Making the Most of Tax Reform in Your Year-End Tax Planning

Since the Tax Cuts and Jobs Act (TCJA) passed in late 2017, businesses have worked to understand its effects on the tax landscape. Now the first tax season under TCJA is looming, making it a good time to examine your tax strategies, determine which tried-and-true approaches are still viable, and identify how your business can seize the most advantage from the new law.

New savings, tough choices

Tax reform opens up new avenues of potential tax savings for businesses; however, taking some of these new roads will require hard decisions.

For example, the TCJA has led some businesses to question whether they should restructure to become a C corporation or a pass-through entity. The former is subject to potential double taxation (at the entity and dividend levels) but now enjoys a corporate tax rate of just 21% (down from 35%). Pass-through entities face only an individual tax rate, which can run as high as 37%, but some could qualify for a new, full 20% deduction on qualified business income (QBI).

For those who qualify for a full QBI deduction, the maximum effective tax rate for pass-through entities will be 29.6%. But there are other factors to consider. For example, the TCJA limits the state and local tax deduction for individual pass-through owners but not for corporations. Furthermore, the new corporate rate is permanent, while the QBI deduction is scheduled to sunset after 2025.

Ultimately, the best structure for each business depends on its facts and circumstances. A business that goes the pass-through route, though, has several tactics available to maximize its QBI deduction.

The deduction is subject to limits based on W-2 wages paid, the unadjusted basis of a taxpayer’s qualified property and taxable income. A business, therefore, might increase its wages by converting independent contractors to employees, assuming the benefit isn’t outweighed by higher payroll taxes, employee benefit costs and similar considerations. It could also purchase assets before year end to pump up its unadjusted basis. And individual pass-through owners can maximize their above-the-line and itemized deductions to reduce their taxable income.

The TCJA also establishes a business tax credit for paid family and medical leave — a credit that businesses can claim for 2018 as long as they adopt a retroactive policy before the end of the year. Eligible employers may claim the credit if they have a written policy that provides at least two weeks of annual paid family and medical leave to all employees who meet certain requirements, at a pay rate of at least 50% of normal wages. The maximum credit is 25% of wages paid during leave.

Shifting strategies and a warning about QIP

Not surprisingly, the TCJA alters several year-end strategies businesses have used in the past to curb liability. It bolsters some strategies, while trimming or ending the advantages of others.

Asset acquisitions are a good example. For several years, such acquisitions have offered a smart way to cut taxes through bonus depreciation and Section 179 depreciation deductions. The TCJA expands both types of deductions, potentially making investments in equipment and other assets even more advantageous.

Businesses could immediately write off 50% bonus depreciation on qualified new property purchased in 2017. Before the TCJA, eligible property included new computers, software, vehicles, machinery, equipment, office furniture and qualified improvement property (QIP, generally defined as interior improvements to nonresidential real property).

The TCJA extends and modifies bonus depreciation for qualified property purchased after September 27, 2017, and before January 1, 2023. Businesses can expense the entire cost of such property (both new and used, subject to certain conditions) in the year the property is placed in service. The deduction will begin to phase out in 2023, dropping 20% each year for four years until it disappears in 2027, unless Congress acts to extend it. Be aware that certain property with a longer production period will be eligible for the bonus depreciation for an extra year, as the phase-out doesn’t start until 2024.

Be aware that Congress removed QIP from the definition of qualified property eligible for bonus depreciation, intending that it would nonetheless remain eligible because its recovery period would be reduced to 15 years. (Qualified property must have a recovery period of 20 years or less.) Due to a drafting error, though, the TCJA didn’t define QIP as 15-year property, so it defaults to a 39-year recovery period. Without a technical correction or regulatory guidance, QIP won’t qualify for bonus depreciation in 2018.

QIP placed in service after December 31, 2017, is eligible for immediate expensing (deducting the entire cost) under Section 179. The TCJA expands this depreciation to several improvements to nonresidential real property — roofs, HVAC, fire protection systems, alarm systems and security systems. It also almost doubles the maximum deduction for qualifying property, from $510,000 to $1 million. (The maximum deduction remains limited to the amount of income from business activity.) The TCJA increases the phase-out threshold to $2.5 million from $2.03 million in 2017.

Businesses have traditionally used employee benefits to shrink their tax liability; however, the TCJA narrows those opportunities. For example, it eliminates or tightens tax breaks for transportation benefits, on-premises meals, moving expenses reimbursement and achievement awards. (Some of these changes are only temporary.) Businesses might, however, reap tax benefits from Health Savings Accounts, Flexible Spending Accounts, Health Reimbursement Accounts, health insurance and group term-life insurance. Moreover, a business could have nontax-related reasons, such as employee recruitment and retention, to offer certain benefits.

Old favorites — surviving tax credits

Although many tax credits were in the crosshairs as the TCJA was being drafted, several of the most popular survived, including the Work Opportunity tax credit, Small Business Health Care tax credit, the New Markets tax credit and the research credit.

The TCJA even boosts the value of the research credit. That’s because taxpayers generally must either reduce their business deductions by the amount of their research credit or take a reduced research credit to preempt a double tax benefit. The reduced credit is computed based on the maximum corporate tax rate. By cutting that rate from 35% to 21%, the TCJA increases the net benefit of the research credit to 79%, compared to 65% in previous years.

Businesses looking to trim their tax bills also can continue to turn to the trusty standby strategy of deferring income into 2019 and accelerating deductions into 2018. For example, a business that uses cash-basis accounting might “slow roll” its invoices to push the receivables into the new year or prepay expenses. Notably, the TCJA has greatly expanded eligibility for cash-basis accounting, making it generally available to businesses with three-year average annual gross receipts of $25 million or less.

You still have time to take advantage

Whether your business operates on a calendar- or fiscal-year basis, your 2018 tax bill isn’t yet written in stone. It’s not too late to execute some strategies that reduce your business’s tax liabilities and improve its bottom line.

© 2018