Business tax planning tips guide for 2019 tax year filing
Happy New Year, everyone! As we are getting closer to our favorite time of the year, “tax season,” I wanted to write a post about a few small business tax considerations and planning for the 2019 tax filing year. Last month, I wrote about “10 year-end tax saving strategies to lower your 2019 tax bill” that was geared towards helping individuals save money, so I would like to do the same for business owners.
This article will cover some tax considerations and developments that I believe could create opportunities or uncover risks for companies in 2019 and beyond. It is not a complete list of all tax issues (such the one RSMUS did in a PDF, or a BDO tax letter) that may affect your business, but it is written to help you make informed decisions related to planning and getting prepared for tax filing season. In a year with many complexities and dependencies, planning becomes all the more crucial.
Since the Tax Cuts and Jobs Act (TCJA) was signed into law by President Trump over 2 years ago, there has been a ton of guidance released by both the U.S. Treasury and the IRS in the form of proposed and final regulations. It may be a little daunting to keep up. As we are approaching this upcoming tax deadline, business taxpayers are continuing to look for more clarity around certain issues where guidance may be still pending and also assess how any revisions to temporary regulations could have an impact on their business. No matter the size, location or industry, companies of all kinds are still navigating the effects of massive changes to the federal tax code. And no matter what type of business you operate, there are favorable strategies to lower your total tax liability by optimizing your federal tax planning.
And, because of all the uncertainty and changes in the law, many corporations have found it a little hard to reap the full advantages of the opportunities provided by the biggest tax code change since 1986. Taxpayers should be putting their focus and time into planning opportunities based on the knowledge acquired over the last 2 tax filing years. This tax article focuses on federal income tax planning, but your business should also delve into the complexities of applicable California state taxes.
This article will touch upon tax strategy tips related to areas such as:
- Corporate and transactional considerations
- Considerations for pass-through entities
So before we jump to any particular areas of potential tax savings, each business owner or executive finance team must assess its total tax liability. BDO has a pretty good article on what is a total tax liability is. This requires analysis of the entire tax portfolio, including income tax, indirect tax, property tax, payroll tax, excise tax, as well as tax credits, incentives and customs and duties. This will help shed some light upon 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 thoroughly examine 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 things such:
- Bonus depreciation and expensing rules
- The new qualified business income deduction
- Potential changes to your entity status
- Business loss claims
Deductions and Revenue planning
For businesses that want to reduce their taxable income (such as minimizing current taxes payable) or accelerate income ( for purposes of reducing current year net operating losses – NOLs), there are a few different accounting method approaches that could be implemented to reach these goals. Some of these strategies can include:
- Switching from the cash basis to the accrual of accounting or vise-versa
- Conducting inventory planning (such as doing a uniform capitalization -UNICAP- review or electing new last-in, first-out-sub-methods)
- Accelerating certain deductions or electing to capitalize prepaid expenses for the current year under the 12-month rule
- Electing to recover 36 months or currently deduct self-developed software expenses or costs
- Deferring amounts received from advance payments for goods or services
- Properly taking advantage of recurring-item exception for taxes, rebates and or refunds
- Build up bonus plan requirements to substantiate deductions this year employees provide the related services
- Accelerating recovery of real property through cost segregation and or repair studies
Small Taxpayer Designation
So the Trump tax reform TCJA raised the threshold for defining a small business taxpayer to include those average annual gross receipts of $26 million or less for the three prior tax years, for the tax years, for the tax year beginning after December 31, 2018. This amount is indexed annually for inflation. Those qualifying under the small business taxpayer designation may be able to use the overall cash method and become exempt from applying certain inventory rules and be exempt from the limitation on interest deductions.
100 percent an additional first-year (bonus depreciation is available for qualified property acquired and placed in service after September 27, 2017. The IRS issued final and re-proposed regulations related to when taxpayers acquire an asset under a written, binding contract. The TCJA tax law reform expanded bonus depreciation to qualify used property. And what is interesting is this expansion to used property can allow certain business acquisitions to recover a portion of the purchase price immediately through 100% bonus depreciation.
