Top 10 Year-End 2018 Tax Planning Ideas for Business Owners
For businesses, the centerpiece of the Tax Cuts and Jobs Act (TCJA) that was signed into law on December 22, 2017 was a permanent reduction of the corporate tax rate to a flat 21%. Also, the Act permanently repealed the corporate alternative minimum tax (AMT). The intricacies of the new pass-through business income deduction are being clarified through Treasury and Internal Revenue Service (IRS) guidance.
Regardless of whether a version of Tax Cuts 2.0 (also referred to as “Tax Reform 2.0”) will come to pass before year-end, there are still several ideas that business owners can implement before 2018 winds down.
The Top 10 Year-End Tax Planning Ideas for Business Owners
1. Review Retirement Plan Options
Qualified retirement plans can be a powerful way to defer business income and lower current tax liabilities. Individuals who already have these plans should use the end of the year as an opportunity to fully fund their contributions.
Business owners who do not should consider implementing a plan after a review of the potential benefits and tax savings. Along with defined contribution plans, small business owners might consider defined benefit plans, cash balance plans, or combinations of the two. Deductible contributions to these plans might dwarf the limits of IRAs, 401(k)s, or other defined contribution plans.
Business owners can also use nonqualified deferred compensation plans to attract and retain talent. While there is no current deduction when the plan is funded, tax can be deferred on the growth of the assets that fund the plan by using cash value life insurance.
2. Take Advantage of the Business Expensing Election
Small businesses may elect under IRC Section 179 to expense the cost of qualified property, rather than recover such costs through depreciation deductions. The Tax Cuts and Jobs Act increased the maximum amount that can be expensed in 2018 from $520,000 to $1,000,000, and the threshold at which the maximum deduction begins to phase out from $2,070,000 to $2,500,000. Both the $1,000,000 and $2,500,000 amounts will be increased to reflect inflation in years after 2018.
The new law also expanded the range of property eligible for expensing. Beware that some states may not allow full expensing for state income tax purposes.
3. Take Advantage of "Bonus" Depreciation
For qualified property that's both acquired and placed in service after September 27, 2017, 100% of the adjusted basis of the property can be deducted in the year the property is first placed in service. The first-year 100% bonus depreciation percentage amount is reduced by 20% each year starting in 2023 (i.e., the first-year bonus percentage amount will be 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026) until bonus depreciation is eliminated altogether beginning in 2027. The purchase of used property now qualifies for bonus depreciation.
4. Maximize the Pass-Through Business Income Deduction (Section 199A Deduction)
For tax years 2018 through 2025, a new deduction is available equal to 20% of qualified business income from partnerships, S corporations, and sole proprietorships. The IRS recently issued guidance on some previously proposed strategies thought to be able to maximize the use of the deduction.
For businesses that are considered to operate in specified service trade or business and that are expected to exceed the income thresholds, you cannot spin-off various business functions into separate entities (that would be considered to operate in a non-specified service trade or business) and be eligible for the full Qualified Business Income (QBI) deduction.
Proceed with caution regarding setting up trusts for children or others that are separately taxed to own interests in businesses that qualify for the deduction where parents would otherwise not qualify because of their income levels or other factors. Such trusts may not be respected for purposes of the Section 199A deduction.
One strategy that remains is that if you are in a non-specified service trade or business, but you exceed the income limitations and thus are subject to the additional W-2 wage and capital (qualified property) limitation, you should consider making additional qualified capital purchases or increasing wages to increase your available QBI deduction.
5. Make Sure Your Records to Substantiate Your Business Deductions are in Order
Small business owners especially, should ensure they have adequate substantiation for expenses such as travel miles, business meals etc. These include daily logs, actual receipts and other substantiation records. Business meals continue to be 50% deductible.
Remember: that a business meal must be substantiated (time, place, amount and business purposes) and it cannot be lavish or extravagant under the circumstances and the taxpayer (or an employee of the taxpayer) must be present in furnishing such food or beverages.
Because of the TCJA, entertainment expenses, even if associated with the active conduct of a trade or business, are no longer deductible.
6. Review Compliance With the Employer Healthcare Insurance Mandate
Efforts to repeal and replace the Affordable Care Act (ACA) continue to be discussed without resolution. The employer mandate to provide minimum essential coverage imposed by the ACA remains unaffected by the 2017 TCJA.
The current employer reporting obligations and penalties remain in effect. Review healthcare insurance and coverage and verify that you are in compliance with the Affordable Care Act (ACA).
Keep in mind that ACA reporting is an ongoing process. Make sure you are ready for next year’s annual reporting and filing deadlines.
7. Splitting the Tax Bill Among Family Members
Family business owners, in particular, can take advantage of ways to shift income to lower overall taxes. Paying reasonable salaries to family members for providing bona-fide services reduces the amount of business income. A child’s earned income could be taxed at the low-bracket rate of 10% (on taxable income of up to $9,525 for 2018). The salary would also be earned income, thus allowing children to establish and contribute to a Roth IRA or retirement plan.
Closely-held business owners who wish to shift some ownership, but not management or control, can divide the ownership into voting and non-voting interests and only gift the non-voting interests.
8. Rethink Your Choice of Entity Decision
C corporation status may be more attractive now, given the lower flat tax rate of 21%. However, it may make more sense to operate as a pass-through entity especially if you can claim the full 20% deduction for qualified business income and you plan to exit the business in a relatively short period of time.
Remember: though that under current tax law, the reduced corporate rate is permanent whereas the 20% Section 199A deduction will sunset at the end of 2025.
9. Take Advantage of the Ability to Use the Cash Method of Accounting
The TCJA expanded the ability to use the cash method. Any entity with a three-year average annual gross receipts of $25 million or less can use the cash method regardless of whether the purchase, production or sale of merchandise (inventory) is an income-producing factor.
The cash method of accounting may be more attractive due to its simplicity and flexibility in managing the amount of taxable income reported in a tax year. Identify actionable opportunities for filing accounting method changes with the IRS.
10. Take Advantage of the Increased Estate Tax Exemption for Passing on Your Business
With the increased Federal Estate Tax Exemption to $11,180,000 for individuals or $22,360,000 for married couples, take advantage of passing the business without incurring estate or gift tax.
For more information about tax planning strategies for business owners, contact your Key Private Bank Advisor.