Over the past six months, we've digested the many tax law changes brought by the Tax Cuts and Jobs Act (TCJA). Froma significantly lower corporate tax rate to a new deduction for qualified business income, the TCJA brings a host of planning opportunities for your business. This letter presents some tax planning ideas under the TCJA for you to think about this summer while there's sufficient time left in 2018 to take tax-saving actions.
Maximize Your Qualified Business Income Deduction
You may have heard talk in the news about a new deduction for "pass-through" income. This is misleading as this deduction is actually available for qualified business income from a sole proprietorship (including a farm), as well as from pass-through entities such as partnerships, LLCs, and S corporations. Under the TCJA, business owners may deduct up to 20% of their qualified business income; however, the deduction is subject to various rules and limitations.
Although official guidance is lacking on this new deduction, there are some planning strategies that can be considered now. For example, there are ways to adjust your business's W-2 wages to maximize your qualified business income deduction. Also, it may be helpful to convert your independent contractors to employees, assuming the benefit of the deduction outweighs the increased payroll tax burden. Other planning strategies include investing in tangible assets, restructuring the business, and leasing or selling property between businesses. We can work with you to determine the best strategies for your business.
Thanks to the TCJA, this is a great time to acquire business assets. Your business may be able to take advantage of very generous Section 179 deduction rules. Under these rules, businesses can elect to write off the entire cost of qualifying property rather than recovering it through depreciation. The maximum amount that can be expensed this year is $1 million (up from $510,000 for 2017). This amount in some cases is reduced. There's more good news. The Section 179 deduction is now available for certain tangible personal property used predominantly to furnish lodging and certain improvements to nonresidential real property (such as roofs, HVAC, fire protection systems, alarm systems, and security systems).
Note: Watch out if your business is already expected to have a tax loss for the year (or close) before considering any Section 179 deduction. This is because you can't claim a Section 179 write-off that would create or increase an overall business tax loss. Please contact us if you think this might be an issue for your business.
Above and beyond the Section 179 deduction, your business also can claim first-year bonus depreciation. The TCJA establishes a 100% first-year deduction for qualified property acquired and placed in service after 9/27/17 and before 1/1/23). Unlike under prior law, this provision applies to new and used property. Note that 100% bonus depreciation deductions can create or increase a Net Operating Loss (NOL) for your business's 2018 tax year. Under the TCJA, the NOL generally can't be carried back to an earlier tax year. However, it can be carried forward indefinitely. Unfortunately, one new provision states that NOLs arising in tax years beginning after 2017 can't reduce taxable income by more than 80%.
Given these generous provisions, your asset acquisition plan is more important than ever. If you're planning on acquiring a business, we suggest you pursue an asset acquisition rather than a stock deal. Also, there may be reasons to elect out of bonus deprecation or use different expensing techniques in individual tax years. We can help with that.
Adopt a More Favorable Accounting Method
The cash method of accounting, which allows you to recognize sales when cash is received, is attractive to many small businesses due to its simplicity. For tax years beginning after 2017, the ability to use the cash method is greatly expanded. Any entity (other than a tax shelter) with 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 is an income-producing factor.
Under pre-TCJA law, if the purchase, production, or sale of merchandise was an income-producing factor, inventories were required to be maintained, and the cash method wasn't allowed unless the taxpayer met a $1 million gross receipts test or a $10 million gross receipts test (which only applied if the taxpayer's principal business activity was an eligible activity).
Now that the rules have changed, your business may be eligible to adopt the cash method of accounting. Since the $25 million gross receipts test is made on a year-by-year basis, we can monitor whether your average annual gross receipts fall below the threshold. If they do, we can discuss the pros and cons of changing your accounting method. Assuming a change would be beneficial, we can file the appropriate paperwork with the IRS to change your method of accounting.
Watch Out for New Business Interest Expense Limit
Regardless of its form, every business will be subject to a net interest expense disallowance. Starting in 2018, net interest expense in excess of 30% of your business's adjusted taxable income will be disallowed. However, your business won't be subject to this rule if its average annual gross receipts for the prior three years is $25 million or less. Also, real property trades or businesses can choose to have the rule not apply if they elect the Alternative Depreciation System (ADS) for real property used in their trade or business. Since ADS is a slower way to depreciate property, real property trades or businesses will need to look at the trade-off between currently deducting their business interest expense and deferring depreciation expense. If you find yourself in this predicament, we can model out both scenarios to determine the best course of action.
Consider Qualified Equity Grants
The TCJA provides a new tax election for equity-based compensation from private employers. Specifically, the election covers stock received in connection with the exercise of an option or in settlement of a Restricted Stock Unit (RSU). From a tax perspective, many employees struggle with these forms of compensation because they don't have the ability to liquidate their shares to pay their tax bill. This new election provides some relief.
Starting with options exercised or RSUs settled after 2017, qualified employees of eligible private companies may elect to defer income from those instruments for up to five years. To take advantage of this election, various requirements must be met. This includes having a written plan under which at least 80% of full-time employees are granted stock options or RSUs.
If you're interested in offering qualified equity grants to your employees, we can determine if you're an eligible corporation under this new provision. We can also assist you and your legal counsel in preparing the necessary documentation. Please contact us if you have questions or want more information.
This letter is to get you thinking about tax planning moves for the rest of the year. This year is definitely unique given the numerous tax law changes brought by the TCJA. Even with uncertainty about some of the TCJA's provisions, there are things you can do to improve your business's situation. Please don't hesitate to contact us if you want more details or would like to schedule a tax planning session.