Do you have a plan for dealing with all the new taxes affecting business owners in 2018?
Failing to meet with your tax advisor can result in you paying much more in taxes than legally required.
I had a client who set up a business using the wrong business entity. This increased his taxes by thousands of dollars every year. By simply correcting how the business was structured, I saved him $45,000 that year. This isn’t just a one-year savings. Restructuring will continue to save him this amount every year. If he stays in business 10 years, that’s $450,000 in savings! In 20 years, he will have saved $900,000 that he would otherwise have paid the IRS, just by having the wrong business structure! I’m sure we can all find something better to do with that kind of money.
But that is just one of the many ways business owners are overpaying their taxes. Here are some additional steps you can take to avoid overpaying income taxes on your business profits.
1) Know the basic rules of income tax liability. Find out what’s nontaxable, and then figure out a way to earn as much of it as possible. The general rule is that if you can’t find a place in the code that says something is nontaxable, it’s taxable.
2) Shift income to later years. This is most often accomplished with a tax-deferred retirement plan or annuity, or by collecting receivables in January instead of December. It’s based on the concept that while you’re in your peak earning years, you are shifted into a higher graduated tax bracket. The idea is to avoid having all of your income taxed at the highest possible tax rate. Shift it to years when you’re not working as much and probably won’t have as much income.
3) Accelerate deductions. Review your income statement to see what can be paid before December 31. If you are considering purchasing equipment early next year, buy it in December instead.
4) Use a credit card to pay deductible expenses before year-end. This will allow you to take the deduction even if the credit card is paid in later years. (You can’t deduct the item again when you pay the bill.)
5) If you expect your income to be higher next year, reverse number 2 and 3 above—accelerate income and postpone deductions. The goal is to use the tax rates to pay less in both years combined than you would have if you had skipped tax planning.
6) Shift income to taxpayers in lower tax brackets than yourself. This can be between you and other family members or by establishing a C-corporation. Warning: Don’t forget the Kiddie Tax implications.
7) Turn after-tax expenditures into tax-deductible items. I had a boss once who said every taxpayer should own a peanut or popcorn stand. What he meant was that everybody should have some side business, even if you’re a wage earner, which allows you to deduct things that you normally would buy anyway on an after-tax basis.
8) Take advantage of as many adjustments to income, deductions, and tax credits as possible. There’s no real magic trick here. You just have to know what is available to you. Tax preparers are not mind readers. We’re going to ask you lots of questions, but you might have something out of the ordinary. Believe me, there are hundreds of thousands of tax deductions, and we can't just put all of them on your tax return! No client is going to sit still long enough for us to ask about every single possible deduction they might qualify for. As tax preparers, we are only going to ask about the most common ones.
9) Choose the right business entity for your particular business. As a general rule, real estate should not be held in a C-corporation. Profits from a future sale would be taxed twice—once at the corporate level and again at the individual level as dividend income when the money is taken out of the corporation. Almost all real estate is held in an LLC and taxed as a partnership.
Normally, though, between 85 and 90 percent of small businesses are set up as S-corporations for two reasons:
• It eliminates the double taxation discussed above. If I have a business in a C-corp and it does well, the IRS says I can’t take profits out. I can only pay myself a fair salary. The excess must be distributed as dividends and taxed a second time at the individual level.
• An S-corporation allows you to limit Social Security and Medicare tax payments to the amount of the owner’s salary rather than the total profits of the company. But be careful! The owner must receive a fair and reasonable salary. The IRS is auditing S-corporations that pay the owner little or no salary.
10) Hire your family members. You’re most likely going to pay your children an allowance anyway; you might as well have them work for the money so you can deduct the payment! You’ll also be teaching them some valuable lessons. I did this with all three of my kids. They’d come in and do some filing, answer the phones, or run errands. Now, they must actually be working. You can’t just give them money, and you’ve got to give them a fair wage.
11) Set up a medical reimbursement plan (MRP/105 plan). Healthcare costs can only be taken as an itemized deduction if the out-of-pocket amount exceeds 10 percent of your income. This greatly reduces the amount that high-income earners or taxpayers who don’t normally itemize can deduct. These plans can be tricky to set up and require quite a bit of planning, so consult your tax professional before setting one of these up on your own.
12) If a medical reimbursement plan isn’t appropriate or is too expensive due to a high number of employees, consider setting up an HSA.
13) Take advantage of a home office deduction. This deduction is probably the most misunderstood deduction in the entire tax code. For years, it was an IRS red flag. Now it’s much less likely to be an issue because there are certain steps you have to go through. It must be either your principal place of business or a place to meet with customers in the normal course of business. You may also deduct a home office if the space is a separate structure detached from your residence but used in connection with the business.
14) Consider renting your main home or a vacation home to your business for fewer than 15 days. Your business can deduct the rental and you will not have to report the income personally.
