Sunday, December 17, 2017

A 2017 federal tax deduction for prepaying anticipated 2018 state income taxes? Not likely!

In anticipation of enactment of the House and Senate proposed federal tax legislation, some commentators and tax practitioners are suggesting that — in view of the likely elimination of the state income tax deduction for 2018 and subsequent years — individual taxpayers prepay their 2018 state income tax liability and claim the deduction on their 2017 federal income tax returns. Aside from the problem that many high-income taxpayers will find benefits significantly limited because they will face the alternative minimum tax, we believe there is scant authority, if any, in federal tax law to support the position of deductibility of a prepayment of tax for a year that has not yet arrived.

Prior revenue rulings

Commentators have cited Rev. Rul. 71-190 and Rev. Rul. 82-208 as the basis for claiming a 2017 deduction for payments made in 2017 to be applied to a tax liability in 2018 — notably, a year that has not even arrived at the time of payment, let alone produced any income, deductions, credits, or other items to support a tax calculation. Any payment might be in the form of an estimated tax — to be credited against the 2018 tax liability when it is determined. Some states (e.g., Wisconsin) have a form for receiving a payment in advance. However, neither of those rulings addresses this type of situation. They both address a payment of taxes very late in a given tax year — for example in 2017 — with respect to that tax year (i.e., 2017 in this example). In fact, the latter ruling was adverse to the taxpayer (the payment was held not deductible) because the taxpayer had no reasonable basis to believe he owed additional state taxes and was apparently only attempting to reduce his federal tax for the year at issue.
Other tax professionals have cited the capitalization regulations — Regs. Sec. 1.263(a)-4(f) — as authority, as the regulations allow the deduction of expenses paid in advance where the tax benefit does not extend beyond 12 months. This is an exception to those regulations’ general requirement at Regs. Sec. 1.263(a)-4(d)(3) that prepaid expenses must be capitalized. However, not only is there no direct reference or example of a deduction for taxes paid in advance for a year that has not yet arrived, but the purpose of the regulations is to govern business-related expenditures “paid to acquire or create intangibles,” a very different situation from an advance payment of personal income taxes for a subsequent year. In fact, we believe the regulations have no applicability to the issue discussed here.
In addition, Regs. Sec. 1.263(a)-4(f)(4) provides that Regs. Sec. 1.263(a)-4(f)(1) does not apply to amounts paid to create (or facilitate the creation of) an intangible of indefinite duration. Where there is no liability yet in existence, the payment of an excessive 2017 estimated tax payment would apply against a future liability that is not limited in duration. There is no certainty, for example, as to whether the taxpayer would exist in order to recognize the income. The taxpayer may die in an accident early in 2018 before recognizing any income. It cannot be said that there is a liability for state income tax beyond Dec. 31, 2017.

