As your company prepares for the upcoming tax season, now is a good time to review the lessons learned from last year’s first exposure to the provisions of the Tax Cuts and Jobs Act. Here are seven end-of-year steps that owners, financial officers, and tax executives in closely held businesses should take now to prepare.
1) Maximize Pass-Through Deductions
One of the most significant provisions of tax reform for sole proprietorships, partnerships, and S corporations is the qualified business income (QBI) deduction, also known as the section 199A deduction. This allows business owners to deduct up to 20 percent of pass-through business income, and it also provides for a 20 percent reduction of certain types of rental income.
But, as many taxpayers discovered last year, the deduction is subject to some complex limitations. If you have not done so already, you should review how your business is structured and how profits are distributed to see if there are changes you could make that would apply this deduction more effectively.
2) Re-evaluate Depreciation Strategies
Another important year-end review involves how the depreciation of capital assets is handled, particularly in view of the new tax law’s changes to Section 179 of the tax code and its expansion of bonus depreciation. Deciding which approach to take is not always a simple decision.
In addition to different caps and general limitations, the two approaches also impose different limits on vehicles and certain types of equipment, as well as on rental properties and property improvements. Also note that bonus depreciation can be used to create a net loss for the year, while Section 179 deductions cannot. Because of these complexities—and many others—you should consider longer-term impact to the P&L when evaluating which method is the most beneficial to your business.
3) Analyze Business Interest Expense
Tax reform made important changes to the deductibility of net business interest expense, limiting the deduction to 30 percent of earnings before interest, taxes, depreciation, and amortization (EBITDA). But that limitation does not apply to businesses with average annual gross receipts of less than $25 million for the prior three tax years.
The law also allows certain real estate companies to avoid the limitation by electing an Alternative Depreciation System (ADS) for real property. If your company falls into this category and is at or near the $25 million threshold, it is prudent to consider the implications of ADS as a depreciation method to determine if making this election would be beneficial.
4) Review Entertainment and Meals Expenses
New limits on the deductibility of business entertainment expenses and meals caused considerable confusion during the 2018 tax cycle. With the benefit of hindsight, now is the time to review your company’s handling of these expenses.
5) Check for State and Local Tax Conformity
State and local compliance can be especially challenging if your business expanded into a new jurisdiction during the year. Some states’ tax codes mirror the federal code while others differ drastically.
6) Update Employment Records
The end of the year is a good time to make sure employment records are up to date. Verify you have current addresses and other information for Forms 1099 and W-2. And keep in mind a new Form W-4 will be coming out soon.
7) Review Independent Contractors’ Status
Improperly categorizing workers as independent contractors rather than employees is a hot button issue for the IRS. So it’s wise to review the status of all workers annually.
Contact Holbrook & Manter today with any questions you may have regarding your tax situation.