Tag Archives: tax planning

How Active Traders Can Benefit from the New Tax Law (TradeStation Recording)

April 21, 2018 | By: Robert A. Green, CPA

If you’re in and out of positions several times a day, last year’s tax reform law (Tax Cuts and Jobs Act of 2017) could benefit you significantly when you file in April 2019. On May 9 at 4:30 p.m., join Robert A. Green, CPA, CEO of GreenTraderTax.com, and learn how to make the most of the new law – specifically, claiming Trader Tax Status (TTS) in a sole proprietorship, S-corporation, or partnership. TradeStation has many professional traders among its customers, who likely qualify for TTS benefits.

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How To Set Up A Trading Business In 2018 (Interactive Brokers)

February 26, 2018 | By: Robert A. Green, CPA

Join trader tax expert Robert A. Green, CPA of GreenTraderTax as he explains how active traders may structure trading businesses to maximize tax benefits under the Tax Cuts and Jobs Act. Learn the advantages and challenges of sole proprietorships, general partnerships, LLCs, S-Corps, and C-Corps.

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How The Tax Cuts And Jobs Act Impacts Investors, Traders And Investment Managers (Lightspeed)

February 5, 2018 | By: Robert A. Green, CPA

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Join Robert A. Green, CPA, and CEO of GreenTraderTax.com for this Webinar.

The Act impacts investors in many ways, some negative and others positive. Investors with significant investment expenses will decry the suspension of that miscellaneous itemized deduction.

Like many small business owners, traders eligible for trader tax status and investment managers are considering a restructuring of their business for 2018 to take maximum advantage of the new law. Two tax benefits catch their eye: the 20% deduction on pass-through qualified business income (QBI), and the C-Corp 21% flat tax rate.

The new law suspended or trimmed several cherished tax deductions that individuals count on for savings. So, exactly how bad is it and what can you do about it?

Webinar hosted and recording produced by Lightspeed Trading.

 

 

How The Tax Cuts And Jobs Act Impacts Investors, Traders And Investment Managers (TradeStation Recording)

February 3, 2018 | By: Robert A. Green, CPA

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Presented by Robert A. Green, CPA, CEO of GreenTraderTax.com

Wondering how the Tax Cuts and Jobs of 2017 will affect you? Then join Robert A. Green, CPA, CEO of GreenTraderTax.com, on February 14 at 1 p.m. ET as he reviews the laws many impacts, some negative and others positive. The new law suspends or trims several cherished tax deductions, but also contains tax benefits that could benefit traders and investors. Learn what’s in the law and what you can do about it.

Webinar hosted and recording produced by TradeStation.

How The Tax Cuts And Jobs Act Impacts Investors, Traders And Investment Managers (Interactive Brokers)

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

shutterstockTaxReform640

Join Robert A. Green, CPA, and CEO of GreenTraderTax.com for this Webinar.

The Act impacts investors in many ways, some negative and others positive. Investors with significant investment expenses will decry the suspension of that miscellaneous itemized deduction.

Like many small business owners, traders eligible for trader tax status and investment managers are considering a restructuring of their business for 2018 to take maximum advantage of the new law. Two tax benefits catch their eye: the 20% deduction on pass-through qualified business income (QBI), and the C-Corp 21% flat tax rate.

The new law suspended or trimmed several cherished tax deductions that individuals count on for savings. So, exactly how bad is it and what can you do about it?

Webinar hosted and recording produced by:

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Account referral

 

 

How Trading Businesses Can Save Taxes In 2017 And 2018 (Recording)

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

Join Robert A. Green, CPA, and CEO of GreenTraderTax.com for this Webinar. Timing is perfect: With three weeks remaining in 2017, trading businesses should do year-end tax planning, including vital execution of officer payroll and related employee benefits (health and retirement) in an S-Corp or C-Corp management company.

Congress could pass the “Tax Cut & Jobs Act” around year-end, which includes significant tax cuts for business. A trading business with Section 475 MTM ordinary income might qualify for tax breaks on pass-throughs. Learn how the Act affects trading businesses, and if traders should consider a change of business entity for 2018.

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How Businesses Can Save Taxes For 2017 Before Year-End

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

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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

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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.

 

Year-End Tax Planning Considering The Tax Cut & Jobs Act Bill (Recording)

October 13, 2017 | By: Robert A. Green, CPA

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.

Join Robert A. Green, CPA, and CEO of GreenTraderTax.com to learn valuable tax planning tips for individuals.

This 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.

Webinar hosted and recording produced by:

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How Tax Reform Framework Impacts Traders And Investors

September 29, 2017 | By: Robert A. Green, CPA

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Forbes

On Sept. 27, the Big Six tax writers released an updated Unified Framework for tax reform making concrete steps forward on corporate and individual tax rates. As expected, they left many details and decisions to Congress on which deductions, credits, and industry-specific tax incentives to repeal to offset the massive reduction in tax rates granted to corporations and pass-throughs (PTE). Over the coming months, tax lobbyists will inevitably hover over tax writers like bees. Until we see the final bill, it’s hard to assess its impact on traders and investors.

