Tax planning could be a challenge for businesses this year. As of this writing, several valuable tax breaks that expired Dec. 31, 2013, have not been revived by Congress. In addition, some significant tax-related changes under the ACA require attention. Finally, with the economic recovery continuing to move forward at a snail’s pace in many sectors, you may not know which tax strategies will be appropriate this year. You can tackle these challenges head on by reviewing the information here and then discussing the relevant issues with your tax advisor.
Projecting income
Projecting your business’s income for this year and next can allow you to time income and deductions to your advantage. It’s generally — but not always — better to defer tax, so consider:
*Deferring income to next year. If your business uses the cash method of accounting, you can defer billing for products or services. If you use the accrual method, you can delay shipping products or delivering services.
*Accelerating deductible expenses into the current year. If you’re a cash-basis taxpayer, you may make a state estimated tax payment by Dec. 31, so you can deduct it this year rather than next. But consider the alternative minimum tax (AMT) consequences first. Both cash- and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid.
Warning: Don’t let tax considerations get in the way of sound business decisions. For example, the negative impact of these strategies on your cash flow may not be worth the potential tax benefit.
*Taking the opposite approach. If it’s likely you’ll be in a higher tax bracket next year, accelerating income and deferring deductible expenses may save you more tax.
Depreciation
For assets with a useful life of more than one year, you generally must depreciate the cost over a period of years. In most cases, the Modified Accelerated Cost Recovery System (MACRS) will be prefer- able to the straight-line method because you’ll get larger deductions in the early years of an asset’s life.
But if you make more than 40% of the year’s asset purchases in the last quarter, you could be subject to the typically less favorable mid quarter convention. Careful planning can help you maximize depreciation deductions in the year of purchase.
Other depreciation-related breaks and strategies also may be available:
*Section 179 expensing election. This allows you to deduct (rather than depreciate over a number of years) the cost of purchasing eligible new or used assets, such as equipment, furniture and off-the-shelf computer software. As of this writing, the expensing limit for 2014 is $25,000, and the break begins to phase out dollar-for-dollar when total asset acqui- sitions for the tax year exceed $200,000. You can claim the election only to offset net income, not to reduce it below zero to create an NOL.
Warning: The expensing limit and phaseout threshold have dropped significantl from their 2013 levels. And the break allowing up to $250,000 of Sec. 179 expensing for qualified leasehold-improvement, restaurant and retail-improvement property also expired Dec. 31, 2013. Congress may revive the enhanced Sec. 179 breaks. So check with your tax advisor for the latest information.
*50% bonus depreciation. This additional first-year depreciation allowance expired Dec. 31, 2013, with a few exceptions. But Congress may revive bonus depreciation. Check with your tax advisor for the latest information.
*Accelerated depreciation. The break allowing a shortened recovery period of 15 years — rather than 39 years — for qualified leasehold-improvement, restaurant and retail-improvement property expired Dec. 31, 2013. However, it might be revived. Check with your tax advisor for the latest information.
*Cost segregation study. If you’ve recently purchased or built a building or are remodeling existing space, consider a cost segregation study. It identified property components that can be depreciated much faster, increasing your current deductions. Typical assets that qualify include decorative fixture, security equipment, parking lots and landscaping.
Vehicle-related deductions
Business-related vehicle expenses can be deducted using the mileage-rate method (56 cents per mile driven in 2014) or the actual-cost method (total out-of-pocket expenses for fuel, insurance and repairs, plus depreciation).
Purchases of new or used vehicles may be eligible for Sec. 179 expensing. However, many rules and limits apply. For example, the normal Sec. 179 expensing limit generally applies to vehicles weighing more than 14,000 pounds. Even when the normal Sec. 179 expensing limit is higher, a $25,000 limit applies to SUVs weighing more than 6,000 pounds.
Vehicles weighing 6,000 pounds or less are subject to the passenger automobile limits. For autos placed in service in 2014, the first-yea depreciation limit is $3,160. The amount that may be deducted under the combination of MACRS depreciation and Sec. 179 for the first year is limited under the luxury auto rules.
