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Questions and Answers on the Qualified Business Income Deduction

  • Written by Sidney Kess, CPA, J.D., LL.M.

kess sidneyThe Tax Cuts and Jobs Act of 2017 introduced a new write-off for owners of pass-through entities that runs from 2018 through 2025. This deduction doesn’t require any cash outlay or special action to be eligible for it, but using it reduces the effective tax rate on business income. There is much confusion about this new deduction and some clarification will need IRS guidance. Here is what is clear so far, how it impacts attorneys, and what needs IRS and/or Congress to explain further.

Overview

Q: What is the new deduction?

A: Under new Code Section 199A there is a 20% deduction for qualified business income from a sole proprietorship or a pass-through entity.

Q: Where is the deduction taken?

A: The deduction is not a business deduction used to reduce profits subject to tax; it does not reduce net earnings for self-employment tax purposes. It is not a reduction to gross income taken in the Adjusted Gross Income section of Form 1040. It is a deduction from adjusted gross income much like the standard deduction or itemized deductions used to reduce taxable income.

Terminology

Q: What is a pass-through entity for purposes of Code Sec. 199A?

A: Many business owners may be eligible to take the deduction on their personal returns, including:

• Schedule C filers: Sole proprietors, independent contractors, and single-member limited liability companies (LLCs)
• Schedule E filers: S corporation shareholders, partners, members in multi-member LLCs, real estate investors, beneficiaries of trusts and estates, owners of REITs, and those with interests in qualified cooperatives
• Schedule F filers: farmers and ranchers

Q: What is qualified business income?

A: The deduction applies to this income, but it isn’t merely the owner’s share of net income from the business. It is the net amount of income, gain, deduction, and loss from a qualified U.S. trade or business (including Puerto Rico). It does not include investment items, such as short-term and long-term capital gains and losses, dividends, and interest other than what’s allocable to the business. And it doesn’t include reasonable compensation or guaranteed payments to owners. But it does include most REIT dividends and income from publicly traded partnerships.

Q: What is a specified service trade or business?

A: This is a business where the owner must reduce the amount of qualified business income on which the deduction is taken (explained below). It includes any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services, as well the performance of services that consist of investing and investment management, trading or dealing in securities, partnership interests or commodities. It also includes any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.

The TCJA deleted engineering and architecture, but the IRS could still view such businesses as a qualified service business based on the “reputation or skill” clause.

Deduction Amount

Q: What is the deduction amount? A: Technically the deduction is the sum of:

• The lesser of (1) the individual’s combined qualified business income or (2) 20% of the excess of taxable income over net capital gain plus qualified cooperative dividends
• The lesser of (1) 20% of cooperative dividends or (2) taxable income reduced by net capital gains.

Essentially, the deduction is 20% of qualified business income. But due to the technical definition of the deduction, it means that the 20% deduction is based on taxable income if it is less than qualified business income.

Q: Who can claim the full 20%-of-qualified business-income deduction?

A: An individual who has taxable income below set levels can apply the 20% deduction against qualified business income. This is so whether or not the taxpayer is in a qualified service business. For 2018, the taxable income limit is $315,000 for a married couple filing a joint return and $157,500 for any other filer. These taxable income thresholds are where the 24% tax brackets end and the 32% tax brackets begin for 2018. The taxable income limit will be adjusted for inflation after 2018. Thus, an attorney or accountant with taxable income below the applicable threshold amount for his or her filing status would be able to claim the deduction with respect to income from a practice.

Limitations

Q: What is the W-2 limitation?

A: If the owner’s taxable income is above the threshold, then a limitation comes into play. The deduction is the lesser of:

• 20% of qualified business income, or
• The greater of (1) 50% of W-2 wages for the qualified business, or (2) 25% of the W-2 wages with respect to the business plus 2.5% of the unadjusted basis (immediately before acquisition) of qualified property.

If the amount of qualified business income is greater than the taxpayer’s taxable income, then the 20% applies only to the extent of taxable income as explained earlier.

