NEW TAX LAW

Here is a look at many of the provisions in the bill affecting individuals.

Tax rates

For tax years 2018 through 2025, the following rates apply to individual taxpayers: 

Single taxpayers

Heads of households

Married taxpayers filing joint returns and surviving spouses

Married taxpayers filing separately

Estates and trusts

Special brackets will apply for certain children with unearned income.

The system for taxing capital gains and qualified dividends did not change under the act, except that the income levels at which the 15% and 20% rates apply were altered (and will be adjusted for inflation after 2018). For 2018, the 15% rate will start at $77,200 for married taxpayers filing jointly, $51,700 for heads of household, and $38,600 for other individuals. The 20% rate will start at $479,000 for married taxpayers filing jointly, $452,400 for heads of household, and $425,800 for other individuals.

Standard deduction

 The act increased the standard deduction through 2025 for individual taxpayers to $24,000 for married taxpayers filing jointly, $18,000 for heads of household, and $12,000 for all other individuals. The additional standard deduction for elderly and blind taxpayers was not changed by the act.

Personal exemptions

 The act repealed all personal exemptions through 2025. The withholding rules will be modified to reflect the fact that individuals can no longer claim personal exemptions.

Child tax credit

The act increased the amount of the child tax credit to $2,000 per qualifying child. The maximum refundable amount of the credit is $1,400. The act also created a new nonrefundable $500 credit for qualifying dependents who are not qualifying children. The threshold at which the credit begins to phase out was increased to $400,000 for married taxpayers filing a joint return and $200,000 for other taxpayers.

Other credits for individuals

The House version of the bill would have repealed several credits that are retained in the final version of the act. These include:

• The Sec. 22 credit for the elderly and permanently disabled;
• The Sec. 30D credit for plug-in electric drive motor vehicles; and
• The Sec. 25 credit for interest on certain home mortgages.

The House bill’s proposed modifications to the American opportunity tax credit and lifetime learning credit also did not make it into the final act.

Itemized deductions

The act repealed the overall limitation on itemized deductions, through 2025.

Mortgage interest: The home mortgage interest deduction was modified to reduce the limit on acquisition indebtedness to $750,000 (from the prior-law limit of $1 million).

A taxpayer who entered into a binding written contract before Dec. 15, 2017, to close on the purchase of a principal residence before Jan. 1, 2018, and who purchases that residence before April 1, 2018, will be considered to have incurred acquisition indebtedness prior to Dec. 15, 2017, under this provision, meaning that he or she will be allowed the prior-law $1 million limit.

Home-equity loans: The home-equity loan interest deduction was repealed through 2025.

State and local taxes: Under the act, individuals are allowed to deduct up to $10,000 ($5,000 for married taxpayers filing separately) in state and local income or property taxes.

The conference report on the bill specifies that taxpayers cannot take a deduction in 2017 for prepaid 2018 state income taxes.

Casualty losses: Under the act, taxpayers can take a deduction for casualty losses only if the loss is attributable to a presidentially declared disaster.

Gambling losses: The act clarified that the term “losses from wagering transactions” in Sec. 165(d) includes any otherwise allowable deduction incurred in carrying on a wagering transaction. This is intended, according to the conference report, to clarify that the limitation of losses from wagering transactions applies not only to the actual costs of wagers, but also to other expenses the taxpayer incurred  in connection with his or her gambling activity.

Charitable contributions: The act increased the income-based percentage limit for charitable contributions of cash to public charities to 60%. It also denies a charitable deduction for payments made for college athletic event seating rights. Finally, it repealed the statutory provision that provides an exception to the contemporaneous written acknowledgment requirement for certain contributions that are reported on the donee organization’s return — a prior-law provision that had never been put in effect because regulations were never issued.

Miscellaneous itemized deductions: All miscellaneous itemized deductions subject to the 2% floor under current law are repealed through 2025 by the act.

Medical expenses: The act reduced the threshold for deduction of medical expenses to 7.5% of adjusted gross income for 2017 and 2018.

Other provisions for individuals

Alimony: For any divorce or separation agreement executed after Dec. 31, 2018, the act provides that alimony and separate maintenance payments are not deductible by the payer spouse. It repealed the provisions that provided that those payments were includible in income by the payee spouse.

Moving expenses: The moving expense deduction is repealed through 2025, except for members of the armed forces on active duty who move pursuant to a military order and incident to a permanent change of station.

Archer MSAs: The House bill would have eliminated the deduction for contributions to Archer medical savings accounts (MSAs); the final act did not include this provision.

