Income

Article Dean Dorton

As of January 12, 2018, Kentucky became the first state to require many of its Medicaid recipients to work in order to receive coverage. This new provision is effective beginning in July 2018.

The new rule states that one must complete 80 hours per month of “community engagement” and applies to able-bodied individuals between the ages of 19 and 64 (not applicable if you are pregnant, medically frail, a full-time student, or a primary caregiver of dependents).

Community engagement includes the individual:

Obtaining a job,Attending school,Participating in a job training course, and/orPerforming community service.

If one does not submit proper proof of participation after one month, the individual will receive a notice. That person is then given one more month to reverse their violation. After the second month, benefits will terminate until they can prove they have begun following the guidelines.

Kentuckians will be required to pay a small monthly premium ($1 to $15 per month, dependent on income) for Medicaid insurance. Incentives will be offered to purchase additional benefits (such as dental and vision) through a rewards program. Activities to obtain rewards include getting an annual physical, completing a diabetes or weight management class, partaking in an anti-smoking program, et cetera. Those who are above the federal poverty line, who fail to pay the required premiums or do not reapply in time to determine if they remain eligible, can be locked out of the program for six months. Individuals can also be penalized for not promptly reporting a change in their income.

According to Governor Matt Bevin, this new plan should save taxpayers more than $300 million over the next five years. It is estimated that nearly 95,000 people will lose their Medicaid coverage by not fulfilling the requirements or by finding jobs which push them out of the low-income tax bracket.

Article Dean Dorton

The Section 199 deduction is intended to encourage domestic manufacturing. In fact, it’s often referred to as the “manufacturers’ deduction.” But this potentially valuable tax break can be used by many other types of businesses besides manufacturing companies.

Sec. 199 deduction 101

The Sec. 199 deduction, also called the “domestic production activities deduction,” is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts.

Yes, the deduction is available to traditional manufacturers. But businesses engaged in activities such as construction, engineering, architecture, computer software production and agricultural processing also may be eligible.

The deduction isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the alternative minimum tax.

How income is calculated

To determine a company’s Sec. 199 deduction, its qualified production activities income must be calculated. This is the amount of domestic production gross receipts (DPGR) exceeding the cost of goods sold and other expenses allocable to that DPGR. Most companies will need to allocate receipts between those that qualify as DPGR and those that don’t — unless less than 5% of receipts aren’t attributable to DPGR.

DPGR can come from a number of activities, including the construction of real property in the United States, as well as engineering or architectural services performed stateside to construct real property. It also can result from the lease, rental, licensing or sale of qualifying production property, such as:

  • Tangible personal property (for example, machinery and office equipment),
  • Computer software, and
  • Master copies of sound recordings.

The property must have been manufactured, produced, grown or extracted in whole or “significantly” within the United States. While each situation is assessed on its merits, the IRS has said that, if the labor and overhead incurred in the United States accounted for at least 20% of the total cost of goods sold, the activity typically qualifies.

Contact us to learn whether this potentially powerful deduction could reduce your business’s tax liability when you file your 2016 return.

Article Dean Dorton

Investment interest — interest on debt used to buy assets held for investment, such as margin debt used to buy securities — generally is deductible for both regular tax and alternative minimum tax purposes. But special rules apply that can make this itemized deduction less beneficial than you might think.

Limits on the deduction

First, you can’t deduct interest you incurred to produce tax-exempt income. For example, if you borrow money to invest in municipal bonds, which are exempt from federal income tax, you can’t deduct the interest.

Second, and perhaps more significant, your investment interest deduction is limited to your net investment income, which, for the purposes of this deduction, generally includes taxable interest, nonqualified dividends and net short-term capital gains, reduced by other investment expenses. In other words, long-term capital gains and qualified dividends aren’t included.

However, any disallowed interest is carried forward. You can then deduct the disallowed interest in a later year if you have excess net investment income.

