Home Equity Loans May Still Be Deductible

house-lawn_LI Home Equity Loans May Still Be Deductible
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The Tax Cuts and Jobs Act of 2017 affected the tax deduction for interest paid on home equity debt as of 2018. Under prior law, you could deduct interest on up to $100,000 of home equity debt, no matter how you used the money. The old rule is scheduled to return in 2026.

The bad news is that you now cannot deduct interest on home equity loans or home equity lines of credit if you use the money for college bills, medical expenses, paying down credit card debt, and so on. The good news is that the IRS has announced “Interest on Home Equity Loans Often Still Deductible Under New Law.” The details are in IR 2018-32, a news release from the IRS.

The Book, Not The Cover

According to the IRS, even if a loan is labeled “home equity,” the interest may be deductible on your tax return. The key is how the borrowed money is used. In addition, the $100,000 ceiling doesn’t apply.

For home loan interest to be tax deductible, the taxpayer that secures the loan must use the money to buy, build, or substantially improve his or her home. Beginning in 2018, taxpayers may only deduct interest on $750,000 of such “qualified residence loans,” or $375,000 for a married taxpayer filing separately.

Those numbers apply to the total of a taxpayer’s home loans, but older loans up to $1 million and $500,000, respectively, may have fully deductible interest. As before, home loan interest on debt that exceeds the cost of the home won’t be eligible for an interest deduction, among other requirements.

Fine Points

For home loans obtained in 2018 and future years, some tax rules are clear, but some are more complex.

Example 1: Eve Harper gets a $500,000 loan from Main Street Bank to buy a home in July 2018. In November 2018, Eve gets a $50,000 “home equity” loan from Broad Street Bank, which she uses to buy a car. The interest on the second loan is not tax deductible.

Example 2: Same as example 1, except that Eve uses the Broad Street Bank loan to install central air conditioning, add a powder room, and upgrade plumbing throughout her new home. The interest on both of these loans will be deductible.

The tax treatment of these examples may seem straightforward, but that’s not always true.

Example 3: Same as example 1, except that the Broad Street Bank loan is used to make a down payment on a mountain cabin, where Eve plans to go for vacations. Interest on this $50,000 loan is deductible because the total of both loans does not exceed $750,000, and the $50,000 loan is secured by the cabin. Indeed, Eve could get a loan up to $250,000 (for a $750,000 total of home loans) to buy the cabin and still deduct the interest, as long as this loan is secured by the cabin.

Example 4: Same as example 3, except that the Broad Street Bank loan is secured by Eve’s main home, not by the cabin she’s buying. Now, the Broad Street Bank loan would be considered home equity debt no matter how much was borrowed, and no interest on that loan could be deducted.

Over the Limit

What would happen if Eve gets a $500,000 loan in June to buy her main house and another $500,000 loan in November to buy a vacation home? She would be over the $750,000 debt limit for deducting interest on 2018 home loans, so only a percentage of the interest paid would be tax deductible.

The bottom line is that if you intend to use a home equity loan to buy, build, or substantially improve a home, you should be careful about how the debt is secured. Be prepared to show that the money really was used for qualified purposes.

Moreover, qualified home loans obtained on or before December 15, 2017, are grandfathered, with tax deductions allowed for interest up to $1 million or $500,000, as explained. Some questions remain, though, about how refinancing those grandfathered loans will affect the tax treatment. If you are considering refinancing a home loan that’s now grandfathered, our office can provide the latest guidance on how your taxes might be affected.

Secured Debt

  • Home loan interest is deductible, up to the applicable limit, only if the obligation is a secured debt.
  • You must sign an instrument, such as a mortgage, deed of trust, or land contract, that makes your ownership interest in a qualified home security for payment of the debt.
  • A qualified home includes a house, condominium, mobile home, boat, or house trailer with sleeping, cooking, and toilet facilities that is your main home or second home.
  • In case of default, the home used as security can satisfy the debt.
  • This arrangement must be recorded or otherwise officially noted under the relevant state or local law.

Make an appointment with one of our tax professionals or financial advisors to make sure you’re receiving the most deducted possible as a home owner. You could also complete the following form to reach us.

