Small Business Taxes & ManagementTM--Copyright 2018, A/N Group, Inc.
The Tax Cuts and Jobs Act of 2017 was in full force for 2018. The big changes for individuals are the loss of some itemized deductions and exemptions coupled with a higher standard deduction. Tax rates are lower than in 2017, and your chances of getting caught by the alternative minimum tax (AMT) are far less than in the past. The loss of itemized deductions means there are far less planning opportunities for taxpayers whose income comes substantially all from wages. For taxpayers with more complex situations, planning opportunities continue to exist.
Before doing any serious planning you should review your income and expenses for the year. If you have a business that operating as an S corporation, partnership, LLC, or sole proprietorship, the income and losses will be passed through to you. So you've got to have a good idea of how the business is doing. Much the same applies if you have a rental property (or properties) and can deduct the losses or if the property throws off income. Fortunately, rental properties tend to be more stable than an operating business.
Level Income There's no question that moving income from one year to another to level out income generally makes sense. While it's late in the year, if you have a business you can accelerate income into 2018 by collecting from customers or deferring expenses into 2019 if you're on the cash basis of accounting. That makes sense if you're in a low bracket this year, but expect to be in a higher one next year.
On the other hand, if this year is particularly good and you expect to be in a lower bracket next year, defer income if possible and accelerate expenses. Year-end equipment purchases could generate a deduction for 2018. There are limits on cars, light trucks, and SUVs. There are limits as to what you can do. There's a limit on how much you can "prepay". Ask your accountant for help in your particular situation.
Caution--Before taking any tax action, evaluate all the factors surrounding the decision. Don't risk an economic loss for a small tax saving. Even if you're in the highest bracket (figure federal and state), a $1 tax deduction won't save more than about 42 cents in taxes (slightly more if it's a business deduction and you're subject to the self-employment tax). That means a $100 expenditure will cost you $58 out of pocket; more if you're in a lower bracket. The best tax planning moves are those that don't cost you anything or increase your risk but merely save taxes such as moving deductions between years. Also keep in mind that while buying a new truck can reduce your taxes, that outlay could also affect your cash position, your cashflow, and the makeup of your balance sheet. The latter can be important if you have creditors that monitor your debt, liquidity, etc. Finally, if the new truck won't be used effectively in your business, you could be throwing money away.
The best approach is to go after the biggest savings first and work your way down. At some point you reach diminishing returns--and you don't know what next year will bring. You could reduce your top bracket this year only to find business particularly good next year resulting in a much higher bracket.
There are a number of thresholds that can be important because benefits such as the AMT exemption, child tax credit, etc. are phased out as your income rises. Fortunately, the ones with the most impact on your return have been increased significantly. And the only way to totally analyze the effect of the phase outs is to put your pro forma numbers in tax software and have it work through the numbers for you.
You should also keep in mind that for most businesses (there's an exception for farmers), net operating losses can no longer be carried back. They can be carried forward, but that may be small comfort. In addition, any net operating losses are limited to 80% of your income. There's another complication. Any pass-through losses will be limited to $250,000 ($500,000 for married, joint) in any one year. Any amount unused at the end of the year can be carried forward, but again, that may not produce the optimal tax result.
Your taxable income will also determine the tax rate on long-term capital gains and qualifying dividends. The tax rates for these items are the same as in the past; 0% and the lowest level; 15% for the next breakpoint and 20% for married, filing joint, with income over $479,000 ($425,000 if single). Capital gains, interest, dividends, rental income, passive income there's an additional tax of 3.8% (the net investment income tax) for incomes above $250,000 (married, joint; $200,000 for single). Thus, the effective tax rate on capital gains an dividends could be 18.8% or 23.8%. Net losses can be carried forward to offset other capital gains or you can take up to $3,000 ($1,500 single) of losses against ordinary income each year. For more than a few investors this year has been less than fruitful. If you've taken gains earlier in the year, consider taking unrecognized losses to offset some or all of the gains. As always, investment considerations should come first. You may have a loss in a position and want to take the loss this year, but like the stock and want to hold on. If you sell the stock (or bond) and purchase the identical security within 30 days before or after, the loss will be disallowed. For example, you sell 100 shares of Madison Inc. at a loss on December 28, 2018. If you bought 100 shares of Madison Inc. within the 30-day window, say on December 10, 2018 or January 20, 2019, the loss would not be allowed for tax purposes. It's not lost. Your basis is adjusted and you get the benefit when the new stock is sold. But it will defeat the purpose. And remember the rules. The required holding period for long-term status is more than a year.
The wash sale rule only applies to losses. You can sell a security with a profit, take the gain, and repurchase it immediately. This makes sense if you've got losses and you like the securities on which you're showing gains. For example, you bought KiWi Networks at $5 a share and it's selling for $100 but you think it will go higher. You can sell some shares, take the gain to offset losses and repurchase the shares the next day. If you do a 1-for-1 offset you pay no taxes on the sale, but have a new, higher basis in the new shares of KiWi.
