As 2018 draws to a close, it’s time to consider tax planning strategies that will lower your 2018 tax liability. There is still time to implement many tax savings strategies before the end of the year which can lower your tax bill for 2018 and beyond. There are many overlooked situations which business owners can use to their advantage. With that in mind, we have compiled a list of the top 10 tax topics you should know before December 31st.
1) Making your spouse a business partner to reduce taxes
If you currently own a sole proprietorship or are planning to start a general partnership or LLC, you can utilize your spouse as a partner to lower your tax burden. By making your spouse a limited partner in your business, their income from the business will not be subject to self-employment tax. Your spouse is viewed as an investor and as such, they are not required to pay self-employment taxes on their share of net income. Because your spouse will be viewed strictly as an investor, they cannot participate in the day-to-day activities or management of the business.
Additionally, you and your spouse will qualify for the new Section 199A passthrough income deduction. The 199A deduction provides up to a 20 percent tax deduction on qualified business income from the partnership.
2) Employ your child to lower your taxable income
Hiring children to work as legitimate employees in your business is a great tax savings strategy and recent changes in tax law have made it even more advantageous. Under the Tax Cuts and Jobs Act of 2017 (“TCJA”), the standard deduction was raised to $12,000. This means that a business owner can pay a child up to $12,000 of wages tax free and the business will receive a tax deduction of $12,000.
If your business is operated as a sole proprietorship or spousal partnership, wages paid to your child, under the age of 18, are exempt from FICA taxes. Wages paid to a child under 21 will also be exempt from unemployment taxes.
Example: You employ your 12, and 14 year old children to work in your sole proprietorship. In return you pay them a fair market wage for their services at $12,000 per child for the year. For a total of $24,000 of wages paid to your children for the year.
The result is that your children do not pay any taxes on the income because they have no taxable income due to the new standard deduction of $12,000. The business gets a $24,000 deduction on Schedule C for the wages paid. This reduces both businesses taxable income and self employment taxes for the business owner.
The example above would only apply to a sole proprietorship or spousal partnership that pays wages to children under age 18.
3) Convert your personal vehicle to a business vehicle and deduct up to 100%
If you use your vehicle for business, you should consider converting it from a personal vehicle to a business vehicle. When you contribute your vehicle to the business, the IRS views this as the business placing the vehicle in service at that time. By contributing the vehicle to the business, the vehicle can be depreciated. The TCJA allows unlimited 100% first-year bonus depreciation for qualifying new and used assets that were acquired and placed in service during 2018. This means that if you convert your personal vehicle to a business vehicle you could potentially deduct 100% of the basis of your vehicle this year. In order to do this, follow our guidance below.
First, you need to determine your vehicle’s basis to use for depreciation. To find this for your converted vehicle, you will use the lesser of:
- Fair market value on the date of conversion from personal to business use; or,
- Adjusted basis of the property (the amount you originally paid for the vehicle plus any improvements)
Example. A business owner purchased a car for $25,000 in 2017. In its current condition, the fair market value of the vehicle is $20,000. Because the fair market value of the vehicle is less than the adjusted basis the $20,000 fair market value of the vehicle is used as the beginning basis.
Bonus depreciation for most qualified assets purchased after September 27, 2017 is:
- 50% – If you elect to sub 50% for 100% during the first taxable year ending after 9/27/17
- If restricted by the luxury vehicle rules, limited to business use of $8,000
If a taxpayer is not using the IRS optional mileage rates for their vehicle, the basis after conversion would be one of the following:
- 100% bonus depreciation
- If restricted by the luxury vehicle rules, limited to business use of $8,000
- If you elected out of bonus depreciation, MACRS depreciation
The depreciation deduction would be limited proportionally if the vehicle’s business use is less than 100%.
Following our example above, the depreciable basis of the vehicle is $20,000. If the owner claims to use the vehicle 50% for personal and 50% for business, the business would be able to take a $10,000 depreciation deduction ($20,000 X 50%) for the vehicle.
4) Rental property and the new 199A Deduction
In order to to claim the Section 199A deduction, a taxpayer must be engaged in a qualified trade or business activity. The good news is that certain rental activities are considered qualified business activities meaning the IRS allows income generated from these properties to be treated as qualified business income and owners are allowed the deduction.
In order for the property to qualify, it must pass one of the following tests:
- The rental property qualifies as a trade or business under tax code Section 162; or,
- You rent the property to a “commonly controlled” trade or business.
If your rental property falls under one of these two situations, it is eligible for the Section 199A deduction.
For rental activities, qualifying property does not include the following:
- Land (which is non-depreciable)
- Property expensed under $2,500/$5,000 de minimis safe harbor
- Improvements expensed under the small taxpayer safe harbor
Keep in mind that there are income limitations to the 199A deduction. Single taxpayers with wages and qualified property above the income limitations ($157,500 single/$315,000 married) will be phased out of the deduction.
5) Personal home vs Tax home
Often times, business owners confuse the difference between a personal home and a tax home. It is an often overlooked concept which has cost business owners deductions in the past. Here’s a look at how they differ and what you should know to avoid any issues.
Personal home – Simply put, this is where you live.
Tax home – Per the IRS is “the entire city or general area where your main place of business or work is located, regardless of where you maintain your family home”.
As an example, a business owner may have a personal home which he and his family live in and a tax home, where he works, 150 miles away.
An example of a business owner losing their deduction in this case would be deducting their car and transportation costs between their personal and tax home. This is not allowed because the costs are viewed as personal and non-deductible.
