Small Business Taxes & ManagementTM--Copyright 2017, A/N Group, Inc.
Changing Tax Landscape
Last year we said that tax reform was most likely on the way, but the timing uncertain. Now tax reform has a high probability of passage, but it's still not a sure thing. Both the House and Senate bills contain some provisions unacceptable to certain legislators. Still, the best bet is to assume passage of a reconciled bill in some form. Throughout this article, keep in mind that nothing is set in stone yet. The House version has four tax rates; the Senate has seven. And there are differences in the tax rate thresholds. It does seem clear that the brackets are higher so, all things being equal, your taxes would decrease. That's particularly true for income over about $500,000 for a married couple who would be in the 35% bracket under the proposed law versus solidly in the 39.6% bracket under current law. That's important if you do business as a pass-through entity (e.g., sole proprietorship, LLC, S corp.). Between a cap on the rate for a portion of the pass-through's income and the rate cut, if your income is similar between 2017 and 2018, you'll get a tax cut next year. That means deferring income to 2018 will generally make sense. But much will depend on your individual situation.
The theory behind business tax planning is similar to planning for your personal return. You want to defer the income to a low tax rate year. If you do business as a sole proprietorship (i.e., file a Schedule C), S corporation, partnership, or LLC (limited liability company), income and losses of the business are passed through and reported on your personal tax return. Thus, your approach to year-end planning is similar to that for individual planning. (There are some factors that can complicate the issue; they're discussed below.) And, yes, while it's true you can save taxes by making equipment and other purchases, you'll still likely to be out of pocket more than 50% of the cost. If you're self-employed or doing business as a partnership or LLC, your rate could be slightly higher when you add in the self-employment tax. (Want to get a better idea of the cost? Go to What's a Deduction Worth? on our Frequently Asked Questions page. Best suggestion? Don't buy what you don't need; don't buy more than you need.
The discussion below assumes your business is on a December 31 fiscal yearend.
As of this writing, December 1, we still have two versions--House and Senate--passed that must be reconciled (i.e., changes made to one or both) and passed by both houses. The best suggestion is to stay as flexible as possible and be able to take action on passage.
Projecting Your Income
We discussed the basics of income projection in our introductory article Year-End Planning--Part 1 last month. You can't do any serious planning if you don't have an idea of where you're at now--and some idea of where you're going next year.
Personal Income Tax Rates
Much of tax planning involves your personal tax rate. If you're involved in an S corporation, partnership, LLC or just have several rental properties, chances are this income is reported on your personal return. If you do business as a C corporation, the corporation pays it's own taxes, but you're getting a salary, so your personal tax rate is still important.
The first step, obviously, is to find your top bracket. Unfortunately, it's not as simple as it used to be. Once your income exceeds the net investment income tax threshold ($250,000 for married joint; $200,000 for others except married separate) you need to add tax at 3.8% to the tax that would apply to the income (generally, interest, dividends, capital gains, passive income). For example, if you're in the 39.6% bracket and receive $1,000 of interest you'll pay taxes at 43.4% on that amount. You'll pay an extra 0.9% tax on wages also. Taking a large mortgage interest deduction? Your deduction will be limited if your AGI is above $313,800 (married, joint, 2017). That effectively increases your tax rate. There are other phaseouts that can increase your effective rate. In some income ranges the imposition of the alternative minimum tax will increase your effective rate. We'll discuss this in more detail in your Year-End Planning--Individuals article.
A final note. The 35% tax bracket is narrow. For married, filing joint it ranges from $416,700 to $470,700. For individuals it ranges from $416,700 to $418,400, virtually nonexistent. Income above those thresholds is taxed at 39.6%. That makes planning difficult.
