Business tax planning made easier

And it doesn't have to wait until year end

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Jeremy Smith, CPA

Year-end tax planning moves don’t have to wait until year end. Businesses across the country are looking for possible tax savings throughout the year, and many times doing so prior to the year even starting. No matter when you start your planning, certain tax savings opportunities may apply regardless of how your business is structured. No matter the type of your business entity, year-end tax planning should consider all possibilities to effectively lower your total tax liability.

Even though the most recent federal tax reform will be two years old this December 22nd, it still deserves great focus and attention for those who have not fully implemented certain aspects of tax law changes.

The Corporate tax rate was reduced from 35% to 21%. For those entities already taxed as a C Corporation, this provided immediate benefits. For those other pass-through business entities, does it make sense to convert to a C Corporation? There is no easy answer to this. You need to consider everything from your desire to distribute cash annually, to how and when you are going to exit your business, and many other items in between. But the planning exercise could prove very beneficial even if you don’t change your business structure.

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The ability to use the cash method of accounting was expanded to those applicable trades or businesses with under $25,000,000 in average annual gross receipts. If your business is under this threshold, the conversion to cash basis could provide the ability to defer significant tax savings.

§199A for deduction for qualified business income (QBI)

Most business owners that were eligible for this 20% deduction are already seeing the benefits of this law change. But, now that we have the first full tax year (2018) of this provision already behind us, many businesses experienced the not-so-straight-forward pieces of this provision.   Proposed regulations provide much-needed guidance. However, in order to maximize the Section 199A benefits, pass-through entities will need to work through a number of potentially complex steps including:

  1. Identify each trade or business conducted by the pass-through entity
  2. Evaluate whether each identified trade or business is a specified service business
  3. Identify and allocate each item of QBI to each identified trade or business
  4. Determine and allocate W-2 wages and unadjusted basis of qualified property to the QBI attributable to each identified trade or business
  5. Confirm the ability to satisfy the reporting requirements
  6. Evaluate applicability of the de minimis and anti-abuse rules

Depreciation

Whether it be bonus deprecation or §179, both have been expanded.

Plan purchases of eligible property to assure maximum use of this annual asset expense election and bonus depreciation as the 100 percent bonus depreciation deduction ends after 2023. The ability to claim 100 percent bonus depreciation on new and used qualified property benefits taxpayers that acquire assets that constitute a trade or business, rather than acquisitions of stock, because the buyer can potentially deduct much of the purchase price in the year of purchase.

International tax provisions

This article is not intended to cover any of the international tax saving and/or planning moves. But, if your business is doing any transactions globally, whether it be selling overseas, shipping outside of the U.S., employing people abroad, setting up subsidiaries, or having foreign ownership of your U.S. business, you need to make sure your advisor is well versed in international tax law.

Federal tax credits

There are many federal tax credits available to your business. But these two are the most important:

  • Research & Development Tax Credit – If your business incurs expenses related to services in any technological field, e.g. physics, chemistry, biology, engineering, computer sciences, you should consider whether this tax credit can benefit you. It is based on a percentage of wages, supplies, and certain contract work done in the U.S.
  • Work Opportunity Tax Credit – If you employ individuals who meet certain criteria, federal tax credits are available to you ranging between $2400-$9600. This program is not something that you can go back and get if you determine a certain employee could have been eligible. You can start it at any time, but it will only apply to potential new hires that you prequalify for this prior to their start of employment.

Interest expense deduction limitation

Section 163(j) may limit the deductibility of business interest expense to the sum of:

  • Business interest income
  • 30 percent of the adjusted taxable income of the taxpayer; and
  • The floor plan financing interest of the taxpayer for the taxable year (applicable to dealers of vehicles, boats, farm machinery or construction machinery)

For purposes of the Section 163(j) limitation, adjusted taxable income is equal to the taxable income of the taxpayer without regard to:

  • Any nonbusiness income, gain, deduction or loss
  • Business interest and business interest income
  • Any net operating loss (NOL) deduction, and
  • Any deduction allowable for depreciation, amortization or depletion

However, for taxable years beginning after December 31, 2021, the adjusted taxable income calculation will no longer exclude the deduction allowable for depreciation, amortization, or depletion.

Qualified Improvement Property

TaxQIP is defined as any improvement to an interior of a building that is nonresidential real property if that improvement is placed in service after the building was first placed in service by any taxpayer. With the expanded definition of QIP, the intent of Congress was that QIP would be assigned a 15-year life, and thus be eligible for bonus depreciation. Due to a drafting error, the 2017 tax reform legislation does not assign such 15-year life to QIP. Unless, and until, a technical corrections bill is passed, QIP acquired after September 27, 2017, and placed in service after December 31, 2017, will be subject to a 39-year recovery period and will not be eligible for bonus depreciation.

