Economy

Private School Tuition is Now a Qualified Education Expense for 529 Plans

posted by Hannity Staff - 1.23.18

William G. Lako, Jr., CFP®
Principal, Henssler Financial

It was touch-and-go there for a minute—Congress almost repealed more than a half-dozen provisions in the tax code that help students of low- and middle-income families afford a higher education. Much to the benefit of many taxpayers, many of the provisions were retained that encourage saving for higher education, help students and families pay for college, and assist with the student loan repayment.

The most significant change is that 529 Plans now include tax-free distributions to pay for private kindergarten through high school tuition and expenses. Prior to the reform, 529 Plans earnings growth and withdrawals were only tax-free when used to pay for qualified higher education costs. If families wanted to invest funds to pay for private school in a tax-advantaged account, they were limited to Coverdell Education Savings Accounts. These carry the low maximum annual contribution of $2,000 and contributions were phased out for tax filers with adjusted gross income of $220,000 for married filing jointly, and $110,000 for all others. Furthermore, contributions to Coverdell ESAs are not tax-deductible.

This is a meaningful benefit to families who choose to enroll their children in private schools

The Tax Cuts and Jobs Act amended the treatment of 529 plans so that families can withdraw up to $10,000 per year tax-free for private elementary and high school tuition. This is a meaningful benefit to families who choose to enroll their children in private schools. The National Center for Education Statistics reports that nearly 10 percent of all students are enrolled in a private school. According to Private School Review, an online resource for evaluating potential schools, the national average for private school tuition is around $10,300 per year, which includes both elementary and high school tuition.

When contributing to any savings account with tax-free growth, the longer you can let the investment compound, the more tax benefit you’ll see. If you choose to begin taking withdrawals from your child’s 529 Plan for K-12 education expenses, you may see less tax-advantaged growth. However, more than 30 states offer state tax deductions for contributions to a 529 plan.

If you are currently saving to a Coverdell ESA, you may consider rolling the account into a 529 Plan to take advantage of the absence of annual contribution limits. In 2018, individuals can contribute up to $15,000 to a 529 plan before incurring gift tax issues. That limit is doubled for couples married filing jointly. Overall plan limits vary by state, ranging from $235,000 to $520,000. Some taxpayers may benefit from establishing two 529 plan accounts, one for K-12 expenses and one for college costs. This will allow you to pick investments that correspond to your time horizon. Many plans offer investment tracks that gradually shift to more conservative investments as the beneficiary reaches college age. If you intend to use the funds for private elementary or secondary schools, you may consider a static investment that contains a mix of fixed and growth investments.

Before you spend your 529 Plan funds for K-12 education, make sure your state’s tax laws have been amended to account for these withdrawals. The language that governs state tax deductions for contributions and qualified withdrawals may differ from federal laws—you want to avoid any unintended tax consequences.

William G. Lako, Jr., CFP®, is a principal at Henssler Financial, a financial advisory and wealth management firm that has been delivering comprehensive financial solutions to its individual, corporate, and institutional clients for 30 years. Mr. Lako is a Certified Financial Planner™ professional.

EYE ON YOUR MONEY: Not All Business Tax Cuts Are Simple

posted by Charley Mills - 12.29.17

One of the key promises during President Trump’s campaign was to lower taxes for businesses from 35 percent to 15 percent and eliminate the corporate alternative minimum tax. The final version of the tax bill did eliminate the corporate alternative minimum tax, and lowered the tax for corporations to 21 percent in 2018. Furthermore, businesses organized as “pass-throughs” could get taxed at a less than 30 percent rate.

Taxes are never simple – despite the promise to simplify the tax code

Pass-through businesses are your LLCs, partnerships, S corporation, and sole proprietorships, in which the entity is not subject to income tax. Owners are taxed individually on the income, calculating tax on their share of the profits and losses. Because these business owners were at the mercy of their individual tax rates, some business owners could be taxed as much as 39.6 percent, not including the phase out of itemized deductions for high income earners.

In the finalized bill, pass-through businesses receive a 20 percent deduction of their qualified business income. Because taxes are never simple—despite the promise to simplify the tax code—the deduction is actually the lesser of: 20 percent of the taxpayer’s “qualified business income” or the greater of: 50 percent of the W-2 wages with respect to the business, or 25 percent of the W-2 wages with respect to the business plus 2.5 percent of the unadjusted basis of all qualified property.

