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Beginning in 2018, the personal casualty and theft loss deduction is limited to casualty losses incurred in a federally declared disaster area. The casualty and theft deduction is only available to those who itemize their deductions, not to those who take the standard deduction.

In the instructions for the 2018 Form 4684 (Casualties and Theft Loss Deductions), the IRS defines a disaster loss as “a loss that occurred in an area determined by the President of the United States to warrant federal disaster assistance and that is attributable to a federally declared disaster. It includes a major disaster or emergency declaration.” A list of federally declared disasters can be found at https://www.fema.gov/Disasters.

There are two limitations to qualify for the deduction:

1. A loss must exceed $100 per casualty
2. Net total loss must exceed 10 percent of your AGI (adjusted gross income)

You can still elect to deduct the casualty loss in the tax year immediately preceding the tax year in which you incurred the disaster loss. IRS Publication 976 provides information about personal casualty losses resulting from disasters that occurred in 2016 and certain 2017 disasters, including Hurricane Harvey, Tropical Storm Harvey, Hurricane Irma, Hurricane Maria, and the California wildfires.

An exception to the rule above limiting the personal casualty and theft loss deduction to losses incurred in a federally declared disaster area applies if you have personal casualty gains for the tax year. In this case, you will reduce your personal casualty gains by any casualty losses not attributable to a federally declared disaster. Any federal disaster losses that remain are subject to the 10% AGI limitation.

In a recent publication clarifying some of the new tax reform laws (Publication 5307), the IRS touched on how some of the recent laws enacted in 2018 make it easier for retirement plan participants to access their retirement plan funds. This may allow affected taxpayers to:

• waive the 10% additional tax on early distributions and
• include a qualified hurricane distribution in income over a 3-year period
• repay their distributions to the plan
• have expanded loan availability
• extend the loan repayment period

We certainly hope you weren’t affected by a disaster last year, but if you were, we have you covered tax-wise. Contact us for your tax and accounting needs.

1. Stay on top of cash account balances.

If you’re collecting money in more than one account, be sure to move your money on a regular basis when your balances get high. One example is your PayPal account.  If money is coming in faster than you’re spending it, transfer the money to your main operating account so the money is not just sitting there.

2. Invoice faster or more frequently.

The best way to smooth cash flow is to make sure outflows are in sync with inflows. If you make payroll weekly but only invoice monthly, your cash flow is likely to dip more often than it rises. When possible, invoice more frequently or stagger your invoice due dates to smooth your cash balances.

Take a look at how long it takes you to invoice for your work after it’s been completed.  If it’s longer than a few weeks, consider changing your invoicing process by shortening the time it takes to send out invoices. That way, you’ll get paid sooner.

3. Collect faster.

Got clients who drag their heels when it comes to paying you? Try to get a credit card on file or an ACH authorization so you’re in control of their payment.

Put a process in place the day the invoice becomes late. Perhaps the client has a question or misplaced the bill. Be aggressive about following up when the bill is 45, 60, and 90 days past due. Turn it over to collections quickly; the older the bill is, the less likely it is to get paid.

4. Pay off debt.

As your cash flow gets healthier, make a plan to pay off any business loans or credit cards that you have. The sooner you can do this, the less interest expense you’ll incur and the more profit you’ll have.

Interest expense can really add up. If you have loans at higher interest rates, you might try to get them refinanced at a lower rate, so you won’t have to pay as much interest expense.

5. Reduce spending.

You don’t always have to give up things to reduce spending. Look at your expenses from last year and ask yourself:

• What did you spend that was a really great investment for your business?
• What did you spend that was a colossal mistake?
• Where could you re-negotiate contracts to save a little?
• What do you take for granted that you can cut?
• Where could you tighten up if you need to?

Managing cash flow is always a challenge, and these tips will help give you a little cushion to make it easier.

And this new law works in some unusual ways that can tax you even when you have no real income for the year. When you know how this ugly new rule works, you have some planning opportunities to dodge the problem.