Professional standards

Any deduction in 2017 for a payment of anticipated 2018 state income taxes is clearly a tax position that requires the CPA adviser-tax preparer to comply with AICPA Statements on Standards for Tax Services (SSTS) No. 1, Tax Return Positions, for preparation of a return and SSTS No. 7, Form and Content of Advice to Taxpayers, for advising on the position. In addition, tax preparers must comply with the preparer penalty provisions of Sec. 6694 (and the regulations thereunder) and Circular 230, Section 10.34, standards with respect to tax returns and documents, affidavits, and other papers, and Section 10.37 if the advice is provided in writing.
Basically, these professional standards with regard to taking and advising on a tax position are quite similar and consistent in that they require a tax preparer or tax adviser to identify substantial authority for any non-tax shelter position that he or she recommends or takes on a tax return that is not disclosed in some fashion. Lacking substantial authority, the tax preparer or tax adviser may recommend a tax position for which he or she believes there is a reasonable basis, provided disclosure is made in the return.
Disclosure is generally made by the taxpayer on either a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement (where the taxpayer takes a position contrary to a regulation). Substantial authority has often been described by respected commentators as a 40% to 45% chance of prevailing administratively or judicially on the merits if challenged by the government. Reasonable basis has been similarly described as a 25% chance of prevailing. Both confidence thresholds are based on authorities set forth in Regs. Sec. 1.6662-4.
In interpreting authorities, the IRS and the courts have given significant weight to direct reference with respect to the tax treatment of an item in a return, and far less weight is given when a taxpayer argues the tax treatment should be based on analogous authority applicable to tax treatment of another item, however arguably similar. This would be particularly true with regard to attempting to assert analogous treatment of an item if Congress did not intend for the item to be in fact treated in a similar manner.
It is noted that Rev. Proc. 2016-13 does provide that the reasonable-basis and disclosure standard is satisfied for certain items entered on a tax return if the item is reflected on the proper line in the return and is entered in accordance with the form’s instructions. Among those items are state income taxes entered on Schedule A, Itemized Deductions. However, the procedure specifically states that it does not reflect law changes after Dec. 31, 2015. It does not insulate a taxpayer from penalties for claiming a deduction for which there is no liability. Therefore, we believe that the procedure would not insulate a taxpayer (and preparer or adviser) from the disclosure requirements with regard to a 2017 payment of 2018 taxes if the tax reform legislation is enacted. We believe this is particularly true as it would appear to attempt to secure a tax deduction for an amount that Congress does not intend to allow as a deduction.
Payments in 2017 of state tax liabilities projected for 2018 are not deductible on their 2017 federal income tax returns. There is simply no authority for that position, and Rev. Rul. 82-208 is authority against that position. The payment sent to a state or local government before 2018 to apply against 2018 tax liability is a mere deposit. Tax deductions are not available for deposits (Rev. Rul. 79-229).

How Individual Taxpayers Can Exploit the New Tax Bill Right Now

Here are suggestions on how to make the most of this opportunity. Keep in mind that the best advice depends specifically on how you’re going to be affected by the tax bill. While most Americans would get a tax cut in the short term, some taxpayers could see higher tax bills in 2018. No individual is average. An average is a composite of multiple individuals.

1. Give to Charity

A typical piece of end-of-the-year advice is to increase your potential deductions before Jan. 1. Deductions claimed for things you did this year will lower tax bills due the following April. Wait until January, and you’ll need to cool your heels for more than a year to get the benefit of deductions claimed.
This year, beefing up your charitable giving could be even more effective. If your tax rate is falling in 2018, your deductions are more valuable if claimed against this year’s income. Giving to charity, a tax deduction that’s preserved under the tax bill, is an effective way to boost your 2017 deductions on short notice.
And even if your tax rate is going up next year under the new bill, you may still want to make a bunch of charitable donations in 2017. Most deductions, including the charitable one, can only be claimed if you itemize your tax return. The bill would sharply limit the number of taxpayers who would benefit from itemizing: First it raises the standard deduction from $6,350 to $12,000 for single people, and $12,700 to $24,000 for married couples. Second, it limits other deductions—most famously for state and local taxes—so it’s harder for taxpayers to reach the threshold where itemizing makes sense.

2. Defer Income

Another traditional recommendation for this time of year is to defer income. While salaried workers generally can’t choose when they get paid, business owners can often delay registering income until the following year, lowering their April tax bill in the process. Investors can also control their taxable income—and thus lower capital gains tax bills—by selling losing stocks or waiting to sell winning stocks until 2018. In most years, deferring income merely delays the taxes you will have to pay eventually. But, if you expect your tax rate to fall next year, deferring income into 2018 could actually save you money. (There’s also some good news for equity investors when it comes to the FIFO rule.)

3. Pay Your Taxes—If You Can

As we noted, the tax bill would limit how much state and local taxes (or SALT) individuals can deduct, to no more than $10,000 of a combination of property taxes and either income or sales taxes. The move by the Republican-controlled Congress was criticized by Democrats as an effort to make citizens of high-tax blue states pay for benefits to corporations and citizens of low-tax red states. As a result, advisers had been planning to instruct clients targeted by this provision to find ways to maximize their SALT deduction in 2017, by pre-paying next year’s taxes as much as allowed and deducting them under the old rules. But the final compromise bill, unveiled Friday by Republicans in the Senate and House, explicitly closes this loophole. Any 2018 local taxes that are paid this year would need to be counted on next year’s taxes, according to the bill. However, any taxes due for 2017—or any late taxes from previous years—could still be deducted on a tax return due this April.

