Although 2020 is quickly approaching, it’s not too late to implement planning strategies that can help your business save on 2019 taxes. Before the year ends, make sure to assess strategic tax moves for your business that fully take advantage of the changes implemented by the tax reform law commonly known as the Tax Cuts and Jobs Act (TCJA). These tax planning strategies generally fall into three categories: recovering the cost of business property, dispositions of business property, and tax attributes and corporate issues.
Recovering Business Property Costs
There are several strategies to deploy for recovering property costs, using traditional techniques as well as new benefits available under the TCJA.
Changes to Qualifying Properties
Bonus Depreciation: Under the TCJA, bonus depreciation now extends to both new and used properties, and features full expensing – a 100% bonus rate – available for qualifying property placed in service in 2019. The TCJA also increases the depreciation deduction limits on new or used luxury autos (including light trucks and vans) purchased and placed in service in 2019 to $10,100 in the first year and $16,100 in the second year, with additional bonus deprecation of $8,000 available in the first year. Additionally, there is still no limitation on bonus depreciation for heavy trucks, vans and SUVs (gross vehicle weight rating over 6,000 lbs.), so businesses considering purchases of vehicles for executives may prefer to purchase a qualifying “heavy” SUV.
It's important to note that the TCJA also created a category of real property called Qualified Improvement Property (QIP), which encompasses the prior-law categories of Qualified Leasehold Improvement, Qualified Retail Improvement, and Qualified Restaurant Property. Due to a drafting error in the TCJA, QIP is depreciated over 39 years, rather than 15, and is not eligible for bonus depreciation.
Additionally, there are several deductions on qualifying properties to consider under TCJA, including the following:
- Immediate Expensing (Section 179) Election: Businesses can now elect to deduct the cost of qualifying property placed in service during the year, rather than depreciating the property costs over time, with a maximum expensing amount of $1,020,000 for 2019. Eligible property includes “tangible, depreciable, and personal property” like computer software and leasehold improvements made after the building is placed in service. Section 179 can be particularly useful in situations where property is not eligible for 100% bonus depreciation, including building improvements to roofs, heating or ventilation systems, and security systems. A cost segregation study can properly categorize building assets.
- Safe Harbor: The de minimis safe harbor election allows businesses to deduct expenses for small units of property that would otherwise be subject to capitalization. An accounting policy must be in place at the beginning of the year that establishes the thresholds to be used for books and records.
The tax methods of accounting used by a business can be re-evaluated to maximize tax savings. Additionally, the TCJA expanded and amended certain of these accounting methods that can lead to added year-end tax savings and benefits.
- Routine Maintenance Safe Harbor: The Routine Maintenance Safe Harbor allows businesses to establish an accounting method whereby routine expenditures on personal property and buildings can be deducted rather than capitalized. An Application for Change in Accounting Method (Form 3115) is required.
- Cash Method of Accounting: Taxpayers meeting a $26 million average gross receipts test (and that are not tax shelters) are eligible under the TCJA to use the overall cash method of accounting. These taxpayers are also exempt from the uniform capitalization requirements of Section 263A. Both of these opportunities are open to businesses even if they maintain inventory as an income-producing factor and can produce significant savings for business owners.
- Accounting for Inventories: Previously, taxpayers were required to account for inventories under Section 471, but under the TCJA, taxpayers meeting the $26 million average gross receipts test (and that are not tax shelters) have the option of using an alternative accounting method for inventories. Additionally, businesses may opt to switch to the LIFO accounting method, which is beneficial in times of inflation.
Dispositions of Business Property
For 2019 sales and transfers of business properties, taxpayers should consider the particulars of installment sales and like-kind exchanges for year-end tax planning.
Installment reporting for tax purposes permits gain recognition on the sale of property that is timed generally on a ratable basis as payments are received. When considering gains and deferrals on installment sales, it’s important to note that some sales are ineligible, including sales of inventory, partnership interests, and publicly traded securities. Be aware of accelerated gains through sales to related parties or the disposition of an installment note. It’s also worth noting that large installment notes of over $5 million are subject to additional interest charges. If you’re preparing multiple business assets for sale, an agreement to allocate installment payments to particular assets can maximize tax deferral, particularly if some assets have less gain potential.