Things get more complicated, and there's a chance to save more tax dollars, if you do business as a C (regular) corporation. Unlike an S corporation or a partnership, a C corporation is taxed as a separate entity. Moreover, the first $50,000 of income is taxed at only 15%. The next $25,000 is taxed at 25%; the next $25,000 is taxed at 34%. Taxable income from $100,000 to $335,000 is taxed at 39%. (That's to eliminate the graduated rates on income below $100,000.) You may be able to take advantage of the graduated rates to substantially reduce this year's tax bite. The approach is called 'marginal tax rate analysis and it's very effective.
Example--Fred Flood is an employee and the sole shareholder of Madison Inc., a C corporation. Based on Fred's best estimates, Madison will have taxable income of $125,000 during 2017. So far this year, Fred has taken only $65,000 in salary. He and his wife together have taxable income of $75,000. That puts them at the lower end of the 25% bracket. On the other hand, the last $25,000 of income of Madison will be taxed at 39%. If Fred increases his salary by $25,000 Madison's income will decrease by that amount, saving $9,750 in taxes. His personal income will go up by the same amount, resulting in an additional $6,250 in taxes. The difference, $3,500 ($9,750 reduction in corporate taxes less $6,250 increase in personal taxes), is a permanent tax saving.
You can quickly figure the tax saving by finding the difference between your tax bracket and your corporation's. In this case the difference is 14% (39% less 25%). Multiply that by the income shift and you've got your answer.
It may be advantageous to shift income in the other direction.
Example--Fred is an employee and sole shareholder of Madison. Fred normally takes a small salary during the year but a big bonus in December. That totals $200,000. In addition, he has other sources of income. If he does that this year, Madison will have only $20,000 of income, all taxed at 15%. Meanwhile, Fred's individual marginal tax rate will be 33% (not counting the effect of other taxes such as medicare and net investment income tax). Assume Fred can forgo $25,000 of salary. The difference in the tax rates is 18%. Multiply that by $25,000 and the dollar saving is $4,500.
You've got to be careful here. Shift too much income and you'll end up with diminishing returns; the lower tax bracket will rise and the higher bracket will fall. At some point, shifting more income will actually increase taxes. Moreover, taking too much out in salary could result in the IRS recharacterizing the salary as a constructive dividend.
If you're in the top bracket on your personal return, the approach is trickier. You could be in the 39.6% bracket personally and, if the corporation's taxable income is between $335,000 and $10 million, the marginal rate is 34%. Moreover, increasing your salary to bring you into the 39.6% individual bracket will also mean taxes on capital gains will rise 5 percentage points to 20% from 15%. (That's before taking into account the 3.8% net investment income tax on other income.)
Even individual taxpayers in lower brackets can feel a pinch beyond just a higher tax rate. The net investment income tax (NII) starts at adjusted gross income of $200,000 ($250,000 married, joint) and there are phaseouts of itemized deductions, etc. (The net investment income tax applies to dividends, interest, passive income, capital gains, etc.)
Generally, the idea is to move income from one year to the next to be taxed at the lower rate.
If you've got carryforward losses from prior years and income in 2017, those losses could offset your corporate income. And if you have a loss for 2017 you can generally carry that loss back 2 years to offset profits and claim a refund for those years. Any losses that can't be carried back can be carried forward 20 years. That could be good news for your cash flow, but will mean you'll have to examine a number of scenarios before taking action. For example in 2015 you had $340,000 of net income as a result of several big sales. Generally, your net averages $100,000. For 2017 you've got a substantial loss which you can carry back to 2015 and generate a refund. Talk to your tax adviser.
There are some other points.
S Corporations, Partnerships, etc.
If you do business as an S corporation, partnership, sole proprietorship, etc. the net income (or loss) of the business is passed through to you and reported on your individual tax return. You want to defer income to next year if you anticipate being in a lower tax bracket. Conversely, you want to accelerate income into 2017 if you think you'll be in a higher bracket next year. (Note, LLCs are generally treated the same as partnerships or, if there is only a single member, treated as a sole proprietorship.)
