November 2017

Senate’s Five Haircuts On The Tax Deduction For Pass-Through Entities

November 24, 2017 | By: Robert A. Green, CPA

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Forbes

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Update Dec. 16: As expected, the Conference Agreement (CA) adopted the Senate Amendment on the pass-through deduction, and it reduced the rate to 20% from 23%. To meet the House part-way, it lowered the taxable income threshold to $157,500 single and $315,000 married, for the “specified service activity” (SSA) and wages limitations.  The CA retained the phase-out ranges above the threshold of $50,000 single and $100,000 married. If an individual’s taxable income is over $207,500 single or $415,000 married, he or she won’t get a pass-through deduction on an SSA. But, they might get a deduction on a non-SSA, subject to the wages limitations. The CA added an alternative to the 50% wage limitation: 25% of wages plus 2.5% of “unadjusted basis, immediately after acquisition, of all qualified property.” The House bill had a capital percentage, so contrary to media reports, a capital factor did not come from out of the blue. In the CA on pages 28 – 37, there are examples for how the phase-out range works. The CA raised the C-Corp flat tax rate to 21%, and it adopted the House commencement date in 2018.  

The Senate Finance Committee posted the legislative text for the “Tax Cuts and Jobs Act” bill. There are five haircuts on calculating the deduction on qualified business income (QBI) for pass-through entities.

It’s a bit of a maze, but it could be a significant deduction and will take plenty of tax compliance work to determine and support it. Trader tax status traders using Section 475 are service businesses, which may use the QBI deduction providing their taxable income is under the upper-income limitation.

Haircut No. 1: 50% of wages limitation
On each separate pass-through entity (PTE), the 17.4% QBI deduction may not exceed 50% of employees’ W-2 wages in that PTE. One PTE may have a wage limitation and another may not. Look for wage amounts on 2018 Schedule K-1s from partnerships and S-Corps.

Exception from wage limit: The 50% wage limitation does not apply to taxpayers with taxable income under $500,000 married and $250,000 for others. There is an annual inflation adjustment on the threshold. Per the modified mark, “the application of the W-2 wage limit is phased in for individuals with taxable income exceeding this $500,000 (or $250,000) amount over the next $100,000 of taxable income for married individuals filing jointly or $50,000 for other individuals.” The phase-in calculations are even more complicated and beyond the scope of this article.

Haircut No. 2: Service businesses limited to upper-income threshold
The bill excludes “specified service activities” from taking a QBI deduction unless the taxpayer has taxable income under $500,000 married and $250,000 for others. There is an annual inflation adjustment on the threshold. The modified mark states, “the benefit of the deduction for service businesses is phased out over the next $100,000 of taxable income for married individuals filing jointly or $50,000 for other individuals.” The phase-out calculations are also quite complicated and beyond the scope of this article.

The bill states, “The term ‘specified service trade or business’ means any trade or business involving the performance of services described in section 1202(e)(3)(A), including investing, and investment management, trading, or dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)).”

In Section 475 Traders May Be Eligible For Pass-Through Tax Cuts, I expected the Senate legislation text would mirror the House bill’s definition.

Haircut No. 3: Deduction on QBI or modified taxable income
Calculate the 17.4% QBI deduction based on total QBI or modified taxable income — whichever amount is lower.

First, calculate the 17.4% deduction on domestic QBI per PTE, after applying the wage limitation, and total it up. Next, figure modified taxable income: Take taxable income and exclude long-term capital gains and qualified dividend income (capital gains preferences). Calculate 17.4% of modified taxable income. Finally, take the lower of those two amounts.

Here’s an example: An S-Corp consulting service business has net income of $150,000 after deducting officer compensation of $50,000 (reasonable compensation of 25% of net income), business expenses and employee benefits (health insurance and retirement plan). The 50%-wage limitation doesn’t apply since the taxpayer is under the upper-income threshold. There are no investment-related items to exclude from QBI. The taxpayer has itemized deductions of $30,000 due to charitable contributions. Therefore, taxable income is $170,000, comprised of $50,000 wages, $150,000 S-Corp net income, and less $30,000 itemized deductions. This single taxpayer should calculate the 17.4% QBI deduction on taxable income of $170,000 since it’s lower than total QBI of $200,000. The QBI deduction is $29,580.

Haircut No. 4: Exclude capital gain preferences
Assume the same taxpayer also has $40,000 of long-term capital gains and $5,000 of qualified dividends. Gross income is $245,000 and taxable income is $215,000. Modified taxable income is $170,000 after excluding the capital gains preferences. The result is the same as above: Use the 17.4% QBI deduction based on modified taxable income since it’s less than the QBI deduction based on QBI of $200,000.

Haircut No. 5: Carryover of losses
The Senate bill requires a carryover of total qualified business losses (QBL) to the subsequent tax year. For example, assume total QBL in 2018 is $50,000, and QBI in 2019 is $300,000. The 2018 QBL is carried over to 2019, which reduces 2019 QBI to $250,000. It’s important to note that this QBL carryover does not change taxable income; it only affects the QBI deduction in the subsequent tax year.

The Senate bill has a separate provision (Limitation On Excess Business Losses For Noncorporate Taxpayers) limiting losses, which does change taxable income for the current and subsequent tax years. (See How The Senate Tax Bill Disallows Excess Business Losses In Pass-Throughs.)

Reason for the haircuts on the QBI deduction
The Senate provides the 17.4% QBI deduction to incentivize small businesses to create jobs and increase wages. It targets non-service activities, like manufacturing for “Made in America.” The Senate includes all pass-throughs, including service businesses and passive-activity owners, in waiving the wage limitation and using the upper-income threshold.

The tax code is voluminous because Congress adds complicated anti-abuse provisions to block taxpayers and tax advisers from gaming their tax regime. Several haircuts for this deduction prevent “double-dipping” of tax loopholes. The Senate Finance Committee felt it would be inappropriate to provide a QBI deduction that leads to a net operating loss (NOL) carryover, on income already taxed at lower capital gains tax rates, or on itemized deductions. It also did not want to leave out service businesses and passive-activity owners. It had to meld this code with existing code. Slaying the tax code beast is nearly impossible.

These haircuts make the tax code more complicated and will lead to confusing tax compliance, which is contrary to the goals of tax reform.  These provisions are significantly different from the House’s bill, too. There could be changes to the Senate bill this week when it’s subject to floor debate and amendments. Stay tuned to our blog as we continue to cover this fluid situation.