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1360792598 Home Equity Loans May Still Be Deductible



 

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

Many Business Expenses Are No Longer Deductible

business-expense_LI Many Business Expenses Are No Longer Deductible
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The good news is that the TCJA of 2017 lowered corporate tax rates from a graduated schedule that reached 35% to a 21% flat rate. The bad news? Many business expenses are no longer tax deductible. That list includes all outlays that might be considered entertainment or recreation.

As of 2018, tickets to sports events can’t be deducted, even if you walk away from the game with a new client or a lucrative contract. The same is true if you treat a prospect to seats at a Broadway play or take a valued vendor out for a round of golf. Those outlays will be true costs for business owners without any tax relief.

Drilling Down 

Does that mean that you should drop all your season tickets supporting local teams? Cancel club memberships? Pack away your putter and your tennis racquet? Before taking any actions in this area, take a breath and crunch some numbers.

Example: In recent years, Luke Watson spent about $20,000 a year on various forms of entertainment, which his company claimed as a business expense. Indeed, these were valid expenses and helped his LW Corp. grow rapidly.

Assume that LW Corp. paid income tax at a 34% rate. In 2017 and prior years, business entertaining was only 50% deductible. Thus, LW Corp. deducted $10,000 (half of Luke’s expenses) and saved $3,400 (34% of $10,000). With $3,400 of tax savings and $20,000 of out-of-pocket costs, Luke’s net cost for entertaining was $16,600 under the law in effect during 2017.

Now suppose that Luke has the same $20,000 of entertainment costs in 2018 and that those costs would have still been 50% tax deductible at the new 21% tax rate. His tax savings would have been only $2,100, so the net entertainment cost would have been $17,900. As it is, under the new law his actual entertainment cost would be the full $20,000 with no tax benefit.

This example assumes that LW Corp. pays the corporate income tax on its profits. If Luke operates his business as an LLC or an S corporation, with business income passed through to his personal tax return, the calculation would be different, but the principle would be the same.

Business entertainment has been done mainly with after-tax dollars. Under the new TCJA, you’ll entertain clients and prospects solely with after-tax dollars. You should be careful about how this money is spent and judge the expected benefit. Nevertheless, if business entertaining has paid off for your company in the past, it may still prove to be valuable even without tax breaks.

Fine Points 

Meal expenses associated with operating a trade or business, including employee travel meals, generally continue to be 50% tax deductible. However, keep in mind that the rules have changed for meals provided for the employer’s convenience. Previously, these were 100% deductible if they were excludible from employees’ gross income as de minimis fringe benefits. That might have been the cost of providing free drinks and snacks to employees at the workplace. Now outlays for such meals are only 50% deductible and they’re scheduled to become nondeductible after 2025.

On the bright side, the new law doesn’t affect expenses for recreation, social, or similar activities primarily for the benefit of a company’s employees, other than highly compensated employees. So, your business likely can still pay for holiday office parties with pre-tax dollars.

Give us a call if you have questions about business expenses for yourself or your staff. We are glad to help you to understand the tax changes businesses are going through.

 

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

Bond Funds Are Not Riskless – Holdings Diversity is Key

stock-market_LI Bond Funds Are Not Riskless - Holdings Diversity is Key
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Typically, bond funds with low yields have relatively low risk (see the CPA Client Bulletin, March 2018). That doesn’t mean that these funds are riskless, though. With interest rates expected to rise this year, all types of bond values could drop, leading to an overall pullback in the prices of bond fund shares.

One way to respond to this unwelcome outlook is to diversify your fixed-income holdings.

Example: Jane Miller has a target asset allocation of 60% in stocks and 40% in bonds. Working with her financial adviser, Jane puts half of that fixed income allocation (20% of her entire portfolio) into bond funds that mainly hold short-term issues from government entities and financially sound corporations. Such funds are likely to have low yields, but they probably will hold most or all of their value in the coming months and years.

These lower risk funds may be considered core fixed-income investments.

