Tax Updates

1. Tax Updates Raul O. Serrano, Jr C.P.A.Christin Bucci, Attorney , LL.M., CPAAlan J. Harriet, MBA, CPA

2. What’s news in tax TAX CUTS AND JOBS ACT (TCJA)2018 is the year of the implementation for the majority of the Tax Cuts and Jobs Act provisions.

3. Business Classifications NON-Service Service T.I. less than $315,000.00 (MFJ) 20% deduction 20% deduction T.I. greater than $315,000.00 but Less than $415,000.00 Limitation Phased-In Deduction phased- out T.I. greater than $415,000.00 Wage/capital testing No Deduction

4. What’s news in tax • Step 1: Are you a trade or business. • Does your business rise to the level of a trade or business? • In Groetzinger, the Supreme Court stated that to rise to the level of a Section 162 trade or business, “the taxpayer must be involved in the activity with continuity and irregularity, a sporadic activity, a hobby, or an amusement diversion does not qualify” • Step 2: for each trade or business compute the QBI (qualified business income). • What counts as QBI? • It’s the net amount of the business’ qualified items of income, gain, deduction, and loss. QBI doesn’t include investment-related items of income, gain, deduction, and loss. • Both of these rules apply to active and passive investments.

5. What’s new in tax • Step 3: what is your business taxable income for the year? • If less than $157,500.00 or $315,000.00 for taxpayers married filing jointly, you need nothing else but to compute 20% of your QBI apply the overall limit based on taxable income and you are done. (Add 20% of qualify REIT dividends and publicly traded partnership (PTP) income if applicable). • Step 4: if your business owners’ taxable income is greater than $157,500.00 ($315,000.00 for married filing jointly), than that’s where it gets complicated.

6. Computational-SSTB • Applicable percentage rate= 100% less the excess of the T.I. over the threshold amount divided by the range amount. • 100%less (T.I. –threshold amount /50,000.00all others or 100,000.00 JF=%)=applicable %. • Example: Single taxpayer with T.I. of $200,000.00, included in the amount is $100,000.00 in income from his Law practice with applicable W-2 wages of $90,000.00. • Applicable %= 100%- (200,000.00-157,500/50,000.00=85%)=15%. • QBI $100,000.00 *.15= $15,000.00 , W2 wages + 90,000.00*15%=$13,500.00. • After applying the applicable rate , your deduction is the lesser of 20% of includable QBI (20% of $15,000.00=$3,000.00) or 50% of the W2 wages (50% of 13,500.00=$6,750.00) • The lesser is $3,000.00.

7. COMPUTATIONAL-EXAMPLES Single-35% Retailer-S Co. Lawyer-S Co. Business Income 250,000. 250,000. Less W-2 87,500. 87,500. Less payroll Taxes 6,694. 6,694. ------------- ------------- Net Business Income 155,806. 155,806. Itemized deductions ( 12,000.) (12,000.) --------------- -------------- T.I.b.199A 231,306. 231,306. IRC Section 199A deduction 31,161. 0 -------------- -------------- Tax benefit of 199A $10,906. 0

8. COMPUTATIONAL EXAMPLES • Section 199A W-2 wage limit =$87,500.00 • 50%=$43,750.00 • We used the lower of $31,161.00.

9. An employee not an owner , section 199A? • If a person was an employee of an employer, but suddenly becomes an independent contractor while providing the substantially the same services or indirectly to the former employer, it is presumed for the next three years that they are still an employee for purposes of Section 199A, and thus ineligible for the Section 199A deduction.

10. New Proposed Regulation under section 199Aprovides guidance • Definition of a Specified service trade or business for section 199A is; • a. trade or business; • b. Reputation & skill. • Exempted some types of business from SSTBs; • Narrows SSBT; • Ancillary services; • Section 199A aggregation rules; • De Minimis rule • Anti-Abuse Rules.

11. The Definition of SSTB for 199A purpoSES • 1. any trade or business involving the performances of services in the fields of; • a. health; • b. law; • c. accounting; • d. actuarial science; • e. performing arts; • f. consulting; • g. athletics; • h. financial services • i. brokerage services; • j. or any other trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, and, 2. Any trade or business that involves the performance of services that consist of investing and investment management, trading, or dealing in securities ( as defined in section 475(c )(2)), partnerships interest, or commodities (as defined in section 475(e )(2)).