15) Document all of your deductible business meals. If you are ever audited and have no documentation, an IRS agent will disallow the deduction. For each expenditure keep track of the date, amount, and business purpose of the expenditure, as well as who attended. The best thing to do is to take the receipt and write all of this information on the back. Scan the receipt and then toss it, because restaurant receipts are notorious for fading away. By the time you need it two or three years from now, you won’t have it.
16) Pay property taxes in December, not January. Pay your January 2019 rent or building payment in December 2018.
17) Look into creating a retirement plan. The vast number of tax-deductible retirement plan options makes this a subject well beyond the scope of this article. There are many options available to business owners, so call your CPA for more information.
18) Year-end hiring equals savings. Take advantage of the small employer health insurance credit. It’s one of the few things that really do help small employers under ObamaCare. The credit is worth up to 50 percent of the premiums paid. This is very tricky to calculate, so get a tax professional to help you.
19) If you’re going to buy equipment, do it before year-end. The Section 179 expensing allowance has increased from $500,000 to $1 million for 2018 and beyond with a provision for inflation indexing. Additionally, the threshold for phasing out Section 179 is increased from $2 million to $2.5 million. The deduction is limited to the taxpayer's business income.
20) The “bonus” depreciation is massively improved under the new tax law. For years 2018 through 2022, your business can claim a 100% bonus depreciation deduction. This is up from 50% in 2017 and applies to both new and used assets.
21) For years beginning after December 31, 2017, expensing is also available for Qualified Improvement Property. This is normally improvements to the interior of the business property (not enlargements). It also includes roof improvements, HVAC, fire protection, alarm systems, and security systems.
22) Buying a heavy pickup or SUV for work in 2018 can result in a big tax write-off.
23) Buy a new business car. The new law increases the amount that can be deducted in the first year of ownership. If you buy a new car in 2018, the maximum you can deduct is $10,000 as opposed to the $3,160 allowed in 2017. You may also be eligible for an extra $8,000 bonus deduction for a vehicle placed in 2018.
24) Calculate your auto deduction under the actual cost method and the mileage method, and then deduct the amount that is best for you. As a general rule of thumb, if you drive more than 14,000 miles a year for business, you’re probably better off using the mileage method.
25) If you have losses in a partnership or an S-corporation, be sure you have enough basis to deduct them. In English, that means enough investment. If you’re personally liable for a loan, that counts. In a partnership, a loss is only deductible to the extent of your basis—your investment in the partnership. An S-corporation shareholder can only deduct his share of losses up to the amount of the basis and debt owed to him by the corporation.
26) Write off your bad debts. If you’re on a cash basis, this won’t work because you didn’t collect the funds. Truthfully, there are many advantages to being on an accrual basis, unless you’re a doctor or dentist and you have a lot of write-offs. Even then, I argue you’re probably better off if you’re pretty diligent about writing off your bad debts.
27) Write off your old inventory. I just talked to a client who hadn’t written off bad inventory in 10 years! He finally wrote it off only because he didn’t want to pay the property tax. You can value inventory at the lower of your cost or its market value. If it’s worth less than you paid, you can take a write-off even if the inventory is not bad.
28) Donate old inventory or equipment you no longer use. You can write off one-half of the difference of the fair market value less your remaining basis, which is your original cost less depreciation. You probably wrote off most of this equipment all at once, so what we’re talking about is one-half of the fair market value. Go on eBay, see what it's worth, and give it away. It’s better than nothing.
29) Don’t miss out on the new 20% business deduction. Starting in 2018, only 80% of your qualified business income will be taxed. This is a large break for small businesses but it comes with many limitations and is very complicated. If you own a profitable business, you definitely need to contact your tax advisor to ensure that you don’t miss out on this valuable deduction.
30) The TCJA creates a new tax credit for wages paid to employees on family or medical leave. To qualify, your company must offer at least two weeks of paid family or medical leave annually for your full-time employees. The credit is generally equal to 12.5% of wages if employees are paid at least 50% of normal wages on leave. The credit can increase up to 25% for higher payouts. The credit will is scheduled to expire after 2019.
31) The new law eliminates your employees’ ability to deduct the 50% deduction for meals and entertainment they pay out of their own pockets. If they use their own vehicle they will also not be able to deduct their auto expenses on their return. Consider reimbursing them under an accountable plan (one where they turn an expense report) so the company can deduct the expenses and the employee doesn’t have to pick up the reimbursement as income.
32) Switch to the cash basis method of accounting. Business owners prefer to use the cash basis for tax returns since it is simpler and you don’t owe taxes until the customer pays you. Under the old law, a C-corporation could not use the cash method if average gross receipts exceeded $5 million. The new law increases the limit to $25 million. Personal service corporations and most pass-through entities can use the cash method without regard to their gross receipts.