Darren Neuschwander CPA contributed to this blog post.


Section 475 Traders May Be Eligible For Pass-Through Tax Cuts

November 20, 2017 | By: Robert A. Green, CPA

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Forbes

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Update Nov. 24: The Senate Finance Committee posted the legislative text for the “Tax Cuts and Jobs Act” bill on Nov. 22. There are five haircuts on calculating the deduction on qualified business income for pass-through entities. The Senate bill’s definition of a “specified service activity” includes a trading business. (See my next blog post, Five Haircuts On The Tax Deduction For Pass-Through Entities.)

Owners of a trading business are anxious to learn if they will qualify for tax cuts with the House’s 25% pass-through rate or the Senate’s 17.4% pass-through tax deduction. While the two bills have a few things in common, they are vastly different, and both contain nuances for a trading business.

The House bill provides little relief for active owners of a service business, which likely includes a trading business. The Senate bill has a more generous provision for service companies.

Last week, the House passed its bill, the “Tax Cut & Jobs Act” (H.R.-1), and the Senate Finance Committee approved its modified mark. The Senate expects the Joint Committee on Taxation (JCT) to complete drafting its bill this week and release it for floor debate the week after Thanksgiving. Republican Senator Ron Johnson came out in opposition to tax reform proposals, saying they don’t go far enough to help small-business pass-throughs vs. big corporations. He’s right. In current form, the Senate’s modified mark is better than the House bill for active owners of pass-throughs, and I hope GOP leaders choose the Senate’s pass-through proposals, with further improvement, for final legislation.

Here are the steps required for a trading business to achieve tax relief under the House vs. Senate proposals. (Spoiler alert: It’s much easier in the Senate.)

The first requirement is business income
Because the House and Senate bills limit pass-through tax cuts to business income, a big question remains: Does income in a pass-through entity meet the definition of “qualified business income”? A trading business, eligible for trader tax status (TTS), with capital gains income, is likely not included in the definition of business income. But a trading business with Section 475 MTM ordinary income might be included.

Here’s my rationale. The House bill’s summary states, “Certain other investment income that is subject to ordinary rates such as short-term capital gains, dividends, and foreign currency gains and hedges not related to the business needs, would also not be eligible to be recharacterized as business income.”

The House bill goes on to state, “Net business income or loss shall be determined with respect to any business activity by appropriately netting items of income, gain, deduction, and loss with respect to such business activity.” The bill notes “certain investment-related” exceptions, a list that includes short-term and long-term capital gains, dividend income, any interest income other than interest income that is properly allocable to a trade or business, and annuities.

Section 475 ordinary income and rental income are not on the exceptions list. A TTS futures trader has lower Section 1256 contract 60/40 capital gains tax rates (60% is a long-term capital gain), so it’s doubtful he or she could qualify for the more moderate pass-through rates.

The Senate mark (JCX-51-17, Nov. 9) states, “Qualified business income or loss does not include certain investment-related income, gain, deductions, or loss.” This language is similar to the House summary.

A TTS forex trader has foreign currency ordinary income (Section 988) that is business-related. Without TTS, that forex trader’s ordinary income is investment-related. Forex traders may want to consider a capital gains election to be eligible for Section 1256(g) 60/40 tax rates on “major” pairs, but that may disqualify them from pass-through benefits. They can consider which is better for them.

Section 475 ordinary income is also considered business-related for TTS traders.  Steven Rosenthal, Senior Fellow, Urban-Brookings Tax Policy Center, weighs in: “Section 475 treats the gain as ordinary income,” he says. “Section 64 provides that gain that is ordinary income shall not be treated as gain from the sale of a capital asset.” Mr. Rosenthal thinks Section 475 income is business income under the House bill and Senate mark. (Section 475(f)(1)(D) excludes Section 475 ordinary income from self-employment income and self-employment tax.)

The next requirements for receiving pass-through tax cuts vary significantly in the House vs. Senate bills.

Does the House bill consider a trading business a service activity?
It’s essential because active owners of service businesses may receive a tiny pass-through tax cut in the House bill. The bill states, “The term ‘specified service activity’ means any activity involving the performance of services described in section 1202(e)(3)(A), including investing, trading, or dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)).” When my partner Darren Neuschwander, CPA, and I read this definition two weeks ago, we thought it expressly included a trading business.

The House summary that accompanies the bill is different from the actual bill, it states, “certain personal services businesses (e.g., businesses involving the performance of services in the fields of law, accounting, consulting, engineering, financial services, or performing arts) would be zero percent.” Notice the summary version dropped the second part, “including investing, trading, or dealing in securities.” Section 1202(e)(3)(A) lists the personal service fields.

The thousand dollar question is: Does the House consider a trading business a specified service activity, or not? Rosenthal believes a hedge fund with Section 475 ordinary income does not meet the House definition of specified service activity. His interpretation is that an investment manager offers trading services to a hedge fund and the fund receives those services. The manager is a service activity; the hedge fund is not. It’s about how Rosenthal interprets the comma placement in the definition, which he knows well because he used to be a legislation counsel at JCT.

I pointed out to Rosenthal that a management company is the general partner of a hedge fund limited partnership, to bring trader tax status to the fund level, which is a requirement for the hedge fund using Section 475. For this blog post, I assume a trading business is a service company based on how I read the House bill’s definition.

The House gives little benefit to active owners of service companies
An active owner of a non-service activity receives a 70% labor percentage and a 30% capital percentage. Calculate the pass-through benefit as “distributed” business income, multiplied by the capital percentage, multiplied by the maximum pass-through rate (25% for the 35% and 39.6% ordinary brackets and 9% for 12% ordinary bracket).

Active owners of a service business get a 100% labor percentage and 0% capital percentage. If they have a significant investment in business equipment and other fixed assets, they may have an “alternative capital percentage,” providing it’s at least 10%. Most TTS trading businesses won’t have an alternative capital percentage and therefore won’t get any relief in the House bill, except for the preferential 9% rate.

The House bill’s summary states, “Under the provision, the first $75,000 of an active owner or shareholder’s net business taxable income would be subject to a 9-percent rate in lieu of the ordinary 12-percent rate. Owners or shareholders in personal service businesses would be eligible for the preferential 9-percent rate.” This provision gives a small tax benefit to a service business.

The House bill favors passive business activities
The bill summary states, “Net income derived from a passive business activity would be treated entirely as business income and fully eligible for the 25-percent maximum rate.”

