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Tax Law: An Art or a Science? May 29, 2019

Posted by bradstreetblogger in : Business consulting, General, tax changes, Tax Planning Tips, Tax Tip, Taxes , add a comment

Is preparing tax returns an art or a science? My answer may depend upon the day you ask me. But, more often than not, I would say that tax preparation is a blend of an art AND a science.

Too often when people are presented with a tax problem of sorts – what do they do? Well, of course, they pull out their smartphone and GOOGLE their question. In all honesty I am guilty of this quick fix as well. Naturally, we are all looking for the answer that we wish to hear. That being anything that will save us taxes. Most GOOGLE responses, especially the ones near the top of the search page are click bait. They have the answers you want to see. You are doing yourself a disservice if you stop with that “fast and loose” answer. You have to look for the “odd” stuff, the twists and turns that accompany the exceptions to every tax rule. Some of these may help you while others will cost you money. Even once you have found the exceptions then one must continue to look for how your question fits in with or conflicts with other sections of the Internal Revenue Code. And, what about that tax law change or court case that was handed down yesterday. What about that new tax law on the horizon? Did you notice that the website where you fell in love with the answer is six (6) years old?

The “art” part comes from trying to hit a moving target. A target that is not always visible but at the end of the day you have to take the shot. Or, at least spin it in a fashion so that you have not crossed the often-fuzzy line and stayed in the gray.

                                        –    Mark Bradstreet

An Internal Revenue Service official once introduced me to the rule of PUNG. When writing about taxes, he said, make frequent use of the words “probably, usually, normally and generally.”

That’s generally good advice—not only for tax columnists struggling to explain tricky tax laws but also for tens of millions of taxpayers racing to file their returns on time. “The law is chock-full of exceptions and counterintuitive twists that are easy to overlook and can often have an important impact on your tax bill”, says Claudia Hill, owner of TaxMam Inc., a tax services firm in Cupertino, Calif.

With the tax-filing deadline fast approaching for most of us, here are a few reminders from tax pros on how the fine print can sometimes be your friend.

Filing deadline: For most taxpayers, the filing deadline is April 15. But it’s April 17 for taxpayers who live in Maine or Massachusetts because of the Patriots’ Day holiday there on April 15 and the Emancipation Day holiday in the District of Columbia on April 16. It can be even later for other taxpayers, such as those in places designated as federal disaster areas.

If you need more time to file, as millions of people do each year, don’t panic: The IRS gives automatic six-month extensions until Oct. 15. But its website notes that an “extension of time to file your return doesn’t grant you any extension of time to pay your taxes.” The IRS estimates it will receive more than 14.6 million extension requests; a spokesman says.

Casualty losses: Fires, floods, mudslides, tornadoes, hurricanes and many other natural disasters made 2018 a year many of us are eager to forget, and this year already is shaping up as another grim reminder of Mother Nature’s awesome power.

At first glance, the wide-ranging tax law enacted in late 2017 might seem like yet another disaster for the many people who suffered major casualty losses. That law generally eliminated personal casualty and theft-loss deductions for most taxpayers, starting last year. But there is an important exception, says Jackie Perlman, principal tax research analyst at The Tax Institute at H&R Block Inc. in Kansas City, Mo. Victims still are eligible to deduct net personal casualty losses “to the extent they’re attributable to a federally declared disaster,” the IRS says.

Warning: There are important loss limitations and other tricky calculations to consider. For details, see IRS Publication 547.

Here is a holdover from the old law that may surprise some people because it sounds counterintuitive: Victims in federal disaster areas can choose to claim their losses for the year in which the disaster actually struck or for the prior year. For example, taxpayers with net personal casualty losses this year could claim their losses on their return for 2018—or they could wait until next year and claim it on their return for 2019, says Ms. Jackie Perlman of H&R Block. Taxpayers who suffered losses in 2018 could claim those losses on their return for that year—or on their return for 2017 (typically by filing an amended return).

14-day rule: As a general rule, the net rental income you get from renting out your home is subject to tax. But “there’s a special rule if you use a dwelling unit as a residence and rent it for fewer than 15 days,” the IRS says on its website. “In this case, don’t report any of the rental income and don’t deduct any expenses as rental expenses.”

Those 14 days don’t have to be consecutive, says Ms. Claudia Hill, who is also an enrolled agent (enrolled agents are tax specialists authorized to represent taxpayers at all levels of the IRS). But if you rent your home for 15 days or more, include all of that rental income in your income, says Ms. Jackie Perlman.

Refund claims: Don’t assume that you have forever to file your federal income-tax return as long as you are entitled to a refund. About 1.2 million taxpayers could lose almost $1.4 billion in unclaimed refunds because they still haven’t filed a 2015 Form 1040 return, the IRS warned in a recent press release.

“In cases where a federal income tax return was not filed, the law provides most taxpayers with a three-year window of opportunity to claim a tax refund,” the IRS says. If they miss that deadline, “the money becomes the property of the U.S. Treasury. For 2015 tax returns, the window closes April 15, 2019, for most taxpayers.”

Here are other reasons to pay attention: The IRS reminded taxpayers seeking a 2015 tax refund “that their checks may be held if they have not filed tax returns for 2016 and 2017. In addition, the refund will be applied to any amounts still owed to the IRS or a state tax agency and may be used to offset unpaid child support or past due federal debts, such as student loans.”

Credit for excess Social Security tax: Most people probably assume it’s a waste of time to check and see how much their employers withheld from their paychecks for Social Security. But consider doing it anyway, especially if you’re a high-income taxpayer who worked for two or more employers last year. The maximum amount that should have been withheld for 2018 was $7,960.80 (6.2% of $128,400, which was the maximum amount of wages subject to the tax.) If more than that was withheld, claim a credit for the excess amount. However, if any single employer withheld too much, ask the employer to adjust the tax for you, the IRS says. “If the employer doesn’t adjust the overcollection you can file a claim for refund using Form 843.”

Interesting exception: Interest income you receive on U.S. Treasury bills, notes and bonds is taxable at the federal level. But don’t forget that such interest is tax-free at the state and local level. That can be especially important for taxpayers in New York City, California or other high-tax areas.

Additional standard deduction: Thanks to the 2017 law, tax professionals predict many more people will claim the standard deduction for 2018, rather than itemizing. That law included a sharp increase in the basic standard deduction and generally limited state and local tax deductions to $10,000 per household. The basic standard deduction for 2018 is $24,000 for married couples filing jointly, or $12,000 for most singles and those who are married but filing separately.

But there is an extra amount for older taxpayers, those who qualify as blind, or both. For example, if you’re married filing jointly and you and your spouse each are 65 or older, the total standard deduction for 2018 would be $26,600. See IRS Publication 17 for more details.

IRA deadline: It might seem logical to assume there is nothing you can do now to affect your return for 2018. But for some people, it isn’t too late: The IRS says contributions to a traditional IRA can be made for a year “at any time during the year or by the due date for filing your return for that year, not including extensions. For most people, this means that contributions for 2018 must be made by April 15, 2019 (April 17, 2019, if you live in Maine or Massachusetts).”

