Small Business Taxes & ManagementTM--Copyright 2018, A/N Group, Inc.
If you haven't read the introduction to our first article on the new law, please go to Tax Cuts and Jobs Act--Part 1. In this installment we're continuing our discussion of items affecting individuals.
Recharacterization of IRA Contributions
If you make a contribution to an IRA (traditional or Roth) for a taxable year, you're permitted to recharacterize the contribution as a contribution ato the other type (Roth or traditional) by making a trustee-to-trustee transfer to the other type of IRA before the due date for your income tax return of that year. In a recharacterization, the contribution is treated as having been made to the transferee IRA (and not the original, transferor IRA) as of the date of the original contribution. Both regular contributions and conversion contributions to a Roth IRA can be recharacterized as having been made to a traditional IRA. In both cases, the recharacterization essentially undoes the conversion.
The new law repeals the special rule allowing a conversion contribution to a Roth IRA to be recharacterized as a contribution to a traditional IRA, but still allows an original contribution from a traditional or Roth IRA to be recharacterized as a contribution to the other type. That is, recharacterization can no longer be used to unwind a Roth conversion. For example, Fred makes a $5,000 contribution to his traditional IRA in 2018. He can recharacterize that as a contribution to Roth as late as October 15, 2019 (the extended due date of his return). Carol makes a $5,000 contribution to a Roth IRA in 2018. She can recharacterize it as a contribution to a traditional IRA as late as October 15, 2019. In 2018 Sue converts $20,000 of her traditional IRA into a Roth, paying tax on the $20,000 of income. In June 2019 the value of the converted shares declines substantially under the new law she can't recharacterize (undo) the conversion and is stuck with the consequences.
While not done all that frequently, this change will require taxpayers making a conversion contribution to a Roth to consider their actions carefully since they can no longer be undone. This provision applies to tax years beginning after December 31, 2017.
Qualified 2016 Disaster Distribution
Distributions from qualified retirement plans that occur before the participant reaches age 59-1/2 and don't qualify for any other exception are generally subject to a 10% early withdrawal tax. Under the new law, an exception to the 10% tax applies in the case of a qualified 2016 disaster distribution from a qualified retirement plan, a Sec. 403(b) plan, or an IRA. In addition, income attributable to such a distribution may be included in income ratably over three years, and the amount of a qualified 2016 disaster distribution may be recontributed to an eligible retirement plan within three years. A qualified 2016 disaster distribution is a distribution from an eligible retirement plan made on or after January 1, 2016 and before January 1, 2018, to an individual whose principal place of abode at any time durng calendar 2016 was located in a 20-16 disaster area and who sustained an economic loss by reason of the events giving rise to the Presidential disaster declaration. Only the first $100,000 of distributions qualify for such treatment.
Rollovers of Plan Loan Offset Amounts
If you take a loan from a defined contribution plan and fail to repay the amount or default on the loan the outstanding balance is income and subject to the 10% early withdrawal tax. If an employee terminates employment his or her obligation to repay a loan is accelerated and, if the loan is not repaid, it's canceled and the amount in employee's account balance is offset by the amount of the unpaid loan balance. The loan offset is treated as an actual distribution from the plan and the amount of the distribution is eligible for tax-free rollover to another eligible retirement plan within 60 days. However, the plan is not required to offer a direct rollover. The new law extends the period during which a qualified plan loan offset may be contributed as a rollover contribution is extended from 60 days to to the due date (including extensions) for filing the Federal income tax return for the taxable year in which the plan kloan offset occurs.
Qualified Tuition Program Distributions
The income on contributions made to a Sec. 529 qualified tuition plan (QTP) are not taxable on distribution if made to pay qualified higher education expenses. Under the new law qualified higher education expenses also include tuition in connection with enrollment or attendance of the beneficiary at a public, private or religious elementary or secondary school. Qualified distributions under this provision is limited to $10,000 per tax year. The $10,000 limitation applies on a per-student, rather than a per-account basis.
The provision also modifies the definition of higher education expenses to include certain expenses incurred in connection with a home school. Those expenses are curriculum and curricular materials; books or other instruction materials; online educational materials; tuition for tutoring or educational classes outside of the home (but only if the tutor or instructor is not related to the student; dual enrollment in an institution of higher education; and educational therapies for students with disabilities.
