California wildfires.)

Maximize charitable contributions
You should make tax-deductible donations before year-end by check and credit card. Property donations of clothing, household goods, and appreciated securities can also be deducted. The itemized deduction is calculated based on fair market value (FMV), or another acceptable method. The FMV of clothing and household goods is usually a small fraction of the purchase price. When you deduct the FMV of appreciated securities, you avoid capital gains taxes. For charitable donations over $250, the IRS requires a written acknowledgment letter. Expect a reduction of the contribution amount based on the value of goods and services you receive, for example at a charity dinner.

The IRS permits individuals age 70½ or older to make charitable gifts up to $100,000 per person, per year, directly from their IRAs, and this generates several tax benefits. The strategy is more tax efficient than taking an income distribution and potentially losing some of the deduction with the Pease itemized deduction limitation for upper-income taxpayers or using the standard deduction. Avoiding an IRA withdrawal lowers AGI, which may unlock middle-income deductions and credits and avert net investment tax (NIT). The charitable donation amount also counts toward meeting the required minimum distribution (RMD) rule. You may not receive goods and services in connection with this donation from the IRA, other than an intangible religious benefit.

Other itemized-deduction limitations
Upper-income individuals should be aware of the 2017 Pease itemized deduction limitation, indexed for inflation: $261,500 single and $313,800 married filing joint for 2017. It wipes away many of your itemized deductions.

The AGI percentage threshold for medical expenses is 10%, and for miscellaneous itemized deductions it’s 2%. Investment interest expenses are limited to investment income, and an investment interest carryover likely won’t be beneficial in 2018 since tax reform repeals it.

Capital gains and net investment tax
The tax reform framework omitted capital gains tax cuts. Previous blueprints applied lower long-term capital gains rates to all capital gains, dividends and interest income, but I expect the current law to continue.

Many investors hoped Republicans would repeal the Obamacare 3.8% net investment tax (NIT) on unearned income, but they retained NIT in the healthcare bills and tax reform framework. Consider reducing income under the thresholds for triggering NIT (modified AGI of $200,000 single, $250,000 married, and not indexed for inflation), or defer net investment income to 2018. The repeal of investment expenses in 2018 will likely also repeal them as a deduction from net investment income (NII), used to calculate NIT.

Tax loss selling
A taxpayer with capital gains can reduce taxes by selling losing securities positions, realizing capital losses, before year-end. This continues to be a smart strategy in 2017, however, if you already have a $3,000 capital loss limitation, tax loss selling won’t help.

Wash sale loss adjustments
Be careful not to trigger a wash sale loss adjustment at year-end by buying back a substantially identical position 30 days before or after realizing a tax loss on a security. In a taxable account, a wash sale loss adjustment from December is deferred to January, adding the tax loss to the replacement position’s cost basis. It accelerates income, when your plan may be to delay income. Congress doesn’t want taxpayers to realize “tax losses” that are not “economic losses.”

If you realize a tax loss in an individual taxable account and buy back a substantially identical position in a traditional IRA or Roth IRA, you will never get the benefit of that tax loss. Avoid this catastrophic problem with “Do Not Trade Lists” between your IRA and taxable accounts.

In taxable accounts, avoid wash-sale loss adjustments at year-end by “breaking the chain.” Sell open positions and don’t get back into substantially identical positions for 30 days before and after selling them. For example, sell the entire position on Dec. 15 and don’t repurchase it until Jan. 16. In December, use trade accounting software to identify potential wash sale loss adjustments so you can break the chain before year-end.

Don’t solely look at a broker’s tax report or 1099-B for identifying potential wash sale losses. The IRS requires taxpayers to assess wash sales across all brokerage accounts, whereas, brokers only look at a single brokerage account. Brokers calculate wash sales based on an exact symbol (identical position), whereas, taxpayers must base wash sales on “substantially identical positions,” an equity and its equity options, at different expiration dates. Many active securities traders are surprised with big tax bills on April 15 because they mishandled wash sale losses at year-end.

Mark-to-market accounting
Section 1256 contracts, which include futures and broad-based indexes, and Section 475 trades for traders with trader tax status (TTS), are both mark-to-market (MTM) code sections. MTM imputes sales of open positions at year-end, so you are reporting realized and unrealized gains and losses. That negates the need to do tax loss selling. MTM comes with Section 1256 by default, and Section 1256 is capital gain and loss treatment.