Well, that's the general rule. But if the tax reform bill passes planning will be much more difficult than in the past. The devil is in the details, and the details depend on your particular situation. Here are some considerations. First, it looks like most deductions on your personal return will be limited next year. Depending on the final bill, you could lose all your state and local tax deductions. You could lose your deduction for medical expenses, and miscellaneous itemized deductions. That means, all things being equal, your taxes would rise. But all things are not equal--tax rates are scheduled to go down for most individuals. By how much depends on your situation. Second, S corporations, partnerships, etc. are scheduled to get a rate break. That could take the form of a maximum tax rate on qualified income of 25% or a special 9% rate for certain businesses (House bill) or a deduction from income based on a percentage of your income (Senate bill). But these rules would only apply to a capital-based business. Certain businesses such as the practice of medicine, law, architecture, accounting, consulting, etc. where capital is not a factor would not get the benefit of these provisions. All the pass-through income would be taxed at individual rates as it is currently.
In the case of an S corporation, under the House bill 70% of the income would be subject to the self-employment tax (100% for the businesses discussed immediately above). That could raise the income for some small S corporations where the shareholders/officers take a small salary relative to the net income. This could also impact limited partners and LLC members who are not active in the business.
Not only are these offsetting factors difficult to analyze, we're not yet sure of the final rules. Because of the potential impact on businesses, this could be a contentious issue when the bill is being reconciled.
Caution--The big unknown is what individual tax rates will be 2018 and beyond. If a bill passes rates will be lower, but by how much? For taxpayers making over $1 million, they may still be taxed at the same or close to the same 39.6% as currently on that higher income. But that's not true for everyone. For example, this year you were unemployed and your wife's business had a bad year. You'll be in the 12% bracket (under the Senate plan). Next year you expect to be fully employed and your wife's business will have recovered. You could be in the 22.5% bracket (Senate) for a substantial portion of income even if rates drop.That's true for two salaried individuals working regular jobs also. However, when planning for a business, you can encounter much wider income swings than if your income is from salary, interest, dividends, etc. alone. A bad year for the business can produce a substantial loss. Under current tax rules a net operating loss can be carried back two years or forward 20. The new law would only provide for carryforwards and, under one version, only 80% would be usable. C corporations report the carryback on their own returns. Net losses by a sole proprietorship, partnership, or S corporation account for net operating losses on the owner's personal tax return (Form 1040).
Example--You're the sole shareholder of Madison Inc., an S corporation. You anticipate a loss of $100,000 in 2017 and are projecting a profit of $120,000 in 2018. You and your wife have very little other income. At first glance you'd want to accelerate income into 2017 or defer deductions to 2018. But in 2015 Madison had an outstanding year, netting $250,000. You might want to increase your 2017 loss and carry it back to 2015 when you were in a high bracket. An added plus is that you'd get back cash from an earlier year. Finally, if rates drop, those losses won't be as valuable in futue years. If you have carryforward losses you should consider carefully using them in 2017.
There are some special considerations applicable to these entities. Keep these points in mind.
Not only is the net income or loss of the business passed through to the owner, so are certain 'separately stated items'. For example, if a partnership has $1,000 of interest income from bank accounts, your share of that item is passed through and reported as interest income on your personal return. That interest or dividend income will help you use any investment interest expense you have. Capital gains and losses will also be passed through. While you may not have sold any stocks through your business, you could have a capital gain (or ordinary income) on the sale of business assets such as a building, equipment, etc. They should be taken into account in your personal tax planning. Income or losses on real estate rental properties held by the S corporation or partnership is generally treated in the same way as if you owned the property in your own name.
We're assuming in the discussion below that you materially participate in the business. If you don't, the income, but not the losses, can be passed through to you. We can't define material participation in detail here (see our FAQ Material Participation), but you'd better talk to your accountant if you spend less than 500 hours per year in the business. And simply checking the books at the end of the week doesn't qualify. If you don't materially participate, planning is trickier. Losses that can't be used currently can be carried forward, but profits can't. You've got to report them currently.
