For the second time in a week, House Republicans are pushing policy changes that seem to conflict with key elements of last year’s Tax Cuts and Jobs Act (TCJA). This time, the House says it is worried about the growing numbers of self-employed workers and is giving the IRS 90 days to explain how it will improve their tax compliance.
An inversion arises when a U.S. corporation either creates a foreign corporation to be its new parent or merges into a smaller existing foreign corporation. After the inversion, the combined firm can lower its U.S. tax bill by shifting profits abroad, either through inter-corporate transactions or increased operations abroad.
Investors may no longer deduct investment expenses, including those passed through from an investment partnership. Restructuring these expenses into a management company might achieve business expense treatment providing it’s a genuine family office with substantial staff rendering financial services to extended family members and outside clients.
The Tax Cuts and Jobs Act (TCJA) is plagued by a recurrent problem: Many parts of the law tax similar income or assets at different rates. That tendency has created an enormous mess with the tax treatment of pass-through businesses, where certain income from certain taxpayers enjoys a 20 percent individual income tax deduction while similar income from other taxpayers does not.
Tax alpha is an aspect of investment portfolio management whereby strategies are utilized to reduce, delay or eliminate taxation. The tactics that are utilized are not “schemes” and are not implemented in an attempt to not pay tax. Tax minimization is not the primary consideration in investment management, but it should be a factor when allocating and making adjustments to a portfolio.
Tax alpha can benefit all portfolios regardless of whether they are owned by trusts, corporations or individuals. The benefits are certainly relative to the size of the taxable assets and can benefit even small portfolios. The greatest impact, however, is likely to benefit those who are faced with the highest marginal ordinary income tax rate and large portfolios. The reason for this is the variance between the long-term capital gains rate and the marginal ordinary income rate when making holding period decisions.
Taxation is one of many costs working against maximizing portfolio returns. Commissions, fees, interest and many other factors seem to be proactively managed while taxation tends to be overlooked. Portfolios are managed throughout the year, tax statements are delivered to the portfolio owner, who forwards them without looking at them, to the CPA who enters the data into software that produces the tax return. In this too-frequent scenario, nobody takes responsibility for minimizing the portfolio’s tax consequences. The effect of taxation on portfolio returns should be the responsibility of the portfolio manager and stated as such in an Investment Policy Statement.
Tax alpha is produced using a number of different strategies: tax loss harvesting, gain resets, asset location, holding period management and security type selection.
Tax loss harvesting is generally executed at the end of the year but can be utilized at any time. If the portfolio has realized gains (securities were sold at some point during the year), securities that will produce a loss are sold in order to offset those gains. This is a simple explanation, but when harvesting losses, investors need to be aware of the difference between short-term and long-term gains rates and how losses are applied to gains. One also needs to be mindful of the IRS’s wash sale rule, which requires the investor to wait no fewer than 31 days to repurchase the same security in order to deduct losses.
Many plaintiffs will face higher taxes on lawsuit settlements under the recently passed tax reform law. Some will be taxed on their gross recoveries, with no deduction for attorney fees even if their lawyer takes 40% off the top. In a $100,000 case, that means paying tax on $100,000, even if $40,000 goes to the lawyer. The new law should generally not impact qualified personal physical injury cases, where the entire recovery is tax free. It also should generally not impact plaintiffs who bring claims against their employers. They are still allowed an above the line deduction for legal fees (although there are new wrinkles in sexual harassment cases).
For most other types of claims, if the suit is not related to the plaintiff's trade or business, there may be no write-off for legal fees or costs. That means you are taxed on 100% of your recovery.
Tax professionals are pleading with the IRS for details as soon as possible. The American Institute of CPAs asked for “immediate guidance” on the pass-through provision in a Feb. 21 letter to the IRS. “Taxpayers and practitioners need clarity” to comply with their tax obligations and “make informed decisions regarding cash-flow, entity structure, and other tax planning issues,” the AICPA said.
This much is clear: If you’re a pass-through business owner who earns less than $157,500, or $315,000 for a married couple, you get full access to the deduction no matter what you do.
Above those thresholds, the deduction fades for certain “service” industries specified in the law including health, law, consulting, athletics, financial and brokerage services. (The break is completely eliminated for service business owners earning more than $207,500 if they’re single, or $415,000 if they’re married.)
Are you self-employed or a small business owner? If you work from home you may be able to take the home office deduction. Here is what you need to know to figure out if you qualify and get a better understanding of how this often-scary deduction works.
The home office deduction has a reputation for being an audit red flag. While this may be true in some cases, you have nothing to worry about if you have good records and actually qualify for the deduction.
Working from home sure has its benefits. You can’t beat the commute and you might have more time to spend with your family. The cherry on top may be some extra money in your pocket from not having to pay for an office and from a potential tax deduction.
Growing numbers of solo-preneurs and small business owners working from home have made the home office deduction an even more important topic for you to understand. I’ve spoken with many business owners over the years who are likely eligible for this tax break but don’t take it. Why? Because they are just afraid of any undue scrutiny of their tax returns.
Tax law is complex and, with the new GOP tax plan, things are not going to get any easier for the self-employed. The record-keeping hassles of the home office deduction have scared many away over the years. Also, there is a depreciation recapture provision that could mean higher taxes if you sold your home after taking the home office deduction.