Many tax professionals are already providing their small business clients with tax planning advice, in addition to tax compliance services. Implementing the provisions of the Tax Cuts and Jobs Act presents a good opportunity for all practitioners to perform advisory services by looking at their clients’ 2019 tax situations and identifying tax savings opportunities, especially as we approach year end. Here are various tax law provisions and year-end tax planning tips you’ll want to know about and pass on to your clients.
20% Qualified Business Income Deduction
The qualified business income (QBI) deduction is one of the key tax reform measures that gives small business owners a 20% deduction on pass-through income from sole proprietorships (Schedules C, E and F on Form 1040), limited liability companies, partnerships, and S corporations. Small businesses qualifying for the 20% tax deduction could see their effective marginal tax rate reduced to 29.6%.
There are some comprehensive rules surrounding this deduction, including a phase-out of the deduction for high-income earners (over $160,700 for single filers and $321,400 for joint filers). The rules associated with the provision opens the door for some planning techniques to maximize the deduction and reduce taxable income and tax liability.
- If you’re over the taxable income threshold, think about deferring income and/or accelerating expenses, such as contributing to a retirement plan, to bring down taxable income in the current year, and thus, increasing the QBI deduction.
- If you’re subject to the wage/depreciable property limits, think about hiring W-2 employees instead of independent contractors to increase the QBI deduction. Remember to take into account increased payroll tax and employee benefits.
- If you’re subject to the 20% taxable income limit, think about increasing taxable income, such as taking on a second job, to increase the QBI deduction.
- If you have a specified service trade or business, and are subject to the phase-out, think about establishing a separate business, separate entity or C corporation. Be careful because there are rules constraining some of these tactics.
- If you have no or low QBI, see if there are opportunities to become a business owner, such as an employee becoming a consultant. Remember to take into account all considerations, including the benefits package.
Depreciation Perks Under Tax Reform
In an effort to reduce taxable income and save tax dollars, you can meet with your small business clients to see if it makes sense to invest in depreciable property before year-end.
Bonus depreciation. The government increased bonus depreciation from 50% to 100%. Generally, bonus depreciation applies to personal property, such as furniture and equipment, but used property now qualifies. You can elect out of bonus depreciation on an asset class basis only, and you must attach an election statement.
- Be careful claiming bonus depreciation when you cannot fully use the benefits in the current year. Net operating losses need to be carried over and the self-employment tax doesn’t allow for loss carryovers.
- Bonus depreciation may reduce your 20% QBI deduction, but could also take you below the phase-out threshold and allow for a greater deduction – so plan carefully.
Section 179 expensing. The limit increased to $1,020,000 for 2019, but remember it is limited to business income and is recaptured if the business use percentage drops below 50%.
- Section 179 deduction allows for more flexibility than bonus depreciation because you’re able to pick and choose the assets and amounts to expense.
- Section 179 may reduce your 20% QBI deduction, but could also take you below the phase-out threshold and allow for a greater deduction so plan carefully.
Choosing the Best Entity Type
Under tax reform, the tax rate for C corporations dropped from 35% (top marginal rate) to 21% (flat tax). To simplify things even more, Congress repealed the corporate alternative minimum tax. Reducing the corporate rate to 21% and the new 20% deduction for flow-through entities opens the door for small businesses to choose the most favorable entity type. In addition to crunching the numbers, be sure to consider all the factors, such as administrative duties and legal liability implications.
It’s always a good idea to plan for retirement early, especially with the government handing out lucrative tax incentives. There are a variety of retirement plans available to small businesses that allow the employer and employee a tax-favored way to save for retirement. Contributions made by the owner for themselves and for employees can be deducted. Furthermore, the earnings on the contributions grow tax free until the money is distributed from the plan. Please note: With Roth plans, you don’t get a deduction for the contribution, but the earnings escape taxation (not just deferral). The small business owner is also allowed a tax credit equal to 50% of the first $1,000 incurred in starting up a plan.
Small businesses are sometimes reluctant to save for retirement because they don’t have enough cash. For some plans, the rules allow you to wait until the filing deadline to contribute and still get a deduction for the previous year.
New Credit for Employer-Paid Family and Medical Leave
One nice new perk for businesses and their employees allows business owners to claim a credit for wages paid to employees on family and medical leave. It starts at 12.5% for payments of 50% salary and goes up to 25% if the leave payment rate is 100% of the normal rate. The maximum leave allowed for any employee is 12 weeks per year. To qualify, you need to have a written policy that provides at least two weeks of paid leave.
Businesses of all sizes and types should learn to keep good records as an integral part of being successful. Recordkeeping is key because it helps monitor financial health and business progress, identifies sources of income and expenses, and leads to easier financial statement and tax return preparation.
For efficiency, small businesses can choose an electronic, cloud-based system such as QuickBooks® Online to record transactions, and track revenue and expenses. In general, the IRS suggests that taxpayers retain their records for three years.
Focus on Your Clients
As you perform these services, it’s important to point out the return on investment to your clients so they can see the value of the services – for example, how much they are saving versus how much it will cost them to do the extra work. Overall, the goal is to enhance your standing as your clients’ trusted advisor to set yourself apart from the competition.
Editor’s note: This article was originally published in the CPA Practice Advisor.