March 2018

IRS Clarification: Home Equity Loan Interest May Still Be Deductible

Posted on March 13, 2018 by Debra Barcuch

The IRS recently announced that in many cases, taxpayers can continue to deduct interest paid on home equity loans. The tax agency issued the clarification because there were questions and concerns that such expenses were no longer deductible under the Tax Cuts and Jobs Act (TCJA), which was signed into law on December 22, 2017.

Background Basics

Taxpayers can deduct interest on mortgage debt that’s “acquisition debt” under the tax law. Acquisition debt means debt that is:

1. Secured by the taxpayer’s principal home and/or a second home, and

2. Incurred in acquiring, constructing, or substantially improving the home. This rule hasn’t been changed by the TCJA.

Under prior law, the maximum amount that was treated as acquisition debt for the purpose of deducting interest was $1 million ($500,000 for married individuals filing separate tax returns). This meant that a taxpayer could deduct interest on no more than $1 million of acquisition debt. Taxpayers could also deduct interest on home equity debt. “Home equity debt,” as specially defined for purposes of the mortgage interest deduction, meant debt that:

Was secured by the taxpayer’s home, and
Wasn’t “acquisition indebtedness.” (In other words, it wasn’t incurred to acquire, construct, or substantially improve the home.)

Therefore, the rule allowed taxpayers to deduct interest on home equity debt and enabled taxpayers to deduct interest on debt that wasn’t incurred to acquire, construct, or substantially improve a home — in other words, debt that could be used for any purpose. As with acquisition debt, the rules in place before the TCJA limited the maximum amount of “home equity debt” on which interest could be deducted; here, the limit was the lesser of $100,000 ($50,000 for a married taxpayer filing separately), or the taxpayer’s equity in the home.

Under the TCJA, for tax years beginning after December 31, 2017 and before January 1, 2026, the limit on acquisition debt is reduced to $750,000 ($375,000 for a married taxpayer filing separately). The $1 million, pre-TCJA limit applies to acquisition debt incurred before December 15, 2017, and to debt arising from refinancing pre-December 15, 2017 acquisition debt, to the extent the debt resulting from the refinancing doesn’t exceed the original debt amount.

Under the TCJA, for tax years beginning after December 31, 2017 and before January 1, 2026, there’s no longer a deduction for interest on “home equity debt.” The elimination of the deduction for interest on home equity debt applies regardless of when the home equity debt was incurred.

New Release

In the IRS’s Internal Release 2018-32, the tax agency stated that despite the newly-enacted restrictions on home mortgages under the TCJA, taxpayers can often still deduct interest on a home equity loan, home equity line of credit (HELOC), or second mortgage, regardless of how the loan is labeled.

The IRS clarified that the TCJA suspends the deduction for interest paid on home equity loans and lines of credit, unless they’re used to buy, build or substantially improve the taxpayer’s home that secures the loan.

For example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses — such as credit card debts — isn’t deductible. As under pre-TCJA law, for the interest to be deductible, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.

For anyone considering taking out a mortgage, the TCJA imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction. The lower limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home.

In its release, the IRS provided the following examples:

Illustration 1: In January 2018, John takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, he takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total doesn’t exceed the cost of the home. Because the total amount of both loans doesn’t exceed $750,000, all of the interest paid on the loans is deductible. However, if John used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan wouldn’t be deductible.

Illustration 2: In January 2018, Mary takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, she takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages doesn’t exceed $750,000, all of the interest paid on both mortgages is deductible. However, if Mary took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan wouldn’t be deductible.

Illustration 3: In January 2018, Bob takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, he takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. Only a percentage of the total interest paid is deductible.

If you have questions about home equity loans or other provisions of the TCJA, consult with your Cornwell Jackson Tax Advisor.

TCJA Tax Law: Six Changes that Effect Payroll

Posted on March 12, 2018July 22, 2024 by Debra Barcuch

The Tax Cuts and Jobs Act (TCJA) is the biggest overhaul of the tax code in more than 30 years.

For instance, the TCJA cuts income tax rates for individuals and corporations, doubles the standard deduction, eliminates personal exemptions and repeals or modifies numerous deductions. It will have a major impact in 2018 and beyond.

But there’s more. In addition to withholding changes already reflected in employees’ paychecks, the TJCA includes other benefit-related provisions affecting payroll. Following are six prime examples:

1. Credit for employer-paid family and medical leave.

This is brand new. The TCJA creates a tax credit for wages paid to qualifying employees on family and medical leave. This credit can be as high as 25% of the wages paid.

To qualify, an employer must offer at least two weeks of annual paid family and medical leave, as described by the Family and Medical Leave Act (FMLA), to qualified employees. The paid leave must provide at least 50% of the employee’s wages.

Qualified individuals are those who have been working for the employer for at least one year, and, in the preceding year, weren’t paid compensation that exceeded 60% of $72,000 (threshold will be indexed for inflation).

The credit equals 12.5% of the amount of wages paid during a leave period and tops out at 25%. The credit is increased gradually for payments above 50% of wages paid. No double-dipping: Employers can’t also deduct wages claimed for the credit.

