As we make our final approach towards closing out the tax year, business owners should be mindful of their business performance even more so due to the impending changes to our tax laws. Both President Trump and the Senate have proposed their own versions of plans to overhaul our tax system.
While both make radical claims to reduce taxes for all, they appear to do little more than lower the tax rates at the expense of eliminating many deductions that business owners, the wealthy, and even the middle class rely on to lower their tax bills. This article does not go into too much detail about the outstanding tax proposals, as it seems far too early to determine how things will take shape. In addition, I’ve identified a number of quick read articles available on the Internet that do a good job at summarizing the two plans.
I prefer to focus attention on keeping a close eye on positioning the company for growth while leveraging my favorite two deductions: the Section 179 deduction for capital purchases and contributions to pension and profit-sharing plans to defer income to owners and reward key employees.
The New York Times has thoroughly analyzed the Trump and Senate tax plans, including a comparison of the two plans, at the following links:
Trump Tax Plan
https://www.nytimes.com/interactive/2017/09/27/us/politics/six-charts-to-explain-the-republican-tax-plan.html
Senate Tax Plan
https://www.nytimes.com/2017/11/10/us/politics/senate-tax-bill.html
A Comparison of the Two Plans
https://www.nytimes.com/2017/11/09/us/politics/facing-math-trouble-house-panel-races-to-adjust-tax-bill.html
Overall, the Trump tax proposal and Senate tax bill aim to lower taxes for most Americans. While the plans diverge on a number of issues, some of the highlights of these plans include:
- Cut the corporate tax rate
- Cut individual tax rates and reduce the number of tax brackets
- Eliminate the Alternative Minimum Tax
- Eliminate the Estate tax
These reductions in taxes sound pretty good, especially the wealthier you are. However, they appear to come at a hefty price for those who rely on deductions such as:
- State and local income taxes
- Property tax and home mortgage interest
- Personal exemptions
- Domestic Productions Activities Deduction
In the end, the expected result would be that on average, everybody’s tax burden is a little less. In reality, it will most likely depend on each individual’s tax position. More importantly, opportunities for tax planning are abundant.
The two business deductions that Congress and the House have consistently supported are the deductions for capital investment (Section 179) and deductions for retirement (Section 401). The IRS is basically saying: invest in the future and we will reward you. Thus, as 2017 comes to a close, I suggest to focus on these more certain deductions, all the while keeping a keen eye on corporate planning in order to position your company for the best growth opportunities moving forward.
In fact, while we want to comply with all tax laws and minimize the tax burden, achieving financial and operational goals and positioning the company with the best possible financial picture to investors, lenders, banks, sureties, and other interested parties continue to be at top my list. As November is quickly underway and we are less than two months from closing out the year, below please find my my recommended approach to tax planning:
First, it is important to make sure your books are up to date through September 30 or October 31 (for calendar year filers). By now, there is enough information known about the year that most business owners should know how they are going to end the year. We want to make sure that we project sales and expenses for the remainder of the year with as much certainty as possible. Then, we want to develop processes to communicate the strategy with management to help close out the year with predictability by continuously reporting on and monitoring progress towards our financial and operational goals.
A number of important questions I ask as I consult on the preparation of financial statements include:
- Do I adhere to all my bank covenants?
- How much cash do I need?
- What are my working capital needs?
- How much income should I report?
- How much do I need to collect / bill? What does my accounts receivable aging look like?
- How much do I need to spend?
- Do I need to acquire any new assets?
- How do I reward employees?
- How did we perform in relation to the industry and/or our competitors?
- How did I perform with my top customers / projects?
- How much leverage and/or risk can my company afford?
Operationally and financially speaking, there is much more we can do to create value than to minimize taxes. And, we want to avoid the possibility of putting the company in too risky of a financial position by eliminating too much income. However, to the extent that there is excess operating cash or capacity for debt, it may make sense to invest into the future by acquiring capital assets (and generating Section 179 deductions) and investing in retirement (by making profit sharing or 401(k) plan contributions).
Section 179 Deduction
In 2017, the Section 179 deduction is current capped at $510,000 per company and per individual, and it is proposed that the Section 179 deduction becomes unlimited. One way to identify potential Section 179 deductions is to review your equipment expense ledger for equipment that you have rented over the last year that may make sense to purchase. Purchasing may give you a lower total cost of ownership. Also, you may not have to come up with any cash out of pocket to generate a Section 179 deduction if debt and lease instruments are properly drafted. The Section 179 deduction is especially beneficial if you are considering technology enhancements. Many hardware and software acquisitions can be structured to qualify for Section 179 (and may not even require a capital outlay before the end of 2017).