Over the years, lawmakers have implemented rules that limit your ability to use your business or rental losses against other income sources. The big three are:

1. The “at risk” limitation, which limits your losses to amounts that you have at risk in the activity
2. The partnership and S corporation basis limitations, which limit your losses to the extent of your basis in your partnership interest or S corporation stock
3. The passive loss limitation, which limits your passive losses to the extent of your passive income unless an exception applies

The TCJA tax reform added Section 461(l) to the tax code, and it applies to individuals (not corporations) for tax years 2018 through 2025

The big picture under this new provision: You can’t use the portion of your business losses deemed by the new

law to be an “excess business loss” in the current year. Instead, you’ll treat the excess business loss as if it were a net operating loss (NOL) carryover to the next taxable year.

To determine your excess business loss, follow these three steps:

1. Add the net income or loss from all your trade or business activities.
2. If step 1 is an overall loss, then compare it to the maximum allowed loss amount: $250,000 (or $500,000 on a joint return).
3. The amount by which your overall loss exceeds the maximum allowed loss amount is your new tax law–defined “excess business loss.”

Example

Paul invested $850,000 in a start-up business in 2018, and the business passed through a $750,000 loss to Paul. He has sufficient basis to use the entire loss, and it is not a passive activity. Paul’s wife had 2018 wages of $50,000, and they had other 2018 non-business income of $600,000.

Under prior law, Paul’s loss would offset all other income on the tax return and they’d owe no federal income tax. Under the TCJA tax reform that applies to years 2018 through 2025 (assuming the wages are trade or business income):

• Their overall business loss is $700,000 ($750,000 – $50,000).
• The excess business loss is $200,000 ($700,000 overall loss less $500,000).
• $150,000 of income ($600,000 + $50,000 – $500,000) flows through the rest of their tax return.
• They’ll have a $200,000 NOL to carry forward to 2019.

To avoid this ugly rule, you’ll need to keep your overall business loss to no more than $250,000 (or $500,000 joint). Your two big-picture strategies to make this happen are

• accelerating business income, and
• delaying business deductions.

Answers to Common Section 199A Questions

For most small businesses and the self-employed, the 20 percent tax deduction from new tax code Section 199A is the most valuable deduction to come out of the Tax Cuts and Jobs Act.

The Section 199A tax deduction is complicated, and many questions remain unanswered even after the IRS issued its proposed regulations on the provision. And to further complicate matters, there’s also a lot of misinformation out there about Section 199A.

Six common questions about this new 199A tax deduction.

Question 1. Are real estate agents and brokers in an out-of-favor specified service trade or business for purposes of Section 199A?

Answer 1. No.

Question 2. Do my S corporation shareholder wages count as wages paid by the S corporation for purposes of the 50 percent Section 199A wage limitation?

Answer 2. Yes.

Question 3. Will my allowable SEP/SIMPLE/401(k) contribution as a Schedule C taxpayer be based only on Schedule C net earnings, or do I first subtract the Section 199A deduction?

Answer 3. You’ll continue to use Schedule C net earnings with no adjustment for Section 199A.

Question 4. Is my qualified business income for the Section 199A deduction reduced by either bonus depreciation or Section 179 expensing?

Answer 4. Yes, to both.

Question 5. I took out a loan to buy S corporation stock. The interest is deductible on my Schedule E. Does the interest reduce my Section 199A qualified business income?

Answer 5. Yes, in most circumstances.

Question 6. The out-of-favor specified service trade or business does not qualify for the Section 199A deduction, correct?

Answer 6. Incorrect.

Looking at your taxable income is the first step to see whether you qualify for the Section 199A tax deduction. If your taxable income on IRS Form 1040 is $157,500 or less (single) or $315,000 or less (married, filing jointly) and you have a pass-through business such as a proprietorship, partnership, or S corporation, you qualify for the Section 199A deduction.

With taxable income equal to or below the thresholds above, your type of pass-through business makes no difference. Retail store owners and medical doctors with income equal to or below the thresholds qualify in the same exact manner.

Avoid the 1099 Prepaid-Rent Mismatch

Two questions:

• Did you prepay your 2019 rent so that you have a big 2018 tax deduction?
• How do you identify in your accounting records the monies you put on your IRS Form 1099-MISC for the business rent payments to your landlord?