Changing the tax treatment

You may elect to treat net long-term capital gains or qualified dividends as investment income in order to deduct more of your investment interest. But if you do, that portion of the long-term capital gain or dividend will be taxed at ordinary-income rates.

If you’re wondering whether you can claim the investment interest expense deduction on your 2016 return, please contact us. We can run the numbers to calculate your potential deduction or to determine whether you could benefit from treating gains or dividends differently to maximize your deduction.

Article Dean Dorton

Whether you’re happy or not about the outcome of Tuesday’s election, now that we know we have Republicans in the White House, both houses of Congress, the governorship and the state legislature, it’s time to start thinking about taxes. It is quite possible that there will be significant changes to federal income and estate taxes for 2017 and possible (though perhaps not until 2018) to Kentucky income and other taxes.

With the potential for lower income tax rates for 2017, more than most years, it’s important to consider accelerating deductions to 2016 and deferring income to 2017. Below are tables showing proposed individual rates the House Republican Tax Plan and Trump’s Tax Plan from the Tax Foundation (see below for links).

Tax Brackets Under Current Law and the House Republican Tax Plan

Ordinary Income Capital Gains & Dividends
Current Law Proposal Current Law Proposal Single Married Filing Jointly Head of Household
10% 12% 0% 6% $0 to $9,275 $0 to $18,550 $0 to $13,250
15% 12% 0% 6% $9,275 to $37,650 $18,550 to $75,300 $13,250 to $50,400
25% 25% 15% 12.5% $37,650 to $91,150 $75,300 to $151,900 $50,400 to $130,150
28% 25% 15% 12.5% $91,150 to $190,150 $151,900 to $231,450 $130,150 to $210,800
33% 33% 15% 16.5% $190,150 to $413,350 $231,450 to $413,350 $210,800 to $413,350
35% 33% 15% 16.5% $413,350 to $415,050 $413,350 to $466,950 $413,350 to $441,000
39.6% 33% 20% 16.5% $415,050+ $466,950+ $441,000+

Tax Brackets Under the Trump Plan

Ordinary Income Capital Gains Single Filers Married Filing Jointly
12% 0% $0 to $37,500 $0 to $75,000
25% 15% $37,500 to $112,500 $75,000 to $225,000
33% 20% $112,500+ $225,000+

Other plan elements:

  • Both plans eliminate the estate and gift taxes and the step-up in basis – the House plan completely eliminates the step-up; the Trump plan disallows a step-up for estates of $10 million or more.
  • The House plan eliminates all itemized deductions other than mortgage interest and charitable contributions.  The Trump plan caps itemized deductions at $100,000 for single filers and $200,000 for married filers.
  • Both plans eliminate the alternative minimum tax.
  • The House plan reduces the top corporate rate from 35% to 20%, the Trump plan calls for an even lower 15% maximum rate.
  • The House plan allows immediate deduction of the cost of capital investments but disallows the deduction for net interest expense on future loans for all businesses.  The Trump plan allows businesses to choose between an immediate deduction for capital items and a deduction for interest paid.
  • Both plans eliminate the domestic production deduction and all other business credits except for the R&D credit.
  • The House plan taxes business income on a territorial basis rather than a worldwide basis and creates a “deemed” repatriation of currently deferred foreign profits taxed at 8.75% for cash profits and 3.5% on other profits.  Trump’s plan proposes a 10% tax.

While we don’t yet know if any of these plans will be enacted or what their final form may be, it’s worth considering the potential impact on your tax bill.

Links to Tax Foundation articles on proposed tax plans:

Contact your Dean Dorton advisor if we can be of assistance.

Article Dean Dorton

Many tax breaks are reduced or eliminated for higher-income taxpayers. Two of particular note are the itemized deduction reduction and the personal exemption phaseout.

Income thresholds

If your adjusted gross income (AGI) exceeds the applicable threshold, most of your itemized deductions will be reduced by 3% of the AGI amount that exceeds the threshold (not to exceed 80% of otherwise allowable deductions). For 2016, the thresholds are $259,400 (single), $285,350 (head of household), $311,300 (married filing jointly) and $155,650 (married filing separately). The limitation doesn’t apply to deductions for medical expenses, investment interest, or casualty, theft or wagering losses.

