The new Section 199A provides self-employed taxpayers with a new pass-through deduction. For many, this deduction will be simple to calculate – 20% of Qualified Business Income (QBI). However, Congress included a safeguard to prevent high-income taxpayers from abusing the new deduction. You can refer to this safeguard as the W-2 limitation.

W-2 Limitation

A taxpayer may only deduct 20% of QBI up to a certain limit. This limit is the greater of

1. 50% of the W-2 wages paid by the qualified trade or business, or
2. The sum of 25% of the W-2 wages paid by the qualified trade or business, plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property.

For example, if a taxpayer has $200,000 of QBI, his pass-through deduction would otherwise be $40,000 (20% of QBI). Let’s assume that the taxpayer also has $20,000 of W-2 wages from the business. This taxpayer’s may only claim a $10,000 (50% of W-2 wages is the lesser amount) pass-through deduction.

By now you should be wondering how anyone could take the full 20% deduction. Naturally, the rules attach to this provision an exception that makes the W-2 limitation only applicable to high-income taxpayer’s. See below.

Taxable Income Exception

The new law contains an exception to the W-2 limitation rule discussed above. This exception states that if a taxpayer’s taxable income is below a certain threshold the taxpayer can ignore the W-2 limitation rule.

For 2018, the threshold amount is $157,500 (or $315,000 if married filing joint). This threshold figure will be indexed for inflation in future years. Also, please note that taxable income should be factored without including any potential pass-through deduction.

Phase-ins and Phase-Outs

The taxable income exception threshold discussed above is not absolute. The regulations give the taxpayer an additional $50,000 (or $100,000 if married filing joint) to phase-out the deduction. Therefore, taxpayers may still receive a partial deduction if their taxable income is above the threshold amount, but within the phase-out range.

You can find out more information on the W-2 Limitations and the calculation of the W2 wages for purposes of this limitation on the IRS website.

If you need help with your taxes, give us a call or email us.

The Tax Cuts and Jobs Act (TCJA) made a lot of tax changes and raises many questions for taxpayers looking to plan for the coming year. Below are answers to some of them.

Do I need to adjust my withholding allowances, given that tax brackets have changed?

You may notice a change in your net paycheck as a result of the tax law, which alters tax rates, brackets, and other items that affect how much tax is withheld from your pay. The IRS has already issued new withholding tables, and your employer should adjust its withholding without requiring any action on your part. But you may want to take the opportunity to make sure you are claiming the appropriate number of withholding allowances by filling out IRS Form W-4. This form is used to determine your withholding based on your filing status and other information. The IRS suggests that you consider completing a new Form W-4 each year and when your personal or financial situation changes.

Can I take advantage of the new deduction for pass-through business income?

The tax changes also implement new rules for owners of pass-through entities — partnerships, limited liability companies, S corporations, and sole proprietorships — which allow them to deduct 20% of their business pass-through income. The 20% deduction is available to owners of almost any type of trade or business whose taxable income does not exceed $315,000 (joint return) or $157,500 (other returns). Above those amounts, the deduction is subject to certain limitations based on business assets and wages. Different deduction restrictions apply to individuals in specified service businesses (e.g., law, medicine, and accounting).

Can I still deduct mortgage interest and real estate taxes paid on a second home?

Yes, but the new tax changes limit these deductions. The deduction for total mortgage interest is limited to the amount paid on underlying debt of up to $750,000 ($375,000 for married individuals filing separately). Previously, the limit was $1 million. Note that the new restriction will not apply to taxpayers with home acquisition debt incurred on or before December 15, 2017. Additionally, the deduction for interest on home equity loans (new and existing) is suspended and will not be available for tax years 2018-2025.

Note that the law also establishes a $10,000 limit on the combined total deduction for state and local income (or sales) taxes, real estate taxes, and personal property taxes. As a result, your ability to deduct real estate taxes may be limited.

Are there any tax changes to capital gains rates and rules that I should know about?

The rules concerning how capital gains are determined and taxed remain essentially unchanged. But since short-term gains (for assets held one year or less) are taxed as ordinary income, they will be taxed at the new ordinary income rates and brackets. Net long-term gains will still be taxed at rates of 0%, 15%, or 20%, depending on your taxable income. And the 3.8% net investment income tax that applies to certain high earners will still apply for both types of capital gains.

2018 Long-Term Capital Gains Breakpoints

Rate	Single Filers	Joint Filers	Head of Household	Married Filing Separately
0%	Below $38,600	Below $77,200	Below $51,700	Below $38,600
15%	$38,600-$425,799	$77,200-$478,999	$51,700-$452,399	$38,600-$239,499
20%	$425,800 and above	$479,000 and above	$452,400 and above	$239,500 and above

Can I still deduct my student loan interest?

Yes. Although some earlier versions of the tax bill disallowed the deduction, the final law left it intact. That means that student loan borrowers will still be able to deduct up to $2,500 of the interest they paid during the year on a qualified student loan. The deduction is gradually reduced and eventually eliminated when modified adjusted gross income reaches $80,000 for those whose filing status is single or head of household, and over $165,000 for those filing a joint return.