For the 1099-MISC, do you simply look at your checkbook or payment ledgers to identify the amounts you are going to report? If so, you will create an incorrect 1099 for your landlord that’s going to cause your landlord a tax problem.

One golden rule when it comes to your landlord is “do not cause your landlord tax trouble.”

Let’s say you wrote a $55,000 check to your landlord on December 31 and mailed it that day. Your landlord received the check on January 3. Here’s how your Form 1099-MISC can create a tax problem for your landlord:

• Your Form 1099-MISC to the landlord shows rent paid of $105,000 ($50,000 paid during the year and then the $55,000 prepayment on December 31).
• The landlord’s 2018 federal income tax return shows $50,000 in rent received (he received the $55,000 in 2019).
• IRS computers note the difference and start an inquiry.

An incorrect 1099 that overstates the landlord’s income is a problem that can lead to a tax audit.

IRS Reg. Section 1.6041-1(f) says:

The amount to be reported as paid to a payee is the amount includible in the gross income of the payee . . .

Note. As you will see below, this amount does not necessarily equal the tax deduction claimed by the payor.

Reg. Section 1.6041-1(h) says:

For purposes of a return of information, an amount is deemed to have been paid when it is credited or set apart to a person without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and is made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition.

The 1099-MISC is a “return of information.”

The landlord did not have control of the money until he or she had possession of the check in 2019.

In Cheryl Mayfield Therapy Center, the court stated:

A “payment” is made for purposes of section 6041 information returns when an amount is made available to a person “so that it may be drawn at any time, and its receipt brought within his own control and disposition.”

Surprisingly, the 1099 could contain a taxable amount to the payee that is different from the deduction amount of the payor.

For example, in this case, the correct 1099-MISC amount is $50,000. That’s the amount you should put on the 1099-MISC you send to the landlord for 2018 even though you are going to deduct $105,000 as a cash-basis taxpayer.

Avoiding the Kiddie Tax after Tax Reform

If your family has trouble with the kiddie tax, you face some new wrinkles for tax years 2018 through 2025 thanks to the Tax Cuts and Jobs Act (TCJA) tax reform. This is one of the many areas where tax planning can pay off.

For 2018–2025, the TCJA tax reform changes the kiddie tax rules to tax a portion of an affected child’s or young adult’s unearned income at the federal income tax rates paid by trusts and estates. Trust tax rates can be as high as 37 percent or, for long-term capital gains and qualified dividends, as high as 20 percent.

Unearned income means income other than wages, salaries, professional fees, and other amounts received as compensation for personal services. So, among other things, unearned income includes capital gains, dividends, and interest. Earned income from a job or self-employment is never subject to the kiddie tax.

Your dependent child or young adult faces no kiddie tax problems if he or she does not have unearned income in excess of the kiddie tax unearned income threshold ($2,100 for 2018 and $2,200 for 2019). And when your dependent child exceeds the threshold by only a minor amount, the kiddie tax hit is minimal and nothing to get too upset about.

But if your child is getting hit hard by the kiddie tax, your tax planning should consider

• employing your child so that he or she has earned income sufficient to eliminate the kiddie tax, or
• changing the investment mix from income generation to capital growth.

Tax Reform’s New Qualified Opportunity Funds

Qualified opportunity funds are a new tax-planning strategy created by the Tax Cuts and Jobs Act tax reform.

The new funds have the ability to defer current-year capital gains, eliminate some of them later, and then on the new investment make capital gains tax-free. To put the benefits in place, you need to navigate some new rules and time frames.

Example: On December 1, 2018, you sell $8 million of stock with a cost basis of $3 million for a long-term capital gain of $5 million.

1. Within 180 days, you invest the $5 million gain in a qualified opportunity fund.
2. You make an election on your 2018 tax return to defer the $5 million in long-term capital gain income, meaning no taxes on this gain in 2018.
3. On December 31, 2026, your qualified opportunity fund has a basis of $750,000 (15 percent of the deferred $5 million capital gain), since you held it for at least seven years.
4. Let’s assume the fund has a fair market value of $7 million on December 31, 2026. You’ll have a deemed sale on December 31, 2026, and recognize $4.25 million in income, computed as follows:

• $5 million, which is the lesser of the deferred gain ($5 million) or the fair market value of the fund ($7 million), less
• $750,000, the basis in the fund.