W-2 wages are amounts reported as such to the Social Security Administration for owners and other employees. Payments to independent contractors do not factor in. For partners, LLC members, and S corporation owners, the allocations of W-2 wages and the unadjusted basis of property are made in the same way as the allocation of qualified business income, and likely will have to be reported on Schedule K-1.

Q: What is the limitation for a qualified service business?

A: For purposes of figuring the W-2 limitation, the owner of a qualified service business with taxable income above the threshold reduces the amount of qualified business income to which the deduction applies. The reduction is a percentage derived from the ratio of taxable income for the year in excess of the threshold over $100,000 on a joint return or $50,000 for all other filers. In effect, if taxable income for the owner of a qualified service business who files jointly is $415,000 or over in 2018 (or $207,500 for other filers), then no deduction can be claimed because there is no qualified business income on which to apply the deduction. Thus, attorneys with taxable income over $415,000, or $207,500, depending on filing status, cannot claim any deduction.

If an individual above the taxable income threshold owns a qualified service business as well as a nonqualified service business, it is not yet clear whether the deduction can be taken with respect the nonqualified service business even though he or she phases out for the deduction on the qualified service business income.

Q: What is a Section 199A loss and how does it impact the deduction?

A: If the net amount of income, gain, deduction, and loss is less than zero, the net amount is treated as a loss in the succeeding year.

It is not clear whether the loss is carried forward only to the following year or continues to be carried forward indefinitely until used up. And it’s not clear whether the loss is used to offset only income in the subsequent year from the business that generated it or must be used to offset income from all of a taxpayer’s businesses.

Conclusion

As is clear from the questions and answers above, much is not clear. Additional guidance from the IRS may not be immediately forthcoming in this tax filing season. Once this is done, then business owners can decide on what to do, including changing their form of entity, deciding whether to add independent contractors to the payroll, or taking other actions.


Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is senior consultant for Citrin Cooperman, consulting editor to CCH and Of Counsel to Kostelanetz & Fink.

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Tax Cuts and Jobs Act of 2017: Impact on Individuals

  • Written by Sidney Kess, CPA, J.D., LL.M.

kess sidneyOn December 19, 2017, Congress passed a major tax package (H.R. 1) designed to cut taxes on individuals and businesses, and to stimulate the economy and create jobs. The tax cuts are projected to be nearly $1.5 trillion. The long-term impact on the deficit is unclear; the measure adds to the deficit in the short term but could reduce it in the long term if predictions of economic growth come true. The following is a roundup of the key provisions impacting individuals. Those impacting businesses are in a subsequent column. All of the following provisions apply starting in 2018 unless otherwise noted. Most of the provisions for individuals are temporary; they expire after 2025 unless Congress takes further action.

Tax Rate Reduction

The linchpin to this tax legislation is a reduction in individual tax rates. While the current number of tax brackets has been retained, each one has been reduced slightly.

Tax Brackets
The brackets for individuals are cut to 10%, 12%, 22%, 24%, 32%, 35%, and 37% (Code Sec 1). The top tax rate applies to joint filers with taxable income over $600,000 (single filers over $500,000).

Tax Rates for Owners of Pass-Through Entities
There is no special tax rate or cap for taxes on pass-through income. There is, however, a new 20% deduction for business income, although many restrictions apply that prevent this break from being claimed by most attorneys, accountants, and number of other professionals (new Code Sec. 199A).

Capital Gains and Dividends
The 15% and 20% tax rates on long-term capital gains and qualified dividends have been retained. Those in the 10% or 12% tax bracket pay zero tax on these gains and dividends. Also, there had been proposals to require the use of first-in, first-out (FIFO) in determining basis on the sale of stock and mutual fund shares rather than allowing investors to designate which shares are being sold when shares were acquired at different times. This measure was not included in the final package.

AMT
The tax rates for the alternative minimum tax (AMT) are retained, but the exemption amounts are increased (Code Secs. 53, and 55-59). More specifically, the exemption amounts increase to $109,400 for joint filers, $54,700 for married filing separately, and $70,300 for other filers. The phase-out threshold for the exemption increases to $1 million for joint filers and $500,000 for other filers; phase-out amounts are indexed for inflation after 2018. Also, the current 10%-of-AGI threshold for medical expenses deductible for AMT purposes is decreased to the 7.5%-of-adjusted-gross-income (AGI) threshold for 2017 and 2018.

