Running a profitable business these days isn’t easy. You have to operate efficiently, market aggressively and respond swiftly to competitive and financial challenges. Even when you do all of that, taxes may drag down your bottom line more than they should.
Projecting your business’s income for this year and next can allow you to time income and deductions to your advantage. It’s generally — but not always — better to defer tax, so consider:
Deferring income to next year
If your business uses the cash method of accounting, you can defer billing for products or services at year-end. If you use the accrual method, you can delay shipping products or delivering services.
Accelerating deductible expenses into the current year
If you’re a cash-basis taxpayer, you may pay business expenses by December 31 so you can deduct them this year rather than next. Both cash- and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid. You may also choose to take the opposite approach. If it’s likely you’ll be in a higher tax bracket next year, accelerating income and deferring deductible expenses may save you more tax over the two-year period.
Don’t forget about depreciation of larger assets as a way to reduce taxable income. For assets with a useful life of more than one year, you generally must depreciate the cost over a period of years. In most cases, the Modified Accelerated Cost Recovery System (MACRS) will be preferable to other methods because you’ll get larger deductions in the early years of an asset’s life. But if you made more than 40% of the year’s asset purchases in the last quarter of 2016, you could be subject to the typically less favorable midquarter convention. Careful planning can help you maximize depreciation deductions in 2017. Other depreciation-related breaks and strategies may still be available for 2016:
Section 179 expensing election
This election allows you to deduct (rather than depreciate over a number of years) the cost of purchasing eligible new or used assets, such as equipment and furniture. The expensing limit for 2015 had been $25,000 — and the break was to begin to phase out dollar-for-dollar when total asset acquisitions for the tax year exceeded $200,000 — but Congress revived the 2014 levels of $500,000 and $2 million, respectively, for 2015. These amounts are annually adjusted for inflation, with the election at $2.01 million and $500,000 for 2016.
The new expensing election permanently includes off-the-shelf computer software as qualified property. Beginning in 2016, it adds air conditioning and heating units to the list. You can claim the election only to offset net income from a “trade or business,” not to reduce it below zero to create a loss.
The break allowing Section 179 expensing for qualified leasehold improvement, restaurant and retail-improvement property has also been made permanent. For 2015, a $250,000 limit applied, but for 2016 the full Sec. 179 expensing limit applies.
50% bonus depreciation
This additional first-year depreciation for qualified assets expired December 31, 2014, but it has now been extended through 2019. However, it will drop to 40% for 2018 and 30% for 2019. Qualified assets include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software, water utility property and qualified leasehold improvement property. Beginning in 2016, the qualified improvement property doesn’t have to be leased.
The break allowing a shortened recovery period of 15 years — rather than 39 years — for qualified leasehold improvement, restaurant and retail-improvement property expired December 31, 2014. However, it has now been made permanent.
Tangible property repairs
A business that has made repairs to tangible property, such as buildings, machinery, equipment and vehicles, can expense those costs and take an immediate deduction. But costs incurred to acquire, produce or improve tangible property must be depreciated. Final IRS regulations released in late 2013 distinguish between repairs and improvements and include safe harbors for qualified businesses and routine maintenance. The final regulations are complex and are still being interpreted, so check with your CPA or tax services advisor on how it may apply to you.
Cost segregation study
If you’ve recently purchased or built a building or are remodeling existing business space, consider a cost segregation study. It identifies property components that can be depreciated much faster, increasing your current deductions. Typical assets that qualify include decorative fixtures, security equipment, parking lots and landscaping.
Hire Your Children
If your children don’t have earned income and you own a business, consider hiring them. As the business owner, you can deduct their pay. Other tax benefits may also apply. The children must be paid in line with what you would pay non-family employees for the same work.
Business-related vehicle expenses can be deducted using the mileage-rate method (54 cents per mile driven in 2016) or the actual-cost method (total out-of-pocket expenses for fuel, insurance, repairs and other vehicle expenses, plus depreciation). Purchases of new or used vehicles may be eligible for Sec. 179 expensing. However, many rules and limits apply.
For autos placed in service in 2016, the first-year depreciation limit is $3,160. The amount that may be deducted under the combination of MACRS depreciation and Sec. 179 for the first year is limited under the luxury auto rules to $11,160. In addition, if a vehicle is used for business and personal purposes, the associated expenses, including depreciation, must be allocated between deductible business use and nondeductible personal use.
A net operating loss occurs when a C corporation’s operating expenses and other deductions for the year exceed its revenues. Generally, an NOL may be carried back two years to generate a refund. Any loss not absorbed is carried forward up to 20 years to offset income. Carrying back an NOL may provide a needed influx of cash. But you can elect to forgo the carryback if carrying the entire loss forward may be more
beneficial. This might be the case if you expect your income to increase substantially compared to the prior two years…or for tax rates to go up in future years.
Section 199 deduction
The Section 199 deduction, also called the “manufacturers’ deduction” or “domestic production activities deduction,” (DPAD) is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts. The deduction is available to traditional manufacturers and to businesses engaged in activities such as construction, engineering, architecture, computer software production and agricultural processing. It isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the Alternative Minimum Tax calculation.
Not all of these deductions will apply to your particular business, but knowing about them supports better business tax planning in 2017.
If you have questions about any of these potential deductions, employee benefits incentives or tax credits for the current or coming tax year, talk to the Tax Services Group at Cornwell Jackson. You may also download our newest Tax Planning Guide.
Gary Jackson, CPA, is the lead tax partner at Cornwell Jackson. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing tax advisory services to individuals and business leaders in the Dallas/Fort Worth area and across North Texas.