The original House bill had a sneaky proposal to expand self-employment tax on the labor percentage of active owners and for all limited partner income. After blowback, the House scrapped the self-employment tax provisions, yet it retained the significant tax break on limited partners. Active owners of non-service businesses get 30% of the benefits vs. limited partners. Many active-owners of service companies will get very few benefits.

I think Congress and the IRS will object to active owners restructuring their interests into general partner vs. limited partner ownership stakes to cash in on the House bill provisions favoring limited partners.

Will hedge fund limited partners get the 25% pass-through rate?
The House bill’s summary states, “The determination of whether a taxpayer is active or passive with respect to a particular business activity would rely on current law material participation and activity rules within regulations governing the limitation on passive activity losses under Code section 469. Under these rules, the determination of whether a taxpayer is active generally is based on the number of hours the taxpayer spends each year participating in the activities of the business.”

Some tax advisers suggest limited partners in hedge funds with TTS and Section 475 income can get the 25% House rate. I think there is likely a problem with that position. Under the “trading rule” exception to Section 469, a hedge fund investment is not a passive activity. Hedge fund investors are “non-active” owners, rather than passive-activity owners so that the House bill may treat them as an active owner of a service business with 0% capital percentage.

The Senate proposal is better for TTS Section 475 traders and funds
The Senate mark’s definition of a “specified service activity” does not include a trading company, but it has not yet released the final bill. It’s conceivable that the Senate could render a trading company a service activity. But, service companies fare much better in the Senate modified mark vs. the House bill.

Active owners of non-service businesses get the full benefit of the Senate pass-through proposals. The Senate’s original mark allows a 17.4% pass-through deduction on net business income, limited to 50% of owner wages.

The Senate’s original mark excluded service activities unless the owner had taxable income under $150,000 married and $75,000 for other individuals. (See How The Pass-Through Tax Cut Is Better In The Senate.)

The Senate modified mark significantly improved the provision for all owners of pass-throughs, including non-service and service businesses. It doesn’t mention passive activity owners or limited partners, so I presume they should be able to get the benefits since the Senate waived the wage limitation under the income threshold.

The modified mark states, “Under a special rule, the W-2 wage limit does not apply in the case of a taxpayer with taxable income not exceeding $500,000 for married individuals filing jointly or $250,000 for other individuals. The application of the W-2 wage limit is phased in for individuals with taxable income exceeding this $500,000 (or $250,000) amount over the next $100,000 of taxable income for married individuals filing jointly or $50,000 for other individuals.

“The modification further provides that the exception allowing the 17.4-percent deduction in the case of certain taxpayers with income from a specified service business applies to those whose taxable income does not exceed $500,000 for married individuals filing jointly or $250,000 for other individuals. The benefit of the deduction for service businesses is phased out over the next $100,000 of taxable income for married individuals filing jointly or $50,000 for other individuals.” (See Senate Juices Up Tax Cut For Pass-Throughs.)

The process is moving fast
I look forward to reading the Senate bill after Thanksgiving, and I will update this blog post accordingly. I hope GOP leaders agree to use the Senate bill as the vehicle for passage as they rush to pass tax reform legislation before year-end.

The timing is right for taxpayers and accountants. If Congress finalizes the legislation by mid-December, TTS traders will have time to consider a new tax plan for 2018, which might include a revised entity solution and a Section 475 election.

TTS traders with Section 475 should not count their tax chickens on pass-through tax breaks before they hatch. Stay tuned for updates.

Darren Neuschwander CPA contributed to this blog post.

We invite you to register for our Webinar on Dec. 6, 2017: How Trading Businesses Can Save Taxes In 2017 And 2018 and watch the recording after. 

 

 


Senate Juices Up Tax Cut For Pass-Throughs

November 15, 2017 | By: Robert A. Green, CPA

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Forbes

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Update Nov. 24: The Senate Finance Committee posted the legislative text for the “Tax Cuts and Jobs Act” bill on Nov. 22. There are five haircuts on calculating the deduction on qualified business income for pass-through entities. The Senate bill’s definition of a “specified service activity” includes a trading business. (See my blog post, Five Haircuts On The Tax Deduction For Pass-Through Entities.)

In the Nov. 14 modified mark of the tax cut bill prepared by the staff of the Joint Committee On Taxation for the Senate Finance Committee, there are two significant improvements in the 17.4% deduction for pass-through businesses for taxpayers with taxable income up to $500,000 (married) and $250,000 (other individuals). Under this upper-income threshold, the Senate committee removed the 50% wage limitation and allowed specified service businesses to use the 17.4% pass-through deduction. There are phase-out rules over the limit of $100,000 (married) and $50,000 (other individuals).

In the original mark, the specified service business income threshold was $150,000 (married) and $75,000 (other individuals). The 50% wage limitation is complicated for taxpayers over the income limit.

The House improved its pass-through provisions with modifications to HR-1 in 115–39, scrapping the original bill’s expansion of self-employment income (SEI). The modified House bill helps middle-income taxpayers by adding an 11% maximum pass-through tax rate, phasing down to 9%, on the first $75,000 of business income, which phases out between $150,000 and $225,000 for married filers.

I prefer the Senate’s modified markup to the House’ modified bill for pass-through provisions. Deciphering the House’s complicated rules is difficult. For many small business taxpayers, the Senate’s modified mark delivers more significant tax savings.

I look forward to seeing the Senate committee’s actual bill — I hear it should be the vehicle for the final legislation negotiated by conferees in the Senate and House.

The text of the Senate’s modified provision is as follows (download the entire document JCX-56-17.pdf here):

“The Chairman’s modification provides that in the case of a taxpayer who has qualified business income from a partnership, S corporation or sole proprietorship, the amount of the 17.4-percent deduction is generally limited to 50 percent of the taxpayer’s allocable or pro rata share of W-2 wages of the partnership or S corporation or 50 percent of the W-2 wages of the sole proprietorship.

“W-2 wages of a partnership, S corporation, or sole proprietorship is the sum of wages subject to wage withholding, elective deferrals, and deferred compensation paid by the partnership, S corporation, or sole proprietorship during the calendar year ending during the taxable year.

“Under a special rule, the W-2 wage limit does not apply in the case of a taxpayer with taxable income not exceeding $500,000 for married individuals filing jointly or $250,000 for other individuals. The application of the W-2 wage limit is phased in for individuals with taxable income exceeding this $500,000 (or $250,000) amount over the next $100,000 of taxable income for married individuals filing jointly or $50,000 for other individuals.