Taxpayers also may defer the gain realized on the sale of property when like-kind replacement property is acquired in a qualifying transaction. The changes to Section 1031 under TCJA limit eligible like-kind exchange properties to real property. No tax deferral is allowed for an exchange of real property held primarily for sale to customers in the ordinary course of trade or business. If you’re planning to utilize Section 1031 in conjunction with Section 179, be aware that any shorter lived properties identified in a Cost Segregation Study will not be a part of a like-kind exchange and will instead be treated as taxable asset dispositions. Therefore, clients who anticipate a like-kind exchange as an exit strategy should consider carefully the accelerated benefits of a Cost Segregation Study.
Using a related party to accomplish an exchange is a useful strategy in like-kind exchanges, but may result in ordinary income or acceleration of gain in installment sales. Therefore, it’s important to understand the nuances of related parties when considering the disposition of business properties.
While the definition can vary by transaction, related parties typically include:
- A corporation and its more than 50% owner
- Partnerships and partners
- S corporations and shareholders
- Corporations with more than 50% common ownership
- Corporation and partnership with more than 50% common ownership
- Trusts and estates with common grantors or beneficiaries
- Constructive stock ownership by such entities attributed to the owners of such entities
- Constructive stock ownership by an individual’s family attributed to individual’s 2019 year-end
Tax Attributes and Corporate Issues
Reporting losses and debts for corporate entities has changed slightly under TCJA and can offer additional opportunities to maximize savings. Here are some of the changes that are useful considerations for 2019 reporting:
Net Operating Losses (NOLs): The TCJA eliminates the two-year carryback period and limits the net operating loss deduction to 80% of taxable income, impairing the monetary value of NOLs under the new law. However, NOLs are still a valuable attribute that offer the potential for generating future profits tax-free. For example, if a taxpayer’s deduction for the purchase of property would give rise to an NOL, it may be advantageous to defer the purchase until the succeeding year (if profits are anticipated and full expensing is still available in that year), since the purchase could then offset 100% (not 80%) of taxable income in that succeeding year.
Excess Business Losses: New restrictions on excess benefit losses limit deductions for individuals and trusts to amounts exceeding $250,000 (for single filers) or $500,000 (married filing a joint return). Excess business losses over these amounts are treated as NOLs, which carry forward to subsequent years. Because W-2 wages are treated as part of business income, they will offset losses in determining whether a taxpayer has exceeded the threshold. Also, taxpayers who have the option to control tax deductions flowing through from pass-through entities may want to limit the entity level deductions if they would create excess business losses for the individual.
Executive Compensation Limit: A prior exception for “performance based compensation” permitted public companies to deduct executive compensation in excess of $1 million; however, this exception was eliminated by the TCJA. Additionally, the definition of a “covered employee” was expanded to include an employer’s chief financial officer and any individual who was previously a covered employee, so that the deductibility limitation continues to apply to payments made to former covered employees or their estates.
Debt Forgiveness: While cancellation of debt is typically included in taxable income, businesses can elect to exclude Qualified Real Property Indebtedness from gross income to the extent of a company’s insolvency.
Tax Credits and Incentives: Although the oft-used Domestic Production Activities Deduction (DPAD) was eliminated by the TCJA, businesses can still claim the Research & Development Credit (also known as the Research & Experimentation Credit). The R&D tax credit, made permanent by the Protecting Americans from Tax Hikes Act of 2015, allows businesses to take a deduction on qualifying research expenses, payments, and certain products and software. Eligible small businesses (less than $5 million in gross receipts) can use up to $250,000 of their R&D credit to offset their 6.2% payroll tax.
ASC 740 (FIN 48) and Schedule UTP: ASC Topic 740 and Schedule UTP (Form 1120) require businesses to report uncertain income tax positions. ASC Topic 740 primarily applies to C corporations and requires the company to document income tax positions that are not more likely than not to be sustained on audit, and to measure the tax benefit of those positions. Form 1120 Schedule UTP requires reporting of all uncertain tax positions for corporations that have recorded a reserve with respect to such position on an applicable financial statement, and have total assets of at least $10 million.
Download the full 2019 Business Tax Planning Supplement for additional insights into year-end savings and tax benefits.
For more information about year-end tax planning strategies, please contact us.
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