Planning for the Net Investment Income Tax

Despite its name, the Tax Cuts and Jobs Act (TCJA) didn’t cut all types of taxes. It left several taxes unchanged, including the 3.8% tax on net investment income (NII) of high-income taxpayers.

You’re potentially liable for the NII tax if your modified adjusted gross income (MAGI) exceeds $200,000 ($250,000 for joint filers and qualifying widows or widowers; $125,000 for married taxpayers filing separately). Generally, MAGI is the same as adjusted gross income. However, it may be higher if you have foreign earned income and certain foreign investments.

To calculate the tax, multiply 3.8% by the lesser of 1) your NII, or 2) the amount by which your MAGI exceeds the threshold. For example, if you’re single with $250,000 in MAGI and $75,000 in NII, your tax would be 3.8% × $50,000 ($250,000 – $200,000), or $1,900.

NII generally includes net income from, among others, taxable interest, dividends, capital gains, rents, royalties and passive business activities. Several types of income are excluded from NII, such as wages, most nonpassive business income, retirement plan distributions and Social Security benefits. Also excluded is the nontaxable gain on the sale of a personal residence.

Given the way the NII tax is calculated, you can reduce the tax either by reducing your MAGI or reducing your NII. To accomplish the former, you could maximize contributions to IRAs and qualified retirement plans. To do the latter, you might invest in tax-exempt municipal bonds or in growth stocks that pay little or no dividends.

There are many strategies for reducing the NII tax. Consult with one of our professionals before implementing any of them. And remember that, while tax reduction is important, it’s not the only factor in prudent investment decision-making.

What Every Teacher Should Know About Their Usual Tax Break

When teachers are setting up their classrooms for the new school year, it’s common for them to pay for a portion of their classroom supplies out of pocket. A special tax break allows these educators to deduct some of their expenses. This educator expense deduction is especially important now due to some changes under the Tax Cuts and Jobs Act (TCJA).


Old School

Before 2018, employee business expenses were potentially deductible if they were unreimbursed by the employer and ordinary and necessary to the “business” of being an employee. A teacher’s out-of-pocket classroom expenses could qualify.

But these expenses had to be claimed as a miscellaneous itemized deduction and were subject to a 2% of adjusted gross income (AGI) floor. This meant employees, including teachers, could enjoy a tax benefit only if they itemized deductions (rather than taking the standard deduction) and only to the extent that all their deductions subject to the floor, combined, exceeded 2% of their AGI.

Now, for 2018 through 2025, the TCJA has suspended miscellaneous itemized deductions subject to the 2% of AGI floor. Fortunately, qualifying educators can still deduct some of their unreimbursed out-of-pocket classroom costs under the educator expense deduction.

New School

Back in 2002, Congress created the above-the-line educator expense deduction because, for many teachers, the 2% of AGI threshold for the miscellaneous itemized deduction was difficult to meet. An above-the-line deduction is one that’s subtracted from your gross income to determine your AGI.

You don’t have to itemize to claim an above-the-line deduction. This is especially significant with the TCJA’s near doubling of the standard deduction, which means fewer taxpayers will benefit from itemizing.

Qualifying elementary and secondary school teachers and other eligible educators (such as counselors and principals) can deduct above the line up to $250 of qualified expenses. If you’re married filing jointly and both you and your spouse are educators, you can deduct up to $500 of unreimbursed expenses — but not more than $250 each.

Qualified expenses include amounts paid or incurred during the tax year for books, supplies, computer equipment (including related software and services), other equipment and supplementary materials that you use in the classroom. For courses in health and physical education, the costs of supplies are qualified expenses only if related to athletics.

More Details

Some additional rules apply to the educator expense deduction. If you’re an educator or know one who might be interested in this tax break, please contact us for more details.

Tax Document Retention Guidelines for Small Businesses

You may have breathed a sigh of relief after filing your 2018 income tax return (or requesting an extension). But is your office strewn with reams of paper consisting of years’ worth of tax returns, receipts, canceled checks and other financial records? Or perhaps your computer desktop is filled with a multitude of digital tax-related files? You’ll find it easier to file next year if you cut down on the clutter. To perform a summer cleanup, follow these retention guidelines.


General Rules

Retain records that support items shown on your tax return at least until the statute of limitations runs out — generally three years from the due date of the return or the date you filed, whichever is later. That means you can now potentially throw out records for the 2015 tax year if you filed the return for that year by the regular filing deadline. But some records should be kept longer.

For example, there’s no statute of limitations if you fail to file a tax return or file a fraudulent one. So, you’ll generally want to keep copies of your returns themselves permanently, so you can show that you did file a legitimate return.

Also bear in mind that, if you understate your adjusted gross income by more than 25%, the statute of limitations period is six years.

Some Business Specifics

Records substantiating costs and deductions associated with business property are necessary to determine the basis and any gain or loss when the property is sold. According to IRS guidelines, you should keep these for as long as you own the property, plus seven years.

The IRS recommends keeping employee records for three years after an employee has been terminated. In addition, you should maintain records that support employee earnings for at least four years. (This timeframe generally will cover varying state and federal requirements.) Also keep employment tax records for four years from the date the tax was due or the date it was paid, whichever is longer.

