GEORGE JOHNSON & COMPANY
2019 Year-End Tax Planning – For Businesses
All businesses seek to reduce costs, and year-end tax planning presents the chance for significant savings that affect your bottom line. After substantial changes to the federal tax code, businesses need to ensure continued compliance with new rules and understand how to optimize their tax liability for both 2019 and 2020. Depending on the type and structure of your business, this 2019 Year-End Tax Planning for Businesses Letter can help determine the opportunities for saving on year-end and year-round taxes for the following entities:
* All businesses
* Partnerships, limited liability companies, and S corporations
* C corporations
Tax planning for businesses also entails determining how this impacts the individual owners, so we recommend reviewing the 2019 Year-End Tax Planning for Individuals Letter as well.
To fully grasp all the potential tax savings, each business must assess its total tax liability. This requires a review of the entire tax portfolio, including income tax, indirect tax, property tax, payroll tax and excise tax, as well as tax credits, incentives and customs and duties. This will help illuminate the total tax impact of decisions made across the business, providing a complete portrait of how these affect tax liability for the entire organization and individual owners.
Once you assess your business’ current financial posture and define a vision for the future, you can analyze the gaps and plan ahead. By determining the projected marginal tax rate for each year, you can weigh the advantages of accelerating income or deductions into 2019 or deferring them until 2020. Important considerations include:
* Bonus depreciation and expensing rules
* The new qualified business income deduction
* Potential changes to your entity status
* Compensation deductions
* Business loss claims
If you can’t reduce your overall tax liability for this year, then it’s generally best to defer as much tax liability as possible to 2020.
This letter was written prior to the release of the inflation-adjusted tax rate schedules and other key tax figures for 2020. See IRS Revenue Procedure 2019-44 for updates on the figures discussed in this letter for 2020.
This tax letter focuses on federal income tax planning, but your business should also delve into the complexities of applicable state taxes. Consult your client service professional regarding relevant factors for planning around state taxes, and whether certain software solutions can help navigate compliance and liability matters.
We hope you enjoy this edition of the GJC Advisor. Wishing you Happy Holidays and a Happy New Year! As always, if you have any questions, feel free to contact us.
Tax Saving Opportunities for All Businesses
2019 VERSUS 2020 MARGINAL TAX RATES
Whether you choose to accelerate taxable income into 2019 or defer it until 2020 depends, in part, on your business’ projected marginal tax rate for each year. Generally, unless your 2019 marginal tax rate will be significantly lower than your 2020 marginal tax rate, you should defer income and accelerate deductions to reduce your 2019 taxable income.
TOP ACCOUNTING METHOD CHANGES TO CONSIDER FOR 2019
Cash flow continues to be an important focus for many companies in the current economy. Accounting method changes provide a valuable opportunity for taxpayers to reduce their current tax expense and increase cash flow by accelerating deductions, deferring income based on current tax law, or both. Accounting methods affect the timing of an item, or items, of income or expense reported on the federal income tax return. Once an accounting method change for an item has been adopted or established on prior year tax returns, a taxpayer wishing to change the timing of reporting an item must generally file a Form 3115, Application for Change in Accounting Method, with the IRS to receive permission to change to a different method of accounting.
NON-QUALIFIED DEFERRED COMPENSATION
Section 404(a)(5) dictates that the employer’s deduction for deferred compensation is allowed in the taxable year that the employee is taxed on the compensation. For deferred compensation arrangements that comply with the Section 409A restrictions on the timing of distributions from, and contributions to, non-qualified deferred compensation plans, the deduction will be allowed when paid. For non-compliant arrangements, Section 409A taxation to the participant deems taxable income as the compensation vests and accordingly the employer’s deduction is accelerated.
CORPORATE AMT REPEALED
The 2017 tax reform repealed the corporate AMT, which was imposed on corporations and was added to their regular tax if and to the extent the tentative minimum tax exceeds the regular tax. Repeal of the corporate AMT is effective for taxable years beginning after December 31, 2017. AMT credits, or a corporation’s previous AMT liabilities, can offset the regular tax liability for any taxable year after 2017 or can be refunded for any taxable year beginning after 2017 and before 2022 for 50 percent of the excess credit for the taxable year (100 percent for taxable years beginning in 2021).SECTION 199A DEDUCTION FOR QUALIFIED BUSINESS INCOME
Under Section 199A, for taxable years beginning after December 31, 2017, taxpayers (other than C corporations) with taxable income (before computing the QBI Deduction) at or below the threshold amount are entitled to a deduction equal to the lesser of:
1. The combined QBI amount of the taxpayer, or
2. An amount equal to 20 percent of the excess, if any, of the taxable income of the taxpayer for the taxable year over the net capital gain of the taxpayer for such taxable year.
INTEREST EXPENSE DEDUCTION LIMITATION
For taxable years beginning after December 31, 2017, Section 163(j) may limit the deductibility of business interest expense to the sum of (1) business interest income, (2) 30 percent of the adjusted taxable income of the taxpayer, and (3) the floor plan financing interest of the taxpayer for the taxable year (applicable to dealers of vehicles, boats, or farm machinery or equipment).
