Charitable giving can be a powerful tax-saving strategy: Donations to qualified charities are generally fully deductible, and you have complete control over when and how much you give. Here are some important considerations to keep in mind this year to ensure you receive the tax benefits you desire.
To be deductible on your 2017 return, a charitable donation must be made by Dec. 31, 2017. According to the IRS, a donation generally is “made” at the time of its “unconditional delivery.” But what does this mean? Is it the date you, for example, write a check or make an online gift via your credit card? Or is it the date the charity actually receives the funds — or perhaps the date of the charity’s acknowledgment of your gift?
The delivery date depends in part on what you donate and how you donate it. Here are a few examples for common donations:
Check. The date you mail it.
Credit card. The date you make the charge.
Pay-by-phone account. The date the financial institution pays the amount.
Stock certificate. The date you mail the properly endorsed stock certificate to the charity.
Qualified charity status
To be deductible, a donation also must be made to a “qualified charity” — one that’s eligible to receive tax-deductible contributions.
The IRS’s online search tool, Exempt Organizations (EO) Select Check, can help you more easily find out whether an organization is eligible to receive tax-deductible charitable contributions. You can access EO Select Check at http://apps.irs.gov/app/eos. Information about organizations eligible to receive deductible contributions is updated monthly.
Potential impact of tax reform
The charitable donation deduction isn’t among the deductions that have been proposed for elimination or reduction under tax reform. In fact, income-based limits on how much can be deducted in a particular year might be expanded, which will benefit higher-income taxpayers who make substantial charitable gifts.
However, for many taxpayers, accelerating into this year donations that they might normally give next year may make sense for a couple of tax-reform-related reasons:
- If your tax rate goes down for 2018, then 2017 donations will save you more tax because deductions are more powerful when rates are higher.
- If the standard deduction is raised significantly and many itemized deductions are eliminated or reduced, then it may not make sense for you to itemize deductions in 2018, in which case you wouldn’t benefit from charitable donation deduction next year.
Many additional rules apply to the charitable donation deduction, so please contact us if you have questions about the deductibility of a gift you’ve made or are considering making — or the potential impact of tax reform on your charitable giving plans.
A fundamental tax planning strategy is to accelerate deductible expenses into the current year. This typically will defer (and in some cases permanently reduce) your taxes. But there are exceptions. One is if the additional deductions this year trigger the alternative minimum tax (AMT).
Complicating matters for 2017 is the fact that tax legislation might be signed into law between now and year end that could affect year-end tax planning. For example, as released by the Ways and Means Committee of the U.S. House of Representatives on November 2, the Tax Cuts and Jobs Act would repeal the AMT for 2018 and beyond. But the bill would also limit the benefit of some deductions and eliminate others.
The AMT and deductions
Some deductions that currently are allowed for regular tax purposes can trigger the AMT because they aren’t allowed for AMT purposes:
- State and local income tax deductions,
- Property tax deductions, and
- Miscellaneous itemized deductions subject to the 2% of adjusted gross income floor, such as investment expenses, tax return preparation expenses and unreimbursed employee business expenses.
Under traditional AMT strategies, if you expected to be subject to the AMT this year but not next year, to the extent possible, you’d try to defer these expenses until next year. If you ended up not being subject to the AMT this year, in the long-term you generally wouldn’t be any worse off because you could enjoy the tax benefits of these deferred expenses next year.
But under the November 2 version of the House bill, the state and local income tax deduction and certain miscellaneous itemized deductions would be eliminated beginning in 2018. And the property tax deduction would be limited. So if you were to defer such expenses to next year, you might permanently lose some or all of their tax benefit.
Income-related AMT triggers
Deductions aren’t the only things that can trigger the AMT. So can certain income-related items, such as:
- Incentive stock option exercises,
- Tax-exempt interest on certain private activity bonds, and
- Accelerated depreciation adjustments and related gain or loss differences when assets are sold.
If you could be subject to the AMT this year, you may want to avoid exercising stock options. And before executing any asset sales that could involve depreciation adjustments, carefully consider the AMT implications.
Uncertainty complicates planning
It’s still uncertain whether the AMT will be repealed and whether various deductions will be eliminated or limited. The House bill will be revised as lawmakers negotiate on tax reform, and the Senate is releasing its own tax reform bill. It’s also possible Congress won’t be able to pass tax legislation this year.