OK, you want this in English. Qualified business income is income less ordinary deductions that you earn from a pass-through business, such as an LLC, sole-proprietorship, S corporation, or partnership. This does not include wages you earn as an employee. Let’s say you have an LLC (not a “specified service” trade or business), and your share of the qualified business income is $500,000. Multiply that by 20 percent and you get a deduction of $100,000. Woo hoo! Not so fast. There are limitations on the calculation that were added to prevent abuse of the rules.
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How does this work? Let’s look at the example of your LLC of which you only own 40 percent. The company produced $1.25 million in ordinary income. The company paid W-2 wages of $455,000 and holds $200,000 in property. Your allocation of the wages is $182,000 and 50 percent of that is $91,000. One more calculation: 25 percent of the W-2 wages with respect to the business plus 2.5 percent of the unadjusted basis of all qualified property—in our example, this comes to $47,500 ($45,500 + $2,000). You’ve got two numbers: $91,000 and $47,500. The greater of the two is $91,000. This is your income limitation. So, your deduction on your $500,000 qualified business income is now $91,000 versus the simple 20 percent. Mindboggling, isn’t it? And this example was highly simplified for your convenience.

Now, not every LLC is making $1.25 million. Lots of small businesses make around $125,000 a year. There is an exception for you! If your taxable income is less than $157,500 or $315,000 for married filing jointly, you should be able to ignore the W-2 income limitations.

To make things more complicated if you are part of a “specified service” trade or business you will be faced with a phase out.

Wait, what? Yes, “Any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.” Will be deemed to be a “specified Service”.

This means if your income is above $207,500 for individuals and $415,000 for joint filers you will not be eligible for the deduction. Welcome to simpler taxes.

William G. Lako, Jr., CFP®, is a principal at Henssler Financial, a financial advisory and wealth management firm that has been delivering comprehensive financial solutions to its individual, corporate, and institutional clients for 30 years. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.

TAX LOOPHOLE? Advice for businesses looking to qualify for the 20 percent tax deduction

posted by Charley Mills - 1.09.18

William G. Lako, Jr., CFP®, is a principal at Henssler Financial, a financial advisory and wealth management firm that has been delivering comprehensive financial solutions to its individual, corporate, and institutional clients for 30 years. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.

As a small-business owner, you’re probably thrilled to hear you may receive a 20 percent deduction on qualified business income from pass-through entities. This deduction does not apply to interest, dividends, and capital gains. This is a complex area where we are likely to see a lot of taxpayers restructuring to qualify for the deduction.

The law states that anyone who is in the business of being an employee and any “specified service trade or business” is not eligible for the 20 percent of qualified business income deduction. The law vaguely defines “specified service trade or business” as, any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and investing and investment management, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.

Basically, this exclusion seems to be targeting businesses that don’t sell goods or make products. They simply provide a service. The thought behind this is that the payment for a service is a wage, so any business that provides a service should have their income taxed like wages without a 20 percent deduction.

As a small-business owner, you’re probably thrilled to hear you may receive a 20 percent deduction

But, then there is another exception that even if you’re one of the “specified service businesses” and your taxable income is less than $315,000 joint or $157,000 for all other taxpayers, you can still claim the 20 percent deduction. The deduction phases out as taxable income increases above this threshold until it disappears at $415,000 for joint and $207,500 for all others.

For example, let’s look at Joe, an accountant. Joe is paid a salary of $100,000. For simplicity sake, Joe is married but his spouse doesn’t work so after his standard deduction, his joint taxable income will fall into the 12 percent tax bracket.
Joe decides to quit working for someone else and forms his own limited liability company to provide accounting services for $100,000. Despite Joe’s business being considered a disqualified service business, his taxable income is less than $315,000 MFJ, so he could take a 20 percent deduction on his qualified business income of $100,000. Depending on how he structures the business it could save him close to $8,500 in taxes. Sounds like a good deal, but then he is on the hook for his own health insurance and he must pay the full 15.3 percent Social Security and Medicare tax. Plus, there are retirement plans, insurance costs and other fringe benefits he might miss out on by not being an employee.

Let’s say Joe determines his LLC is worth the hassle, and his company brings in $170,000. He’s going along just fine enjoying his 20 percent deduction on qualified business income until his wife decides to rejoin the workforce. She is paid $175,000 a year in wages, which pushes joint taxable income to $321,000, $6,000 above the $315,000 threshold. Despite being in a disallowed service industry, Joe can still take a deduction after applying the phaseout mentioned above.
If Joe were to take on more clients and bring in $300,000 and his wife earned $175,000 in wages, their joint taxable income would be above $415,000, the top threshold of the phaseout of the 20 percent deduction. Joe’s pass-through business income is then taxed without a 20 percent deduction.

Joe could also consider being a C corporation. Each scenario is unique and requires detailed analysis and planning to determine if the tax savings would be worth a more complicated structure.

William G. Lako, Jr., CFP®, is a principal at Henssler Financial, a financial advisory and wealth management firm that has been delivering comprehensive financial solutions to its individual, corporate, and institutional clients for 30 years. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.

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