Tax Reform

Dear Friends, Clients and Colleagues:

In recent days many of you have been contacting us regarding the recent Tax Act.  We are happy to continue to answer your individual and specific questions; however I thought it good to also provide a high level summary of the more important items.  Note these changes do not go into effect until January 1, 2018 (and in some cases later) and so your 2017 returns will be very similar to 2016.

State and Local Income Tax Deduction (SALT)

 This is probably the biggest change particularly for those of us in high tax states like California.  The deduction for state and local taxes will now be capped at $10,000.  This includes property tax as well.  So your total deduction for state taxes and property taxes cannot exceed $10,000.  For those who are generally not subject to the AMT (alternative minimum tax) this is a significant and unpleasant change.  For those generally subject to the AMT the impact is less profound as these taxes are an “add back” for AMT purposes anyway.

Note for Owners of Rental Properties:  Many of you have asked if the deduction for property tax on rental properties is similarly limited to $10,000.  It is not.  Property taxes will continue to be fully deductible as a rental property expense.

Action Item:  Consider prepaying the 2nd installment of your property tax by December 31 as well as making an estimated payment for any CA tax that may be due.  This is particularly important if you are not subject to the AMT.  By paying before year end they will be deductible on your 2017 return but if you wait until 2018 they will not be deductible on your 2018 return (except up to $10,000).

Miscellaneous Itemized Deductions (investment expenses, unreimbursed employee expenses, etc.)

These will be going away so consider prepaying any by December 31, 2017

For some of you this is significant.  Particularly for those of you with significant unreimbursed employee expenses including the home office expense.  You may wish to consider whether you can restructure your activity as a business activity (e.g. self-employed) to be able to continue to deduct.  For those of you for whom this makes sense this could include discuss with your employer about switching to “contractor” status.  Please note this is a major decision with additional considerations and best to discuss with us before making any decisions.

Note:  For those of you who are self employed (file schedule C) all expenses, including home office, continue to be deductible.  This affect only W2 employees.

Mortgage Interest:

 The new mortgage interest limitation will drop from $1M to $750,000 which means only the interest on the first $750,000 of debt will be deductible.

Note:  This affects new loans only.  Existing mortgages will be grandfathered in and you may still deduct the interest associated with the first $1M of debt.

Capital Gains

 These rates and taxes will remain unchanged and are still subject to the Net Investment Income Tax as well.

Pass-through entities

 This is by far one of the more complex areas of the new bill.  There is a new 20% deduction at the individual level for pass through income.  This basically means that you pay tax on only 80% of your net income.  However there are limits and qualifications.  Many types of businesses will not qualify for this deduction.  This is best discussed on a case by case situation.

Estate and Gift

 The exclusion for estate and gift tax will nearly double to $10M for individuals and $20M for couples.  However, note that this is scheduled to “sunset” and revert back to existing law in 2025.

Kiddie Tax

 The Kiddie tax regime has been modified by essentially taxing the earned income of a child at the rate for single individuals and the unearned income at the estate and trust rate.

Alimony Deduction

 For divorce or separation agreements entered into after December 31, 2018 or entered into before that but modified after the payor will no longer receive a deduction and the recipient will no longer be required to report as income.

This entry was posted on Thursday, December 28th, 2017 at 7:19 pm and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed.

Contributing Real Estate to a C Corporation

Welcome to Evans & Company’s tax blog site. My vision for this site is to publish a new article on a monthly basis. Unlike many “canned” tax news sites my vision for this feature is that original articles written by Nicholas Evans will be published on a monthly basis. Posts may be based on current tax news/changes or, as in the case of this initial post, on actual client situations. By focusing on issues that apply to our client base the hope is that this will educate Evans & Company clients in particular with regards to tax issues/strategies that are specific to them as well as providing a resource to the broader tax community. Please feel free to contact us directly with any questions or comments you may have on a particular post.

With that said it is time to get right to it! Today’s post will explore when it COULD be actually beneficial to contribute real estate to your C-Corporation (a long taboo subject). This is based on an actual client situation where we developed this unusual strategy to achieve significant tax savings. As will always be the case in looking at specific client situations actual client names have not been used.

WHY IT’S NOT ALWAYS A BAD IDEA TO CONTRIBUTE REAL ESTATE TO YOUR C-CORPORATION

Every newly minted CPA has been instructed almost from Day 1 to inform their clients that it is unwise to contribute appreciated property (specifically real estate) to their C-Corporation. This philosophy has, in fact, become so ingrained that it is almost accepted as a matter of faith. A conversation might go as follows:

Client: I’m thinking about putting my building into the name of my Corporation. What do you think?

CPA: That’s really not a good idea.

Client: Really. How come?

CPA: It just isn’t . . . there could be some pretty bad tax consequences.

Client: Hmmm. Okay, thanks.

As the above hypothetical conversation shows (and it’s really not all that hypothetical) many new and even mid-level CPAs have become so indoctrinated in this theory that they often lose sight of the reason why it’s not a good idea to put property into a C Corp. Instead they tend to fall back to the tried and true response of “it just isn’t,” or some variation thereof. In fact this bias has become so accepted that a CPA who even suggests otherwise runs the risk of being chided by their more erudite colleagues.

To be sure this has not become such an ingrained philosophy for no reason. Generally speaking putting real estate into a C Corporation is indeed unwise. The reason is that doing so often subjects the Taxpayer to the double taxation regime in that gains from the sale of property inside a C-Corporation will be taxable initially to the Corporation, then when the shareholder(s) go to take the proceeds out of the Corporation the distributions will often be taxed again as a taxable dividend. An example illustrates:

Example 1:

John buys a piece of property for $400,000 and immediate contributes the property to his Corporation, Double Tax Me, Inc. 7 years later the property is now worth $1,000,000 and he sells it and, after paying off the mortgage and other closing costs, nets $700,000 in proceeds which John then proceeds to distribute to himself. The Corporation recognizes $600,000 of gain and pays tax on same ($1,000,000 –

400,000). Then the $700,000 of net proceeds John distributed to himself becomes taxable to him personally as a taxable divided.

Net, net, between the Corporation and himself this transaction resulted in $1.3 million of taxable income ($600,000 + 700,000). Ouch! Had John simply left the building in his own name he simply would have paid capital gain tax himself on the $600,000 of gain with no additional tax on the actual proceeds. Put in this way the perils of putting real estate into a C Corporation are plainly obvious, but consider the follow actual client situation:

Example 2:

Same facts as example 1 except this time the name of the Corporation is Loss Corporation, Inc. which has a $700,000 net operating loss and also has debts, including shareholder loans, of $700,000. In this case the $700,000 NOL offsets all of the $600,000 gain on sale so no Corporate tax due and better, if John/Loss Corporation uses the $700,000 of net proceeds to pay off the corporate debts, including those owed by the Loss Corporation, to John there is no taxable dividend on the $700,000.

So in example 1, contributing the building to the corporation subjected John to an additional $700,000 of taxable income (the amount of the proceeds distributed) but in example 2 it actually saved John $600,000 in taxable income as had he not contributed the building he would have had that amount of personal capital gain and would have had to pay tax on it, but by contributing the building to the Corporation the Corporate NOL (which otherwise would have been wasted) could be used to offset that gain.

To be sure the above is a somewhat unusual set of facts but it did arise from an actual client situation and can happen. By recognizing the situation we were able to save the client a considerable amount of tax on the transaction. As always the regulations in this area are complex and each situation needs to be identified and judged on its own merits. Please do call if you have questions regarding this scenario or any other tax issues we can assist with.

This entry was posted on Wednesday, July 23rd, 2014 at 5:17 pm and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed.