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Taxes Articles and Resources

New Rules for HELOCs

Your Home is No Longer a Full Service Tax Deducting ATM

Have you ever tapped the equity in your home to pay for a new car or a college tuition? With a HELOC, also known as a home equity loan or line of credit, you could do so. Better yet, you could deduct the interest you paid on those loans on your tax return.

The new tax law has changed all of this (at least through 2025, when this portion of the tax law expires). With over 14 million HELOCs borrowing over $500 billion, the new rules affect many Americans for the tax year starting 2018.

You can still tap into your home’s equity for whatever you want. But under the new tax law, you can’t deduct the interest in every circumstance. And there are limits on how much you can deduct even if you are using the money correctly.

What is a proper usage for an interest deduction?

Borrowings used to “buy, build or substantially improve” your home are accepted. Fast cars are not. (But again, you can still buy the car and just not deduct the interest.)

The borrowing must be used to improve the house securing the loan. So you can’t use a HELOC on your primary residence to improve a vacation home.

Interest can only be deducted on the total debt of up to $750,000 for up to two homes. If you had a debt of up to $1 million on one or two homes before December 15, 2017 (the last date before the tax law changed) you can still deduct the interest if the money was used to improve, build or buy a home.

How does the $750,000 limit come into play?

Let’s say John has a $700,000 mortgage on a primary residence and borrows $100,000 on a HELOC to make improvements on that property. His total borrowings are now $800,000. John can only deduct interest on the first $50,000 of the HELOC. The remaining $50,000 in interest is over the $750,000 limit.

Mary has a primary residence and a vacation home. Her residence has a $300,000 mortgage on it with the vacation home having a $200,000 mortgage. Her total borrowings are $500,000. Mary then borrows $100,000 against each property. The money borrowed against her primary residence goes for improvements on that property. Likewise, the $100,000 vacation home borrowing is used for a landscaping project on that property. Mary’s total borrowings are now $700,000. Because she used the money the right way on each property she can deduct the full amount of interest on the $700,000 in loans.

There is another wrinkle to be aware of here. You can only deduct interest on a HELOC of up to $100,000. And that HELOC deduction is limited to the price you paid for the property.

Let’s say you bought a Detroit fixer-upper for $50,000. Somehow, you are able to get a HELOC on it for $75,000 so you can completely remodel it. You can only deduct interest on the first $50,000 of the loan, because that is what you paid for the place.

Once again, the tax law benefits single persons. Two singles could deduct a combined $1.5 million in mortgage debt ($750,000 each) if they bought a home together. Married couples are limited to the $750,000 amount.

Of course, record keeping becomes important in this arena. You’ve got to be able to prove all of this up to the IRS. Track your spending and save all of your invoices. If you don’t already have one, consider using a bookkeeper to assist with it. Save these records for a good long time. The IRS may take years to get at any audits on this. You may need to be prepared into the distant future.

State Franchise Fees: Beware of Delaware’s New Rules

Delaware’s New Rules Are a Cost To Consider When Forming Your Entity

Delaware recently increased the various fees assessed by their Secretary of State as Annual Franchise Tax Fees for Delaware corporations. While the changes do not apply to Limited Liability Companies (LLCs) or Limited Partnerships (LPs), and religious and charitable non-stock corporations remain exempt from the tax, the increased fees for corporations must be considered when forming an entity.

All corporations incorporated in the State of Delaware, irrespective of whether they actually do business in the State of Delaware, must file an Annual Franchise Tax Report and pay an Annual Franchise Tax. The Annual Franchise Tax is calculated on capital stock, and it is levied on corporations even if they are not producing any income.

The changes in the new law are fourfold: (1) the Franchise Tax Cap has been increased; (2) the Authorized Shares Method for calculating the Annual Franchise Tax has been modified; (3) the Assumed Par Value Capital Method for calculating the Annual Franchise Tax has been modified; and (4) the Late Penalty has been modified.