If your income is low this year you might want to consider converting some of your regular IRA investments into a Roth. This is not a decision to be taken lightly. If the stocks decline you'll have reported income from the conversion and not get the benefit. You might consider selling stocks that have been beaten down. Talk to your investment advisor before taking action.
Shareholder in S corporation? Partner in partnership? Member in an LLC? You can only deduct losses up to your basis. (And only if you materially participate in the business.) In an S corporation that's your equity investment plus any qualifying loans you made to the corporation, plus accumulated earnings, less distributions and losses. If you don't have enough basis to use the losses, you might want to make an equity investment or loan the corporation funds. You should also check your basis before making any distributions or receiving any loan repayments. In some situations these can generate taxable income. Note. Any unused losses can be carried forward to later years. For partners, many of the rules are similar, but more complicated. Check with your tax advisor. For help in computing your basis and for other information on these entities, see S Corporations, Partnerships, and LLCs--Basics, Misconceptions and Traps--Part I and Part II and our S Corporation Basis and Partnership Basis forms. Remember, losses can generally only be used to offset other income if you materially participate in the business.
The basis issue is more important now that in the past. There's a new question on Schedule E of Form 1040 that requires a basis computation if you have losses, distributions, dispose of stock or receive a loan repayment from an S corporation you'll have to include a basis computation.
With the estate tax exemption at $11,400,000 per individual, it's unlikely you'll get hit with the federal estate tax. (Some states have an estate tax and the exemption is generally lower.) But making year-end gifts to children or grandchildren of no more than $15,000 can allow you to avoid filing a gift tax return. (You'll have to file a gift tax return if you want to make a larger gift and use your spouse's exemption.) Making regular gifts can allow you to avoid later issues with your estate. The drawback is that the basis of the gift in the donee's hands is generally that of the donor. That is, there's no step up in basis.
Schedule A This is where many of the big changes are in 2018. You can now deduct only the first $10,000 ($5,000 if married, filing separately) of taxes. That includes real estate, income, and personal property taxes. In addition, interest on home equity loans and miscellaneous itemized deductions subject to the 2% threshold are no longer deductible. Miscellaneous itemized deductions could include a home office for an employee, unreimbursed employee business expenses, investment expenses, etc. As a result of these changes, many taxpayers will take the standard deduction because it's larger. Married, and rent? Retired? Married with a low mortgage? There's a high probability you'll take the standard deduction. Single taxpayers in higher tax states will probably stand a better chance of itemizing.
There isn't much you can do here. The standard deduction for 2018 is $12,000 for single individuals and $24,000 for a married couple filing separately. If you max out on taxes ($10,000) and you have enough mortgage interest to allow you to itemize (say $25,000) you should be careful to even out your deductions. For example, you have no state and local income taxes, but your real estate taxes total $11,000. Make sure you pay the $11,000 in 2018. Don't pay $5,500 in 2018 and $16,500 in 2019. You'll end up deducting $5,500 in one year and $10,000 in the next instead of $10,000 in both years.
On the other hand, you may be able to bunch expenses so you can itemize in one year and take the standard deduction in another. That's most likely to work if you're close to the standard deduction threshold, but don't quite make it. For example, your taxes run $7,000 a year. You might arrange your tax payments so that you make the $10,000 maximum one year, but only $4,000 the next. You'll have to work through the numbers. And there are some fine points here. Talk to your tax advisor.
Casualty losses are only deductible in 2018 if they occur as the result of a federally declared disaster. Floods, hurricanes, some storms, etc. qualify. But if your home is destroyed by a kitchen fire, no deduction.
Charitable contributions are still deductible, but as in the past, only if you itemize. If you can't itemize, but you've got to take a required minimum distribution from your IRA, consider making a contribution through the IRA. That way you avoid the increase in income the IRA distribution would create.
The old rules are still in effect. Cash and credit card payments before the end of the year count; pledges don't. You've got considerable opportunity here to accelerate deductions. Check or credit card payments are best. If the contribution is $250 or more, a receipt from the organization is necessary. For a contribution of any amount you'll need a receipt, canceled check, or credit card proof. If you make charitable donations of property of more than $500 you'll have to file a special form with your return. Donations of household goods or clothing that are not in good used condition or better are allowed only if the deduction for a single item exceeds $500 and a qualified appraisal is attached to the return. (The appraisal requirement makes such donations unattractive.) Special rules apply to vehicle donations of over $500. Donate more than $5,000 of similar property and you'll need a formal appraisal. (E.g., $3,000 of artwork to the Madison Public Library and $2,500 of paintings to the Chatham Museum.) Publicly held stock for which market quotations are available escape this requirement. An appraisal summary has to be partially completed for nonpublicly traded stock valued at $5,000 to $10,000. A full appraisal is needed for nonpublicly traded stock if the contribution exceeds $10,000. You might want to avoid those thresholds.
