Several states are considering proposals in an attempt to reduce the impact of federal tax reform’s $10,000 limit on state and local tax (SALT) deductions. In New York, the Governor’s budget proposal includes establishing two charitable organizations (one for health care and one for education) that will enable taxpayers to make a contribution to those funds and receive a credit for 85 percent of the amount donated to offset SALT liabilities. California’s SB 227 similarly creates a charitable organization (California Excellence Fund) and provides a credit against the California income tax for contributions made. Oregon has a similar proposal pending and New Jersey’s Governor indicated that his state is looking into such a plan as well. All of these proposals would give taxpayers the opportunity to make the charitable contribution and get a federal tax deduction and reduce their SALT liability which would be subject to the $10,000 limitation.
Recently proposed legislation would require sellers to collect sales and use tax on the sales price of certain services to California businesses.
On Feb. 5, 2018, California Senator Robert Hertzberg introduced a bill, which if enacted, would impose sales and use tax on purchases of services by businesses for benefit and use in California, effective Jan. 1, 2019. For services that benefit or are used by the purchaser’s California and non-California operations, a share of the services would be apportioned to California. The proposed tax rate has not yet been determined. Notably, the tax would not apply to purchases of services by individuals.
He may be dead but his troubles are not over. In a unique Qui Tam case under the New York False Claims Act, the failure to file a New York estate tax return and pay estate tax was claimed to be fraudulent because the decedent, as of the date of his death, had not actually changed his domicile to Florida from New York.1 The case was commenced by a former employee of the decedent physician’s medical practice. The employee alleged that although the physician had sold his home in New York and taken steps to change his domicile from New York to Florida, all of these acts were fraudulent and intended to evade the New York estate tax. For individuals who have or are contemplating changing their state tax residence from New York, this development emphasizes the importance of understanding the ways that New York can challenge such a tax planning technique. It also highlights how easy it might be for a third party to tip-off the New York Department of Taxation if the guidelines to change the state of tax residence have not been followed.
The president signed the Tax Cuts and Jobs Act (the 2017 Tax Legislation) into law on Dec. 22, 2017. The 2017 Tax Legislation made direct changes to the tax rules for tax-advantaged bonds, including eliminating advance refunding bonds and tax-credit bonds, and made other changes that will indirectly effect tax-advantage bonds, including reducing corporate tax rates and eliminating alternative minimum tax on corporations. This legislation is the most comprehensive tax legislation since 1986. Congress’ expedited passage of this significant legislation set precedent: the legislation went from first introduction of the House bill to enactment in just over seven weeks. As a result, the legislation left significant unanswered questions. There is speculation about tax legislation in 2018, including a technical corrections bill to address some of these open issues and an infrastructure bill that may include additional changes to the tax-advantaged bond rules. Putting this potential legislation aside, this GT Alert addresses certain implications and questions that arise from the enacted 2017 Tax Legislation.
The Internal Revenue Service (IRS) publishes a monthly update to the applicable federal rates (AFRs) and 7520 rates.
Planning professionals and their clients should take note of fluctuations in these rates and be mindful of planning opportunities that come with rate changes.
The AFR is calculated by the IRS under Section 1274(d) of the Internal Revenue Code (the Code) and is used for many purposes. One of its most common applications is to establish the minimum interest rate that can be charged on an intrafamily loan without income or gift tax consequences. These “safe harbor rates” are dependent upon two factors: (i) the term of the loan and (ii) the frequency of compounding of interest.
For these purposes:
- Demand notes and notes with a term of three years or less are considered short-term obligations,
- Notes with a term of more than three years but less than nine years are considered mid-term obligations, and
- Notes with a term of more than nine years are considered long-term obligations.
The AFR rates for February 2018 and the preceding six months are as follows:
The 7520 rates are used to calculate the present value of an annuity, an interest for life or for a term of years, or a remainder or a reversionary interest. They are calculated by the IRS under Code Section 7520 (hence, the name 7520 rates) and are always 120% of the AFR for mid-term obligations with semi-annual compounding.
The 7520 rates for February 2018 and the preceding six months are as follows:
Rates are typically published by the 20th day of each month and provide planning opportunities for certain estate planning vehicles which are interest rate sensitive. For example:
- Lower rates are generally preferable for intra-family loans, grantor retained annuity trusts (GRATs), installment sales to grantor trusts and charitable lead annuity trusts (CLATs).
- Higher rates are generally preferable for qualified personal residence trusts (QPRTs) and charitable remainder annuity trusts (CRATs).
As rates continue to change, advisors and clients should maintain an open dialogue so that clients can take advantage of any planning opportunities tied to increasing or decreasing rates.
The following is a summary of the real estate provisions of the Tax Cuts and Jobs Act (TCJA) signed into law by President Trump on Dec. 22, 2017.
Individual Rates (Temporary)
General tax rate and bracket reductions for individuals (top rate of 37 percent applies to income above $600,000 for joint filers, $500,000 for single filers). Increases the AMT exemption level and AMT exemption phase-out level. New rates and AMT rules expire after 2025. The 3.8% net investment income tax remains in effect.
