Tuesday, May 22, 2018
* PAYCHEX reminds us that the “ACA Individual Mandate Penalty Reduced to $0 in 2019” – but NOT for 2018. The penalty is still alive and well on the 2018 Form 1040 (or 1040A).
* A Spacebook post reminded me of one of the “ugly” in the GOP Tax Act via a March post by Robert W Wood at FORBES.COM - “New Tax On Lawsuit Settlements -- Legal Fees Can't Be Deducted”.
* Remaining on the subject of the GOP Act, Kay Bell celebrated “National Bike to Work Day” by reminding us “Bicycling commuters lose job benefit under new tax law” at DON’T MESS WITH TAXES.
* While I am a bit of an Anglophile, I did not watch any of the royal wedding coverage. A couple of fellow bloggers discovered tax topics related to the event.
At FORBES.COM Robert W Wood told us “As Prince Harry & Meghan Markle Wedding Arrives, So Do Taxes”.
And Kay Bell gave us “After ‘I do’ say ‘I donate’ my wedding dress” at DON’T MESS WITH TAXES
* Now that tax filing season is over here is some good advice from Kelly Phillips Erb, the FORBES.COM TaxGirl - “If You Itemize Your Deductions,It's Time For A Checkup On Your Taxes”.
BTW, I am working away on my book on dealing with the GOP Tax Act and should be ready to “go to press” soon.
Monday, May 21, 2018
This actually happened on a 2017 Form 1040 I prepared this past tax filing season.
Here’s the story.
The client taxpayers, a married couple, received an advance premium credit for 2017 that was applied to reduce the monthly health insurance premium bill for a policy purchased via the Obamacare “Marketplace”.
Based on the initial calculation of the 2017 Adjusted Gross Income the taxpayers received $1,600+ in excess advance premium credit. The household MAGI was exactly 200% of the appropriate poverty level amount, so the maximum payback of excess credit the taxpayers owed to the IRA was $1,500.
I advised the taxpayers to make a $1,000 contribution to a traditional IRA for 2017 before April 17th, which would be fully deductible on their 2017 Form 1040.
The $1,000 deductible contribution saved the taxpayers $100 in federal income tax (their net taxable income had put them in the 10% bracket).
The $1,000 deductible contribution reduced the 2017 household MAGI so that it was now 194% of the poverty level, making the maximum payback of the advance premium credit $600.
The $1,000 IRA contribution was eligible for a 50% Retirement Savings Credit of $500.
A $1,000 deductible contribution to an IRA saved the taxpayers $1,500!
They saved $100 in federal income tax due to reduced net taxable income, reduced the payback of excess advance premium credit by $900 ($1,500 - $600) and received a $500 credit toward the $600 credit payback. $100 + $900 + $500 = $1,500.
The $1,000 IRA contribution effectively cost them nothing to make and provided an immediate 50% return on investment.
The moral of the story - it can really pay to use an experienced and knowledgeable independent tax professional to prepare your tax returns.
Friday, May 18, 2018
Yesterday I attended the NJ chapter of the National Association of Tax Professionals’ “The Definitive Tax Cuts & Jobs Act Seminar” in Mt Laurel NJ.
Obviously, at this point in the year, it cannot really be the “definitive” seminar on the GOP Tax Act. To quote one of the seminar speakers, who expressed what might very well be the theme of the day, “There’s so many things in this law we are not sure of”. But it was comprehensive.
Much of the mechanics of how the new laws will be applied and how they will interact with existing unchanged Tax Code Sections will remain unknown until the IRS issues regulations and various interpretations are tested in Tax Court.
Let me cut to the chase and give you the bottom line, at least from my point of view, of the discussion on the new Section 199A deduction (20% of "Qualified Business Income"). The sessions on this topic verified the underlying truth of a famous quote from Mark Twain – “Suppose you were an idiot, and suppose you were a member of Congress; but I repeat myself.”
