Business owners are still getting used to the massive tax law changes that generally went into effect last year. But it’s still possible to take steps before the end of the year to reduce liability. This article presents some options to consider, such as making capital purchases, establishing a new retirement plan and reviewing entity structure. The article also points out that all of these strategies could affect other aspects of a business’s tax planning, so obtaining professional advice is essential.
While business owners are still getting used to the massive tax law changes that generally went into effect last year, one thing remains the same — you can still take steps before the end of the year to reduce your liability. Here are some options you should consider.
Make some capital purchases
Under the Tax Cuts and Jobs Act’s (TCJA’s) expansion of bonus depreciation, you generally can deduct 100% of the cost of qualified property purchased after September 27, 2017, and before January 1, 2023, in the year you place the property in service. (The percentage begins to be reduced in 2023.) Special rules apply to property with a longer production period.
The deduction is available for both new and used qualified property, subject to certain conditions. If you’re planning to buy tangible personal property such as vehicles, office equipment, or heavy equipment and machinery next year, think about moving your timeline to 2019.
Unfortunately, as of this writing, Congress has yet to correct the drafting error in the TCJA that left qualified improvement property (QIP)(generally, interior improvements to nonresidential real property) ineligible for bonus depreciation. But QIP placed in service after December 31, 2017, is eligible for Section 179 expensing.
Under Sec. 179, for 2019, you can deduct up to $1.02 million of qualifying property placed in service before the end of the year, but no more than your amount of taxable income from business activity. The expensing deduction begins phasing out on a dollar-for-dollar basis when qualifying property placed in service this year exceeds $2.55 million.
Establish a new retirement plan
If you haven’t already set up a retirement plan or if you’ve outgrown your original plan, you could cut your taxes by launching a new plan, such as a SIMPLE IRA, SEP IRA, 401(k) or profit-sharing plan. Contributions you make for yourself and your employees generally are tax-deductible. Different plans have different timing requirements for establishing a plan and making contributions.
Depending on factors such as staff size and the type of plan, you also might qualify for a tax credit that can offset the start-up costs. The credit could cut your taxes by as much as $500 per year for three years, including the tax year before the plan takes effect.
Review your structure
Most businesses stick with their original entity structure, but the TCJA provides good reason to re-evaluate the tax repercussions of your current structure. For example, while a C corporation is subject to potential double taxation (at the entity and dividend levels), the corporate tax rate now is only 21%.
A pass-through entity owner pays an individual tax rate that can run as high as 37% but could qualify for the 20% qualified business income (QBI) deduction. (See below.) With the full QBI deduction, the effective tax rate for pass-through entities comes out to 29.6%.
But the TCJA limits the state and local taxes deduction for individual pass-through owners and not for corporations. And the new corporate rate is permanent, while the QBI deduction is scheduled to sunset after 2025. Your individual circumstances will dictate the best structure choice for your business.
Maximize your QBI deduction
If you are or become a sole proprietorship or a pass-through entity — a partnership, limited liability company (LLC), or S corporation — you have several options for boosting your QBI deduction. For example, the deduction is subject to limits based on W-2 wages paid, the unadjusted basis of qualified property, and taxable income. So you could increase wages by converting independent contractors to employees (assuming the benefit isn’t outweighed by other considerations).
If you’re an S corporation owner and the W-2 wage limitation doesn’t limit the QBI deduction for you, it’s possible to increase the deduction by minimizing the amount of wages the business pays you. Conversely, if the W-2 wage limitation does limit the deduction, it might be possible to take a greater deduction by increasing your wages.
An important caveat
It’s key to remember that all of these strategies could affect other aspects of your tax planning. For example, reducing your income may help or hinder the QBI deduction, depending on a variety of factors.
Daniel J. Torczon
Prior to joining Hancock & Dana, Dan spent nine years working in the audit function at Deloitte & Touche as an Audit Senior Manager. Dan works primarily with audit in the financial services sector, with a specific emphasis on insurance. He also has extensive experience auditing in the manufacturing, mutual fund, and transportation industries.