Capital gains and investment income tax cuts retracted
I searched the nine-page framework document and was surprised not to find any mention of capital gains. I find that odd considering earlier blueprints promised investors lower capital gains rates on “all” capital gains, dividends, and interest income. “All” includes short-term capital gains and non-qualifying dividends. At first, I wondered if it was an oversight, or because they felt it was unworthy of inclusion in the overview. I became concerned they may have scrapped these tax cuts for traders and investors since they have to scale back some tax cuts for budget reconciliation. I confirmed my suspicions when I saw the following tweet after writing this article: Wall Street Journal tax journalist, “Richard Rubin (@RichardRubinDC) 9/28/17, 11:54 AM @SpeakerRyan on lack of capital gains tax cut: You just can’t do everything you want to do.”

Comparing the framework to earlier versions
BNA’s Comparison Chart of Trump Tax Plan and House Republican Blueprint is an excellent resource. According to “Savings and Investment Income” on p. 3:

Current law: “Long-term capital gain and qualified dividends taxed at rates of 0%, 15%, and 20%. (Top rate plus NIIT equals 23.8%.) Short-term capital gain, interest income and non-qualified dividends taxed at ordinary rates.”

Trump campaign tax plan: “Maximum rate of 20%.” (Current law.)

Trump administration tax reform outline: “Not specifically addressed.” (This omission was the first indication they were backtracking.)

House Republican Blueprint: “Deduction for 50% of net capital gains, dividends, and interest income, leading to rates of 6%, 12.5%, and 16.5%.” The House Blueprint A Better Way “provides for reduced tax on investment income. Families and individuals will be able to deduct 50% of their net capital gains, dividends, and interest income, leading to basic rates of 6%, 12.5%, and 16.5% on such investment income depending on the individual’s tax bracket.”

The new framework doesn’t mention any of these provisions. It only states: “The committees also may consider methods to reduce the double taxation of corporate earnings.”

The new framework omits mention of “carried interest” tax breaks for hedge funds and private equity firms. Does omission indicate they are backtracking on a repeal of this tax break? Perhaps not, as it may not have been worthy of mention since the broad statements about closing industry-specific tax breaks may include carried interest. Hedge funds and private equity have significant lobbying efforts in D.C. Carried-interest for hedge fund managers is like sweat-equity for founders of start-ups.

Pass-through vs. corporations
The new framework’s top tax rate for corporations is 20%, PTE 25%, and individuals 35%. Taxpayers and their advisers will want to consider reorganization to maximize tax benefits. It would be nice to know all this before year-end to reorganize by the start of 2018.

The framework narrowed the definition of which businesses may qualify for the PTE rate: “The business income of small and family-owned businesses conducted as sole proprietorships, partnerships and S corporations.” Traders, eligible for trader tax status (TTS), are small, family-owned businesses.

The framework also calls for measures to prevent abuse of the PTE rate: “the committees [i.e., Ways and Means, and the Senate Finance Committee] will adopt measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate.” We have to wait for the committees to define “wealthy” in this context. I hope the tax writers don’t consider TTS trading gains as personal income rather than business income.

When the prior framework was released, journalists jumped on the fact that individuals would recast themselves as PTE or corporations to avoid the higher individual rate. Independent contractors are already a significant trend for employers to avoid payroll taxes, unemployment insurance, and employee benefit plans. Employees like the business status to deduct business expenses, reducing income taxes and self-employment taxes.

Treasury Secretary Stephen Mnuchin recently suggested service companies, like accounting, law and financial firms, shouldn’t be eligible for the PTE rate. I disagree. Service companies could recast as software-to-service or house intellectual property in a corporation to collect royalties rather than service revenues. Congress should not be picking winners and losers and penalizing service companies who are stellar performers in the American economy with tremendous job creation. Congress should keep the PTE rules straightforward and easy to enforce in the interests of tax simplification.

Some tax writers floated the idea of a 70/30 split of wage income vs. business income as a way to prevent abuse. For example, if an S-Corp has a net income before officer compensation of $1 million, the IRS would require the owner/officer to have “reasonable compensation” of $700,000, subjected to the individual rate up to 35%. The net income of $300,000 would be business income subjected to the PTE rate up to 25%.

With this labor/capital split, the effective PTE rate would be 32%.

This is calculated as follows: (70% wages x 35% individual rate) + (30% business income x 25% PTE rate) = 32% (only 3% less than the top individual rate of 35%). The Obamacare Medicare surcharge of 3.8% applies on the $700,000 of wages, which could negate much of the PTE tax benefit in an S-Corp. With a 70/30 split, many taxpayers may not find much tax savings using a PTE. If the committees use percentage allocation, I hope it’s more like 50/50. Perhaps, a corporation is better.