Beyond the Norm

Assume that Jane can tolerate some volatility in her portfolio. If so, she might put the other half of her fixed income allocation into these types of bond funds:

  • High-yield funds. These funds typically invest in corporate bonds that are unrated or low rated by specialized agencies, perhaps because the issuers are not in excellent financial condition. Fund holdings may be known as junk bonds. Yields are relatively high, but bond prices might drop in times of economic weakness, which can raise doubts about the companies’ ability to meet interest and redemption promises. This danger, known as credit risk, may be reduced if the fund holds many issues because most of a professionally chosen portfolio is likely to avoid defaults.
  • Emerging markets bond funds. Holdings include bonds from governments and companies based in areas considered to be developing economically. For example, such places could range from Brazil to Russia to South Africa. Currency movements may affect returns positively or negatively, but there might be little influence from U.S. interest rate moves.
  • Bank loan funds. As the name indicates, such funds purchase loans made by banks. The borrowers are usually companies; frequently, the loans are used to finance acquisitions. Questions about the borrowers’ ability to repay the debt make these funds vulnerable to recessions and low growth periods. On the other hand, bank loan funds generally invest in variable rate debt, so borrowers’ payment obligations (and the dividends to investors) can go up when interest rates rise.
  • Preferred stock funds. Whereas familiar stock funds own common stock of issuers, these funds buy preferred The name indicates that investors will be paid before common stock holders, in case the issuer can’t meet all its obligations. Preferred stock payouts come before dividends on common shares. In practice, preferred shares tend to pay fixed bond-like yields, and trading prices may have low volatility. Preferred stock funds can be considered more like bond funds than stock funds.
  • Municipal high yield funds. These funds hold tax-exempt municipal bonds from issuers that do not have a sterling credit rating. In essence, these funds are the tax-exempt cousin of the high-yield funds mentioned previously in this article, which pay taxable interest.

As is the case with all municipal bonds and muni bond funds, they should be held in taxable accounts to use their exemption. The other types of funds covered here may be favored for tax-deferred accounts such as IRAs, for which the high dividend payments can compound without a current tax haircut.

Staying Put

All of the fund categories mentioned in this article have numerous entrants, so yields will vary from fund to fund. You may be able to find yields around 5% in some funds, whereas core bond funds might be yielding 3% or 2% or even less. Over a lengthy holding period, the difference between compounding a 5% yield and compounding a 2% or 3% yield can be sizable.

Moreover, bond funds tend to buy new bonds because of bond sales, bond redemptions, and new money from investors. If interest rates are rising, fund purchases will bring higher yields, whereas lower yielding bonds are replaced. Again, investors should plan on holding for the long term in order to maximize the value of using bond funds with relatively high yields.

Proceed with Caution

High yields generally mean substantial risks, so you may want to mix such bond funds with lower yielding but less volatile bond funds. You could hold funds from every category mentioned here, or you could select only one or two categories to perhaps improve fixed income returns.

If you already hold mutual funds and you’re pleased with the results, you might want to see if the fund company has a high-yield fund, an emerging markets bond fund, and so on. Look at the fund’s past performance, manager tenure, and investment philosophy before making decisions. The same criteria apply if you’re choosing among funds from other companies on your own or if you’re working with an adviser.

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

Future Divorce Tactics Impacted by Tax Reform

divorce_LI Future Divorce Tactics Impacted by Tax Reform
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When couples divorce, financial negotiations often involve alimony. The tax rules regarding alimony were dramatically changed by the Tax Cuts and Jobs Act (TCJA) of 2017, but existing agreements have been grandfathered. In addition, the old rules remain in effect for divorce and separation agreements executed during 2018.

Next year, the rules will change, and the roles will be reversed.

Under divorce or separation agreements executed in 2018, and for many years in the past, alimony payments have been tax deductible. Moreover, these deductions reduce adjusted gross income, so they may have benefits elsewhere on a tax return. While the spouse or former spouse paying the alimony gets a tax deduction, the recipient reports alimony as taxable income.

Shifting Into Reverse

Beginning with agreements executed in 2019, there will be no tax deduction for alimony. As an offset, alimony recipients won’t include the payments in income.

Example 1: Joe and Kim Alexander get divorced in 2018. Joe expects to be in a 35% tax bracket in the future, whereas Kim anticipates being in a 22% bracket. Suppose that the proposed agreement has Joe paying $3,500 a month ($42,000 a year) in alimony.