It’s also important to note that If a business owner has multiple businesses, their tax home is considered the office where the most time is spent and the most money is made. Additionally, if you have one business with multiple offices, your tax home is the office which you spend the most time, do the most important things, and make the most money.
6) Employer credit for family and medical leave benefits
A new tax credit created by the TCJA allows employers to claim a credit for paid family and medical leave. Employers may claim the credit based on wages paid to qualifying employees while they are on family and medical leave.
In order to be an “eligible employer” and claim the credit, you must have a written policy in place which meets the following requirements:
- Employers must provide at least two weeks of paid family and medical leave annually to all qualifying employees who work full time. This can be prorated for employees who work part time.
- The paid leave must be not less than 50 percent of the wages normally paid to the employee.
What qualifies as family and medical leave? For the credit, family and medical leave is leave taken by a qualified employee for the following reasons:
- Birth of son or daughter, in order to take care of the son or daughter
- Placement of a son or daughter with the employee for adoption or foster care.
- A serious health condition of employees spouse, son, daughter, or parent.
- A serious health condition that makes the employee unable to perform the functions of their position
- Any qualifying event due to an employee’s spouse, child, or parent being on covered active duty – or being called to duty – in the Armed Forces.
- To care for a service member who is the employee’s spouse, child, parent, or next of kin.
There are limitations on the credit. The max length of paid leave taken by an employee who can qualify for the credit is 12 weeks per tax year. Also, The total credit for each employee for a taxable year cannot exceed the employee’s hourly rate multiplied by the number of hours that leave is taken.
Example: An employee’s hourly wage is $25 per hour. If this employee takes 80 hours of family and medical leave, the company’s credit cannot exceed $2,000 ($25 X 80).
7) Business meals with clients and prospects
With the new Tax Cuts and Jobs Act came many questions of whether or not a deduction for business meals with clients and prospects would still be allowed. In Revenue Notice 2018-76, the IRS stated that client and prospect business meals will continue to be allowed as tax deductions.
Under the new guidance, business owners are allowed to deduct 50% of these meals if the following are met:
- The expense is ordinary and necessary under Section 162(a).
- The expense is not lavish or extravagant.
- The taxpayer, or employee of must be present at the furnishing of the food or beverages.
- The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact.
- In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts. The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.
The IRS requires anyone taking the deduction to keep documentation to support that these expenses are business meals. Without supporting documentation, the IRS can completely disallow any deductions taken.
8) Rent from spouse and reduce self employment taxes
Anyone running a business as a sole proprietorship knows that self employment taxes can dig into profits. If you own the building where your offices are located and currently pay yourself rent, one simple way to lower self-employment taxes is to transfer the building to your spouse and set up a rental arrangement with your spouse.
Here’s a quick example of how this could work:
You gift the office building to your spouse and then rent it from them for $1,500 per month. By setting up the building as rental activity in your spouse’s name, you can move the $18,000 of rental income you report on Schedule C to Schedule E of your 1040. Unlike the Schedule C income, the Schedule E rental activity income is not subject to self-employment taxes. Moving $18,000 from your Schedule C to your Schedule E would save you a total of $2,543.32 in self employment taxes.
There are some stipulations which apply and in order to deduct 100% of your rental payments, your spouse must own 100% of the property.
9) Net operating loss changes for 2018
A net operating loss (NOL) is the amount by which a taxpayer’s business losses exceed its income. The Tax Cuts and Jobs Act made two big changes to how businesses must treat NOLs. The first notable change is that businesses can not carry back an NOL, with the exception of certain qualified farming losses. The second change is that your NOL carryforward can only offset up to 80% of your taxable income in any given tax year.
The immediate result of these changes are that the taxpayer is no longer able to carry back net operating losses to previous tax years to claim a refund of prior years tax paid, and delayed tax benefits from future loss carry forwards.
Despite these changes, there some tactics you can use to utilize your loss in the current year and avoid delaying the tax benefits to future years.
One such way you can make the losses work for you is to use your losses to take a tax free IRA withdrawal.
Another way to take advantage of losses would be to sell an asset which has appreciated. You can use your business losses to offset taxable gains on the sale of the asset.
10) Deducting Section 179 property.
Section 179 of the Internal Revenue Code allows businesses to deduct the full purchase price of certain qualifying property in the year it was purchased. Qualifying Section 179 property includes both new and used property placed in service during the year. The TCJA increased the maximum 179 deduction from $510,000 to $1,000,000 for 2018. This means that for most small businesses the entire cost of qualifying property can be written off in 2018. The deductions does come with some limits though. The maximum deduction in 2018 is $1,000,000 and the deduction begins to phase-out on a dollar-for-dollar basis after $2,500,000 of qualifying property is placed in service.
Another change that was made to this deduction for 2018 is that the definition of Section 179 property was expanded to include tangible personal property used primarily to furnish lodging. This means that business owners can deduct the full cost of property such as beds, appliances, and other equipment used in the living quarters of a lodging facility.
Section 179 also allows owners to deduct “qualified improvement property”. Qualified improvement property includes any improvement to an interior portion of a nonresidential property, if the improvement is placed in service after the building was placed in service. Qualified property also includes improvement or replacement of roofs, HVAC systems, fire protection systems, alarm systems, and security systems. However, certain expenses such as elevators, internal structure framework of the building, and the expansion/enlargement of the building do not qualify for the deduction.
As a small business owner, you know that long-term planning is critical to your success and planning for taxes and implementing tax planning strategies is a key aspect of planning for the future. For many small business owners tax planning may seem daunting, but it doesn’t need to be. Implementing one or two of the tax strategies above can result in significant tax savings for your small business this year and for years to come.