1. Franchise Tax Cap

Effective for Fiscal Year 2018, the Franchise Tax Cap has been increased to from $180,000 to $200,000 per year ($250,000 per year for some large corporate filers). It should be noted that LLCs and partnerships only pay $300 per year. But corporations with a large number of shares must take note.

2. Authorized Shares Method

There are two ways to calculate what you owe Delaware each year. The first focuses on how many shares you have authorized.

Under this method, the rate presently is $175 for a corporation with 5,000 authorized shares or less; $250 for a corporation with 5,001 to 10,000 authorized shares; and $75 for each additional 10,000 shares or portion thereof. Effective for fiscal year 2018, HB 175 has increased this rate from $75 to $85 for each additional 10,000 shares of portion thereof. For example, a corporation with 1,000,000 authorized shares now will owe $250 for the first 10,000 shares, plus an additional $8,415 ($85 times 99), for a total due of $8,665, plus $50 for the Annual Report Fee. These thousands of dollars compare with Wyoming’s annual fee of just $50.

3. Assumed Par Value Capital Method

Delaware also employs an alternative method for calculating the Annual Franchise Tax. This method is denominated as the Assumed Par Value Capital Method, and a taxpayer is free to use either method, and use whichever amount is less. The Assumed Par Value Capital Method is difficult to compare to the Authorized Shares Method because it necessarily makes certain assumptions about total gross assets. It is also difficult to calculate, period. Here is an example of how it works:

To use this method, you must give figures for all issued shares (including treasury shares) and total gross assets in the space provided in your Annual Franchise Tax Report. Total Gross Assets shall be those “total assets” reported on the U.S. Form 1120, Schedule L (Federal Return) relative to the company’s fiscal year ending the calendar year of the report. The tax rate under this method is $400 per million or portion of a million. If the assumed par value capital is less than $1,000,000, the tax is calculated by dividing the assumed par value capital by $1,000,000 then multiplying that result by $400.

The example cited below is for a corporation having 1,000,000 shares of stock with a par value of $1.00 and 250,000 shares of stock with a par value of $5.00, gross assets of $1,000,000.00 and issued shares totaling 485,000.

  1.  Divide your total gross assets by your total issued shares carrying to 6 decimal places. The result is your “assumed par.” Example: $1,000,000 assets, 485,000 issued shares = $2.061856 assumed par.
  2.  Multiply the assumed par by the number of authorized shares having a par value of less than the assumed par. Example: $2.061856 assumed par, 1,000,000 shares = $2,061,856.
  3.  Multiply the number of authorized shares with a par value greater than the assumed par by their respective par value. Example: 250,000 shares $5.00 par value – $1,250,000.
  4.  Add the results of #2 and #3 above.  The result is your assumed par value capital.  Example: $2,061,856 plus $1,250,000 = $3,311,856 assumed par value capital.
  5.  Figure your tax by dividing the assumed par value capital, rounded up to the next million if it is over $1,000,000, by 1,000,000 and then multiply by $400.00. Example: 4 x $400.00 = $1,600.00.
  6.  The minimum tax for the Assumed Par Value Capital Method of calculation is $400.00.

As you can see, the calculation is pretty complicated. Be sure to work with your tax advisor to get it right. Or maybe incorporate in another state without such rules and fees.

The new law increased the minimum amount of Annual Franchise Tax that is due and payable by a Delaware corporation under this alternative method. The minimum amount of Annual Franchise Tax for a Delaware corporation now is $400 per year, effective for fiscal year 2018.

4. Late Penalty

The new law has increased the Late Penalty from $125 to $250.

A COMPARISON

As noted above, the minimum amount of Annual Franchise Tax now payable by a Delaware corporation is $450 per year, effective for fiscal year 2018. It is informative to compare this $450 per year minimum amount of Annual Franchise Tax to similar taxes and fees in the States of California, Nevada and Wyoming.

