Standard or Itemized Deduction

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Which shall it be?

Under the new, as well as prior, tax law, taxpayers can either take a standard deduction or itemize deductions on Schedule A of IRS Form 1040. Typically, tax preparation involves comparing the total of itemized deductions with the standard deduction and choosing the larger amount.

Most people have used the standard deduction and that probably will continue to be true, even more so for 2018 returns. If you plan to use the standard deduction, you can bypass planning for items on Schedule A and move on to other areas.

Larger and Smaller

One reason that the standard deduction likely will be more widely used is the increase under the TCJA. In 2018, the standard deduction is $12,000 for single taxpayers and married individuals filing separately (up from $6,350 in 2017), $24,000 for couples filing jointly (up from $12,700), and $18,000 for heads of household (up from $9,350).

Unmarried individuals who are not surviving spouses and who are 65 or older can add $1,600 to the preceding numbers. This amount is reduced to $1,300 per married taxpayer. The same additions to the standard deduction also apply to those who are blind.

The other reason for increased focus on the standard deduction is the reduction in potential itemized deductions. State and local tax deductions now are capped at $10,000 ($5,000 for married individuals filing separately). Miscellaneous itemized deductions, such as unreimbursed employee business expenses and tax preparation fees can no longer be deducted; the same is true for the interest paid on home equity debt that is used to buy, build, or substantially improve the home that secures the loan. Other cutbacks also apply.

The Bottom Line

The bottom line is that the 2018 standard deduction has a greater chance of exceeding your 2018 itemized deductions.

Example: Paul and Diane Brown have always itemized deductions on Schedule A, largely due to the amounts they pay in state income tax and local property tax. Both are over age 65, so their standard deduction this year is $26,600: $24,000 + $1,300 + $1,300.

Besides their capped $10,000 itemized deduction for taxes paid, the Browns expect to be able to deduct only modest amounts of mortgage interest and charitable contributions. They anticipate taking their standard deduction, so they won’t do any planning for itemized deductions in 2018.

Close Calls

The situation would be different if the Browns expected to pay $20,000 in home mortgage interest and make $10,000 in charitable gifts. They would be well over the standard deduction amount, including their $10,000 deduction for taxes paid, so planning could be useful. Depending on their situation, the Browns might want to choose elective medical procedures and accelerate charitable donations into 2018 to pay with tax-deductible dollars.

Planning is possible if the Browns project a total of, say, $23,000 in itemized deductions. They could move some deductible outlays into 2018 or defer some expenses into 2019 in order to itemize deductions in one of the two years.

If you are on the borderline between itemizing or taking the standard deduction in 2018, our staff can help you make tax-effective decisions at year-end. Give us a call. 

Standard Deduction Increases While Others Are Trimmed

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The Tax Cuts and Jobs Act generally took effect in 2018. Therefore, the fourth quarter of this year provides the first, real opportunity for year-end planning under what has been called the most important tax law passed in more than 30 years.

Broadly, the TCJA lowered income tax rates for individuals and for businesses. As you’ll read in the November Client Bulletin, the standard deduction has been substantially increased, but many deductions have been trimmed or eliminated, and some innovative tax benefits have been introduced.

Still, much of the tax code remains the same, and so does year-end planning. Retirement plans are largely unchanged. Business equipment purchases still qualify for favorable tax treatment, although the exclusion amount has doubled (a big tax break), and the federal estate tax is still combined with the gift tax.

download-pill-sm Standard Deduction Increases While Others Are Trimmed

 

 

 

Download the November Client Bulletin that provides tips for blending new tax-saving opportunities with old, reliable strategies.

Sales Tax and the Out-of-State Buyer

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If your company makes sales to out-of-state buyers, do you need to collect state sales tax? Until recently, Supreme Court decisions from the 20th-century declared that would not necessarily be the case.

Example 1: ABC Corp., based in Alabama, sends a catalog to customers and prospects. A consumer who lives in Wyoming places a $100 order.

Assume that ABC has neither employees nor property in Wyoming. ABC would not be required to collect Wyoming sales tax on the $100 purchase price and remit to Wyoming under those Supreme Court decisions because ABC had no “physical presence” in that state. (Wyoming, like most states, requires consumers to pay a use tax instead of a sales tax, but states have found it difficult to enforce compliance with their use taxes.)