Note that the new credit is only available for 2018 and 2019. It could, however, be extended by a future act of Congress.

2. Transportation benefits.

Prior to 2018, employers could deduct certain transportation benefits of up to $250 a month (indexed to $255 per month in 2017) that were provided tax-free to employees. These included:

Mass transit passes. This is any pass, token, fare card, voucher or similar item entitling a person to ride free of charge or at a reduced rate on mass transit or in a vehicle seating at least six adults plus the driver if the person operating the vehicle is in the business of transporting persons for pay or hire.
Commuter highway vehicle expenses. These vehicles must seat at least six adults plus the driver. There must have been a reasonable expectation that at least 80% of the vehicle mileage would be for transporting employees between their homes and workplaces. Employees also had to occupy at least 50% of the seats (not including the driver’s seat).
Qualified parking fees. This benefit covered employer-provided parking for employees on or near the business premises. It also provided fees for parking on or near the location from which employees commuted to work using mass transit, commuter highway vehicles or carpools, such as the parking lot of a train station.

A tax-free benefit of up to $20 a month was allowed for bicycle commuting.

The TCJA eliminates the tax deduction for these three main transportation benefits beginning in 2018. But the benefits remain tax-free to employees. The tax exclusion for bicycle commuting is repealed.

3. Entertainment expenses.

Under prior law, an employer could deduct 50% of the cost of business entertainment and meal expenses that were “directly-related to” or “associated with” the business. Notably, this included entertainment in a clear business setting and meals immediately preceding or following a “substantial business discussion.”

Tax regulations imposed strict recordkeeping requirements for deducting business entertainment expenses. For example, you had to record the time, place and date of the entertainment, the person or people entertained and the business relationships of the parties.

Beginning in 2018, this deduction is repealed. However, employers may still deduct 50% of the cost of business meals while traveling away from home.

4. On-premises meals.

In the past, employers could deduct certain meals provided to employees on the business premises if those meals qualified as a de minimis fringe benefit. For instance, the deduction could be applied to meals furnished while employees worked late hours, as well as food and beverages provided to employees at on-site eating facilities such as a company cafeteria. The value of these benefits was tax-free for employees.

An employer could deduct 100% of the cost of these benefits.

Under the TCJA, the deduction is reduced to 50% of the cost and is eliminated after 2025. However, the value continues to be tax-free to employees.

5. Moving expense reimbursements.

Previously, if employees qualified under a two-part test involving distance and time, they could deduct their out-of-pocket job-related moving expenses on their personal income tax returns. The deductions were claimed “above-the-line,” so they were available to both those who itemized and those who claimed the standard deduction. Alternatively, employers may have reimbursed employees tax-free for qualified moving expenses.

Now, starting in 2018, the TCJA repeals both the moving expense deduction and the tax exclusion except for active duty military personal.

6. Achievement awards.

Currently, an employer can deduct up to $400 of the value of achievement awards to employees for length of service or safety. The tax exclusion is multiplied by four to $1,600 for awards under a written nondiscriminatory achievement plan. On the receiving end, employees aren’t taxed on the value of the awards that don’t exceed the employer’s deduction.

Beginning in 2018, the TCJA clarifies that the tax deduction and corresponding tax exclusion don’t apply to cash, gift coupons or certificates, vacations, meals, lodging, tickets to sporting or theater events, securities and “other similar items.” However, the tax breaks are still available for gift certificates that allow the recipient to select tangible property from a limited range of items preselected by the employer.

Reminder: This is only an overview of six of the key tax law changes affecting payroll matters. Do you have any questions about the new law’s impact on benefits? Don’t hesitate to contact your payroll providers for more details.

Fringe Benefits Surviving the Axe

Several fringe benefit crackdowns threatened by Congress didn’t make it into the final version of the new tax law. The items on the chopping block that were eventually spared include:

Dependent care assistance plans,
Adoption assistance programs,
Employer-provided housing, and
Educational assistance programs.

Also, certain liberalizations of the hardship distribution safe-harbor rules were contemplated, but eventually skipped by the lawmakers.

R&D Credit Is Now Improved for Manufacturers

Posted on March 10, 2018July 22, 2024 by Debra Barcuch

After being extended more than a dozen times by various pieces of legislation, the research and development (R&D) credit was finally made permanent by the Protecting Americans from Tax Hikes (PATH) Act of 2015.Now the Tax Cuts and Jobs Act (TCJA), goes one step farther. Not only does the law preserve the credit in all its glory, it generally enhances it in context of several other provisions.

Calculate the R&D Credit

The R&D credit is intended to encourage spending on research activities by both established firms and start-ups. Generally, the credit equals the sum of:

20% of the excess of qualified research expenses for the year over a base amount,
The university basic research credit (20% of the basic research payments), and
20% of the qualified energy research expenses undertaken by an energy research consortium.

The base amount is a fixed-base percentage of average annual receipts — net of returns and allowances — for the four years before the R&D credit is claimed. The fixed-base percentage can’t exceed 16% and the base amount can’t be less than 50% of the annual qualified research expenses.

Alternatively, a manufacturer or other business entity may claim a simplified R&D credit of 14% of the amount by which its qualified research expenses for the year exceed 50% of its average qualified research expenses for the preceding three tax years.