Educator’s classroom expenses: The final act did not change the allowance of an above-the-line $250 deduction for educators’ expenses incurred for professional development or to purchase classroom materials.

Exclusion for bicycle commuting reimbursements: The act repealed through 2025 the exclusion from gross income or wages of qualified bicycle commuting expenses.

Sale of a principal residence: The act did not change the current rules regarding exclusion of gain from the sale of a principal residence.

Moving expense reimbursements: The act repealed through 2025 the exclusion from gross income and wages for qualified moving expense reimbursements, except in the case of a member of the armed forces on active duty who moves pursuant to a military order.

IRA recharacterizations: The act excludes conversion contributions to Roth IRAs from the rule that allows IRA contributions to one type of IRA to be recharacterized as a contribution to the other type of IRA. This is designed to prevent taxpayers from using recharacterization to unwind a Roth conversion.

Pass through income deduction

For tax years after 2017 and before 2026, individuals will be allowed to deduct 20% of “qualified business income” from a partnership, S corporation, or sole proprietorship, as well as 20% of qualified real estate investment trust (REIT) dividends, qualified cooperative dividends, and qualified publicly traded partnership income. (Special rules would apply to specified agricultural or horticultural cooperatives.)

A limitation on the deduction is phased in based on W-2 wages above a threshold amount of taxable income. The deduction is disallowed for specified service trades or businesses with income above a threshold.

For these purposes, “qualified business income” means the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer. These items must be effectively connected with the conduct of a trade or business within the United States. They do not include specified investment-related income, deductions, or losses.

“Qualified business income” does not include an S corporation shareholder’s reasonable compensation, guaranteed payments, or — to the extent provided in regulations — payments to a partner who is acting in a capacity other than his or her capacity as a partner.

“Specified service trades or businesses” include any trade or business in the fields of accounting, health, law, consulting, athletics, financial services, brokerage services, or any business where the principal asset of the business is the reputation or skill of one or more of its employees.

The exclusion from the definition of a qualified business for specified service trades or businesses phases out for a taxpayer with taxable income in excess of $157,500, or $315,000 in the case of a joint return.

For each qualified trade or business, the taxpayer is allowed to deduct 20% of the qualified business income for that trade or business. Generally, the deduction is limited to 50% of the W-2 wages paid with respect to the business. Alternatively, capital-intensive businesses may get a higher benefit under a rule that takes into consideration 25% of wages paid plus a portion of the business’s basis in its tangible assets. However, if the taxpayer’s income is below the threshold amount, the deductible amount for each qualified trade or business is equal to 20% of the qualified business income for each respective trade or business.

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Education provisions

The act modifies Sec. 529 plans to allow them to distribute no more than $10,000 in expenses for tuition incurred during the tax year at an elementary or secondary school. This limitation applies on a per-student basis, rather than on a per-account basis.

The act modified the exclusion of student loan discharges from gross income by including within the exclusion certain discharges on account of death or disability.

The House bill’s provisions repealing the student loan interest deduction and the deduction for qualified tuition and related expenses were not retained in the final act.

The House bill’s proposed repeal of the exclusion for interest on Series EE savings bonds used for qualified higher education expenses and repeal of the exclusion for educational assistance programs also did not appear in the final act.

Estate, gift, and generation-skipping transfer taxes

The act doubles the estate and gift tax exemption for estates of decedents dying and gifts made after Dec. 31, 2017, and before Jan. 1, 2026. The basic exclusion amount provided in Sec. 2010(c)(3) increased from $5 million to $10 million and will be indexed for inflation occurring after 2011.

Individual AMT

While the House version of the bill would have repealed the alternative minimum tax (AMT) for individuals, the final act kept the tax, but increased the exemption.

For tax years beginning after Dec. 31, 2017, and beginning before Jan. 1, 2026, the AMT exemption amount increases to $109,400 for married taxpayers filing a joint return (half this amount for married taxpayers filing a separate return) and $70,300 for all other taxpayers (other than estates and trusts). The phase-out thresholds are increased to $1 million for married taxpayers filing a joint return and $500,000 for all other taxpayers (other than estates and trusts). The exemption and threshold amounts will be indexed for inflation.

Individual mandate

The act reduces to zero the amount of the penalty under Sec. 5000A, imposed on taxpayers who do not obtain health insurance that provides at least minimum essential coverage, effective after 2018.

How to Avoid An Audit

Most people cringe when they hear the word audit. Going through the ropes and ultimately resolving an audit is no fun and could be costly, so it’s important to determine a plan of action to avoid being audited in the first place.

What Is A Tax Audit?