Whether or not you can deduct a loss from an S corporation, partnership, or LLC on your personal return also depends on your basis and amount at risk in the business; you must be actively involved in the management of the company. If you don't have enough basis in the business and want to take the losses this year, contribute equity capital or loan the business money. (Partnerships may have some other options.) On the other hand, if the losses would be better utilized next year (you anticipate being in a much higher bracket), don't increase your basis. This can be a tricky issue. Check with your tax advisor.
Some activities generate adjustments for the alternative minimum tax (AMT). Again, a complex subject. As your income increases, the AMT exemption amounts usually are phased out. Large depreciation deductions are the most common business item to trigger an AMT problem. Farm activities are another one.
Deferring Income--Accelerating Deductions
By now you should have a good idea of which way you're headed. If 2017 is a big year and '18 won't be as good, you want to push income into 2018. If it's a tossup, and your projected income with any additional amount won't be high enough to put you in above the threshold where rates could be increased, you should probably still defer income; it'll improve your cash flow by delaying tax payments. Again, don't overdo it. Even if rates are lower, unless you're income will be in the higher brackets which will see the biggest drop (but not over $1 million, married joint or $500,000 single). Here are some strategies.
Depreciation. Last-minute, year-end purchases may qualify for a depreciation deduction, but only if the asset is 'placed in service' in 2017. (See our Glossary for a definition.) You can either expense the asset using Sec. 179 (see below) or take the 50% bonus depreciation for new assets. With bonus depreciation your total depreciation over the life of the asset is the same, you're just able to write off more in the first year, reducing taxes currently and improving cash flow. You can opt out of the bonus depreciation for any class of property, potentially improving tax options when you go to file your return.
Caution--If you buy too much in the last quarter of the year (more than 40% of your purchases for the full year), you may have to use the mid-quarter convention to compute depreciation on all assets put in service during the year. There's a slight chance you may come out ahead, but more than likely, you total depreciation for the year will be lower. Moreover, you'll have to endure depreciation computations more complex than usual. One approach is to try to keep your purchases below the 40% threshold. Items expensed using Sec. 179 are taken out of the mix. See below.
Caution--Buying an expensive auto may not help you out as much as you think. The maximum depreciation for the first year is $11,160 (2017 amount; $3,160 for used autos), no matter how expensive the car is. Depreciation in later years is also limited, $5,100 in year two, $3,050 in year three and $1,875 in the fourth and subsequent years. Slightly higher limits apply to trucks and vans. Vehicles built on a truck chassis that exceed 6,000 pounds gross vehicle weight aren't subject to this rule.
Expense option. The law (Sec. 179) also allows you to expense up to $510,000 (2017 amount) in asset purchases such as shop equipment, furniture and fixtures, etc., but not real property (see an exception below). (That maximum first-year depreciation for luxury cars also applies here.) There's another plus. Any expensed asset doesn't count toward the total assets placed in service under the mid-quarter convention rule. Thus, if you buy a $15,000 machine in December and elect to expense it under this provision, it's removed from the base. Any assets that qualify reduce your income dollar for dollar. The assets must generally be tangible personal property. And there are two limitations--one is a business income limitation (it can't reduce your income below zero); the other applies if you put more than $2,030,000 (2017) of such property in service during the year. If you can't use the writeoff because of the income limitation the unused amount can be carried forward.
Property that can be expensed under Section 179 also includes qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.
Accelerate purchases. Purchase office and operating supplies you might need next year, do repairs and maintenance on equipment, get started on that advertising program, etc. Be careful, however. Special rules apply to companies that must capitalize more costs into inventory. Manufacturers are especially vulnerable. And make sure the repairs are really repairs, not capital improvements.
Small equipment. Most businesses can expense up to $2,500 per invoice in equipment. (The limit is $5,000 for taxpayers with an applicable financial statement; generally for a small business that means an audited statement.) That means a $1,600 computer, desk, etc. can be expensed without resorting to using the Section 179 expense option on it. This is a big advantage from several standpoints. First, you don't have to track the equipment for depreciation purposes. (You've still got to keep records on the purchase.) Second, the purchase doesn't fall under some of the Section 179 rules which can be restrictive. The flip side is that you have to have a policy (unwritten is acceptable; written is preferred) of expensing up to $2,500 (or some lower number). And you'll have to use the same approach for book and tax purposes.
