“New Tax Laws” – Lee Phillips

The IRS is your major impediment to financial success. You still have a little time to plan your 2018 tax return and see if you can remove some of the road blocks the IRS puts in your path to success. Yes, you need to plan now to take advantage of the tax “loopholes” that have been created by the new Tax Cuts and Jobs Act. There is no question that the new laws give you the most significant tax planning opportunities of any tax law in the 21st Century.

The fact is, the advantages offered by the new tax law will be lost for many Americans. The Tax Cuts and Jobs Act made life simpler for many Americans, but not real estate investors or small business folks. For you, the new tax laws are probably just another deep layer of complexity on top of an already messed up IRS Code.

The week after the tax law was passed, the Los Angeles Times wrote, “The tax plan that President Trump signed into law last week creates one of the largest new loopholes in decades, a 20% deduction for ‘pass-through income.’ In reality, the new deduction disproportionately benefits the wealthy, penalizes workers and, in part because it is so complex, will ultimately reward those who can afford the best tax advice.”

I think the new tax laws give you and me some really good tax breaks. Ben Rucker, the former IRS special auditor that now works with me, recalculated his 2017 taxes using the new tax laws and he would take home an extra $30,000+ if he could refile is 2017 taxes using the 2018 tax laws. That’s pretty good for someone who makes a good living but isn’t “the wealthy.”

My newsletter readers are folks who make a good living but aren’t “the wealthy.” There is no reason you can’t cash in on some great tax savings this year, but you will probably have to do some planning well before the end of the year. If you haven’t been to my Boot Camp, come to the October one this year. I’ll guarantee it will be worth your investment of time and money. We will spend extra time on tax issues at this Boot Camp. Because my newsletter is a couple of days late, I will extend the early bird discount to you until the 5th of October.

In May, I introduced the new 20% tax deduction for small business people and real estate investors. Let’s go through some of the basics of the 20% deduction and other issues of interest in the new tax laws.

The 199A 20% Deduction

The new Section 199A is really very complex, but I’ll try to boil it down so you can see the intent of the law. Once you see the big picture, you will have to get Ben Rucker or your accountant dude or dudette to help you.

Basically, you get to take a deduction on your 1040 of 20% of your “qualified business income.” Qualified business income has to be generated in a “pass-through” entity. A pass-through entity is a corporation or LLC taxed under Subchapter S of the IRS Code, a partnership or LLC taxed as a partnership, or an LLC or individual filing a Schedule C or Schedule E.

The stripped down analysis of 199A is after you have taken all your expenses in the pass-through entity, paid your salaries, and everything else, 20% of your “profit” can be deducted off your 1040 as if it were an expense. That means 20% of your profit is basically tax free. Nancy Pelosi calls these crumbs. I like my crumbs and don’t want Nancy to take them back.
The bad news is the deduction is on your 1040 “below the line.” That means the deduction will not lower your adjusted gross income, so it doesn’t affect your taxable income, tax rate, phase outs, and all that sort of stuff.

The 20% only applies to “qualified business income.” The definition of qualified business income is quite complicated. Generally, it is your net business income after expenses, salaries, etc. The income can include rents in most cases, so real estate investors are okay, PROVIDED the real estate investing rises to the level of a “trade or business.” That doesn’t mean you are a “dealer.” The regulations say you must be engaged in your real estate investing with “regularity and continuity.” The regulations also talk about having “several” real estate investments. That may mean that an investor with only one property may not qualify to have “qualified business income” from their rents. But an Airbnb is regular and continuing. Because there is so much uncertainty in the law, if you get rental income, I would include it for the 199A deduction. The most the IRS can do later is disallow it.

If you are married and have a tax return showing under $315,000 in taxable income ($157,500 for singles), you are basically home free. The 20% deduction pretty much applies no questions asked. If your taxable income is above those levels, then things get snakey. The 20% deduction starts to phase out at $315,000/$157,500 and is gone by the time you hit $415,000 for marrieds or $207,500 for singles – IF you are in a “specified service business.”

There are tons of exceptions to the 20% deduction. For example, specified service businesses are prohibited from participating in the 20% deduction after they reach the phase out. The law is stupid because it defines a service business as any business that specifically requires the skill of the owner to make money. Duh! Every business requires the skill of the owner to make money. The law specifically gives examples of service businesses as lawyers, doctors, accountants, performing artists, consultants, brokers, financial services, athletes, and even actuaries. (Note that Congress finally stuck it to the lawyers.)

