7 Year-End Tax Planning Strategies for Small Businesses
You still have time to significantly reduce your 2018 business income tax bill. Here are seven year-end moves to consider, taking into account changes included in the Tax Cuts and Jobs Act (TCJA).
1. Claim 100% bonus depreciation for asset additions
Thanks to the TCJA, 100% first-year bonus depreciation is available for qualified new and used property that is acquired and placed in service in calendar year 2018. That means your business might be able to write off the entire cost of some or all of your 2018 asset additions on this year’s return. So consider making additional acquisitions between now and year-end. Contact your tax pro for details on the 100% bonus depreciation break and what types of assets qualify.
2. Claim 100% bonus depreciation for heavy SUV, pickup or van
The 100% bonus depreciation provision can have a hugely beneficial impact on first-year depreciation deductions for new and used heavy vehicles used over 50% for business. That’s because heavy SUVs, pickups, and vans are treated for tax purposes as transportation equipment, and that means they qualify for 100% bonus depreciation. Specifically, 100% bonus depreciation is only available when the SUV, pickup, or van has a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds. You can verify a vehicle’s GVWR by looking at the manufacturer’s label, which is usually found on the inside edge of the driver’s side door where the door hinges meet the frame. If you are considering buying an eligible vehicle, doing so and placing it in service before the end of this tax year could deliver a juicy write-off on this year’s return.
3. Cash in on more generous Section 179 deduction rules
For qualifying property placed in service in tax years beginning in 2018, the TCJA increased the maximum Section 179 deduction to a whopping $1 million (up from $510,000 for tax years beginning in 2017). The following additional beneficial changes were also made by the TCJA.
Property used for lodging
For property placed in service in tax years beginning in 2018 and beyond, the TCJA removed the prior-law provision that disallowed Section 179 deductions for personal property used in connection with furnishing lodging. Examples of such property apparently include furniture, kitchen appliances, lawn mowers, and other equipment used in the living quarters of a lodging facility or in connection with a lodging facility such as a hotel, motel, apartment house, or a rental condo or single-family home.
Qualifying real property
Section 179 deductions can be claimed for qualifying real property expenditures, up to the maximum annual Section 179 deduction allowance ($1 million for tax years beginning in 2018). There is no separate limit for qualifying real property expenditures, so Section 179 deductions claimed for real property reduce the maximum annual allowance dollar for dollar. Qualifying real property means any improvement to an interior portion of a nonresidential building that is placed in service after the date the building is first placed in service, except for expenditures attributable to the enlargement of the building, any elevator or escalator, or the building’s internal structural framework.
For tax years beginning in 2018 and beyond, the TCJA expanded the definition of real property eligible for the Section 179 deduction to include qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential real property. To qualify, these items must be placed in service in tax years beginning after 2017 and after the nonresidential building has been placed in service.
Warning: Various limitations can apply to Section 179 deductions, especially if you conduct your business as a partnership, LLC treated as a partnership for tax purposes, or S corporation. Consult your tax pro to make sure your business collects the expected tax savings from the Section 179 deduction privilege.
4. Time business income and deductions for tax savings
If you conduct your business using a pass-through entity — meaning a sole proprietorship, S corporation, LLC, or partnership — your shares of the business’s income and deductions are passed through to you and taxed at your personal rates. Next year’s individual federal income tax rate brackets will be the same as this year’s, with modest bumps for inflation. So the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2018 until 2019.
On the other hand, if you expect to be in a higher tax bracket in 2019, take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2019. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate.
5. How to defer taxable income
Most small businesses are allowed to use cash-method accounting for tax purposes. Assuming your business is eligible, cash-method accounting allows you to micro-manage your 2018 and 2019 business taxable income in order to minimize taxes over the two-year period. If you expect your business income will be taxed at the same or lower rate next year, here are specific cash-method moves to defer some taxable income until 2019.
* Charge recurring expenses that you would normally pay early next year on credit cards. You can claim 2018 deductions even though the credit card bills won’t actually be paid until 2019.
* Pay expenses with checks and mail them a few days before year-end. The tax rules say you can deduct the expenses in the year you mail the checks, even though they won’t be cashed or deposited until early next year. For big-ticket expenses, consider sending checks via registered or certified mail, so you can prove they were mailed this year.
* Before year-end, prepay some expenses. As long as the economic benefit from the prepayment does not extend beyond the earlier of: (1) 12 months after the first date on which your business realizes the benefit of the expenditure or (2) the end of the next tax year. For example, this rule allows you to claim 2016 deductions for prepaying the first three months of next year’s office rent or prepaying the premium for property insurance coverage for the first half of next year.
* On the income side, the general rule for cash-basis businesses is that you don’t have to report income until the year you receive cash or checks in hand or through the mail. To take advantage of this rule, consider waiting until near year-end to send out some invoices to customers. That will defer some income until 2019, because you won’t collect the money until early next year. Needless to say, this idea should only be used for customers with solid payment histories.
6. Maximize the new deduction for pass-through business income
The new deduction based on qualified business income (QBI) from pass-through entities was a key element of the TCJA. For tax years beginning in 2018-2025, the deduction can be up to 20% of a pass-through entity owner’s QBI, subject to restrictions that can apply at higher income levels and another restriction based on the owner’s taxable income.
For QBI deduction purposes, pass-through entities are defined as sole proprietorships, single-member LLCs that are treated as sole proprietorships for tax purposes, partnerships, LLCs that are treated as partnerships for tax purposes, and S corporations.
The QBI deduction is only available to non-corporate taxpayers which means individuals, trusts, and estates.
The QBI deduction can also be claimed for up to 20% of income from qualified REIT dividends and 20% of qualified income from publicly-traded partnerships (PTPs). So the deduction can potentially be a big tax saver.
Because of various limitations on the QBI deduction, tax planning moves (or non-moves) can unexpectedly increase or decrease your allowable QBI deduction. For example, moves that reduce this year’s taxable income can have the negative side effect of reducing your QBI deduction. So if you are one who can benefit from the deduction, work with your tax pro to optimize your results on this year’s return.
7. Establish a tax-favored retirement plan
If your business doesn’t already have a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions. For example if you are self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $55,000 for 2018. If you are employed by your own corporation, up to 25% of your salary can be contributed to your account, with a maximum contribution of $55,000.
Other small business retirement plan options include the 401(k) plan which can even be set up for just one person (a sole-called solo 401(k)), the defined benefit pension plan, and the SIMPLE-IRA. Depending on your circumstances, these other types of plans may allow bigger deductible contributions.
The deadline for setting up a SEP-IRA for a sole proprietorship business and making the initial deductible contribution for the 2018 tax year is October 15, 2019 if you extend your 2018 return to that date. Other types of plans generally must be established by December 31, 2018 if you want to make a deductible contribution for the 2018 tax year, but the deadline for the contribution itself is the extended due date for your 2018 return. However, to make a SIMPLE-IRA contribution for 2018, you must have set up the plan by October 1. So you might have to wait until next year if the SIMPLE-IRA option is appealing.
Contact your tax pro for more information on small business retirement plan alternatives, and be aware that if your business has employees, you may have to cover them too.
By Bill Bischoff for Market Watch