Educator Expenses: Teachers and other educators who pay for educational supplies and other expenses out of their own pockets should be aware that those costs may be deductible up to $250 a year. This special deduction applies to teachers from kindergarten through grade 12, instructors, counselors, principals or aides in school for at least 900 hours during a school year. Qualified expenses include “ordinary and necessary expenses paid in connection with books, supplies, equipment (including computer equipment, software, and services), and other materials used in the classroom,” the IRS says. But you can’t deduct expenses for home schooling or for “nonathletic supplies for courses in health or physical education.”

If you and your spouse file jointly and both are eligible, “the maximum deduction is $500,” the IRS says. “However, neither spouse can deduct more than $250 of his or her qualified expenses.” This deduction goes on Schedule 1 of Form 1040, line 23.

Credit given to: Tom Herman. This article was written for the WSJ on Monday, March 25, 2019. Mr. Herman is a writer in New York City. He was formerly The Wall Street Journal’s Tax Report columnist. Send comments and tax questions to taxquestions@wsj.com.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | Hmmm…When Should I Get Married? May 15, 2019

Posted by bradstreetblogger in : Deductions, General, tax changes, Tax Planning Tips, Tax Tip, Taxes, Uncategorized , add a comment

As long as I can remember, the IRS has penalized couples for being married with higher income taxes (as opposed to being single). However, the latest tax laws have significantly reduced; and, even in many cases, eliminated the so-called “marriage penalty.” Now, for many couples, the “marriage penalty” does not exist until their combined taxable income hits the top marginal income tax bracket of 37%. If these high-income couples are considering a wedding late in the year – they may wish to consider waiting to marry early the next year instead.  

On the other hand, the “marriage penalty” does still exist when considering some of the tax deductions. For example, only one $10,000 state and local tax ceiling on itemized deductions is available for a married couple. If single, each would have the same $10,000 available for their state and local tax deductions. Other scenarios might include when one spouse has significant unreimbursed medical expenses or circumstances surrounding the 20% Qualified Business Income Deduction. 

The tax filing status of married filing separately is still an option but not as beneficial as it once was. But, regardless, the numbers still need run to optimize the best filing status.  

An article written by Ms. Winokur Munk published in the WSJ on Monday, March 18, 2019 follows. It delves further into the tax ramifications of being married.

– Mark Bradstreet

Among many things, the Tax Cuts and Jobs Act of 2017 affected the so-called marriage penalty, which occurs when a couple’s total tax bill rises as a result of getting married and filing their taxes jointly.

Under the old tax code, the marriage penalty hit medium- to high-income earners particularly hard. That had to do with differences in the income-tax brackets for married couples vs. individuals. Now, however, those brackets have been adjusted to eliminate those discrepancies—except for taxpayers who are subject to the top 37% marginal rate.

The 37% marginal tax rate kicks in at taxable income above $500,000 for single individuals, or over $600,000 for married couples filing jointly—so two people with income well below $500,000 each can be pushed into the highest bracket if they’re married and filing together.

Meanwhile, a marriage penalty remains in place for some other federal taxes, and a new one has been created by new limitations on deductions.

What impact will the tax-law changes have on married couples, and what do couples planning to tie the knot need to know about how their planned nuptials could affect their taxes?

The Wall Street Journal invited three experts to discuss these issues: Mitchell Drossman, national director of wealth-planning strategies at U.S. Trust; Mela Garber, a tax principal at accounting firm Anchin, Block & Anchin; and Robert Westley, a vice president and wealth adviser at Northern Trust and member of the American Institute of Certified Public Accountants’ Personal Financial Specialist Credential Committee.

Here are edited excerpts of the discussion.

Savings and penalties

WSJ: Can you provide an example or two of how the marriage penalty might affect couples under the new law?

MS. GARBER: Under the old law, two single taxpayers who earned $95,000 and $125,000 would have had a combined tax bill of $41,965 after the standard deduction and personal exemptions, whereas filing jointly as a married couple they would have had to pay $42,661—a marriage penalty of $696. Under the new rules, however, the couple would pay a total of $35,619 in taxes, $7 less than the single filers.

MR. DROSSMAN: Even for taxpayers who are high wage earners, the marriage penalty generally isn’t as significant as it once was. If two single people are each earning $350,000, their individual tax liability would be $94,000 each—$188,000 in total. However, by getting married and filing a joint return, their tax liability becomes $189,500. Under those circumstances, the marriage penalty is $1,500, whereas under the previous tax laws the marriage penalty would have been in the neighborhood of $24,000—a significant difference.

WSJ: So, the new tax law reduces the marriage penalty in those cases. Where does it increase the marriage penalty?

MR. WESTLEY: A marriage penalty can also occur on the deduction side. For example, the new tax act limits the deduction for state and local taxes to $10,000. That means two single taxpayers can each deduct their own state and local taxes up to $10,000. However, as a married couple, they are limited to the same $10,000 deduction cap, since it’s not doubled for married couples filing joint tax returns. Filing separately does not avoid the disparate treatment, since married taxpayers filing separately are limited to a $5,000 deduction.

MS. GARBER: The $10,000 state income- and property-tax deduction cap will hit especially hard for taxpayers who live in states that have high income and property taxes, such as New York, New Jersey, Connecticut and California.

MR. DROSSMAN: In addition, under the new law couples still have to contend with the Medicare surtax and the surtax on net investment income. Both surtaxes apply to individuals with earnings above $200,000 or married couples with income over $250,000.

Easing the pain

WSJ: What can couples do to mitigate the effects of a marriage penalty?

MR. WESTLEY: For high-wage-earning couples, it might make sense for one person to scale back on work so as not to reach the income threshold where the penalty kicks in. Given added hassles and expenses that can come with working, it’s a conversation that’s at least worth having.

MR. DROSSMAN: Even with the new tax rules, high-earning couples thinking about a late-year wedding may be better off deferring it until the following year if they can save some taxes.

WSJ: Are there publicly available tools to help couples decide whether it pays to file as individuals or jointly?

MR. WESTLEY: Yes, the Tax Policy Center has a great calculator that can help taxpayers understand how their tax liability will change as a result of getting married. Another excellent resource for taxpayers is the Marginal Tax Rate Calculator from the AICPA’s 360 Degrees of Financial Literacy website. This calculator allows you to estimate your income-tax liability and choose between different filing statuses to see how the results differ. Still, there are many possible tax situations and nuances, so I think most taxpayers would benefit from working closely with a trusted professional.

Marriage prep

WSJ: What tax-related advice do you have for couples getting married?

MR. WESTLEY: I think many couples assume that filing separately when they are married is the same as filing as a single taxpayer. But once you’re married, you no longer have the option to file as a single taxpayer. While you can file separately as a married couple, in most cases filing separately is likely to raise their overall household tax bill.

There can be, however, a few situations where it may make economic sense to file separately. If, for example, one spouse has significant unreimbursed medical expenses and both spouses are income earners, filing separately will lower their adjusted gross income and allow the spouse with high unreimbursed medical expenses to achieve a greater deduction amount.