“The modification further provides that the exception allowing the 17.4-percent deduction in the case of certain taxpayers with income from a specified service business applies to those whose taxable income does not exceed $500,000 for married individuals filing jointly or $250,000 for other individuals. The benefit of the deduction for service businesses is phased out over the next $100,000 of taxable income for married individuals filing jointly or $50,000 for other individuals.”


How The Pass-Through Tax Cut Is Better In The Senate

November 11, 2017 | By: Robert A. Green, CPA

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Forbes

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Update Nov. 15: In its Nov. 14 modified mark of the tax cut bill, the Senate committee made two significant improvements in the deduction for pass-through businesses for taxpayers with taxable income up to $500,000 married, and $250,000 for other individuals. Under this upper-income threshold, the Senate committee removed the 50% wage limitation and allowed specified service businesses to use the 17.4% pass-through deduction. There are phase-out rules over the limit, $100,000 married and $50,000 for other individuals.

Update Nov. 14: The House improved HR-1′s pass-through entity provisions with RULES COMMITTEE PRINT 115–39, scrapping the original bill’s expansion of self-employment income (SEI). The modified House bill helps middle-income taxpayers by adding an 11% maximum pass-through tax rate, phasing down to 9%, on the first $75,000 of business income, which phases out between $150,000 and $225,000 of married income.  

After the release of the Senate’s tax plan summary on Thursday (Nov. 9), the media has been dissecting the language and comparing it to the House bill and the current law. But what plan is better for pass-through businesses? The Senate seems to deliver more tax savings to a non-service business with its 17.4% pass-through deduction vs. the House’s 25% pass-through (PTE) rate.

The Senate’s pass-through deduction for non-service businesses works well in all brackets, whereas, the House doesn’t seem to deliver savings in brackets under 25% ordinary rate. Furthermore, the House’s 25% PTE rate is misleading — in the 35% ordinary bracket, the blended PTE rate for an active owner of a non-service business is 32%, providing just a 3% rate savings. In my below example, the non-service business owner lowers his federal tax rate by 6% with the Senate proposal. Also, the Senate pass-through deduction could save taxes on state income tax returns (unless a state decouples from the federal rules). The House PTE rate does not deliver tax savings on state returns, just like a long-term capital gain rate is not reflected on the state level.

The Senate allows service companies to use the pass-through deduction providing they are middle-income taxpayers with taxable income under the phase-out range. The House bill provides service companies to use the PTE rate only if they have an “alternative capital percentage.” Increasingly, many service businesses invest in automation, robots, and other equipment. (See my blog post, Why The House Tax Cut May Disappoint Owners Of Pass-Through Entities.)

Traders with trader tax status have trading and investment income, including capital gains and Section 475 ordinary income, and therefore are excluded from the Senate’s pass-through deduction since only business income qualifies. Traders in a middle-income bracket might want to consider a dual entity solution: A trading partnership and S-Corp management company, with the S-Corp qualifying for a service company pass-through deduction. The House excludes trading income from the PTE rate.

The Senate requires a business loss to be carried over to the subsequent tax year to reduce the pass-through deduction in that year. Also, the Senate proposes an “excess business loss” limitation. The House bill does not have these two provisions. (See How The Senate Tax Bill Disallows Excess Business Losses In Pass-Throughs.)

The House bill extends self-employment taxes to non-passive owners of S-Corps, limited partners, and on rental income. The Senate summary does not mention changes to self-employment income or SE taxes.

The Senate’s Bill
I have included some of the text from the summary below and my thoughts. (See The Chairman’s Mark Of The “Tax Cuts And Jobs Act”)

Senate plan: “An individual taxpayer generally may deduct 17.4 percent of domestic qualified business income from a partnership, S corporation, or sole proprietorship.

“The deduction does not apply to specified service businesses, except in the case of a taxpayer whose taxable income does not exceed $150,000 (for married individuals filing jointly; $75,000 for other individuals). The benefit of the deduction for service providers is phased out over a $50,000 range (for married individuals filing jointly; $25,000 for other individuals). The phase-out applies for taxable income exceeding $150,000 (for married individuals filing jointly; $75,000 for other individuals).

“In the case of a taxpayer who has qualified business income from a partnership or S corporation, the amount of the deduction is limited to 50 percent of the W-2 wages of the taxpayer. W-2 wages of a person is the sum of wages subject to wage withholding, elective deferrals, and deferred compensation paid by the person during the calendar year ending during the taxable year. Only those wages that are properly allocable to qualified business income are taken into account.”

Robert Green: Partners don’t have wages; they have guaranteed payments, which are similar to salaries. The “50% of wages limitation” is the Senate’s way of incentivizing owners of S-Corps and partnerships to have “reasonable compensation” for active owners. Payroll brings payment of payroll taxes including Social Security and Medicare.

Assume a non-service business S-Corp’s net income before officer compensation is $400,000. The S-Corp pays reasonable compensation of 25% of net income ($100,000 wages by industry practice). The “50% of wages limitation” is $50,000. The pass-through deduction before limitation is $52,200 (17.4% multiplied by $300,000 net income). The pass-through deduction is $50,000 since the 50% wage limitation is a lower amount. The owner would likely increase wages to get the full deduction if the accounting was in order before year-end. In a 35% tax bracket, a $52,200 pass-through deduction is worth $18,270 in federal tax savings, plus state tax savings could increase it to about $21,000. Tax savings of $21,000 divided by $300,000 net income is 7%.

The Senate summary does not address the issue of passive owners who do not have officer compensation. Without compensation, the passive owner may face a zero wage limitation, meaning there would be no pass-through deduction for passive owners. In the House bill, passive owners get the entire 25% PTE rate benefit since they do not have a labor percentage. The House bill also subjects passive owners to self-employment taxes. The Senate summary encourages more SE tax with the wage limitation.

Senate plan: “Qualified business income for a taxable year means the net amount of domestic qualified items of income, gain, deduction, and loss with respect to the taxpayer’s qualified businesses (that is, any trade or business other than specified service trades or businesses, defined below).

“If the amount of qualified business income is less than zero for a taxable year, i.e., is a loss, the amount of the loss is treated as a loss from qualified businesses in the next taxable year.

“Qualified business income or loss does not include certain investment-related income, gain, deductions, or loss.

“A specified service trade or business means any trade or business activity involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.”

