Year-End Tax Planning in a TCJA World

It’s a TCJA world, and businesses are just planning in it. For many, the first tax-filing season under the Tax Cuts and Jobs Act (TCJA) was a time of uncertainty as they struggled with the law’s sweeping changes for their bottom lines and the resulting implications. You can incorporate the lessons learned into your year-end tax planning, especially with the next filing so near. Several areas are ripe with opportunities to reduce your 2019 federal tax liability.

Choices for Your Company

It is worthwhile to re-evaluate whether your current entity type is the most tax-favorable, especially the qualified business income (QBI) deduction for pass-through entities, paired with the corporate tax rate reduction to a flat 21% rate from a 35% top rate.

Traditionally, pass-through entities, including sole proprietorships, partnerships and S corporations, have been seen as a way to avoid potential C corporation double taxation at the entity and dividend levels. Pass-through entities are taxed only once at an individual tax rate, but that rate can be as high as 37%. Although it’s not always the case (see below), if they qualify for the full 20% QBI deduction, their effective tax rate is about 30%.

Additionally, deduction for state and local taxes also play a role in choice. The TCJA limits the deduction amount for individual pass-through entities, not for corporations.

Although the QBI deduction is slated to end after 2025, remember that the reduced corporate rate is permanent (or as permanent as any tax cut can be). Your business’ individual circumstances will ultimately determine the optimal structure.

Maximize QBI Deductions

Before December 31, pass-through entities can take several steps to maximize their QBI deduction. The deduction is subject to phased-in limitations based on W-2 wages paid (including many employee benefits), the qualified property unadjusted basis and taxable income. By increasing wages (by hiring new employees, giving raises or making independent contractors employees), you could boost your deduction. You can invest in qualified property by year-end to increase your adjusted basis.

If the W-2 wages limitation doesn’t limit the QBI deduction, S corporation owners can increase their deductions by reducing their own wages; this tactic won’t work for sole proprietorships or partnerships, because they don’t pay their owners salaries. However, if the W-2 wages limitation limits the QBI deduction, they might increase the deduction by increasing their wages.

Your Tax Credit Potential

Some of the most popular tax credits survived the tax overhaul, including the Work Opportunity Tax Credit (WOTC), the Small Business Health Care tax credit, the New Markets Tax Credit (NMTC) and the research credit (also called the “research and development,” “R&D” or “research and experimentation” credit). Smaller businesses may qualify for a credit by starting new retirement plans.

It’s important to make qualified hires before the year’s end; the WOTC is scheduled to expire on December 31st, and it is typically worth a maximum of $2,400 per employee (although for certain employees that can increase to $9,600). Also set to expire at year-end is the NMTC — 39% over seven years.

Claim Your Capital Asset Investments

For years, a valuable tool for reducing taxable income has been purchasing equipment and other qualified capital assets. Now, the TCJA has expanded bonus depreciation and Section 179 expensing (that is, deducting the entire cost in the current tax year).

You can deduct the entire cost of new and used (subject to certain conditions) qualified property in the year the property is utilized if the qualified property was purchased after September 27, 2017, and before January 1, 2023. For property with a longer production period, special rules apply.

Computer systems, computer software, vehicles, machinery, equipment and office furniture is considered eligible property. Starting in 2023, the deduction amount will drop 20% each year going forward, disappearing altogether in 2027, absent congressional action.

Thus far, Congress has failed to take corrective action on a drafting error in the TCJA that leaves qualified improvement property (generally interior improvements to nonresidential real property) ineligible for bonus deprecation.

However, qualified improvement property is eligible for Sec. 179 expensing. The TCJA made this available for several improvements to nonresidential real property, including roofs, HVAC, fire protection systems, alarm systems and security systems. It also increases the maximum deduction for qualifying property; the limit is $1.02 million for 2019 (the maximum deduction is limited to the amount of income from business activity). When qualifying property used this year exceeds $2.55 million, the expensing deduction begins phasing out on a dollar-for-dollar basis.

Deferring Income and Accelerating Expenses

This technique has long been employed by businesses that don’t expect to be in a higher tax bracket the following year. For example, if you use cash-basis accounting, you might defer income into 2020 by sending your December invoices toward the end of the month (note that the TCJA now allows businesses with three-year average annual gross receipts of $25 million or less to use cash-basis accounting). You can delay goods and services delivery until January if your accounting is done on an accrual basis.

Any business can accelerate deductible expenses into 2019 by putting them on a credit card in late December and paying them off in 2020 (subject to limitations). As well as certain other expenses, cash-basis businesses can prepay bills due in January. Some caveats now apply to this approach. First, it could affect the QBI deduction for pass-through entities. Maximizing the deduction while it’s still available might make more sense — the deduction currently is scheduled to cease after 2025 and, depending on the results of the 2020 elections, could be eliminated prior. Moreover, this tactic isn’t advisable if you’re likely to face higher tax rates in the future.

The Time is Now

You still have time to make a significant dent in your business’s federal tax liability for 2019. Weaver can help you chart the best course forward to minimize your tax bill and put you on solid ground for upcoming tax years.