Tax reform expands availability of cash accounting

Under the Tax Cuts and Jobs Act (TCJA), many more businesses are now eligible to use the cash method of accounting for federal tax purposes. The cash method offers greater tax-planning flexibility, allowing some businesses to defer taxable income. Newly eligible businesses should determine whether the cash method would be advantageous and, if so, consider switching methods.

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Buy business assets before year end to reduce your 2018 tax liability

The Tax Cuts and Jobs Act (TCJA) has enhanced two depreciation-related breaks that are popular year-end tax planning tools for businesses. To take advantage of these breaks, you must purchase qualifying assets and place them in service by the end of the tax year. That means there’s still time to reduce your 2018 tax liability with these breaks, but you need to act soon.

Section 179 expensing

Sec. 179 expensing is valuable because it allows businesses to deduct up to 100% of the cost of qualifying assets in Year 1 instead of depreciating the cost over a number of years. Sec. 179 expensing can be used for assets such as equipment, furniture and software. Beginning in 2018, the TCJA expanded the list of qualifying assets to include qualified improvement property, certain property used primarily to furnish lodging and the following improvements to nonresidential real property: roofs, HVAC equipment, fire protection and alarm systems, and security systems.

The maximum Sec. 179 deduction for 2018 is $1 million, up from $510,000 for 2017. The deduction begins to phase out dollar-for-dollar for 2018 when total asset acquisitions for the tax year exceed $2.5 million, up from $2.03 million for 2017.

100% bonus depreciation

For qualified assets that your business places in service in 2018, the TCJA allows you to claim 100% first-year bonus depreciation • compared to 50% in 2017. This break is available when buying computer systems, software, machinery, equipment and office furniture. The TCJA has expanded eligible assets to include used assets; previously, only new assets were eligible.

However, due to a TCJA drafting error, qualified improvement property will be eligible only if a technical correction is issued. Also be aware that, under the TCJA, certain businesses aren’t eligible for bonus depreciation in 2018, such as real estate businesses that elect to deduct 100% of their business interest and auto dealerships with floor plan financing (if the dealership has average annual gross receipts of more than $25 million for the three previous tax years).

Traditional, powerful strategy

Keep in mind that Sec. 179 expensing and bonus depreciation can also be used for business vehicles. So purchasing vehicles before year end could reduce your 2018 tax liability. But, depending on the type of vehicle, additional limits may apply.

Investing in business assets is a traditional and powerful year-end tax planning strategy, and it might make even more sense in 2018 because of the TCJA enhancements to Sec. 179 expensing and bonus depreciation. Using these new provisions may not be as straightforward as they appear. Other factors to consider include taxable income and the new Qualified Business Income “QBI” deduction. If you have questions about these breaks or other ways to maximize your depreciation deductions, please contact us.

Recent Developments That May Affect Your Tax Situation

The following is a summary of important tax developments that have occurred in July, August, and September that may affect you, your family, your investments, and your livelihood. Please call Launch Consulting Inc at 512-666-0729 for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

IRS shoots down states’ SALT limitation workaround. For 2018 through 2025, the Tax Cuts and Jobs Act (TCJA) limits an individual taxpayer’s annual SALT (state and local tax) deductions to a maximum of $10,000, with no carryover for taxes paid in excess of that amount. (The SALT deduction limit doesn’t apply to property taxes paid by a trade or business or in connection with the production of income.) As a result of this change, many taxpayers will not get a full federal income tax deduction for their payments of state and local taxes. Following the TCJA’s passage, some high-tax states implemented workarounds to mitigate the effect of the SALT deduction limit for their residents. One method used was the establishment of charitable funds to which taxpayers can contribute and receive a tax credit in exchange. The IRS has issued proposed regulations, which would apply to contributions after Aug. 27, 2018, that effectively kill this workaround. The regulations would provide that a taxpayer who makes payments to or transfers property to an entity eligible to receive tax deductible contributions must reduce his or her charitable deduction by the amount of any state or local tax credit the taxpayer receives or expects to receive.