A tax audit takes place when the Internal Revenue Service or a state agency conducts a closer review of the financial records of a business, an organization, or an individual. The IRS primarily focuses on examining tax returns. This examination is done to ensure that all information is being properly reported on an actual tax form, such as IRS Form 1040.

In addition to traditional audits, there are also joint tax audits. A joint audit is the examination of a business or individual tax return by 2 or more auditors in 2 or more states who examine cross-border tax issues. These auditors work together on a single audit to gain a full understanding of the situation at-hand.

How Does An Audit Work?

While the process of flagging tax returns for potential audits may seem random, the IRS uses the Discriminate Income Function (DIF) – a computer program that compares your deductions with those of others in your income bracket – to search for inconsistencies.
If you get audited, it’s likely you’ll receive a notice in the mail that indicates you’re being audited, along with the specific reason. From there, you can either agree or disagree with the audit. To agree, you must sign off on the paperwork and send it back with any requested documents and payments to account for the inconsistencies on your audited return.

For an in-person audit, the auditor will visit your office or place of business to conduct a thorough review of your records. This process may involve examining your printed documents or computer systems. It varies on how long such an audit can take. In some cases, it could take an auditor several days – or even a few weeks –to sufficiently review the records in your office.

If you do receive a notice from the IRS detailing the issue with your tax return, make the recommended changes and send the requested documentation to fulfill the request. If you disagree with an audit, you can file an appeal with the IRS, which could ultimately lead to landing in a tax court if the issue cannot be resolved between you and the auditor.

What Causes An Audit?

Certain discrepancies raise red flags for auditors, such as miscalculations on tax returns, overestimations on deductions, and other information that appears to be inaccurate, inconsistent, or out of the ordinary.

Let’s take a look at a hypothetical example of a tax audit:

Jack miscalculated his home office deduction by claiming more expenses than he actually incurred while running his small business from home. Instead of writing down $500 for his home office deduction, he wrote down $5,000 on his tax return. The IRS agent reviewing the tax form noticed the unusually large deduction and flagged the return for an audit. The IRS then mailed Jack an audit notice, requesting that he clarify the write-off. He submitted his records, and it became evident to the agent that he miscalculated the deduction. It took 3 months to resolve the issue, and Jack had to file for an extension to avoid late-filing fees. He ultimately was able to claim the correct $500 amount for the home office deduction.

Who Normally Gets Audited?

In 2014, the IRS audited more than 1.2 million taxpayers. IRS statistics show that out of every 37 returns for people with incomes of $200,000 or higher, someone will get audited. For those who earn $1 million or higher, the probability is more like 1 out of 13.

But don’t think that the only people getting audited are the ones with yearly incomes that reach 6 or 7 figures. If you are a waitress, bartender, hairdresser, or are involved in any cash-based industry, you’re already more likely to be audited. The same goes for doctors, lawyers, or accountants who normally keep their own books. Sole proprietors and Schedule C filers also have a higher chance of getting audited than formally established business owners who operate LLCs or corporations.

Why To Avoid An Audit

There are several reasons why you should do your best to avoid being audited. For one, an audit can be a time-consuming process that will take away valuable time from focusing on your priorities and could result in you having to pay more in taxes to the IRS. Additional accuracy-related penalties exist for filers whose returns are incorrectly reported. Nobody wants to owe more money than they think they do. Also, the chances of a future audit increase if you’ve been audited before. Getting in major hot water can occur when taxpayers try to evade the IRS or file fraudulent returns. These actions could result in criminal charges.

IRS auditors are instructed to close audits within 28 months of the date you filed your tax return or the date it was due – whichever is later. This means an audit can be hanging over your head for over 2 years.

An audit could involve sending and receiving several pieces of mail in order to fully resolve the issue and pay any requested fees you owe to the IRS. Imagine having to open your mailbox every day wondering what your latest letter from Uncle Sam will say. Audits can be very tedious because of how much detail is involved in getting on the same page with the IRS. It can be what seems like a never-ending, back-and-forth nightmare.

Who wants to deal with the IRS for any reason at all – let alone for a long period of time in order to resolve one audited return? Of course, nobody does.

Tips To Avoid A Tax Audit

There are a few basic strategies you can use to significantly reduce your chances of getting that dreaded audit notice in your mailbox:

1) Ensure your tax return is 100% complete.

After your tax return has been completely filled out from top to bottom, review it with a fine-tooth comb. Make sure that every line that is applicable to your tax situation has been filled out completely and correctly. If you submit an incomplete tax return, a tax authority may question why you did not disclose certain information on your return.

If a line on your return doesn’t apply to you, still fill it in with a “0” or dash (—) so that nothing is left blank. A blank space can raise a big red flag.

