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Tax Reform: Understanding the Basics

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Presentation on theme: "Tax Reform: Understanding the Basics"— Presentation transcript:

1 Tax Reform: Understanding the Basics
Presented by: Donald S. Johnston

2 OVERVIEW OF THE DAY Understanding the basics of the TCJA
Impact on families and individuals Impact on pass-through entities Impact on businesses Other tax issues Revenue recognition and changes to lease accounting

3 Understanding the Basics of the tcja
Tax Cuts and Jobs Act passed on December 20, 2017, enacted on December 22, 2017

4 Understanding the Basics of the tcja
Goals of proposed legislation Tax relief for middle-class families Simplicity of “postcard” tax filing for vast majority of Americans Tax relief for businesses, especially small businesses End incentives for shipping jobs, capital, tax revenue overseas Broaden tax base and provide greater fairness for all Americans by closing special interest tax breaks and loopholes

5 Understanding the Basics of the tcja
What you need to know: Individual changes – rates, itemized deductions and exemptions have dramatically changed, change to child tax credit, standard deduction nearly doubled Pass-through deduction – 20% for qualifying business owners Business changes – tax rates, interest expense limitations, accelerated depreciation changes

6 IMPACT ON FAMILIES AND INDIVIDUALS
Note that all individual provisions are TEMPORARY For tax years beginning in 2026, the TCJA provisions sunset, and pre-TCJA laws kick back in

7 IMPACT ON FAMILIES AND INDIVIDUALS
Changes to the standard deduction Old Law New Law $ 6,500 $ 12,000 9,550 18,000 13,000 24,000 Single Head of Household Married filing joint Change will benefit those who would not have been itemizing The increased standard deduction will substantially reduce the number of taxpayers who itemize

8 IMPACT ON FAMILIES AND INDIVIDUALS
Repeal of the deduction for personal and dependency exemptions The TCJA temporarily repeals the deduction for personal and dependency exemptions for tax years beginning after December 31, 2017, and before January 1, 2026

9 IMPACT ON FAMILIES AND INDIVIDUALS
Expansion of the child tax credit Increased and expanded to address negative outcome created by the repeal of deductions for personal and dependency exemptions Previously, taxpayer could claim up to $1,000 for each qualifying child; now, the credit is $2,000, and the related phase-out thresholds are increased

10 IMPACT ON FAMILIES AND INDIVIDUALS
Prior to the TCJA, the primary itemized deductions consisted of: Medical expenses State and local taxes Mortgage and home equity interest Charitable donations Miscellaneous itemized deductions Expanded Limited Eliminated

11 IMPACT ON PASS-THROUGH ENTITIES

12 Impact on pass-through entity income
The TCJA aims to reduce tax for pass-through business owners by creating a new 20% pass-through deduction for qualified taxpayers

13 IMPACT ON PASS-THROUGH ENTITIES
What are pass-through entities? S-Corporations Partnerships LLCs taxed as Partnerships or S Corporations Sole Proprietorships Certain rental property entities

14 IMPACT ON PASS-THROUGH ENTITIES
Mechanics of the QBI Deduction An individual can claim the deduction for the sum of: The lesser of: “20% of the combined qualified business income,” or 20% of the excess of the taxpayer’s taxable income, over the sum of: (i) the taxpayer’s net capital gain, and (ii) the taxpayer’s aggregate qualified cooperative dividends PLUS, the lesser of: − 20% of the taxpayer’s aggregate qualified cooperative dividends; or the taxpayer’s taxable income, minus the taxpayer’s net capital gain

15 The qbi deduction – example 1
Wages $ 60.00 K-1 Income 90.00 AGI 150.00 Standard deduction (24.00) QBI deduction - (18.00) Taxable income 126.00 108.00 Tax 31.50 27.00 Savings 4.50

16 The qbi deduction – example 2
Wages $ 10.00 K-1 Income 90.00 AGI 100.00 Standard deduction (24.00) QBI deduction - (15.20) Taxable income 76.00 60.80 Tax 19.00 15.20 Savings 3.80

17 The qbi deduction – example 3
Wages $ 9.00 K-1 Income 330.00 AGI 339.00 Standard deduction (24.00) QBI deduction - (63.00) Taxable income 315.00 252.00 Tax 78.80 63.00 Savings 15.75

18 IMPACT ON PASS-THROUGH ENTITIES
QBI Deduction – the fine print The deduction may be disallowed if: Your taxable income is too high, and you are either an SSTB and/or you fail the wage/qualified property test MFJ income test $315,000 - $415,000 – phase-in begins Single income test $157,500 - $207, 500 – phase-in begins SSTB issues Wage/qualified property issues

19 IMPACT ON PASS-THROUGH ENTITIES
Lender Warning: The QBI deduction may lead to certain changes to the way a business pays its partners going forward Some partnerships are eliminating or reducing guaranteed payments, which increases book income and EBITDA Cash-out flows from the partnership are the same, but the income is inflated (as compared to prior years)

20 LENDER Warning: GUARANTEED PAYMENT CHANGES
Before After Pre-GP Book Income $ 400 Guaranteed Payment 250 - Book Income 150