In addition, if a vehicle is used for business and personal purposes, the associated expenses, including depreciation, must be allocated between deductible business use and non deductible personal use. The depreciation limit is reduced if the business use is less than 100%. If business use is 50% or less, you can’t use Sec. 179 expensing or the accelerated regular MACRS; you must use the straight-line method.
*Manufacturers’ deduction
The manufacturers’ deduction, also called the “Section 199” or “domestic production activities deduction,” is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts.
The deduction is available to traditional manufacturers and to businesses engaged in activities such as construction, engineering, architecture, computer software production and agricultural processing. It isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the AMT.
*Employee benefit
Offering a variety of benefit not only can help you attract and retain the best employees, but also may save tax:
**Qualified deferred compensation plans. These include pension, profit- sharing, SEP and 401(k) plans, as well as SIMPLEs. You take a tax deduction for your contributions to employees’ accounts. Certain small employers may also be eligible for a credit when setting up a plan.
**HSAs and FSAs. If you provide employees with a qualified high-deductible health plan (HDHP), you can also offer them Health Savings Accounts. Regardless of the type of health insurance you provide, you can offer Flexible Spending Accounts for health care. If you have employees who incur day care expenses, consider offering FSAs for child and dependent care.
**HRAs. A Health Reimbursement Account reimburses an employee for medical expenses up to a maximum dollar amount. Unlike an HSA, no HDHP is required. Unlike an FSA, any unused portion can be carried forward to the next year. But only the employer can contribute to an HRA.
**Fringe benefit. Some fringe benefit — such as employee discounts, group term- life insurance (up to $50,000 annually per person), parking (up to $250 per month), mass transit / van pooling (up to only $130 per month, unless Congress revives transit benefi parity; check with your tax advisor for the latest information), and health insurance — aren’t included in employee income. Yet the employer can still receive a deduction for the portion, if any, of the benefi it pays and typically avoid payroll tax as well.
NOLs
A net operating loss occurs when operating expenses and other deductions for the year exceed revenues. Generally, an NOL may be carried back two years to generate a refund. Any loss not absorbed is carried forward up to 20 years to offset income.
Carrying back an NOL may provide a needed influx of cash. But you can elect to forgo the carry back if carrying the entire loss forward may be more beneficial. This might be the case if you expect your income to increase substantially or tax rates to go up.
Tax credits
Tax credits reduce tax liability dollar- for-dollar, making them particularly valuable. Numerous credits are avail- able, but two of the most valuable expired Dec. 31, 2013, and, as of this writing, have yet to be revived:
1. Research credit. When available, this credit (also commonly referred to as the “research and development” or “research and experimentation” credit) generally is equal to a portion of qualified research expenses.
2. Work Opportunity credit. This credit was designed to encourage hiring from certain disadvantaged groups. Examples of groups that have qualified in the past include food stamp recipients, ex-felons and certain veterans.
Check with your tax advisor for the latest information on the status of these and other expired credits.
One credit that didn’t expire is the retirement plan credit. Small employers (generally those with 100 or fewer employees) that create a retirement plan may be eligible for a $500 credit per year for three years. The credit is limited to 50% of qualified startup costs.
Business structure
Income taxation and owner liability are the main factors that differentiate one business structure from another. (See Chart 3 to compare the tax treatments.) Many businesses choose entities that combine flow-through taxation with limited liability, namely limited liability companies (LLCs) and S corporations.
The top individual rate is now higher (39.6%) than the top corporate rate (generally 35%), which might affect business structure decisions. For tax or other reasons, a structure change may be benefcial in certain situations, but there also may be unwelcome tax consequences.
Some tax differences between structures may provide tax planning opportunities, such as differences related to salary vs. distributions/dividends:
*S corporations. Only income that shareholder-employees receive as salary is subject to employment taxes and, if applicable, the 0.9% Medicare tax. To reduce these taxes, you may want to keep your salary relatively (but not unreasonably) low and increase your distributions of company income — which generally isn’t taxed at the corporate level or subject to the 0.9% Medicare tax (see page 3) or 3.8% NIIT (see page 6).