Uniform Capitalization Regulations
In November 2018, the IRS and U.S. Treasury issued new UNICAP regulations which provide businesses new rules and a new method for capitalizing inventory costs. This new method is one of several that companies can ponder when capitalizing costs to inventory and it can provide some simplification as well as more tax efficiency and compliance. The final regulations take effect for tax years beginning on or after November 20, 2018. And remember calendar-year taxpayers must apply the new regulations as of their 2019 tax returns. Any changes in accounting method (usually automatic) are required to comply with the new regulations. The rules affect both producers and resellers, but actually affect producers to a larger extent.
For many companies inventory, can be one of the biggest assets on the balance sheet, of a producer or reseller and historic UNICAP methods are quite complicated and often not even in compliance. Fortunately, the new regs., and the accompanying automatic change procedures offer businesses the opportunity to comply with the new regs., while getting the benefit of prior-year audit protection for historic UNICAP methods. Now is a good time to do more research to see if this can be beneficial to your company.
Health Reimbursement Arrangements
During the past 2019 year, the Federal agencies of the Human Services, U.S. Treasury and Labor released a jointly contributed article of the final regulations for health reimbursement arrangements (HRAs). What are HRAs? They are account-based health plans that employers can use to reimburse employees for their medical care expenses and bills. The purpose of these new regulations was to allow employers more choices for providing health insurance benefits to their workers on a tax-advantageous basis. What these regulations do is create 2 new kinds of HRAs starting January 1, 2020:
- Individual Coverage HRAs
- Excepted Benefit HRAs
Both large and small businesses may want to check and possibly add these features to their plans to their employees to pay for health insurance premiums as well as other medical bills on a tax-advantaged basis.
Like-Kind Exchange Changes (1031)
So as a result of the TCJA deferral of gain under section 1031 is now limited to real property transactions as of January 1, 2018. Real estate exchanges are subject to the same rules and regulations as under pre-TCJA law. But in a footnote 726 in the Conference Committee report on TCJA, it clarifies that “real property eligible for like-kind exchange treatment under pre-TCJA rules is intended to remain eligible; meaning the definition of real property has not changed.
So for tangible real property, the full expensing election may provide relief for those taxpayers affected by this change. Now even though the gain from the sale of personal property may no longer be deferred in a like-kind exchange, the full expensing deduction may be utilized to offset gain triggered.
Affordable Care Act Update
So although the TCJA tax reform eliminated the penalty on individuals starting in 2019, the TCJA did not repeal the employer penalty. Meaning applicable large employers (ALEs) that fail to offer employee health insurance that meets the Affordable Care Act (ACA) also known as Obamacare, standards may be assessed a shared responsibility payment by the IRS. A business is in ALE if it averaged at least 50 full-time workers ( including full-time equivalents) during the preceding calendar year, or was in a group of related companies that meet the large employer threshold or criteria.
In order to avoid the penalty, a large employer must offer minimum essential health coverage to substantially all (95%) of its employees and their dependents. This coverage must be affordable and provide minimum value (by covering a certain percentage of all medical expenses incurred (by their employees.)
Now to determine which employers owe this penalty, the IRS requires ALEs to file Forms 1095-C and 1094-C to report workforce and health plan information. For the tax year 2019, the due date to provide employees with Form 1095-C is on January 31, 2020 (similar to Form W-2), and an employer must file Form 1095-C and the related Form 1094-C to the IRS by February 28, 2020. If you are filing on paper (or April 1, 2020, if filing electronically.
Currently, the IRS is assessing penalties on ALEs that did not offer ACA-compliant coverage to their employees starting in 2015. In addition, the IRS is going after ALEs who failed to file Forms 1095-C and 1094-C in prior years. Since the penalties can be pretty significant, businesses who are subject to these ACA requirements should definitely review their compliance efforts and understand any potential risk for non-compliance.