IRS also clarified that the proposed regulation crackdown on the SALT limitation workaround doesn’t apply to businesses. In other words, a business generally can deduct a payment to a charitable or governmental entity if the payment is made with a business purpose.

IRS clarifies who is a qualifying relative for family credit purposes. Under the TCJA, effective for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, you can’t claim a dependency exemption for dependents, including qualifying relatives, but you may be eligible for a $2,000 credit for each qualifying child and a $500 credit (called the “family credit”) for each qualifying non-child dependent, including qualifying relatives. One of the conditions for being a qualifying relative is that the person’s gross income for the year can’t be more than the exemption amount. That condition remains the same in the Tax Code, but the exemption amount has been reduced to zero because the dependency exemption has has been eliminated. The IRS has clarified that the gross income limit for a qualifying relative for tax credit purposes (as well as for other purposes, such as head-of-household status), is determined by reference to what the exemption amount would have been if it hadn’t been reduced to zero by the TCJA. Thus, after 2017 and before 2026, the gross income limit is $4,150, adjusted for inflation after 2018.

IRS explains 20% deduction for qualified business income. The IRS has issued regulations on the new 20% deduction for qualified business income (QBI) created by the TCJA, also known as the pass-through deduction. Here’s a summary of the basic rules:

For tax years beginning after Dec. 31, 2017, taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income (QBI) from a domestic business operated as a sole proprietorship, or through a partnership, S corporation, trust or estate. This deduction can be taken in addition to the standard or itemized deductions.

In general, the deduction is equal to the lesser of:

A. 20% of QBI plus 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income, or
B. 20% of taxable income minus net capital gains.

QBI generally is the net amount of qualified items of income, gain, deduction, and loss, from any qualified trade or business. But QBI doesn’t include capital gains and losses, certain dividends and interest income, reasonable compensation paid to the taxpayer by any qualified trade or business for services rendered for that trade or business, and any guaranteed payment to a partner for services to the business.

Generally, the deduction for QBI can’t be more than the greater of:

a. 50% of the W-2 wages from the qualified trade or business; or
b. 25% of the W-2 wages from the qualified trade or business plus 2.5% of the unadjusted basis of certain tangible, depreciable property held and used by the business during the year for production of QBI.

But this limit on the deduction for QBI doesn’t apply to taxpayers with taxable income below a threshold amount ($315,000 for married individuals filing jointly, $157,500 for other individuals, indexed for inflation after 2018), with a phase-in for taxable income over this amount.

A qualified trade or business doesn’t include performing services as an employee. Additionally, a qualified trade or business doesn’t include a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. This exception only applies if a taxpayer’s taxable income exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers; the benefit of the deduction is phased out for taxable income over this amount.

The IRS’s new regulations explaining the 20% deduction for QBI are highly detailed and complex. A sampling of the important guidance contained in the guidance follows:
• Partnership guaranteed payments are not considered attributable to a trade or business and thus do not constitute QBI.
• To the extent that any previously disallowed losses or deductions are allowed in the tax year, they are treated as items attributable to the trade or business for that tax year. But this rule doesn’t apply for losses or deductions that were disallowed for tax years beginning before Jan. 1, 2018; they are not taken into account for purposes of computing QBI in a later tax year.
• Generally, a deduction for a net operating loss (NOL) is not considered attributable to a trade or business and therefore,is not taken into account in computing QBI. However, to the extent the NOL is comprised of amounts attributable to a trade or business that were disallowed under a specialized excess business loss limitation for noncorporate taxpayers, the NOL is considered attributable to that trade or business.
• Interest income received on working capital, reserves, and similar accounts is not properly allocable to a trade or business. In contrast, interest income received on accounts or notes receivable for services or goods provided by the trade or business is not income from assets held for investment, but income received on assets acquired in the ordinary course of trade or business.
• The 20% deduction for QBI does not reduce net earnings from self-employment or net investment income under the rules for the 3.8% surtax on net investment income.
• Where a business (or a major portion of it, or a separate unit of it) is bought or sold during the year, the W-2 wages of the individual or entity for the calendar year of the acquisition or disposition are allocated between each individual or entity based on the period during which the employees of the acquired or disposed-of trade or business were employed by the individual or entity.
• The rule generally barring a health services business from being a qualified trade or business doesn’t include the provision of services not directly related to a medical field, even though the services may purportedly relate to the health of the service recipient. For example, the performance of services in the field of health does not include the operation of health clubs or health spas that provide physical exercise or conditioning to their customers, payment processing, or research, testing, and manufacture and/or sales of pharmaceuticals or medical devices.
• The rule generally barring the performance of services in the field of actuarial science from being a qualified trade or business does not include the provision of services by analysts, economists, mathematicians, and statisticians not engaged in analyzing or assessing the financial costs of risk or uncertainty of events.
• The rule barring consulting from being a qualified trade or business doesn’t apply to consulting that is embedded in, or ancillary to, the sale of goods if there is no separate payment for the consulting services. For example, a company that sells computers may provide customers with consulting services relating to the setup, operation, and repair of the computers, or a contractor who remodels homes may provide consulting prior to remodeling a kitchen.

