Tag: 2017 taxes

First run at the new tax law

Just for fun, I created a quick spreadsheet to calculate individual taxes based on the new tax law – at least the parts that make sense this morning.  I will be adding to it as I go along.  The calculations are based upon the Senate version.

It is simpler, I will give congress that.  I put the spreadsheet together in about 30 minutes from scratch.  Here is something to think about though, $12,000 is a lot of property tax and mortgage interest.  And $24,000 is a heck of a hurdle for a married couple.

If your current mortgage value is under $200,000 and your property tax is less than $3,500 you will probably not get above $12,000 for the standard deduction if you are single.  If you are married you will need a mortgage above $450,000 to get close to the $24,000 limit.

A single person making $50,000 will have a 2018 tax liability of $4,370 under the Senate plan.  A single person making this amount will likely not have a mortgage above $200,000, and will therefore take the standard deduction of $12,000.

A married couple making $72,000 combined and with one child under 16 will owe taxes of $5,379, before the child tax credit.  If the tax credit is $2,000, their net tax is $3,379.

Since it is unlikely that this couple would have a mortgage above $450,000, they would also take the standard deduction.

A married couple with no children who makes $150,000 with a $450,000 mortgage will likely itemize as their property tax and interest will be above $24,000.  Their tax would be $17,430.  If they didn’t have a mortgage, their tax would be about $17,700.

The single person making $50,000 has an effective tax rate of 11.5%

The married couple making $150,000 with a mortgage has an effective tax rate of 14%

The married couple making $150,000 without a mortgage has an effective tax rate of 14.4%

A married couple making $150,000 with a mortgage and 2 children has an effective tax rate of 10.8%

Obviously, it is what is missing that matters.  Many of our clients have employment related expenses that will no longer be allowed as a miscellaneous itemized deduction.  And, from what I have read, medical expenses will no longer be taken into consideration.  We have several families with an aged parent in a care facility because they cannot be left alone.  This is $80,000 that is no longer a deduction and those gains, interest and dividends, pensions and social security will end up with a tax hit of about $10,000 or an effective tax rate of 14.6%.

I will spend some time looking at the corporate side the rest of the day and tomorrow and have some thoughts on that by the end of the weekend.

Enjoy your Saturday.

 

 

 

 

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Taxes and Small Business

In our research for the upcoming Lunch and Learn, we discovered something quite interesting. I thought I would work through it here and try to figure out how to help small businesses plan effectively.

As part of the potential for tax reduction is an attempt to deal with flow-through entities; that is sole proprietorships, S Corporations and LLC’s. Currently, with flow-through entities, the tax on profits is paid by the owners. The problem becomes defining profits. Let’s look at 3 companies A, B and C.

Profits and Compensation

All 3 companies make $100,000 before owner compensation. A decides to pay herself $50,000 of wages, B decides not to pay any and C pays almost all in the form of wages. The tax consequences are remarkably different.

A B C
Taxable Income Before Owner Compensation      100,000      100,000      100,000
Owner Compensation        50,000              –        92,500
Company Payroll Taxes 8.0%          4,000              –          7,400
Taxable Income Passed Through        46,000      100,000            100
Income Tax for Owner
Wages        50,000              –        92,500
Taxable Income Passed Through        46,000      100,000            100
Taxable Income for Owner        96,000      100,000        92,600
Tax Liabilities 25.0%        24,000        25,000        23,150
Total Taxes Paid
Company Payroll Taxes          4,000              –          7,400
Owner Payroll Taxes          4,000              –          7,400
Income Taxes        24,000        25,000        23,150
Total Taxes        32,000        25,000        37,950
Taxes as a Percent of Income Before Comp 32.0% 25.0% 38.0%

The difference between the results is the payroll taxes which every employee pays and which every employer matches.  The problem is that the only statutory requirement is that “Compensation must be Reasonable”.   And this has been an audit headache as the term “Reasonable Compensation” is based upon the facts and circumstances of the particular taxpayer and Company.

This difference in the tax law has been around for decades and has been left to auditors and taxpayers to argue about the term “Reasonable Compensation”.    In this case, we have argued on all sides – that A’s and C’s compensation is reasonable and so is B’s.   Most professionals would worry about losing in B’s position but clearly any compensation less than the amount of taxable income before owner compensation is a win for the taxpayer by reducing employment taxes.

Given that there is already this disparity and given that Congress knows about it and has elected not to touch it yet should give us all pause for concern as Congress looks at passing a substantial rewrite of the tax law to both reduce rates as well as treat Business earnings with a different tax rate.

Deemed Wages

To address this issue Congress will need to figure out a way to address owner compensation. So far, in all the proposals they use a phrase “Deemed Wages” to account for owner compensation. Randy and I have debated this and we are of the opinion that what is likely to happen is that the IRS will publish a table of expected compensation for various businesses and the owner’s compensation should be close to that in order to be considered reasonable. If an owner wants to pay differently, there should be some written justification for the position, such as minutes to the board of directors or a memo from a meeting between the owners and their representatives.

Keep in mind though, that this is one areas where is almost no guidance as it hasn’t been touched before.

This change to how small business reflects taxable income will be major.  By addressing the disparity shown above, Congress will potentially eliminate an audit headache and improve compliance.  It may mean that some pay more and some pay less, but it could also help give taxpayers peace of mind by addressing the unknown of “Reasonable Compensation” and reducing the risk of money spent on litigating this issue.