*C corporations. Only income that shareholder-employees receive as salary (which is deductible at the corporate level) is subject to employment taxes and, if applicable, the 0.9% Medicare tax. Nevertheless, you may prefer to take more income as salary as opposed to dividends (which aren’t deductible at the corporate level, but are taxed at the shareholder level and could be subject to the 3.8% NIIT) if the overall tax paid by both the corporation and you would be less.
Warning: The IRS is cracking down on misclassifcation of corporate payments to shareholder-employees, so tread carefully.
Sale or acquisition
Whether you’re selling your business or acquiring another company, the tax consequences can have a major impact on the transaction’s success or failure.
Consider installment sales, for example. A taxable sale might be structured as an installment sale if the buyer lacks sufficient cash or pays a contingent amount based on the business’s performance. An installment sale also may make sense if the seller wishes to spread the gain over a number of years — which could be especially ben- efcial if it would allow the seller to stay under the thresholds for triggering the 3.8% NIIT or the 20% long-term capital
gains rate. But an installment sale can backfire on the seller. For example:
** Depreciation recapture must be reported as gain in the year of sale, no matter how much cash the seller receives.
**If tax rates increase, the overall tax could wind up being more.
With a corporation, a key consideration is whether the deal should be structured as an asset sale or a stock sale. If a stock sale is chosen, another important question is whether it should be a tax-deferred transfer or a taxable sale.
Of course, tax consequences are only one of many important considerations when planning a sale or acquisition.
The self-employed
If you’re self-employed, you can deduct 100% of health insurance costs for your- self, your spouse and your dependents. This above-the-line deduction is limited to your net self-employment income. You also can take an above-the-line deduction for contributions made to a retirement plan and, if you’re eligible, an HSA for yourself.
You pay both the employee and employer portions of employment taxes on your self-employment income, and the employer portion of the tax paid (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible above the line.
And you may be able to deduct home offic expenses from your self- employment income.
WHAT’S NEW!
ACA’s play-or-pay provision scheduled to take effect Jan. 1, 2015
Who’s affected: “Large” employers, which for 2015 generally include those with at least 100 full-time employees or the equivalent, as define by the ACA. However, the threshold is scheduled to drop to 50 beginning in 2016.
Key changes: The play-or-pay provision imposes a penalty on large employers if just one full-time employee receives a premium tax credit. Under the ACA, premium tax credits are available to employees who enroll in a qualified health plan through a government-run Health Insurance Marketplace and meet certain income requirements — but only if:
* They don’t have access to “minimum essential coverage” from their employer, or
*The employer coverage offered is “unaffordable” or doesn’t provide “minimum value.”
The IRS has issued detailed guidance on what these terms mean and how employers can determine whether they’re a “large” employer and, if so, whether they’re offering sufficient coverage to avoid the risk of penalties. Final IRS regulations issued in February 2014 offer some transitional relief.
Planning tips: Although the play-or-pay provision isn’t scheduled to take effect until Jan. 1, 2015, if your business could be subject to the penalties, start reviewing your workforce and coverage offerings now. There may be changes you could make to avoid or minimize penalties. Or it may be cheaper to pay the penalties. But remember that penalties aren’t deductible, and not offering health care coverage could make it harder to attract and retain the best employees. Finally, keep in mind that the IRS may issue additional guidance or transitional relief, or Congress could make changes to the law. Check with your tax advisor for the latest information.
WHAT’S NEW!
Small businesses might enjoy a larger health care coverage credit in 2014
Who’s affected: Businesses with fewer than 25 full-time equivalent employees (FTEs as defned by the ACA for purposes of this credit) and average annual wages of less than $50,800 (for 2014).
Key changes: A few significant changes go into effect in 2014:
*Maximum credit. It has increased to 50% (from 35% in 2013) of group health coverage premiums paid by the employer, provided it contributes at least 50% of the total premium or of a benchmark premium. The qualification requirements for the full credit vs. a partial credit remain the same: The full credit is available for employers with 10 or fewer FTEs and average annual wages of $25,400 (for 2014) or less per employee. Partial credits are available on a sliding scale to businesses with fewer than 25 FTEs and average annual wages of less than $50,800 (for 2014).