However, couples need to remember that when filing separately both spouses must either itemize or use the standard deduction. Therefore, if only one spouse has enough itemized deductions to exceed the current standard deduction, filing separately may not save tax for the household in the aggregate.

The creation of the 20% qualified business income deduction under the new act is a new area that may induce some couples to file separately. When one spouse qualifies for the 20% QBI deduction but the other spouse’s income pushes the couple over the phaseout threshold, filing separately may be advantageous.

Again, there are many quirks with the married-filing-separately tax status, so it’s imperative to go through the actual calculations with a qualified professional. Married-filing-separately is generally unfavorable, since it limits or disqualifies the use of many tax breaks that couples filing jointly can otherwise take.

MS. GARBER: It may benefit a couple getting married to do tax planning and prepare a projected tax return. This exercise may save them money when the time comes to file their first joint tax return. For example, if they are charitable and intend to give donations, given that the standard deduction increased substantially under the new tax law, they may want to consider bunching and combining two or more years’ worth of donations into one year to get the benefit of their deduction. Otherwise, the risk is that neither year’s contributions will be eligible for the deduction.

The projected return should also show whether the couple’s investments are aligned with their income-tax bracket. For instance, if two individuals have investments in taxable bonds, which worked well when they were filing as singles, it may no longer be beneficial to hold these types of bonds. Perhaps they should switch to municipal bonds, because combining their income together will push them up into higher tax brackets. Preparation of their projected tax return will show which investments will generate higher net-of-tax returns.

Credit Given to:  Cheryl Winokur Munk.  Ms. Winokur Munk is a writer in West Orange, N.J. Email her at reports@wsj.com. Appeared in the March 18, 2019, print edition as ‘Does It Pay (Taxwise) To Get Married?’

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration.

We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | Was Your Tax Refund What You Wanted? May 8, 2019

Posted by bradstreetblogger in : Deductions, General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

Many taxpayers were surprised this year by the amount of their tax refund or their tax balance due. Most refunds were less than the prior year and those who typically owe money, owed more. There were also those people who normally received a refund who were now dismayed to discover a balance due. Even tax preparers were surprised to the extent of these tax refund reductions or additional amounts due. Yes, multiple warnings were issued by the “Chicken Littles” during the year. Well, these “Chicken Littles” turned out to be correct. The new 2018 withholding tables not only gave you an early refund from the new tax law BUT some “extra.” This “extra” is what reduced your withholdings which lead to the nasty tax return surprises. Adding insult to injury, your 2019 refunds (or balances due) may be even worse since the new 2018 withholding tables were not for a full year. They may have started as late as February 15, 2018 (and I am sure some employers began later than that.) So, if you want your bottom line on your tax return to look like times of old – better increase your withholding now.

The below WSJ article published April 13-14, 2019 by Laura Saunders further explains this situation along with some possible remedies.  

                                                          –    Mark Bradstreet

Congratulations American taxpayers, you made it through the first filing season after the largest tax overhaul in a generation. Now do yourself a favor and check your withholding.

For weeks, news articles, message boards, and family dinners have been filled with unhappy taxpayers lamenting tax-refund shortfalls or surprise bills. For many, that’s because they didn’t watch their withholding.

Among them is Alaric DeArment, a 36-year-old biotechnology journalist in New York City.

He got a tax cut from the overhaul, as did two-thirds of American households. For 2018, his federal bill is $2,400 lower than in 2017. But his tax cut didn’t feel like one, he says, because he didn’t know that last year the Treasury Department lowered paycheck withholding for millions of workers in order to speed up delivery of the tax cuts.

So, his customary tax refund of between $1,000 and $3,000 became a surprise tax bill of $785 this year. As a result, Mr. DeArment can’t use a refund to help pay for a trip to Eastern Europe or a new laptop, as he planned. Instead, he’s paying his tax due in installments.

“It’s horrible, a bummer,” he says. He says he’ll change his withholding soon.

So far, about 1.2 million fewer filers are getting refunds compared with last year, according to the latest data from the Internal Revenue Service. Total refunds are down by about $5.8 billion, or 2.6%. The average refund is $2,833, down $31 from this time last year.

This data doesn’t measure the number of filers who have gotten unwelcome surprises this year, such as a lower refund or higher payment due, because of the withholding changes.

Tax preparers say there are many. Don Rosenberg, an enrolled agent in Yorktown Heights, N.Y., says that despite the overall tax cuts, 75% of his clients are unhappy with their tax results this year, many of them because of withholding changes.

“Anybody who says refund size doesn’t matter should sit in my office for a week,” he says.

The emotional response to tax refunds or bills has a logic of its own. People often use tax refunds to help with big purchases, although it means they’ve made an interest-free loan to Uncle Sam by letting the government have more of their money during the year.

The bottom line: If you’re upset by this year’s refund or tax bill, consider changing your withholding to prevent a rerun next year.

Tax specialists at H&R Block, which prepares 20 million returns a year, warn that many filers with smaller refunds this year are set for even lower ones for 2019, because Treasury’s withholding changes will be in effect for the full year. The average refund for this group will be $200 lower next year without adjustments to withholding, based on analysis of their clients.

In addition, the IRS approved broad waivers of penalties on 2018 underpayments. These likely won’t be extended for 2019, and most filers need to pay 90% of what they owe during the year to avoid penalties. Here’s more information about changing your withholding.

Know the options. You can consult a tax preparer, but there are ways to do it yourself. The simplest is to take the additional total amount you want withheld, based on this year’s outcome, and divide it by remaining paychecks. Then put that on the IRS’s Form W-4 and give it to your employer.

You can also recalculate your withholding using the W-4 form, but this can be confusing. The IRS hasn’t finished a redesign following the overhaul, and a proposal released last year proved controversial because it asked workers to share private information with employers. An update is due soon.

You can also use an IRS calculator to figure what you’ll owe for 2019. It allows inputs for more than one earner, investment income and more. Users need their most recent tax return plus recent pay stubs and perhaps other information.

Make good use of paycheck withholding. Do you have nonwage income, as from outside gigs or investments? To avoid penalties, you may need to pay quarterly taxes on this income. If so, it often makes sense to increase paycheck withholding instead, as it’s not subject to the same timing requirements as quarterly payments. 

For example, taxes on nonwage earnings from the first quarter are due April 15 in order to avoid penalties. But if the same taxes are paid through increased withholding in November, there are often no penalties.

Pay attention to pensions. Withholding was lowered for pension payments as well as for paychecks. If you want to raise it, use Form W-4P.

Beware of bonuses. The tax overhaul cut the withholding on bonuses from 25% to 22%, so that can contribute to lower refunds or higher tax bills. Employers will withhold more if requested.

Credit given to Laura Saunders. Write to Laura Saunders at laura.saunders@wsj.com.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration.  

We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA

–until next week.