Exceeding the applicable AGI threshold also could cause your personal exemptions to be reduced or even eliminated. The personal exemption phaseout reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s AGI exceeds the applicable threshold (2% for each $1,250 for married taxpayers filing separately).

The limits in action

These AGI-based limits can be very costly to high-income taxpayers. Consider this example:

Steve and Mary are married and have four dependent children. In 2016, they expect to have an AGI of $1 million and will be in the top tax bracket (39.6%). Without the AGI-based exemption phaseout, their $24,300 of personal exemptions ($4,050 × 6) would save them $9,623 in taxes ($24,300 × 39.6%). But because their personal exemptions are completely phased out, they’ll lose that tax benefit.

The AGI-based itemized deduction reduction can also be expensive. Steve and Mary could lose the benefit of as much as $20,661 [3% × ($1 million − $311,300)] of their itemized deductions that are subject to the reduction — at a tax cost as high as $8,182 ($20,661 × 39.6%).

These two AGI-based provisions combined could increase the couple’s tax by $17,805!

Year-end tips

If your AGI is close to the applicable threshold, AGI-reduction strategies — such as contributing to a retirement plan or Health Savings Account — may allow you to stay under it. If that’s not possible, consider the reduced tax benefit of the affected deductions before implementing strategies to accelerate deductible expenses into 2016. If you expect to be under the threshold in 2017, you may be better off deferring certain deductible expenses to next year.

For more details on these and other income-based limits, help assessing whether you’re likely to be affected by them or more tips for reducing their impact, please contact us.

Article Dean Dorton

In addition to income tax, you must pay Social Security and Medicare taxes on earned income, such as salary and self-employment income. The 12.4% Social Security tax applies only up to the Social Security wage base of $118,500 for 2016. All earned income is subject to the 2.9% Medicare tax.

The taxes are split equally between the employee and the employer. But if you’re self-employed, you pay both the employee and employer portions of these taxes on your self-employment income.

Additional 0.9% Medicare tax

Another employment tax that higher-income taxpayers must be aware of is the additional 0.9% Medicare tax. It applies to FICA wages and net self-employment income exceeding $200,000 per year ($250,000 for married filing jointly and $125,000 for married filing separately).

If your wages or self-employment income varies significantly from year to year or you’re close to the threshold for triggering the additional Medicare tax, income timing strategies may help you avoid or minimize it. For example, as a self-employed taxpayer, you may have flexibility on when you purchase new equipment or invoice customers. If your self-employment income is from a part-time activity and you’re also an employee elsewhere, perhaps you can time with your employer when you receive a bonus.

Something else to consider in this situation is the withholding rules. Employers must withhold the additional Medicare tax beginning in the pay period when wages exceed $200,000 for the calendar year — without regard to an employee’s filing status or income from other sources. So your employer might not withhold the tax even though you are liable for it due to your self-employment income.

If you do owe the tax but your employer isn’t withholding it, consider filing a W-4 form to request additional income tax withholding, which can be used to cover the shortfall and avoid interest and penalties. Or you can make estimated tax payments.

Deductions for the self-employed

For the self-employed, the employer portion of employment taxes (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible above the line. (No portion of the additional Medicare tax is deductible, because there’s no employer portion of that tax.)

As a self-employed taxpayer, you may benefit from other above-the-line deductions as well. You can deduct 100% of health insurance costs for yourself, your spouse and your dependents, up to your net self-employment income. You also can deduct contributions to a retirement plan and, if you’re eligible, an HSA for yourself. Above-the-line deductions are particularly valuable because they reduce your adjusted gross income (AGI) and modified AGI (MAGI), which are the triggers for certain additional taxes and the phaseouts of many tax breaks.

For more information on the ins and outs of employment taxes and tax breaks for the self-employed, please contact us.