Congress gave people, who are in non-specified service businesses (pass-through entities) that have incomes above the stated thresholds ($315,000 or $157,500), a chance to get the 20% deduction even on incomes much larger than the thresholds. However, for the non-specified service businesses, the deduction becomes limited to the lesser amount derived from one of the two following ways of calculating the deduction:

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The 20% qualified business income deduction

OR

The greater of either:
A. 50% of the W-2 wages of the business
OR
B. The sum of 25% of the W-2 wages of the business and 2.5% of the unadjusted basis immediately after acquisition of all qualified property.

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The short story is, if you have a pass-through business of any type with qualified business income and you are under the $315,000/$157,500 threshold amounts, you get 20% of your profit tax free plain and simple. If you are in a specified service business, your 20% deduction will phase out if you are above the threshold amounts. If you are not a specified service business and have income above the threshold amounts, the best way to get in on the 199A deductions becomes complicated. For example, you may want to take more in wage in order to qualify under the 50% of wages exception. It may become critical to get your adjusted gross income down so that your income falls under the threshold amounts.

The revision of the Advanced Tax Tactics is almost finished to take into account the new Trump tax laws. It gives you ten ways you can lower your adjusted gross income by tens of thousands of dollars. That could help get your taxable income below the threshold amounts. For example, you could make contributions to your solo 401(k), SEP, or other retirement type plan to get your adjusted gross income down, which directly affects your adjusted gross income thresholds. There is a lot of money at stake for folks making good livings.

If you can’t get under the threshold amounts, then you had better get hold of your tax dude fast to see if you can figure out a way to get in on the 199A loophole.

As a simple example of what the 199A deduction could mean, assume you make $100,000 in your business or in your real estate investing where the rental units are spread over 5 LLCs (your totals of Schedule C or Schedule E shows $100,000 in profit). We will assume (nobody knows for sure) that the at least 5 pieces of real estate in the 5 LLCs makes it so your real estate investing qualifies as a trade or business, because you do it with “regularity and continuity.” We will also assume that the income from the 5 LLCs can be aggregated. (It is logical to aggregate the income, but not addressed in 199A itself.) Let’s say your spouse makes $60,000 in a W-2 job. In order to lower your taxable income, let’s say you take the standard deduction, which has doubled under the Trump laws to $24,000 for marrieds. Plus, you contribute $26,000 to your solo 401(k). This takes $50,000 off your taxable income and knocks it down to a total of $110,000, which is under the threshold of $315,000 and above your qualified business earnings of $100,000. You can see that this gets complicated. But in this case, the full $100,000 in your business profit would qualify for the 199A 20% deduction. You will deduct $20,000 off your income before you make a final filing. You will only pay tax on $90,000 ($110,000 – $20,000). I will take that crumb and eat it up – thank you Trump.

The whole thing gets complicated, unless you fit the simple mold of a pass-through business and you are under the $315,000/$157,500 thresholds. If you are in a gray area of the 199A rules, get with Ben or your tax planner, because you will have to take some actions. (I kind of shamelessly push Ben and the boot camp in this situation, because we have found a lot of tax advisors that have no clue about 199A.) I do know that the sooner you take some action the better.

The new law has a lot of other aspects to it. Let’s just overview some of the issues.

Standard Deduction
The standard deductions were doubled from 2017. For 2018 – 2025 they are:
Single or Married Filing Separately……………$12,000
Married Filing Jointly or Qualifying Widow(er).$24,000
Head of Household ……………………………$18,000

Additionally, there is now an additional standard deduction bump which applies for a taxpayer who is 65 or older or blind, per person, per event:

Married Filing Jointly, Married Filing Separately, or
Qualifying Widow(er)…………………………..$1,300
Single or Head of Household …………………..$1,600

For many people it will be easier and give a better tax result if they just claim the standard deductions, rather than try to itemize their deductions. You should keep track of your possible deductions and run the numbers both ways at the end of the year. Of course, the deductions we are talking about here don’t really include deductions available to your business or real estate investing. Remember, your little business and real estate investing are not only ways to make money, they are your most important tax shelters.

Itemized Deductions

Prior to the Trump tax changes, you could take itemized deductions, but they would often phase out depending on your taxable income (basically, adjusted gross income). The phase-out provisions have been suspended. We say suspended rather than eliminated, because like most of the Trump tax law, the law ends in 2025 and everything resets to what it was before the Trump laws were passed. This is because of a procedural rule in Congress which requires more votes to make a law permanent than to pass the law for a number of years. If you like the new laws, you had better tell Congress to make them permanent.

Medical

The ability to deduct medical expenses this year, 2018, was lowered from 10% to 7.5% of adjusted gross income for all taxpayers. That means you have to reach a cumulative amount of medical expenses equal to 7.5% of your adjusted gross income before you can actually start to deduct medical expenses. After 2018, the threshold increases to 10% for all taxpayers for both regular tax and AMT purposes.