*Two-year limit. The credit now can be taken for only two years, which must be consecutive years. But, even if you claimed it for tax years before 2014, you can still claim the credit for two years beginning in 2014 or later.
* SHOP requirement. Beginning in 2014, the ACA requires you to purchase Small Business Health Options Program (SHOP) coverage to qualify for the credit. However, the Treasury Department announced that employers without access to SHOP coverage will be eligible for the credit as long as they provide coverage that meets the guidelines of a SHOP plan.
Planning tips: If you’re eligible for the credit this year but you think it could pro- vide a greater benefit in a future year, you may want to refrain from taking it now.
Income Tax Differences based on business structure
CHART
*Flow-through entity
or sole proprietorship
One level of taxation: The business’s income
flows through to the owner(s)
The top individual tax rate is 39.6%.
*C Corporation
Two levels of taxation: The business is taxed on income, and then shareholders are taxed on any dividends they receive.
Losses flow through to the owner(s). Losses remain at the corporate level.
The top corporate tax rate is generally 35%1, and the top rate on qualified dividends is 20%.
WHAT’S NEW!
IRS has issued final regs for tangible property repairs vs. improvements
*Who’s affected: Businesses that have made repairs or improvements to tangible property, such as buildings, machinery, equipment and vehicles.
*Key changes: Costs incurred to acquire, produce or improve tangible property must be depreciated. But costs incurred on incidental repairs and maintenance can be expensed and immediately deducted. The final IRS regulations make distinguishing between repairs and improvements simpler. Here are some key provisions:
* *Routine maintenance safe harbor. Recurring activities dedicated to keeping property in efficient operating condition can be expensed. Routine activities are those that your business reasonably expects to perform more than once during the property’s “class life,” as defined by the IRS.
** Small business safe harbor. For buildings that initially cost $1 million or less, qualified small businesses may elect to deduct the lesser of $10,000 or 2% of the adjusted basis of the property for repairs, maintenance, improvements and similar activities each year. (A qualified small business is generally one with gross receipts of $10 million or less.)
**Materials and supplies. The fnal regs increase the dollar threshold for property that’s exempt from depreciation to $200 (from $100). In addition: w Incidental materials and supplies (such as office and cleaning supplies)
can be deducted when purchased.
** Non incidental materials and supplies (such as small engine parts, saw blades, and fuel and motor oil) can be deducted only after first used or consumed.
The final regs also address how to identify “units of property” when distinguishing repairs from improvements in relation to commercial buildings.
Planning tips: These are only some of the rules under the final regs, which apply to tax years beginning on or after Jan. 1, 2014. Contact your tax advisor to learn exactly how the final regs apply to you and ensure that you’re taking all of the repair and maintenance deductions you’re entitled to.
For the next several weeks, join us in educating you to the world of Tax Planning, 2014, but please , contact your tax advisor to learn exactly which strategies can benefit you the most.
Chapter 2 INCOME & DEDUCTIONS
Chapter 3 FAMILY & EDUCATION
Chapter 4 INVESTING
Chapter 5 BUSINESS (you are reading)
Chapter 6 RETIREMENT
Chapter 7 ESTATE PLANNING
Chapter 8 TAX RATES
Anthony Rivieccio is the founder & The CEO of The Financial Advisors Group, celebrating their 18th year as a fee only financial planning firm specializing in solving one’s financial problems. Anthony has been a recognized financial expert since 1986. He has been seen, heard or read by many national and local media outlets including: Klipingers Personal Finance Magazine, The New York Post, News12 The Bronx, Bloomberg News Radio, Bronxnet Channel 67 TV, The Norwood News, The West Side Manhattan Gazette, Labor Press Magazine, Financial Planning Magazine, WINS1010 Radio, The Bronx News newspaper and The Bronx Chronicle. Anthony can be reached at 347.575.5045
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