Tax Tip of the Week | Real Estate – Tax Basis April 24, 2019

Posted by bradstreetblogger in : Depreciation options, General, Section 168, Section 179, tax changes, Tax Tip, Taxes, Uncategorized , add a comment

In an earlier Tax Tip, different tax categories of real estate were briefly discussed. This week we will discuss how a tax gain or loss is treated upon sale by the various classifications as listed below:

1.    Principal residence – Your gain (loss) is calculated by subtracting your tax basis from your sales price. Your tax basis starts with your original cost, adds in any qualifying improvements, and includes most of the selling expenses you incur when sold. Provided certain tests are met, gain is excludable up to $500,000 on a joint return, or $250,000 for a single filer. Exception: Any depreciation taken after May 6, 1997 is usually taxable. Depreciation may have been taken on an office in the home or any business usage. Any loss upon the sale of a personal residence in non-deductible.

2.    Second home – Your tax basis is calculated in the same manner as a personal residence. Any gain is taxed as capital gain. No exclusion is allowed as with a personal residence. No one may designate more than one property as a personal residence. Just as with a personal residence, any loss upon the sale of a second home is non-deductible.

3.    Rental property – The tax basis is calculated in the same manner as a personal residence with one major exception.   Because rental properties are depreciated over time, basis has to be reduced by the depreciation allowed or allowable. Any gain on the sale of a rental property is taxed as capital gain. However, the gain attributable to the depreciation taken could be taxed as high as 25%. This in known as Section 1250 recapture. Any excess gain is taxed as normal capital gain with a maximum rate of 20%. A loss on the sale of a rental property is normally deductible as an ordinary loss (not subject to the $3,000 per year net capital loss limitation).

4.    Investment property – Depreciation is not normally allowed on investment property. A loss is deductible to the extent of capital gains plus $3,000 per year for joint or single filers, and $1,500 per year for a married filing separate return.

5.    Business property – Same as rental property above if owned individually.

6.    Gifted property – Your tax basis in a property received as a gift is the same as the basis was in the hands of the giver.

7.    Inherited property – Your tax basis in an inherited property is generally the fair market value of the property as of the date of death of the decedent, commonly called a “stepped-up basis”.

As noted above, gains and losses are often treated very differently depending upon the type of property. Please understand what your type of property is and that its character may change for a variety of reasons including your intentions. Being able to substantiate all of this may be important.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This week’s author – Norman S. Hicks, CPA

–until next week.

Tax Tip of the Week | Trusts – The Very Basics April 3, 2019

Posted by bradstreetblogger in : General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes , add a comment

While a trust may be considered an “entity”, it is actually a fiduciary relationship whereby a trustee holds legal title to property and has a duty to manage that property for the benefit of others (known as beneficiaries).

A trust is formed by a trust agreement. There are many types and purposes of trusts, so the trust agreement has to be written specifically to accommodate the goals of the one setting up the trust who is known as the grantor. Once the trust has been set up, the grantor, also referred to as the settlor, or trustor, can then transfer property to the trust to be managed by the trustee.

A trust can be revocable, or irrevocable. A revocable trust, sometimes referred to as a living trust, is generally set up by a grantor who is also the trustee and beneficiary, and who retains the power to revoke or amend the trust. These trusts are legal entities, but are disregarded for federal tax purposes. In fact, they usually use the social security number of the grantor, and all income is reported on the grantor’s tax return. As such, a revocable trust does not file its own return.

On the other hand, an irrevocable trust does usually need to file a tax return, and, depending on the trust agreement, any tax due will be paid by the trust, or by the beneficiaries, or in some cases, by both the trust and the beneficiaries. It is usually better tax-wise if the beneficiaries pay the tax due to the short tax brackets applicable to trusts (and estates). The highest tax rate for a trust is the same as an individual’s, 37% for 2018. However, the highest tax bracket for an individual for 2018 begins at a taxable income of $500,000, while the highest bracket for a trust begins at $12,500. Trusts can also be taxable at the state level. For Ohio, trust rules are governed by the Ohio Trust Code which was enacted January 1, 2007.

There are several reasons for setting up trusts. One is to avoid probate. Revocable living trusts are generally used for this purpose. A trust can help your estate retain privacy whereas the probate process creates a public record. In addition, probate fees can be significant.

Another reason for a trust is to help preserve estate exemptions. A-B trusts, also known as bypass or marital trusts, can be used for this purpose. Other types of trusts used for marital purposes include the QTIP Trust and the Power of Appointment Trust.

Irrevocable Life Insurance Trusts (ILIT’s) are used to prevent the taxability of life insurance within an estate. Dynasty Trusts are used to preserve assets for children and grandchildren or other beneficiaries. Incentive trusts can be used to encourage the behavior of beneficiaries, such as getting a college degree, or to address specific problems such as drug abuse. Special needs trusts can be set up for a physically or mentally disabled child. Spendthrift trusts can provide protection from creditors. Spendthrift clauses can be used in other types of trusts as well. Some additional types of trusts include the charitable remainder, charitable lead, Medicaid trusts, grantor retained annuity trusts, and numerous others.

The taxability of these trusts rests with the trust agreement. Before the trust agreement can be drafted, various questions must be answered. Some of the more important ones are:

•    How much control do I want?
•    Who will be the trustee and can the trustee be trusted?
•    Can I fire the trustee and name a new one?
•    Do I want to be able to revoke, or amend the trust?
•    Can I change the beneficiaries?
•    Do I want the income to be distributed?

As you can see, trusts and their taxation are very complicated. If you are considering setting up a trust, please seek the help of an attorney and a tax professional.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This Week’s Author – Norman S Hicks, CPA

–until next week.

Tax Tip of the Week | All You Need to Know About Student Loan Forgiveness March 27, 2019

Posted by bradstreetblogger in : Deductions, General, tax changes, Tax Deadlines, Tax Planning Tips, Taxes , add a comment

The sheer magnitude of our outstanding student loan debt is beyond my feeble comprehension. According to the Federal Reserve, student-loan debt hit $1.53 trillion at the end of the second quarter of 2018. I may understand “millions” and just perhaps “billions,” but the concept of “trillions” totally escapes me. Almost two-thirds of that total debt or about $900 billion is carried by women.

An article written in the WSJ on December 17, 2018 by Ms. Berman, a reporter at MarketWatch follows. Her article discusses some limited options on having some of the student-loans forgiven, but, very often someone has to jump through some really high hoops to qualify. So keep your fingers crossed, but I wouldn’t hold your breath.

                                                                                                    – Mark C. Bradstreet

“Student-loan forgiveness might seem out of reach for many of the 44 million people who have educational debt. But some of these borrowers may qualify for relief—if they know where to look.

Student-loan forgiveness has gotten somewhat of a bad rap in recent months, largely because of controversy surrounding the federal Public Service Loan Forgiveness program, which allows public servants with a certain type of federal student loans to have their debt discharged after 120 monthly payments.

The first cohorts of borrowers became eligible for forgiveness under PSLF in the fall of 2017 and in the months since, advocates have grown concerned that confusion about the program’s requirements, combined with sloppy implementation on the part of student-loan companies and the government, has made it difficult for eligible borrowers to qualify. Of the roughly 28,000 people who filed an application for debt forgiveness under the program as of June 2018, just 96 had their loans forgiven, government data show.