21 IMPACT ON PASS-THROUGH ENTITIES
Summary Considerations Related to the QBI Deduction Taxable income below the thresholds should allow for a deduction at 20% of QBI without limitation If the results of the W-2 wages/qualified property test exceed 20% of QBI, all owners should be able to take the QBI deduction at 20% of QBI (in consideration of other pass-through entities) (Unless the pass-through entity constitutes a Specified Service Trade or Business)

22 IMPACT ON PASS-THROUGH ENTITIES
Summary Considerations Related to the QBI Deduction If the pass-through entity results fail to meet the W-2 wages/qualified property test, the taxpayer will have to work through the W-2 wages/qualified property limits calculations to determine the amount of the QBI deduction

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35 IMPACT ON BUSINESSES

36 IMPACT ON BUSINESSES Corporate income tax rate reduction
Permanently reduced to a 21% flat rate (graduated rates ranging from 15% to 35% under prior law) Effective for tax years beginning after December 31, 2017

37 IMPACT ON BUSINESSES Business interest limitation
Changes to bonus depreciation rules (temporary) Section 179 expensing (permanent) Simplified accounting rules for small businesses This one is a big deal!

38 CONCLUSION AND PRACTICAL CONSIDERATIONS

39 CONCLUSION AND PRACTICAL CONSIDERATIONS
Individuals should consider: QBI deduction Expansion of standard deduction, loss of personal and dependent exemptions Ramifications of losing state and local income tax deduction, miscellaneous deductions, home office deductions Assessing charitable giving strategies

40 FINAL THOUGHTS Other Important Matters:
Understanding your current and future tax consequences (income, and sales tax) Pennsylvania tax awareness U.S. Supreme Court case (South Dakota v. Wayfair)

41 FASB ASC TOPIC 842 Good morning!
I’ve got a brief, 10 minute, presentation for you this morning on the upcoming changes to accounting for leases. We’re going to cover the high points, but keep in mind that this is a significant ASU that when released was ~500 pages in length. Like with anything, the high points are easy. The details can be more complex. Dates Issued February 2016 Effective dates Public - FYs beginning after 12/15/18 Nonpublic - FYs beginning after 12/15/19 Early adoption is permitted Lessors On the whole, Lessor accounting remains reasonably consistent. Targeted improvements intended to align lessor accounting with the lessee model and with the updated revenue recognition guidance issued in 2014.

42 LESSEE ACCOUNTING Lessees
We’re going to focus this morning on lessees, since that’s where some of the more significant changes are. Contrary to what you may have heard leading up to the issuance of this literature, the FASB has generally maintained a distinction between capital and operating leases. Capital leases will now be called Finance Leases. As you can see in this model from the FASB, there really isn’t much change on the income statement or cash flow presentation. Before the ASU was issued, there was a belief that the FASB might push everything to a finance lease presentation, like the IASB However, operating leases are still expensed as either COGS or SGA as payments are made. The asset related to the finance lease will still be amortized and interest expense will still be recorded. Operating leases will still show as cash flows from operations. Payments under finance leases will still show as financing activities. Interest paid will continue to be in operating activities. The big changes is on the balance sheet, particularly for operating leases, where a new right of use concept will come into play. Right of use assets will now be recorded along with a lease liability. The right of use asset is initially measured at the present value of the lease payments (including initial direct costs). As payments are made, the liability is reduced. The asset will be charged to expense on a straight-line basis. There is an exception from the balance sheet treatment for short terms leases – 12 months or less. Classification of leases between capital and operating has historically been based on 5 (rules-oriented) criteria. These criteria largely remain in the new literature, but are now more principles based than rules based. For example, a lease is a finance lease if the lease term = major part of remaining economic life of underlying asset. Previously, there was a 75% bright line test.

43 Overview of new leases standard
The FASB lists these benefits and costs associated with the new standard…

44 LESSEE ACCOUNTING Balance sheet gross up – potential impact on ratios
Possible increase in number of finance leases – lease term consideration Better visibility for lenders on balance sheet This standard may impact the bank’s accounting for leases

45 Revenue recognition Eliminates the transaction and industry-specific revenue recognition guidance under current GAAP Replaces it with a principles-based approach for determining revenue recognition (Largely) converged standard with IFRS 15 This standard may impact the bank’s accounting for leases

46 Effective dates Public entities Nonpublic entities
Effective for annual reporting beginning after 12/15/17, including interim periods within reporting period Nonpublic entities Effective for annual reporting periods beginning after 12/15/18 and interim periods in annual periods beginning after 12/15/18 Early adoption is permitted in annual periods beginning after 12/15/16 This standard may impact the bank’s accounting for leases

47 Five-step process Identify the contract with a customer (Agreement)
Identify the separate performance obligations (Distinct) Determine the transaction price (Consideration) Allocate the transaction price to the separate performance obligations (Stand-alone) Recognize revenue when or as the entity satisfies each performance obligation (Control) This standard may impact the bank’s accounting for leases

48 Please go to our website to subscribe to receive timely updates about tax reform and other accounting issues

49 THANK YOU!


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