Based on my 47 tax seasons of experience preparing tax returns, which is by no means all inclusive, nothing that has ever appeared in the United States Tax Code has ever been as complicated, convoluted and nonsensical as Section 199A. Hearing the discussion of this new deduction has proven that not a single Congressperson actually read the Tax Cuts and Jobs Act before voting on it (to be fair - just as not a single Congressperson actually read the Affordable Care Act before voting on it).
Any simplification accomplished in the GOP Tax Act has been, in certain circumstances, substantially overshadowed by the complexity of this monstrosity.
It will take several years for Congress to pass the needed technical corrections and the IRS to issue all the needed regulations for Section 199a, for various interpretations to be tested in Court, and for tax preparers to get a good handle on and feel confident with the application of the many aspects of the Section. By the time all this is done, I predict, it will have been repealed.
I actually learned something new at the seminar – something that I had not seen in any of the dozens of publications, articles and blog posts I had read on the GOP Tax Act. It involves loans from employer retirement plans that are unpaid upon an employee’s termination.
If permitted by the plan document, employees can borrow from their, for example, 401(k) plan balances, paying the plan back over time. If the employee is terminated, or the plan itself is terminated, before the full amount borrowed is paid back the outstanding balance is treated as a distribution from the plan and taxed as such, with a Form 1099R being issued to identify the amount. The outstanding balance is deemed to have been repaid to the plan, and cash distributed to the employee. As with any retirement plan distribution, the employee can “rollover” all or part of the distribution into an IRA within 60 days of the date of the distribution and avoid paying tax on this amount.
Now the employee has until the due date of the return for the year of termination, including extensions, to rollover the amount. The example given in the presentation explains that a taxpayer who was terminated on January 5, 2018 with an outstanding plan loan balance has until October 15, 2019 (if the 2018 return is extended) to come up with the amount of the presumed distribution (the outstanding plan loan amount as of January 5, 2018) and “rollover” this amount to an IRA. That is a lot more than 60 days.
This new rule is permanent – it does not “sunset” in 2025.
As usual, the speakers were well-informed (as well as they could be with the new Act) and gave good presentations. Tax attorney Alan Kornstein did an excellent job of summarizing the many complexities of Section 199a, pointing out its areas of confusion and unclarity (is that a word?). Several days could be devoted to this topic, which I do believe national NATP is doing (click here), and Alan did the best he could in his allotted time. My only criticism of the day’s schedule is that the last presentation was redundant and confusing. More time should have been given to Alan. Anyway, kudos to Anthony and Rose and company.
An aside: On Wednesday I posted that I was looking forward to attending “the GOP Tax Act workshop” on the NJNATP Spacebook group page. A fellow member commented – “Do you feel that referring to it as the ‘GOP Tax Act’ politicizes it?”
By calling the legislation the GOP Tax Act I was not attempting to “politicize” anything. I was not making a political comment nor was I criticizing the Act. I was merely making a statement of fact. Calling a spade a shovel, if you will. “The Tax Cuts and Jobs Act” is the GOP Tax Act. It was written and passed exclusively by the Republican Party.
Just as, which the same member also commented, the ACA is called “Obamacare” – it was written and passed by Democrats. In both cases the legislation is based on a good and laudable premise but was written hastily without bipartisan input and passed hastily without proper discussion and debate. As I have posted in the past, both Acts contain good, bad and ugly.
Thursday, May 17, 2018
Tax reform discussions rarely touch on the many inequities and basic “unfairness” in the US Tax Code.
Here are three examples of “unfairness” that still remain in the US Tax Code. They were not addressed in the GOP Tax Act but should be in future tax reform legislation. I have posted separately about these in the past – but here they are together in one post.
As an aside, many of the inequities in the pre-TCJA code involved or were made worse by the dreaded Alternative Minimum Tax. But the Act makes the AMT no longer an issue in most cases.