I hope Congress merges the best features of the Senate and House tax bills to accommodate the essential interests of small business owners, whether middle income or upper income. Service companies have been stellar performers in the U.S. economy for decades, and they outcompete their foreign competition. They hire millions of Americans with good paying jobs and benefits, and they deserve tax relief.


How The Senate Tax Bill Disallows Excess Business Losses In Pass Throughs

November 10, 2017 | By: Robert A. Green, CPA

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Forbes

Read it on Forbes.

Update Nov. 24: The Senate Finance Committee posted the legislative text for the “Tax Cuts and Jobs Act” bill on Nov. 22 and this section, Limitation On Excess Business Losses Of Noncorporate Taxpayers, matches the modified mark language below. 

A summary of the Senate Finance Committee’s “Tax Cut & Jobs Act” is now available, alarming owners of pass-through entities with a provision that serves to limit net business losses deducted on an active owner’s tax return.

The Senate’s bill summary extends the present law for “excess farm losses” to owners who are active in a trade or businesses operating as pass-throughs, including sole proprietors, partnerships, and S-Corps. (Apparently, it’s no longer just for certain farming businesses!)

The maximum allowed loss is the threshold amount of $500,000 married and $250,000 single, indexed each year for inflation. The summary lacks essential details, so it is not clear if the loss limitation is per tax return or investment.

The excess business loss becomes a net operating loss (NOL) carryforward, which a taxpayer may use against any income in the subsequent year. Both the Senate and House bills are proposing to repeal NOL carrybacks and limit NOL carryforwards to 90% of taxable income in the year applied. Both bills repeal the standard two-year NOL carryback, only allowing NOL carryforwards. The GOP Congress seems to be working hard to disenfranchise small business owners from tax benefits they have under present law. This one-two punch constitutes a massive tax hike on small businesses and will have a chilling effect on job creation.

The excess business loss rule is not as draconian as the passive activity loss rules. Losses from passive activities may only offset other passive activities with net income, until and unless the taxpayer sells the investment realizing the loss. The excess business loss rule for active businesses allows a reasonable loss amount, and the excess is a NOL carryover, which is more useful and valuable than a suspended passive loss.

Entrepreneurs with substantial capital investment may have losses that exceed the threshold, and the Senate is proposing to force them to wait at least one year to get a tax refund.

Here’s an example of how the Senate’s excess business loss provision would work:

Joe Smith leaves his job in 2017 to pursue his dream, a technology start-up. Joe is single and invests $500,000 of capital, and so does his partner Mary White, who is married. The 2018 LLC partnership tax return reports a net loss of $700,000. Each active partner shows a $350,000 loss on 2018 individual tax return Schedule E.

Joe has an excess business loss of $100,000 ($350,000 minus the $250,000 threshold for single). The loss is an NOL carryforward. Under present law, Joe has sufficient income in the two years preceding 2018 to fully deduct the 2018 business loss as an NOL carryback to maximize his tax refund. But, he does not have enough income in 2019 or 2020, so he cannot monetize the NOL carryforward. Mary can use the full loss in 2018 since it’s less than the $500,000 married threshold. Mary’s spouse has substantial income to utilize her loss and generate a 2018 tax refund. The Senate’s tax bill changes significantly hurt Joe; he is unable to replenish capital in the company with a tax refund to retain jobs.

The U.S. economy became the best in the world partially due to our tax code, which was favorable to entrepreneurs. The business loss and NOL carryback provisions give businesses the opportunity to spread income and taxes over several years. Why is a Republican Congress turning its back on small business job creators now?

SENATE COMMITTEE ON FINANCE DESCRIPTION OF THE CHAIRMAN’S MARK OF THE “TAX CUTS AND JOBS ACT”

1.B.2. Limitation on losses for taxpayers other than corporations

Description of Proposal:

The proposal expands the limitation on excess farm losses. Under the proposal, excess business losses of a taxpayer other than a C corporation are not allowed for the taxable year. Such losses are carried forward and treated as part of the taxpayer’s net operating loss (NOL) carryforward in subsequent taxable years. NOL carryovers are allowed for a taxable year up to the lesser of the carryover amount or 90 percent of taxable income determined without regard to the deduction for NOLs.

An excess business loss for the taxable year is the excess of aggregate deductions of the taxpayer attributable to trades or businesses of the taxpayer, over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount. The threshold amount for a taxable year is $500,000 for married individuals filing jointly, and $250,000 for other individuals. The $500,000 and $250,000 thresholds are indexed for inflation. In the case of a partnership or S corporation, the proposal applies at the partner or shareholder level. Each partner’s or S corporation shareholder’s share of items of income, gain, deduction, or loss of the partnership or S corporation are taken into account in applying the limitation under the proposal for the taxable year of the partner or S corporation. Regulatory authority is provided to apply the proposal to any other passthrough entity to the extent necessary to carry out the proposal. Regulatory authority is also provided to require any additional reporting as the Secretary determines is appropriate to carry out the purposes of the proposal.

5. Modification of net operating loss deduction

Description of Proposal:

The proposal limits the NOL deduction to 90 percent of taxable income (determined without regard to the deduction). Carryovers to other years are adjusted to take account of this limitation, and may be carried forward indefinitely.

The proposal repeals the two-year carryback and the special carryback provisions, but provides a two-year carryback in the case of certain losses incurred in the trade or business of farming.

 


Why The House Tax Cut May Disappoint Owners Of Pass-Through Entities

November 5, 2017 | By: Robert A. Green, CPA

shutterstockTaxReforms

Forbes

Read it on Forbes.

Nov. 14 update: The House improved HR-1′s pass-through entity provisions with RULES COMMITTEE PRINT 115–39, scrapping the original bill’s expansion of self-employment income (SEI). (See the details of the original proposal below.) The modified House bill helps middle-income taxpayers by adding an 11% maximum pass-through tax rate, phasing down to 9%, on the first $75,000 of business income, which phases out between $150,000 and $225,000 of income. Otherwise, the maximum 25% pass-through rate only provides tax relief in the 35% and 39.6% brackets. It’s not clear if a trading company, eligible for trader tax status and using Section 475 ordinary income, has “business income” and may qualify for the pass-through tax rate. 

Most small business owners who saw the aggressive advertising about tax reform thought they would receive a significant tax cut on pass-through entity (PTE) business income, but now that the House released its tax cut bill (Tax Cut & Jobs Act), we see the savings will be far less than expected. Additionally, the bill extends self-employment taxes to owners of S-Corporations, limited partners, and on rental income.

