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Understand the Hurdles of a Partnership Before Creating One

Approximately 543,000 new businesses get started each month, adding to the roughly 19.4 million existing nonemployer businesses. Of the those total businesses, roughly 8% are partnerships. If you are considering forming a partnership to run a business there are some specific legal and tax considerations involved in operating in that fashion.

Unlike a corporation, a partnership is not a taxable entity. Rather, each partner is taxed directly on his or her share of partnership profits or losses. This is an advantage over operating as a corporation where profits could be taxed twice, once at the corporate level and again at the owner level when dividends are distributed to shareholders.

A new business often has losses in the early years. By operating as a partnership, you can use your share of the partnership’s losses to offset income from other sources, such as investments and compensation from employment. However, to be able to deduct losses currently, you must satisfy the so-called passive activity loss (PAL) rules. As a general rule, as long as you materially participate in the business conducted by the partnership, you will meet the PAL rules.

A partner is not considered an employee of the partnership. Instead, partners pay self-employment tax on the partnership income. One component of self-employment tax is the Social Security portion, which is computed on earnings up to $128,400 for 2018, and the Medicare portion, which has no upper limit.

Managing a partnership can be tough and there’s at least one legal downside of operating as a partnership. For instance, general partners are exposed to unlimited liability from lawsuits that arise in connection with the business even when they are based on the acts or omissions of a partner. This is to be contrasted with operating a business as a corporation where, as a general rule, only the corporation’s funds are at risk.

Fortunately, you do not have to forgo the tax advantages of operating as a partnership to limit your potential liability. You can operate as an S corporation to minimize your liability exposure and yet be taxed similarly (but not identically) to the way you would be taxed if you operated as a partnership. Another option is the limited liability company. With this choice, your liability exposure also would be reduced and you would be taxed even more like a partnership than if you operated as an S corporation.

If you’re considering starting a partnership, or any business, it’s best to consult your tax advisor or call 916-372-8577 before your sign any papers. They’ll be able to help you ensure that the business construct you use is going to be right for you.

Perform a Paycheck Checkup With New IRS Withholding Calculator

With the new tax laws in effect for 2018 its a good idea to do a quick checkup on the amount of taxes you’re having withheld. The IRS has made with this simple to do with its new online Withholding Calculator.  The Calculator helps you identify your tax withholding to make sure you have the right amount of tax withheld from your paycheck at work.

There are several reasons to check your withholding:

  • Checking your withholding can help protect against having too little tax withheld and facing an unexpected tax bill or penalty at tax time next year.
  • At the same time, with the average refund topping $2,800, you may prefer to have less tax withheld up front and receive more in your paychecks.

If you are an employee, the Withholding Calculator helps you determine whether you need to give your employer a new Form W-4, Employee’s Withholding Allowance Certificate. You can use your results from the Calculator to help fill out the form and adjust your income tax withholding.

Tax payers with simple situations might not need to make any changes. Simple situations include singles and married couples with only one job, who have no dependents, and who have not claimed itemized deductions, adjustments to income, or tax credits.

People with more complicated financial situations might need to revise their W-4. With the new tax law changes, it’s especially important for these people to use the Withholding Calculator to make sure they have the right amount of withholding.

Among the groups who should check their withholding are:

  • Two-income families.
  • People with two or more jobs at the same time or who only work for part of the year.
  • People with children who claim credits such as the Child Tax Credit.
  • People who itemized deductions in 2017.
  • People with high incomes and more complex tax returns.

As always, if you have any questions about your withholding or your tax situation in general, you should contact your tax professional. More information is also available in the special Withholding Calculator Frequently Asked Questions.

New Limits on Business Interest Deduction

While the The Tax Cuts and Jobs Act of 2017 is generally seen as being loaded with benefits for businesses, there is at least one exception. In an effort to discourage companies from becoming too indebted or taking on too much leverage, the new law caps the business deduction for net interest expenses. Regardless of whether your business is over-leveraged or under-leveraged you should be aware of some of the important points surrounding business interest deduction.

Beginning in 2018, the deduction for business interest is limited to:

  • business interest income for the tax year;
  • 30 percent of adjusted taxable income for the year, including any increases in adjusted taxable income as a result of a distributive share in a partnership or S corporation (discussed below), but not below zero; and
  • floor plan financing interest of the taxpayer for the tax year.

In effect, the new law limits the deduction to 30 percent of adjusted taxable income. Adjusted taxable income is not the same as taxable income, but rather is determined by a special formula defined in the new law.

Exceptions to the limitation

There are, however, exceptions to this limitation:

  • the limitation does not apply for small businesses with average gross receipts of $25 million or less;
  • floor plan financing used by automobile dealers is permitted to the full extent of business interest income and floor plan financing interest; and
  • certain real property or farming businesses may elect to be excluded from the limitation.

Even though the Tax Cuts and Jobs Act lowered corporate tax rates, the limitation on interest deductions may result in higher tax liability for certain businesses.  Be sure to speak with your tax professional (phone 916-372-8577) who can help determine whether you will be affected by this new law, and if so to work with you to reduce its impact on your business.