Research and Development (R&D) Tax Credit
The Research and development (R&D) tax credit, is a quite beneficial incentive in the tax code that was made easier (since the TCJA repealed most of the alternative minimum tax,) to leverage the R&D tax credit to offset and reduce your startup’s tax liabilities. According to BDO “The elimination of the corporate AMT means that such companies, who weren’t permitted to use the Research Credit to offset their AMT, now can benefit currently from the credit by offsetting any current regular income tax or carrying the credit forward for up to 20 years.” How it works, a small business startup may be eligible to claim the credit, up to 250K, against its FICA payroll tax liability if it had less than $5 million in gross receipts for the current taxable year and no gross receipts for any taxable year prior to the 5-taxable-year-period ending with the current taxable year. If you are interested in making this election and you are currently outsourcing your payroll to a 3rd party provider (such ADP or others like it), you need to discuss it with them as soon as possible, because the payroll provider must file certain forms on your company’s behalf.
There is also something called the alternative simplified credit (ASC) which another procedure or method elected to compute the research and development (R&D) tax credits. According to an article by IPC, “companies using the ASC computation may be able to claim a credit even if they do not qualify for the traditional tax credit claims.” The reason being that only relies on the prior 3 years of qualified research expenses to compute the base amount. Compared to the regular credit method that requires a more complicated base amount that can be hard to document. The ASC election should be done by filling out section B on Form 6765 on the original tax return. Depending on your industry of course, but R&D is crucial in advancing technology, growing a business, and expanding a product line.
Keep In Mind: during an R&D credit examination, the IRS sometimes will ask for more detailed information and documentation. So it is important that taxpayers document R&D project activities and differentiate R&D project costs in their accounting records.
These developments have increased the Research Credit’s value, and companies who aren’t looking into this opportunity should, especially if they incur expenses related to services in any technological field, e.g., physics, chemistry, biology, engineering, computer sciences. If you aren’t looking into Research Credits because you think your activities don’t qualify or you think you don’t have the required documentation, please consult with a stratup tax advisor service professional.
Energy Tax Credits
So tax credits for a variety of kinds of renewable energy were retroactively reinstated by the Bipartisan Budget Act of 2018. For example, the residential energy efficient property credit was extended with certain reduced-rate modifications through 2021. The business energy investment credit was also further extended for solar and extended with a phase-out for other renewables as follows:
- The 30% investment tax credit for a qualified solar property is available through 2019, with a 26% credit available in 2020 and a 22% credit available in 20121. Now after 2023, the credit is reduced to 10%.
- The 30% investment tax credit for fiber-optic solar lighting, qualified fuel cell property and qualified small wind property is available through 2019, with a 26% credit available if building begins in 2020, a 22% credit available if building begins in 2021 and no credit if placed in service after 2023.
- The 10% investment tax credit for qualified microturbine property and combined heat and power system property (with certain properties rate modifications) is available if the building begins before 2022.
- The credit remains at 10% for geothermal equipment with no expiration.
The renewable electricity production tax credit (PTC) for large wid projects is at a rate of one cent per kilowatt-hour of electricity sold each year for 10 years. If the taxpayer makes an election to claim the investment tax credit related to qualified wind property in lieu of the PTC, the credit rate is 12% if construction begins in 2019. Taxpayers who wish to take advantage of the PTC when the property is placed into service should either plan to spend more than 5% of eligible wind farm construction costs by the end of 2019 or take steps to begin the actual work of a significant nature on the facility.
IRS Account Transcripts
A business’s IRS record of account transcript contains useful information, such as the data necessary to confirm estimated payments or credit elects applied to the 2019 tax year before preparing an extension or filing the return. For prior years, the record of account transcript can find or identify items of which a company may be unaware, such as penalty or interest assessments, computing/math error adjustments or examination indicators. Therefore, corporations should consider ordering an account transcript this month of January 2020, for 2019 and earlier tax years. Starting last June, 28, 2019, the IRS stopped transmitting transcripts to requesting companies via fax. Instead, the IRS will mail the transcript to the company’s address of record. It can take up to 10 days for it to come in the mail. That is why you should request it by January 15, 2020, to make it arrives promptly. To get it just call the IRS business line 1-800-908-9946.