Deductions

The personal and dependency exemptions are repealed, while the deduction for student interest that had been slated for repeal has been retained. Other changes to deductions include:

Above-the-Line Deductions
The alimony deduction is eliminated, but this repeal only applies for payments under agreements entered into or substantially changed after 2018 (Code Sec. 71). This means that recipients of alimony under agreements entered into or substantially changed after 2018 will not be taxed on the payments they receive. The deduction for moving expenses is also repealed, except for members of the military (Code Sec. 217). A deduction for legal fees and court costs in whistleblower cases can be deducted from gross income.

Standard Deduction
The standard deduction increases to $24,000 for joint filers, $18,000 for heads of households, and $12,000 for other filers. These amounts are indexed for inflation after 2018. The additional standard deduction amounts for age and blindness have been retained. Currently, about two-thirds of individuals claim the standard deduction. The number of taxpayers who do not itemize their personal deductions is expected to increase when the higher standard deduction amounts are implemented.

Itemized Deductions
Many of the itemized deduction rules have changed:

• The medical deduction is retained, with the 7.5%-of-AGI floor retained for all taxpayers for 2017 and 2018 (Code Sec. 213). After 2018, the threshold returns to 10%-of-AGI.
• The cap for deducting mortgage interest for buying or building a home is reduced from the current $1 million cap to $750,000; no interest is deductible for home equity debt (Code Sec. 163(h)).
• The deduction for state and local income, property, and sales taxes is capped at $10,000 (Code Sec. 164). This so-called SALT deduction, which stands for state and local taxes, is a substantial reduction from the former rule allowing all property taxes, plus all state and local income or sales taxes, to be claimed as an itemized deduction. Prepaying 2018 state and local income taxes in 2017 does not help; no deduction in 2017 is allowed for such prepayment.
• The percentage of AGI for charitable contributions is increased from 50% to 60% for cash donations, but no deduction is allowed for donations in exchange for college athletic event seating rights (Code Sec. 170). The cents-per-mile rate for driving for charitable purposes has not been changed; it remains at 14 cents per mile.
• The casualty loss deduction is repealed, except for losses in federally-declared disasters (Code Sec. 165). Miscellaneous itemized deductions subject to the 2%-of-AGI floor, such as unreimbursed employee business expenses and tax preparation fees, are repealed (Code Secs. 61, 67, and 212)).
• The phase-out of itemized deductions for high-income taxpayers is also repealed.

Credits

Despite various proposals in the House bill, the final measure retained most current tax credits, including the child and dependent care credit, the credit for the elderly and permanently disabled, and the credit for plug-in electric drive motor vehicles. However, some credit changes were made:

Child Tax Credit
The amount of the credit increases to $2,000 per qualifying child (up from $1,000) (Code Sec. 24). The refundable portion of the credit increases to $1,400. There is a nonrefundable $500 credit for a qualifying dependent other than a qualifying child that applies through 2025. The AGI phase-out for the child tax credit increases substantially, but is not indexed for inflation.

Other Credits
There are some modifications to the earned income tax credit (Code Sec. 32). The credit for nonbusiness energy property for installing insulation, storm windows, etc., which expired at the end of 2016, has not been extended.

Other Provisions

The new law contains various other tax rules of note, including:

Individual Mandate
The shared responsibility payment for individual mandate, which is a penalty for not having required minimum essential health coverage and no exemption from the mandate, is repealed (Code Sec. 5000A). However, this change does not take effect until 2019. Thus, it continues to apply for 2017 and 2018. No changes have been made in the premium tax credit for those who choose to buy health coverage from a government Marketplace.

Roth IRA Conversions
The ability to unwind a Roth IRA conversion by recharacterizing it as an IRA by October 15th can no longer be done (Code Sec. 408A). This means that conversions are permanent.

529 Plans
The use of these plans is expanded in two ways:

• Tax-free distributions up to $10,000 can be made for tuition at elementary and secondary schools, whether public, private, or religious (Code Sec. 529).
• Rollovers of funds from 529 plans to ABLE accounts—special savings accounts for the benefit of a qualified disabled individual—can be made on a tax-free basis (Code Secs 529 and 529A).