Because they must collect sales tax, in-state retailers have been at a significant disadvantage versus out-of-state sellers who don’t collect sales tax.

South Dakota v. Wayfair

The 20th-century reasoning of the physical presence requirement did not recognize the realities of the 21st century, a divided (5-4) Supreme Court found earlier this year. In South Dakota v. Wayfair, Inc., 6/21/18, the Court held that the physical presence requirement no longer applied, paving the way for enforcement of a South Dakota law that requires many “remote” sellers to collect applicable sales tax on purchases by South Dakota residents.

The majority in the Wayfair decision pointed to some favorable aspects of the South Dakota law. For one, it applies only to remote sellers with at least 200 transactions or $100,000 in revenue from South Dakota buyers in a calendar year. Therefore, a company that occasionally ships a few moderately priced items across state lines needn’t master all the sales tax rules pertaining to South Dakota buyers and collect the tax and remit it to the state.

In addition, South Dakota is a party to the Streamlined Sales and Use Tax Agreement, which reportedly has 24 member states. This agreement, designed to standardize taxes in order to reduce administrative and compliance costs, provides sellers access to sales tax administration software.

Going Forward

After this Supreme Court decision, many (perhaps most) states will consider new legislation that requires out-of-state vendors to collect and forward sales tax, even without a physical presence in the buyer’s state. However, Congress might pass a federal law addressing the issue of interstate sales tax collection.

If no federal law is passed, the focus will remain on states’ actions. Assuming that states follow the format of the South Dakota law, companies that do a minimum amount of online retailing may not be greatly affected.

Contact Us

Conversely, small businesses that do a great deal of online selling, or plan to do so, might have to make extensive efforts to collect and forward sales tax to multiple states. We can help such companies comply with any requirements that arise. Contact us for help and guidance.

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Funding Company’s Buy-Sell With Life Insurance Can Be Tricky

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Photo: Stock

Among the trigger events of a small company buy-sell agreement, death of a co-owner typically is included.

Example 1: Wendy Young and Victor Thomas both own 50% of YT Corp. They have a buy-sell, which calls for Wendy to buy Victor’s interest in YT if he dies. Similarly, Victor will buy Wendy’s interest in YT from her estate if she is the first to die.

Small company buy-sells such as the one for YT Corp. often fall into one of two categories:

  • Cross purchase. Wendy will buy Victor’s shares directly from his heirs, or vice versa.
  • Here, YT Corp. will buy the decedent’s interest. If Victor is first to die, YT will buy his shares, leaving Wendy as the sole owner.

Finding the Funds 

With either type of buy-sell, a “buy” must be made, and the decedent’s interest in the company might be extremely valuable. Therefore, life insurance often is used to provide the funds for the buyout.

Example 2: In a cross-purchase arrangement, Wendy will acquire a policy on Victor’s life, and Victor will own a policy on Wendy’s life. If Victor dies, the insurance payout will go to Wendy, generally free of income tax. Wendy can use this money to buy Victor’s interest in YT Corp. from his estate at the price set in the buy-sell.

If Victor is the survivor, the process will take place in reverse.

Pros and Cons

There are some advantages to a cross-purchase arrangement. If the shares have appreciated over the years, Wendy will get a basis step-up to current value when she buys Victor’s shares. That could reduce the tax on a future sale of all of Wendy’s shares.

On the other hand, the premiums on a large life insurance policy could be substantial. Wendy and Victor might not be willing and able to pay these costs personally. This issue could be further complicated if, say, Victor is much older than Wendy and in poor health. The premiums on a policy insuring Victor could be much higher than the premiums for a policy insuring Wendy; this disparity may have to be resolved by some financial arrangement between the owners.

In addition, not every small company has 2 co-owners. With 3 owners, each would have to own life insurance policies on 2 others, for a total of 6 policies. Four owners would need 12 policies, and so on.

Regarding Redemptions 

Some of these cross-purchase problems can be resolved by using a corporate redemption plan.

Example 3: In a redemption plan, YT Corp. needs to buy only two life insurance policies: one on Wendy and the other on Victor. If Victor dies, the death benefit goes to YT, which uses the money to redeem Victor’s shares. If Wendy dies first, YT will buy her shares.

