Tax Reform and What Does It Mean – Part 2
Today, we continue our look at the recent tax reform. We will be examining the impacts related to the changes in the deductions that we as Californians have long relied upon. To be sure, there is a lot of questions regarding the state of deductions following tax reform.
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Tax Reform and What Does It Mean – Part 2
In our first article
, we examined the initial reductions in tax rates for both individuals and corporations. We looked how the corporate rates were made permanent while individual rate reductions had an expiration. We also looked at some changes in the standard deductions. Today we look at the limitations placed upon some of the deductions that we as Californians are now faced with. The tax reform changes significantly reduced certain important deductions that we routinely rely on in completing our taxes.
The reason many Californians opposed the reform was related to the reduction in the most significant write-off highly taxed Californians had and that was the reduction in the SALT (State and Local Tax) deduction. Under the previous law, residents could deduct the entirety of their state income tax and property tax payments on their federal return. In states such California where there is a high tax burden compared to other states, this was a beneficial deduction. However, in the tax reform, this deduction will be limited to a combined $10,000. That means once your combined payments of state income tax and property tax exceed $10,000 those extra taxes are no longer tax deductible. Functionally, if one exceeds the $10,000 payment those dollars are getting taxed twice. Once at the state level and once at the federal level.
Many proponents of the tax reform urge that this reduction in the SALT deduction will not adversely impact Californians because of the reduction in the income tax rates. This remains to be seen. While the rates were shifted downwards, it is not necessarily certain that the reduction in the ability to deduct will be offset by the reduced tax rates.
Mortgage Interest Deduction
Additionally, the mortgage interest deduction was reduced from $1,000,000 in qualifying mortgage debt to $750,000 in qualified mortgage debt. In high cost of living states like California, again this could be problematic, especially in high-cost areas like the Bay Area or Los Angeles where housing prices easily and consistently exceed $750,000. While this reduction won’t affect as many as the SALT deduction will, it was certainly a shot across California’s bow.
Other deductions that took hits in the tax reform law was the suspension in certain instances of the home office deduction, professional society dues, certain moving expenses, work clothes deductions and licensing fees. These are routine deductions utilized by the professional working-class Americans, many of which own and operate small businesses right here in California.
While corporations saw significant benefits in reduced tax rates, those in the professional service industries, such as financial services, health, law and potentially real estate brokers did not get the same reduction in corporate tax rates. Many such corporations are pass-through entities, meaning they pass the profits through to the owners and pay personal income tax on the money. The tax reform creates a 20% pass-through income capped at the first $315,000 of pass-through income. A complex QBI calculation is required to determine the value of the deduction for each individual pass-through entity. For a good article on the complex rules of QBI check out this article
.While it is an interesting concept, until we figure out exactly how it will work, it remains to be seen what in any relief the owner of the pass-through entity will receive.
One area, however, that will likely be beneficial to owners of pass-through entities was the change to allow immediate expensing of short-lived capital investments. Rather, than owner being required to depreciate capital investment over time, certain investments will be allowed to immediately expense and get the benefit of that expensing in the year of the investment. Depending on the nature of the investment, sound tax strategy advice will be necessary especially for business owners that make seldom but large capital investments into their companies.
One thing that is certain is that the tax reform has created a great amount of questioning. It remains to be seen whether it will actually be beneficial here California. The consensus is that corporations will do well under the tax reform, but will those on the main street receive the same benefit? Time will tell.
The attorneys of BPE Law Group, PC. have been advising our clients on real estate, business, and estate planning issues for over 20 years and have assisted numerous clients in business and real estate matters. If you have questions concerning any legal matter, give us a call at (916) 966-2260 or e-mail Keith at email@example.com. Our flat fee consults for new clients may get you the answers you need for the questions you have.
The information presented in this Article is not to be taken as legal advice. Every person’s situation is different. If you are facing a legal issue of any kind, get competent legal advice in your State immediately so that you can determine your best options.