Special Tax Considerations for Victims of Recent Wildfires

There’s no doubt that 2017 was a year plagued by wildfires that resulted in catastrophic destruction to the environment and personal property. In October alone, wildfires that tore across Northern California numbered more than a dozen. Some of these stand out as among the most damaging to ever hit the state.

In light of the devastation, President Trump declared that a major disaster existed in the State of California. Following that disaster declaration issued by the Federal Emergency Management Agency, the IRS announced that affected taxpayers in California would receive tax relief.

If you have suffered a loss to personal property due to the recent California wildfires, you may be eligible for special tax treatment.

Usually, a personal loss from a casualty or theft must exceed 10 percent of your adjusted gross income to be deductible; but for losses arising in the California wildfires disaster areas in 2017, that 10 percent threshold is waived. However, the dollar threshold for net losses, which is normally $100, is increased to $500 for losses in this disaster.

Loss Threshold for Deduction Normally Due to Wildfires
% Adjusted Gross Income Must exceed 10% No threshold
Minimum Amount of net losses $100 $500

Deduction may be available even if you don’t itemize
Generally you must itemize your deductions in order to take a casualty or theft loss. However, under special rules available for losses due the California wildfires disaster, you can take an additional standard deduction for the amount of your net loss even if you don’t itemize.

Consult your tax professional
Facing loss as the result of a natural disaster is burdensome. Now is the time to lessen at least some of your loss by taking advantage of the tax benefits provided for those who have suffered from this disaster. As always, be sure to contact your tax professional (phone 916-372-8577), in order to get a full understanding of the benefits you may be entitled to.

2017 Tax Cuts Act: What it Means For Businesses

The Tax Cuts and Jobs Act was signed by President Trump on December 22. The Act makes sweeping changes to the U.S. tax code and impacts virtually every individual taxpayer. For businesses, tax benefits include a reduction in the corporate tax rate, increase in the bonus depreciation allowance, an enhancement to the Code Sec. 179 expense and repeal of the alternative minimum tax. And, there’s more. Owners of partnerships, S corporations, and sole proprietorships are allowed a temporary deduction as a percentage of qualified income of pass-through entities, subject to a number of limitations and qualifications. On the other hand, numerous business tax preferences are eliminated.

Corporate Taxes

A reduced 21-percent corporate tax rate is permanent beginning in 2018. Also, the 80-percent and 70-percent dividends received deductions under current law are reduced to 65-percent and 50-percent, respectively. The Tax Cuts and Jobs Act also repeals the alternative minimum tax on corporations.

Bonus Depreciation

The bonus depreciation rate has fluctuated wildly over the last 15 years, from as low as zero percent to as high as 100 percent. It is often seen as a means to incentivize business growth and job creation. The Tax Cuts and Jobs Act temporarily increases the 50-percent “bonus depreciation” allowance to 100 percent. It also removes the requirement that the original use of qualified property must commence with the taxpayer, thus allowing bonus depreciation on the purchase of used property.

Section 179 Expensing

The Tax Cuts and Jobs Act sets the Code Sec. 179 dollar limitation at $1 million and the investment limitation at $2.5 million. Although the differences between bonus depreciation and Code Sec. 179 expensing would now be narrowed if both offer 100-percent write-offs for new or used property, some advantages and disadvantages for each will remain. For example, Code Sec. 179 property is subject to recapture if business use of the property during a tax year falls to 50 percent or less; but Code Sec. 179 allows a taxpayer to elect to expense only particular qualifying assets within any asset class.

Deductions and Credits

Numerous business tax preferences are eliminated. These include the Code Sec. 199 domestic production activities deduction, non-real property like-kind exchanges, and more. Additionally, the rules for business meals are revised, as are the rules for the rehabilitation credit. However, the Tax Cuts and Jobs Act leaves the research and development credit in place, but requires five-year amortization of research and development expenditures. It also creates a temporary credit for employers paying employees who are on family and medical leave.

Interest Deductions

In an attempt to “level the playing field” between businesses that capitalize through equity and those that borrow, the Tax Cuts and Jobs Act generally caps the deduction for net interest expenses at 30 percent of adjusted taxable income, among other criteria. Exceptions exist for small businesses, including an exemption for businesses with average gross receipts of $25 million or less.

Pass-Through Businesses

Currently, up to the end of 2017, owners of partnerships, S corporations, and sole proprietorships – as “pass-through” entities – pay tax at the individual rates, with the highest rate at 39.6 percent. The Tax Cuts and Jobs Act allows a temporary deduction in an amount equal to 20 percent of qualified income of pass-through entities, subject to a number of limitations and qualifications.

The Tax Cuts and Jobs Act contains rules that will prevent pass-through owners—particularly service providers such as accountants, doctors, lawyers, etc.—from converting their compensation income taxed at higher rates into profits taxed at the lower rate.

Net Operating Losses

The Tax Cuts and Jobs Act modifies current rules for net operating losses (NOLs). Generally, NOLs will be limited to 80 percent of taxable income for losses arising in tax years beginning after December 31, 2017. It also denies the carryback for NOLs in most cases while providing for an indefinite carryforward, subject to the percentage limitation.

These are just highlights of the changes and impact of the Tax Cuts and Jobs Act. There is much more to discuss than can be covered in this one article. Speak with your tax professional about the immediate and long-term impact of the Tax Cuts and Jobs Act on your situation.

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