Joe will save $14,700 in tax (35% times $42,000), but Kim will owe $9,240 (22% times $42,000). Net, the couple will save over $5,000 per year in taxes. This type of calculation will affect the negotiations, as it has in the past. Assuming the relevant rules are followed, it may make sense to tip the agreement toward Joe paying alimony to Kim, perhaps in return for other considerations.

Example 2: Assume that the Alexanders’ neighbors, Len and Marie Baker, have identical finances. They divorce in 2019. If Len pays $42,000 a year in alimony, he will get no deduction and won’t get the $14,700 in annual tax savings that Joe did in example 1. Marie, on the other hand, will pocket $42,000, tax-free, without the $9,240 tax bill faced by Kim in example 1.

Moving Things Along

Just as people shouldn’t “let the tax tail wag the investment dog,” so taxes shouldn’t dominate divorce or separation proceedings. However, it’s also true that taxes shouldn’t be ignored. If you are in such a situation, our office can help explain to both parties the possible savings available from executing an agreement during 2018, rather than in a future year.

The new rules will be in effect beginning in 2019. With no alimony deduction and a tax exemption for alimony income, it may be desirable to consider after-tax, rather than pre-tax, income when making decisions. Speaking very generally, there may be less cash for the couple to use after-tax.

Keep in mind that, as of 2019, not all states will have alimony tax laws that conform to the new federal rule. Your state may still offer tax deductions for alimony payments and impose income tax on alimony received. That’s all the more reason to look at after-tax results when calculating a divorce or separation agreement.

Getting Personal

The impact of the new TCJA on spousal negotiations may go beyond the taxation of alimony. Among other provisions to consider, the TCJA abolishes personal exemptions. As a tradeoff, the standard deduction was almost doubled.

In some past instances, divorcing spouses would agree that the high bracket party would claim the children’s personal exemptions, which effectively were tax deductions, in return for some other consideration. Now those exemptions don’t exist, so they shouldn’t be part of divorce negotiations. If you previously entered into an agreement that included the treatment of children’s personal exemptions, you may want to consult with counsel to see about possible revisions.

Defining Alimony

Payments to a spouse or former spouse must meet several requirements to be treated as alimony for tax purposes. The following are some key tests:

  • The payments are made under a divorce or separation agreement. 
  • There is no liability to continue the payments after the recipient’s death.
  • The payments aren’t treated as child support or a property settlement.
  • The payments are made in cash (including checks or money orders).

If you have a situation like one of the above, give us a call to help you understand the potential tax implications in future returns.

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

Do you know your true tax rate?

man-warehouse_LI Do you know your true tax rate?

It has been widely reported that the TCJA lowers federal income tax rates for many people. The highest tax rate, for example, has fallen from 39.6% to 37%. Many people who are in lower brackets also stand to benefit.

Example 1: Alice Young had $100,000 of taxable income in 2017. As a single filer, Alice was in the 28% tax bracket. If Alice has that same $100,000 in taxable income in 2018, she will be in a 24% bracket. Indeed, Alice could add as much as $57,500 in taxable income this year and maintain her lower 24% tax rate.

Not for Everyone

However, there are some quirks in the new tax rates. Some people actually face higher rates.

Example 2: Brad Walker had $220,000 of taxable income in 2017, which put him in a 33% tax bracket. With the same income in 2018, Brad will face a 35% tax rate.

In addition, the federal tax rates such as 24% or 35% are just one factor in determining the true rate you’ll pay by adding taxable income, or the true amount you’ll save with a tax deduction. Many people owe state or even local income tax, which might be fully or partially deductible on a federal tax return or not deductible at all. Various other provisions of the tax code will also impact your marginal tax rate—the percent you’ll owe or save by adding or reducing taxable income.

Knowing your true tax rate can help you make knowledgeable financial decisions.

By starting with your 2017 tax return and incorporating your expectations, as well as your plans for 2018, our team can help you determine the value of tax-related actions. Give us a call to discuss the changes you can make in 2018 that will impact future returns.

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