PSLF may be the best known loan-forgiveness program, but it isn’t the only one. Not only are there other federal programs, cities and states across the country offer some debt forgiveness for people who work in certain jobs or even live in certain areas.

Here is a closer look at some programs and their requirements:

Federal programs

PSLF: To be eligible, borrowers must work full-time in a public-service job for the right type of employer—typically a federal, state or local government or a nonprofit with a 501(c)3 designation. They must have the right type of loan—a federal Direct Loan—and be in an income-driven repayment plan to benefit. Borrowers also need to have made 120 on-time payments toward their debt to have the remainder forgiven under PSLF.

It’s hard to say exactly why so many borrowers who applied to have their loans forgiven were rejected. It could be that many simply hadn’t been working in public service or paying down their loans for the full 10 years. But some data indicate that confusion over the program’s requirements played a role.

Of borrowers who have had at least one employment certification form (the document borrowers can use to ensure they’re on track toward forgiveness) approved, nearly 12% are repaying their loans under a nonqualifying repayment plan, according to the Education Department. Congress authorized a temporary expansion of PSLF earlier this year for borrowers who met all of the program’s other requirements but were using certain nonqualifying repayment plans.

Advocates also worry that borrowers who have Federal Family Education Loans, which don’t qualify for PSLF, are working in eligible jobs and repaying their debt, assuming they’ll qualify for forgiveness only to later face a rude awakening. Borrowers can consolidate FFEL debt into Direct Loans, but they may not know to do that unless they receive information about it from their student-loan servicer. (Borrowers who think they might qualify for PSLF should reach out to their servicer and ask whether they have Direct Loans, and if not, how they can consolidate their student debt into Direct Loans.)

Liz Hill, an Education Department spokeswoman, says the agency’s office of Federal Student Aid is approving every eligible application for PSLF under the “strict rules” established by Congress. It is also conducting regular outreach to borrowers about the program via social media, webinars and in person events.

“FSA is committed to enhancing the process, outreach, and communications related to the program,” she wrote in an email.

Are You Eligible?
Borrowers who want to know if they are on track to qualify for the federal Public Service Loan Forgiveness program can submit an employment certification form. A separate application is needed to claim forgiveness.

Teacher loan forgiveness: Teachers who work for five consecutive years in qualifying schools—typically those serving low-income students-—can receive up to $17,500 in forgiveness on certain federal loans; depending on what subject they teach. They need to have been a new borrower as of Oct. 1, 1998, meaning that they had no prior loans still outstanding as of this date. Also, they must have completed at least one of their qualifying years of teaching after the 1997-1998 academic year.

Teachers can’t use this program and PSLF at the same time, so they need to pick that one that best suits their financial needs. The American Federation of Teachers, a national teachers union, tends to advise borrowers to focus on PSLF, which offers superior benefits, unless the borrower doesn’t plan to stay in public service for the full 10 years.

Perkins Loan cancellation: Nurses, firefighters, public defenders and others may be eligible for cancellation of their Perkins Loans, federal need-based loans for both undergraduate and graduate students. Typically, a percentage of the loan is forgiven for each year of service, culminating in 100% of the loan being discharged after up to seven years.

Congress ended schools’ authority to make new Perkins Loans last year, so there won’t be any new borrowers receiving them—at least for now.

Income-driven repayment forgiveness: Borrowers using income-driven plans for federal loans can have the balance of the debt discharged after 20 or 25 years of payments, even if they aren’t working in public service. But under current law, debt relief is taxed as income, so borrowers may face a heftier-than-normal tax bill after their loans are discharged.

State, local programs

States and regions across the country offer a variety of student-loan forgiveness programs, most of which fall into two categories: those tied to a specific occupation or those tied to living in a specific region, or both. Many of these programs cover private student loans, which federal debt-forgiveness programs don’t.

“Almost every single state has at least one program,” says Betsy Mayotte, president of the Institute of Student Loan Advisors, which recently compiled a list of 115 debt-forgiveness programs.

While the list is a good place to start, Ms. Mayotte cautions that the eligibility criteria and funding available for many of these programs changes constantly, so borrowers need to check with the entities offering forgiveness directly before making a financial plan based on them.

In some cases, borrowers may be able to combine a state or local program with Public Service Loan Forgiveness, says Heather Jarvis, an attorney and student-loan expert. For example, borrowers can use some loan-repayment assistance programs sponsored by states, nonprofits or their employers to help defray the cost of their loan payments during the 10 years they’re working to become eligible for PSLF.

Occupation-focused programs typically center on health care, education or legal-services jobs, Ms. Mayotte says.

Michigan’s Department of Health and Human Services will pay off a significant chunk of health professionals’ loans—both federal and private—if they agree to work in primary care in an underserved area. The initiative, which doctors, dentists, nurse practitioners and other health professionals can use to pay off up to $200,000 of debt over eight years, was designed “specifically to recruit and retain primary-care providers in underserved areas in Michigan,” says Elizabeth Nagel of the policy, planning and legislative-services administration at the Michigan Department of Health & Human Services.

Location-based programs, while not as widespread, simply require the borrower to live in a certain region, Ms. Mayotte says.

Kansas launched its Rural Opportunity Zones program in 2011 to encourage educated workers to move to certain rural regions experiencing population decline, says Rachéll Rowand, the program manager.

Borrowers with an associate’s, bachelor’s or graduate degree and a student-loan balance in their own name can become eligible for some debt relief by establishing residency in a ROZ county on or after the date the county opted into the program. They also need a sponsor, which can be an employer or the county itself. Borrowers can receive up to $15,000 in assistance on federal and private student loans over five years. And they can use the program along with PSLF if they qualify.

Of course, when considering any loan-forgiveness program tied to a job or place, borrowers need to ask themselves how committed they are to staying put for a long period.

While a loan-forgiveness program essentially helps to make a low-paying career possible with high student-debt levels, it “really isn’t an incentive to go into a particular occupation,” says Mark Kantrowitz, the publisher of Savingforcollege.com and a financial-aid expert.

“In most cases,” he says, “you might actually be better off taking a job in a different field that pays better.”

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This Week’s Author – Mark C. Bradstreet, CPA

-until next week

Tax Tip of the Week | 5 Ways to Fail a Sales Tax Audit March 20, 2019

Posted by bradstreetblogger in : General, tax changes, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

IRS audits are horrible! Sales tax audits are worse. In some areas, a sales tax auditor has more legal authority than an IRS agent. Yes, that is scary! Some businesses think that it is not a big deal failing to collect sales tax from a “favorite” customer since the customer would be liable anyway in an audit. It is not that easy – the sales tax agent collects this shortfall from whoever they are auditing. You might be paying the sales tax for your “favorite” customer. Good luck trying to get those dollars back from them.

