One year ago, the Tax Cuts and Jobs Act (TCJA) was signed into law. Its centerpiece was a permanent reduction of the corporate tax rate to a flat 21 percent. It also permanently repealed the corporate alternative minimum tax (AMT). As we move toward 2019, here are several wealth planning ideas that business owners should consider that can have a real benefit.
Review retirement plan options
Qualified retirement plans can be a powerful way to defer business income and lower current tax liabilities. Individuals who already have these plans should use the end of the year as an opportunity to fully fund their contributions. Business owners who do not should consider implementing a plan after a review of the potential benefits and tax savings. Along with defined contribution plans, small business owners might consider defined benefit plans, cash balance plans or combinations of the two.
Deductible contributions to these plans might dwarf the limits of IRAs, 401(k)s or other defined contribution plans. Business owners can also use nonqualified deferred compensation plans to attract and retain talent. While there is no current deduction when the plan is funded, tax can be deferred on the growth of the assets that fund the plan by using cash-value life insurance.
The business expensing election
Small businesses may elect under IRC Section 179 to expense the cost of qualified property, rather than recover such costs through depreciation deductions. The TCJA increased the maximum amount that can be expensed from $520,000 to $1,000,000, and the threshold at which the maximum deduction begins to phase out from $2,070,000 to $2,500,000. Both the $1,000,000 and $2,500,000 amounts will be increased in the coming years to reflect inflation.
The new law also expanded the range of property eligible for expensing. Beware that some states may not allow full expensing for state income tax purposes.
For qualified property that was both acquired and placed in service after Sept. 27, 2017, 100 percent of the adjusted basis of the property can be deducted in the year the property is first placed in service. The first-year 100 percent bonus depreciation percentage amount is reduced by 20 percent each year starting in 2023 (i.e., the first-year bonus percentage amount will be 80 percent in 2023, 60 percent in 2024, 40 percent in 2025 and 20 percent in 2026) until bonus depreciation is eliminated altogether beginning in 2027. The purchase of used property now qualifies for bonus depreciation.
Section 199A deduction
For tax years 2018 through 2025, a new deduction is available equal to 20 percent of qualified business income from partnerships, S corporations and sole proprietorships. The IRS recently issued guidance on some previously proposed strategies thought to be able to maximize the use of the deduction.
Proceed with caution regarding setting up trusts for children or others. Specifically, look at ones that are separately taxed to own interests in businesses that qualify for the deduction where parents would otherwise not qualify because of their income levels or other factors. Such trusts may not be respected for purposes of the Section 199A deduction.
One strategy that remains is that if you are in a nonspecified service trade or business, but you exceed the income limitations and thus are subject to the additional W-2 wage and capital (qualified property) limitation, you should consider making additional qualified capital purchases or increasing wages to increase your available QBI deduction.
Small business owners especially should ensure they have adequate substantiation for expenses such as travel miles, business meals, etc. These include daily logs, actual receipts and other substantiation records. Business meals continue to be 50 percent deductible.
Because of the TCJA, entertainment expenses, even if associated with the active conduct of a trade or business, are no longer deductible.
Family members can split the bill
Family business owners, in particular, can take advantage of ways to shift income to lower overall taxes. Paying reasonable salaries to family members for providing bona-fide services reduces the amount of business income. A child’s earned income could be taxed at the low-bracket rate of 10 percent (on taxable income of up to $9,525 for 2018). The salary would also be earned income, thus allowing children to establish and contribute to a Roth IRA or retirement plan.
Closely held business owners who wish to shift some ownership, but not management or control, can divide the ownership into voting and nonvoting interests and only gift the nonvoting interests
Cash method of accounting
The TCJA expanded the ability to use the cash method of accounting. Any entity with three-year average annual gross receipts of $25 million or less can use the cash method regardless of whether the purchase, production or sale of merchandise (inventory) is an income-producing factor. The cash method of accounting may be more attractive to businesses due to its simplicity and flexibility in managing the amount of taxable income reported in a tax year. Identify actionable opportunities for filing accounting method changes with the IRS.
Increased estate tax exemption
Lastly, with the increased federal estate tax exemption to $11,180,000 for individuals or $22,360,000 for married couples, take advantage of passing the business without incurring estate or gift tax.
James Barger is president of KeyBank’s Rochester Market. He may be reached by phone at 585-238-4121 or email at [email protected].