Itemized Deduction Limit (Temporary)
Miscellaneous itemized deductions, previously subject to the two percent floor (e.g., investment management fees), are no longer deductible. Expires after 2025.
Corporate Tax Rate (Permanent)
Flat 21 percent tax rate for C corporations; repeals the corporate AMT.
Disallowance of Deductions for State and Local Income Tax and Property Tax (Temporary)
- Limited to $10,000 per year.
- No limit for real property taxes paid or accrued in connection with a trade or business. However, state income taxes that are payable by a non-corporate investor in a pass-through entity are subject to this $10,000 aggregate deduction limitation. For example, assume that Jeff is a 50 percent member of an LLC which owns an office building in Illinois. The LLC pays $200,000 in real property taxes, and has total net income of $500,000. Jeff’s 50 percent share of the property taxes ($100,000) is fully deductible for federal income tax purposes, but the Illinois income taxes that he pays on his 50 percent share of the net income (the state tax on his $250,000 share of the profits), along with (i) any other state income taxes he pays and (ii) any real property taxes he pays that are not associated with a trade or business, are subject to the $10,000 limit on state and local taxes that would be allowed as a deduction
- Expires after 2025
U.S. Supreme Court grants certiorari in South Dakota v. Wayfair, et al.
The U.S. Supreme Court will review the validity of a South Dakota law which requires remote retailers to collect the state’s sales and use tax even if the retailer does not have a physical presence there. If this state law is upheld by the high court, it may result in a tidal wave of similar legislation around the country, requiring online retailers who do not already do so to collect and remit tax and be subject to audits by state and local taxing authorities.
Many U.S. taxpayers are trying to prepay their 2018 real property taxes by Dec. 31 in order to avoid the $10,000 cap on deductibility of state and local taxes that will go into effect for the 2018 tax year under the new tax law signed by President Trump last week. The IRS said in a news release today that the prepayment of 2018 real property taxes before year-end will be deductible on your 2017 income tax return only if the tax has been assessed in 2017. This means that homeowners in many states will not be able to deduct their 2018 real property taxes on their 2017 returns. For example, if the assessment date under state law for 2018 is Jan. 1 (as it is in many states), the prepayment of tax on Dec. 31, 2017 would not be deductible. On the other hand, if the state law specifies an assessment date in the middle of the year, then you would be able to deduct the portion of the taxes that accrue in 2018 so long as you pay by Dec. 31. The IRS press release gives two examples of such a situation. In example 1, the assessment date under the state law is July 1,2017, with two installment due dates, the first installment due on Sept. 30, 2017 and the second installment due on Jan. 1, 2018. In this example, if the second installment due on Jan. 31, 2018 is paid by Dec. 31, 2017, it would be deductible on the 2017 tax return, since it was assessed in 2017. However, example 2 says that prepaying anticipated tax to be assessed on July 1, 2018 in 2017 would not be deductible on a 2017 return.
If you are in a state where a deduction for a portion of the 2018 taxes is allowed, you will need to make the payment by year-end. You do not necessarily have to stand in line at the tax office to pay. It would be adequate to mail the payment in by year-end (if the taxing authority provides this option for prepaying tax payments due in 2018 by mail), but you should be able to document that it was mailed by Dec. 31. The best way to do this would be to mail it from a post office by certified mail, return receipt requested, and ask the postal clerk for a receipt to show it was mailed by Dec. 30 (since post offices will not be open on Sunday, Dec. 31). You should write on the portion of the receipt that will be stamped to confirm delivery your name with statement “Payment of 2018 property taxes” to be able to prove payment in 2017.
Unfortunately, state income taxes for the 2018 tax year are not deductible if prepaid in 2017. Here, the law expressly prohibits a deduction for pre-paid 2018 state income taxes on a 2017 tax return. However, any estimated tax payments that are made in 2017 for 2017 state income taxes would be deductible. Accordingly, it would be beneficial to pay any state estimated tax payment for the 2017 tax year that is due in January 2018 by Dec. 31 this year, so that the estimated tax payment can be deducted on your 2017 federal income tax return. Once again, you should be able to document that the estimated tax payment was mailed by Dec. 31.
So if you are thinking of standing in line at the tax collector’s office to prepay you 2018 taxes this week so that you can deduct them on your 2017 return before the $10,000 limit on state and local taxes kicks in, you might be disappointed.
It is possible that the IRS might change its mind, or that Congress might pass a law to allow a deduction for 2018 taxes paid this year, or the IRS position might be struck down by the courts, but for now, it looks like the prepayment of taxes before they are assessed will not be deductible for 2017. Linked is a 50 state chart from Checkpoint showing the assessment date for real property taxes.
Jonathan M. Forster, a shareholder at Greenberg Traurig, authored an article, “Wealth Transfer Planning Post-Tax Reform – It’s A Brave New World.” In the Private Wealth Magazine article, Forster discusses the opportunity for wealth transfer planning with the new tax reform legislation. Click here to read more.
Greenberg Traurig’s Tax team thanks our clients, colleagues and fellow industry members for a successful 2017 and looks forward to the new year ahead.