This may be a quick way to reduce income and get your money's worth out of a tax deduction. Small purchases can be done quickly. Many small items can be ordered from a vendor's stock. Larger equipment could entail a custom order which might not be "placed in service" by December 31. But be careful. Buying an item that may not be used for over a year that comes with a 1-year warranty may be a poor business decision. So is buying equipment you may never need or fully utilize just to get a bigger deduction.
Inventory purchases don't count. True inventory purchases are generally not deductible until the items are sold. (But see below for obsolete inventory.)
If you're on the cash basis, payments made by December 31 are generally deductible. Thus, make sure you pay any bills before the end of the year. Payments made in cash, by credit card, or a check mailed before the end of the year count.
If you're on the accrual basis, the rules become more complex. You may have to show that, by the end of the year, the liability was fixed, and the goods or services were provided. (There's more to this issue, but it's beyond the scope of this article.) You may be able to accelerate the deduction by cutting a check before the end of the year. Additionally, if there's any uncertainty as to the liability (for example, you contract to have a project done, but the price is contingent on a number of factors), firm it up before the end of the year.
Pay bonuses to employees. If it's been a good year, pay bonuses to employees. Be sure to warn them that it may be a one-time event so they don't believe it's part of their salary. There are no special tax implications here. The bonuses are just like additional salary. (But check the withholding rules.)
Expense accounts. Make sure all employees turn in their expense reports on time. If you're on the cash basis, consider an earlier cut off, say December 20, so that the reports can be processed and the checks cut before the end of the year. Then a second report for the 11-day short period.
Writeoffs. You can write off any undepreciated value of equipment abandoned before the end of the year. In order to claim a loss you have to take some affirmative action. You can sell it for scrap (get a receipt), donate it, or sell it to another business. Leaving it in the corner of the shop won't do.
You can deduct business bad debts that are partially or wholly worthless, but, once again, proof is important. Make a concerted effort to collect the debt before the end of the year. Consider turning collection over to an attorney who specializes in this area. You may have to pay him 25% to 50% of what he recovers, but that's a small price to pay if he collects some cash for you and you get a tax deduction for the remainder.
Inventory writeoffs are trickier, but may produce much more in savings. You've got to be able to show the decrease in value. Not too much trouble if you use the 'lower of cost or market' method and can prove the market prices. But more likely than not, that option is not available. You can show the price is below carrying cost by actual (bona fide) sales within 30 days of the inventory date. Value the inventory at the selling price less costs of disposal. Inventory that may qualify for the writedown includes shopworn, obsolete, out of style, etc. goods. You can also write down the value of unsalable goods. For example, those damaged in processing, returns, etc. Figure the cost of reworking them. Check with your tax advisor on the details here.
Farmers and ranchers. Farmers and ranchers using the cash method can deduct prepaid feed costs in the year of payment if the expenditure is a payment and not a deposit; there's a business purpose for the payment; and deducting the amount doesn't materially distort income. Farmers should keep in mind that they can income average their farm income.
State income taxes. Compute and make any estimated state income taxes before the end of the year. Special rules may apply. Talk to your tax advisor.
Charitable contributions. A C corporation can deduct charitable contributions accrued before the end of the year if paid within 2-1/2 months of yearend. The contribution must be authorized by the board of directors and a copy of the minutes must be attached to the tax return. This doesn't apply to other entities. S corporations, partnerships, etc. must make the contribution before the end of the year and the deduction is passed through to the shareholders or partners and reported on their personal return.
Related taxpayers. 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, 2017 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 2018. Madison can't accrue the expenses in 2017; they're only deductible when paid in 2018.
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.