With proper planning, you may be able to avoid the AMT, reduce its impact or even take advantage of its lower maximum rate (28% vs. 39.6%). But AMT planning is more complicated this year because of tax law uncertainty. We can help you determine the best strategies for your situation.
Many investors, especially more risk-averse ones, hold much of their portfolios in “income investments” — those that pay interest or dividends, with less emphasis on growth in value. But all income investments aren’t alike when it comes to taxes. So it’s important to be aware of the different tax treatments when managing your income investments.
Varying tax treatment
The tax treatment of investment income varies partly based on whether the income is in the form of dividends or interest. Qualified dividends are taxed at your favorable long-term capital gains tax rate (currently 0%, 15% or 20%, depending on your tax bracket) rather than at your ordinary-income tax rate (which might be as high as 39.6%). Interest income generally is taxed at ordinary-income rates. So stocks that pay dividends might be more attractive tax-wise than interest-paying income investments, such as CDs and bonds.
But there are exceptions. For example, some dividends aren’t qualified and therefore are subject to ordinary-income rates, such as certain dividends from:
- Real estate investment trusts (REITs),
- Regulated investment companies (RICs),
- Money market mutual funds, and
- Certain foreign investments.
Also, the tax treatment of bond interest varies. For example:
- Interest on U.S. government bonds is taxable on federal returns but exempt on state and local returns.
- Interest on state and local government bonds is excludable on federal returns. If the bonds were issued in your home state, interest also might be excludable on your state return.
- Corporate bond interest is fully taxable for federal and state purposes.
One of many factors
Keep in mind that tax reform legislation could affect the tax considerations for income investments. For example, if your ordinary rate goes down under tax reform, there could be less of a difference between the tax rate you’d pay on qualified vs. nonqualified dividends.
While tax treatment shouldn’t drive investment decisions, it’s one factor to consider — especially when it comes to income investments. For help factoring taxes into your investment strategy, contact us.
Does your small business engage in qualified research activities? If so, you may be eligible for a research tax credit that you can use to offset your federal payroll tax bill.
This relatively new privilege allows the research credit to benefit small businesses that may not generate enough taxable income to use the credit to offset their federal income tax bills, such as those that are still in the unprofitable start-up phase where they owe little or no federal income tax.
Under the Protecting Americans from Tax Hikes Act of 2015, a qualified small business (QSB) can elect to use up to $250,000 of its research credit to reduce the Social Security tax portion of its federalpayroll tax bills. Under the old rules, businesses could use the credit to offset only their federal incometax bills. However, many small businesses owe little or no federal income tax, especially small start-ups that tend to incur significant research expenses.
For the purposes of the research credit, a QSB is generally defined as a business with:
- Gross receipts of less than $5 million for the current tax year, and
- No gross receipts for any taxable year preceding the five-taxable-year period ending with the current tax year.
The allowable payroll tax reduction credit can’t exceed the employer portion of the Social Security tax liability imposed for any calendar quarter. Any excess credit can be carried forward to the next calendar quarter, subject to the Social Security tax limitation for that quarter.
Research activities that qualify
To be eligible for the research credit, a business must have engaged in “qualified” research activities. To be considered “qualified,” activities must meet the following four-factor test:
- The purpose must be to create new (or improve existing) functionality, performance, reliability or quality of a product, process, technique, invention, formula or computer software that will be sold or used in your trade or business.
- There must be an intention to eliminate uncertainty.
- There must be a process of experimentation. In other words, there must be a trial-and-error process.
- The process of experimentation must fundamentally rely on principles of physical or biological science, engineering or computer science.
Expenses that qualify for the credit include wages for time spent engaging in supporting, supervising or performing qualified research, supplies consumed in the process of experimentation, and 65% of any contracted outside research expenses.
The ability to use the research credit to reduce payroll tax is a welcome change for eligible small businesses, but the rules are complex and we’ve only touched on the basics here. We can help you determine whether you qualify and, if you do, assist you with making the election for your business and filing payroll tax returns to take advantage of the new privilege.