The 25% PTE rate only applies to the “capital percentage,” which by default is 30% for non-service businesses and 0% for service businesses. It does not apply to the remaining “labor percentage” attributed to the officer/owners. PTEs may use an “alternative capital percentage based on the business’s capital investments,” but for many, that may not improve the results by much.

Assume an active owner of a non-service business is in the 35% ordinary tax bracket. His actual PTE rate is 32%, calculated as follows: 70% labor percentage multiplied by the 35% ordinary rate; plus 30% capital percentage multiplied by the 25% PTE rate. The blended rate is just 3% less than the 35% ordinary rate — not a significant tax saving.

The bill’s Section-by-Section Summary (page 3) states, “Under the provision, a portion of net income distributed by a pass-through entity to an owner or shareholder may be treated as “business income” subject to a maximum rate of 25 percent, instead of ordinary individual income tax rates. The remaining portion of net business income would be treated as compensation and continue to be subject to ordinary individual income tax rates.”

Service businesses
The bill disfavors service companies probably related to the anti-abuse provision to prevent people from reclassifying employee wages as service company revenues. Service companies have a 0% default capital percentage, so zero business income is subject to the lower PTE rate.

The bill permits PTEs to use an “alternative capital percentage based on the business’s capital investments.” Manufacturers have significant business capital investments, but many service companies do not. If a service business operates virtually in the cloud, it may not have much capital investment in equipment. Service companies with significant capital equipment may receive some tax benefits from the PTE rules, but the savings won’t be substantial.

Trading vs. investment management businesses
The bill treats trader entities with trader tax status (TTS) and investment managers as service companies, but there is a critical difference. In a trading company, trading and investment income do not constitute “business income,” so a trading company may not use the 25% PTE rate, even if it has an alternative capital percentage.

Conversely, an investment manager’s advisory fees are business income, but the profit-allocation (carried interest) of trading and investment income are not business income. The investment manager with net business income may utilize the 25% PTE rate if it has an alternative capital percentage. Investment managers may have trading workstations and high-frequency trading equipment that may deliver a decent alternative capital percentage.

The bill expressly excludes trading and investment capital from the business capital investment, and it states that trading and investment income are not business income.

The bill states, “SPECIFIED SERVICE ACTIVITY.—The term ‘specified service activity’ means any activity involving the performance of services described in section 1202(e)(3)(A), including investing, trading, or dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)).”

Limited partners get the PTE rate
The bill treats a limited partner’s entire distribution of business income as a capital percentage subject to the favorable maximum 25% PTE rate. The bill states, “Net income derived from a passive business activity would be treated entirely as business income and fully eligible for the 25% maximum rate.” Limited partners do not have a labor percentage since they are passive-activity owners. Some limited partners perform minor services, but not enough to satisfy the material participation standards in Section 469. The bill also subjects limited partner income to self-employment (SE) tax in Section 1402(a).

The bill expands self-employment income
Taxpayers calculate SE taxes based on self-employment income (SEI). It’s essential to understand SEI included vs. excluded items. SE taxes include Social Security and Medicare taxes. Social Security taxes are 12.4% up to the social security base amount ($128,700 for 2018) and 2.9 Medicare tax without an income limit. Obamacare added a 0.9%-Medicare surtax on earned income for people with AGI incomes over $200,000 single and $250,000 married.

The bill significantly expands the base of Section 1402 SEI for assessing SE tax. Tax writers did not mention this in earlier blueprints.

The bill adds these items to Section 1402(a):

• Labor percentage and capital percentage for PTEs.

• “Adjustment For S Corporation Wages – For purposes of this subsection, proper adjustment shall be made for wages paid to the taxpayer with respect to any trade or business carried on by an S corporation in which the taxpayer is a shareholder.”

• Application to rental income – Strikes Section 1402(a)(1), which had “excluded rentals from real estate and from personal property leased with the real estate.”

• Application to limited partners – Strikes Section 1402(a)(13), which had “excluded the distributive share of any item of income or loss of a limited partner.”

The bill does not add investment and trading income to SEI. That would be contrary to Republican tax policy; the GOP is trying to repeal the Obamacare 3.8% Medicare surtax (net investment tax) on investment and other unearned income.

The bill closes the S-Corp SE tax reduction loophole
Under current law, S-Corps do not pass SEI to owners. The IRS requires S-Corps with underlying earned income to have “reasonable compensation” for officer/owners. Industry practice for determining reasonable compensation in an S-Corp is 25% to 50% of net income before officer compensation.

The bill enshrines a labor percentage for S-Corps in Section 1402(a). Accountants should be able to use an S-Corp’s labor percentage, adjusted for office compensation paid, for determining SEI from the S-Corp.

For example, assume a non-service business S-Corp with a 70% labor percentage has $200,000 of income before officer compensation. It pays the officer $50,000, resulting in a net income of $150,000. The labor percentage amount is $140,000 (70% labor percentage multiplied by $200,000 income before officer compensation). SEI is $90,000 (labor percentage amount $140,000 less $50,000 officer compensation.)

For a non-service business S-Corp officer/owner, it’s an SE tax hike from 25% to 70% of income. For a service business, its a hike to 100%.

Trading S-Corps
A trader tax status (TTS) S-Corp does not have business income; it has investment income on capital assets. The bill summary expressly states, “Certain other investment income that is subject to ordinary rates such as short-term capital gains, dividends, and foreign currency gains and hedges not related to the business needs, would also not be eligible to be recharacterized as business income.” I assume Section 475 MTM ordinary income fits the catchall “certain other investment income,” since it’s trading income on capital assets.

The IRS should not apply a labor percentage to a TTS trader S-Corp or partnership since the entity does not have business income. Currently, the IRS does not require a TTS trading S-Corp to have “reasonable compensation” for officer/owners because there is no underlying earned income.

Trader S-Corp retirement plan deduction in 2018
Assume a TTS trader S-Corp makes $200,000 in net income before officer compensation and employee benefit deductions. Assume the IRS does not assess a labor percentage on a trading S-Corp. Assume the S-Corp pays officer compensation of $19,000 to create some earned income. That unlocks a 100% deductible Solo 401(k) elective deferral deduction of $18,500, the maximum limit for 2018. (The bill does not change 401(k) limits).

The trader owner saves income taxes on the $18,500 deduction, figure at 30.3% for federal and state, and pays payroll taxes of 15.3% on $19,000. The owner enjoys a 15% tax savings on $18,500, which is $2,775. The owner could also do the maximum 25%-deductible profit sharing plan of $36,500 on wages of $146,000. That increases the net tax savings of income tax savings over payroll tax costs.