Bonus depreciation may be claimed for used property. The TCJA boosted the first-year bonus depreciation allowance from 50% to 100% for qualified property acquired and placed in service after Sept. 27, 2017 and before Jan. 1, 2023. That means a business can write off the cost of most machinery and equipment in the year it’s placed in service. And, for the first time ever, for property acquired and placed in service after Sept. 27, 2017, bonus depreciation may be claimed for used as well as new equipment. The IRS has explained that used equipment and machinery qualifies for the 100% bonus first-year depreciation allowance if: the taxpayer (or a predecessor) didn’t use the property at any time before the acquisition; the property wasn’t acquired from a related party or from a component member of a controlled corporate group; and the taxpayer’s basis in the used property isn’t figured by reference to the basis of the property in the hands of the seller or transferor.

Form W-4 for 2019 will be similar to 2018 version. The IRS has announced that the 2019 version of the Form W-4 (Employee’s Withholding Allowance Certificate) will be similar to the current 2018 version. IRS had earlier issued a draft W-4 for 2019 that was longer than the 2018 version and more complex due to changes made by the TCJA. Bowing to complaints that the proposed changes to the form were too confusing and too complicated, the IRS relented and announced that the Form W-4 for 2019 will be similar to the current 2018 version.

Simplified per-diem increase for post-Sept. 30, 2018 travel. An employer may pay a per-diem amount to an employee on business-travel status instead of reimbursing actual substantiated expenses for away-from-home lodging, meal and incidental expenses (M&E). If the rate paid doesn’t exceed the IRS-approved maximums, and the employee provides simplified substantiation, the reimbursement isn’t subject to income- or payroll-tax withholding and isn’t reported on the employee’s Form W-2. Instead of using actual per-diems, employers may use a simplified “high-low” per-diem, under which there is one uniform per-diem rate for all “high-cost” areas within the continental U.S. (CONUS), and another per-diem rate for all other areas within CONUS. The IRS released the “high-low” simplified per-diem rates for post-Sept. 30, 2018, travel. Under the optional high-low method for post-Sept. 30, 2018 travel, the high-cost-area per diem is $287 (up from $284), consisting of $216 for lodging and $71 for M&IE. The per-diem for all other localities is $195 (up from $191), consisting of $135 for lodging and $60 for M&IE.

Now’s the time to review your business expenses

As we approach the end of the year, it’s a good idea to review your business’s expenses for deductibility. At the same time, consider whether your business would benefit from accelerating certain expenses into this year.

Be sure to evaluate the impact of the Tax Cuts and Jobs Act (TCJA), which reduces or eliminates many deductions. In some cases, it may be necessary or desirable to change your expense and reimbursement policies.

What’s deductible, anyway?