4. Employee Expenses

Current tax law allows employees to deduct unreimbursed expenses related to their jobs as long as they’re more than 2 percent of income. The tax bill ends these itemized deductions after the end of this year. So, workers should think about whether they can pay —and get the receipts—for as many of these expenses as possible this month. Examples of unreimbursed expenses for employees might include tools and supplies, occupational taxes, work uniforms, union dues, and expenses for work-related travel. Self-employed people and business owners would still be able to deduct expenses under the new tax bill.

5. Pay For Your Move

Under the proposed law, you’ll no longer be allowed to deduct work-related moving expenses after the new year (unless you’re in the military). Of course it might be difficult to schedule a cross-country move on such short notice, but, if you did move, make sure you clear up any moving-related expenses by Dec. 31. And if your destination happens to be a low-tax red state, maybe thank Santa Claus for your good luck.

6.  Stock Transactions

Another typical tax planning issue involves your capital transactions. Capital gains are an area ripe for end-of-the-year planning as taxpayers can determine whether to buy or sell investments to either recognize a gain or loss.
A popular strategy is to sell investments with built-in losses in to offset any capital gains a taxpayer had earlier in the year. However, if capital losses exceed capital gains for the year, taxpayers are only able to deduct up to $3,000 of the losses against ordinary income. Any net capital losses above $3,000 must be carried over and deducted in subsequent years. However, watch the wash sale rules if you plan on repurchasing the investment you just sold, which rules could prevent the recognition of the loss

Tuesday, October 3, 2017

What’s better done in fall than spring? Often, the answer is taxes

Fall is upon us and it’s a good idea to start thinking about your 2017 tax return now.
While most people wait until March or April to file, there can be advantages to filing early. Some deductions may be lost if you don’t act by Dec. 31.
It’s wise to engage your CPA in these planning strategies now and early in 2018 when they typically have more time to assist.
Congress is currently considering tax legislation. Some parts of the bill could be “retroactive,” meaning they will go in effect for the 2017 tax year. We should monitor this situation and its potential effect on this year’s tax return.

Year-end tax considerations

It’s a good idea to estimate what your capital gains distributions will be for the year. Most mutual fund companies will tell shareholders ahead of time what they plan to distribute to shareholders and when.
It’s possible for an investor to avoid these gains in some circumstances. It’s also a good idea to determine if any capital gains losses are available and if so, if it would be wise to sell before the end of the year to “harvest” these losses and reduce capital gains taxes for 2017.
To lower taxable income, be sure to maximize contributions to 401K and other retirement accounts.
While 2017 IRA and Roth IRA contributions can be made until April of 2018, employer sponsored retirement plans typically have a contribution deadline of the end of the calendar year.
Determine if there is money left in your Flexible Spending Account.
Will it be lost at the end of the year? Deposits to Health Savings Accounts and 529 Savings Plans can be valuable ways to save for health care and education expenses while reducing current income, but their contribution deadlines are Dec. 31.
Be sure to make any charitable contributions by the end of the calendar year and don’t forget to save receipts for “non-cash” contributions to organization like the Goodwill and Salvation Army.

Estimate income for this year and next

Understand your probable income before the end of the year. Will your income be significantly higher or lower this year or next?
If your income is higher than normal this year, consider paying certain 2018 deductible expenses — like property taxes, business expenses, or mortgage payments — early so you can deduct them in 2017. But remember you won’t be able to take these deductions again in 2018.
It’s possible you may have less income this year than you would expect in 2018. If that’s the case, you can delay certain payments until January so they are deductible in 2018 when the benefit of the deduction is greater.
You may also consider selling investment positions now and generating capital gains in 2017 or converting a traditional IRA to a Roth IRA if you are in a lower tax bracket this year as opposed to next year.

Consider filing early

After you have a good tax planning strategy in place, get organized and file early in 2018. While many 1099s are not required to be sent to you until mid-February, you can gather receipts and other tax filing documents while you are waiting.
The Equifax data breach may have exposed your Social Security number to hackers who sell your information. Filing early is a good way to thwart thieves who file fake tax returns using your Social Security number.
Above all, be sure to file your tax return and pay your taxes. Because tax prison is still prison!