The credit is only available for qualified expenses, which must:

Qualify as a “research and experimentation (R&E) expenditure” under Section 174 of the tax code (see box below “Change in Store for R&E Deduction”), and
Relate to research undertaken to discover information that is technological in nature and the application of which is intended to be useful in developing a new or improved business component.

In addition, substantially all the research activities must relate to a new or improved function, performance, reliability or quality.

While the R&D credit has always offered tax saving benefits for manufacturers, the TCJA opens even more opportunities to use the credit.

Enter the TCJA

Under the TCJA, the benefits of the R&D credit are enhanced when the following related provisions are taken into account:

Corporate AMT.

Previously, the corporate alternative minimum tax (AMT) was a thorn in the side of firms utilizing the R&D credit. But the TCJA changes the landscape.

Before the TCJA, a manufacturing firm generally could use the R&D credit only to offset regular tax liability, but not the corporate alternative minimum tax (AMT). Under a provision in the PATH Act, a limited exception was approved under which a business with $50 million or less in average gross receipts for the previous year could use the R&D credit to offset AMT liability.

That issue is largely moot, as the new law repeals the corporate AMT beginning in 2018. As a result, some larger firms will realize the tax benefits of the R&D credit. For individuals, though the AMT still exists, albeit at higher limits. Thus, if your R&D credit is from a pass-through entity, your ability to use it to offset the AMT may continue to be limited.

Expensing.

The TCJA enhances both the Section 179 deduction and bonus depreciation. Under Sec. 179, the maximum expensing allowance is doubled from $500,000 to $1 million for property placed in service in 2018. The phase-out level increases from $2 million to $2.5 million. In addition, 50% bonus depreciation is doubled to 100% for a five-year period, beginning in 2018, before being gradually phased out over the following five years.

Thus, the new law encourages businesses to buy depreciable equipment for its research activities. In most cases, a firm will be able to expense the full cost in the year the equipment is placed in service.

Net operating losses (NOLs).

Previously, a business could carry back an NOL for two years before carrying it forward for 20 years. Beginning in 2018, NOLs generally can’t be carried back and may be carried forward indefinitely. However, they are limited to 80% of taxable income. Consequently, the R&D credit may be a valuable tool for firms with an NOL, because to the extent that they are not able to use an NOL to shelter income, the credit can be used to offset the tax that would otherwise be due.

Maximize the Credit

The R&D credit is still standing after the tax reform law and can be an even more effective tax shelter for manufacturers in the wake of the new law. Consult with your tax advisor for ways to maximize this credit and its related tax-savings opportunities.

Change in Store for R&E Deduction

The Tax Cuts and Jobs Act (TCJA) makes a significant change in the deduction for research and experimental (R&E) expenditures allowed by Section 174.

Briefly stated, the TCJA requires firms to spread out the tax benefit over time, rather than deduct the expenditures, starting in 2022.

Prior to the TCJA, taxpayers could either currently deduct R&E expenditures or amortize the costs over a period of not less than 60 months. Qualified expenses are limited to the following:

In-house wages and supplies attributable to qualified research,
Certain time-sharing costs for computer use in qualified research, and
65% of contract research expenses, that is, amounts paid to outside contractors in the U.S. for conducting qualified research on the taxpayer’s behalf, or, in the case of qualified research consortium, 75%.

Under the TCJA, firms can deduct R&D costs through 2021. Beginning in 2022, firms must amortize R&E expenditures over a five-year period (or a 15-year period for foreign R&D expenditures).

5 Stages for Integrated Product Delivery

Posted on March 9, 2018July 22, 2024 by Debra Barcuch

How IPD is slowly altering the construction process.

It’s not a stretch to say that the construction industry didn’t change much for decades before technology started making inroads around the turn of the century.And the forces of change are clearly at work in the current environment, encompassing the use of new and improved tools, revised methodologies, and faster approaches to the jobs at hand.

Arguably, first and foremost for many construction firms is the transformation to an integrated product delivery (IPD) system. This approach emphasizes innovation and collaboration to reduce waste, cut costs and boost productivity. Leading professional associations such as the American Institute of Architects and the Associated General Contractors are spearheading the movement, creating standards and guidelines to be used in the process.

Team Effort

The main goal of IDP is to initiate a “team effort” of the owners of construction firms, architects, engineers, managers and subcontractors. Unlike traditional construction projects, where these individuals and groups generally act independently, IDP incorporates joint planning from the outset.

This approach to construction projects leverages knowledge and expertise that each team member brings, guided by these principles:

Trust
Transparency
Information sharing
Mutual objectives
Shared risk
Shared reward
Collaborative decisions
Total use of technological capabilities
Early involvement Early goal definition

Each team member’s skills are maximized and the focus shifts from meeting individual expectations to collectively achieving goals. The upshot: Success is measured by the degree to which those shared goals are achieved.

Traditional contracting and construction work is based on separate silos of responsibility. Practically speaking, transferring from one silo to another often results in inefficiency. The notion of breaking down silos of responsibility and requiring cooperation among all the main participants is a sea change in the construction industry.