Home Sales
There had been proposals to change the rules for excluding gain on the sale of a principal residence (Code Sec. 121). The proposals were not included in the final measure.

Estate and Gift Taxes
These transfer taxes are retained but the exemption amount is increased substantially. The $5 million exemption doubles to $10 million (Code Secs. 2001 and 2010). The $10 million amount is indexed for inflation after 2011, making it more than $11 million for 2018. For a couple, this means estates can be transferred tax free up to $22 million.

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Death of an Employee: Tax Ramifications

  • Written by Sidney Kess, CPA, J.D., LL.M.

mug sid kessWhen an employee dies, family members, co-workers and others may experience profound loss. For the family and the company, there are important tax considerations that arise. Here are some of the issues of note.

Retirement Benefits

If a deceased employee was a participant in a company’s qualified retirement plan, benefits are paid to the designated beneficiary. This is usually a surviving spouse if there is one. If an employee had wanted benefits to be payable to someone other than a surviving spouse, the surviving spouse would have had to consent in writing to this arrangement (Code Secs. 401(a)(11)(F) and 417(a)). The plan administrator should have a record of who was designated as the beneficiary or what happens if there is no such beneficiary (e.g., the beneficiary predeceased the employee).

The person inheriting retirement benefits is not immediately taxed on the inheritance (Code 102). However, when benefits are distributed to the beneficiary, they become taxable to the same extent that they would have been taxable to the employee.

A surviving spouse can roll over the benefits to his/her own account. This allows the surviving spouse to name his/her own beneficiary and to postpone required minimum distributions until age 70½.

A non-spouse beneficiary may direct the trustee of the plan to transfer inherited funds directly to an IRA set up for this purpose. The account should be titled: [Beneficiary’s name], a beneficiary of [employee’s name]. While the non-spouse beneficiary must take distributions over his/her life expectancy (Table I in the appendices to IRS Publication 590-B), this avoids an immediate distribution of the entire inheritance. Generally, distributions must begin by the end of the year following the year of death. However, under a five-year rule, no distributions are required until the end of the fifth year following the year of death, at which time the entire account must be withdrawn.

If the deceased employee’s estate paid federal estate tax, then a beneficiary can claim a miscellaneous itemized deduction for the portion of this tax when benefits are included in his/her income (Code Sec. 691(c)). It is not subject to the 2%-of-adjusted-gross-income floor that applies to most miscellaneous itemized deductions; it is subject to the phase-out for high-income taxpayers.

COBRA Coverage

Under federal law, if the employer has 20 or more full- and part-time employees for at least half of the business days during the previous year and has a group health plan, COBRA coverage (a continuation of the company health plan) must be offered to a surviving spouse and a dependent child (Consolidated Omnibus Budget Reconciliation Act of 1985). A number of states have “mini-COBRA,” which requires the offer of continuing coverage by smaller firms.

The employer must notify the qualifying beneficiary (spouse/dependent child) within 14 days the plan received notice of the qualifying event (the death of the covered employee) about COBRA. This notice of election must spell out what it means and how to make it. What it means is that the qualifying beneficiary can continue the same or reduced coverage for up to 36 months. This election is voluntary, so if the spouse has access to better or less costly coverage elsewhere (e.g., through the Medicare for the spouse; through the children’s health insurance program [CHIP] for the child), making the election may not be advisable. The qualifying beneficiary must pay the cost of coverage, plus an administrative fee up to 2% (unless the company voluntarily pays for some or all of this coverage).

COBRA does not apply to:

• Health savings accounts (HSAs) (discussed later), even though coverage under a company’s high-deductible health plan (HDHP) is subject to COBRA

• Disability insurance for short-term or long-term disability

• Long-term care insurance

Life Insurance

Insurance on the life of an employee is payable at death to the beneficiary of the policy. Depending on the type of coverage, this may be the surviving spouse, the company, or anyone else. As a general rule, the receipt of insurance proceeds payable on account of the death of the insured is tax-free (Code Sec. 101).