12. Trade or business • The preamble to the proposed regulations provides that for purposes of the section 199A, the definition of a trade or business is provided under section 162(a), however , the term “trade or business” is not defined in the Internal Revenue Code (IRC), treasury regulation, or IRS guidance. • The proposed regulations incorporated the Code Section 162 rules for determining what constitutes a trade or business. However, a rental activity that does not meet the code section 162 requirements also qualifies as a business if it rents or licenses tangible or intangible property to a commonly control business. Business is commonly controlled if the same person or persons own at least 50% of each business.

13. Revenue Procedure 2019-7 • Rental : In Revenue Procedure 2019-7, The IRS offered a safe harbor providing that a rental activity (or multiple rentals if the taxpayer chooses to treat them as a combined enterprise, with the understanding that commercial properties cannot be grouped with residential properties) will rise to the level of a Section 162 trade or business if: • a. Separate books and records are maintained for each rental activity (or the combined enterprise if grouped together). • b. 250 hours or more of “rental services” are performed per year for the activity (or combined enterprise), and • c. The taxpayer maintains contemporaneous records, including time reports or similar documents, regarding 1) hours of all services performed, 2) description of all services performed, 3) dates on which such services are performed, and 4) who performed the services. • NOT QUALIFYING FOR THE SAFE HARBOR-triple net leases.

14. SELF-RENTAL • A rental activity will be treated as a Section 162 trade or business if it is rented to a “commonly controlled” trade or business owned by the taxpayer. • In order to be “commonly controlled “the property must be rented to an individual or pass-through (no C Corporation), and the same owner or group of owners must own 50% or more of both the property and business. (For this purposes, the 50% standard is measured by using the attribution rules of Sections 707 and 267. (departure from the proposed regulations). • Forms 1099 need to be file if treated as a trade or business, also any mortgage interest is now “business Interest” and subject to the new interest limitations under Section 163(j).

15. reputation and skill • The definition of “reputation and skill” of the owner was also significantly narrowed in the proposed regulations. The updated definition is; • Receiving income for endorsing products or services; • Licensing or receiving income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity; or • Receiving appearance fees or income (including fees or income to reality performers performing as themselves on television, social media, or other forums, radio, television, and other media hosts, and video game players.

16. Exempted some types ofbusiness from SSTBs • The proposed regulations exempted some types of business from SSTBs, including; • real estate agents and brokers; • insurance agents and brokers; • property managers; • Bankers taking deposits or making loans.

17. Narrows SSBT; • Example; • Sales of medical equipment are not an SSBT, even though physician health care services are. • Performing artists are service business, but not the maintenance and operation of equipment or facilities for use in the performing arts.

18. Ancillary services; • Question: business operating on the fringes of what‘s defined? • Example: We know doctors fall within that category, but there may be a number of ancillary services that you don’t have a medical doctor providing the service, and they don’t fit cleanly within the particular list. We might be uncertain as to whether those services are health care related. One example of this is assisted-living facilities. Where do you draw the line between a specified service trade or business and a non-specified service trade or business? • Additionally, from the definition of an SSTB, real estate management type services don’t seem to be captured within any of the definitions of consulting or investment management or things of that nature.

19. Section 199A aggregation rules; • A taxpayer may not have more than one trade of business, but a single trade or business generally cannot be conducted through more than one single entity. Taxpayers’ cannot use passive activity rules to group multiple activities into a single business. However, an individual may aggregate businesses if: • Each one is a trade or business; • The same person or groups owns a majority interest in each; • All items attributable to them are reported on returns using the same tax year; • None is a specified service trade or business; and • They are actually part of a larger, integrated trade or business. • NOTE: relevant pass-through entities (RPEs) cannot aggregate businesses.

20. Entity disclosure to owners • Under the proposed regulations, a determination as to whether a trade or business operated by a partnership or S corporation is an SSTB is made by the entity itself. The entity then discloses that information to its owners.

21. De Minimis rule • The proposed regulations provides a de Minimis rule to which a trade or business is not an SSTB if it provides only a small amount of services in a specified activity. Specifically, a trade or business is not an SSBT if less than 5 % (10% in the case of a trade or business with gross receipts of $25 million or less) of its gross receipts are attributable to the performance of services in an SSBT (the De Minimis threshold).

22. Anti-Abuse RuleS • Anti-Abuse Rules. The regulations adopt an anti-abuse rule that applies to an SSTB with related businesses with common ownership that generate at least 80 percent of their income from the entity that engages in the SSTB, such as when partners of a law firm that is an SSTB and the partners also own a building and the entire building is leased to the law firm. Under the anti-abuse rule, the rental income will be characterized as income from an SSTB.

