Tax Attic for 11/22/2018

I recently attended one of those educational tax seminars that just seemed to go on forever.  It did last from 8:00 in the morning until 9:00 at night so that almost qualifies as “forever”.  You know when there are two breaks for full meals, it’s a long seminar.  However, Marilyn Meredith, the instructor, came over from the Port Huron area and is one of the best tax instructors in the entire USA.  She really knows her material and is able to add much to the written materials.  Marilyn is one of those people who can take mundane tax rules and make the discussion at least somewhat interesting.

The first three-quarters of the program covered changes made by the Tax Cuts and Job Act of 2017 (TCJA2017) while final quarter covered all State of Michigan and City tax changes.  Since the TCJA2017 was passed, everyone involved in the tax business has been looking, waiting, and hoping for guidance on some of the areas that were most dramatically affected by the Act.  For example, the entire Schedule A has now undergone a large amount of change.  We are getting guidance and clarifications almost daily now and Marilyn spent a fair amount of time covering that guidance and those clarifications.  Next week, I will begin going over those changes.  They are so dramatic that, in the estimation of the Internal Revenue Service, only about 10 million taxpayers will be able to use a Schedule A in 2018.  That is down from about 30 million itemizers in 2017.  Of course, there will be winners and losers and many who will simply break even with the changes. We will look at that closer to help you determine, in a broad manner, if you will be a winner, a loser, or a break-even taxpayer when getting your return prepared in 2018.

Another part of TCJA2017 that we spent a great deal of time on was the new Code Section 199A.  Section 199A creates a deduction called the “Qualified Business Income” (QBI) deduction. QBI only applies to non-corporate or individual taxpayers who are self-employed with a Schedule C; are a member of a Partnership; or a shareholder in a Sub S Corporation.  The IRS released proposed regulations this past August that clarified many of the questions that all of us in the tax business had.  I won’t say that I was staying up at night worrying about those questions, but Action Tax does prepare a fair number of Schedule C returns, Partnership tax returns, and Sub S Corporation tax returns.  In other words, we have many clients who will potentially benefit from the QBI deduction so we had questions on a number of levels about calculating that 20% figure.  Basically, the QBI deduction is 20% of a new calculation called the Qualified Business Income Amount (QBIA).  Calculating the QBIA is really the most important part of the process.  Before this is all said and done, there will be whole volumes of texts written on determining the QBIA.  It may become a whole industry in and of itself.  Once we determine that QBIA amount, the deduction is simply 20% and that figure, subject to phase-out limitations, is taken over to the taxpayer’s Form 1040 where it becomes a subtraction from the taxpayer’s taxable income.  The new 2018 Form 1040 has a separate line on the page 2 of the 1040 form, line 9, where the subtraction is entered.  The location of the deduction is incredibly important for at least three reasons.  First, line 9 comes after line 7, of course.  Line 7 is the calculation of a taxpayer’s adjusted gross income (AGI).  Many income phase-outs, as well as most tax credits and deductions are based on that AGI figure.  If the QBI deduction comes after the AGI, all of those phase-outs, credits, and deductions remain in place.  They are not affected by the QBI.  Second, many state tax returns, including Michigan, start their calculations with the federal AGI.  If the QBI deduction reduced AGI, Michigan’s tax collections would have been adversely affected by that deduction.   Our new Governor, Gretchen Whitmer, would not be happy.  I’m guessing that taxing marijuana sales would still not have made that a break-even proposition.  Michigan would have probably determined they would force taxpayers to add back the QBI deduction before calculating tax but since the QBI deduction is after the AGI, no state adjustment has to be made.  Third, the fact that the QBI deduction is taken on line 9 of the Form 1040 and not on the Schedule C, the partnership or the Sub S return means that it is not taken into account when determining how much self-employment or social security tax the business owner has to pay with his return.  The QBI deduction will save income tax only and not self-employment or social security tax.  It will still be a tremendously popular deduction.

Next week, let’s discuss those Schedule A, Itemized Deductions, changes and clarifications.  Let’s see if anything can be done to mitigate losing a Schedule A or if losing it and not being able to itemize is a tax advantage that we should just take and be happy.  This is Jerry Coon signing off and wishing each of you a very Happy Thanksgiving!

Jerry Coon is an Enrolled Agent.

He owns Action Tax Service on Northland Dr in Rockford.

Contact Jerry at www.actiontaxservice.com