There’s no master list of deductible business expenses in the Internal Revenue Code (IRC). Although some deductions are expressly authorized or excluded, most are governed by the general rule of IRC Sec. 162, which permits businesses to deduct their “ordinary and necessary” expenses.

An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your business. (It need not be indispensable.) Even if an expense is ordinary and necessary, it may not be deductible if the IRS considers it lavish or extravagant.

What did the TCJA change?

The TCJA contains many provisions that affect the deductibility of business expenses. Significant changes include these deductions:

Meals and entertainment. The act eliminates most deductions for entertainment expenses, but retains the 50% deduction for business meals. What about business meals provided in connection with nondeductible entertainment? In a recent notice, the IRS clarified that such meals continue to be 50% deductible, provided they’re purchased separately from the entertainment or their cost is separately stated on invoices or receipts.

Transportation. The act eliminates most deductions for qualified transportation fringe benefits, such as parking, vanpooling and transit passes. This change may lead some employers to discontinue these benefits, although others will continue to provide them because 1) they’re a valuable employee benefit (they’re still tax-free to employees) or 2) they’re required by local law.

Employee expenses. The act suspends employee deductions for unreimbursed job expenses — previously treated as miscellaneous itemized deductions — through 2025. Some businesses may want to implement a reimbursement plan for these expenses. So long as the plan meets IRS requirements, reimbursements are deductible by the business and tax-free to employees.

Need help?

The deductibility of certain expenses, such as employee wages or office supplies, is obvious. In other cases, it may be necessary to consult IRS rulings or court cases for guidance.

For questions about tax deductions specific to your business, give Launch Consulting a call today.

Tax-free fringe benefits help small businesses and their employees

Tax-free fringe benefits help small businesses and their employees.

In today’s tightening job market, to attract and retain the best employees, small businesses need to offer not only competitive pay, but also appealing fringe benefits. Benefits that are tax-free are especially attractive to employees. Let’s take a quick look at some popular options.

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Be sure your employee travel expense reimbursements will pass muster with the IRS

Does your business reimburse employees’ work-related travel expenses? If you do, you know that it can help you attract and retain employees. If you don’t, you might want to start, because changes under the Tax Cuts and Jobs Act (TCJA) make such reimbursements even more attractive to employees. Travel reimbursements also come with tax benefits, but only if you follow a method that passes muster with the IRS.

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Close-up on the new QBI deduction’s wage limit

The Tax Cuts and Jobs Act (TCJA) provides a valuable new tax break to noncorporate owners of pass-through entities: a deduction for a portion of qualified business income (QBI). The deduction generally applies to income from sole proprietorships, partnerships, S corporations and, typically, limited liability companies (LLCs). It can equal as much as 20% of QBI. But once taxable income exceeds $315,000 for married couples filing jointly or $157,500 for other filers, a wage limit begins to phase in.

Full vs. partial phase-in

When the wage limit is fully phased in, at $415,000 for joint filers and $207,500 for other filers, the QBI deduction generally can’t exceed the greater of the owner’s share of:

  • 50% of the amount of W-2 wages paid to employees during the tax year, or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified business property (QBP).

When the wage limit applies but isn’t yet fully phased in, the amount of the limit is reduced and the final deduction is calculated as follows:

  1. The difference between taxable income and the applicable threshold is divided by $100,000 for joint filers or $50,000 for other filers.
  2. The resulting percentage is multiplied by the difference between the gross deduction and the fully wage-limited deduction.
  3. The result is subtracted from the gross deduction to determine the final deduction.

Some examples

Let’s say Chris and Leslie have taxable income of $600,000. This includes $300,000 of QBI from Chris’s pass-through business, which pays $100,000 in wages and has $200,000 of QBP. The gross deduction would be $60,000 (20% of $300,000), but the wage limit applies in full because the married couple’s taxable income exceeds the $415,000 top of the phase-in range for joint filers. Computing the deduction is fairly straightforward in this situation.

The first option for the wage limit calculation is $50,000 (50% of $100,000). The second option is $30,000 (25% of $100,000 + 2.5% of $200,000). So the wage limit — and the deduction — is $50,000.