Five Essential Stages

Although the details will vary from project to project, there are generally five critical stages to the IPD process:

1. Information-gathering and conceptualization.

A meeting of the minds must occur before the first shovel hits the ground. This requires brainstorming sessions about objectives and ways to avoid potential problems. There’s a heavy emphasis on minimizing the risks and mistakes that can typically plague a construction project.

2. Design.

The next logical step is to incorporate decision from the first stage into the design process, taking into account regulations and other applicable laws. Involving all team members at this stage helps reduce waste and provide overall savings.

3. Project execution.

When the design is complete, the project can be executed using computer modeling and design data analysis. Frequently, digital representations using Building Information Modeling (BIM) will be included, helping to predict outcomes. (See The Expanding Role of BIM below.) Be aware that any data generated from proposed projects must be analyzed and virtually tested to help ensure the desired results.

4. Actual construction.

In the past, this was typically the first step for a construction company. But, when using IDP, ground-breaking begins after the general contractor and perhaps certain subcontractors have already been involved in first three stages. Typically, this is the stage where the benefits of the integrated model are realized. The project should run smoothly without delays and design conflicts; change orders and waste should be avoided; and, most importantly, the job should come in on time and on budget.

5. Operations.

If initial objectives are met, operations will continue successfully, with reduced costs and maintenance expenses. This is likely to impress surrounding neighbors, potentially prompting additional projects. Big Benefits on Tap

For many participants in IPD, the favorable results can’t be ignored. Among the benefits are:

Risks and rewards can be predicted.
Construction results can be assessed and analyzed.
Higher standards can be achieved.
Regulations can be more easily observed.
Construction procedural issues can be detected and accommodated quickly with minimum distraction and delay.
Contracts can be prepared for all team members, filling in gaps that can appear when parties work independently.
Cost estimations can be more precise.

The times, they are a-changin’. New technology allows for significant advances in efficiency and accuracy that translate into upgrades in delivery methods. To be successful, however, an IPD project requires all team members to tackle new roles. This dramatic cultural change is slowly evolving.

Adapt and Embrace

Don’t be left behind in the dust. Start adapting to the IPD framework now and embrace the shift that’s slowly changing the industry.

The Expanding Role of BIM

Building Information Modeling (BIM) is a powerful tool that can be used in a collaborative process.

When BIM is incorporated into integrated project delivery, it can create a solid visualization of the project and identify actual construction behavior, performance and other relevant data. It facilitates the process by clarifying intent and recording and sharing accurate information.

Similarly, BIM provides reliable data that reduces the need for requests for information, change orders and rework.

Practical advice: Require all the parties to use BIM and to share the information electronically.

Outsourcing Payroll Administration and Compliance

Posted on March 8, 2018July 23, 2024 by Debra Barcuch

There is a common story we see across small businesses of all sizes. Owners and operators of the company are focused on top line growth, hitting the pavement to bring in new business. They add employees to support the new business growth. They add benefits to keep those great employees. Before realizing it, the owners and small bookkeeping staff are overwhelmed with benefit and payroll administration. Is the company doing it right? Do owners and employees know what they don’t know?

At this point, the owners seek advice from other business owners and their CPA. Would outsourcing payroll make sense or should they add in-house staff to manage it better? After reviewing a few payroll services, the company is understandably faced with more questions about which service provides the best options — not to mention price.

Once decided on a payroll service, the real education begins. The company is still providing a lot of information to the payroll service to set up the structure and system, such as personnel information, their employment status, types of benefits and how each employee wants those wages and benefits managed through payroll. Later, staff also must reach out when there are new hires, promotions and changes to benefits. Depending on the payroll service, owners and operators might not get a lot of help understanding everything. They are also on their own to figure out internal processes that make information gathering and sharing simpler.

Let’s say the business expands even more to another state. Then the owner is faced with multi-state payroll complications. Although the solution to a well-managed payroll and benefits system takes time and strategy, the opportunity to address payroll complexity first lies with your CPA. This relationship can either simplify or increase complexity, so let’s look at some of the payroll pitfalls and questions every business owner should consider.

Pitfalls of Poorly Managed Payroll Administration

Businesses can face serious fines and penalties from the Internal Revenue Service and other tax authorities for failing to comply with timely payments and reporting. At a minimum, employers must account for federal income tax, federal and state unemployment tax, Social Security and Medicare. Many companies have run into trouble in the areas of paying unemployment taxes, making late payroll deposits, incorrectly classifying employees as independent contractors on 1099s and assuming that depositing payroll is the same as reporting.

Penalties can be classified and pursued as “failure to deposit,” “failure to pay” or “failure to file.” Worst-case scenarios if payroll issues aren’t resolved could include losing the business and/or being charged with a federal crime. Individual shareholders and even corporate officers can be pursued and assessed penalties under certain circumstances.

The Department of Labor’s impending changes to overtime exemption rules are creating even more angst in the area of wage and hour compliance. Employees previously exempt from overtime rules may now be considered non-exempt, leading to the need to track overtime hours and communicate possible changes in benefits. It may even require employers to dictate how employees can take time off or how they work outside of normal business hours. These changes tie directly into payroll administration and tax planning.