5. On January 1, 2027, your basis in the qualified opportunity fund is $5 million ($750,000 original basis plus $4.25 million of deferred gain recognized and taxed in 2026).
6. If you sell the qualified opportunity zone fund in August 2028 for $10 million, then your basis in the fund is $10 million and you recognize no taxable gain on the sale, since you held it for more than 10 years.

Overall, you have a total of $10 million in gains from these transactions: $5 million from 2018 and $5 million in 2028. Using the qualified opportunity fund investment strategy, you

• temporarily defer $4.25 million of long-term capital gain from 2018 to 2026, and
• permanently exclude from tax $750,000 of long-term capital gain from 2018 and $5 million of gain in 2028.

For this strategy to make great financial sense, you need (a) appreciation in your qualified opportunity fund and (b) to hold the investment for at least 10 years so that the appreciation is tax-free to you when you sell your investment.

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Properly organized documentation, like bank reconciliations, bank statements and operating transaction receipts, is the best strategy in preventing your business operations to be treated as hobby, instead than a for profit entity, by the IRS. Expense deductions are not allowed under section 162 or 212 for activities which are carried primarily as a sport, hobby, or for recreation.^[1]  The determination whether an activity is engaged in for profit is made by reference to objective standards, taking into account all of the facts and circumstances of each case. At PTA, we assist our clients organize and structure their businesses by transforming data into useful financial reports and staying in compliance with the law.

Will Your Business Pass the Test?

The factors the IRS takes into account to determine whether your business is engaged in for profit are the following^[2]:

1. Manner in which the taxpayer carries on the activity: The fact that the taxpayer carries on the activity in a businesslike manner and maintains complete and accurate books and records may indicate that the activity is engaged in for profit.
2. The expertise of the taxpayer or his advisors: Preparation for the activity by extensive study of its accepted business, economic, and scientific practices, or consultation with those who are expert therein, may indicate that the taxpayer has a profit motive.
3. The time and effort expended by the taxpayer in carrying on the activity: The fact that the taxpayer devotes much of his personal time and effort to carrying on an activity, particularly if the activity does not have substantial personal or recreational aspects, may indicate an intention to derive a profit.
4. Expectation that assets used in activity may appreciate in value: The term “profit” encompasses appreciation in the value of assets, such as horses, used in the activity.
5. The success of the taxpayer in carrying on other similar or dissimilar activities: The fact that the taxpayer has engaged in similar activities in the past and converted them from unprofitable to profitable enterprises may indicate that he is engaged in the present activity for profit, even though the activity is presently unprofitable.
6. The taxpayer’s history of income or losses with respect to the activity: A series of losses during the initial or start-up stage of an activity may not necessarily be an indication that the activity is not engaged in for profit. However, where losses continue to be sustained beyond the period which customarily is necessary to bring the operation to profitable status such continued losses, if not explainable, as due to customary business risks or reverses, may be indicative that the activity is not being engaged in for profit. If losses are sustained because of unforeseen or fortuitous circumstances which are beyond the control of the taxpayer, such as drought, disease, fire, theft, weather damages, other involuntary conversions, or depressed market conditions, such losses would not be an indication that the activity is not engaged in for profit. A series of years in which net income was realized would of course be strong evidence that the activity is engaged in for profit.
7. The amount of occasional profits, if any, which are earned: The amount of profits in relation to the amount of losses incurred, and in relation to the amount of the taxpayer’s investment and the value of the assets used in the activity, may provide useful criteria in determining the taxpayer’s intent.
8. The financial status of the taxpayer: The fact that the taxpayer does not have substantial income or capital from sources other than the activity may indicate that an activity is engaged in for profit.