Rollovers Between Qualified Tuition Programs and Qualified ABLE Programs
A qualified ABLE program is a tax-favored savings program intended to benefit disabled individuals. The program is established and maintained by a State agency or instrumentality. The new law allows for amounts from qualified tuition programs (Sec. 529) to be rolled over to an ABLE account without penalty, provided that the ABLE account is owned by the designated beneficiary of the 529 account, or a member of such designated beneficiary's family. Such rolled over amounts count towards the overall limitation on amounts that can be contributed to an ABLE account for a taxable year. Any amount rolled over that is in excess of this limitation shall be includible in the gross income of the distributee.
The requirement to file an income tax return for a citizen or a resident alien is based on a certain income level. The thresholds vary by filing status and age (65 or older) and whether or not a taxpayer is legally blind. The thresholds are adjusted for inflation every year. Because of the increased standard deduction, the filing thresholds are higher for every filing status. The new thresholds (assuming no inflation) for 2018 are:
Single $12,000 for 65 or older or blind add 1,600 for 65 or older and blind add 3,200 Married, filing separate 12,000 Married, joint 24,000 one spouse 65 or older or blind add 1,300 one spouse 65 or older and blind add 1,300 both spouses 65 or older or blind add 2,600 both spouses 65 or older and blind add 5,200 Head of household 18,000 for 65 or older or blind add 1,600 for 65 or older and blind add 3,200 Qualifying widow(er) (surviving spouse) 24,000 for 65 or older or blind add 1,300 for 65 or older and blind add 2,600The new law also adds to the due diligence requirement of tax preparers to ensure clients qualify for the education and earned income tax credits the requirement a client qualifies to file as head of household. The penalty for failure to do so is $500.
Estate and Gift Tax
The new law increases the federal estate, gift, and generation-skipping transfer tax exemption to $10 million for the estates of decedents dying and gifts and transfers made after 2017. This provision expires at the end of 2025. Before the adjustments for inflation in the old law, the exemption is doubled. The $10 million amount is also adjusted for inflation. The $10 million amount is essentially doubled for a married couple because of the availability of the deceased spousal unused exclusion (DSUE). The obvious result is that far fewer taxpayers will have to worry about the estate tax in their financial planning. In 2016 only 4,142 returns were filed with a gross estate that exceeded $10 million and only 2,204 of those contained a tax liability. (Those returns represent decedents who died in earlier years, but the return was filed in 2016.) The step-up in basis rule remains in effect.
The new concern is that the exemption will revert to the lower amount when the new law expires at the end of 2025. Taxpayers who could exceed that lower amount should seriously consider careful estate planning. While making gifts may make sense for estate tax purposes, the basis rules for gifts dictate a carry-over basis rather than a step-up basis. That's an important consideration. Making gifts to lower generations can make sense with the larger exemption, but the portability exemption does not apply to the generation skipping tax exemption amount of $10 million.
Rollover of Gain on Publicly Traded Securities
Under prior law a taxpayer could elect to roll over tax-free any capital gain realized on the sale of publicly-traded securities to the extent of the funds used to purchase common stock or a partnership interest in a specialized small business investment company within 60 days of the sale. There were dollar limits on the amount of the gain that could be rolled over. That provision has been repealed under the new law, effective for sales after December 31, 2017.
Self-Created Property not Capital Asset
Under prior law property created by a taxpayer (whether or not associated with his trade or business) was considered a capital asset and would qualify for long-term capital gain treatment on a sale. Certain items were specifically excluded from favorable treatment such as inventory property, certain self-created intangibles, and property subject to depreciation. Self-created intangibles subject to the exception are copyrights, literary, musical or artistic compositions, letters or memoranda, or similar property which is held either by the taxpayer who created the property, or for whom the property was produced. A taxpayer could elect to treat musical compositions and copyrights in musical works as capital assets.
The new law amends Section 1221(a)(3), resulting in the exclusion of a patent, invention, model or design (whether or not patented), and a secret formula or process which is either held by the taxpayer who created the property or a taxpayer with a substituted or transferred basis from the taxpayer who created the property (or for whom the property was created) from the definition of a capital asset. Thus, gains or losses on such assets will not receive capital gain treatment. The provision applies to dispositions after December 31, 2017.
Copyright 2018 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 02/06/18