With no labor percentage applied in a TTS trading S-Corp, the officer/owner retains control over compensation and retirement plan choices.

Alternative structures for TTS traders
If the IRS insists on 100% self-employment income for a trading business S-Corp, then traders should consider alternative arrangements. I don’t think the IRS will require SEI for a trading S-Corp, and the bill has a long way to becoming law.

A TTS trader can be a sole proprietor using a Schedule C or a trading partnership and pay a C-Corp management company reasonable administration fees. The C-Corp can deduct health insurance, a retirement plan contribution, and fringe benefit plans, including a health reimbursement arrangement. The management company would be deemed a “personal service C-Corp,” with a 25% rate in the bill, not the 20% rate for other types of C-Corps.

The TTS trader could skip employee benefits and remain a sole proprietor. If married, the sole proprietor trader could hire their spouse, and the spouse could have a health insurance deduction for family coverage (HSA and HRA). The spouse could also have a tax-deductible retirement plan contribution. A sole proprietor may not pay himself as an employee. Trading gains are not SEI, so these machinations are required for employee benefit deductions.

We are looking into whether a C-Corp can be a good option for some traders, so stay tuned.

Alternative structures for companies with business income
The PTE rate deal is disappointing, and S-Corps face an SE tax hike with a 70% to 100% labor percentage. Some small businesses may want to consider changing to a C-Corp for the 20% rate, or 25% rate on personal service corporations.

LLCs taxed as S-Corps may consider revoking the S-Corp election to convert to a C-Corp. Consult with a tax advisor to avoid pitfalls on certain types of reorganization, which could result in taxation. You should consider a tax-free reorganization. If you have a personal service company C-Corp with a 25% rate, plus a qualified dividend rate of 20%, the total federal tax rate would be 45%. C-Corps also must contend with the 20% accumulated earnings tax, which may apply if you avoid paying sufficient qualified dividends.  Don’t forget to factor in state double-taxation.

Our firm is considering various options for traders and other business for 2018 so stay tuned. The bill would take effect in years after Dec. 31, 2017, except for a few provisions like increased expensing and the change in mortgage deduction.

See my other blog post, How The House Tax Cut Bill Impacts Traders And Investment Managers.

If you have any questions, contact us soon.


How The House Tax Cut Bill Impacts Traders And Investment Managers

| By: Robert A. Green, CPA

shutterstockTaxReform

Forbes

Read it on Forbes.

In the eyes of many individual taxpayers who toil hard to pay significant tax bills, the Tax Cuts & Jobs Act (H.R.- 1 bill) released by the House Ways & Means Committee this week doles out too many tax cuts to big business, and not enough to small business and individuals.

The advertised 25% tax rate on small business pass-through entities (PTE) turned out to be deceptive and a dud. The media should stop calling it a 25% rate it’s more like 32%, or even higher. (See my blog post, Why The House Tax Cut May Disappoint Owners Of Pass-Through Entities.)

“This bill leaves too many small businesses behind,” said National Federation of Independent Business CEO Juanita Duggan in a statement. “We are concerned that the pass-through provision does not help most small businesses.”

In the spirit of tax reform and simplification, the bill repeals essential deductions for individuals including itemized deductions for state and local income, sales and personal property taxes, medical expenses, casualty losses, unreimbursed employee business expenses, and tax compliance fees. The bill repeals AGI deductions for alimony, moving expenses, student loan interest, and tuition expenses. The bill also repeals a business deduction for entertainment expenses. To curry last-minute support from members of Congress in high-tax states, the House agreed to an itemized deduction for real property taxes up to $10,000 per year.

The bill would take effect in years after Dec. 31, 2017, except for a few provisions like increased expensing and the change in mortgage deduction.

The winners
The investment management industry and investors come out with flying colors, probably thanks to tax writers being cozy with Wall Street banks, and billionaires operating hedge funds and private equity firms.

Sneakily, the bill retains carried interest tax breaks for hedge funds and private equity firms. Most people recall how President Trump pledged many times on the campaign trail to repeal the carried interest loophole, which occurs when an investment manager receives a portion of investors’ long-term capital gains (taxed up to 20%) rather than incentive fees subject to ordinary tax rates and Social Security and Medicare taxes. (I am not opposed to carried interest; it’s long-standing partnership tax law for owners with sweat equity.) (Postscript Nov. 6: Ways & Means changed the carried interest provision in the tax bill to require a three year holding period for long-term capital gains earned by managers.)

Without any explanation, the bill also quietly retains itemized deductions for investment interest expenses and investment expenses. Earlier tax reform blueprints repealed all itemized deductions, except mortgage interest and charitable contributions. Someone slipped this back in. Under current law, investment expenses are deductible as a “miscellaneous itemized deduction” if they are more than 2% of AGI. Miscellaneous itemized deductions are not allowed for AMT. The bill repeals AMT, which has the effect of expanding the investment expense deduction for upper-income taxpayers, many of whom have significant investment portfolios.

Investment interest expense is limited to investment income. I was concerned that repealing these tax breaks for investors and investment managers might upset financial markets and the investment management industry. Many in the investment industry must be cheering!

Traders face the same tax compliance challenges in 2018
The tax simplification measures don’t affect traders eligible for trader tax status (TTS). Investors and TTS traders should expect to receive complicated 1099-Bs from securities brokers in 2018, have wash-sale loss adjustments on securities, and deal with different tax treatment on various financial products including securities, futures, forex, options, ETFs, ETNs, cryptocurrencies, and more. I cannot think of any TTS trader that will file a tax return on a “postcard.”

In 2018, TTS traders can continue to deduct tax compliance fees as a business expense, whereas individuals without a business lose that itemized deduction. TTS traders can probably have a business expense for a portion of state and local taxes related to business income.

The proposal covers a multitude of tax law changes, but I focus on changes that affect our clients the most. Here’s the breakdown.

The bill doesn’t change:

• Capital gains and losses
The bill does not affect capital gains and losses. The tax code retains long-term capital gains rates (up to 20%), including on qualified dividends and the 60% long-term capital gains portion of Section 1256 “60/40″ capital gains rates.

The bill does not change Section 1091 wash sale loss adjustments, Section 475 MTM ordinary gain or loss treatment for TTS traders, and Section 988 forex ordinary loss treatment and the forex capital gains election. The bill does not affect the rules for TTS traders having business expense treatment but investment income (not business income). The press release mentions including interest income in the lower long-term capital gains rate.