Tax Return Due Date Reminders
For tax years beginning after December 31, 2015, tax return due dates changed. The calendar year C corporation returns and most fiscal year returns are due on the 15th day of the month following the end of the fiscal year, and S corporation and partnership returns due on the 15th day of the third month following the end of the fiscal year. Form 7004 provides for an automatic extension of six months after the regular due date.
For C corporations with a fiscal year ending on June 30, the effective date change is delayed until the first tax year beginning after December 31, 2025. Accordingly, those returns are due September 15. The deadline for filing Forms W-2, W-3 and 1099-Misc(Box 7) reports with the Social Security Administration is Jan. 31 for paper or electronic filing.
Pass-Through Entity Considerations
Application of Section 199A Deduction
Consider the application of the Section 199a deduction. I have written about the topic extensively but to recap, the Section 199a allows for a deduction of up to 20% of a taxpayer’s qualified business income”, (QBI). QBI usually includes most “trade or business” income reportable on an individual’s income tax return, often attributable to the individual’s share of pass-through entities. Although certain exceptions apply. Such as foreign source income, investment income, and income from certain listed “specified services trades or businesses,” among other items, generally will not constitute QBI and would therefore not be eligible for the deduction. For income that does not constitute QBI, this deduction effectively reduced the top income tax rate applicable to that income from 37% to 29.6%. The deduction does not apply to self-employment or net investment income taxes.
Pass-through owners whose taxable income exceeds $160,700 ($321,400 for a joint return) are subject to limitations on deductions. These taxpayers may see the deduction reduced or fully eliminated if the business does not pay sufficient wages to the employees: does not employ a sufficient amount of tangible, depreciable assets in the business: or conducts business considered in whole or part to be a “specified service” business described in the law.
While beneficial to many, this new deduction has brought with a lot of confusing reporting requirements and complexities for pass-through entities and their owners. The proposed regulations issued in 2018 addressed many areas of uncertainty and have since been updated with final regulations which I linked to. For tax years 2019 and beyond taxpayers may no longer rely on the proposed regulations and instead are now subject to the rules outlined in the final.
Now, of course, some uncertainty still exists in several areas, such as whether certain business activities involve the performance of services in certain non-qualifying “specified service” business fields – such as consulting and healthcare for example. Also, the new guidance has made the reporting requirements associated with entity-level aggregation of businesses for purposes of calculating the deduction a little more complex than it was originally anticipated.
So given the complexity, pass-through business owners should consult their tax advisors or CPA firms when evaluating their eligibility for the 20% deduction, examining compliance with the final regulations and considering whether changes to their business could enhance the benefit more favorably.
Bonus Depreciation Available for Certain “step-up” Basis Transactions
This applies to tax planning for partnerships. Historically, purchasers of partnership interests were able to generate additional depreciation deductions through step-up basis elections; however, step-ups were not eligible for bonus depreciation, as they usually represented the indirect purchase of a used asset. But the TCJA changed the rules to allow bonus depreciation for the purchase of used assets. First regulations regarding bonus depreciation issued in 2019 closely follow the proposed regulations issued in 2018. The final regulations clarify (see REG-104397-18) how the rules affect step-up depreciation generated by the acquisition of an interest in an existing partnership and similar transactions. In many instances, not all, the purchaser will benefit from the immediate deduction to the extent of its share of the step-up is allocable to qualified assets. So now although that the final regulations provide some clarity on the application of the bonus depreciation rules to certain step-up transactions,
There is still uncertainty surrounding the availability of certain transaction structures. Such as those involving the purchase of all interests in a partnership by an existing partner or the contribution of assets to a partnership in exchange for both equity and money.