Sunday, October 1, 2017

Year-End Tax Planning Strategies

The fourth quarter of the year, when individuals are typically planning for the holidays, is also a great time for financial advisors to revisit the plans they’ve created for their clients. Year-end is a time when advisors must confirm if their clients satisfied their required minimum distributions and maxed out their retirement contributions, as well as rebalance portfolios and consider tax strategies. Below we look at the different tax strategies, investment vehicles and top managers that provide tax efficiencies.

One doesn’t have to search long for a reason why investors want to reduce their tax liabilities as much as possible, when you consider the tax ramifications of investing. Investment returns could be reduced by as much as 40 percent in any given year when factoring in federal income and capital gains, state and local taxes, and the alternative minimum tax. Helping reduce your clients’ tax liability is instrumental to growing their assets and helping them achieve their financial goals.

Tax Strategies to Consider

It’s important to understand what type of investment is most appropriate for each specific type of account. For example, due to their high taxable yields, high-yield bonds are more appropriate to be in tax-deferred or tax-exempt accounts versus taxable accounts. Conversely, equity securities that are intended to be held for a long time period are more suitable for taxable accounts, as their gains are taxed at long-term capital gains rates.

Tax-loss harvesting is a great strategy to help reduce your client’s taxable gains. Tax-loss harvesting allows your clients to offset their investment gains with their realized investment losses. We are currently in the midst of the second longest bull market in history, so it may be difficult to locate investment losses, but if your clients do have any, the timing might be right to sell them to offset the recent gains. An investor can use any remaining losses to offset up to $3,000 of ordinary income each year.

Rebalancing your client’s portfolio is vital to keeping the allocations in line with your client’s risk tolerance, however, rebalancing a portfolio can also cause taxable capital gains. There are different thoughts on how often one should rebalance a portfolio, typically, annual rebalancing provides greater potential long-term performance, less trading fees and more tax efficiencies.

Investment Vehicles to Consider

Mutual funds are required to distribute at least 90 percent of net investment income and 98 percent of net capital gains every year, which can be a tax liability for investors. Due to their low trading activity and minimal annual distributions, passive investments such as Index funds and ETFs have gained in popularity for the tax-conscious investor.

Separately managed accounts (SMA) should be considered by financial advisors when looking for a tax-efficient investment. One of the baked-in benefits of investing in an SMA is that the investor is the registered owner of the individual underlying securities, which provides additional flexibility for investors and their ability to participate in additional tax strategies. For example, harvesting losses can be easier when the investor holds the individual securities versus a pooled mutual fund.

Below are some of the top strategies listed in the PSN Global Manager Neighborhood database that might help financial advisors construct a tax-efficient portfolio for their clients.

When looking for tax-efficient investments, municipal bonds are first to come to mind. Municipal bonds typically provide income that is exempt from federal taxes; additionally, if your client holds municipals specific to their state of residence, these bonds provide state tax-exempt income. Municipals provide a lower yield compared to most taxable fixed income products, so it’s important to look at the taxable-equivalent yield when comparing yields. Below are some of the top municipal bond strategies found within the PSN Global Manager Neighborhood database.

A strategy’s turnover ratio is a good indicator if the strategy is tax efficient due to its reduced trading of the underlying securities, which reduces the potential for taxable distributions. Below are some of the strategies in the PSN Global Manager Neighborhood who stand out with low turnover.

Some managed products’ investment objectives are to be tax efficient, while being actively managed. These products are managed in ways to reduce their taxable distributions. Some of the strategies these managers employ include reducing turnover, investing in non-dividend paying stocks, and selling less attractive stocks at a loss. These strategies provide additional options for financial advisors when constructing a well-diversified, tax-efficient portfolio. Below are some tax-managed strategies listed in the PSN Global Manager Neighborhood database.

Selling an investment for tax considerations is important, but one must balance the tax benefits of selling to the market opportunity of potentially selling low. When implementing tax strategies to help reduce your client’s tax liabilities, it is important to keep your client’s investment objectives in mind, and prepare a plan that best fits the needs of your client.