The article below is advertising from an Avalara blog. I do not know anything about Avalara other than this tongue in cheek article which makes a lot of sense at least from my experience over the years.
                                                      By Mark Bradstreet

 FROM THE AVALARA BLOG JANUARY 23, 2019

 “All businesses relish a good sales tax audit. After all, what’s not to like? And did you know it’s possible to spend more time, money, and resources than absolutely necessary during an audit? It’s true. Simply follow the five tips below and you’ll dramatically increase your chances of having to pay those coveted audit penalties. 

[From the Avalara blog.]

1. Give the auditor a hard time

Spare no inconvenience. Send the auditor on coffee runs. Set the auditor up in your most cramped and unappealing space then make the auditor sort through the messiest records. First impressions matter when it comes to audits, so make yours a terrible one. The harder the experience for the auditor, the more likely that auditor will help you spend more money, resources, and time.

2. Assume you don’t need to collect tax

This is a high-risk move. If you have nexus in a state, you’re required to collect and remit sales tax; and while nexus used to refer primarily to some sort of physical presence, that’s no longer the case.

On June 21, 2018, the Supreme Court of the United States ruled physical presence is not a requisite for sales tax collection. Since the decision in South Dakota v. Wayfair, Inc., more than 30 states have broadened their sales tax laws to include a business’s “economic and virtual contacts” with the state, or economic nexus. That trend is likely to continue until all states with a general sales tax impose a sales tax collection obligation on remote sellers.

If you want to ensure you run afoul of auditors, just keep on not collecting in states where you make significant sales: Tax authorities are looking for you; they’ll likely find you.

3. Put your exemption certificates in a box in the warehouse

This gives you two advantages. First, it forces the auditor to dig through a potentially rat-infested box for the records needed, thus wasting more time. Second, it increases your chances of losing certificates to flood, fire, or vermin.

If you don’t have a complete certificate that proves a customer is exempt, you’ll owe the state for the sales tax you didn’t charge — plus bonus penalties and interest.

4. Keep incorrect records

You want to fail a sales tax audit? Make sure your records don’t match your bank accounts. If you have more or less money in your account than shows up on your sales tax records, you’re begging for an audit penalty.

If incorrect records are too blatant for your taste, strive for incomplete records. Don’t stress about recording every cent of sales tax charged to your customers. Scribble sales tax records down on a sheet of paper so you’ll never know where to find them when you need them. The auditor will linger as long as there’s a clear discrepancy between how much you collect and how much you record.

5. Pay less than you owe

This one’s about your overall method. You can drastically increase your risk of penalties during an audit by manually managing sales tax. Paying less sales tax than what your business owes will substantiate incorrect record-keeping, shoddy certificate storage, and (purposeful) ignorance about nexus. Plus, think of all of the other opportunities for error that await when you manually manage the following:

•    State and local jurisdiction rate changes
•    Filing methods and schedules for each taxing jurisdiction
•    Changing product taxability rules

But seriously

We know you don’t actually want to waste time, money, and resources. So, hopefully these tips give you some ideas of what not to do.

The right technology can turn sales tax management from painful and risky to easy and more accurate. Avalara’s suite of solutions can reduce your risk by automating calculations, certificate management, timely filing, and easy-to-access reports.”

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This Week’s Author – Mark C. Bradstreet, CPA

-until next week

Five Things to Know About Proposed Tweaks to the Retirement Systems March 13, 2019

Posted by bradstreetblogger in : Deductions, tax changes, Tax Deadlines, Tax Planning Tips, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

The following article, by Anne Tergesen (WSJ), discusses possible revisions to the USA retirement system. These “proposed tweaks” may never happen or if they do, the changes will most likely be different than what follows. When I first began in taxes, an elderly tax practitioner told me to stop worrying about the future tax law changes and to make my decisions based upon the current law. For more often than not, I thought that was good advice. But that is not to say, we should bury our heads in the sand and not consider the provisions that Congress is working on.

-Mark Bradstreet

“In addition to giving annuities a greater role in 401(k) plans as part of its proposals to tweak the U.S. retirement system, Congress is considering provisions that could serve to expand workers’ access to retirement-savings plans and make it easier for savers to tap their accounts in case of emergencies. Here are five changes Americans could see in their 401(k) plans and individual retirement accounts.

(1)     A New Item on 401(k) Disclosures
Currently, 401(k) plans are required to send participants quarterly and annual account statements with their balance. Under the proposed legislation, plan sponsors would have to show an estimate of the monthly income a participant’s balance could generate with an annuity, a detail akin to the payoff disclosures required on credit-card statements. The goal is to help workers better understand how prepared they are to maintain their income in retirement.

(2) A Repeal of the Age Limit on IRA Contributions
If you are 70 ½ or older, you can’t currently make deductible contributions to a traditional IRA. Congress is considering removing the age cap and allowing people above 70 ½ or older to deposit up to $6,500 a year in either a traditional IRA or a Roth IRA. With a traditional IRA, account holder’s generally get to subtract their contributions from their income but they must pay ordinary income taxes on the money when they withdraw it – something they are required to do starting at age 70 ½ (the bill would do nothing to change that). With a Roth IRA, there is no upfront tax deduction but the money increases tax-free.

(3) More Types of Savings Accounts
Among the proposals under consideration is a new type of universal savings account that would offer more-flexible withdrawal rules than existing retirement accounts, according to Rep. Kenny Marchant (R, Texas) Employers could also be allowed to automatically enroll workers into emergency savings accounts. (Employees would be free to opt out.)

(4)  More Ways for Graduate Students to Fund IRAs
The bill would allow students to contribute taxable stipend or fellowship payments to an IRA, something that’s not currently possible.

(5)  Pooled 401(k) Plans
For years policy makers have tried to make retirement-savings plans more attractive and affordable to small businesses, many of which have no plan at all. About one-half of private-sector employees, many of whom work for small companies, lack access to a workplace retirement plan. Under one measure before Congress, small employers would be able to more easily band together to spread out the administrative costs of 401(k) plans. The proposal would eliminate a requirement that employers have a connection, such as being members of the same industry trade group, in order to join a so-called multiple-employer plan. Congress is also considering expanding a tax credit available to small companies to offset the costs of starting a new retirement plan. The annual credit amount would increase from $500 to as much as $5,000 for three years.”

Credit given to Anne Tergesen, WSJ
Saturday/Sunday July 21-22, 2018

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This week’s author – Mark Bradstreet, CPA
–until next week.

Tax Tip of the Week |Offshore Tax Cheats – The IRS is Still Coming for You March 6, 2019

Posted by bradstreetblogger in : General, tax changes, Tax Tip, Taxes, Taxes, Uncategorized , add a comment

Having an offshore account is not illegal, provided the accounts are in compliance with U.S. tax laws which include appropriate disclosure. And, yes, you can get into serious trouble for failing to attach the appropriate forms to your income tax return. So, please be certain to advise your tax preparer of any foreign assets you may have. But, where things get really dicey, is the situation of using these “secret” accounts to hide your money and not paying any income tax (offshore tax evasions is a criminal act). More details from Laura Saunders follow.

  • Mark Bradstreet

“Hiding money from the U.S. government is a lot harder than it used to be.  

On Sept. 28, the Internal Revenue Service will end (now ended) its program allowing American tax cheats with secret offshore accounts to confess them and avoid prison. In a statement, the IRS said it’s closing the program because of declining demand.