On the benefits side, employers can offer a variety of things to compete for talent as well as help employees work efficiently. Properly classifying these benefits and properly withholding for pre-tax or taxable benefits simply adds to the complexity. Handle something wrong, and you will have compliance problems as well as upset employees.

It is fair to say that payroll administration and compliance is a big deal, and the decision on whether or not to outsource should not be taken lightly.

Payroll is the most up-to-date KPI in a business — and the most expensive. Business owners we talked to are more than happy to find ways to save money in this area. Are you ready to consider an alternative to your current system of payroll administration? Call the payroll team at Cornwell Jackson.

Continue Reading: Things to Ask your CPA about Payroll Outsourcing

Scott Bates, CPA, is a partner in the audit practice and leads the firm’s business services practice, which includes a dedicated team for outsourced accounting, bookkeeping and payroll services. He provides consulting to clients in healthcare, real estate, auto, transportation, technology, service, dealerships and manufacturing and distribution. Contact Scott at scott.bates@cornwelljackson.com or 972-202-8000.

Blog originally published April 6, 2016. Updated on March 8, 2018.

Fair Market Value Test Can Render Related Finance Companies Invalid

Posted on March 6, 2018July 23, 2024 by Debra Barcuch

Related finance companies have been around for a long time…and so have the IRS guidelines for valid RFCs that auto dealerships must follow for tax compliance.

Like third-party lenders, RFCs can offer to acquire receivables at a 25-40 percent, up-front discount of fair market value (FMV). Problems arise, however, when the discount is not based on FMV or when the dealer cannot prove an actual benefit from the transaction of either improving cash flow or shifting risk.

After the transaction, if the dealer is still directly responsible for the asset in terms of collecting payments, owning title, or collecting any insurance proceeds, for example, the IRS will question whether a sale of property actually occurred.

Discounts on Fair Market Value

A discount is typically acceptable in nearly all transfers of receivables. The level of discount is influenced by credit history, past payment history, time on the note and age of the vehicle. Related Finance Companies can offer to buy notes at a discount regardless of whether they buy in bulk or choose transactions selectively.

The IRS can consider the following in determining whether a dealer sold receivables to an RFC at fair market value:

Car jackets for loans that were sold to the RFC compared to loans that were sold to third parties
- Could the debtor have obtained financing from third parties or was it unlikely? The car jacket usually includes a credit report on the borrower. If the discount rate is large, the customer will have a poor credit history.
- If these loans were sold to the RFC at FMV, then similar loans sold to third parties will have a similar discount rate.
Frequency of payments on the loan required: weekly, biweekly, or monthly?
- Required weekly payments generally indicate higher credit risk.
The dealer’s collection history on the loans prior to the discount date
- Poor customer collections decrease the value of the note receivables.
- Average dealer markup on dealer-financed sales compared to the average dealer markup on third-party financed and cash sales
If the markup is the same, then the face amount of the note should be the FMV of the note on the loan date. To the extent the markup is higher on dealer-financed sales, the FMV of the loans are less than their face value on the loan date.

In addition to these considerations of FMV, the IRS will look at the date of the discount relative to the date of the loan transaction. The closer the discount date is to the loan date, the less likely that factors such as a change in interest rates could impact the FMV calculation.

Related Finance Companies: Cash and Risk Benefits

The IRS may also determine that the transfer of dealer notes to the RFC was not a true sale of property based upon the following factors:

Upon the transfer of the notes, the dealer still had burdens of ownership:
- Dealer’s employees collected the payments and performed repossessions
- Dealer bared the risks of the credit-worthiness of the notes
- Dealer’s financial position did not change when the notes were transferred to the RFC
RFC was thinly capitalized
Dealer, not the RFC, was responsible for repossessions
Title was not transferred to the RFC and RFC could not have sold the notes
Borrowers were not notified that the loan was reassigned to the RFC
If a vehicle was damaged in an accident, the dealer (not the RFC) had the right to any insurance proceeds
No written sales contracts were drawn up between the dealer and the RFC

If the IRS determines that no actual sales transaction took place with an entity separate from the dealership, auditors may perform a tax adjustment calculation.

This calculation equals the dealer’s increase in taxable income, which can be substantial depending on the number of transactions in a given tax year or years. All other unrelated income or expenses of the RFC will also remain on the RFC return.

Again, it can be very complex and time-consuming to regularly review the multiple areas of your entity forms, operations, transactions and tax reporting to ensure full compliance with the IRS on related finance company operations. This is why many dealerships fall short in the event of an IRS query.

To help you determine if it’s the right time to review financial management of your auto dealership or RFC operations, the IRS provides a helpful checklist of common questions to consider.

Download Cornwell Jackson’s whitepaper and checklist on RFC risk management.

Scott Bates is an assurance and business services partner for Cornwell Jackson and supports the firms auto dealership practice. His clients include small business owners for whom he directs a team that provides outsourced accounting solutions, assurance, tax compliance services, and strategic advice. If you would like to learn more about how this topic might affect your business, please email or call Scott Bates.

Blog originally published Dec. 4, 2015. Updated on March 6, 2018.

How the New Tax Law Affects Rental Real Estate Owners

Posted on March 5, 2018July 22, 2024 by Debra Barcuch

Do you own residential or commercial rental real estate? The New Tax Law – Tax Cuts and Jobs Act (TCJA) brings several important changes that owners of rental properties should understand.