Group-term life insurance. Typically proceeds are payable to the surviving spouse or the employee’s child. If the employee has not designated a beneficiary, proceeds are payable according to state law. In order of precedence, this is usually a current spouse, but if there is none, then to children or descendants. If none, then to parents, and then to the employee’s estate.

Key person insurance. This is coverage owned by the company and is designed to provide a financial backstop needed during a replacement period for the deceased employee.

Insurance under buy-sell agreements. If the deceased employee is an owner and there is a buy-sell agreement that has been funded by life insurance, the proceeds are paid out to the company if the company owned the policy (an entity purchase buy-sell agreement), or to co-owners if they owned the policy (a cross purchase buy-sell agreement).

Workers’ Compensation

If an employee dies because of a work-related injury or illness, a death benefit is payable to eligible dependents (usually a surviving spouse and minor children, but to others if there is no spouse or minor child). The receipt of these benefits is tax-free (Code Sec. 104(a)(1)).

The amount of the benefit varies from state to state. For example, in New York the death benefit is two-thirds of the deceased spouse’s average weekly wage for the year before the accident (but not more than a maximum amount adjusted annually), or less if there is no surviving spouse, children, grandchildren, grandparents, siblings, parents, or grandparents. In addition, there may be a payment for funeral expenses.

When there is a work-related death covered by workers’ compensation, this usually becomes the sole remedy against the employer. However, an action against the employer may not be barred in some situations (e.g., death because of toxic substances, defective products, intentional actions by the employer).

FSAs

If the deceased employee had been contributing to a flexible spending account for health care or dependent care costs, contributions cease at death. The executor can continue to submit claims for reimbursement for eligible expenses incurred before death; these reimbursements are tax-free. The plan administrator can provide details about the deadline for these submissions.

Restricted Stock and Stock Options

What happens to restricted stock and stock options when an employee dies varies greatly from company to company. Unvested grants may vest upon death. For example, the terms of a stock option plan may immediately vest any unvested grant, allowing the estate of the deceased employee to exercise the options within a set period.

Nonqualified stock options become part of the deceased employee’s estate. If the executor exercises them, income is taxable to the estate (Form 1099-MISC is issued to the estate). There is no withholding required. Similarly, any restricted stock released to the estate becomes taxable to it (assuming that the employee did not make a Sec. 83(b) election); there is no withholding required.

Special Benefits

In addition to what the law requires, some companies may offer families of deceased employees special benefits. For example, Google pays 50% of a deceased employee’s salary to a surviving spouse or domestic partner for 10 years (http://money.cnn.com/2012/08/09/technology/google-death-benefits/index.html). The company also pays each dependent child a monthly amount until age 19, or 23 if a full-time student.

Conclusion

Families must present death certificates to the company in order to receive any employment-related benefits on behalf of the deceased employee. They should also work with the company to undo other entanglements, such as company credit cards and company vehicles.

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Charitable Contributions for High-Income Taxpayers

  • Written by Sidney Kess, CPA, J.D., LL.M.

mug sid kessThe government views those with income of $200,000 or more as “high-income taxpayers,” and charitable contributions are a popular write-off for this group of individuals. For 2015 (the most recent year for which statistics are available), the average charitable contribution deduction for those with adjusted gross income (AGI) of $200,000 to under $250,000 was $11,370. For those with AGI of $250,000 or more, the average deduction was $16,580. In this period of tax uncertainty resulting from Congressional goals of tax reform, what can high-income taxpayers do to maximize their tax-advantaged giving opportunities?

Tax Rules for Charitable Contributions

High-income taxpayers should understand the basic charitable contribution rules for federal income tax purposes, which are fairly straightforward (Code Sec. 170):

• A taxpayer must itemize deductions. No above-the-line deduction for non-itemizers is allowed.

• Donations must go to an IRS-recognized charity, which can be found in Publication 78 online (https://www.irs.gov/charities-non-profits/organizations-eligible-to-receive-tax-deductible-charitable-contributions).

• A taxpayer must follow substantiation rules, with may include obtaining written acknowledgments from the charity and qualified appraisals from outside appraisers.