Currently, a valuable income tax deduction related to real estate is for depreciation, but the depreciation period for such property is long and land itself isn’t depreciable. Whether real estate is occupied by your business or rented out, here’s how you can maximize your deductions.
Segregate personal property from buildings
Generally, buildings and improvements to them must be depreciated over 39 years (27.5 years for residential rental real estate and certain other types of buildings or improvements). But personal property, such as furniture and equipment, generally can be depreciated over much shorter periods. Plus, for the tax year such assets are acquired and put into service, they may qualify for 50% bonus depreciation or Section 179 expensing (up to $510,000 for 2017, subject to a phaseout if total asset acquisitions for the tax year exceed $2.03 million).
If you can identify and document the items that are personal property, the depreciation deductions for those items generally can be taken more quickly. In some cases, items you’d expect to be considered parts of the building actually can qualify as personal property. For example, depending on the circumstances, lighting, wall and floor coverings, and even plumbing and electrical systems, may qualify.
Carve out improvements from land
As noted above, the cost of land isn’t depreciable. But the cost of improvements to land is depreciable. Separating out land improvement costs from the land itself by identifying and documenting those improvements can provide depreciation deductions. Common examples include landscaping, roads, and, in some cases, grading and clearing.
Convert land into a deductible asset
Because land isn’t depreciable, you may want to consider real estate investment alternatives that don’t involve traditional ownership. Such options can allow you to enjoy tax deductions for land costs that provide a similar tax benefit to depreciation deductions. For example, you can lease land long-term. Rent you pay under such a “ground lease” is deductible.
Another option is to purchase an “estate-for-years,” under which you own the land for a set period and an unrelated party owns the interest in the land that begins when your estate-for-years ends. You can deduct the cost of the estate-for-years over its duration.
More limits and considerations
There are additional limits and considerations involved in these strategies. Also keep in mind that tax reform legislation could affect these techniques. For example, immediate deductions could become more widely available for many costs that currently must be depreciated. If you’d like to learn more about saving income taxes with business real estate, please contact us.
On October 12, an executive order was signed that, among other things, seeks to expand Health Reimbursement Arrangements (HRAs). HRAs are just one type of tax-advantaged account you can provide your employees to help fund their health care expenses. Also available are Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs). Which one should you include in your benefits package? Here’s a look at the similarities and differences:
HRA. An HRA is an employer-sponsored account that reimburses employees for medical expenses. Contributions are excluded from taxable income and there’s no government-set limit on their annual amount. But only you as the employer can contribute to an HRA; employees aren’t allowed to contribute.
Also, the Affordable Care Act puts some limits on how HRAs can be offered. The October 12 executive order directs the Secretaries of the Treasury, Labor, and Health and Human Services to consider proposing regs or revising guidance to “increase the usability of HRAs,” expand the ability of employers to offer HRAs to their employees, and “allow HRAs to be used in conjunction with nongroup coverage.”
HSA. If you provide employees a qualified high-deductible health plan (HDHP), you can also sponsor HSAs for them. Pretax contributions can be made by both you and the employee. The 2017 contribution limits (employer and employee combined) are $3,400 for self-only coverage and $6,750 for family coverage. The 2018 limits are $3,450 and $6,900, respectively. Plus, for employees age 55 or older, an additional $1,000 can be contributed.
The employee owns the account, which can bear interest or be invested, growing tax-deferred similar to an IRA. Withdrawals for qualified medical expenses are tax-free, and employees can carry over a balance from year to year.
FSA. Regardless of whether you provide an HDHP, you can sponsor FSAs that allow employees to redirect pretax income up to a limit you set (not to exceed $2,600 in 2017 and expected to remain the same for 2018). You, as the employer, can make additional contributions, generally either by matching employer contributions up to 100% or by contributing up to $500. The plan pays or reimburses employees for qualified medical expenses.
What employees don’t use by the plan year’s end, they generally lose — though you can choose to have your plan allow employees to roll over up to $500 to the next year or give them a 2 1/2-month grace period to incur expenses to use up the previous year’s contribution. If employees have an HSA, their FSA must be limited to funding certain “permitted” expenses.
If you’d like to offer your employees a tax-advantaged way to fund health care costs but are unsure which type of account is best for your business and your employees, please contact us. We can provide the additional details you need to make a sound decision.