What are the Changes in Mortgage Interest Deductions?
The new tax laws made three major changes in the deduction of interest paid on a home. First, the rules on home equity loan debt and interest changed. The definitions of acquisition debt (AD) and home equity debt (HED) did not change. HED is any debt secured by the taxpayer’s residence where the proceeds were not used to buy, build or improve that residence. Interest paid on HED is no longer deductible.

Second, AD is now limited to $750,000. Interest paid on debt secured by the taxpayer’s principal residence or secondary residence is only a deduction for the first $750,000 in principal balance.
Third, AD must be secured by the residence on which the proceeds were used. Loan proceeds that were not used to buy, build or improve the residence securing the loan must be subtracted from the principal and classified as HED. HED interest is not deductible.

Many mortgages are a mix of AD and HED often caused by refinancing. The IRS is very serious about tracing rules used to determine the deductible interest in mixed loans. HED, since interest is not deductible, is the least tax beneficial. Under the tracing rules, the principal portion of the mortgage payment is first applied to the HED portion of a mixed loan.  The ratio of AD and HED principal balances is then multiplied by the total mortgage interest payment to obtain the deductible AD interest and the non-deductible HED interest. Note that the AD portion remains the same until the entire HED principal is paid since no principal payments apply to the AD until there is no more HED.

Finally, there is no grandfathering. In audit, the IRS will require the entire history of financing of the property(s) to determine the AD and HED balances. The tracing rules apply to each year even though in years before 2018 both AD and HED interest was deductible.

Changes to Home Loans and Equity Loans
TCJA reduced the deduction for some home loans and completely eliminated deduction of interest on equity loans. These changes will impact many taxpayers.

Taxpayers who use funds from loans secured by a home must be able to trace the funds to home improvement and other uses then reduce the deduction shown on the forms 1098 from their lender by the appropriate ratio. The taxpayer must retain substantiation of the trace of each dollar to its final use for the life of the loan because while the loan may have been taken out years past the statute of limitations, interest is current.

A taxpayer may choose to treat any debt secured by a qualified residence as not secured by the home.  This is known as a “10T” election. This election applies to the entire secured debt as opposed to the allocation tracing approach. The reason for such an election is that interest on a debt secured by a home is classed as Qualified Home Equity Interest subject to limits that apply to same. The 10T election establishes a different classification to which the limits may be different.

A common use of home equity is the purchase of a second home, a “cabin in the mountains,” for recreation or a future retirement home. Before the recent tax act, interest paid on a home equity loan was deductible. No longer. Loans against the equity in a qualified residence can only be used for improvements on that same residence, not for purchase or improvement of any other property. To gain deductible interest, the loan must be secured by that second property, not by the principal residence.

By the way, you cannot add that interest to the basis of the second property either.

New California Law Defining Independent Contractors
Law inspired by a California Supreme Court decision placing Uber and Lyft drivers under labor
laws now defines what workers can be classed as independent contractors. It is called the ABC
test.

A- the worker cannot be under the direct supervision or guidance of the hiring entity. This is
unchanged from prior law.
B- the work cannot be within the scope of the usual business of the hiring entity. This is the
major change. See below for an example.
C - the worker must customarily perform the same or similar work for others. This is also
unchanged from prior law.

Example of where criteria B comes into play. Let us say that you hire someone to flip an
advertising sign directing people to your business or to a special sale. Is this within the scope of
your usual business? Advertising is certainly within the scope of your business, so does that force
you to make this person an employee with labor law benefits, registration and taxation as an
employee? He would also fail the C test, so probably EDD would say he was an employee.
This new law would almost eliminate independent contractor classification. How do you work
around this? Anyone who satisfies the C test is in business to perform the work and is a vendor
or subcontractor. You can hire subcontractors to do work directly related to your usual business
as a common practice, especially in the GIG economy. A properly worded contract would take
care of any needed guidance on guidance for A. Simply do not call them an independent
contractor and make sure you have a signed contract.

Big Changes for NOLs
NOLs will change carry back and carry forward aspects in 2018. TCJA also limits the amount of NOL that can be applied relative to other income.
Starting in 2018 NOLs can only be carried forward. There is no carry back. And, the taxpayer may only offset 80% of current income with the NOLs. The carry forward is forever.
Excess business losses are disallowed under TCJA and are instead carried forward as a NOL. For non-corporate taxpayers, an excess business loss is the excess of the aggregate of all the taxpayer’s trade or business deduction over gross revenues plus a threshold amount.  For 2018 the threshold is $250,000 ($500,000 for a joint return).