• Cash donations are limited to 50% of adjusted gross income. Donations of appreciated property usually are limited to 30% of AGI (with the exception of donations of conservation easements explained later). Deductions in excess of these limits can be carried forward for up to five years.

• The deduction for charitable contributions is subject to the phase-out of itemized deductions for high-income taxpayers. This means that the tax write-off for contributions can be reduced by as much as 80%.

Conservation Easements

Conservation easements are a type of special arrangement to let taxpayers have their cake and eat it too. Property owners can give away interests, take a tax deduction, and continue to enjoy the property.

To be deductible, the donation must be a contribution of a qualified real property interest (i.e., a restriction granted in perpetuity on the use which may be made of the real property) to a qualified organization exclusively for conservation purposes (Code Sec. 170(h) and Reg. §1.170A-14). The types of conservation contributions include:

• Preservation of land areas for outdoor recreation by, or the education of, the general public.

• Protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem.

• Preservation of open space (including farmland and forest land).

• Preservation of a historically important land area or a certified historic structure (such as a building façade).

Donations of conservation easements are limited to 50%of AGI minus the deduction for other charitable contributions. Any excess amount can be carried forward for up to 15 years. For donations by farmers and ranchers, the AGI limit is 100%, rather than the usual 50%, with the same 15-year carryover.

However, the IRS has made syndicated conservation easements a reportable transaction that must be disclosed on a taxpayer’s return and may invite IRS scrutiny (Notice 2017-10, IRB 2017-4, 544). For more details about conservation easements in general, see the IRS’s Conservation Easement Audit Technique Guide (https://www.irs.gov/pub/irs-utl/conservation_easement.pdf).

Qualified Charitable Distributions

An IRA owner who is at least age 70½ has an additional way to give to charity. They can make a qualified charitable distribution (QCD) of up to $100,000 annually from the IRA (Code Sec. 408(d)(8)). The distribution is not taxed, and can be counted toward a required minimum distribution (RMD). But no charitable contribution deduction can be taken; no double tax break is allowed.

QCDs are restricted to regular IRAs. They cannot be made from IRA-type accounts, such as SEP-IRAs or SIMPLE-IRAs.

Donor-Advised Funds

A donor-­advised fund is a fund or account in which a donor can advise but not dictate how to distribute or invest amounts held in the fund (Code Sec. 170(f)(18)). Usually, a taxpayer giving cash or property to a donor-advised fund can take an immediate tax deduction even though the funds have not yet been disbursed to a charity.

Donor-advised funds from some major brokerage firms and mutual funds have minimum contribution amounts and fees.

Business Donations

High-income taxpayers may own businesses that can make donations.

• For C corporations, donations are limited to 10% of taxable income.

• For owners of pass-through entities, their share of the businesses’ donations is reported on their personal returns.

Usually, donations of inventory are deductible to the extent of the lesser of the fair market value on the date of the contribution or its basis (typically cost). If the cost of donated inventory is not included in your opening inventory, the inventory's basis is zero so no deduction can be claimed. However, businesses that donate inventory for the care of the ill, the needy, or infants, an enhanced deduction is allowed (Code Sec. 170(e)(3)).

Leave-based donation programs. Companies may have programs that enable employees to donate their unused personal, sick, or vacation days, with this time used by other employees in medical emergencies or disasters. Donated leave time is taxable compensation to the donors, subject to payroll taxes. Employees cannot take any charitable contribution for their donations.

A special rule applies for donations to benefit victims of Hurricane Harvey. The IRS has guidance (https://www.irs.gov/pub/irs-drop/n-17-48.pdf) on the tax treatment of these leave-based donation programs. Employees are not taxed on their donations for this purpose, and no employment taxes are owed on employee contributions for this purpose. Employer can then donate the amount of these donations to a charity providing relief to victims of Hurricane Harvey and claim a tax deduction for this action. Employer donations to tax-exempt organizations must be made before January 1, 2019.

Other Rules

There are many variations on charitable giving, each with special tax ramifications. Some examples:

• Donations of appreciated property held more than one year are deductible at the property’s fair market value on the date of the contribution. Potential capital gain is never recognized.