Personal service corporations. The related taxpayer rule is extended for personal service corporations. They can't deduct payments made to any shareholder/employees before the amounts are includible in the income of the recipient.
Example--Dr. Flood is a 5% shareholder in Madison Healthcare Inc., a regular corporation. At the end of 2017 Madison accrues $12,000 in salary to the doctor. If Madison doesn't pay the doctor before December 31 it can't deduct the amount until it's paid in 2018.
Disabled access. The law contains two special provisions that can help your year-end planning. The first is the disabled access credit. You can take a credit of up to 50% of the amount of any eligible expenditure that enables a small business to comply with the requirements of the Americans with Disabilities Act. For example, removing architectural barriers such as putting in a ramp, widening booths in a restaurant, modifying equipment or devices for disabled workers or customers, etc. The eligible expenditures can't exceed $10,250 for the year.
Second, you can immediately expense, rather than capitalize, costs to remove architectural and transportation barriers to elderly and disabled individuals. Careful. While there's some overlap with the disabled access credit, only expenditures to remove architectural barriers apply here. You can get the maximum benefit by taking the credit on some items and saving the expense election for others. There's an annual limit of $15,000 on these expenses.
There's still time this year to take advantage of both benefits, but you must act quickly.
Incentive stock options. If you've issued incentive stock options to employees and some of them have exercised, but not sold the stock, encourage them to make a disqualifying disposition. By selling the stock early, and before the end of the year, they avoid any alternative minimum tax treatment and the company gets a tax deduction.
Defer income. Cash-basis taxpayers can delay billing customers until it's too late to get the check before next year.
If you're on the accrual basis, deferring income is more difficult. Income is taxable when all events that determine the right to receive the income have occurred and the amount is determined with reasonable certainty. A complete discussion is beyond the scope of this article. However, you can't defer reporting the income by not billing. Selling goods on consignment (if that's possible) can defer income.
You should also be careful with respect to customer deposits. If you have unrestricted use of the funds and you do not have to repay the amount, a deposit becomes taxable income when received. Similarly, amounts received before services have been provided or goods have been delivered are reportable.
This can quickly become a tricky issue. It gets even more complicated if you want to report an amount for financial statement purposes, but defer it for tax reporting. The ultimate outcome will depend heavily on the facts and circumstances. Best to discuss the details with your tax advisor.
Installment sale. You may be able to defer taxes with an installment sale. That won't work for stock in trade (i.e., inventory items), but can be helpful if you're selling equipment, real estate, etc. Careful. You can't defer recognition of any depreciation recapture. That's all income in the year of sale.
Like-kind exchange. If you need new equipment, trucks, etc. a like-kind exchange will defer any gain on the sale. That includes any depreciation recapture. CAUTION. The equipment must be of the same class. For example, a truck for a truck. You can't trade 5 computers for a truck. Caution, a like-kind exchange will also defer a loss. Analyze your situation carefully.
Simplified Employee Pension. Probably the simplest of all plans. The business makes a contribution to the employee's SEP-IRA. Payment doesn't have to be made till the extended due date of the business return. The business gets a deduction, but it's not taxable to the employee for income or FICA. You decide every year how much to contribute. Use Form 5305-SEP to set up the plan.
Accelerating Income--Deferring Deductions
If you think you'll be in a higher bracket next year you should weigh accelerating income into 2017. Be careful not to overdo it. Fortunately, this is often easier than deferring income. Again, with rates anticipated to be lower in 2018 under any scenario, you should thread carefully here.
Accelerating income. Cash-basis taxpayers can bill customers earlier. Many may want to pay before the end of the year. You might want to offer a discount for early payment.
Accrual-basis taxpayers can make sure income will be included in 2017 by finishing projects, delivering goods or services, or making sure that both the right to receive the income is fixed and the amount is determinable with reasonable accuracy. It should be pretty easy to word a contract or agreement in such a way as to guarantee the amount will be includible. Check with your accountant on the details.
