2017 Year-end tax planning: Our top tips for businesses
Tax reform has been a hot topic during the 2016 campaign and throughout 2017, but no changes have been enacted — yet. As a result, businesses will need to plan based on the current rules but also consider how different tax reform proposals might change those plans.
- Challenge your assumptions, now and for the future. Whether your business is just starting out or has been established for years, annual planning is often a good time to consider whether your original choice of entity still fits your needs. Owners of flow-through entities like partnerships and S corporations pay one tier of tax at the owner level, but the top individual rate is currently higher than the top corporate rate. Double taxation of C corporation earnings can be particularly expensive if you make distributions or sell the business during the year. On the other hand, some C corporations have access to special benefits like the gain exclusion for small business stock and tax-deferred sales of stock to employee stock ownership plans (ESOPs).
As you plan ahead, project income based on your expected numbers for at least the next two years. Plug in some of the proposed tax rates from different plans to see how changes might affect your business. Your planning may reveal that you have the right business structure for current rules but that a change may be warranted under some tax reform scenarios.
- New rules for partnerships. A recent law changes the way that the IRS will treat partnerships (and LLCs taxed as partnerships) in an audit for taxable years starting after December 31, 2016. IRS guidance details the Service’s plans to collect any additional tax resulting from an exam at the partnership level. The rules do allow for some taxpayers to opt out of the new treatment if certain conditions are met. If your business is treated as a partnership for tax purposes, you need to understand how the government’s new exam approach could affect you and, if necessary, adjust your partnership agreement in light of the new rules.
- Consider compensation and basis for S corps. While S corporations deliver certain tax benefits, the IRS is likely to scrutinize the following areas:
a. Owners who work for the corporation need to draw a reasonable wage from the business. Because income received as distributions isn’t subject to FICA taxes, the IRS may reclassify some distributions as wages if the owner’s compensation is considered unreasonably low.
b. If the business is struggling and losses are flowing through to an owner’s personal income taxes, the IRS may look more closely at the taxpayer’s basis in the stock. Most losses are deductible for an owner only to the extent that they don’t exceed his or her basis. If the losses do exceed basis, they need to be carried forward to a future period.
- Understand the effects of accounting rules and income taxes. New accounting rules for revenue recognition and the recognition of lease obligations will come into effect over the next couple of years. Those rules may affect the process of reconciling differences between book and tax income. Some businesses may want to file for tax accounting method changes in order to more closely align book and tax income.
- Plan for an exit. No matter where a business is in its life cycle, owners should always have an eye on their exit strategy. Whether you plan to sell the business to an outside party, or you’re looking to transfer it to inside managers, family members, or an ESOP, the operations should be structured to effectively and efficiently transfer ownership when the time comes.
If you haven’t done so already, a sell side inspection/due diligence review could pay dividends now, even if you’re not planning to sell. These examinations provide you with useful information that every executive should know, such as an accurate assessment of the market value of the business for use in retirement planning.
- Embrace the old standbys. If tax reform happens, it’s likely to include lower tax rates on business income in the future. That would make deductions worth more this year if you can take them at the current, higher tax rate. When it comes to capital investments, make sure you’ve taken full advantage of bonus depreciation that lets you write off 50 percent of the cost of qualified capital assets in the year they’re placed in service and the Section 179 expensing incentive that lets you deduct the full cost of certain assets in the year of purchase.
- Consider the R&D credit and DPAD. Always take the time to evaluate changes to your business or tax law that may result in changes on your return. Did you modify a process or product in a way that might generate research and development expenses? Did you start exporting products in a manner that might qualify for a domestic production activities credit? When you talk with your tax advisor, be sure to tell the whole story of your business year, not just the bottom line.
- New growth may bring new tax obligations. Speaking of sharing the whole story of your business year, another important issue that you need to discuss with your tax advisor is any expansion of your business into another state. The concept of “nexus,” the connection between a business and a jurisdiction that can lead to the imposition of tax, is being interpreted as broadly and aggressively now as any time since the income tax came into existence. Even if it’s as seemingly inconsequential as “We shipped product to a new state for the first time this year,” you should make sure to point it out to anyone helping you prepare your 2017 taxes and plan for 2018 and beyond.
The potential remains high for tax reform in the near future
New rules for partnerships change how the IRS will treat these businesses in an audit.
For additional information, please consult our 2017 Tax Planning Guide. As always, if you have questions, please give us a call.