Opportunity Zones 

New opportunity zones tax incentives allow investors to defer tax on capital gains by investing in Qualified Opportunity Funds. Taxpayers can defer taxes by reinvesting capital gains from an asset sale into a qualified opportunity fund during the 180-day period beginning on the date of the sale or exchange giving rise to the capital gain. Once rolled over, the capital gain will be tax-free until the fund is divested or the end of 2026, whichever occurs first. The investment in the fund will have a zero-tax basis.

If the investment is held for five years, there is a 10-percent step-up in basis and a 15-percent step-up if held for seven years. If the investment is held in the opportunity fund for at least 10 years, those capital gains in excess of the rollover amount (i.e., not the original gain but the post-acquisition appreciation) would be permanently exempt from taxes. To maximize the potential benefits, taxpayers must invest in a Qualified Opportunity Fund before December 31, 2019.

Economic Nexus/Wayfair 

The South Dakota vWayfair decision means that states are now free to subject companies to state taxes based on an “economic” presence within their state. Taxpayers must now determine their nexus and filing obligations in states and localities, where compliance was not required before. This landmark decision presents an opportunity for taxpayers to enhance their technology solutions and update their reporting tools as they comply with state law changes.

Learn more about the Wayfair decision 

Other items

In addition to the items above from the tax law passed in late 2017, the remaining items listed below are the tried and true items that are not really new, yet they are still extremely important to consider.

Deferring income and accelerating deductions – there is nothing new here. But many businesses overlook the opportunities provided by using the tax laws that have been around for years. Does your business accept advance payments for good or services? Is it deferring the income recognition of these payments? Are you accruing the appropriate expenses at year end so you can take those deductions in the current year?

Make sure and pay any related party accruals prior to year-end. Any items accrued, but not paid, to a related party will not be able to be deducted.

Have you purchased real estate or made any substantial improvements to real estate? You should consider the benefits of a cost segregation study. This can properly classify certain items of your building as either personal property or real property.  Personal property items usually have a shorter tax life and are eligible for faster depreciation options.

The tangible property regulations have been around for a while, but not all businesses are taking advantage. You can elect a de minimis expensing safe harbor ($2,500 without an applicable financial statement (AFS) and $5,000 with an AFS). You can deduct routine maintenance for equipment and buildings; and you are able to recognize partial disposition of real property.

Tax basis planning

This can vary greatly between S Corporations and Partnerships/LLC, mainly because of how debt is classified for basis purposes between the two entities. If you find yourself funding losses via the use of debt (from an unrelated party), you will need to be sure you are considered having tax basis to take the losses. An owner’s personal guarantee will provide tax basis in a Partnership/LLC, but it will not in a S Corporation. Be careful of this, as well as many other potential limitations around the concept of tax basis.

Deferral of capital gains under §1031

Real property like kind exchanges are still a valuable tool for deferring taxes on the sale of real property. But, remember that personal property (cars, airplanes, etc.) items are no longer eligible for gain deferral under §1031. The generous accelerated depreciation rules may soften the blow on this, but there is still much to consider when selling any substantial pieces of real or personal property.

Succession and family business planning

Every year could be a time to plan for your company’s succession and the transfer of your wealth to your heirs in a manner that minimizes transfer taxes. Be sure you are talking with your advisor because it is never to early to start planning here.

Exit planning

If you are not planning to transition your business to the next generation of family members, then it is also never too early to start planning for your exit event. Many times, businesses are so focused on short-term tax planning that they overlook the long-term goal of maximizing their business value. Don’t get aggressive to save taxes in the short term if it greatly diminishes your ability to get 5-10 times your EBITDA in the future.

Business tax planning is very complex. Careful planning involves more than just focusing on lowering taxes for the current and future years. How each potential tax saving opportunity affects the entire business must also be considered. In addition, planning for closely-held entities requires a delicate balance between planning for the business and planning for its owners.

This 2018 Year-End Tax Letter for Businesses cannot cover every tax-saving opportunity that may be available to you and your business. Inasmuch as taxes are among your largest expenses, we urge you to meet with your advisor. We can provide a comprehensive review of the tax-saving opportunities appropriate to your particular situation.

 

Jeremy Smith, CPA, Partner, specializes in consulting, tax planning and compliance work for both individuals and closely held businesses. He can be reached at (480) 839-4900 or JeremyS@hhcpa.com.