Collapse installment sale. You can make all the unrecognized gain on an installment contract taxable in 2017 by pledging the installment note for a loan or by selling the note. This approach can have substantial costs (e.g., you may have to discount the note), so be sure to weigh all the pros and cons.
Equipment sales. If you got some equipment that's not being used, consider selling it. The sale will generate cash, only some of which will be offset by the tax. In most cases any gain will be ordinary income from depreciation recapture. You could also have a loss. Any loss is generally fully deductible, without the capital loss limitations. (See below for some capital gain/loss strategies for regular corporations.)
Another option is a sale and leaseback. This is usually used just to generate cash, but there's nothing wrong with using it to create taxable income. If the asset is fully depreciated or almost so, you may be able to generate deductions in future years. This option shouldn't be taken lightly. Work through the numbers with your accountant.
Defer depreciation. While you need take no action now, you can reduce your depreciation expense for 2017 by not electing the Sec. 179 expense allowance. The 50% bonus depreciation is automatic; you can, however, make an election not to take it. There may be more than one way to reduce your depreciation deduction. The elections are made when you file your return.
You can defer any depreciation on new equipment to next year by delaying the purchase of the asset or at least making sure that it doesn't qualify as being placed in service (see the glossary) in 2017.
Delay writeoffs. You may not have to write off obsolete equipment or inventory this year. However, things are trickier for bad debts. You must generally write them off in the year they become worthless.
Defer expenses. You can defer expenses by not making repairs, delaying bonuses, waiting until 2018 to buy office supplies, stretching out some contractual payments, etc.
Casualties. If you suffered a casualty loss in 2017 that was fully reimbursed by insurance, and don't buy qualified replacement property during the applicable replacement period, you'll have to report a gain (or loss) as a result of the casualty.
Example--Your equipment was destroyed by a fire. At the time of the fire the property was worth $250,000, but your adjusted basis in the equipment was only $50,000. You got a check from the insurance company for $250,000. If you buy suitable replacement property you can avoid recognizing the $200,000 gain. However, because of the fire you'll have a $300,000 operating loss for the year. Because of losses in prior years you can't carry the loss back and it could take years to use it up as a carryforward. The best approach here could be to not replace the property. Report the gain. Because of the losses you'll still pay no taxes and can start fresh, using those higher depreciation deductions in future years when they'll do the most good.
Election to amortize. There are a number of expenses that may be deductible or can be capitalized and amortized over a number of years. In addition, sometimes it's possible to choose an amortization period that's longer than normal. Stretching out a deduction can often be beneficial for a start-up company.
C Corporations have some special problems and planning possibilities, particularly this year. Here's a review of some of the more frequently encountered ones.
Lower rate in 2018. Generally you want to level income tol stay below the top bracket if you're a smaller corporation. But in 2018 the top rate could be 20% so there's a great incentive to defer income to 2018 and accelerate deductions into 2017. the Senate version would delay the lower rate to 2019.
Capital gains and losses. Capital gains of a C corporation are generally taxed at ordinary income rates, but no more than 35%. Capital losses can be carried back 3 years and forward 5. After that they're lost. If you have capital losses that may be expiring, try to generate offsetting capital gains.
Net operating losses. Net operating losses (NOLs) can be carried back or forward. See the discussion at the beginning of this article. If you have, or could have, an NOL this year, you may want to increase the loss if the year to which it will be carried was a high tax one. For example, you're usually in the 15% bracket, but in 2015 you were in the 35% bracket.
Paying dividends. You might want to consider paying a dividend out of the corporation. Such a move might reduce the risk of an accumulated earnings or unreasonable compensation issue in the future, or can reduce your accumulated earnings and profits if you're thinking of switching to a S corporation. With the tax rate on dividends for individuals now 15% (0% for those in the 10% or 15% bracket; 20% in the 39.6% bracket; add 3.8% if you're subject to the net investment income tax), the tax bite isn't as onerous as it once was. Since the corporation still won't get a deduction, paying a salary or other deductible expense to get cash into the shareholder's pockets generally still makes the most sense. Consider longer-term financing needs. It may not make sense to pay a dividend now if you'll need the money down the road to finance equipment, purchase a building, etc. Check with your tax advisor.