I have a large family and formerly got to take an exemption for each member. Is there anything in the new law that compensates for the loss of these exemptions?

The new law suspends exemptions for you, your spouse, and dependents. In 2017, each full exemption translated into a $4,050 deduction from taxable income which, for large families, added up. Compensating for this loss, the new law almost doubles the standard deduction to $12,000 for single filers and $24,000 for joint filers. Additionally, the child tax credit is doubled to $2,000 per child, and the income levels at which the credit phases out are significantly increased. Depending on your situation, these new provisions could potentially offset the suspension of personal exemptions.

I have been gifting friends and relatives $14,000 per year to reduce my taxable estate. Can I still do this?

Yes, you may still make an annual gift of up to $15,000 in 2018 (increased from $14,000 in 2017) to as many people as you want without triggering gift tax reporting or using any of your federal estate and gift tax exemption. But TCJA also doubles the exemption to an estimated $11.2 million ($22.4 million for married couples) in 2018. So anyone who anticipates having a taxable estate lower than these thresholds may be able to gift above the annual $15,000 per-recipient limit and ultimately not incur any federal estate or gift tax. Note, however, that the higher exemption amount and many of TCJA’s other tax changes to personal taxes are scheduled to expire after 2025, unless Congress acts to extend them.

This communication is not intended to be tax advice and should not be treated as such. Each individual’s tax circumstances are different. Give us a call to discuss your particular situation.

If you suddenly discover a mistake on the income-tax return you just filed, don’t panic. You can correct it. And you’re probably better off correcting it yourself rather than waiting to see if the IRS discovers the error.

Hot to Fix the Mistake

The IRS has a special form you can use to correct mistakes — Form 1040X, in the case of a individual tax return. You list the amount you originally reported in the first column of the form, changes in the numbers in the second column, and the corrected figures in the third. Write an explanation of your changes in Part III of the form.

You then have to attach to Form 1040X the forms and schedules of your income tax return that were affected by the error, both as originally filed and as amended.

If the error is the result of a corrected W-2 or 1099, attach a copy of that form to your return. And if the error is due to a missed deduction, attach a copy of the receipt to your return. The more documentation you provide, the better.

For a corporation return, you can correct the mistake by filing Form 1120X.  If the business is an S corporation, you will redo Form 1120S and check “Amended Return” box at the top of the first page. The same applies for a business filing as a partnership: you redo Form 1065 and check the “Amended Return” box at the top of the first page.

You must be careful when amending a return for a business taxed as an S corporation or as a partnership. When amending a business return of a flow-through entity, this will generate an amended K1 form that will flow on the owners’ personal returns. Thus the business owners will now have to amend their own personal income tax return by filing Form 1040X.

Don’t Delay

Generally, for an individual tax return, for a credit or refund, you must file Form 1040X within three years after the date you filed the original return or within two years after the date you paid the tax, whichever is later.

Give us a call today, so we can help you determine the right course of action for you.

Once you’ve filed your tax return, you may be tempted to clean house and get rid of some of your old records that are taking up space. The guidelines that follow will help you decide which items can go and which should stay in your files.¹

Records for Income and Expenses

Keep for at least three years after the date you file your return (or its due date, if later) the records proving your income and expenses, such as:

• Form(s) W-2
• Form(s) 1099
• Form(s) K-1
• Bank and brokerage statements
• Canceled checks or other proof of payment

Three years is generally considered a minimum. The IRS advises keeping employment records for a minimum of four years.

If you can, consider keeping your documentation for six years, the IRS’s time limit for auditing a return when income is substantially understated and no fraud exists.

If fraud exists, the IRS doesn’t have a time limit for auditing your return and records must be kept indefinitely.

Investments Records

You’ll need your investment documents to figure your gains and losses when you sell the investments. After you’ve sold an investment, continue to retain your records for as long as you keep the other items supporting the tax return on which you report the sale (three or six years). Investment records include statements showing when you purchased the investment, the purchase price, brokerage commissions, and any reinvested dividends.

Residence Purchases and Improvements Documentation

Hold on to closing statements and other paperwork related to the purchase of your principal residence for use when you eventually sell the home. Put records of any home improvements you’ve made in the file, too. While many homeowners won’t have a taxable gain when they sell their homes because of the $250,000 ($500,000 for married couples) exemption, special circumstances, such as renting out your home or having a home office, could result in a taxable profit.

Your Tax Returns

Maintain one or more permanent files with important personal documents, including your tax returns. If you don’t file a return, the IRS can assess tax at any time. You’ll need a copy of your return in case the IRS has no record of your filing.

You can find additional information about how long you should keep your records on the IRS website.

Source/Disclaimer:

¹This communication is not intended to be tax advice and should not be treated as such. Each individual’s tax situation is different. Contact us to discuss your personal situation.