• Donations can be arranged through special trusts, such as charitable remainder trusts. The donor (and spouse) can enjoy the property for life (or a term of years), with the remainder passed to a named charity. The donor can take a current deduction for the present value of the remainder interest. Another trust option is the charitable lead trust.

• Wealthy individuals can set up their own private foundations to further their philanthropic goals. Special tax rules apply to these foundations.

Year-End Tax Planning

At present, it is uncertain whether there will be any changes in the rules for charitable contributions and, if so, when they will become effective. Likely, the charitable contribution rules for 2017 will be unchanged. However, a decline in tax rates would mean that tax value of donations would be reduced. For example, a $1,000 donation for someone in the 39.6% tax bracket saves nearly $400 in federal income taxes. If the rate for the same taxpayer declines to 25%, the savings would be only $250.

Conclusion

While high-income taxpayers may continue to be generous donors, regardless of tax breaks for giving, thought should be given now to making donations before the end of the year. Review charitable giving to year-to-date and project the tax savings for additional gifts that can be made by December 31, 2017. Allow sufficient time when making donations that require qualified appraisals and legal documentation.

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Key Tax Laws by Birthday

  • Written by Sidney Kess, CPA, J.D., LL.M.

mug sid kessMany of the tax rules for individual taxpayers depend on age. Attaining a birthday may entitle an individual to a special tax break or end entitlement to another. Here is a rundown of key birthdays and what they mean for federal income taxes. It should be noted that some apply on the date of the birthday, some rules apply when the birthday is achieved as of the close of the taxable year, and some apply with respect to the half-year birthday.

Age 13

The dependent care credit can be claimed for a child who has not attained age 13 (Code Sec. 21(b)(1)(A)). This means that expenses up to this birthday can be taken into account for the year in which this birthday occurs.

Age, however, is disregarded if the child is a dependent who is physically or mentally incapable of self care (Code Sec. 21(b) (1)(B)).

Age 17

A tax credit of up to $1,000 can be claimed for a child under the age of 17 (Code Sec. 24(c)(1)). If they turn 17 during the year, no credit is allowed for that year; the credit is not prorated for this purpose. There is no age exception for a disabled child (Polsky, CA-3, USTC ¶ 50,506).

Age 18

A contribution of up to $2,000 can be made annually to a Coverdell Education Savings Account (ESA) until a child attains age 18 (Code Sec. 530(b)(1)(A)(ii)). However, a contribution can be made until the birthday. For example, if a child becomes 18 years old on May 1, 2017, a contribution of up to $2,000 can be made for 2017 until April 30, 2017. The contribution amount does not have to be prorated for the portion of the year in which the child was under age 18.

Ages 19 and 24

For purposes of treating a child as a qualifying child for the dependency exemption, these two birthdays come into play (Code Sec. 152(c)(1)(C)). A child can be a qualifying child if younger than the taxpayer claiming the exemption and is under age 19. A child can continue to be a qualifying child up to the age of 24 if he/she is a full-time student and younger than the taxpayer.

However, a parent may still claim a dependency exemption for a child who does not meet the definition of a qualifying child if the child can be treated as a qualifying relative (Code Sec. 152(d)). Thus, if a parent is supporting a child who is 32 years old in the parent’s home, a dependency exemption can be claimed as long as the child’s gross income is not more than a set amount ($4,050 in 2017) and other requirements are met.

Ages 19 and 24 are also key birthdays for the kiddie tax (Code Sec. 1(g)). Once this age is obtained, all of a child’s unearned income is taxed only at the child’s rates rather than the parent’s top tax rates.

Age 26

Under the Affordable Care Act, a child can remain on his/her parent’s insurance policy until the age of 26. This is so whether the child is a dependent or even lives with the parent. However, once the child attains age 26, this coverage is no longer permissible.

Age 30

When a beneficiary in a Coverdell ESA attains age 30, the account must be distributed to him or her within 30 days of this birthday (Code Sec. 530(b)(1)(E)). Even if there is no actual distribution, it is deemed to occur on this date. Earnings in the account become taxable at this time.

