Year-end planning for 2018 takes place against the backdrop of the Tax Cuts and Jobs Act (“TCJA”), which has some significant changes in the tax rules for individuals and businesses. Now is the time to think of planning moves that will help lower your tax bill for this year and possibly next.
Section 1 – Tax Planning Moves for Individuals
Section 2 – Tax Planning Moves for Businesses & Business Owners
Section 3 – State and Local Tax Planning Points
Section 4 – Cost Segregation
Section 5 – Global Transfer Pricing Strategies
For individuals, among many other changes: there are new, lower income tax rates; a substantially increased standard deduction, but a severely limited itemized deductions and no personal exemptions; an increased child tax credit; and a watered-down alternative minimum tax (“AMT”).
For businesses: the corporate tax rate is cut to 21%; the corporate AMT was eliminated; there are new limits on business interest deductions; there are significantly liberalized expensing and depreciation rules; and there is a new deduction for non-corporate taxpayers with qualified business income (“QBI” deduction) from pass-through entities.
Below is a list of planning ideas and actions based on the current tax rules that may help you save tax dollars if you act before year-end. Not all the planning ideas will apply or make sense for your particular situation, but we welcome a conversation to see how we can tailor a solution to fit your needs. If you’d like to explore any of the suggestions below, or any other year-end planning options, please contact us.
Section 1: Year-End Tax Planning Moves for Individuals
Beginning in 2018, many taxpayers who claimed itemized deductions previously will no longer be able to do so. This is because the standard deduction has been increased (to $24,000 for joint filers, $12,000 for single filers and married individuals filing separately, and $18,000 for heads of household), and many itemized deductions have been curtailed or eliminated:
It’s more important than ever to manage the timing of deductions to maximize the tax benefit. You can still itemize medical expenses to the extent they exceed 7.5% of your adjusted gross income, state and local income and property taxes up to $10,000, charitable contributions, plus interest deductions on a restricted amount of qualifying residence debt; but payments of those items won’t save taxes if they don’t cumulatively exceed the new, higher standard deduction.
Consider “bunching” itemized deductions in one year to maximize the tax benefit. Remember, your total itemized deductions must exceed $12,000 if filing single and $24,000 if married filing jointly in order to provide any tax benefit. Therefore, if you are at risk to fall under that amount in a given year, consider concentrating the expenses in one year:
For those who are charitably inclined, consider establishing a Donor Advised Fund (“DAF”). The deduction is allowable in the year funded, but provides individuals with the ability to distribute the funds to charitable organizations over the course of several years.
Consider using a credit card to pay deductible expenses and to make charitable contributions before the end of the year. Doing so will increase your 2018 deductions even if you don’t pay your credit card bill until after the end of the year.
If you are age 70-½ or older by the end of 2018, and particularly if you can’t itemize your deductions, consider making 2018 charitable donations via qualified charitable distributions from your IRAs. Such distributions are made directly to charities from traditional IRAs, and the amount of the contribution is neither included in gross income nor eligible as an itemized deduction. This can be an effective tool for tax savings, especially for those in higher marginal income tax brackets. The amount of your qualified charitable distributions counts towards an individual’s required minimum distribution for the year.
Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. The exclusion applies to gifts of up to $15,000 made in 2018 to each of an unlimited number of individuals. You cannot carry over unused exclusions from one year to the next. Such transfers may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
Consider using a qualified tuition (529) plan to pay for the tuition of children in kindergarten through high school. Previously allowed only for higher education expenses, the new law provides added flexibility with the ability to distribute up to $10,000 per student. Note this amount applies exclusively to tuition payments.
If you were in an area affected by Hurricane Florence or any other federally declared disaster area, and you suffered uninsured or unreimbursed disaster-related losses, keep in mind you can choose to claim them on either the return for the year the loss occurred (in this instance, the 2018 return normally filed next year), or the return for the prior year (2017). You may want to settle an insurance or damage claim in 2018 in order to maximize your casualty loss deduction this year.