Deductions for Pension and Profit-sharing Contributions
Because it is a tight labor market, it may be easier to identify recurring tasks that are being performed by over-worked employees that can be more cheaply performed by machines, computers, and/or software. Contributions to profit-sharing, 401(k) and other retirement plans basically defer income into the future. What you deduct today gets taxed when you pull it out during retirement. While 401(k) and other defined contribution plans max out at $18,000 in 2017, SEP IRAs and defined benefit plans allow for contributions of up to $54,000 and $215,000, respectively. If structured and planned-for properly, actual cash contributions do not need to be made until tax returns are filed in 2018. Many plans can be structured to reward and retain key employees and provide owners with abundant long-term financial benefits.
Many of the decisions for making capital expenditures or forming profit-sharing plans take time to put in place. These next couple weeks are crucial in order to make final decisions so that contracts can be put in place before year end. And, beyond the simple mechanics of getting these types of transactions done, there are many complex decisions to make these larger, long-term transactions that are more difficult and costly to unwind. Finally, it is imperative to understand the company’s need to balance cash, profit, debt and the needs of its reporting constituents as we work to minimize the tax burden.
A few additional opportunities that are relevant for 2017 tax planning are as follows:
Employ Your Child
If you are self-employed, I suggest that you evaluate the opportunity to employ your child before the end of the year. Doing so has tax benefits in that it shifts income from you to your child, who normally is in a lower tax bracket or may avoid tax entirely due to the standard deduction. There can also be payroll tax savings since wages paid by sole proprietors to their children age 17 and younger are exempt from both social security and unemployment taxes. Employing your children has the added benefit of providing them with earned income, which enables them to contribute to an IRA. Children with IRAs, particularly Roth IRAs, have a great start on retirement savings since the compounded growth of the funds can be significant.
When employing your child, the wages paid must be reasonable given the child’s age and work skills. Second, if the child is in college, or is entering soon, having too much earned income can have a detrimental impact on the student’s need-based financial aid eligibility.
Review Your Health Insurance Costs and Coverage
Make Sure You Have Adequate Health Insurance Coverage. If you and your family don’t have adequate medical coverage (referred to as minimum essential coverage), you may be subject to a penalty. Medical insurance provided by your employer or through an individual plan purchased through a state insurance marketplace generally qualifies as adequate coverage. The penalty amount varies based on the number of uninsured members of your household and your household income. If you have three or more uninsured household members, the penalty is expected to be approximately $2,085, depending on your household income. Also, If you employ more than 50 FTEs, it is important to have your plan evaluated by a professional to determine compliance with ACA coverage.
Take Advantage of Flexible Spending Accounts (FSAs)
If your company has a healthcare and/or dependent care FSA, before year-end you must specify how much of your 2017 salary to convert into tax free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying dependent care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts-you don’t want to set aside more than what you’ll likely have in qualifying expenses for the year.
If you currently have a healthcare FSA, make sure you drain it by incurring eligible expenses before the deadline for this year. Otherwise, you’ll lose the remaining balance. It’s not that hard to drum some things up: new glasses or contacts, dental work you’ve been putting off, or prescriptions that can be filled early.
Consider a Health Savings Account (HSA)
If you are enrolled in a high-deductible health plan and don’t have any other coverage, you may be eligible to make pre-tax or tax-deductible contributions to an HSA of up to $6,750 for a family coverage or $3,350 for individual coverage-plus an extra $1,000 if you will be 55 or older by the end of 2016. Distributions from the HSA will be tax free as long as the funds are used to pay unreimbursed qualified medical expenses. Furthermore, there’s no time limit on when you can use your contributions to cover expenses. Unlike a healthcare FSA, amounts remaining in the HSA at the end of the year can be carried over indefinitely.
Make an Extra Property Tax Payment before Year End
If you are able to utilize the itemized deduction for property taxes, it may be beneficial to make an extra payment before the end of the year, especially if you are worried that this deduction will be eliminated or reduced in the future.
I look forward to helping you close out the year on a high note all the while minimizing your taxes. Please contact me at adam@minowcpa.com or at 714.900.9853 if you would like to discuss any tax planning or year-end planning opportunities.