Monday, February 27, 2017

5 Retirement Income Mistakes to Avoid

Congratulations! You feel you are in a position to retire. But then you feel a chill and the hair on the back of your neck rises up as the reality of producing a monthly "paycheck" from your various investment accounts starts to scare you. How in the world can you make this happen?
Most of us will retire with various accounts...retirement accounts like 401(k)s and IRAs, non-qualified accounts (which are accounts that are simply owned in your name or you and a partner). If retiring, your goal is, in its simplest form, to create a recurring deposit into your checking account from your pile of investments. This seems like a daunting task and in reality it is not easy. Which account do you tap first? Should you convert all of your investments into an income stream? What about tax considerations? All of these questions are important.
Allow me to share the five most common retirement income mistakes that I have seen.
1. Making things too complicated. If you are an engineer this one may hurt a little. Spreadsheets with multiple tabs, year by year analysis and projections, tax rate variables, expense variables, Presidential cycle assumptions, and more can be overkill. As a financial professional, we actually do an in depth analysis of our client's retirement period for many good reasons. However, setting up an income stream usually boils down to a very simple strategy. Noting that every situation is different, in many cases simply taking a proportionate amount of income from each type of account that you own is a good way to create income. For example, let's say that 60% of your wealth is in IRAs and 40% is in an individual/joint account. If you are old enough to not have to worry about premature distribution penalties, consider simply setting up a distribution that is about 60/40 that satisfies your monthly income need. Yes, it could be that simple.
2. Making things too simple. Many people have the urge to cash in all of their investments and convert the balance to a monthly income stream. You may also call this the "annuity" strategy. Once again, every situation is different, however, in most cases there are valid reasons to not follow this approach. I won't get into the reasons that I don't like this strategy today, just understand that this is most likely not the path that you need to take.
3. Create your income by tapping only your non-IRA assets (also called non-qualified). If you ask your CPA, they will most likely advise you to create all of your retirement income by taking money out of your non-qualified assets. Why? This will most likely produce the lowest tax bill thus allowing you to keep more of your assets intact. Sounds good, right? To start it will be. I have two issues with this strategy. First, it may put you in a position down the road, when you have reduced the balance of your non IRA assets, where are forced to turn to your IRA for any expense need that you may have. Once you use up all of your non-qualified assets you may limit your tax options by forcing all distributions to come out of the IRA. Second, it could set you up for a bad tax surprise at age 70 ½ (see mistake number 4).
4. Forget to plan for your Required Minimum Distributions. The IRS likes for you to pay taxes and in that light they have a rule that most call Required Minimum Distributions or RMD for short. In summary, when one turns 70 ½ the IRS will require you to pull out a set amount of money from your IRA each year. The amount is calculated using the account value, your age, assumed growth rate and your life expectancy. Basically, they want you to withdraw all of the money over your projected lifetime and of course pay the tax on those distributions. Let's say you follow your gut and spend years taking money out of your non IRA assets (like mistake number 3) while your IRA balance just keeps getting bigger and bigger. A larger IRA balance can mean a larger required distribution when you hit 70 ½. I once saw someone who did not plan for this that ended up having to withdraw about $600,000 per year when they only needed about $200,000 to live on. In my book they ended up having to pay income taxes on $400,000 of income that they did not need. Poor tax planning indeed.
5. Failing to think about your ultimate beneficiaries. I am talking about your kids or grandkids that will eventually get the remainder of your wealth. Most of you reading this will still have money at the end of your life. Where do you want this to go? Yes, your family. Why not think about which assets will pass with the least tax consequence to those deserving...or Some assets, like a Roth IRA, may be able to pass to your children or grandchildren with no tax consequence. In other words, they get 100% of the money. Other assets, like your IRA, most likely will be treated as taxable income when your family withdraws the money at whatever tax bracket they may be in at the time of withdrawal. They may not get all of the money that you so kindly gifted to them.
The bottom line is that income planning may actually be a little complicated but with careful planning and some thoughtful foresight about what may happen 15 to 20 years down the road, you can not only set up a good income stream for you but also think about those that you benefit from the legacy that you leave.

