Accounting On Us
3 Obscure tax rules coming back into play
How these changes impact your taxes
Donna H. Laubscher, CPA
Everybody has heard the stories of how big the volumes of tax rules are. Well, with anything that big, there’s bound to be some areas that don’t get looked at or delved into very often. But, with the advent of the tax reform legislation that was passed in December of 2017, some of the more obscure tax areas are coming back into play and could even be a part of your future.
1202 Stock is a provision where the corporation issuing the stock must be a qualified small business as of the date of the issuance and during substantially all of the period that the taxpayer owns the stock. Then when you – the taxpayer – sell your stock, you don’t have to pay any tax on the gain. Pretty cool, right? Who doesn’t want to own a business, have it appreciate, sell it and not pay any tax on the gain? There are, of course, several limitations on the sale of this qualified small business stock:
- Acquired under original issuance,
- Your business can’t have ever been anything other than a C Corporation, and
- You must hold the stock for a minimum of five years
There are a lot more rules (and even some exceptions to those rules) that are associated with this, so it’s not a good idea to attempt setting this up on your own.
Converting from an S Corporation to a C Corporation
Before tax reform, it was almost always beneficial for a small business to operate as an S Corporation as opposed to a C Corporation. The main reason was because taking earnings out of a C Corp had to be in the form of dividends. So, the corporation was paying tax on its earnings at a higher rate and the dividends were also subject to dividend rates on the shareholder’s individual tax return. This is what is commonly referred to as double taxation.
However, thanks to tax reform, the C Corp rates are now a maximum of 21%, which is much lower than the 37% maximum rate at the individual level. The earnings, if removed from the C Corp, are still subject to double taxation, but converting from an S Corp to a C Corp for those businesses that retain most of their earnings inside the corporation and don’t remove them for the benefit of the shareholders, will have a lesser overall tax burden.
Under the old tax law, when C Corp rates neared or were higher than the individual rates, converting back to a C Corp from an S Corp rarely made sense. While it is possible that this strategy may not apply to most small business owners, it is possible for it to have wider applicability in today’s tax world.
Hobby losses did not change their characteristics with tax reform, but they did go from not providing a good tax outcome to potentially leading to a horrific tax outcome. Before tax reform, the income from any activity deemed to be a hobby was included in your total income on the front of the tax return. But any expenses could only be deducted as an itemized deduction, subject to a limitation of 2% of adjusted gross income (AGI). So, not a great story. For this reason, it was always a good idea to do things correctly and get activities to qualify as a trade or business.
Now, with tax reform, there are no longer miscellaneous itemized deductions subject to 2% of your AGI. The result is that you get to pick up any income, but you don’t get to deduct any of the expenses. Not one nickel. Not one dime. That right there is a whole lot of ugly.
As with all major changes to your tax picture, be sure to contact your professional advisor at Henry+Horne.
Donna H. Laubscher, CPA, Partner, specializes in tax planning and consulting for individuals. She can be reached at DonnaL@hhcpa.com or (480) 483-1170.