2) Report all taxable income on your return.

Taxpayers who are categorized into higher income tax brackets – particularly earners of over $200,000 per year – typically have a higher chance of getting audited. While the good majority of individuals bring in most of this income legitimately from a small business, a W-2 job, or through interest or investments, all taxable income must be reported on your return. The IRS wants to know about every taxable penny you earn, so be sure you disclose it appropriately.

3) Avoid claiming large itemized tax deductions.

If you choose to itemize your tax deductions rather than claiming the standard deduction, the IRS may compare your write-offs to what fellow taxpayers in your income tax bracket claim on their returns. If the agent reviewing your return determines that your deductions are a little high, they might give it a second look.

4) Properly claim all eligible tax deductions on expenses.

Home office deduction: To claim the home office deduction when filing your return, you must use a specific area of your residence for business activities. You can write off either an appropriate percentage of your bills, or you can claim the flat-rate deduction of $5 per square foot with a maximum deduction of $1,500 for up to 300 square feet of home office space. It’s critical to fully document all of your home office expenses.

Meals and entertainment deduction: Self-employed professionals are also allowed to write off 50% of business-related meals and entertainment activities as a tax deduction. But you must follow a few rules to ensure the agent reviewing your return doesn’t question the deduction. Stick to the 50% write-off amount, document who was present at the gathering, and don’t forget to write down the type of business that was conducted or discussed. Saving receipts is a must, and failing to do any of these things could trigger an audit.

Travel expenses: Don’t forget travel expenses you can also write off. As long as you travel by plane, train, or automobile for business purposes, you can deduct these costs. Let’s say you fly from New York City to Los Angeles to meet with a client. You can deduct your flight, rental car, hotel, and any other travel expenses you incur for the trip. If you’re an employee, you may write off unreimbursed employee expenses, which could include travel costs.

Deducting charitable contributions: As a business owner, it’s also nice to be philanthropic. And you can save on taxes while helping others, too. Consider making donations to your favorite charity – clothing, toys, household goods, or even a vehicle. As long as you donate to a qualifying charity and save your receipts, you can deduct 100% of your non-cash charitable contributions on your tax return. Documentation is key here to help you avoid an audit.

5) Always claim accurate deductions on business losses you incur.

Business losses are commonly incurred, especially during the startup phase of a brand new company. To properly deduct any business losses you incur, they must qualify as deductible losses. The best way to meet this requirement is to launch or maintain a formally established business entity, such as an LLC, S corporation, or C corporation. Doing so helps you prove to the IRS that these losses are actually tied to your business and are not simply personal losses.

6) Explain yourself to the IRS.

If you think your tax return has a good chance of raising an audit flag, you should include extra forms, worksheets, or receipts with your filing. Use them to explain inconsistencies on any audited returns from the last few years in areas such as your name, your dependents, deduction amounts, and income. This can help you avoid unnecessary correspondence with the IRS when it comes to clarifying your information.

7) Double-check your numbers.

It’s easy to skip over numbers or calculations – Especially when you consider how many figures can appear on your tax form. So, you could easily make errors between the number 100 and the number 1,000 if you’re in a hurry to fill out your return. Calculations should always be done on a calculator – or even with an app on your smartphone – to ensure accuracy. Make the same calculations more than once to guarantee certainty in the numbers you record on your return for income and deductions. Pay close attention to zeroes, decimal points, and commas.

8) Incorporate if you work for yourself.

Filing a Schedule C as a self-employed taxpayer automatically increases your audit risk. If you are your own boss, consider incorporating or setting up an LLC for yourself. In general, corporations and LLCs are audited less frequently than sole proprietorships and partnerships. This is because what would ordinarily look abnormal on a personal return would make more sense for a business.

In essence, having a formal entity proves to the IRS that you are indeed operating a business, rather than claiming you are.

9) Avoid filing amendments to your IRS tax returns.

If you file an amended return, your original return could also come under scrutiny, so make an effort to file correctly the first time around. An amended tax return is filed in order to make corrections to an original return. This may involve correcting income amounts or deductions you are claiming. If you file an amended return, your original return could also get a second look. That’s why it’s critical to file correctly from the get-go. You don’t want the IRS to get suspicious when you’re submitting numerous returns for a single tax year.

The Bottom Line on Audits

There is no surefire way to guarantee that you will never receive an IRS audit notice in the mail in your lifetime. The same can be said for audits from non-federal agencies like state and local tax authorities. However, the aforementioned steps can significantly reduce your chances. It is also wise to work with an accounting professional who has dealt with audits in the past and knows how to avoid them in the future.