Other Considerations If you have yet to pay your state estimated taxes for the year, consider doing so now. Waiting until April 15 will only add penalties. For most taxpayers, January 15th is the deadline for both federal and state estimated payments. If you can itemize making your state payment this year might make sense.
Have an S corporation? If you haven't taken a salary, or the amount you've taken is relatively small and you've taken distributions, you should probably take more before the end of the year. The IRS is getting more information on salaries and continues to question no or low salaries of shareholder/officers.
The new law limits excess business losses from S corporations, partnerships, sole proprietorships, etc. And excess business loss is the excess of deductions from the trades or businesses over the sume of aggregate gross income from the businesses plus a threshold amount. The threshold amount for 2018 is $250,000 ($250,000 for a joint return). That could put a severe crimp on some start-up businesses. The excess losses are not lost but are carried forward. Still, this will have an effect on your planning and your cash flow. In addition, net operating losses can no longer be carried back to an earlier year but can only be carried forward and those carryforward losses are limited to 80% of taxable income for the year. Special rules apply to farming businesses.
If you do business with a pass-through entity, you may be able to deduct 20% of the net income. For taxpayers below the threshold amount of taxable income of $157,500 ($315,000 for married, joint) the 20%. For taxpayers with taxable income above that amount, the deduction is phased out and will depend on the W-2 wages and unadjusted basis of the property of the business. For certain specified trades or businesses the 20% deduction is also phased out as income rises abouve $167,500 ( $315,000). Special rules apply to farming businesses.
Year-end equipment purchases by businesses can reduce your income for 2018. The cost of most equipment can either be deducted immediately under Sec. 179 or you can claim 100% bonus depreciation. Cars and light trucks are subject to restrictions. The provisions generally don't apply to real property, but there are some limited exceptions.
If you traded in business property in a like-kind exchange (e.g., a pickup truck for a pickup truck) the transaction will no longer be treated as an exchange for tax purposes. Relinquishing the truck is now the same as a sale and will generate depreciation recapture. If you purchase euqipmnet, either similar (e.g., a pickup truck) or even other equipment (e.g., 8 computers) you should be able to secure an immediate, offsetting deduction either through Sec. 179 or business depreciation. If you haven't purchased replacement property before the end of the year, talk to your tax advisor.
Hobby losses never fared well under the law, but it just got worse. In the past if the IRS reclassified an activity as a hobby, you'd bave to report all the income, but you could take a deduction, up to the amount of the income, for legitimate expenses. Unfortunately, that's no longer the case. Deductions would have to be taken on Schedule A under miscellaneous itemized deductions subject to the 2% floor, but that's no longer allowed. This could make the IRS even more eager to recharacterize a sole proprietorship, farm, S corporation, etc. as a not-for-profit activity because the revenue generated will be larger.
Do you make payments to a related entity? When related taxpayers use different accounting methods, the accrual basis payer is placed on a cash basis with respect to payments that generate income or deductions.
Example--Fred is a 60% shareholder in Madison Inc. Madison is a calendar-year taxpayer and uses the accrual method of accounting. At December 31, 2018 Madison owes Fred $1,200 for interest on a loan he made to the business and $4,000 for 2 months rent on a building Fred owns and rents to the business. Madison doesn't pay the $5,200 until 2019. Madison can't accrue the expenses in 2018; they're only deductible when paid in 2019.
This rule applies to any item that would be income to the recipient. Typical ones include interest, rent, bonuses, nonemployee compensation, etc. What constitutes a related taxpayer? There's a long list, but the two most important ones are a more than 50% shareholder in a regular corporation or a shareholder (or partner) who owns any interest in an S corporation (or partnership). The constructive stock ownership rules apply. That is, your son, daughter, etc. is deemed to own whatever stock you own.
Reviewing your entity choice. While taxpayers that do business as an S corporation, partnership, etc. may only have to pay tax on 80% of income, if you're in the higher brackets, you could pay less in taxes by doing business as a C corporation. But there's are some big "ifs" there. If you're just taking a modest salary and the corporation is reinvesting the money in the business (i.e., you're not taking distributions) a C corporation can produce a smaller tax bite. But many small business owners take distributions, either intended by writing themselves a check, or unintended by having the corporation pay for personal items. Dividends from a C corporation are taxed twice, once as income at the corporate level and again as a dividend. Unlike an S corporation, there can be a double tax when you sell the stock. There is a provision that allows you to avoid that, but there are a number of restrictions. This is both an important and complex decision. Discuss it with your tax advisor.
Copyright 2018 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 12/19/18