In general, rental property owners will enjoy lower ordinary income tax rates and other favorable changes to the tax brackets for 2018 through 2025. In addition, the new tax law retains the existing tax rates for long-term capital gains. (See “Close-Up on Tax Rates” in the right-hand box.)

Close-Up on Tax Rates

If you own property as an individual or via a pass-through entity — meaning a sole proprietorship, a limited liability company (LLC) treated as a sole proprietorship for tax purposes, a partnership, an LLC treated as a partnership for tax purposes, or an S corporation — net income from rental properties is taxed at your personal federal income tax rates.

For 2018 through 2025, the TCJA retains seven tax rate brackets, but six of the rates are lower than before. The 2018 ordinary income rates and tax brackets are as follows:

Bracket	Single	Married, Filing Jointly	Head of Household
10% tax bracket	$0 – $9,525	$0 – $19,050	$0 – $13,600
Beginning of 12% bracket	$9,526	$19,051	$13,601
Beginning of 22% bracket	$38,701	$77,401	$51,801
Beginning of 24% bracket	$82,501	$165,001	$82,501
Beginning of 32% bracket	$157,501	$315,001	$157,501
Beginning of 35% bracket	$200,001	$400,001	$200,001
Beginning of 37% bracket	$500,001	$600,001	$500,001

In 2026, the rates and brackets that were in place for 2017 are scheduled to return.

In addition, the new law retains the current tax rates on long-term capital gains and qualified dividends. For 2018, the rate brackets are:

Bracket	Single	Married, Filing Jointly	Head of Household
0% tax bracket	$ 0 – $38,600	$0 – $77,200	$0 – $51,700
Beginning of 15% bracket	$38,601	$77,201	$51,701
Beginning of 20% bracket	$425,801	$479,001	$452,401

These brackets are almost the same as what they would have been under prior law. The only change is the way the 2018 inflation adjustments are calculated.

Additionally, as under prior law, you still face a 25% maximum federal income tax rate (instead of the standard 20% maximum rate) on long-term real estate gains attributable to depreciation deductions.

Unchanged Write-Offs

Consistent with prior law, you can still deduct mortgage interest and state and local real estate taxes on rental properties. While the TCJA imposes new limitations on deducting personal residence mortgage interest and state and local taxes (including property taxes on personal residences), those limitations do not apply to rental properties, unless you also use the property for personal purposes. In that case, the new limitations could apply to mortgage interest and real estate taxes that are allocable to your personal use.

In addition, you can still write off all the other standard operating expenses for rental properties. Examples include depreciation, utilities, insurance, repairs and maintenance, yard care and association fees.

Possible Deduction for Pass-Through Entities

For 2018 and beyond, the TCJA establishes a new deduction based on a noncorporate owner’s qualified business income (QBI) from a pass-through business entity — meaning a sole proprietorship, a limited liability company (LLC) treated as a sole proprietorship for tax purposes, a partnership, an LLC treated as a partnership for tax purposes, or an S corporation. The deduction generally equals 20% of QBI, subject to restrictions that can apply at higher income levels.

While it isn’t entirely clear at this point, the new QBI deduction is apparently available to offset net income from a profitable rental real estate activity that you own through a pass-through entity. The unanswered question is: Does rental real estate activity count as a business for purposes of the QBI deduction? According to one definition, a real property business includes any real property rental, development, redevelopment, construction, reconstruction, acquisition, conversion, operation, management, leasing or brokerage business.

Liberalized Section 179 Deduction Rules

For qualifying property placed in service in tax years beginning after December 31, 2017, the TCJA increases the maximum Section 179 deduction to $1 million (up from $510,000 for tax years beginning in 2017). Sec. 179 allows you to deduct the entire cost of eligible property in the first year it is placed into service.

For real estate owners, eligible property includes improvements to an interior portion of a nonresidential building if the improvements are placed in service after the date the building was placed in service. The TCJA also expands the definition of eligible property to include the expenditures for nonresidential buildings:

Roofs,
HVAC equipment,
Fire protection and alarm systems, and Security systems.

Finally, the new law expands the definition of eligible property to include depreciable tangible personal property used predominantly to furnish lodging. Examples of such property include:

Beds and other furniture,
Appliances, and
Other equipment used in the living quarters of a lodging facility, such as an apartment house, dormitory, or other facility where sleeping accommodations are provided and rented out.

Important: Sec. 179 deductions can’t create or increase an overall tax loss from business activities. So, you need plenty of positive business taxable income to take full advantage of this break.

Expanded Bonus Depreciation Deductions

For qualified property placed in service between September 28, 2017, and December 31, 2022, the TCJA increases the first-year bonus depreciation percentage to 100% (up from 50%). The 100% deduction is allowed for both new and used qualified property.

For this purpose, qualified property includes qualified improvement property, meaning:

Qualified leasehold improvement property,
Qualified restaurant property, and
Qualified retail improvement property.

These types of property are eligible for 15-year straight-line depreciation and are, therefore, also eligible for the alternative of 100% first-year bonus depreciation.