But the agency vowed to keep pursuing the people hiding money offshore and said it will offer them another route to compliance.

What a difference a decade makes.

Before 2008, an American citizen could often walk into a Swiss bank, deposit millions of dollars, and walk out confident that the funds were safe and hidden from Uncle Sam, says Mark Matthews, a lawyer with Caplin & Drysdale who formerly helped the IRS’ criminal division.

Now he says, “Americans hiding money abroad have to go to small islands with sketchy advisers and less reliable financial systems.”

The reason:  a historic crackdown on the longstanding problem of U.S. taxpayers hiding money offshore, U.S. officials ramped it up after a whistleblower revealed that some Swiss banks saw U.S. tax evasions as a profit center and were sending bankers onto U.S. soil to hunt for clients.

The defining moment came in 2008, when Justice Department prosecutors took Swiss banking giant UBS AG to court and managed to pierce the veil of Swiss bank secrecy. In 2009, UBS agreed to pay $780 million and turn over information on hundreds of U.S. customers to avoid criminal prosecution.

The Justice Department repeated the UBS strategy, with variations, for scores of other banks and financial firms in Switzerland, Israel, Liechtenstein and the Caribbean. So far, institutions have paid about $6 billion and turned over once-sacrosanct customer information. More major settlements are still to come.

Prosecutors also successfully pursued more than 150 individuals hiding money abroad. Some defendants earned jail time, and many paid dearly – a total of more than $500 million so far. Dan Horsky, a retired business professor and a startup investor, appears to have handed over the largest amount: $125 million for hiding more than $220 million offshore.  

In many cases, a taxpayer can owe a penalty of half a foreign account’s value, if it’s greater than $10,000 and it’s not reported to the Treasury Department. Ty Warner, the billionaire creator of Beanie Babies plush toys, paid $53.6 million for hiding an account with more than $100 million.

The IRS capitalized on tax cheats’ fears of detection with its Offshore Voluntary Disclosure Program, the limited amnesty that’s ending. It hit confessors with large penalties in exchange for no prosecution. Since 2009, more than 56,000 U.S. taxpayers in the program have paid $11.1 billion to resolve their issues.

To be sure, the U.S. crackdown hasn’t reached everywhere – notably Asia.

Edward Robbins, a criminal tax lawyer in Los Angeles formerly with the IRS and Justice Department, attributes the enforcement gap to the widespread use of human beings, rather than structures like trusts, to shield account ownership in Asia.

“In the Far East, individuals often use other individuals who use other individuals to hold assets. Finding the true owner is a tough nut to crack, unlike in the West,” he says.

The crackdown also had drawbacks, making financial life difficult for many of the roughly 4 million U.S. citizens living abroad. Unlike most countries, the U.S. taxes citizens on income earned both at home and abroad. Often expatriates were stunned to find they could be considered tax cheats under the expansive U.S. Law and that compliance would be onerous.

In reaction, more than 25,000 expats have given up U.S. citizenship since 2008, with some paying a stiff exit tax. Others are working to get Congress to change the taxation of nonresidents.

For expats and others, the IRS now offers a compliance program with lesser penalties, or none, for offshore-account holders who didn’t willfully cheat. About 65,000 taxpayers have entered the program and the IRS says it will remain open for now.

Current and would-be tax cheats should take seriously the IRS’s vow to keep pursuing secret offshore accounts, says Bryan Skarlatos, a criminal tax lawyer with Kostelanetz & Fink who has handled more than 1,500 offshore disclosures to the IRS.

Although the IRS’s staffing is way down, he says, the agency and the Justice Department have far better tools for detecting and combating evasion than 10 years ago.

Among these agencies’ tools are the Fatca law, which requires foreign firms to report information on American account holders.This law is providing the IRS with streams of useful information it’s using in prosecutions.This week brought the first guilty plea for a violation of Fatca rules by a former executive of a bank in Hungary and the Caribbean.

The IRS is also mining data from foreign bank settlements and whistleblower information. The payment of $104 million to UBS whistleblower Bradley Birkenfield, apparently the largest ever, has inspired other informers.

To detect clusters of cheats, U.S. officials now can use a “John Doe summons” to force firms to release information on a class of customers suspected of evading taxes – even if their identities aren’t known, and even if the information isn’t in the U.S.

This strategy has been so successful that the IRS has broadened its use to identify possible tax cheats using cryptocurrencies.

“More than ever, there’s no place to hide,” say Mr. Skarlatos.”

Credit given to Tax Report, Laura Saunders, WSJ, September 15-16, 2018

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This Week’s Author – Mark C. Bradstreet, CPA

-until next week

Tax Tip of the Week | How The New 20% QBI Deduction (199A) May Apply to Rentals (particularly triple net leases) February 27, 2019

Posted by bradstreetblogger in : Deductions, General, tax changes, Tax Preparation, Tax Tip, Taxes, Uncategorized , add a comment

How The New 20% QBI Deduction (199A) May Apply to Rentals (particularly triple net leases)

As a refresher, the QBI deduction is available for the first time on your 2018 Form 1040. So, this is all new stuff for you and us (and the IRS). The new QBI deduction, created by the 2017 Tax Cuts and Jobs Act (TCJA) allows many owners of sole proprietorships, partnerships, S corporations, trusts, or estates to deduct up to 20 percent of their qualified business income. Yes, if you qualify – that may be a huge deduction for you. So, when it comes to the interpretation of 199A, there is a lot at stake for a lot of businesses.

Landlords have anxiously awaited further guidance in regards to Section 199A. There has been much speculation if, when and how the Section 199A would apply for them.  Finally, on Friday, January 18, 2019, the Treasury Department and the Internal Revenue Service issued final regulations on the implementation of the new qualified business income (QBI) deduction for rentals. Now we have to interpret their interpretation. And, only time will tell, whether this final interpretation is their last interpretation (probably not).

What follows is specifically about landlords and the applicability of 199A. For starters, let’s define “triple net lease.” This term often comes up in business conversations. Interestingly, not everyone has the same definition in mind. So, excerpts from the first article below define some different types of leases before moving into the second and last article which tends to revolve around “triple net leases.” Please keep in mind that his interpretation of the final 199A interpretation as well as some of his opinions may differ from ours. Many parts of the new tax law are still fuzzy, moving targets and this one is no exception.

By Mark Bradstreet

By Rob Blundred  – Commercial Sales Associate, Henkle Schueler and Associates
Aug 6, 2018

Net lease
The benefit of a net lease is that the landlord can charge a lower base rent price. However, along with the base rent the tenant is responsible for an “additional rent fee” which covers the operations and maintenance of the property. These costs can cover real estate taxes, property insurance and common area maintenance (CAM) items. The CAM fees cover the landlord costs for janitorial services, property management fees, sewer, water, trash, landscaping, parking lot, fire sprinklers, and any shared area or service.