(1) Taxation of Social Security and Railroad Retirement Benefits
As I am often telling clients each filing season, because of the way Social Security and Railroad Retirement benefits are taxed it is very possible that for every additional $1.00 of income you pay tax on $1.85. So, income that falls within the new 22% bracket can be effectively taxed at 40.7% - almost 4% above the current top tax rate.
Social Security and Railroad Retirement benefits are taxed based on the extent of your other taxable income and tax-exempt interest. You could pay tax on up to 50% or 85% of the gross benefits. So, an additional $100 of dividends, or interest or capital gains or W-2 income can cause an additional $85 of your benefits to be taxed, so the $100 increase causes your AGI to increase by $185.
Because taxable Social Security and Railroad Retirement benefits increase AGI, increases could also reduce tax deductions and credits that are affected by AGI – increasing the effective tax rate of the increase.
As a side bit of unfairness, because increased SS or RR benefits increase AGI, the increase can potentially result in some qualified dividends and long-term capital gains, which have caused the increase in taxable SS or RR, being effectively taxed at more than the “advertised” 0% or 15% rate.
The Solution – tax Social Security benefits the same as any other pension with “after-tax” employee contributions, using the “Simplified Method”. The taxable portion of the benefit would be calculated by SSA and reported as such on the SSA-1099 and RRB-1099, similar to the way partially taxable pension income is reported on the Form 1099-R. Or perhaps treat Social Security and Railroad Retirement like a “ROTH” investment, as employee contributions are not deductible, and do not tax benefits at all. These benefits were not taxed at all until 1984.
(2) Taxation of Gambling Winnings
Gross gambling winnings, reported on Form W-2G, are generally reported in full as income on Line 21 of Page 1 of the Form 1040, increasing AGI, while gambling losses, to the extent of reported winnings, are deductible as an Itemized Deduction. So, it is possible for a taxpayer to pay additional federal income tax on net gambling losses.
John Q Taxpayer buys $10 in state lottery tickets each and every week. One week he hits for $500. He has no other gambling activity for the year. He must report the $500 win in full as taxable income and, if he receives Social Security, potentially increase taxable SS benefits by $425. So, his AGI could increase by $945. If he is unable to itemize due to the increased Standard Deduction he does not get a tax benefit for his losses. So, if he is in the 22% bracket he would pay from $110 up to $204 in federal income tax on $20 in gambling losses.
If the $500 win does cause his taxable SS benefits to increase by $425 but he can itemize and deduct $500 in losses on Schedule A he is still paying $94 in income tax in the 22% bracket. And if he can deduct medical expenses the net taxable income is increased by $69 because the additional income reduces the allowable medical deduction.
Thankfully Tax Court decisions and IRS regulation revisions have corrected this problem for some casino gambling – but not for all gambling situations.
I have no problem with limiting the deduction for gambling losses to gambling winnings – just with where and how the losses are deducted.
The Solution – obviously, report only net gambling winnings, after deducting losses, but not less than 0, as income on Page 1 of Form 1040, as is done on the NJ-1040.
(3) The Marriage Tax Penalty
The Marriage Penalty manifests itself in many ways in the US Tax Code. The result is that two married individuals, each with their own separate sources of income (i.e. W-2 or pension income), pay more income tax by filing as a married couple then by filing two separate returns as unmarried Single taxpayers merely living together.
Filing as Married Filing Separately does not always remove or reduce the Marriage Penalty. Some deductions are “per return” and not “per spouse”. And many tax benefits allowed on a Single return are reduced or just plain not allowed on a Married Filing Separate return – such as the Credit for Child and Dependent Care Expenses, the Earned Income Credit, the Credit for the Elderly or Disabled, or the HOPE or Lifetime Learning Education Credit. A couple filing separately can pay more tax than if they filed a joint return.