New Loss Disallowance Rule

If your rental property generates a tax loss — and most properties do, at least during the early years — things get complicated. The passive activity loss (PAL) rules will usually apply.

In general, the PAL rules only allow you to deduct passive losses to the extent you have passive income from other sources, such as positive income from other rental properties or gains from selling them. Passive losses in excess of passive income are suspended until you 1) have sufficient passive income or gains, or 2) sell the property or properties that produced the losses.

To complicate matters further, the TCJA establishes another hurdle for you to pass beyond the PAL rules: For tax years beginning in 2018 through 2025, you can’t deduct an excess business loss in the current year. An excess business loss is the excess of your aggregate business deductions for the tax year over the sum of:

Your aggregate business income and gains for the tax year, plus
$250,000 or $500,000 if you are a married joint-filer.

The excess business loss is carried over to the following tax year and can be deducted under the rules for net operating loss (NOL) carryforwards.

Important: This new loss deduction rule applies after applying the PAL rules. So, if the PAL rules disallow your rental real estate loss, you don’t get to the new loss limitation rule.

The idea behind this new loss limitation rule is to further restrict the ability of individual taxpayers to use current-year business losses (including losses from rental real estate) to offset income from other sources (such as salary, self-employment income, interest, dividends and capital gains). The practical result is that the taxpayer’s allowable current-year business losses (after considering the PAL rules) can’t offset more than $250,000 of income from such other sources or more than $500,000 for a married joint-filing couple.

Loss Limitation Rules in the Real World

Dave is an unmarried individual who owns two strip malls. In 2018, he has $500,000 of allowable deductions and losses from the rental properties (after considering the PAL rules) and only $200,000 of gross income. So he has a $300,000 loss. He has no other business or rental activities.

Dave’s excess business loss for the year is $50,000 ($300,000 – the $250,000 excess business loss threshold for an unmarried taxpayer). The $50,000 excess business loss must be carried forward to Dave’s 2019 tax year and treated as part of an NOL carryfoward to that year. Under the TCJA’s revised NOL rules for 2018 and beyond, Dave can use the NOL carryforward to shelter up to 80% of his taxable income in the carryforward year.

Important: If Dave’s real estate loss is $250,000 or less, he won’t have an excess business loss, and he would be unaffected by the new loss limitation rule.

Like-Kind Exchanges

The TCJA still allows real estate owners to sell appreciated properties while deferring the federal income hit indefinitely by making like-kind exchanges under Section 1031. With a like-kind exchange, you swap the property you want to unload for another property (the replacement property). You’re allowed to put off paying taxes until you sell the replacement property — or you can arrange yet another like-kind exchange and continue deferring taxes.

Important: For 2018 and beyond, the TCJA eliminates tax-deferred like-kind exchange treatment for exchanges of personal property. However, prior-law rules that allow like-kind exchanges of personal property still apply if one leg of a personal property exchange was completed as of December 31, 2017, but one leg remained open on that date.

Need Help?

The new tax law includes several expanded breaks for real estate owners and one important negative change (the new loss limitation rule). At this point, how to apply the TCJA changes to real-world situations isn’t always clear, based solely on the language of the new law.

In the coming months, the IRS is expected to publish additional guidance on the details and uncertainties. Your tax advisor can keep you up to date on developments.

Capital Gains Rates Before and After the New Tax Law

Posted on March 3, 2018July 22, 2024 by Debra Barcuch

Are you confused about the federal income tax rates on capital gains and dividends under the Tax Cuts and Jobs Act (TCJA)? If so, you’re not alone. Here’s what you should know if you plan to sell long-term investments or expect to receive dividend payments from your investments.

Old Rules

Prior to the TCJA, individual taxpayers faced three federal income tax rates on long-term capital gains and qualified dividends: 0%, 15% and 20%. The rate brackets were tied to the ordinary-income rate brackets.

Specifically, if the long-term capital gains and/or dividends fell within the 10% or 15% ordinary-income brackets, no federal income tax was owed. If they fell within the 25%, 28%, 33% or 35% ordinary-income brackets, they were taxed at 15%. And, if they fell within the maximum 39.6% ordinary-income bracket, they were taxed at the maximum 20% rate.

In addition, higher-income individuals with long-term capital gains and dividends were also hit with the 3.8% net investment income tax (NIIT). So, many people actually paid 18.8% (15% + 3.8% for the NIIT) or 23.8% (20% + 3.8% for the NIIT) on their long-term capital gains and dividends.

New Rules

The TCJA retains the 0%, 15% and 20% rates on long-term capital gains and qualified dividends for individual taxpayers. However, for 2018 through 2025, these rates have their own brackets that are not tied to the ordinary-income brackets. Here are the 2018 brackets for long-term capital gains and qualified dividends:

Tax Rates	Single	Married Joint Filers	Head of Household
0%	$0 – $38,600	$0 – $77,200	$0 – $51,700
15%	$38,601 – $425,800	$77,201 – $479,000	$51,701 – $452,400
20%	$425,801 and up	$479,001 and up	$452,401 and up

After 2018, these brackets will be indexed for inflation.