Home Mortgage Deductions

For new home mortgages secured after December 15, 2017, you can deduct the “home mortgage deduction” only for loans under $750,000. That’s down from a $1 million limitation before the December 15, 2017, change. It should also be noted that interest on home equity debt is no longer deductible, unless it is used for building or improving your home.

State and Local Taxes

State and local income taxes (SALT) used to be fully deductible on your federal tax returns. Now they are limited to a total of $10,000 per year for marrieds and $5,000 for singles.

Itemized Deduction Limitations

There were a bunch of itemized deductions that were subject to a 2% of adjusted gross income limitations. Now they are simply not deductible. These expenses include:

• Investment fees
• Unreimbursed job-related expenses
• Work related education expenses
• Tax planning and preparation fees
• Safe deposit box fees
• Union dues

I would deduct the cost of seminar courses like Accumulation and Preservation of Wealth as an expense of a business or real estate investing. There is probably a 99.9% that the expense will be allowed by an IRS auditor. (I have had one auditor of a student disallow the expense, even when I got involved, so you never know.) But, you will never get in trouble for a deduction that is disallowed. The most you will have to do is pay the tax and interest on the tax assessed when the deduction is disallowed. The only way the IRS can criminally bite you is if you “substantially under report income.”

Children

If you have children, you get double the child credit, which is now $2,000 per child under 16 years old. If the child is older, but still qualifies as a “dependent” under the old dependent rules, then there is a $500 “family credit” for each such child.

Travel, Meals, and Entertainment

Travel is still 100% deductible if it is part of your business. Meals on the road are still generally deductible under the prior Trump rules. However, entertainment took a big hit. Basically, any type of entertainment provided for customers or potential customers you might be courting is not deductible any more. Entertainment provided for employees (team building retreats, birthday parties, year-end parties, etc.) is all still deductible.

Alimony

Divorce is always costly, but it just got more costly. The rules for child support remain the same, but alimony has changed. It used to be that the payor spouse got a deduction and the receiving spouse got to pay income tax on the alimony they got. Now the payor spouse effectively pays the tax because they can’t deduct alimony payments – they are an after tax expense. Of course, the receiving spouse doesn’t have to pay income tax on the alimony they get now. This all ONLY APPLIES to divorce or separation agreements signed after December 31, 2018.

Moving Expenses

Moving expenses are no longer deductible under any case, unless you are active military being moved as part of your military assignment.

Capital Gain and Qualified Dividend Tax Rates

Prior to the Trump laws, capital gain tax rates were based on your regular income tax bracket. The rates are now based on an independent rate system as follows:

Single Taxable Income
$ 0 to 38,600 maximum rate = 0%
38,601 to 425,800 maximum rate = 15%
425,801 and over maximum rate = 20%

Married Filing Jointly or Qualified Widow(er) Taxable Income
$ 0 to 77,200 maximum rate = 0%
77,201 to 479,000 maximum rate = 15%
479,001 and over maximum rate = 20%

Married Filing Separately Taxable Income
$ 0 to 38,600 maximum rate = 0%
38,601 to 239,500 maximum rate = 15%
239,501 and over maximum rate = 20%

Head Of Household Taxable Income
$ 0 to 51,700 maximum rate = 0%
51,701 to 452,400 maximum rate = 15%
452,401 and over maximum rate = 20%

Estates and Trusts Taxable Income
$ 0 to 2,600 maximum rate = 0%
2,601 to 12,700 maximum rate = 15%
12,701 and over maximum rate = 20%

Corporation Tax Rates

The tax rates for C Corporations have been reduced to a flat 21% period. There may be circumstances where a C Corporation would be a good deal, but generally as a real estate investor or small business owner you do not want to use a C Corporation. The only way you can get money out of a C Corporation into your own pocket is to pay a salary subject to all of the “social taxes” or as a dividend that yields a double taxation.

Alternative Minimum Tax

The alternative minimum tax (AMT) has plagued people who really weren’t rich, even though it was intended to make sure the rich paid their fair share. Under the old law, AMT kicked in and you were considered rich if you made just under $100,000 for marrieds and $70,000 for singles. The new Trump law has raised the AMT income levels to where few people will have to worry about AMT any more.

Summary

The new tax laws really do give the “little guy” some good tax planning opportunities, but you might have to adjust your life to take advantage of them. Taxes really are your major impediment to financial success. They are also something that you can control to a great degree, but you have to plan ahead. Planning taxes is a lifestyle change, not a year-end account visit. We are here to help, if we can.