A trading S-Corp only wants enough officer compensation to unlock a retirement plan deduction, and IRS rules for reasonable compensation don’t apply since the entity does not have earned income. We don’t know yet how tax reform may impact trading companies. If they must use a 70/30 split, traders might have to report more compensation than they want, which triggers more payroll taxes and the individual rate. We don’t even know if the IRS will allow traders to be eligible for the PTE rate on trading income including Section 475 ordinary income. We also need to confirm that retirement plan and health insurance deductions will still be permissible for trading companies in 2018.

There is another glaring omission in the new framework: the health insurance premium deduction in a PTE. The framework repeals medical itemized deductions, but it does not address health insurance premiums deducted from adjusted gross income (AGI). “The framework retains tax benefits that encourage work, higher education and retirement security.” In prior blueprints, they included health insurance premiums next to retirement deductions.

I don’t expect the final bill to address trading businesses, as current law is shy on these issues, too. The IRS has to codify the legislation and write regulations, and that will take a long time. Traders should consult their CPAs and tax attorneys.

With reasonable compensation rules for a PTE, and perhaps none for a corporation, it could make the corporate structure more attractive. The devil will be in the details of final legislation, and tax writers better carefully think out incentives and “Freakonomics,” how incentives sometimes have the reverse effect. To date, corporations have been a bad choice of entity for a trading business due to double taxation, no pass-through of trading losses and expenses, no lower 60/40 rates in Section 1256, and more. Corporations have been good as management companies.

Budget reconciliation
Congressional tax writers are under enormous pressure to whittle down earlier vows to squeeze trillions of dollars in tax cuts into a 1.5 trillion-deficit placeholder negotiated for the 2018 budget. They scheduled the budget vote for Oct. 5, 2017. The Big Six plan to use “budget reconciliation,” affording them a majority vote procedure for Senate Republicans to pass tax reform and cuts without any support from Democrats.

Senator John McCain (R-AZ), who voted “no” on both health care repeal and replace bills, said the main reason was he wants “regular order” which requires a bi-partisan 60-vote cloture vote, and he recently said the same goes for tax reform. Senator Bob Corker (R-TN) told reporters, “What I can tell you is that I’m not about to vote for any bill that increases our deficit, period.”

In a letter to Republican leaders, 45 of the 48 Democratic senators requested bi-partisan negotiations, stating Republicans should not use budget reconciliation to pass tax reform. Democrats wrote they wouldn’t support tax cuts for the top 1% and they don’t agree on deficit-financing to pay for tax cuts.  Despite President Trump’s rhetoric about tax cuts not helping him and his family, and other billionaires in the top 1%, it’s not the case.

The effective tax rate for billionaires is close to the long-term capital gains rate of 20%, 15% before 2013. Long-term capital gains are their primary source of income, as many don’t take much compensation. These billionaires pay AMT because the AMT rate of 28% is higher than the long-term capital gains rate. To limit AMT and avoid estate taxes, many billionaires contribute significant amounts of their net worth to charity. The framework repeals AMT and estate tax, which is a massive tax cut for billionaires, including President Trump and his family. The framework doesn’t mention “step-up in basis” rules where heirs can avoid capital gains taxes. Billionaires and the wealthy own valuable corporations and pass-through entities so they will get lower tax rates on that front, too.

AMT and state and local taxes
If Congress repeals AMT, the second tax regime intended to ensure that wealthy taxpayers pay their fair share, it makes sense to repeal state and local taxes, which are one of the largest AMT preference items. To repeal the deduction alone would unlock much greater deductibility since AMT would no longer put a cap on it. That would wind up being a tax cut, rather than a tax increase, as intended. There’s already been significant blowback from members of Congress in high-tax states. Leadership is bending to that pressure. Will a tax increase turn into a tax cut on this measure? Or, will tax writers retain state and local tax deductions and AMT, too. Closing this deal will be tough.

There are a few other things I don’t like about the new framework. As with previous blueprints, it’s heavy on marketing content to convince working people that tax reform is for them rather than wealthy individuals and companies. I don’t like the double-talk. For example, the framework makes a big deal about lowering the top individual tax rate to 35%, but then it empowers tax writers to add a new higher rate without giving any details. It states it’s converting to a “territorial tax system” from a “worldwide tax system,” no longer taxing American companies abroad, but then it introduces a minimum tax on global income.

Timing and tax planning
The framework’s only retroactive provision is “full expensing,” active on the framework-date of Sept. 27, 2017. Other provisions won’t take effect until 2018. The Big Six is encouraging businesses to purchase equipment and other deductible assets before year-end to spur growth in the economy. It will help them argue growth pays for the tax cuts rather than deficit spending. The budget gives Republicans in both the House and the Senate a deadline of Nov. 13 to release legislative text on tax reform.

I am anxious to read final tax reform legislation so we can start crunching numbers to determine the winners and losers and help clients with tax planning for 2018. There will be surprises in the outcomes, “believe me.”

Taxpayers should commence 2017 year-end tax planning with the assumption that Obamacare taxes remain in place, only tax reform’s “full expensing” may start Sept. 27, 2017, and otherwise, tax reform, if passed, won’t be active until 2018.