Now taxpayers who may be considering transactions that may generate a step-up, or in transactions that could be restructured to generate a step-up, should pay particular attention to these final regulations. Prior to finalizing the structure of a transaction, each transaction should be examined to figure out whether, and to what extent, expensing is available, as well as the corresponding tax consequences to the seller. Also, some transactions that have already closed, but are still subject to the new bonus depreciation rules, should be analyzed to ensure that the optimum allowable tax treatment is obtained.
Passive Loss and Net Investment Income Tax Planning
Individuals, closely held C corporations and personal service corporations are generally restricted in their ability to deduct losses from passive activities. Passive losses can include losses from rental activities and other business activities in which the taxpayer is not actively involved. However, taxpayers who can demonstrate the necessary level of participation for these losses may be able to generate substantial tax savings from it. There are a few keys to proving it which are:
- understanding how much participation is necessary and
- ensuring that the participation can be substantiated
In most cases, a taxpayer must devote at least 500 hours to an activity in order to avoid the limitations on passive losses. But in some cases, a taxpayer may only need to participate for 101 hours in an activity to deduct the losses. Therefore, taking action now to increase one’s participation can, in some instances provide a valuable tax deduction.
In circumstances where the business activity generates a net profit, participation is also relevant when trying to minimize exposure to the 3.8% net investment income tax under section 1411. Owners of pass-through entities usually can avoid the tax on their distribution share of income if they participate in the business for at least 101 hours during the year.
In conclusion, finding ways to help owners meaningfully participate in a business can have an additional benefit of significantly reducing their tax burden.
Reconsidering Entity Choice
Many pass-through businesses usually only think about or consider their entity structure only once, which is generally at the time of formation. However, since the Trump tax reform law was enacted which basically taken many of the traditional rules and turned them on their head. Which is now leading many LLCs, partnerships, and S corporations to reconsider their choice of entity structure. So to recap a little, under the TCJA, the corporate tax rates were lowered from 35% to 21%, while pass-through businesses, such as S corporations and partnerships, may now qualify for a pass-through deduction that effectively cut their tax rates from 39.6% to 26.6%.
This has led many businesses to examine whether their current tax structure is still efficient. I wrote an article that compared the tax considerations between a ‘C corporation versus flow-through entity’ but there are a few important issues when evaluating entity choice which include:
- Why should I remain an S corporation, effectively paying a 29.6% or 37% tax rate, if I can get a 21% tax rate as a C corporation?
- Can my partnership convert to C corporation status and enjoy the lower corporate tax rate?
- Are there any issues beyond the annual tax savings I should be considering?
- Are there self-employment tax implications? What about changes to how the owners are currently compensated?
- What role do state and international considerations play in this decision?
- What is the future exit strategy?
Examining the interplay of these potentially competing factors is complex, but understanding the implications of entity type on a business’s overall tax burden is critical in light of these tax rate changes.
New Loss Limitations
So the 2017 tax law includes a new provision that limits an owner’s ability to deduct active business losses against non-business income. Previously, active losses could be offset against all income, with no limitation on deductibility. Under the new law, “excess business loss” deductions are limited to income plus a threshold amount of $250,000 ($500,000 for married filing joint filers). Any losses that are limited under the new provision are carried over and become NOLs in subsequent years. This generally results in a one-year deferral of the excess loss. However, the tax law also limits the utilization of NOLs to 80% of taxable income in any given year. Accordingly, NOLs generated as a result of this new active business loss income limitation will likewise be subject to additional restrictions. Taxpayers should review their active business income and losses to evaluate whether any losses would be fully offset against active-business or whether they may be subject to this new loss limitation.
Self-Employment Tax Considerations For Partners
With several, tax court decisions, in conjunction with other forms of guidance including long-standing and proposed regulations, have created a confusing and somewhat unclear picture for the treatment of members of LLCs and limited liability partnerships (LLP) under the self-employment tax rules.