Individual TTS traders had to elect Section 475 ordinary gain or loss treatment for 2017 by April 18, 2017, or have elected it in a prior year. Existing partnerships and S-Corps had to elect it by March 15, 2017. The next opportunity to file a Section 475 election is for 2018, or within 75 days of inception for a new entity. I call Section 475 “tax loss insurance” because it exempts traders from the capital loss limitation and wash sale loss adjustments.

Try to be eligible for middle-income tax benefits
Each of these tax breaks has different AGI phase-out ranges. Try to reduce your 2017 AGI to maximize deductions for education, and student loan interest, increase child care credits and the personal exemptions and lower AMT and NIT taxes. You may need to prepare a draft tax return to see where you stand on all these moving parts.

Avoid the highest individual ordinary tax rate
Upper-income individuals should try to avoid the top tax bracket of 39.6%, which starts at taxable income of $418,400 for single filers and $470,700 for married filers. The second bracket is 35%, which the tax reform framework uses as its top bracket for 2018. The tax reform framework empowered Congress to add back a higher top bracket for 2018 to ensure tax reform is progressive. Tax writers have not yet committed to the bracket income ranges, which could make all the difference.

Maximize use of the 0% long-term capital gains brackets
Long-term capital gain rate brackets correlate with ordinary rates for 2017. The 20% capital gains rate applies in the 39.6% ordinary-income tax bracket. The 15% capital gains rate applies to ordinary rates over 15% and under 39.6%. The 0% capital gains rate applies for the 10% and 15% ordinary brackets. If you are in the 10% and 15% ordinary tax brackets, try to sell long-term capital gains before year-end to take advantage of zero capital gains taxes. (State taxes may apply.)

There’s a long-term capital gains rate component in Section 1256 contracts: 60% long-term capital gains and 40% short-term capital gains. The blended 60/40 capital gains rate for the 10% bracket is 4%, and for the 15% bracket, it’s 6%. There is no sense in postponing income if you can pay such a low tax rate.

Arrange required minimum distributions
Take RMDs from traditional IRA, Solo 401(k) plan, and employer retirement plans. Commence RMDs by April 1 of the year following the calendar year in which you reach age 70½. Per IRS.gov, “If you do not take any distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required.”

Avoid estimated tax underpayment penalties
Many traders and small business owners don’t pay quarterly estimated taxes in Q1, Q2, and Q3 since they might lose significant money in Q4, so strategies to avoid underpayment penalties are helpful. Consider increasing federal and state tax withholding on paychecks before year-end as the IRS and states treat W-2 tax withholding as being made throughout the year.

Fully fund health plans
If you have a health savings account, be sure to pay the maximum allowed contribution for 2017 before year-end. (Self-only is $3,400, family coverage is $6,750, and $1,000 catch-up contributions are allowed for age 55 or older.) Increase your employer’s health flexible spending account for 2018 if you had too little funding in 2017.

Income acceleration strategy
If you’re in a low tax bracket for 2017 and expect to be in a higher tax bracket for subsequent years, including retirement years, consider a Roth IRA conversion before year-end 2017.

This is often a wise move since Roth IRAs are permanently tax-free, whereas traditional IRAs are only temporarily tax-free. Be careful not to take early withdrawals from any of your Roth IRAs for at least five years, and before you reach age 59½, otherwise you may trigger taxation on nonqualified distributions. Roth IRAs are not subject to RMD rules, which apply to traditional IRAs and qualified plans. If the Roth IRA account substantially drops in value after the conversion date, you can reverse the conversion by Oct. 15, 2018.

In my next post, I cover year-end tax planning for businesses, including traders with trader tax status: How Businesses Can Save Taxes For 2017 Before Year-End.

If you have any questions on tax planning, contact your tax advisor for help. I’m encouraging our clients to sign up for our tax compliance service soon to begin year-end tax planning before Dec. 5, 2017.

Darren Neuschwander CPA contributed to this blog post.

Attend our Webinar or watch the recording after: How To Save Taxes For 2017 Before Year-End.

 


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