Originally published on Forbes.com.
Well, I’m through the Joint Committee version of the Tax Cuts and Jobs Act. And I know you were all worried about this, so rest easy. The bill is good for me. Very good. I applied the provisions to my 2016 return and it reduces my income tax by over four grand – around thirty percent. Thank you, President Trump, my covivant and I will now be able to eat out three times a week instead of once. Well, we could have before, but CV doesn’t think restaurant food is healthy, so I’ll probably do something else with the money. The summary of how that works will give you a sense of some of the key provisions.
I’m Still Itemizing – You’re Probably Not
The standard deduction for a single is now $12,000 and a lot of itemized deductions are out the window. State and local income property and sales taxes are capped at ten grand. Mortgage interest is the same for people who don’t live in palaces or where housing prices are high – down to $750,000 acquisition from a million, but existing mortgages are grandfathered. So lets say you are married and have a $300,000 mortgage at 4%. With the $10,000 for state and local, that brings you to $22,000. What else is there? Pretty much nothing unless you are very sick or above average charitable. As it happens I am above average charitable. Not bragging. Just saying. I wouldn’t think I was above average charitable, if I hadn’t seen so many income tax returns over the years.
Personal Exemption
Well that sucks. It is gone. Costs me nearly a grand. Close enough anyway. It’s just me, but if you have a few kids that will hurt. Then there is the child credit, but why should I care about that? My kids are grown. Here’s the thing. If you want a comprehensive treatment of the bill you can read it yourself. I’ll tell you a trick that nobody told me. Go to page 507 (really) and you will come to the committee explanation of the bill . It is long, but their is a shortcut. Each section of the explanation is structured as – Present Law, House Bill, Senate Amendment, Conference Agreement. Just skip to the Conference Agreement. You might have to go back if it says that the Conference Agreement follows the Senate Amendment, but it saves time. The other thing to do is read Kelly Phillips Erb, aka Tax Girl. She has a different approach than I do, which probably accounts for her having more readers. Also Tony Nitti has a nice summary.
The Rates
The rates are better and in my case that more than makes up for the loss of the personal exemptions. Hurray for me. You can get the rates from Kelly.
The Big Deal
It is qualified business income (Code Section 199A) that is a really big deal for me- a 20% deduction on my taxable income. And 199A is where President Trump’s mixer promise really came true.
It’s in conference right now, but I call it the mixer. I think when it comes out it’s going to be a beautiful mix, there are things that I like better in the Senate bill, there are some things I like better in the House bill… We’ll have some new additions, and we’ll have the best of each.
The House Bill was really oriented toward what I call the New Gentry. Total elimination of the estate tax and a special rate for qualified business income that favored the idle among the rich and did almost nothing for the little people. The Senate Amendment created a deduction which is much more oriented towards companies that provide jobs and small independent businesses. The Senate Amendment would have pretty much given nothing to some forms of commercial real estate. The Conference Committee, on the other hand is great for small independent business and throws a bone to the capital intensive. Here is how it works
Who Are The Little People?
There are restrictions on the 199A deduction, but the only ones that apply to the little people are that if you have an S Corporation, you have to take a reasonable salary, which doesn’t count – nothing new there really – and guaranteed payments from a partnership don’t count. Well my covivant and the other couple that owns the other half of our LLC divide the spoils in pirate-like fashion with no stinking guaranteed payments . And I think with a little creativity the economics of any partnership could be pretty well replicated without guaranteed payments.
This unrestricted nirvana starts phasing out for singles with taxable income of more than $157,500 and twice that on joint returns, which brings us to the restrictions. The phaseout is over $50,000 for singles and $100,000 for joint returns.
The Restrictions
Once you are past the phaseout, the deduction is the lesser of 20% of your qualified business income or 50% of the W-2 wages paid by your flow-through entity. It gets tricky here, if you have more than one trade or business, because the limit is computed on a trade by trade basis. So say that you are a plumber and you own a restaurant. You do the plumbing without any help, but have a lot of employees in the restaurant. You make a lot of money plumbing and barely break even on the restaurant. You are, if you excuse the expression, screwed. No deduction if you are over the threshold. Maybe not such a realistic example, but it gives you the idea.
Now that W-2 test would have been murder on high capital low labor enterprises. Commercial real estate came to mind. So there is an alternative test. 25% of your W-2 wages plus 2.5% of the cost of tangible depreciable assets in the business. That is unadjusted basis, so they count even if you have written them off immediately. They keep counting for the greater of the recovery period or 10 years. They way I figure it, a million dollars in depreciable assets is as good as $50,000 in W-2 wages. This might work out OK if you are leveraged. I’ve got some scenarios I am thinking through, but you have to remember Reilly’s Sixth Law of Tax Planning – Don’t do the math in your head. So that will be a followup.