What if Chris and Leslie’s taxable income falls within the phase-in range? The calculation is a bit more complicated. Let’s say their taxable income is $400,000. The full wage limit is still $50,000, but only 85% of the full limit applies:

($400,000 taxable income – $315,000 threshold)/$100,000 = 85%

To calculate the amount of their deduction, the couple must first calculate 85% of the difference between the gross deduction of $60,000 and the fully wage-limited deduction of $50,000:

($60,000 – $50,000) × 85% = $8,500

That amount is subtracted from the $60,000 gross deduction for a final deduction of $51,500.

That’s not all

Be aware that another restriction may apply: For income from “specified service businesses,” the QBI deduction is reduced if an owner’s taxable income falls within the applicable income range and eliminated if income exceeds it. Please contact us to learn whether your business is a specified service business or if you have other questions about the QBI deduction.

Business deductions for meal, vehicle and travel expenses: Document, document, document

Meal, vehicle and travel expenses are common deductions for businesses. But if you don’t properly document these expenses, you could find your deductions denied by the IRS.

A critical requirement

Subject to various rules and limits, business meal (generally 50%), vehicle and travel expenses may be deductible, whether you pay for the expenses directly or reimburse employees for them. Deductibility depends on a variety of factors, but generally the expenses must be “ordinary and necessary” and directly related to the business.

Proper documentation, however, is one of the most critical requirements. And all too often, when the IRS scrutinizes these deductions, taxpayers don’t have the necessary documentation.

What you need to do

Following some simple steps can help ensure you have documentation that will pass muster with the IRS:

Keep receipts or similar documentation. You generally must have receipts, canceled checks or bills that show amounts and dates of business expenses. If you’re deducting vehicle expenses using the standard mileage rate (54.5 cents for 2018), log business miles driven.

Track business purposes. Be sure to record the business purpose of each expense. This is especially important if on the surface an expense could appear to be a personal one. If the business purpose of an expense is clear from the surrounding circumstances, the IRS might not require a written explanation — but it’s probably better to err on the side of caution and document the business purpose anyway.

Require employees to comply. If you reimburse employees for expenses, make sure they provide you with proper documentation. Also be aware that the reimbursements will be treated as taxable compensation to the employee (and subject to income tax and FICA withholding) unless you make them via an “accountable plan.”

Don’t re-create expense logs at year end or when you receive an IRS deficiency notice. Take a moment to record the details in a log or diary at the time of the event or soon after. The IRS considers timely kept records more reliable, plus it’s easier to track expenses as you go than try to re-create a log later. For expense reimbursements, require employees to submit monthly expense reports (which is also generally a requirement for an accountable plan).

Addressing uncertainty

You’ve probably heard that, under the Tax Cuts and Jobs Act, entertainment expenses are no longer deductible. There’s some debate as to whether this includes business meals with actual or prospective clients. Until there’s more certainty on that issue, it’s a good idea to document these expenses. That way you’ll have what you need to deduct them if Congress or the IRS provides clarification that these expenses are indeed still deductible.

For more information about what meal, vehicle and travel expenses are and aren’t deductible — and how to properly document deductible expenses — please contact us.

Choosing the right accounting method for tax purposes

The Tax Cuts and Jobs Act (TCJA) liberalized the eligibility rules for using the cash method of accounting, making this method — which is simpler than the accrual method — available to more businesses. Now the IRS has provided procedures a small business taxpayer can use to obtain automatic consent to change its method of accounting under the TCJA. If you have the option to use either accounting method, it pays to consider whether switching methods would be beneficial.

Cash vs. accrual

Generally, cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid. Accrual-basis businesses, on the other hand, recognize income when it’s earned and deduct expenses when they’re incurred, without regard to the timing of cash receipts or payments.

In most cases, a business is permitted to use the cash method of accounting for tax purposes unless it’s:

  1. Expressly prohibited from using the cash method, or
  2. Expressly required to use the accrual method.

Cash method advantages

The cash method offers several advantages, including:

Simplicity. It’s easier and cheaper to implement and maintain.

