Year 2020 is fast approaching (and still no flying cars), but there’s still time to get some year-end tax planning done. In this two-part blog series, we’re going to discuss a variety of tax planning strategies. The first part of which needs to be implemented prior to the end of the year, followed by a second set that is not quite as time-sensitive, and can be implemented after December 31.
You have probably heard about several methods of accelerated depreciation on capital expenditures, such as bonus depreciation and Section 179. In a nutshell, both of these provisions allow businesses to deduct 100% of certain large purchases in the year the property is placed in service, rather than being required to depreciate the asset over a number of years (anywhere from five to thirty-nine.) Qualifying property can include furniture, equipment, and certain vehicles and building improvements. However, in order to expense these items in the year of purchase, it is critical that they are actually placed in service prior to the end of the tax year. For example, if you purchase a new refrigerator unit, taking delivery of the unit is not sufficient to apply the accelerated depreciation provisions to the purchase. The unit would need to be installed and operational, at which point it would be eligible for expensing.
On a related note, it is always a good idea to re-visit your capitalization policy every few years and make sure that it still makes sense for your business. Don’t have a capitalization policy, or wondering what that even is? A capitalization policy is a relatively basic statement that should be kept on file in your offices, stating the cost threshold at which capital expenditures will be capitalized and depreciated, rather than simply expensed as “supplies” or “repairs.” If you haven’t updated your policy in the last few years, it likely still has $500 as the threshold. Under current tax law, however, the “de minimis” threshold has been increased to $2,500. There can be reasons to choose a lower figure than $2,500, which are beyond the scope of this blog, but for many business owners, it can be advantageous to take advantage of the $2,500 de minimis threshold and update your capitalization policy accordingly. As always, it is strongly recommended to consult your tax advisor before making changes to your policies so that your specific tax situation can be taken into account.
Perhaps you have been considering setting up a retirement plan for yourself and/or your employees. Retirement plans can be a great way to reduce your tax bill while also stashing money away for the future. In addition to the tax savings, providing a retirement plan benefit for employees is likely to make your business a more enticing place to work, which can improve employee retention and result in significant labor cost savings over the long haul – not to mention the intangible benefit of helping to provide retirement options for one of your most valuable assets, your employees.
There are many varieties of qualified plans, some of which can be organized after the fact, but many of which need to be set up prior to the end of the year in order to be eligible for use during that tax year. Consulting with your tax advisor or retirement plan specialist is strongly recommended, as this is a highly regulated area with many potential pitfalls if not executed correctly. When properly implemented, however, these plans can be a significant asset to your tax strategy, your personal retirement outlook, your employees, and your overall business plan.
In addition to qualified plans such as 401(k)s and profit-sharing plans, there are also non-qualified plans which can include deferred compensation arrangements and life insurance policies for key employees. Unlike qualified plans, which allow for a tax deduction in the year that funds are placed into an employee’s retirement account, non-qualified plans do not allow for a tax deduction until the employee actually receives the funds. While these plans are beneficial for tax deductions down the road, the primary benefit until that point is the retention of key employees. Business owners interested in setting up a non-qualified plan need to be very careful about its creation and administration – the IRS is known for scrutinizing these arrangements to make sure that covered employees have not “constructively received” their funds, generally by making the determination that the employees have too much control over their non-qualified account. If such an arrangement sounds like it might make sense for your business, be sure to consult with an experienced specialist to ensure that the plan is on the up-and-up.
Lastly, as year-end approaches, don’t forget to consider owner compensation figures, as well as methods for payment of owner compensation. If your business is organized as an S-corporation, you likely have been drawing a salary throughout the year. Which is a good thing, as the IRS requires an S-corporation shareholder to be paid a “reasonable” salary for the performance of their business duties. The amount of W-2 wages paid to S-corporation shareholders can have a significant impact on the 20% qualified business income deduction, as well as, potentially causing excessive payroll tax expense if W-2 compensation is above what would be considered reasonable for the duties performed. Without getting too far into the weeds, there is a formula that can be used to calculate the optimal shareholder salary which serves to maximize the qualified business income deduction, while also minimizing owner payroll taxes. I won’t bore you with the math, but meeting with your tax advisor prior to the end of the year to run this calculation can make a significant impact on the personal income tax returns of business owners.
In the same vein, members of businesses organized as partnerships should take a close look at compensation they receive in the form of “guaranteed payments.” These payments are specifically excluded from consideration when calculating the 20% qualified business income deduction – meaning if there is a way to provide compensation through a different mechanism, it may be beneficial to the partners of the business. Under current tax law, the most likely way to structure a legitimate alternative to guaranteed payments is through preferred return agreements, which can be complex and will most likely require amendments to existing operating agreements. Because making such a significant change can be costly and time-consuming, it is very important that your own specific tax circumstances are analyzed before any major decisions are made. There is no one-size-fits-all solution to owner compensation, and we encourage you to contact your tax advisor for a game-plan tailored to your needs.
To conclude part one of this two-part series, my key takeaway is that your friend or neighbor’s tax plan is very likely not the best tax plan for your personal situation. Tax law has only become more complex with the tax reform enacted in 2018, and it is more important than ever to make sure the details of your specific circumstances are considered when developing a tax strategy for your business and personal affairs, whether it is drafting a capitalization policy or structuring owner compensation.
Stay tuned for part two, where we’ll discuss tax planning strategies that you can enact after the New Year. Until then, have a safe and joyous holiday season and always feel free to reach out!
Austin Bradley, CPA