The timing of asset acquisitions is critical to obtain maximum depreciation deductions. Using other depreciation rules to your advantage will also reduce your taxes.Caution: Generally, no depreciation is allowable if the property is placed in service and disposed of in the same taxable year.
APPLICATION OF BONUS DEPRECIATION TO PARTNERS AND PARTNERSHIPS
The recently issued proposed regulations clarify that a partner is considered to have a depreciable interest in property held by a partnership to the extent of its ratio of the share of depreciation deductions allocated to the partner over the total amount of the deductions for the current and prior five taxable years.
QUALIFIED IMPROVEMENT PROPERTY
Tax reform eliminated the qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property asset classifications from Section 168 for property placed in service after December 31, 2017, and replaces them with the qualified improvement property (QIP) classification. QIP is defined as any improvement to an interior of a building that is nonresidential real property as long as that improvement is placed in service after the building was first placed in service by any taxpayer. With the expanded definition of QIP, the intent of Congress was that QIP would be assigned a 15-year life, and thus be eligible for bonus depreciation. Due to a drafting error, the 2017 tax reform legislation does not assign such 15-year life to QIP. The preamble to the final bonus depreciation regulations specifically stated that legislative action is required to remedy this error. Unless and until a technical corrections bill is passed, QIP acquired after September 27, 2017, and placed in service after December 31, 2017, will be subject to a 39-year recovery period and will not be eligible for bonus depreciation.
SECTION 179 EXPENSING ELECTION
If you purchase certain depreciable property, you may elect to treat a specified dollar amount as a deduction for property placed in service during the taxable year. However, the benefits of this election are phased out if more than a specified dollar amount of qualifying property is placed in service. Tax reform increased the maximum deduction and phase-out threshold for Section 179 property. For 2019, the maximum amount that can be expensed is $1,020,000 and is reduced on a dollar-for-dollar basis for eligible property placed in service in excess of $2,550,000. Both amounts are indexed for inflation annually. The election is available for tangible personal property (including a new provision for assets used in lodging), qualified real property, and off-the-shelf computer software. Further, the 2017 tax reform act expands the definition of Section 179 property to allow taxpayers to elect to include qualified improvements made to nonresidential real property, and improvements to roofs, HVAC, fire protection systems, alarm systems and security systems.Planning Suggestion: With the expanded definition of Section 179 property, qualifying taxpayers can fully expense certain assets that are not eligible for bonus depreciation. Taxpayers should consult their client service professional to discuss how best to maximize their depreciation deductions.
PERSONAL PROPERTY VERSUS REAL PROPERTY
For regular tax purposes, real property depreciation deductions are available over 27½ years for residential rental property and 39 years for nonresidential property. However, depreciation deductions may be accelerated for real property components that are essential to manufacturing or other special business functions.
INTERNATIONAL TAX PROVISIONS
The IRS and Treasury issued guidance throughout the year including, but not limited to, temporary regulations under Section 245A (deduction for foreign source-portion of dividends received by domestic corporations from specified 10 percent owned foreign corporations), final regulations under Section 951A (global intangible low-taxed income included in gross income of U.S. shareholders), proposed regulations under Section 958 (rules for determining stock ownership), final regulations under Section 956 (investment of earnings in U.S. property), final regulations under Section 965 (treatment of deferred foreign income upon transition to participation exemption system of taxation), proposed regulations under Section 250 (foreign-derived intangible income and global intangible low-taxed income) and proposed regulations under the passive foreign income corporation provisions of the Code.
FEDERAL RESEARCH CREDIT
Enacted in 1981 to incentivize taxpayers to increase investments to try to develop or improve products, processes, and software, the Research Credit has become even more valuable as a result of recent tax reform.
OPPORTUNITY ZONE PROGRAM
The opportunity zone program was created in the 2017 tax reform legislation to promote investment in economically distressed communities. There are now over 8,700 certified qualified opportunity zones (QOZs) in all 50 states, the District of Columbia, Puerto Rico and the Virgin Islands. To take part in the program, investors must invest in a qualified opportunity fund (QOF) within 180 days after the sale or exchange of a capital asset.
Generally, passive losses currently offset only passive income. Unused passive losses are carried to future years. An unused (suspended) loss generally is deductible when a taxpayer disposes of his or her interest in the passive activity. Regulations define “activity” broadly, and include provisions for the “grouping” of certain undertakings into a single activity.
RENTAL REAL ESTATE
Rental real estate activities are generally passive regardless of the taxpayer’s level of participation. However, for real estate professionals, rental real estate activities are not automatically passive but are subject to the general material participation tests. A taxpayer is a real estate professional if during the taxable year:
CHOICE OF ENTITY DECISION
With one tax filing season over and done following the 2017 tax reform, many businesses may be questioning their entities’ tax status considering their overall 2018 tax liabilities. Now is as good a time as ever for businesses to revisit their choice of entity decision with their client service professionals, especially considering the precipitous 40 percent drop in the overall corporate tax rate from 35 percent to 21 percent.