This method addresses the problems of multiple owners, uneven premium payments, and personal outlays for premiums. On the negative side, a redemption plan places what might be valuable insurance policies in the company’s possession, subject to creditors’ claims. Adverse tax issues also may arise, including the loss of a basis step-up for the surviving co-owner or owners.

Other ways to use life insurance for buy-sells may be suggested by an experienced insurance agent. For instance, a trust might be created and funded by multiple co-owners, with an independent trustee acquiring life insurance policies on those owners’ lives. The taxation of a trusteed buy-sell might be more favorable than taxation of a redemption plan. Our office can explain the likely tax consequences of any strategy you’re considering for funding a buy-sell through life insurance.

If your company initiates a buy-sell to be funded with life insurance, make sure to keep the policies up to date. If the company’s value grows but the coverage doesn’t increase, the insurance payout could be only a fraction of the required purchase price.

 

 

Disclaimer: This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

Life Insurance for More Than Just Cash Flow

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Photo: Stock

 

Many people think of life insurance as a product for family protection. The life of one or two breadwinners is insured; in case of an untimely death, the insurance payout can help with raising children and maintaining the current lifestyle.

Once the children are able to live independently and a surviving spouse is financially secure, insurance coverage may be dropped. Such a strategy uses life insurance as a hedge against the risk of lost income when that cash flow is vital.

This type of planning is often necessary. That said, life insurance may serve other purposes, including some that are not readily apparent.

Final Expenses

When someone dies, funeral and burial expenses can be daunting. In addition, the decedent’s debts might need to be paid off, perhaps including substantial end-of-life medical bills. Many insurers offer policies specifically for these and other post-death obligations, with death benefits commonly ranging from $10,000 to $50,000.

The beneficiary, typically a surviving spouse or child, can receive a cash inflow in a relatively short time. Generally, this payout won’t be subject to income tax. The result might be less stress for beneficiaries during a difficult time and a reduced need to make immediate financial decisions in order to raise funds.

Investment Support

This year’s stock market volatility has worried some investors, who may be tempted to turn to safer holdings, which have little or no long-term growth potential. Prudent use of life insurance might help to allay such fears.

Example 1: Jill Miller has $600,000 in her investment portfolio, where she has a sizable allocation to stocks. She is concerned that an economic downturn could drop her portfolio value to $500,000, $400,000, or less. Therefore, Jill buys a $250,000 policy on her life.

Now Jill knows that her children, the policy beneficiaries, will receive that $250,000 at her death, income-tax-free, in addition to any other assets she’ll pass down. This gives her the confidence to continue holding stocks, which might deliver substantial gains for Jill and her children.

Balancing Acts

Life insurance also can help to treat heirs equally, if that is someone’s intention, but circumstances create challenges.

Example 2: Charles Phillips, a widower, owns a successful business in which his older daughter Diane has become a key executive. Charles would like to leave the company to Diane, but that would exclude his younger daughter Eve, who has other interests.

Therefore, Charles buys a large insurance policy on his life, payable to Eve. This assured death benefit for Eve will help Charles structure his estate plan so that both of his daughters will be treated fairly. There is a potential downside to consider if Charles is wealthy enough to have an estate that is subject to the federal estate tax ($11.18 million in 2018). In this case, a large insurance policy will swell his gross estate, leading to a greater estate tax liability.

Life insurance may be especially helpful when one or both spouses has children from a previous marriage.

Example 3: Jim Devlin’s estate plan calls for most of his assets to be left in trust for his second wife, Robin. At Robin’s death, the trust assets will pass to Jim’s children from his first marriage. Robin is younger than Jim, so it could be many years before his children receive a meaningful inheritance.

Again, life insurance can provide an answer. If Jim insures his life and names his children as beneficiaries, his children may get an ample amount without having a long wait.

Proceed Carefully

The life insurance marketplace ranges from straightforward term policies to so-called permanent policies (forms of variable, universal, or whole life) that have investment accounts with cash value. In some cases, policyholders can tap the cash value for tax-free funds while they’re alive.

Our team can help explain the tax aspects of a policy you’re considering, but you should exercise caution when evaluating any possible purchase of life insurance. Give us a call to find out what you’ll be paying and what you’ll be receiving in return.

Additional Resources

Disclaimer: This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.