Tax-planning flexibility. It offers greater flexibility to control the timing of income and deductible expenses. For example, it allows you to defer income to next year by delaying invoices or to shift deductions into this year by accelerating the payment of expenses. An accrual-basis business doesn’t enjoy this flexibility. For example, to defer income, delaying invoices wouldn’t be enough; the business would have to put off shipping products or performing services.

Cash flow benefits. Because income is taxed in the year it’s received, the cash method does a better job of ensuring that a business has the funds it needs to pay its tax bill.

Accrual method advantages

In some cases, the accrual method may offer tax advantages. For example, accrual-basis businesses may be able to use certain tax-planning strategies that aren’t available to cash-basis businesses, such as deducting year-end bonuses that are paid within the first 2½ months of the following year and deferring income on certain advance payments.

The accrual method also does a better job of matching income and expenses, so it provides a more accurate picture of a business’s financial performance. That’s why it’s required under Generally Accepted Accounting Principles (GAAP).

If your business prepares GAAP-compliant financial statements, you can still use the cash method for tax purposes. But weigh the cost of maintaining two sets of books against the potential tax benefits.

Making a change

Keep in mind that cash and accrual are the two primary tax accounting methods, but they’re not the only ones. Some businesses may qualify for a different method, such as a hybrid of the cash and accrual methods.

If your business is eligible for more than one method, we can help you determine whether switching methods would make sense and can execute the change for you if appropriate.

Choosing the best business entity structure post-TCJA

For tax years beginning in 2018 and beyond, the Tax Cuts and Jobs Act (TCJA) created a flat 21% federal income tax rate for C corporations. Under prior law, C corporations were taxed at rates as high as 35%. The TCJA also reduced individual income tax rates, which apply to sole proprietorships and pass-through entities, including partnerships, S corporations, and, typically, limited liability companies (LLCs). The top rate, however, dropped only slightly, from 39.6% to 37%.

On the surface, that may make choosing C corporation structure seem like a no-brainer. But there are many other considerations involved.

Conventional wisdom

Under prior tax law, conventional wisdom was that most small businesses should be set up as sole proprietorships or pass-through entities to avoid the double taxation of C corporations: A C corporation pays entity-level income tax and then shareholders pay tax on dividends — and on capital gains when they sell the stock. For pass-through entities, there’s no federal income tax at the entity level.

Although C corporations are still potentially subject to double taxation under the TCJA, their new 21% tax rate helps make up for it. This issue is further complicated, however, by another provision of the TCJA that allows noncorporate owners of pass-through entities to take a deduction equal to as much as 20% of qualified business income (QBI), subject to various limits. But, unless Congress extends it, the break is available only for tax years beginning in 2018 through 2025.

There’s no one-size-fits-all answer when deciding how to structure a business. The best choice depends on your business’s unique situation and your situation as an owner.

3 common scenarios

Here are three common scenarios and the entity-choice implications:

  1. Business generates tax losses. For a business that consistently generates losses, there’s no tax advantage to operating as a C corporation. Losses from C corporations can’t be deducted by their owners. A pass-through entity will generally make more sense because losses pass through to the owners’ personal tax returns.
  2. Business distributes all profits to owners. For a profitable business that pays out all income to the owners, operating as a pass-through entity generally will be better if significant QBI deductions are available. If not, it’s probably a toss-up in terms of tax liability.
  3. Business retains all profits to finance growth. For a business that’s profitable but holds on to its profits to fund future growth strategies, operating as a C corporation generally will be advantageous if the corporation is a qualified small business (QSB). Why? A 100% gain exclusion may be available for QSB stock sale gains. If QSB status is unavailable, operating as a C corporation is still probably preferred — unless significant QBI deductions would be available at the owner level.

Many considerations

These are only some of the issues to consider when making the C corporation vs. pass-through entity choice. We can help you evaluate your options

 

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