The new tax law also retains the 3.8% NIIT. So, for 2018 through 2025, the tax rates for higher-income people who recognize long-term capital gains and dividends will actually be 18.8% (15% + 3.8% for the NIIT) or 23.8% (20% + 3.8% for the NIIT).

Rates for Trusts and Estates

For 2018, the brackets for trusts and estates that collect long-term capital gains and qualified dividends are as follows:

Tax Rate	Long-term capital gains and qualified dividends
0%	$0 – $2,600
15%	$2,601 – $12,700
20%	$12,701 and up

For 2018 through 2025, the TCJA stipulates that these trust and estate rates and brackets are also used to calculate the so-called “kiddie tax” when it applies to long-term capital gains and qualified dividends collected by dependent children and young adults. The kiddie tax can potentially apply until the year that a dependent young adult turns age 24. (Under prior law, the kiddie tax was calculated using the marginal rates paid by the parents of affected children and young adults.)

Got Questions?

In a nutshell, the new law keeps the same tax rates for long-term capital gains and qualified dividends, but the rate brackets are no longer tied to the ordinary-income tax brackets for individuals. If you have questions or want more information about how long-term capital gains and qualified dividends are taxed under the TCJA, contact your tax advisor.

Paying Taxes on Short-Term Capital Gains

As under prior law, the Tax Cuts and Jobs Act (TCJA) taxes short-term capital gains recognized by individual taxpayers at the regular ordinary-income rates. For 2018, the ordinary-income rates and brackets are as follows:

Tax Rates	Single	Married Joint Filers	Head of Household
10%	$0 – $9,525	$0 – $19,050	$0 – $13,600
12%	$9,526 – $38,700	$19,051 – $77,400	$13,601 – $51,800
22%	$38,701 – $82,500	$77,401 – $165,000	$51,801 – $82,500
24%	$82,501 – $157,500	$165,001 – $315,000	$82,501 – $157,500
32%	$157,501 – $200,000	$315,001 – $400,000	$157,501– $200,000
35%	$200,001 – $500,000	$400,001 – $600,000	$200,001 – $500,000
37%	$500,001 and up	$600,001 and up	$500,001 and up

Protect Your Restaurant from Employee Embezzlement

Posted on March 1, 2018July 23, 2024 by Debra Barcuch

restaurant employee embezzlement Mitigating the risk of loss in restaurants through theft is an ongoing challenge. Automation has improved security in transactions as well as back-office functions. But with top concerns in the restaurant industry being wholesale food costs and building and maintaining sales volume, the reduction of theft can improve those concerns for restaurateurs. We review the key areas for employee embezzlement and provide guidance on limiting loss with proper checks and balances.

In 2015, Texas reported a 4.8 percent growth rate in restaurant sales, one of the highest in the nation. Restaurant employment grew by 22 percent.

Texas is experiencing one of the highest growth rates in the country for restaurant sales, according to a 2016 survey by the National Restaurant Association. However, members cited the cost of food and the ability to build and maintain sales volumes among their top concerns.

Employee embezzlement could be a hidden contributor.

Restaurant owners and managers are always looking for ways to reduce overhead costs while keeping their prices competitive for the market. A hidden contributor to overhead costs and lost margins is embezzlement. If food or money walks out the door consistently because of employee theft, it needs immediate attention.

Anyone who has worked in a restaurant has probably witnessed questionable behavior — not just from the patrons. History has shown that some employees — from the line cooks to servers and management — can demonstrate unethical and even criminal behavior when presented with an opportunity to put a little extra in their pockets. It is up to management to put safeguards in place to reduce those employee embezzlement opportunities.

Common types of theft in restaurants include:

Food theft from deliveries or freezers
Prepared food and beverages given to patrons (unticketed)
Theft of equipment and supplies
Pocketed cash for undocumented orders
Patrons overcharged and the difference pocketed
Misuse of discounts, reward programs or coupons
Fake accounts payables
Underreporting daily receipts
Underreporting of earnings to franchisor and investors
Theft of recipes, processes or intellectual property

As an owner or franchisor expands to more than one location and relies on management, the risks of theft can increase. The impact of theft over time can be exponential, including a lower return on profits, an inability to reinvest in the business or provide employee benefits as well as difficulty recruiting and retaining staff. Restaurant communities tend to be small, close-knit groups who can quickly identify red flags with regard to a restaurant’s ownership or management. Reputation is critical to keep top talent and attract patrons.

In the next restaurant blog article, we will address each of these risks with solutions that incorporate a combination of automation and sound operational controls.

Continue Reading: The Most Common Types of Restaurant Theft

Cornwell Jackson has worked with retail businesses, including restaurants for decades, and provides direction on compliance as well as business advisory services. We help restaurant owners and franchisors determine policies and procedures, investments in technology and the viability and timing of additional locations. If you have questions around employee theft and how our team can support your accounting processes and daily POS or reconciliation methods, contact us for a consultation.

Scott Bates, CPA , is a partner in Cornwell Jackson’s audit practice and leads the business services practice, including outsourced accounting, bookkeeping, and payroll services. He is an expert for clients in restaurants, healthcare, real estate, auto and transportation, technology, service, construction, retail, and manufacturing and distribution industries.

Originally published on March 1, 2016. Updated in 2018.

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