The maximum amount of combined income or sales and property taxes that can be deducted on Schedule A is $10,000 – but only $5,000 if Married Filing Separate. Two unmarried individuals living together can each deduct $10,000, for a total of $20,000. If the 22% bracket applies, the marriage tax penalty for this item alone is up to $2,200.
A married couple can deduct up to $3,000 in net capital losses per year – but only $1,500 if Married Filing Separate. Two unmarried individuals each with capital losses for the year, or carried forward, in excess of $3,000 can each deduct $3,000, for a total of $6,000. You do the math.
There is also a Marriage Tax Benefit – for households with only one earning spouse. Because of the doubling of many tax benefits on a joint return the couple pays less tax than the earning spouse would pay on a Single return (if one spouse has no taxable income and was not married there is no need to file a return and the Standard Deduction is not claimed if filing as single – but twice the Standard Deduction is allowed on a joint return reporting the same total income; granted the earning taxpayer could claim the non-earning taxpayer as a dependent on the one Single return and possibly get additional tax benefits – but not as much as Married Filing Joint).
In my opinion there should be neither a tax penalty or tax benefit for marriage.
The solution – allow a two-income married couple to file separately as if they were each filing a Single return, with all the benefits and the same tax table and rate schedule as a Single filer. I deal with this in more detail in “The Tax Code Must Be Destroyed”. This at least does away with the marriage penalty. I am not quite sure how to remove the marriage benefit, or if it actually should be removed.
There are many other inequities in the current US Tax Code. I will discuss more in future posts.
Do you have any examples to share.
Wednesday, May 16, 2018
State-level politicians, especially those in states with high income and property taxes, have been obsessing on the affect the limitation of the itemized deduction for taxes will have on the federal returns of residents, and proposing and legislating ridiculous and unworkable ways to try to help residents “get around” the limitation.
Instead they should be focusing on revising their individual state income tax laws so that residents do not see a substantively increased state tax bill next filing season.
Most states with income taxes follow the federal return – except at least my former home state of New Jersey and my current home state of Pennsylvania, which have created unique state tax systems. A taxpayer who itemizes on his federal return can claim the same itemized deductions on the state return, with an adjustment for the deduction of state income taxes. If you claim the Standard Deduction on the federal return you must also claim the state Standard Deduction.
The federal Standard Deduction has increased substantially – but unless the state legislature makes revisions the individual state Standard Deductions do not. And less allowable itemized deductions on the federal return “trickle down” to less allowable itemized deductions on the state return. While states do not generally allow a deduction for state and local income tax, they do allow a deduction, usually in full, for local property taxes. On the federal level a reduction of tax rates makes up for the loss or limitation of deductions in most cases. But the states have not reduced their income tax rates.
Some states have their own personal exemption deductions, while other states begin the taxation of income with federal net taxable income, after the deduction for personal exemptions. On the federal level the personal exemption deduction is gone.
Unless the legislatures in states that follow the federal income tax return make changes to their income tax law many taxpayers will get a big surprise when preparing their 2018 state income tax return. Especially since these states have not revised their withholding tables to reflect the increase in taxable income resulting from the GOP Tax Act federal changes.
Methinks that states will do nothing, and gleefully, at least in private, accept the increased income tax revenues from residents – blaming the federal government on the increase. After all, the state legislatures have not increased taxes – the increase is a result of federal legislation.
So, taxpayers be advised – you may pay less federal income tax for 2018 and beyond, but you will very likely pay more in state income tax!
Tuesday, May 15, 2018
Looking forward to attending my first GOP Tax Act CPE seminar later this week. I will post about what I learn after it is over.
* As part of its “Best States to Retire 2018” report KIPLINGER gives us “All 50 States Ranked for Retirement”. The “slide-show” (52 “slides”) presents the states alphabetically and not in ranking order.
Kiplinger “ranked all 50 states based on financial factors critical to retirees, including living expenses, tax burdens, health care costs, household incomes, poverty rates and the economic wellness of the state itself.”
