2018 Year-End Tax Planning: A Whole New WorldBy Abe Schlisselfeld | November 16, 2018
The Tax Cut and Jobs Act ("TCJA") was passed almost a year ago, and countless hours have been spent discussing the pros and cons/winners and losers of the new law. With almost unanimous consent, members of the professional community are still scratching their heads as to how this reform can be considered “tax simplification.” From the onerous reporting burden now placed on pass-through entities and their tax preparers to the new incentive considerations in the Qualified Opportunity Fund program, 2018 year-end tax planning and compliance will seem like a whole new world.
This article will focus on a few items that business owners really need to think about as we approach year-end.
This may very possibly be the most discussed benefit to business owners. Otherwise known as the “20 percent deduction,” this tax benefit potentially allows the owner of a business with qualified business income to deduct 20 percent of their income for federal income tax payers. With a new maximum tax bracket of 37 percent, this deduction could give a taxpayer in the highest bracket a 29.6 percent effective rate on their business income - 10 percent lower than 2017!
Married filing joint taxpayers with taxable income under $315,000 ($157,500 for others) are allowed this 20 percent deduction for any business income. Above that threshold, the determination must first be made if the type of income qualifies for the deduction, as there are numerous fields (such as health, law, accounting and others) that are deemed a “specified service trade or business” and may not qualify.
In addition, even with qualified business income, if you earn over the threshold, you will be subject to tests based on W2 wages paid by the business, your depreciable unadjusted basis in the property and taxable income limitations that will determine if the 20 percent deduction is limited.
One may wonder: What is the planning opportunity? You either qualify or you don't! As discussed above, if your income is below certain thresholds, you qualify - irrespective of the type of income or the factors that determine your deduction. However, with the proper planning (i.e., timing income and deductions, timing charitable donations, setting up qualified retirement plans and other structuring opportunities), a taxpayer can maximize their 20 percent deduction. There is no one-size-fits-all answer, and each taxpayer should analyze their individual tax situation and run the numbers.
Once we have answers to the numerous questions raised by the proposed regulations issued in August (read more from our Tax Advisory Group), There may be further opportunities to analyze and restructure entities in order for taxpayers to maximize their 20 percent deduction. However, when considering any restructuring, keep in mind that it can be hard to unwind down the road – even after this law expires in 2026 – and you should consider potential unintended consequences with your tax advisor.
QUALIFIED OPPORTUNITY FUNDS
Another frequently discussed provision of the TCJA is the Qualified Opportunity Fund program. While this section of the law – which incentivizes investment of capital gains into low-income communities – has the potential to be very impactful, there is still a lot of uncertainty from a tax, economic and investment perspective, and few taxpayers have utilized the provision thus far.
The IRS just cleared up a few areas of uncertainty when it issued proposed regulations in October 2018. The regulations offer some clarification on gain deferral, taxpayer and investment property eligibility, treatment of land and buildings, and the timing of the basis step up election. Read more from our Real Estate Group on the proposed regulations.
Some areas of the provision necessitate further guidance, such as how leverage will work with this particular investment vehicle, as well as other issues.
Being that it’s football season, we can equate opportunity zones to an on-side kick - everyone is just waiting to pounce on it! However, with continued uncertainty and very little time left in the year to plan, we recommend staying tuned for more information on this matter from our Real Estate Group. Background on the Qualified Opportunity Fund program can be found in our Summer 2018 newsletter.
Wow – two code sections in one article! Under the new law, there is a provision that could potentially limit interest expense for businesses. For taxpayers with gross receipts in excess of $25 million, the interest expense deduction through 2021 is limited to 30 percent of earnings before depreciation, amortization, taxes and business interest (attribution rules apply with other entities – although we await guidance on how those rules will be applied).
Starting in 2022, the calculation is 30 percent of earnings before taxes and business interest. Therefore, the starting point will be a lot lower after 2022. The unallowed/excess interest is a very complicated area that goes beyond the scope of this article, but in short, it’s not lost and can be used in the future.
The real estate industry received a lucky break – a business that is deemed to be a real estate entity (a very encompassing definition) can make an election to deduct all interest expenses. The tradeoff is that any taxpayer making the election must use the ADS recovery period (a longer depreciable life) and, more importantly, may not take bonus depreciation.
The planning required here cannot be stressed enough. The election to be treated as an electing real estate entity is irrevocable. When the election needs to be made is still not certain. While the tangible property regulations allowing more generous deductions of the depreciation may not be as much of an issue for some, they must still be analyzed.
Taxpayers will need to model out the next eight years (until the law sunsets) and determine if they need the interest expense now or if they would rather have the depreciation. This has to be analyzed together with the other aspects of the tax law, such as whether taking bonus depreciation now will not allow the taxpayer to maximize their 20 percent deduction (as discussed above) and factoring in the business loss limitation (as discussed below). State tax issues must also be considered in this analysis.
EXCESS BUSINESS LOSSES
This may be the most under-the-radar, drastic change affecting the real estate industry under the TCJA. In the past, a real estate professional had the ability to deduct all real estate losses against any other income (e.g., wages, investment income). Under the TCJA, a married filing joint taxpayer can only deduct $500,000 of active losses ($250,000 for others) against their other income. The remaining amount is treated as a net operating loss (NOL), which is available in future years against 80 percent of pre-NOL taxable income.
This change may have enormous ramifications for certain real estate professionals who have become accustomed to “sheltering” their wage and investment income with real estate losses. Taxpayers need to determine if taking 100 percent bonus depreciation on a significant amount of assets will result in no benefit from the losses, while there may still be state taxes owed due to addbacks on state returns for a depreciation disallowance.
Once again, the planning here involves looking to the future and modeling out a taxpayer’s income forecast. If a taxpayer consistently has losses from real estate entities and is picking up investment income from other investments, perhaps it’s a good time to liquidate the investment portfolio and invest in real estate deals generating cash and taxable income. Obviously, investment decisions come before tax decisions, but this could be major factor in the investment decision.
Always keep in mind when planning that these are new laws and the IRS will always be looking for ways to close loopholes via legislation or regulations. What seems like a good idea today might turn out to be a problem tomorrow; don’t restructure anything that can’t be unstructured easily.
This upcoming tax season will be one for the books - not a postcard! Make sure to consult with your Marks Paneth advisor about these significant provisions, as well as the other changes that can affect your tax picture: enhanced bonus depreciation (including used assets), 1031 for real property, lower corporate tax rates and many more.
About Abe Schlisselfeld
Abe Schlisselfeld, CPA, EA, is the Co-Partner-in-Charge of the Real Estate Group at Marks Paneth LLP. With more than 20 years of experience in public accounting, Mr. Schlisselfeld’s concentration lies in the real estate industry, where he advises commercial and residential real estate owners, real estate management firms and REITs (real estate investment trusts) on all facets of accounting and taxation. He is a member of the Executive Committee of Marks Paneth, which sets policy and strategy... READ MORE +