Friday, February 24, 2017

Business Tax Planning: 4 Moves For The Coming Year

Yeah, I know. You’re probably just trying to get through the current tax season.
However, one of the best things you can do for your business is to plan ahead for the new year. You should be engaged in tax planning year-round, not just at the beginning of the year as you frantically try to figure out what you can deduct.
Instead, you should be thinking ahead and making sure that you are
Business tax planning can help you save money in the long run. Here are four moves to consider for the coming year:

1. Buy Equipment

Have you been looking to buy equipment? If you need something, plan to buy it this coming year. You can claim a tax deduction when you purchase equipment specifically for use with your business.
If you have been making do with sub-par equipment, or if you’re trying to expand your business and you need more supplies, now might be the time.
It’s a simple thing, but my office chair has finally broken down. I’m ready for a new one, and part of my tax planning for this year is buying a new chair.
Whether it’s getting a new computer or whether you need to get new stations for your employees, buying new equipment can be a solid tax planning move. Just make sure you keep good records and save the receipts.

2. Donate to Charity

Are you in a position where you want to give back? Donating to charity can be a great way to do good for a cause you believe in and build your reputation in the community. Plus, you can also receive a tax break.
Make sure that the charity is a 501(3)(c) organization and tax-deductible. You can donate to other organizations, but you might not get the tax deduction. It can still be worth it to give to a cause that isn’t tax-deductible, but it won’t be part of your business tax planning.

3. Retirement

Don’t forget about retirement contributions. This is not just about good business tax planning now; it can also make a big difference in your long-term financial security. You don’t want to neglect your retirement. Make contributions, and you can get a tax deduction.
That also include when you set up a benefits program for your employees. Your company’s contributions come with a tax break. Talk with a professional who can help you figure out how to offer benefits to your employees for a tax break.
This is a great way to invest in your business because you are more likely to attract high-quality people when you offer benefits.

4. Grow Your Business

Finally, put some money into activities that will help grow your business. Put money into advertising and marketing. Consider outsourcing some of your mundane tasks.
Think about some of the things you do that could be done by someone else or that will ultimately help you get more eyeballs in front of your business.
When you spend money on business activities, you can take a tax deduction. Plus, your return on investment can be very high when you grow your business this way. You spend a little money to make a lot more later.
Look at different ways you can grow your business with a little infusion of cash. You’ll reap big rewards in the future and get a jump on your business tax planning now.


Thursday, February 23, 2017

You or an accountant? Prepping for tax time


Q. How can I decide if I need someone else to do my tax returns?

A. As you start to gather all your documents to prepare your tax returns, this is the perfect time to ask.

It all has to do with your personal situation and how comfortable you are with the tax law, its quirks

If your tax returns are not too complex, then you may be able to do your tax returns on your own, said Patricia Daquila, a certified public accountant with Lassus Wherley in New Providence.

"If you have a W-2 and not too many other sources of income or deductions, then it is possible," Daquila said. "However, there are many complexities in the income tax law may benefit you to have a tax professional prepare your returns."

Daquila said there are several factors that you should consider.

The first factor is your knowledge of the current tax law?

A tax professional such as a Certified Public Accountant (CPA) is licensed and certified by the state, Daquila said. CPAs must have a college degree and pass a national exam.

In addition, they need to complete continuing professional education (CPE) to keep their license active, she said. Specifically in New Jersey, a CPA has to complete 120 hours of CPE every three years to renew their license.

"A CPA who specializes in tax preparation is experienced and should know the current tax laws," she said. "A CPA can prepare your returns accurately and take advantage of deductions and credits of which you may not be aware."

The second factor is time.

Do you have the time to not only gather all of your tax information, but then assemble it, prepare your tax returns, and review them?

The third factor is technology. Are you knowledgeable about using a computer?

"There are many computer software programs that are on the market to aid in the preparation of your tax return," she said. "However, you would need to know how to install the program and input the information."

You would also need to review your tax returns after they are completed, Daquila said, noting that most tax professionals now electronically transmit their tax returns to the IRS, resulting in quicker refunds of overpayments.

The fourth factor is the cost. Do you have the money to pay a professional to prepare your tax return?

"The cost can vary based on the professional that you hire," she said. "It is always recommended to ask for an estimate before engaging a professional."

In the end, Daquila said, ask yourself this question: "If you had a pipe break in your home, would you fix the pipe yourself or would you hire a professional plumber?"

A tax professional is trained, experienced and licensed in the area of taxation, she said.