If going through a divorce, consider finalizing in 2018. Doing so will ensure alimony is deductible to the payor (and taxable to the recipient) for the duration of the agreement.
Corporate Rate – One of the most significant provisions of the Tax Cuts and Jobs Act is the permanently lower federal corporate income tax rate, which decreased from 35 percent to 21 percent. Moreover, with the elimination of the AMT, taxpayers need to consider the proper legal structure going forward.
For tax years beginning after 2017, taxpayers other than “C” corporations may be entitled to a deduction of up to 20% of their qualified business income (“QBI”). For 2018, if taxable income exceeds $315,000 for a married couple filing jointly, or $157,500 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a specified service trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. The limitations are phased in for joint filers with taxable income between $315,000 and $415,000 and for all other taxpayers with taxable income between $157,500 and $207,500.
Taxpayers may be able to achieve significant savings by deferring income or accelerating deductions so as to come under the dollar thresholds (or be subject to a smaller phaseout of the deduction) for 2018. Depending on their business model, taxpayers also may be able to increase the new deduction by increasing W-2 wages before year-end. The rules are quite complex, so don’t make a move in this area without consulting your tax adviser.
More “small businesses” are able to use the cash (as opposed to accrual) method of accounting in 2018 and later years than were allowed to do so in earlier years. To qualify as a “small business” a taxpayer must, among other things, satisfy a gross receipts test. Effective for tax years beginning after December 31, 2017, the gross-receipts test is satisfied if, during a three-year testing period, average annual gross receipts don’t exceed $25 million (the dollar amount used to be $5 million). Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings till next year or by accelerating expenses, for example, paying bills early or by making certain prepayments.
Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2018, the expensing limit is $1,000,000, and the investment ceiling limit is $2,500,000. Expensing is generally available for most depreciable property (other than buildings), and off-the-shelf computer software. For property placed in service in tax years beginning after December 31, 2017, expensing also is available for qualified improvement property (generally, any interior improvement to a building’s interior, but not for enlargement of a building, elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems. The generous dollar ceilings that apply this year mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. Moreover, the expensing deduction is not prorated for the time that the asset is in service during the year. The fact that the expensing deduction may be claimed in full (if you are otherwise eligible to take it) regardless of how long the property is held during the year can be a potent tool for year-end tax planning. Thus, property acquired and placed in service in the last days of 2018, rather than at the beginning of 2019, can result in a full expensing deduction for 2018.
Businesses also can claim a 100% bonus first-year depreciation deduction for machinery and equipment-bought used (with some exceptions) or new-if purchased and placed in service this year. The 100% write-off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2018.
Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs do not have to be capitalized under the Code Section 263A uniform capitalization (“UNICAP”) rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500. Where the UNICAP rules aren’t an issue, consider purchasing such qualifying items before the end of 2018.
A corporation (other than a “large” corporation) that anticipates a small net operating loss (“NOL”) for 2018 (and substantial net income in 2019) may find it worthwhile to accelerate just enough of its 2019 income (or to defer just enough of its 2018 deductions) to create a small amount of net income for 2018. This will permit the corporation to base its 2019 estimated tax installments on the relatively small amount of income shown on its 2018 return, rather than having to pay estimated taxes based on 100% of its much larger 2019 taxable income.
The Opportunity Zone Program, created by the 2017 TCJA, encourages long-term investment in low-income urban and rural communities nationwide by granting investors preferential tax treatment. The preferential tax treatment associated with the Qualified Opportunity Zone Funds include:
Be aware of new rules which limit a taxpayer’s ability to deduct excess business losses starting with the 2018 tax year. If the aggregate of all of a taxpayer’s business income, deductions, gains and losses yield a net operating loss for the year, only $500,000 (MFJ), or $250,000 (all others), of that net loss is currently deductible. The remaining “excess business loss” is treated as an NOL carryover to the 2019 tax year and later.