However, the deemed distribution rule does not apply if the beneficiary has special needs. Also a deemed distribution can be avoided by changing the beneficiary of the account to a “member of the family” (as defined in Code Sec. 529(e)(2), such as the beneficiary’s child, sibling.

Age 50

Individuals with compensation from a job or selfemployment can make a “catch-up” contribution to certain qualified retirement plans and IRAs (including Roth IRAs). These additional contributions are permitted to enable workers to maximize retirement savings. Despite the term “catch up” for those age 50 and older, there is no relationship to prior contributions or the absence of such contributions.

For 2017, the additional catch-up amounts (Notice 2016-62):

• 401(k), 403(b), and 457 plans: $6,000

• SIMPLE IRAs: $3,000

• IRAs and Roth IRAs: $1,000

Age 55

The 10% early distribution penalty on distributions from qualified retirement plans prior to age 59 ½ does not apply if distributions are made because of separation from service after age 55 (Code Sec. 72(t)(2)(A)(v)).

As in the case of retirement plans and IRAs, additional contributions based on age can be made to health savings accounts (HSAs) beginning at age 55. The additional contribution is $1,000. This amount is fixed by law; it is not indexed for inflation.

Age 59½

The 10% early distribution penalty on distributions from qualified retirement plans and IRAs does not apply after attaining age 59 ½ (Code Sec. 72(t)(2)(A)(i)).

Age 65

An individual who uses the standard deduction can claim an additional amount for age (Code Sec. 63(f)). For 2017, the additional standard deduction amount is $1,550 for singles and $1,250 for joint filers (for each spouse age 65 and older).This applies to someone who attains age 65 before the close of the taxable year. It also applies to anyone with a January 1 birthday; he or she is deemed to have reached age 65 in the previous year. For example, a person who attains age 65 on January 1, 2018, can claim the additional standard deduction on a 2017 income tax return.

This age also impacts the threshold for filing an income tax return (Code Sec. 6012(a)(1)(B)). More specifically, the gross income threshold is increased by the additional standard deduction amount.

Age 65 is also the age when distributions from HSAs can be taken penalty free for nonmedical expenses. However, these distributions are still subject to income tax.

Age 70½

Becoming 70½ years old bars any further contributions to an IRA (Code Sec. 219(d)(1)). No contribution is allowed if this age is attained by the end of the year. This contribution limit applies even though the individual continues to work. However, contributions to a SEP and a SIMPLE-IRA, which are IRA-based retirement plans, continue past this age, even though required minimum distributions simultaneously start at this time, explained next.

Attaining age 70½ triggers the required minimum distribution (RMD) rules for qualified retirement plans and IRAs. Owners of these accounts must begin their RMDs by the end of year in which this age is reached. For example, an individual’s 70th birthday is March 1, 2017. She reaches age 70½ in 2017, so her first RMD is due by December 31, 2017. If her birthday had been July 1, she would not attain age 70½ until 2018 and her first RMD would be due by December 31, 2018.

The failure to take an RMD can trigger a 50% penalty (Code Sec. 4974(a)). However, the RMD can be delayed in some circumstances:

• The first RMD is treated as timely if taken by April 1 following the year in which the taxpayer attains age 70½. In the earlier example, she would not have a penalty if her first RMD were taken by April 1, 2018. However, in any event, the second RMD is December 31, 2018.

• An individual who is still working for a company with a qualified plan may postpone RMDs until actual retirement if the plan permits it. However, this delay does not apply to anyone who is a more-than-5% owner of the company. And it does not apply to IRAs and IRA-based plans (e.g., SEPs, SIMPLE IRAs, and SARSEPs).

There are no lifetime RMDs for the owner of a Roth IRA.

Conclusion

Attorneys are used to working with tickler systems and calendars to ensure that key deadlines for certain actions are timely met. The same methods should be used to ensure that age-related tax rules are observed.


Executive Editor Sidney Kess is CPA-attorney, speaker and author of hundreds of tax books. The AICPA established the Sidney Kess Award for Excellence in Continuing Education in his honor, best-known for lecturing to over 700,000 practitioners on tax. Kess is senior consultant for Citrin Cooperman, consulting editor to CCH and Of Counsel to Kostelanetz & Fink.

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