The IRS has taken pretty aggressive moves in this area. Recent decisions tell that in certain cases LLCs may want to consider changes to their governance rules, substantiating the fact that certain portions of income are exclusively a return of capital( and not compensation for personal services), or adopting a limited partnership structure. These modifications may provide greater confidence regarding the application of the self-employment tax to members of LLCs and LLPs.
Partners As Employees
Partnerships or LLCs may find treating partners as employees provide several benefits, including state tax benefits and overall simplification of reporting wages via W-2 instead of Schedule K-1. Several recent developments in the law, which are both favorable and unfavorable, affect when this practice may be permissible. This includes unfavorable regulations denying employee treatment under structures in which the partners of a tax partnership are employees of a single-member LLC owned by the tax partnership. The regulations also clarify that using a professional employer organization does not achieve employee status for partners in the partnership.
A partnership or LLC considering taking or maintaining a position that some of its direct or indirect partners are direct or indirect employees may want to think about adopting a tiered structure so that employees are partners in a holding company rather than the tax partnership that is their actual employee. Additionally, partnerships or LLCs considering taking this position will also want to analyze the impact such a decision may have on their partners’ ability to utilize the new pass-through deduction afforded by section 199a. Specifically, W-2 wages paid to direct or indirect partners will not be considered qualified business income and thus, are not eligible for the new deduction. Tax planning in this area can generally produce a favorable result with minimal hurdles.
New Carried Interest Legislation
The TCJA added a new provision affecting the treatment of so-called “carried interests,” defined generally as partnership interests received in exchange for services in certain specified businesses in the investment and real estate industries. This provision has a practical impact of converting capital gains into ordinary income in certain circumstances.
Although there are quite of few exceptions and nuances that apply to this new recharacterization rule. We recommend that taxpayers expecting a large carried interest realization event consider the applicability of this new provision and discuss potential mitigation strategies with their tax advisors. Taxpayers should be aware that this carried interest info might be reported to all partners via Schedule K-1 footnotes, even when the carried interest rules may not be applicable to the particular partner.
Again taxpayers should consult their CPA accounting firm to figure out whether the carried interest recharacterization rules apply to their individual situations.
New Pass-Through Basis Reporting Requirements
In 2018, the IRS changed the instructions to Forms 1065 and 1040 and including new and expanded reporting requirements. S corporation shareholders are required to include a basis schedule with their tax return when a shareholder receives a distribution, sells stock, recognizes a loss or receives a loan payment. Partnerships are now required to report the beginning and ending tax basis capital for each partner if either amount is negative.
While these changes were made only to the relevant forms and instructions listed above, It is important to note that these changes may have the same effect and enforcement as an actual Treasury regulation, and thus should be followed carefully. During the 2018 tax year, the IRS and Treasury have provided penalty relief for late filings of partners’ negative tax basis capital information. Any negative tax basis capital information for the 2018 tax year must be filed by March 15, 2020, for calendar-year partnerships in order to receive penalty relief for late filings.
These reporting requirements are mandatory and are recommended that pass-through entities consult with their tax advisors immediately, especially in circumstances where shareholders’ or partners’ historical tax basis info has not been tracked.
The Qualified Small Business Stock QSBS
Section 1202 Stock – or certain C corporations satisfying an active trade or business requirement, shareholders that held original issuance stock for more than five years generally can be eligible to have a gain on the stock excluded from tax to the extent of the greater of $10 million or 10 times the original tax basis. I wrote about the “QSBS exclusion” which is shorthand for a provision in Section 1202 of the Internal Revenue Code (IRC).
All businesses seek to reduce costs, and proactive tax planning presents the chance for significant savings that affect your bottom line. Year-end planning for the 2019 tax year which takes place against the backdrop of recently changed tax rules for individuals and businesses. Please feel free to contact us with any questions you might have regarding any of the items above, or if you like to schedule a free consultation with Huckabee CPA to discuss planning strategies that may be applicable to your particular situation.