• High-deductible retirement plans
Tax writers backed off an earlier threat to reduce 401(k) tax-deductible contributions from $18,500 for 2018 to a significantly lower amount.

• Health insurance premium deduction
The bill also leaves health insurance premium deductions alone, including Health Savings Accounts and Health Reimbursement Accounts.

• Obamacare net investment tax
The bill doesn’t repeal the Obamacare 3.8% net investment tax (NIT). State and local taxes should still be deductible for NIT even if repealed as an itemized deduction.

The bill changes:

• Increased expensing
The bill enables increased expensing on new equipment and other Section 179 property, effective Sep. 27, 2017, through 2023. Tax writers give an incentive to businesses to invest in automation and other capital investments, including robots. If a pass-through entity increases capital investment in equipment, it will increase its use of the lower 25% PTE rate, which applies to capital only, not labor.

The bill does not reduce the burden of businesses paying approximately 9% of wages as payroll taxes for most middle-income employees. Employers pay half of Social Security and Medicare taxes, and employees pay the other half. Employers also pay federal and state unemployment insurance and workmen’s compensation expenses. The company may only deduct payroll costs over the useful life of a worker. Conversely, companies get an upfront tax deduction on capital equipment, like robots, which are not subject to payroll tax costs. These fiscal incentives run counter to the title “Tax Cut & Jobs Act.”

• No reduction of interest expenses for a small business
The bill allows small businesses to deduct interest expenses. A trading business should be considered a small business. Investors may have an itemized deduction for investment interest expense to the extent they have investment interest income. The bill limits net business interest deductions for big businesses.

• No entertainment expenses
The bill repeals a deduction for entertainment, amusement, or recreation activities. It retains the 50%-deduction of meals held for business purposes.

• State and local tax deductions
Tax writers dealt with substantial blowback from members of Congress in high-tax states on repealing all state and local tax itemized deductions (SALT). It raises $1.3 trillion to help pay for corporate tax cuts. Tax writers caved into pressure to allow an itemized deduction for real property taxes up to a limit of $10,000 per year, helping states that don’t have an individual income tax like Texas. But it continues to hurt high-income tax states like California, New York, New Jersey, Connecticut, and Massachusetts.

The bill’s summary lists the SALT deduction in the Table of Contents, which states: “Repeal of deduction for certain taxes not paid or accrued in a trade or business.” I am pursuing the idea of allocating a portion of SALT deductions to a pass-through entity (PTE) business reported on Schedule E or Schedule C. 

• Housing-related tax benefits
The bill whittles down the limit on mortgage interest deductions. Years ago, Congress limited home acquisition debt on a primary residence and a second home to $1 million. This bill further reduces this limit to $500,000 on new home acquisition debt originated on Nov. 2, 2017, or after, and only on the primary residence. Existing mortgages before this date are subject to the prior limitation rules. The bill does not allow new home-equity loans, previously allowed up to a limit of $100,000.

“It’s going to be a nightmare keeping track of grandfathered mortgages vs. new mortgages,” says my partner Darren Neuschwander, CPA.

The bill makes it harder to use the exclusion of a capital gain on the sale of a primary residence. The exclusion amount remains at $250,000 single and $500,000 married, but the taxpayer must own and use a home as a principal residence for five out of the previous eight years, up from two out of the previous five years. There are also new income limits, which phase out the exclusion.

Taxpayers with high property taxes are still unhappy with the $10,000 limit. If they live in a state with high-income taxes, and expensive homes, they may face a tax hike under this bill. Traders and investment managers are mobile, and this bill gives them added incentive to move from a high-tax state to a tax-free state. They may have trouble selling a home priced well over $500,000. Homebuilders and realtors oppose the bill for these and other reasons.

• Alternative minimum tax
Most of the financial media are missing a critical point. By repealing many itemized deductions, it’s almost like tax writers adopted AMT as the prevailing tax regime. Why abolish the 28% minimum tax rate on wealthy individuals? That’s a massive tax cut for the wealthiest taxpayers.

• Medical and casualty loss deductions
The timing is terrible: Americans are increasingly getting stuck with escalating out-of-pocket medical bills because they cannot afford health insurance or deductibles are very high. If Congress repeals the Obamacare individual mandate (perhaps in an amendment to this bill), more people will choose to be uninsured.

Climate change is destroying houses and other property from an increased number of more powerful hurricanes and wildfires. Losing the casualty deduction is unfair. (The recent hurricane disaster relief bill allowed victims to add a casualty loss to their standard deduction.)

• Reversals of Roth IRA conversions
An essential feature of a Roth IRA conversion, where the taxpayer converts a traditional IRA to a Roth IRA, is the ability of the taxpayer to change his mind in the following year and reverse the rollover transaction. In a Roth conversion, you pay taxes on the converted value, and then the Roth IRA is permanently tax-free. But if the Roth account drops precipitously in value soon after the conversion, or before Oct. 15 of the subsequent year, the taxpayer currently is entitled to reverse the rollover. The new bill repeals the right to do this, so I expect it to have a chilling effect on Roth IRA conversions. This bill provision takes effect in 2018, so you can still reverse a 2017 Roth conversion before Oct. 15, 2018. Tax writers want to prevent taxpayers from gaming the system.

• NOL carrybacks
The bill repeals the right to do an NOL two-year carryback. It changes the 20-year carry forward to an unlimited carry forward. That’s not a good trade-off: Businesses, including TTS traders with Section 475 MTM ordinary losses, depend on NOL carrybacks to generate immediate tax refunds to refinance and stay in business. Repealing NOL carrybacks may lead to more loss of jobs. Additionally, “taxpayers would be able to deduct an NOL carryover only to the extent of 90 percent of the taxpayer’s taxable income (determined without regard to the NOL deduction).”

• Professional gamblers with net losses
The current code limits gambling losses to winnings, so gamblers, professional or not, may not deduct net losses. A professional gambler may have a net business loss deduction for business expenses only. The bill repeals all losses: Professional gambling expenses together with wagering losses are limited to income from winnings.

• Like-kind exchanges only for real property
The bill limits Section 1031 like-kind exchanges to real property. Many cryptocurrency traders were inappropriately using like-kind exchanges on coin-to-coin trades, and the bill expressly rules it out for an intangible property like cryptocurrency, and art and collectibles.

If you have any questions, please contact us soon.

 


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