Equestrian Businesses

Tax law provides examples of situations where equestrian business investment losses were disallowed by the IRS because the organizations were treated as hobbies, instead of for-profit entities. In Budin,^[3] the taxpayers’ reported horse show income, cost of training, boarding, showing and maintaining horses, depreciation, and breeding expenses for their business were disallowed because the business was held to not be engaged in for profit under Code section 183. In Mckeever,^[4] the court held that the horse breeding activity lacked a profit objective. The equestrian activities in the Price^[5] and Rodriguez^[6] cases also lacked profit objective and were disallowed under Code section 183 eliminating all the tax benefits previously received.

Please contact us to assist you with all your accounting needs! The importance of developing useful financial reports and implementing effective tax strategies cannot be stressed enough. We look forward to helping your business strive and succeed!

Our team is prepared understand your business and to assist you in:

• CFO Services
• Implementing effective tax strategies
• Tax planning for corporate, partnership and individual taxpayers
• Preparation of tax returns including 1120, 1120S, 1065, 990, 1040 tax forms
• Financial Reporting Services
• Preparing financial statements for Management, Financial Institutions, and Investors
• Analyzing financial statements to suggest improvements to work flow and cash flow
• Audit preparation and representation
• Preparing and submitting payroll, sales tax and quarterly payments and reports
• Preparing budgets
• Reconciling general ledger accounts (PP&E, RE, Liabilities, Bank Accounts)
• Ensuring clients are complying with Federal, State, & Local regulatory requirements
• Managing QuickBooks
• Maintaining internal controls & accounting procedures

Show me the money:  Combine or keep separate or both

One of the best ways to avoid conflict is to put your money into three separate piles: yours, your spouse’s, and a joint set of accounts. In this arrangement, each of you has control over some money that is all your own. The household spending will then come out of the joint account, and you both will make contributions to it on a regular basis.

As a couple, you’ll need to discuss who will pay for what as well as what your regular contribution will be to the joint account. This is no small discussion. The more thorough you are, the less conflict you’ll have over money.

One spouse or partner will normally handle the joint finances, and it’s typically the person with the most accounting knowledge. However, you both should have access to this account in case of emergency.

Savings and future purchase goals

Do you have goals about upcoming large purchases?  These might include:

• A home purchase or improvement
• Children’s education
• Health care needs
• Saving for retirement
• A car purchase
• A second home purchase
• A vacation
• Another item such as a boat, furniture, technology gadgets, a plane, or something else
• A nest egg or cushion

If so, calculate how much you need and make a plan to set aside the money you need in the time frame you agree on.

Spending

Do you like to spend more than your spouse? Or is it the other way around? When money is flowing, there is usually no problem. Problems come in when money is tight.

Focus on priorities when there are conflicts in the area of spending. If you can agree on your priorities and goals, it can often shift spending habits.

Budget

You may want to set a budget to stick as close as possible to expected spending limits. Start by recording current spending in these areas, and then agree on the amounts you want to spend in the future.

• Rent or mortgage payment
• Utilities, including electric, gas, water, garbage, phone, internet, cable
• Food and supplies, including grocery, kitchen items, liquor, and eating out
• Entertainment, including travel, vacations, local events, holiday decorations, Netflix subscriptions, tech gadgets, books, etc.
• House maintenance including repairs, cleaning, lawn care, appliances, and decorating
• Automobile, including gas, insurance, licenses, and maintenance
• Clothing and accessories, including dry cleaning
• Health care, including pharmacy, doctor’s visit, and HSA contributions
• Personal care, such as haircuts, nail care, etc.
• Tuition and/or education expenses
• Contribution to retirement and savings accounts
• Charitable contributions
• Taxes, including federal, state, local, school, and property
• Paying down credit card or student loan debt

Retirement

What does retirement look like to both of you? Having this conversation will be enlightening. Know that dreams and goals can change over time as retirement approaches.

You’ll want to have an idea about what you’d like to spend during your final years so that you can make plans to start accumulating that wealth now. The sooner you start, the more years you have to build up your retirement assets.

Monitoring your progress

Keep an eye on your account balances to make sure everything is as it should be. Review bank and brokerage account statements and/or your budget once a month or at least once a quarter so there are no surprises or trends that sneak up on you.

When you reach your goals, reward yourself. Managing money is hard work, and you deserve to pat yourself on the back when a goal is achieved. If there is anything we can do to help you make your financial dreams come true, please reach out any time.