Tax Saving Opportunities for Partnerships, Limited Liability Companies, and S Corporations
Regulations governing the allocation of partnership income and loss can sometimes lead to unanticipated results. The allocation of losses may be particularly sensitive to routine changes in partnership liabilities. Even if these changes do not affect allocations, they may trigger income to the partners in certain circumstances. Contributions, distributions, and interest transfers can also present income recognition issues. Many of these issues depend on the position of the partnership at the end of its taxable year.
LIMITED LIABILITY COMPANIES
Generally, the same federal tax rules that apply to a partnership also apply to a two-or-more member limited liability company (LLC) that is properly classified as a partnership, rather than a corporation, under applicable income tax regulations. Under these same regulations, a single-member LLC owned by an individual can choose to be classified either as a disregarded entity, i.e., sole proprietorship (Schedule C business), or as a corporation, and a single-member LLC owned by a corporation can choose to be classified as a disregarded entity, i.e., part of its corporate owner or a division, or as a separate corporate subsidiary.
All pass-through entities, including partnerships and S corporations, should evaluate their choice of entity as a result of tax reform and the new reduced corporate tax rate. The Section 199A deduction may reduce a pass-through owner’s maximum individual effective tax rate from the highest rate, 37 percent, to as low as 29.6 percent. Converting from a pass-through entity to a C corporation or vice versa requires complex analysis and planning, and is briefly covered in the section entitled Choice of Entity Decision. Your client service professional can be consulted regarding choice of entity considerations, analysis, and planning.
SPECIAL CONSIDERATIONS FOR PASS-THROUGH ENTITIES
Recharacterization of Certain Long-Term Capital Gains Under Section 1061
Gain recognized by a partnership upon sale of a capital asset held for more than one year will generally be characterized as long-term capital gain. However, capital gains recognized after December 31, 2017 with respect to “applicable partnership interests” will be treated as long-term capital gains if the capital asset has been held for more than three years.
Tax Saving Opportunities for C Corporations
RETENTION OF CORPORATE EARNINGS
The new 37 percent top rate for individuals may exceed the marginal tax rate of your corporation. The disparity may be even greater if the combined effect of the additional hospital insurance tax on high wage-earners and the 3.8 percent tax on net investment income of high-income individuals are all considered. In this case, it may be desirable to retain corporate income by deferring compensation payable to employee-shareholders.
Caution: A corporation that accumulates earnings beyond its reasonable business needs may be subject to an additional 20 percent tax on its accumulated taxable income. However, up to $250,000 in earnings may generally be accumulated before this tax applies. Special rules pertain to holding, investment, and personal service corporations.
PERSONAL SERVICE CORPORATIONS
PSCs have historically been denied the benefit of the lower corporate tax brackets and were taxed at a flat 35 percent rate, but they are now taxed at the same 21 percent rate as other C corporations. A PSC is a corporation that performs services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting and also meets certain stock ownership tests.
CORPORATE STOCK AND STOCK OPTIONS
A corporation may obtain a deduction by the issuance of its stock or stock options to pay otherwise deductible expenses. For example, stock issued to employees or independent contractors constitutes deductible compensation when included in the employee’s or independent contractor’s taxable income.
“QUICK REFUND” FOR EXCESS ESTIMATED TAX
If estimated taxes paid exceed the expected annual tax, a corporation may apply for a “quick refund” (on Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax) of the excess tax before the tax return is filed, but only if this excess tax is at least $500 and 10 percent of the expected annual tax.
PLANNING FOR NOLS
NOLs are a valuable corporate attribute. Even NOLs that were not fully reported on a prior year return can be carried forward. However, the ability to use an NOL carryforward may be limited where a loss corporation has experienced a change of stock ownership-for example, as a result of a merger or acquisition, the issuance of new stock, or the acquisition of outstanding stock by one or more shareholders. Your client service professional can assist you with the appropriate planning needed to preserve and maximize the use of NOLs by your corporate business.
SUCCESSION AND FAMILY BUSINESS PLANNING
Year-end is the traditional gift-giving season. This should also be a time to plan for your company’s succession and the transfer of your wealth to your heirs in a manner that minimizes transfer taxes. We urge you to consult with your client service professional for ideas to preserve your family wealth.
Business tax planning is very complex. Careful planning involves more than just focusing on lowering taxes for the current and future years. How each potential tax saving opportunity affects the entire business must also be considered. In addition, planning for closely-held entities requires a delicate balance between planning for the business and planning for its owners.
This 2019 Year-End Tax Letter for Businesses and our 2019 Year-End Tax Letter for Individuals cannot cover every tax-saving opportunity that may be available to you and your business. In as much as taxes are among your largest expenses, we urge you to meet with your client service professional who should be able to provide you with a comprehensive review of the tax-saving opportunities appropriate to your particular situation.