We are just midway through 2018 and already an array of new legislation has come into effect which will have a big impact on tax liability for both individuals and business. As expected, much of the new change in tax liability stems from the recently passed “Tax Cuts and Jobs Act” (otherwise known as the “Trump Tax Plan” or “TCJA”). The TCJA impacts a myriad of areas related to our economy. Some changes are beneficial, some may hurt the taxpayer, and some are too unclear to judge. In order to give further insight into the new law, we have prepared a brief introduction into the good, the bad, and the ugly on a few of the most important updates we’ve encountered
20% Passthrough Entity Deduction – The Good
Beginning in 2018, individuals may automatically deduct up to 20% of their domestic “qualified business income” which will effectively reduce the federal tax rate on pass-through income to 29.6% for those in the 37% top federal tax bracket in 2018 (income over $500,000 for Single or $600,000 Married Filing Jointly). Qualified Business Income (QBI) may include income from services and rental real estate. Qualifying entities are sole proprietorships, partnerships, S Corporations, trusts and estates, real estate investment trusts (REITs) and qualified cooperatives. Individuals with ownership of these qualifying entities may be able to secure lower tax liability if the deductions are correctly applied.
Certain specified businesses, however, are excluded from definition of “Qualified Business Income” such as businesses in the fields of health, law, accounting, performing arts, consulting and financial services. But it’s not cut and dry: the taxpayers in these industries may still qualify for the deduction if the taxable income is between $157,500-$207,500 (Single) or $315,000-$415,000 (Married Filing Joint).
Employee’s Unreimbursed Business Expenses – The Bad
The TCJA reform eliminated a deduction for unreimbursed business expenses. Unreimbursed employee business expenses include commissions, auto, telephone and many others. This change will have an especially negative impact for those in the entertainment industry, where commissions and legal fees alone can often amount to 25% of an individual’s income. In order to overcome the disadvantage, actors, athletes, and other entertainers making over $80,000 and being paid as an employee should consider forming a loan-out corporation. Previously our recommendations to incorporate came at much higher pay scales.
Reduced Federal Withholdings – The Ugly
Many taxpayers have noticed an increase in their paycheck since the new tax reform went into effect. Historically, withholdings were computed based on the number of allowances an employee claimed on Form W4. One of the factors in this calculations was the the number of exemptions claimed – typically one for each member of a taxpayer’s household (spouse + dependents). However, the exemptions for each person no longer exist under the new law. In addition, certain itemized deductions have been reduced or eliminated. As a result, withholdings that were set up prior to 2018 may prove insufficient to ultimately cover the tax liabilities come next April. This change could thus lead to unpleasant surprises including underpayment penalties. Employees who have not reviewed their payroll withholdings for several years may want to do so while there is still time to make changes for 2018. Simple tax projections could be utilized to assess your situation and point you in the right direction.
Alimony – The Ugly
Another area that may hold some ugly surprises is alimony. Before the TCJA was enacted, alimony was deductible by the paying spouse and considered income by the recipient. For example, the spouse paying $100,000 in alimony would get a tax deduction and could save up to $37,000 in taxes. The spouse receiving the alimony would report it in taxable income.
However, that system will be changed under the TCJA provisions set to go into effect later this year. As of December 31, 2018, alimony payments will no longer deductible by the spouse making the payments and will not be included as income by the recipient spouse. Although this may come as great news for the receiving spouse, the paying spouse stands to lose out on a valuable deduction.
Taxpayers currently negotiating divorce settlements must finalize their agreements before December 31, 2018 in order to be grandfathered under the old law, while agreements after that date will follow the new TJCA rules. We are still closely monitoring if California will conform to this provision and alimony payments may continue to be deductible from State income for the time being.
As with any new law, much of the finer details will need to be adjusted, litigated, and reformed as time and experience move forward. The TCJA has both pitfalls and the potential for great benefit. Thus, it is more important than ever to obtain sound tax advice. The accountants and staff of Singer Burke continuously monitor changes in tax regulation to help clients efficiently and effectively navigate the rapidly changing legal landscape. Please do not hesitate to contact us in dealing with any aspect of the new tax law – whether it be the good, the bad, or the ugly.