For travel and transportation expenses supported by mileage logs and other receipts, keep supporting documents for the three-year statute of limitations period. Regulations for sales tax returns vary by state. Check the rules for the states where you file sales tax returns. Retention periods typically range from three to six years.

When in Doubt, Don’t Throw it Out

If you’re unsure whether you should retain a document, a good rule of thumb is to hold on to it for at least six years or, for property-related records, at least seven years after you dispose of the property. But, again, you should keep tax returns themselves permanently, and other rules or guidelines might apply in certain situations. We can answer any questions you might have.

Consider the Flexibility of a Self-Directed IRA

Traditional and Roth IRAs can be relatively “safe” retirement-savings vehicles, depending on what they’re invested in. But a drawback is that they limit your investment choices. A self-directed IRA gives you more flexibility in your investment choices but comes with greater risk as well.


Gaining More Control

A self-directed IRA is simply an IRA that gives you greater control over investment decisions. Traditional IRAs typically offer a selection of stocks, bonds and mutual funds. Self-directed IRAs (available at certain financial institutions) offer greater diversification and potentially higher returns by permitting you to select virtually any type of investment, including real estate, closely held stock, limited liability company and partnership interests, loans, precious metals, and commodities (such as lumber and oil and gas).

A self-directed IRA can be a traditional or Roth IRA, a Simplified Employee Pension (SEP) plan, or a Savings Incentive Match Plan for Employees (SIMPLE). It’s also possible to have a self-directed individual 401(k) plan, Health Savings Account or Coverdell Education Savings Account.

Self-directed Roth IRAs are particularly powerful estate planning tools, because they offer tax-free investment growth. (See “IRAs and your estate plan.”)

Navigating the Tax Traps

To avoid pitfalls that can lead to unwanted tax consequences, caution is required when using self-directed IRAs. The most dangerous traps are the prohibited transaction rules.

These rules are designed to limit dealings between an IRA and “disqualified persons,” including account holders, certain members of account holders’ families, businesses controlled by account holders or their families, and certain IRA advisors or service providers. Among other things, disqualified persons may not sell property or lend money to the IRA, buy property from the IRA, provide goods or services to the IRA, guarantee a loan to the IRA, pledge IRA assets as security for a loan, receive compensation from the IRA or personally use IRA assets.

The penalty for engaging in a prohibited transaction is severe: The IRA is disqualified and all its assets are deemed to have been distributed on the first day of the year in which the transaction took place, subject to income taxes and, potentially, penalties. This makes it very difficult to manage a business, real estate or other investments held in a self-directed IRA. So, unless you’re prepared to accept a purely passive role with respect to the IRA’s assets, this strategy isn’t for you.

Considering the Option

If you have assets such as precious metals, energy or other alternative investments, a self-directed IRA may be worth your while to consider. Contact us to discuss further.

 

Sidebar: IRAs and Your Estate Plan

IRAs are designed primarily as retirement-saving tools, but if you don’t need the funds for retirement, they can provide a tax-advantaged source of wealth for your family. For example, if you name your spouse as beneficiary, your spouse can roll the funds over into his or her own IRA after you die, enabling the funds to continue growing on a tax-deferred basis (tax-free in the case of a Roth IRA).

If you name a child (or someone other than your spouse) as beneficiary, that person will have to begin taking distributions immediately. But if the funds are held in an “inherited IRA,” your beneficiary can stretch the distributions over his or her own life expectancy, maximizing the IRA’s tax benefits.

No Surprises: Why You Should Check Your Tax Bracket

Many taxpayers learned some tough lessons upon completing their 2018 tax returns regarding the changes brought forth by the Tax Cuts and Jobs Act (TCJA). If you were one of them, or even if you weren’t, now’s a good time to check your bracket to avoid any unpleasant surprises next April.

Under the TCJA, the top income tax rate is now 37% (down from 39.6%) for taxpayers with taxable income over $500,000 for 2018 (single and head-of-household filers) or $600,000 for 2018 (married couples filing jointly). These thresholds are higher than they were for the top rate in 2017 ($418,400, $444,550 and $470,700, respectively), so the top rate probably wasn’t too much of a concern for many upper-income filers.

But some singles and heads of households in the middle and upper brackets were likely pushed into a higher tax bracket much more quickly for the 2018 tax year. For example, for 2017 the threshold for the 33% tax bracket was $191,650 for singles and $212,500 for heads of households. For 2018, the rate for this bracket was reduced slightly to 32% — but the threshold for the bracket is now only $157,500 for both singles and heads of households.

So, a lot more of these filers found themselves in this bracket and many more could so again in 2019. Fortunately for joint filers, their threshold for this bracket has increased from $233,350 for 2017 to $315,000 for 2018. The thresholds for these brackets have increased slightly for 2019, due to inflation adjustments. If you expect this year’s income to be near the threshold for a higher bracket, consider strategies for reducing your taxable income and staying out of the next bracket. For example, you could take steps to accelerate deductible expenses.

But carefully consider the changes the TCJA has made to deductions. For example, you might no longer benefit from itemizing because of the nearly doubled standard deduction and the reduction or elimination of certain itemized deductions. For 2019, the standard deduction is $12,200 for singles and married individuals filing separately, $18,350 for heads of households and $24,400 for joint filers.