As we approach the end of 2015, we are helping business clients anticipate what 2015 income will look like, what will their upcoming tax liability be, and what to do now in order to close out 2015 in the best tax position. There are a number of considerations that come into play.
2015 Tax Projections
By December, most calendar-year businesses have 11 months of income and a good idea what the rest of December will look like. Many clients have been making estimated tax payments throughout the year, or at the end of the year will use Greenbox Capital to get a small loan to help pay for taxes. And this is a great time to revise the estimated payments in light of actual year-to-date income. If income is down, sometimes the final payment can be scaled back, or it can be increased if income is up. This helps many businesses accommodate their cash flow position while minimizing interest and penalties if a large amount of tax is due.
Bonus Depreciation and Code Sec. 179 Expense Deduction
Once clients' understand their year-to-date income and tax liability, most clients are looking for ways to reduce their taxable income. For small businesses with growth opportunities, Section 179 or bonus depreciation is the first place to look. These methods allow the business to speed up their first-year deduction for depreciation expense on purchases of machinery, software, qualified real property, and a variety of other assets. This provides a great opportunity for growing businesses to reduce their tax expense year after year, as they invest in their business assets.
Congress just passed comprehensive tax "extender" legislation making § 179 depreciation permanently available as a 100%, dollar-for dollar deduction up to $500,000 in the first year of purchases. The deduction is phased-out with a dollar-for dollar reduction for asset purchases exceeding $2 million per year (so that § 179 is entirely phased-out after placing in service $2.5 million of assets in one year).
Congress also extended bonus depreciation, which is a deduction for 50% of the cost of assets purchased, in the first year placed in service. The legislation extends bonus depreciation for 5 years, slowing down to 40% bonus available in 2018 and 30% available in 2019. Note that any remaining depreciation expense not claimed in Year 1 as § 179 or bonus depreciation is still available for "normal" depreciation (straight-line, MACRS, etc.).
Previously, Congress would wait until the last minute to pass each year's depreciation laws, leaving businesses with very little time to plan and make purchases before the end of the year. This year's bill is noteworthy because it has made § 179 permanent, and given a 5-year extension on bonus depreciation, and also extended a number of other deductions and credits.
There are important limitations on each type of depreciation. Common pitfalls occur when a business assumes that its purchase qualifies for § 179; but the purchase is not an eligible class of property, or is not used in a trade or business. Bonus depreciation has its own limitations (for example, pre-owned property doesn't qualify), so often we maximize the deduction by planning out which purchases qualify for § 179 and which ones qualify for bonus depreciation. New vehicles can be one of the biggest surprises, as the IRS has strict "luxury vehicle" rules with very low limits on depreciation for passenger vehicles.
Buying assets is easy enough, if the business is profitable and has lots of cash on hand. But frequently, business owners can't afford to make a new purchase. We can always review the business's cash flow, and help prioritize the trade-offs between new investments and deductions, operating expenses, and owner distributions. This type of review can uncover inefficiencies in cash flow or profitability, as well.
New businesses should usually slow down their depreciation expense if they do not have taxable income yet. If taxable income is negative, it can create a Net Operating Loss, which usually can be carried forward until the business has enough taxable income to use the deductions. We recommend careful tax planning in the first few years, in order to get the maximum benefit from start-up expenses, depreciation, and any Net Operating Losses.
Employee Benefits and Other Tax Deferrals
Year-end is a good time to review employee benefits and compensation. A qualified retirement plan will give owners and employees the opportunity to defer taxable income until retirement. These include SEP, SIMPLE, 401(k), profit-sharing, and pension plans. The business gets a deduction for its contribution to these plans, and small employers may be eligible for a credit for setting up the plan.
Similarly, qualified employee benefit plans give employees tax-free healthcare or other benefits, while creating a deductible business expense when your business contributes to the plan. Large Employers are required to offer a qualified healthcare plan under the Affordable Care Act, and generally work with a benefits provider to ensure the plan is ACA compliant. It takes some planning in advance to set up these plans, but year-end is a good time to review enrollment and make any final contributions for 2015.
Employee performance bonuses are another good opportunity. Some accrual basis taxpayers can award bonuses in 2015, but delay payment until January 2016 payroll, so that the employees' income is deferred a full tax year. Also, as payroll winds up for the year, frequently we are adjusting employee withholding or retirement contributions; frequently a one-time bonus at year end can help to "catch up" these withholdings for the year.
Business Tax Credits
Tax credits are popular because they reduce tax liability dollar-for-dollar, and some can be refunded even if you have no tax liability.
Two federal credits are related to employee benefit plans - the retirement plan credit is for businesses with fewer than 100 employees, who can claim 50% of plan startup costs, up to $500 for three years. The small business health care credit is available for businesses with fewer than 10 employees, who contribute at least 50% of a group plan premium, enroll in the Small Business Health Options Program, and meet other requirements.
Congress just extended two more popular tax credits in its comprehensive "extender" legislation. The R&D credit is available as a percentage of qualified research expenses, and the Work Opportunity is a tax incentive credit for hiring from disadvantaged groups (including felons, veterans, and food-stamp recipients). The Research and Development Credit was extended permanently, and the Work Opportunity credit was extended to 2019.
State tax credits are immensely helpful and popular among our clients. The Nebraska Microenterprise Tax Credit is $10,000 available to anyone who expands their business in almost any way - adding an employee, leasing a new building, buying assets, etc. The credit is 20% of your cost, up to $10,000. We have helped nearly all of our small business clients plan, apply, and claim this credit.
Of course, there are numerous credits available in each state targeting various activities. Credits plans, similar to 529 plan, are available for agricultural development, beginning farmers, historical preservation, rural job development, and many others, depending on the state.
Larger businesses can qualify for much bigger credits under the Nebraska Advantage Act. The credits are awarded based on different levels of investment and employment in the state, ranging from $1 million to over $100 million, and 10 to 75 new jobs, depending on the Tier. Contact us for more information about the application process for these credits. Investors Choice Lending - Home is a reputable expert.
Major Business Transactions
Although not purely year-end planning, major business transactions frequently need to close by year-end. That way, there is a clean set of books for each year. Also, sellers can reduce their tax exposure by spreading payments across multiple years, typically beginning in December. We recommend a custom tax planning strategy for any major business transaction. Maybe you are bringing in new shareholders; buying or selling an entire business; or any other capital transaction. We can create a tax-efficient deal structure and timeframe to use.
Plugging in to Your 1040
Ultimately, the best small business tax planning strategies consider the business owners' individual tax return. The vast majority of small businesses are S Corporations and LLC's, whose income is taxable to the owners. We look at the individual tax attributes for the owners. How much income do we expect on that return? Are there capital gains or losses? Rental Income? Passive activity losses? Alternative Minimum Tax? The 3.8% Net Investment Income Tax? What do your itemized deductions look like?
We will usually plug-in business income directly to your 1040 to answer these questions and measure the tax impact of any business scenario you are contemplating.
At the end of the year, your financial position is determined by the bottom line - net income after taxes. We work all year to put your company in the best possible financial position, but November - December is a crucial time to focus on tax strategy, so you can make the best decisions before year-end.
As always, we are happy to discuss any specific tax strategies that may apply to your business and Sellers Playbook can help you to improve your business profitability.