23. Computational-SSTB • Applicable percentage rate= 100% less the excess of the T.I. over the threshold amount divided by the range amount. • 100%less (T.I. –threshold amount /50,000.00all others or 100,000.00 JF=%)=applicable %. • Example: Single taxpayer with T.I. of $200,000.00, included in the amount is $100,000.00 in income from his Law practice with applicable W-2 wages of $90,000.00. • Applicable %= 100%- (200,000.00-157,500/50,000.00=85%)=15%. • QBI $100,000.00 *.15= $15,000.00 , W2 wages + 90,000.00*15%=$13,500.00. • After applying the applicable rate , your deduction is the lesser of 20% of includable QBI (20% of $15,000.00=$3,000.00) or 50% of the W2 wages (50% of 13,500.00=$6,750.00) • The lesser is $3,000.00.

24. Other changes are buried in the legislation • The Tax Cuts and Jobs Act was enacted on December 22, 2017 and made several headline-worthy changes to us federal income tax laws. Other changes are buried in the legislation, such as the drastic increase in the penalty for failure to file in a timely manner an IRS form 5472, “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.” For tax years beginning after December 31, 2017, the Act increased the penalty to $25,000 from $10,000 for each return that must be filed.

25. INDIVIDUAL INCOME TAX BRACKETS • Individual Income Tax rates for 2018 were reduced to 7 brackets, With the high bracket reduced to 37% from 39.6%.

26. DEDUCTIONS AND CREDITS: 7. Alimony; the bill repeals the deduction for alimony payments and their inclusion in the income of the recipient. (New rules will apply only to divorces or separations executed after December 31, 2018).

27. DEDUCTIONS AND CREDITS: COMMENT; the IRS has cautioned that, under current law, for tax years 2017, it will not consider a return complete and accurate if the taxpayer does not report full-year coverage, claim a coverage exemption, or report a shared responsibility payment on the return.

28. BUSINESS: • H.R.1 call for a 21% corporate tax rate beginning in 2018. The bill makes the new rate permanent. Current rate tops out at 35%. • Dividend received deductions of 80% and 70% under current law are reduced to 65% and 50%, respectively.

29. BUSINESS: • The corporate AMT is repealed. • Bonus depreciation increases the 50% “bonus depreciation” allowance to 100% for property placed in service after September 27, 2017, and before January 1, 2023.

30. Section 179 expensing: • The bill enhances Code Sec. 179 expensing. The bill sets Code Section 179 dollar limitations at $1 million and the investment limitation at $2.5 million.

31. Deductions and credits: Eliminated were: • Code section 199; • Non-real property like-kind exchanges.

32. Pass-Through Business: The new tax law now provides for a flat 21% tax rate for corporations. If companies were taxed at a lower rate than individuals, the pass-through scheme doesn't work. But creating a new tax rate for the entities would take away the pass-through nature of the entity. Congress' solution?

33. Pass-Through Business: Business income that passes through to an individual from a pass-through entity and income attributable to a sole proprietorship will be taxed at individual tax rates less a deduction of up to 20% to bring the rate lower.

34. Pass-Through Business: • Qualified property. Qualified property is tangible property (typically, things you can touch) subject to depreciation and available for use in your business at the end of the tax year. You must use the property to produce qualified business income (as defined above).

35. Pass-Through Business: • Threshold amount. The threshold amount is the amount above which both the limitation on specified service businesses and the wage limit apply. The threshold amount is $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly. Phase-ins apply: that means that the benefit decreases as income increases.

36. Pass-Through Business: • Now that we've got those definitions down, here's how to figure the deduction: • If your taxable income is below the threshold amount, the deductible amount for each of your businesses is simply 20% of your QBI with respect to each business. • So, if your income TI is $50,000 and your QBI is $40,000, then your deduction is $8,000, or 20% of your QBI. You're under the threshold amount so no need to do any more math.

37. Pass-Through Business: If you are above the threshold amount, you are subject to limitations and exceptions which are determined by your occupation and a wage (and capital) limit.

38. Pass-Through Business: Let's look at specified service trade or businesses first. To figure QBI for a specified service trade or business, you take into account the applicable percentage of qualified items of income, gain, deduction, or loss, and allocable W-2 wages. When figuring the wage (and capital) limit, you'll include total wages paid to employees during the tax year but not those which are properly allocable to QBI (in other words, don't double count).