There are also some special considerations for S corporations. Some of the points below are very technical in nature, but you can achieve considerable tax savings if you're careful. Check with your tax advisor before acting.
Basis problems. You can only deduct losses up to your basis in the S corporation. Unused losses can be carried forward and used later. If you're in a high bracket this year, you might want to consider adding equity capital or making a loan to the corporation to use the losses in 2017. If losses have used up all your equity and debt basis in an S corporation, repayment of debts the corporation owes you will generate taxable income. If you take a distribution from the corporation that exceeds your basis, you may have a capital gain.
C corporation history. If your S corporation was once a C corporation, there's a good chance that there's some accumulated earnings and profits from the C corporation. These 'tainted' amounts can cause problems. If your personal income is low this year, consider a dividend of some or all of these amounts. It'll provide benefits for the S corporation in the future. CAUTION. A special election must be made. Consult your tax advisor.
Deferred compensation. Special rules apply to accrued vacation and similar deferred compensation transactions. You can accrue such payments at the end of 2017, but they'll only be deductible in 2017 if actually paid within 2-1/2 months of yearend. A note, letter of credit, etc. won't work. And this will only work for unrelated employees.
Net investment income tax. This tax is on investment gains, dividends, interest, rental income, etc. It also applies to passive income from S corporations, partnerships, LLCs, etc. Most small business owners materially participate in their business. In such cases the tax isn't a factor. But you could have an equity interest in a friend or relative's business where your participation is minimal. Income from that business will be subject to the 3.8% NII if your AGI exceeds $200,000 ($250,000 for married, joint). It's pretty late in the year to do much about it unless you're near the threshold for material participation.
Salaries. The IRS is getting serious about officers' salaries in an S corporation. If you (or another party) is an officer or provides services to the corporation you must be compensated. The big question is how much. For more information go to S Corporation Salary--Two Recent Cases and S Corporation Officers' Salaries. Taking no salary is very likely to cause a red flag. Taking only a nominal amount may be only slightly better. If you've got excess cash in the corporation taking a substantial distribution this year could make sense. There is talk about imposing social security and medicare withholdings on either distributions or all earnings from an S corporation in the future. There are both tax and nontax issues involved. Discuss this with your tax advisor.
Basis problems. The rules generally follow S corporations (see above) but you can also include amounts for which you, as a partner, are personally at risk. That means loans of the partnership for which you are liable. But that cuts both ways. An increase in such loans increases your amount at risk; a reduction in such loans decreases your amount at risk. Check your status before the end of the year.
NII. Like S corporations, your share of income from partnerships and LLCs where you don't materially participate is subject to the net investment income tax. See the discussion above.
Reconsider Entity Choice
While you're doing your year-end planning you should also take the time to reevaluate your choice of entity. If you do business as a sole proprietor you might want to incorporate or form an LLC. In the past, doing business as a sole proprietorship, LLC, partnership, or S corporation was preferable to a C corporation because of the high rate and double taxation. For many business owners, that may no longer be the case if the proposed legislation is passed. The top rate for C corporations would be 20%--and that could be less than for pass-through entities. If you've got a small business, say a one-man operation and don't expect to expand, a pass-through may continue to make sense.
On the other hand, if the business is substantial and the earnings from a passthrough put you into a higher bracket even under the proposed law, you should consider switching to a C corporation. That's particularly true if the business is retaining income for growth and isn't paying dividends. There are a number of factors to consider here including the future sale of the business and if you could be classified as a personal service corporation (doctors, lawyers, etc.) which are anticipated to be taxed at a higher rate. In addition, disallowed business deductions such as T&E, personal auto usage, etc. can be classified as dividends, nondeductible by the business but income to shareholders. This is not a decision to be made lightly. You have to discuss this with your tax advisor.
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--Last Update 12/01/17