The holidays are upon us and that only means one thing: year-end tax planning. We are now into our second full tax year under the Tax Cuts and Jobs Act (TCJA) and are presented with a lot of tax planning opportunities. Below are a few items to consider prior to year-end that could significantly impact your 2019 taxes.
- Method of accounting – The TCJA increased the gross receipts test from $10M to $25M for 2018 which allowed us to change many companies’ method of accounting. If your company changed the method of accounting from accrual to cash, meaning you only recognize net income based on actual cash received and paid, it would be beneficial to pay down your payables before year-end as much as possible. If your company changed the method of accounting for long-term jobs from percentage-of-completion to completed contract, any gross profit on an open job at the end of the year can be deferred. However, whatever was deferred under completed contract last year will be recognized this year if the job is completed. Generally, under the completed contract method, a job is considered complete for tax purposes when it is over 95 percent complete. The gross receipts test, which is the average gross receipts of the preceding three tax years, needs to be satisfied every year. The threshold was increased for inflation in 2019 to $26M. Once a company’s average gross receipts exceed $26M, they will be required to use percentage-of-accounting for long-term jobs. Keep in mind the gross receipts test follows aggregation rules. If there are several entities with common ownership, the gross receipts for all the entities are included in the gross receipts test.
- Section 179 deduction– Section 179 allows for a direct write-off of eligible tangible personal property purchased during the year. A taxpayer can also elect to treat certain qualified real property placed in service during the year as Section 179 property. This property includes improvements for HVAC, roofs, fire protection and alarm systems, and security systems made to non-residential real property. In 2019, the maximum Section 179 deduction is $1,020,000. The deduction begins to phase-out when the total cost of eligible section 179 assets placed in service during the tax year reaches $2,550,000. For a partnership or s-corporation, these limits apply at the entity level and for each partner or shareholder. If a partner or shareholder owns multiple entities, the total amount of the Section 179 deduction allocated to the individual cannot exceed $1,020,000. If a partner or shareholder is allocated an amount in excess of this limitation, the deduction cannot be carried forward to a future tax year, it will be a lost deduction.
- Bonus depreciation – The TCJA increased bonus depreciation to 100 percent (up from 50 percent) for qualified assets placed in service after September 27, 2017. Bonus depreciation is applicable for new or used property with a class life of 20 years or less, such as, machinery and equipment, office furniture and equipment, and land improvements. Like Section 179, bonus depreciation is a way to fully write-off capitalized asset costs in the year purchased, rather than depreciate the asset over its useful life. Unlike Section 179, there are no limits to the amount of bonus depreciation that can be taken at the entity and individual level. Additionally, while Section 179 can be used for federal and New York State taxes, bonus depreciation is only eligible for federal tax, and therefore requires an addback for New York State tax. The assets are depreciated for New York State purposes using the applicable asset life under MACRS.
- Like-kind exchanges – The TCJA limited the property eligible for like-kind exchange treatment to real property (land and buildings) only. Prior to the TCJA, the like-kind exchange rule also allowed for a deferral of gain on trade-ins of tangible personal property, such as business autos and machinery and equipment. Congress felt that taxpayers received the benefit of deducting the cost of all personal property through the increased Section 179 expensing limits and 100 percent bonus depreciation. Since exchanges of personal property no longer qualify for tax deferral treatment, taxpayers will have to recognize a gain or loss on exchanges of personal property depending on its trade-in value and remaining basis.
- Qualified Business Income (QBI) deduction – In an effort to pass on the reduced tax rate for C-Corporations, the TCJA created a qualified trade or business income deduction for sole proprietors, partners and s-corporation shareholders. Taxpayers can deduct 20 percent of qualified business income on their individual income tax returns. The deduction cannot exceed the larger of 50 percent of wages paid by the business or 25 percent of wages paid plus two and a half percent of the basis of qualified assets. The QBI deduction provides a lot of planning opportunities for business owners, specifically regarding year-end bonuses paid shareholders of s-corporations. Prior to the QBI deduction, shareholders often took year-end bonuses which would result in a deduction by the business but W-2 income for the shareholder. Now, if the 50 percent wage limitation is not an issue, shareholders should consider taking tax-free distributions, basis permitting, from the company. Taxable income from the business will increase, but the shareholder will not have additional wages to report on their tax return, and they will get a 20 percent deduction on the business income. It is important to remember, however, that s-corporation shareholders are required to be paid reasonable compensation, so they still need to take a salary from the business each year.
- W-2 reporting – Personal use of employer-provided vehicles needs to be reported on your employees’ (s-corporation shareholders are considered employees) W-2s. Employees should provide a log of their miles driven, both for personal and business use, throughout the year to calculate the taxable fringe benefit to be added to their W-2 wages. There are a few ways the taxable fringe benefit can be calculated, but generally by taking the percentage of personal miles driven over total miles and multiplying it by the annual lease value of the vehicle (this can be found in IRS Publication 15-B). Health insurance paid for shareholders owning greater than two percent of an s-corporation needs to be reported on their W-2. The amount is reported as taxable wages, however there is a deduction for the same amount to arrive at adjusted taxable income (AGI) on the shareholder’s individual income tax return. The taxable income flowing through from the s-corporation also includes the deduction for health insurance paid on behalf of greater than two percent shareholders.
Under the TCJA there are several tax planning opportunities and reporting requirements. Consult with your tax adviser to ensure you are taking advantage of tax positions that need to be considered prior to year-end. Contact our experts at The Bonadio Group to learn more.