As summer comes to a close and the kids go back to school, now is the perfect time to look at various tax changes that have occurred in the past year.
One of the biggest changes in 2016 was municipal tax reform that went into effect on January 1. Ohio has over 575 municipalities, and prior to January 1, 2016, cities had a lot of flexibility in their taxing systems. Starting in 2016, however, much needed uniformity went into effect for both business and individual tax returns.
For business returns, a significant improvement is the occasional entrant treatment, which modifies the casual entrant exemption to increase the number of days from 12 to 20 per year that an individual may work in a non-principal place of business location without incurring income tax liability in that city. Furthermore, the occasional entrant treatment creates a separate exemption that prohibits the taxation of income of employees of businesses with less than $500,000 in annual revenue by any municipality other than the municipality where the business’ fixed location is located.
For example, assume you are a civil engineer and work in various Ohio cities. In the past, your W-2 might have listed 10 or more taxing locations and corresponding withholding because you spent more than 12 days in each of these cities. Under the new rule, you would have to work in these cities for more than 20 days in order for the withholding to occur. And if your employer has annual revenue of $500,000 or less, you would only have withholding for your employer’s main location regardless of how many days you spent in different cities. This new rule should make both Form W-2 reporting and the corresponding tax return preparation much easier.
Another change is that all cities now have to allow net operating losses (NOLs) and a five-year carryover for unused losses in the year occurred. Previously, some cities allowed NOLs and some did not. Note that this is phased in beginning in January 2017 and permits pre-existing losses to continue to be carried forward if current ordinances allow. This is a major win for taxpayers.
Additionally, taxpayers will receive an automatic municipal tax filing extension if they timely filed a federal extension. This is a significant improvement because a lot of cities required their own city extension even when no money was due. Now, you can file the return in October and include a copy of the federal extension.
Recent tax cases & deduction rulings
There is good news for unmarried filers who jointly purchase and finance a home. In 2015 an appeals court held that unmarried co-owners of a residence who file separate income tax returns can each deduct interest on up to $1 million of acquisition indebtedness and $100,000 of home equity debt. The IRS has stated in 2016 that it accepts this ruling and will follow it in cases with similarly situated taxpayers.
Dressing up for work? If yes, you cannot take a tax deduction for the clothes purchased. In a recent tax court memorandum, the court stated that a Ralph Lauren sales person could not deduct his clothing expense even if the employer required all employees in sales positions to wear the Ralph Lauren brand because the clothes are suitable for personal use outside the workplace.
In another decision, the court held that two brothers who ran a family-owned concrete business were entitled to deduct as wages on their business tax return $11.4 million over a period of two years. The court determined that the wages were reasonable and fully deductible because the company was profitable and had exponential growth due in large part to the two brothers. This is important because if the court would have disallowed, it would have increased taxable income and tax. And the money would have been taxed again when taken out of the company as a dividend. Therefore, if you want to pay yourself a large salary, make sure that you can back it up and ascertain if an outside investor would approve the total compensation paid.
Ohio will once again allow the small business deduction for 2016 income tax returns on 100% of income up to $250,000. In the past it was limited at 75% of $250,000. Income that is eligible for the deduction includes:
- Schedule B income from a business
- Schedule C income
- Schedule D gains/losses from a business
- Schedule E income – rent and income pass-through entities
- Schedule F income
Clark Schaefer Hackett will be closely watching the proposed rules to curtail the use of valuation discounts in family businesses. Under present rules, when an interest in a closely held business is transferred to a family member, the donor is able to claim significant valuation discounts for lack of marketability and control, which can reduce the gift tax cost considerably. The transferred interest is also out of the donor’s estate, lowering the estate tax bill. The proposed rules would restrict the use of valuation discounts in such transfers. The rules are prospective, so there is still time to complete these transfers and take advantage of the discounts.
2016 Tax Planning
Keep in mind that even though fall will quickly be upon us, there is still time to save on your taxes. Here are several ideas for you to consider:
- Make sure that you are contributing to your work retirement plan. The limit for 2016 is $18,000 and an additional $6,000* if you are age 50 or older at December 31, 2016. It is never too late to start or increase retirement savings.
- Contribute to an Ohio §529 plan if you have children or grandchildren. Ohio allows a $2,000 deduction per beneficiary and the earnings will never be taxed so long as they are used for college expenses.
- If you are not subject to the alternative minimum tax, considering prepaying your real estate and state and local estimates by December 31, 2016.
- If you will have large dental or medical expenses in the future, consider participating in your work flexible spending account to pay part of the expense. The money is not subject to tax so long as the money is used for valid medical expenses.
If you have any tax questions, contact your Clark Schaefer Hackett advisor.
* This article originally misstated the catch-up contribution for retirement plans. The item has been corrected.