My former home state of NJ is #47 – not last on the list as in past years probably because of the gradual increase in the Retirement Income Exclusion. NY is #50. My current home state of PA is #14 – so I made a good move in 2012.
* Jason Dinesen makes a good point that apparently needs constant repeating when he states the obvious in “Turning a Profit is Not a Bad Thing” at DINESEN TAX TIMES.
The point (highlight is his) –
“They spent $7,700 to save $1,700 in taxes -- BUT THEY ARE STILL IN THE HOLE A NET OF $6,000 OF NEGATIVE CASH FLOW.”
How many times do I have to say this – taxes are only pennies on a dollar. They may be a lot of pennies – but rarely more than 50.
* A recent real-life situation with a wealthy client underscored the lesson from this 2-year old post from Tony Nitti at FORBES.COM that also bears repeating - “IRS Increases 'Marriage Penalty,' Unmarried Cohabitants To Get Twice The Mortgage Interest Deduction”.
* Speaking of FORBES.COM, TaxGirl Kelly Phillipe Erb tells us “IRS Makes It Easier To Research Charities”.
She is talking about “Tax Exempt Organization Search (TEOS)”.
* Anna Bahney explains “Why you might want both a traditional 401(k) and a Roth” at CNN MONEY.
THE FINAL WORD
Life imitates art.
A while ago DC comics reimagined Superman’s chief villain, evil genius Lex Luthor, as a billionaire who becomes President. Did they have a window into the future?
The big difference is that Donald T Rump is an ignorant self-absorbed reality tv buffoon and is not, by any stretch of the imagination, a “genius”.
Monday, May 14, 2018
I have discussed these take-aways in past posts here at TWTP – but they bear repeating.
(1) Home equity interest – interest on loans secured by a residence whose proceeds are NOT used to “buy, build or substantially improve” the property secured – is no longer deductible. This includes both existing and new borrowings. There is no “grandfathering” of existing home equity loan interest.
If you have refinanced your home or taken out a home equity loan or opened a home equity line of credit, or plan to do any of these in the future, to get money to pay down credit card debt, pay for your children’s college, buy a car, pay medical bills, etc. the interest on this borrowing is not deductible if you itemize on Schedule A.
(2) Home equity debt is defined by the use of the money borrowed and not what the lender calls the loan. If you take out what the lender calls a “home equity loan” or open what the lender calls a “home equity line of credit” and use the money from the loan to pay for capital improvements to (i.e. “substantially improve”) your home this is acquisition debt and the interest is fully deductible on Schedule A, up to the statutory principal limits.
(3) It has always been important to keep separate track of acquisition debt and home equity debt, because of the $100,000 principal limit on the home equity interest deduction. But now it is more important than ever. And you must go back to your initial purchase mortgage and track the use of moneys received and the refinancing costs of all subsequent refinancing and new mortgage loans.
It is the responsibility of the taxpayer, and NOT the tax professional, to keep separate track of mortgage borrowing. However, you certainly can ask, and pay, your tax professional to do this. The time to ask your tax pro to do this is NOW – not next February or March during the tax filing season.
Of course, these take-aways are only important if you are still able to itemize. The combination of the increased Standard Deduction and the loss or limitation of allowable deductions will mean that many taxpayers who had consistently itemized in the past will no longer be able to do so. I expect only half, or less, of taxpayers who itemized in the past will be able to itemize going forward.
For those who want to calculate the separate acquisition and home equity debt on your mortgage borrowings my “Mortgage Interest Guide” – only $2.00 delivered as a pdf email attachment or $3.00 for a print version delivered by postal mail – includes two worksheets for doing this along with detailed instructions and a detailed example. To order send your check or money order, payable to Taxes and Accounting, Inc, and your email or postal address to –
MORTGAGE INTEREST GUIDE
TAXES AND ACCOUNTING, INC
POST OFFICE BOX A
HAWLEY PA 18428