Short-term capital gains are taxed at up to 37%. Your long-term (investments held for longer than one year) capital gains rate can be as much as 20% lower than your ordinary tax rate. If you have already realized large capital gains during the year and want to reduce your tax liability, consider harvesting capital losses in your portfolio before year-end.
Prior law allowed you to take a deduction for $4,050 for yourself, your spouse, and for each of your dependents. In 2018 and until 2026, this deduction no longer exists.
Prior law allowed you to deduct the state and local income taxes you paid, as well as real estate taxes on your home. The new law limits the deduction of these items to $10,000 per year. This limit is in place until 2026.
Fees you paid your accountant, employee business deductions, investment advisor fees, union dues, and other expenses were sometimes deductible as a miscellaneous itemized deduction. The new law completely eliminates this deduction until 2026.
Individuals can now deduct cash charity up to 60% of their income. This applies to contributions made to a public charity. The prior limit was 50%. However, the limit generally remains at 50% of income even for your cash contributions if you also make donations of property, such as appreciated stock.
You benefit from itemizing deductions only if they are greater than your standard deduction. With the standard deduction at $24,000 for joint filers (see below for other amounts), if you have itemized deductions less than that, you take the standard deduction. If you take the standard deduction, then your itemized deductions that year are wasted. Therefore, you are better off paying or prepaying every other year deductible items like taxes, charity, and medical in one year in order to get a large number in excess of the standard deduction. In the next year, you take the standard deduction. A donor advised fund may be a useful means of bunching charitable donations and then having the fund make distributions to the charities yearly.
An individual who does not itemize their deductions takes the Standard Deduction. The Standard Deduction has been increased to $24,000 for married filers, $12,000 for single, and $18,000 for head of household. The prior amounts were $12,700, $6,350, and $9,350 respectively.
Everyone gets to deduct the greater of their Standard Deduction or their Itemized Deductions. Significantly increasing the Standard Deduction like this will result in many people no longer taking itemized deductions.
The tax rates applied to individuals have been decreased to between 10% - 37%. In addition, the highest tax rate now applies to income over $500,000 (single filers) and $600,000 (married filing joint). Previously, the highest rate of 39.6% applied on income over $418,400 (single) and $470,700 (married filing joint).
For 2018 through 2026, there is a new deduction called the Qualified Business Income (QBI) deduction. The deduction equals the smaller of 20% of QBI or 20% of your taxable income. QBI is pretty much any business income and any rental income. If your taxable income is over $315,000 married filing joint, then QBI does not include income from accounting, medical, legal, performing arts, consulting, actuarial science, athletics, financial services, brokerage services, or any other business where the principal asset of such trade or business is the reputation or skill of one or more employees or owners.
QBI includes everything else such as manufacturing, distribution, other service businesses and rental income.
It is important to note that many states do not allow this deduction. California is a good example.
The QBI computation can be tricky as there are some twists to it. Please see the flow chart on the following link: Flow Chart #1
For 2018 through 2026, every business entity with gross receipts over $25 million is limited on deducting business interest. The deduction is limited to 30% of the Adjusted Taxable Income (ATI) of the taxpayer. ATI for 2018 through 2021 is the taxable income with an addback for interest, depreciation, and amortization. After 2021, you no longer add back depreciation and amortization. Therefore, ATI is lower and the limit will be harder to avoid.
If a business is part of a group of companies under common control, all of the companies are added together to test for the $25 million cut off.
The limit is applied to every partnership and corporation separately. Therefore, if one of your companies is making money and the other is losing money, you have to pay tax on the profitable business and the money-losing business is limited in deducting its interest and the loss you benefit from will be less.
Real estate businesses can elect to extend the depreciation by a couple years on their real property and in exchange they are permitted to fully deduct their interest expense. This election applies even if the business is over $25 million. This election does not apply if the real property is rented to a commonly controlled company. The election cannot be revoked once made.
Please see the flow chart on the following link: Flow Chart #2
The new law limits to $500,000 married joint ($250,000 single) the amount of Partnership, S Corporation, Rental, and Self-Employment losses you can deduct. If you add up all the income and loss from businesses, the most net loss you can deduct is $500,000. If you have other income such as wages, investment, and pensions, in excess of that $500,000, you will not be able to offset those with further losses and you will pay taxes on that excess income. Prior law allowed you to fully deduct net losses against all other income.
The IRS has not yet issued guidance as to whether your wages from your controlled business or gains from the sale of business assets will be considered business income that can absorb losses.
Through 2022, you can immediately write off 100% of most non-real estate property a business purchases. This is phased out from 2023 through 2026. Purchases of both new and used property are eligible for this deduction.
Any service business with gross receipts below $25 million can elect to be on the cash method. Businesses on the accrual method have to pay tax on their receivables even though they are not yet collected. Accrual method businesses also get to deduct their payables before they are paid.
By switching to the cash method, the business gets an immediate reduction of income for the net amount of their receivables in excess of payables plus accrued expenses. On a go forward basis, the business only pays tax on its cash collections and only deducts expenses actually paid. This is in almost all cases a large tax benefit.
Manufacturing businesses can also elect to be cash basis. The primary benefit is that certain costs currently added to inventory are immediately deductible.
Please see the flow chart on the following link: Flow Chart #3
The new law restricts deductible meals and entertainment expenses.
Please see the flow chart on the following link: Flow Chart #4
IC-DISC’s are still a significant benefit for manufacturers who export some of their product. If the exporter is an S corporation or LLC, the net tax reduction is equal to approximately 10% times the export profit. For C corporations, the net savings is equal to approximately 5% of their export income. This is less of a benefit than previously because the corporate rate decreased.
The new law decreased the tax paid by C corporations to 21%. S corporations and LLCs flow their income to individuals and individuals pay a top rate of 37%. Therefore, there is potentially a large advantage to being a C corporation. However, there is a second tax when you take your profit out of a C corporation. Therefore, you need to carefully consider this move.
Please see the flow chart on the following link for a decision tree: Flow Chart #5