Cancellation of Debt Income (1099-C)
It has taken a long time, but the FTB and IRS now officially state that “if a property owner cannot be held personally responsible for the difference between the loan balance and the sale price, ... the obligation (is) a non-recourse obligation.” The long string of court cases dates back to at least 1934 where a negotiated settlement of a debt was held to be a price reduction, not a cancellation of debt.

It took a letter by Sen. Barbara Boxer to the IRS requesting clarification of the IRS position on a 2011 California law (CCP 580(e)) followed by a response from the IRS legal office to get them to acknowledge that CODI does not, in general, apply to loans secured by real estate.

The result of some two years of tossing this hot potato around, CCP 580(e) and subsequent clarifications and court cases (Crane and Tufts vs FTB) established that debt secured by real property that was disposed of by foreclosure, repossession or short sale at an amount less than the secured debt should be treated as settlement of a non-recourse loan. Settlement of a non-recourse loan does not result in CODI but may result in capital gains.

Now try telling that to lenders who continue to issue 1099-C forms. A survey by FTB reported that 70% of 1099-C forms incorrectly report the tax consequences. If you received a 1099C notice that is not correct, a properly worded challenge to the IRS and FTB will result in the burden of proof transferred to the tax authorities. They must then request a correction with proof from the lender.

Note that current law only applies to debt secured by real property. Non-payment of a credit card, automobile loan or personal loan still results in taxable income if the notice is correct.

Tax Implications of Family In-Home Care
About half of all adult Americans are part of the “Sandwich Generation.” So called because a parent or a child has moved back into their home. The additional costs of these move-backs places a lot of financial and time pressure on adults who must also earn a living. The result is a need for in-home care provided by relatives or home care businesses.

You can be paid by a State agency to provide care for an elder or to provide care of your relative’s children so that they may work. This is income reported on your tax return but it is not subject to the 15.3% self-employment tax because you are not engaged in a business of providing such care. You can even provide in-home care to unrelated persons without rising to the level of a trade or business subject to SE tax.

If you hire a caregiver, the first question may be “Is the caregiver my employee?” The answer to this question determines the reporting requirements to state and federal tax authorities. It is not a clear cut decision process but depends on facts and circumstances. There have been a large number of court cases defining what simple words like “employ” and “worker” mean for labor laws and tax laws.
In general, caregivers do not satisfy the requirements of special skill, independence from control and permanency to rise to the level of an employee. In addition, hiring an individual to provide such care does not rise your involvement to the level of operating a business of home care. Hence, you do not have to report the caregiver to EDD; you do not have to collect FICA and other taxes from their payments; you do not have to file a 1099-MISC reporting their income.

For your own protection, however, you should ensure that the individual is eligible to work in the USA. The caregiver should present a social security card that is not restricted. Keep a copy.

IRA-to-Charity
The PATH act established an exclusion for taxpayers over age 70 ½ for direct distributions from your IRA to charity. The deduction from your IRA is not counted as gross income and satisfies your RMD. With the new tax law an additional benefit is added.

For older taxpayers charitable contributions may be the primary thing preventing them from receiving the maximum standard deduction. Shifting their charitable giving such that funds are coming directly from their IRA both allows them to take the increased standard deduction and allows them the full benefit of the contribution because it is effectively deducted above the line since it does not count toward taxable income. They get both.

If you have a 401(k) or other retirement plan but not a large IRA, remember that transfers from one retirement plan to an IRA can be ordered at any time and do not make the amount taxable.

Changes to Home Loans and Equity Loans
TCJA reduced the deduction for some home loans and completely eliminated deduction of interest on equity loans. These changes will impact many taxpayers.
Taxpayers who use funds from loans secured by a home must be able to trace the funds to home improvement and other uses then reduce the deduction shown on the forms 1098 from their lender by the appropriate ratio. The taxpayer must retain substantiation of the trace of each dollar to its final use for the life of the loan because while the loan may have been taken out years past the statute of limitations, interest is current.
A taxpayer may choose to treat any debt secured by a qualified residence as not secured by the home.  This is known as a “10T” election. This election applies to the entire secured debt as opposed to the allocation tracing approach. The reason for such an election is that interest on a debt secured by a home is classed as Qualified Home Equity Interest subject to limits that apply to same. The 10T election establishes a different classification to which the limits may be different.

Welcome to my tax topics blog. Here we will post information of interest to our clients and their comments on the topics. See our website if you did not already come from there at www.cfofred.com.