39. Pass-Through Business: • Here's how it works: Figure 20% of your QBI (a) and compare that to an additional formula (b): the greater of 50% of W-2 wages with respect to your trade or business or the sum of 25% of W-2 wages + 2.5% of the unadjusted basis, immediately after acquisition, of all qualified property. Don't forget to take into account the applicable percentage rate - 100% less the excess of the taxable income over the threshold amount divided by the range amount or in more simple terms, it's pro-rated for the amount you're over the threshold.

40. Pass-Through Business: Example: Single taxpayer with T.I. of $200,000., included in the amount is $100,000. in income from his law firm with applicable W-2 wages of $90,000. Calculate the applicable percentage; 100% less (T.I. $200,000.-threshold amount of $157,500./ $50,000.=85%)=15%. Apply the applicable percentage to QBI (15% of $100,000.=$15,000.) and W-2 wages (15% of $90,000.=$13,500.) After applying the applicable percentage, your deduction is the lesser 20% of includible QBI (20% of $15,000.=$3,000.) or 50% of W2 wages (50% *$13,500.=$6,750., or $3,000.

41. Pass-Through Business: • No matter which variation of the formula applies, your deduction may not exceed your taxable income for the year (reduced by net capital gain). If the net amount of your QBI is a loss, you'll carry it forward as a loss to the next tax year. • And remember, these deductions from income reduce your taxable income on your individual return. It does not change how you calculate your taxable income inside your business. Business expenses remain deductible.

42. Pass-Through Business: • If you are a specified service business and your taxable income exceed the threshold amount plus the phase in range ($207,500 for individual taxpayers and $415,000 for married taxpayers filing jointly), then you lose the deduction completely. In that case, the old pass-through rules apply meaning you pay tax using your individual tax rate.

43. Pass-Through Business: • For all other businesses, if your taxable income exceeds the threshold amount, the wage (and capital) limits begin to kick in. The wage (and capital) limit applies fully for a taxpayer (other than a specified service business) when taxable income exceeds the threshold amount plus the phase in range ($207,500 for individual taxpayers and $415,000 for married taxpayers filing jointly).

44. Pass-Through Business: Section 199A decision summary: Specific Service trade or business; • If taxable income is less than $157,500/$315,000. then the 20% deduction is fully available. • If taxable income is greater than $157,500./$315,000. but less than $207,500./$415,000. • then a partial deduction is available. • If taxable income is greater than $207,500./$415,000. then you get no deduction.

45. Pass-Through Business: All Others; • If taxable income is less than $157,500./$315,000. then the 20% deduction is fully available. • If taxable income is greater than $157,500./$315,000. but less than $207,500./$415,000. then a partial deduction is available with the W-2 and depreciable asset limit calculations phase in. • If taxable income is greater than $207,500./ $415,000. then the 20% deduction is compared to the full W-2 and depreciable asset limit calculations.

46. Pass-Through Business: Single-35% Retailer-S Co. Lawyer-S Co. Business Income 250,000. 250,000. Less W-2 87,500. 87,500. Less payroll Taxes 6,694. 6,694. ------------- ------------- Net Business Income 155,806. 155,806. Itemized deductions ( 12,000.) (12,000.) --------------- -------------- T.I.b.199A 231,306. 231,306. IRC Section 199A deduction 31,161. 0 -------------- -------------- Tax benefit of 199A $10,906. 0

47. Pass-Through Business: • Section 199A W-2 wage limit =$87,500.00 • 50%=$43,750.00 • We used the lower of $31,161.00.

48. Net Operating Loss: • The final bill modifies current rules for net operating losses . Generally, NOL’s would be limited to 80% of taxable income for losses arising in tax years beginning after December 31, 2017. The bill also denies the carryback for NOL’s in most cases while providing for an indefinite carryforward, subject to the percentage limitation.

49. International: • Repatriation, A portion of deferred overseas-held earnings and profits of subsidiaries will be taxed at a reduced rate of 15.5 % for cash assets and 8% for illiquid assets. Foreign tax credits carryforwards will be fully available and foreign tax credits triggered by the deemed repatriation would be partially available to offset the US tax.

50. International: • The final bill moves the United States to a territorial system. The bill creates a dividend-exemption system for taxing U.S. corporations on the foreign earnings of their foreign subsidiaries when the earnings are distributed. The foreign tax credit rules are modified, as would the Subpart F rules. The look-through rule for related controlled foreign corporations would be made permanent.