Year-End Planning for Businesses

Year-End Planning Considerations

Increased Expensing and Bonus Depreciation. The increased Code Sec. 179 expensing deduction and the increased bonus depreciation deduction may create new opportunities to reduce current year tax liabilities through the acquisition of qualifying property – including property placed in service between now and the end of the year. However, if a client has expiring net operating losses, then holding off on such purchases until next year or later may be a more appropriate strategy.

Reduced Corporate Tax Rate and the Qualified Business Income Deduction. As a result of the change to the top corporate tax rate and the introduction of a new sole proprietorship and pass-thru entity deduction, businesses may want to rethink their choice of entity. A reduction in the corporate tax rate from 35 percent to 21 percent may appeal to some clients, while the 20 percent QBI deduction for sole proprietorships and pass-through entities may seem enticing to others. One point to remember is that the 21 percent tax rate is permanent, at least until Congress changes it again, while the 20 percent QBI deduction is scheduled to expire after 2025. Additionally, as previously noted, the 20-percent QBI deduction does not apply to many types of businesses, such as health, law, and accounting businesses just to name a few, unless the taxpayer’s taxable income is below a certain threshold. Finally, the QBI deduction is quite complex and can affect, and be affected by, numerous other deductions and tax strategies.

As an example, if a client takes the Code Sec. 179 and bonus depreciation deduction, that deduction reduces QBI and thus decreases a client’s Code Sec. 199A deduction in that year. However, taking the Code Sec. 179 and bonus depreciation in one year also reduces depreciation deductions in future years. While this increases the client’s Code Sec. 199A income in the future, it may cause a client’s taxable income to exceed the $157,500/$315,000 threshold which, absent the availability of the 2.5 percent of qualified property calculation or the availability of W-2 wages, would lead to the complete elimination of the QBI deduction.

Thus, for any particular business thinking about changing the form in which it conducts business as a result of these recent changes in the law, numerous projections and calculations will have to be done to see if this is the best move for a particular client.

Vehicle-Related Deductions and Substantiation of Deductions. Expenses relating to business vehicles can add up to major deductions. So, if a client’s business might benefit from the purchase of a large passenger vehicle, consideration should be given to purchasing a sport utility vehicle weighing more than 6,000 pounds. Vehicles under that weight limit are considered listed property and deductions are more limited. However, if the vehicle is more than 6,000 pounds, up to $25,000 of the cost of the vehicle can be immediately expensed.

Vehicle expense deductions are generally calculated using one of two methods: the standard mileage rate method or the actual expense method. If the standard mileage rate is used, parking fees and tolls incurred for business purposes can be added to the total amount calculated. Since the IRS tends to focus on vehicle expenses in an audit and disallow them if they are not properly substantiated, clients should be counseled to maintain the following tax records with respect to each vehicle used in the business: (1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance); (2) the amount of mileage for each business or investment use and the total miles for the tax period; (3) the date of the expenditure; and (4) the business purpose for the expenditure. The following are considered adequate for substantiating such expenses: (1) records such as a notebook, diary, log, statement of expense, or trip sheets; and (2) documentary evidence such as receipts, canceled checks, bills, or similar evidence. Records are considered adequate to substantiate the element of a vehicle expense only if they are prepared or maintained in such a manner that each recording of an element of the expense is made at or near the time the expense is incurred.

Retirement Plans and Other Fringe Benefits. Because benefits are very attractive to employees, clients might consider using benefits rather than higher wages to attract employees. While a business is not required to have a retirement plan, there are many advantages to having one. For example, by starting a retirement savings plan, an employer not only helps employees save for the future, the employer can also use such a plan to attract and retain qualified employees. Retaining employees longer can impact a business’s bottom line by reducing training costs. In addition, a business owner can take advantage of the plan also, and so can the business owner’s spouse. Where the business owner’s spouse is not currently on the payroll, adding him or her to the payroll and paying a salary up to the maximum amount that can be deferred into a retirement plan is worth considering. For example, if a business owner’s spouse is 50 years old or over and receives a salary of $24,500, all of it could go into a 401(k), leaving the spouse with a retirement account but no taxable income.

By offering a retirement plan, a business owner also generates tax savings to the business because employer contributions are tax deductible and the assets in the retirement plan grow tax free. Additionally, a tax credit is available to certain small employers for the costs of starting a retirement plan.

Also, as noted above, for 2018 and 2019, eligible employers can claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave under an employer’s plan if the rate of payment under the program is 50 percent of the wages normally paid to an employee.

Increasing Basis in Pass-thru Entities. If an S corporation or partnership is going to pass through a loss to a client, it’s advisable to double check that the client has enough basis in the loss-generating entity to deduct the loss. If not, then the client should be encouraged to increase his or her basis in that entity in order to deduct the loss for 2018 taxes if doing so is financially appropriate.

De Minimis Safe Harbor Election. If a client has not already done so, it may be advantageous to elect the annual de minimis safe harbor election in Reg. Sec. 1.263(a)-1(f)(1)(ii)(D) for amounts paid to acquire or produce tangible property. By making this election, and as long as the items purchased don’t have to be capitalized under the uniform capitalization rules and are expensed for financial accounting purposes or in the client’s books and records, the client can deduct up to $2,500 per invoice or item (or up to $5,000 if the client has an applicable financial statement).

Accounting Method Changes. If a client agrees that his or her business might benefit from a change to the cash method of accounting, then the appropriate tax forms will have to be filed to initiate the changes in addition to setting up the client’s books and records to reflect the new method of accounting.

S Corporation Shareholder Salaries. For any business operating as an S corporation, it’s important to ensure that shareholders involved in running the business are paid an amount that is commensurate with their workload. The IRS scrutinizes S corporations which distribute profits instead of paying compensation subject to employment taxes. Failing to pay arm’s length salaries can lead not only to tax deficiencies, but penalties and interest on those deficiencies as well. The key to establishing reasonable compensation is being able to show that the compensation paid for the type of work an owner-employee does for the S corporation is similar to what other corporations would pay for similar work. If a client is in this situation, the tax return workpapers should include documentation of the factors that support the salary the client is being paid.

Centralized Partnership Audit Regime. Finally, the new centralized partnership audit regime took effect in 2018. The rules potentially change which partners may be responsible for additional taxes as a result of audit changes and, as a result, necessitate that partnerships update their partnership agreements to reflect the new regime. Some practitioners are going so far as to refuse to do partnership returns for any partnerships that have not revised their partnership agreement to make it clear which partners will be responsible for any tax deficiencies.