Then there are the disfavored trades. If that is what you are doing you get no benefit once you are past the phase-out. Most of them were cribbed from a list in another part of the code (1202(e)(3)(A) if you must know):
business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees
Only for whatever reason, they dropped engineering and architecture from the list. Then there is also ” investing, trading, or dealing in securities, partnership interests, or commodities”. President Trump has already done enough for those Wall Street guys by making the market go up so much.
Under the House Bill, the disfavored trades would have gotten a break if they had a lot of capital assets. This way they get nothing.
Full Employment For Tax Professionals
The best value for classroom style continuing professional education for working tax professionals in New England is the Boston Tax Institute which is run by Lucien Gauthier. The people at the seminars are the accountants who do the tax returns for the butchers, the bakers and the candlestick makers – and the car dealers and small manufacturers and developers and contractors and more. After the Tax Reform Act of 1986 Act came out with the oxymoronic Passive Activity rules, Lu thought it was the end of the line for sensible tax practice. At his seminars before discussing the rules he would pass out applications to tractor trailer driving school. As it turned out Code Section 469 ended up being great for our industry.
So Lu is excited about Code Section 199A and is determined to become the great authority on it. That’s we he told me a couple of days ago. I told him that I would be competing with him. Maybe we will collaborate.
The problem will be the devilish details. For example as Lu would put it – Query – Will taxpayers have to group activities in the same manner under 199A as they do for 469? . What happens to your asset base if you acquire with a like-kind exchange? And on and on.
Most of us spend an inordinate amount of time to figure out how to classify income as capital gains. Now Congress, in its deep wisdom, has created a brand new flavor of income. It’s not as good as capital gains, but it is better than being poked in the eye with a sharp stick. We will now start scheming so that if we can’t avoid recognition and can’t make it capital gain, we will try to make it qualified business income. I’ll save my schemes for another day. It is important to remember that there will be rulings, regulations and decisions as time goes on. Remember Reilly’s Third Law of Tax Planning – Any clever idea that pops into you head probably has a corresponding rule that makes it not work. In the case of 199A, the rules will be coming.
What Are They Up To?
Not too many couples have taxable income over $315,000. That probably means gross income around $350,000. So the message we are being sent is that we should stop being such slackers and go into business for ourselves. When you join the ranks of the self-employed the big shocker is the SE tax. Instead of having 7.65% taken out of your pay, now you are paying 15.3%. And that is from dollar one. As I have crunched the numbers there is a kind of rough correspondence between that extra SE burden and the benefit of having qualified business income. So if your employer doesn’t need the W-2 wages to qualify there is some money to be saved between you and the employer by you becoming an independent contractor or being made a partner.
It will start looking even better if you can make a case that your business is home based. Its not just the home office deduction. It also means that none of your driving is commuting. And not that this applies to anybody I know, but I have heard that there are some people that are maybe a little aggressive on what they deduct on their Schedule C. Compliance will be pretty easy to enforce on those postcard returns that we have been promised, but it may be a different story with all the Schedule C people that will now be popping up.
Is it possible that the Republicans are trying to create a world in which everybody is either living off capital or being entrepreneurial? Frankly, I don’t think that will work well. Much of what makes the world work is people showing up and doing what they are told with skill, knowledge, and dedication. If they are getting a pretty fair deal, they will be loyal – more loyal than their employers deserve usually. I have a great deal of admiration for entrepreneurs. Part of my job is to understand them. And there are other types of celebrated people that I stand in awe of. But I could probably get by without them better than I could without the guys emptying the dumpster and plowing the snow in my condo complex. And for the life of me, I can’t see why I should pay less tax on the same dollars than they pay.
About That Postcard
One of the most annoying things about the promotion of this act was the idea that many people could do their returns on a postcard. Well you know what. I bet that you could shrink Form 1040-EZ to fit on a postcard. So what they did was make it so a lot fewer people are itemizing. That is great for people who live in low tax states, but it is going to be a real killer for New Yorkers. Well, I won’t be getting a postcard to do my return on, but I will pay less and will get a lot of clean work with no heavy lifting out of the new complexity, so thank you President Trump and Speaker Ryan.
Correction
In an earlier version, I misstated the comparison that you make to arrive at your deduction implying that you compare your qualified business income to 50% of W-2 wages. You actually compare 20% of qualified business income to 50% of your W-2 wages paid.
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