Year-end business tax planning: Five actions to consider now
As we head into the home stretch for 2019, some readers might be surprised that most of our year-end tax highlights for businesses refer to provisions of the Tax Cuts and Jobs Act (TCJA) enacted in late 2017. It makes sense, though, when you consider that the IRS has released a host of regulations and other guidance interpreting many of the new rules and since most taxpayers have now seen the full impact of those changes on their 2018 returns.
Here are five year-end tax items to consider for your business.
An accounting rule change that goes into effect this year for private companies could combine with a tax law change to cause significant unexpected tax obligations for some businesses. If your business isn’t publicly traded and you have financial statements that are audited under Generally Accepted Accounting Principles (GAAP), your process for recognizing revenue will change in 2019 (unless you elected to adopt the new treatment earlier). The new process could result in higher financial statement revenue numbers for some businesses, especially midsize manufacturers, distributors, and service providers.
An increase in financial statement revenue doesn’t automatically translate to higher taxable income, but a TCJA provision could cause tax increases at some businesses that adopt the new accounting standard. The new law requires businesses that have audited financial statements to recognize revenue for tax purposes no later than when it’s recognized for accounting purposes. This change doesn’t apply to the inclusion of expense deductions on the tax returns. If your business is subject to this rule, its 2019 taxable income could increase significantly while the expenses that normally offset it may not be deductible until a later year.
An increase in financial statement revenue doesn’t automatically translate to higher taxable income, but a TCJA provision could cause tax increases for some businesses.
- Consider a tax accounting method change. The process involves filing an application and gaining approval from the IRS, so it’s not automatic. However, if successful, it could result in a better matching of revenue and expenses for tax purposes.
- Consider whether your business needs audited financial statements. If the creditors, owners, and private investors that currently use your audited statements are amenable, you may be able to meet their needs with a financial statement compilation that isn’t audited for GAAP compliance.
Business interest deduction
Another TCJA provision that will affect year-end planning in 2019 is the limit on deductibility of business interest. Most businesses (including groups of related businesses) that have average annual gross receipts over the last three years in excess of $26 million for 2019 must determine if their interest expense exceeds a limitation amount defined by the statute. The limitation amount for a year is the total of the taxpayer’s business interest income plus 30% of adjusted taxable income (as defined in the statute). (Auto dealers can also add “floor plan financing” interest to their limitation amount.)
When the law was enacted, many taxpayers assumed that it was intended to affect only highly leveraged businesses. Based on subsequent IRS guidance and experience with 2018 tax returns, it’s clear that the interest deduction limit affects more businesses than originally expected. Businesses should include projections of their total interest expense (including items treated as interest under proposed regulations) and their estimated limitation calculation as part of their annual tax-planning process.
- Project your annual interest expense for 2019.
- Calculate your estimated interest expense limitation for 2019.
- If your projections suggest that your expense will exceed this year’s limit, consider options that would reduce your interest expense or increase your limitation amount this year.
Qualified business income deduction
2019 will also mark the second year of the 20% deduction for qualified business income (QBI). The provision allows sole proprietors, partners, and S corporation shareholders to deduct up to 20% of the income that they receive from these businesses, subject to certain exceptions and limitations. The exceptions and limitations like the following necessitate extra planning:
Owners who receive income from pass-through entities that operate in certain specified service trades or businesses (SSTBs) listed in the statute, such as health, law, accounting, and consulting, aren’t eligible for the deduction, if their taxable income exceeds a threshold amount. In 2019, the threshold is $321,400 for married taxpayers filing jointly and $160,725 for all others after being indexed for inflation.
Not always a 20% deduction
While this provision is often referred to as “the 20% deduction,” that’s not always accurate. For taxpayers with taxable income exceeding the threshold amount, the QBI deduction is limited, on a per-business basis, to the greater of 50 percent% of wages or 25%of wages plus 2.5% of the adjusted cost basis of qualified property owned at the end of the year.
While the limitation is applied on a per-business basis, certain related businesses may be aggregated and treated as a single business for determining the limitations.
In order to make sure owners qualify for the highest possible deduction, the business needs to track relevant wage and property-basis amounts throughout the year. If it looks like wages or asset bases might limit deductions, the business may have options like paying bonuses early or placing assets in service before year end. In the alternative, if estimates show deductions are unlikely to be limited this year, the business might consider deferring those actions until the start of the new year.
- If your business operates in any of the SSTB categories that aren’t eligible for the deduction above the income threshold, look for ways to keep income shares below that threshold. Consider the possibility that tax planning may include a multiyear cycle alternating between keeping income below the threshold to qualify for the deduction in year two by accelerating some income items into year one and deferring others into year three.
- If you run a non-SSTB pass-through business with income shares above the threshold amount, project your wage expenses and asset balances out to year-end to see if your owners may be subject to limitations. If necessary, evaluate options that could lessen the impact of the limits.
The TCJA’s 100% bonus depreciation rules mean that businesses will get even more tax-deduction bang for their fixed-asset buck when they purchase and place in service new equipment before the end of the year. But it’s important to remember that this provision was enacted with a limited life span. If Congress doesn’t act to extend it, the 100% bonus depreciation deduction will only be available for property acquired and placed in service before Jan. 1, 2023, after which the benefit phases out at the rate of 20% per year.
If your business relies heavily on depreciable, fixed assets, you may want to plan out a replacement schedule that overhauls as much of your equipment as you can before the provision begins to phase out. Remember to include debt and capital management strategies in the plan to make sure your business has access to the resources it needs to purchase new equipment during this period. Although, as previously noted, interest expense deductions related to business debt are now subject to limitation.
If Congress doesn’t act to extend it, the 100% bonus depreciation deduction will only be available for property acquired and placed in service before Jan. 1, 2023.
- Create a fixed asset replacement schedule that overhauls and/or upgrades as much of your property, plant, and equipment as possible prior to the scheduled expiration of the 100% bonus depreciation provision on Jan. 1, 2023.
Transition and exit planning
Anytime we talk about planning for the end of this year and the start of a new one, it’s always helpful to take a step back and think about the longer term. Do you have a long-term transition or exit strategy, and is your business organized and operated in a way that aligns with that plan? Year-end planning provides a great starting point for discussions about things like entity structure, compensation plans, leadership continuity and compliance risks. If you don’t have a plan, we can help you get started on one. If you do have a plan, we can help you review and update it.
- Consult with tax advisor to create or update business exit strategy.
Year-end planning provides a great starting point for discussions about things like entity structure, compensation plans, leadership continuity, and compliance risks.
Tailor your plan to your business
While these five topics provide a good starting point for a year-end tax plan for most businesses, they’re no substitute for a plan that considers the specific facts and circumstances of your business. To learn more about steps that your business can take to prepare for the end of the tax year, please contact your Plante Moran advisor.