State and Local Tax Planning Points
Review your state and local nexus footprint in light of wayfair – An evaluation of your company’s state nexus footprint for both income and sales and use tax purposes is vital for establishing whether your company is subject to tax based on its presence in the states in you do business. Through a nexus study, you can evaluate the presence of your employees (including independent contractors), property and interstate business activity to determine where you should register to do business, file income and use tax returns, and/or collect and remit sales taxes from your customers.
Further, with those states that have adopted an “economic nexus” standard such as California, evaluation of the amount of your sales in-state can exceed the sales thresholds establishing nexus and a consequent filing responsibility whether or not you have a physical presence in-state. This standard was extended to sales and use taxes as a result of the South Dakota v. Wayfair outcome in the U.S. Supreme Court. Sales and use tax economic nexus must be considered in those states which have recently implemented similar thresholds as South Dakota. For most states, over $100,000 in sales or 200 or more individualized transactions will be significant enough to establish a collection and remittance responsibility for sales and use taxes in an increasing number of states. Once the pool of states where nexus is potentially established is determined, your revenue streams need to be reviewed for 1) taxability and 2) exemptions.
Reevaluate your state income tax apportionment methodology and the state conformity to the tax cuts and jobs act – Most clients source their sales based on where they invoice their clients. However, states vary in how they source the sales of services as well as tangible property in certain instances based on your Company’s activities. Evaluating how to effectively track your sales sourcing can correct and often reduce your potential income tax liability. States continually modify and amend both their rules and their formulae regarding how income is classified, segmented and calculated. This only has become more complex with the recent Tax Cuts and Jobs Act. This analysis can also review state conformity and decoupling from the federal impact of this law. Through an apportionment study, you can be confident you are applying both the right formula, sourcing, and treatment of income for your sales, services and intangible streams of income.
Survey your real and personal property taxes – Your business is potentially subject to certain property taxes in several states. The most often seen error in commercial personal property tax is the failure to report only those items which qualify as taxable personal property or fail to file in states where you are subject to property tax. Conducting fixed asset reviews can identify items which establish both 1) nexus for personal property tax purposes, and 2) may contribute to your overall tax base in states with personal property taxes. While real estate taxes may appear unavoidable and the determined liability self-evident, overpayment of real property taxes can be avoided through assessment reviews and appeals. These may lower your property’s valuation for tax purposes and aid in minimizing taxable impact on real property you own that is overvalued by your county and/or state.
Cost segregation is an engineering-based IRS approved strategic tax savings tool that allows companies and individuals who have constructed, purchased, expanded or remodeled real estate to increase their cash flow by accelerating depreciation deductions and deferring their federal and state income taxes.
The goal of cost segregation is to identify, segregate and reclassify the project-related costs typically classified as real property (39 years or 27.5 years) to shorter depreciable tax lives. Such as; land improvements (i.e. landscaping, asphalt paving, utilities, etc.) over 15 years or personal property (carpets, cabinets, counters, various electrical, plumbing, HVAC, etc.) over 7 years or 5 years depending on the building type. By performing a cost segregation study, we will provide you with various benefits such as increased depreciation deductions, reduce tax liabilities, and maximization of your cash flow by reclassifying the various assets of your real estate.
A look-back study can also be performed on any property that was placed into service during prior tax years, allowing the taxpayer to reclassify improperly classified assets and reclaim “missed” depreciation deductions from prior years (without the need to file amended returns).
Cost segregation is even more important today than ever with the passage of Tax Cuts and Jobs Act of 2017. The Tax Act is the largest tax reform law in over 30 years and has provided numerous tax opportunities for real estate owners from 100% bonus depreciation on new and used purchases of real estate and equipment to increasing the Section 179 deduction to $1 million with an investment limitation of $2.5 million…these are just two of the opportunities available.
Global Transfer Pricing Strategies
Transfer Pricing is the internal prices charged between affiliated companies operating in different tax jurisdictions around the world. This includes intercompany activity related to these four types of transfers between affiliated companies:
These “related changes” must be at arm’s-length otherwise the IRS can assess substantial penalties.
These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.