There are several types of net leases:

•    Single net lease (N lease). In this lease, the tenant pays base rent plus their pro rata share of the building’s property tax (meaning a portion of the total bill based on the proportion of total building space leased by the tenant). The landlord covers all other building expenses. The tenant also pays utilities and janitorial services.

•    Double net lease (NN lease). The tenant is responsible for base rent plus their pro-rata share of property taxes and property insurance. The landlord covers expenses for structural repairs and common area maintenance. The tenant once again is responsible for their own janitorial and utility expenses.

•    Triple net lease (NNN lease). This is the most popular type of net lease for commercial freestanding buildings and retail space. The tenant pays all or part of the three “nets” – property taxes, insurance, and CAMS – on top of a base monthly rent.

Absolute triple net lease

The absolute triple net lease is an extreme form of an NNN lease where the tenant absorbs all of the real estate risk and responsibility. The tenant is ultimately responsible for all building-related expenses and repairs, including roof and structure.

Modified gross lease

The appeal of a modified gross lease is the tenant has one set amount to pay each month. In a modified gross lease, the base rent and “nets” (property taxes, insurance and CAMS) are all included in one lump sum payment; excluding utilities and janitorial services, which are typically covered by the tenant.
The benefit of a modified gross lease is their flexibility. They are generally an easier agreement to make between the landlord and tenant. The risk is if insurance, taxes or CAM increase or decrease the cost or savings is passed on to the landlord.

Why Is the IRS Punishing Triple Net Landlords?

Alan Gassman Contributor to Forbes Jan 26, 2019
Retirement  (writes about tax, estate and legal strategies and opportunities.)

“There are horrible people who, instead of solving a problem, tangle it up and make it harder to solve for anyone who wants to deal with it.

Whoever does not know how to hit the nail on the head should be asked not to hit it at all.”

– Friedrich Nietzche

While the IRS as a whole is by no means “horrible,” the new Final Regulations regarding Section 199A of the Internal Revenue Code must seem that way to landlords who lease property under triple net leases. The vast majority of these will not be considered to be “active trades or businesses” for purposes of qualifying for the 20% deduction that will be available to most active landlords.

Code Section 199A was introduced to the Internal Revenue Code as part of the 2017 Tax Cuts and Jobs Act with the intent of giving taxpayers some degree of parity with the 21% income tax bracket bestowed upon large and small companies that are taxed as separate entities (known to tax professionals as “C corporations.” C corporations are different than “S corporations,” as S corporations report their income under the “K-1” system that causes the shareholders to pay the income tax on their personal returns).

Since the term “trade or business” was not defined under Section 199A, the real estate community has been waiting for the Final Regulations which were released on Friday, January 18, and basically follow what the Proposed Regulations (released last August) said, which is that passive investors are not considered to be an active trade or business, even though they take significant economic risks and may work hard to verify that the tenants pay the taxes, insurances and maintenance of the leased property, comply with applicable law and otherwise do what tenants are supposed to do.

The practical result will be that landlords will need to become active and possibly renegotiate lease terms to have at least a chance of being eligible to have the deductions that other landlords will have, or to perhaps qualify under the new safe harbor rules that allow the deduction to non-triple net leases if they satisfy the 250 hour per year requirement, which requires tabulation of the work hours of landlords and agents of landlords, and certain time log and verification procedures.’

This seems very unfair since REIT (Real Estate Investment Trusts) income will often include triple net lease profits that will qualify for the Section 199A deduction, and C corporations only have to pay the 21% rate on net income from triple net leases.

Tax professionals, and masochists may enjoy or derive a better understanding by reading on.

The new Final Regulations refer to several Supreme Court cases to aide in defining what types of enterprises will qualify as a trade or business, and these cases do not bode well for landlords of triple net leases. For example, the Final Regulations cite to the Supreme Court’s 1987 landmark “trade or business” case, Commissioner v. Groetzinger, which held that to be engaged in a trade or business the following two requirements must be met:

1. The taxpayer’s involvement must be continuous and regular; and

2. The primary purpose of the activity must be for income or profit.

The very definition of a triple net lease seemingly disqualifies the majority of triple net landlords from qualifying under this definition under the assumption that they do not have continuous and regular involvement.

With triple net leases, the tenant is usually responsible for the three “nets”: real estate taxes, building insurance, and maintenance. By having the tenant be responsible for most of the on-site responsibilities, the landlord is able to spend more time and effort buying and selling other properties and therefore investing more into the economy.

In turn, triple net lease agreements usually benefit the tenant because the pricing of the agreement will reflect the fact that the tenant will be responsible for a lot of the on-site responsibilities. Now tenants have the upper hand when landlords ask to be allowed to provide at least 250 hours of services per year (cumulatively, as to all leases that the landlord will aggregate under the complicated aggregation rules, which are discussed in our blog post entitled Real Estate: Investing with Section 199A: Don’t Let Your Deductions Fly Out the Window).

The new Final Regulations do, however, contain one saving grace for taxpayers with triple net leases by quoting the 1941 Supreme Court case of Higgins v. Commissioner.

In Higgins the Supreme Court stated that the determination of “whether the activities of a taxpayer are ‘carrying on a business’ requires an examination of the facts in each case.” Since it is a factual determination, a taxpayer with the right facts can successfully argue that his or her triple net or almost triple net rental enterprise should constitute a qualified trade or business.

However, doing so will be a tough and expensive hurdle for many landlords to jump over.

Perhaps Congress will act in a compromise to assist the continued growth in the economy in recognizing that taxpayers with triple net leases put themselves at significant financial risk, in that tenants like Toys R Us and Sears may go bankrupt and leave a landlord high and dry after many months of eviction and then bankruptcy litigation. Many landlords are not aware that the bankruptcy law allows tenants to have the court terminate long term leases and limit damages to one year of rent.

Non-triple net lease landlords who spend considerable time in their leasing activities can take considerable comfort from Notice 2019-7, which was published alongside the new Final Regulations. The Notice provides the above-mentioned safe harbor for non-triple net leases to be “treated as a trade or business solely for the purposes of Section 199A.”

Under the new safe harbor, non-triple net rental real estate may be treated as a trade or business, if the following three requirements are met:

1. separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;

2. 250 or more hours of rental services are performed per year with respect to the rental enterprise; and

3. the taxpayer maintains contemporaneous records, including time reports or similar documents, regarding the following: a) hours of all services performed, b) description of all services performed, c) dates on which such services are performed, and d) who performed the service.

Interestingly, while triple net lease arrangements outside of REITs will likely not qualify under Section 199A, banks that are taxed as S corporations, or partnerships, are eligible for the deduction, although in many respects a loan is like a triple net lease where the landlord has put money out for a long term series of payments, where in many cases the vast majority of the value is in the years of payments to be received, just like a long term promissory note.

It is even more disturbing that other types of businesses involving much less risk on the part of the owner qualify for the deduction. These include brothels, franchisors and vending machine owners. How is it possible that a brothel owner sitting back and receiving rent from independent contractor “professional entertainers” may qualify for the benefits of Section 199A, but taxpayers with triple net leases do not?

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.

This Week’s Author – Mark C. Bradstreet, CPA

-until next week