San Francisco Chronicle - (Sunday)
Answers to questions about taxes on college savings, rental property
Readers had several questions about my recent columns on the new tax deduction for rental income and a bill to create a $10,000 state-income tax deduction for contributions to California’s 529 College Savings plan, called ScholarShare.
I’ll answer them here.
Q: Brian Hull asks, “My wife and I are currently contributing to our five grandchildren’s 529 ScholarShare accounts. If this bill is passed, will grandparents be able to get this tax deduction?” A: It depends on who is named as the account owner. Under AB211, “only the contributions made by the account owner, referred to as the ‘qualified taxpayer’ in the bill, may claim the deduction. Contributors to an account which they do not own will not be eligible,” said Julio Martinez, executive director of ScholarShare, which is part of the California Treasurer’s office.
So if you, the grandparent, own the account and your grandchild is the beneficiary, you get the deduction. If your daughter is the account owner, and your grandchild is the beneficiary, you do not get the deduction for any contributions you make. However, if you give money to your daughter, and she puts it into the account, she could get the tax deduction.
Any state that offers a tax deduction for contributions to its 529 can decide who gets the deduction, said
Mark Kantrowitz, publisher of SavingforCollege.com. Of the 34 states that offer a state income tax deduction, 24 let any contributor get it and 10 restrict the deduction to the account owner.
“This restriction is problematic because it encourages grandparents to be the account owner to claim the state income tax deduction, even though a grandparent-owned 529 plan can hurt the grandchild’s eligibility for needbased financial aid,” Kantrowitz said in an email.
“Although a grandparent-owned 529 plan is not reported as an asset on the Free Application for Federal Student Aid or FAFSA, distributions from the account are counted as untaxed income to the beneficiary, reducing aid eligibility by as much as half the distribution,” he added.
There are workarounds, such as changing the account owner to the parent, or more complicated ones you can read about on Savingforcollege.com at https://bit.ly/ 2SK9MJX.
For my previous column, see https://bit.ly/ 2S5vC6f.
Q: Steve Ross asked, “How difficult will it be to transfer an existing 529 plan from another state into the California plan if this new legislation passes?” A: First, remember that money transferred into ScholarShare from another state plan would not be eligible for the state tax deduction under AB211, if it passes. You could leave money in another state’s plan and put new money into a ScholarShare account that would be eligible for a California state income tax deduction if the bill passes.
If you do want to move money from one state plan to another, here’s what’s involved. “The destination 529 plan usually has a form on its website, which you can use to transfer all or part of another 529 plan to the destination 529 plan,” Kantrowitz said. You will have to specify the account number, account owner and beneficiary of each 529 plan, along with the address and contact information for the old 529 plan.
You might need to provide a “medallion signature guarantee” on the paperwork from a bank, stockbroker or credit union. Getting it notarized is usually not sufficient.
Warning: Before transferring funds, check whether the old 529 plan will “recapture” any state income tax benefits attributable to the amount that will be transferred. Some will.
Q: In response to my column last month on how the new 20 percent deduction for “qualified business income” applies to real estate, Judi Allewelt writes, “I am a Realtor, an independent contractor with Coldwell Banker, who also owns several rentals. Can the 20 percent deduction be taken on both my rental income and my real estate sales income, since they are two separate businesses?”
A: You could potentially qualify for both, but it depends on your income and how much time is spent on the rentals.
Starting with tax year 2018, taxpayers can deduct up to 20 percent of the income they receive from pass-through entities. These include partnerships, sole proprietorships and S corporations, or a limited liability company taxed as one of those. This is known as the qualified business income, pass-through or Section 199A deduction.
If your taxable income for 2018 — from all sources combined — is less than $315,000 (married filing jointly) or $157,500 (all other filers), you get the deduction, no matter what kind of business it is.
If your taxable income is between $315,000 and $415,000 (married) or $157,500 and $207,500 (other filers), your deduction will be reduced if the income comes from what the IRS calls a “specified service trade or business.” This includes a lot of professions such as doctors, lawyers, athletes and artists. It does not include real estate agents. How much it gets reduced depends on a super-complicated formula that takes into account any wages the business paid and the depreciable property it owns.
If you are in this income range and not in one of those specified service professions, your deduction might — or might not — be reduced, according to the same formula.
If your taxable income exceeds the top of that range, you get no deduction if you are in a specified service profession. Your deduction might be limited if it comes from some other type of business.
Being a landlord is generally not a specified service trade or business. If you own rental property that generates income (after all expenses including depreciation), that income might be eligible for the 20 percent deduction — but only if your rental activity rises to the level of being a trade or business.
Because that term is squishy when it comes to the rental business, the IRS created an extensive list of “safe harbor” rules. If you meet them all, your rental income will qualify for the deduction. One is that you — or people you hire — must spend at least 250 hours a year on eligible activities associated with the rental and have paperwork to prove it.
“If you don’t meet the safe harbor requirements, and don’t spend enough time ‘regularly and continuously’ involved in the rental enterprise, the IRS may not consider it a business for this purpose, in which case the deduction would be lost, said Jeff Levine, a financial planner with Blueprint Wealth Alliance.
In my previous column, Levine explained that to qualify for the safe harbor, taxpayers must own the rental property in their own name or in an entity that is taxed as if it’s in their own name. If you have to file a separate tax return for the rental business, it would not qualify for the safe harbor, he said.
That caused some confusion, and Levine said he may have oversimplified for a lay audience. Pass-through entities can qualify for the safe harbor if they own the real estate directly or through “a disregarded entity,” he said.
A disregarded entity is one where the business is separate from the individual for liability purposes, but is ignored for federal tax purposes. A classic example: John Smith owns a piece of real estate and wants to shield it from his personal assets for liability reasons. So he creates a single-member LLC to own the property. John Smith owns 100 percent of the LLC. The real estate has some asset protection, but John Smith will report it on his tax return as if he owned it himself. In that case, it could qualify for the deduction.
For my previous column, see https://bit.ly/ 2GJwwDF.
Q: Reader Al Schwarz wanted to know, if your rental business qualifies as a “trade or business,” will you have to pay self-employment tax?
A: The answer is no.
Kathleen Pender is a San Francisco Chronicle columnist. Email: kpender @sfchronicle.com Twitter: @kathpender