1. California

California has taxes: corporate and personal income tax, California Alternative Minimum Tax, and California Franchise Tax. California Franchise Tax applies to LPs, LLPs, S and C corporations, and LLCs. All pay a minimum amount of $800 per year. But then other taxes kick in depending upon entity type. For S corporations, the California Franchise Tax is 1.5% of the S corporation’s net income, along with the minimum tax of $800 per year. For California LLCs, California Tax is a flat fee, based upon California gross income, plus an Annual Franchise Tax of $800 per year, regardless of income, calculated, as follows:

  • Gross income less than $250,000 – $0 + $800 = $800
  • Gross income from $250,00 to $499,999 – $900 + $800 = $1,700
  • Gross income from $500,000 to $999,999 – $2,500 + $800 = $3,300
  • Gross income from $1,000,000 to $4,999,999 – $6,000 + $800 = $6,800
  • Gross income over $5,000,000 – $11,790 + 800 = $12,590

California C corporations and LLCs electing to be treated as C corporations are subject to the $800 minimum fee plus the California State Corporate Tax of 8.84%, based upon California net income. As well, they are subject to a 6.65% California Alternative Minimum Tax (AMT), based on the Federal AMT, with modifications. If you do business in California, expect to pay some of the highest taxes in the nation.

2. Nevada

Nevada no corporate or personal income tax, and there is no franchise tax for corporations or LLCs; however, there are initial filing fees, renewal filing fees, and a business license fee.

The initial filing fee for a Nevada for-profit corporation is based upon the value of the total number of authorized shares, as follows:

  • $75,000 or less – $75.00
  • Over $75,000 and not over $200,000 – $175.00
  • Over $200,000 and not over $500,000 – $275.00
  • Over $500,000 and not over $1,000,000 – $375.00
  • Over $1,000,000
    • For the first $1,000,000 – $375.00
    • For each additional $500,000, or fraction thereof – $275.00
    • Maximum fee – $35,000.00

To get around these fees you can establish a value of $.001 per share. With 20 million shares at $.001 per share the value of the shares is just $20,000, well under the $75,000 threshold for increased fees. In Delaware you would pay much more every year for that many shares.

The renewal filing fee for a Nevada for-profit corporation is $650, calculated, as follows: (1) Annual List of Officers and Directors – $150; and (2) Business License Fee – $500. Nevada how also has a gross receipts tax on monies generated within Nevada. The tax starts on monies earned at $4 million per year and is dependent on what industry or business you are involved with. Work with your tax advisor to see if this tax would apply to you.

The initial filing fee for a Nevada LLC is $425, calculated, as follows: (1) Articles of Organization – $75; (2) Initial List of Managers of Members – $150; and (3) Business License Fee – $200.

3. Wyoming

Likewise, Wyoming has no personal or corporate income tax. Unlike Nevada, the Equality State has no gross receipts tax. Wyoming does have an Initial Filing Fee of $100, and an Annual Report License Tax for Wyoming for-profit corporations and LLCs, which is either $50 or two-tenths of one mill per dollar of assets ($.0002), whichever is greater, based upon the company’s assets located and employed in the State of Wyoming. For example, a Wyoming for-profit corporation or LLC with $1,000,000 in assets in Wyoming would pay an Initial Filing Fee of $100, a Registered Agent Fee of $25 per year, and $200 per year in Annual Report License Tax ($1,000,000 x 0.0002). For most of our clients the annual Wyoming fee for corporations and LLC’s is just $50 per year.

CONCLUSION

As demonstrated, the number of authorized shares greatly impacts the amount of Annual Franchise Tax for Delaware corporations. Small- and medium-sized Delaware corporations may wish to consider either recapitalizing, and thereby reducing their number of authorized but unneeded shares, or else changing from a corporation to an LLC or an LP.

As well, Delaware corporations can be ‘continued’ into Wyoming. Your original incorporation date and EIN remain the same, as if you had set up in Wyoming in the first place. 

In terms of starting a new corporation, the states of Nevada and Wyoming will generally offer much lower annual franchise fees than will Delaware.