Business Owners: An Exit Strategy Should be Part of Your Tax Plan

Tax planning is a juggling act for business owners. You have to keep your eye on your company’s income and expenses and applicable tax breaks (especially if you own a pass-through entity). But you also must look out for your own financial future.

For example, you need to develop an exit strategy so that taxes don’t trip you up when you retire or leave the business for some other reason. An exit strategy is a plan for passing on responsibility for running the company, transferring ownership and extracting your money from the business.

Buy-sell agreement

When a business has more than one owner, a buy-sell agreement can be a powerful tool. The agreement controls what happens to the business when a specified event occurs, such as an owner’s retirement, disability or death. Among other benefits, a well-drafted agreement:

  • Provides a ready market for the departing owner’s shares,
  • Prescribes a method for setting a price for the shares, and
  • Allows business continuity by preventing disagreements caused by new owners.

A key issue with any buy-sell agreement is providing the buyer(s) with a means of funding the purchase. Life or disability insurance often helps fulfill this need and can give rise to several tax issues and opportunities. One of the biggest advantages of life insurance as a funding method is that proceeds generally are excluded from the beneficiary’s taxable income.

Succession within the family

You can pass your business on to family members by giving them interests, selling them interests or doing some of each. Be sure to consider your income needs, the tax consequences, and how family members will feel about your choice.

Under the annual gift tax exclusion, you can gift up to $15,000 of ownership interests without using up any of your lifetime gift and estate tax exemption. Valuation discounts may further reduce the taxable value of the gift.

With the gift and estate tax exemption approximately doubled through 2025 ($11.4 million for 2019), gift and estate taxes may be less of a concern for some business owners. But others may want to make substantial transfers now to take maximum advantage of the high exemption. What’s right for you will depend on the value of your business and your timeline for transferring ownership.

Plan ahead

If you don’t have co-owners or want to pass the business to family members, other options include a management buyout, an employee stock ownership plan (ESOP) or a sale to an outsider. Each involves a variety of tax and nontax considerations.

Please contact us to discuss your exit strategy. To be successful, your strategy will require planning well in advance of the transition.

© 2018

Does Prepaying Property Taxes Make Sense Anymore?

Prepaying property taxes related to the current year but due the following year has long been one of the most popular and effective year-end tax-planning strategies. But does it still make sense in 2018?

The answer, for some people, is yes — accelerating this expense will increase their itemized deductions, reducing their tax bills. But for many, particularly those in high-tax states, changes made by the Tax Cuts and Jobs Act (TCJA) eliminate the benefits.

What’s changed?

The TCJA made two changes that affect the viability of this strategy. First, it nearly doubled the standard deduction to $24,000 for married couples filing jointly, $18,000 for heads of household, and $12,000 for singles and married couples filing separately, so fewer taxpayers will itemize. Second, it placed a $10,000 cap on state and local tax (SALT) deductions, including property taxes plus income or sales taxes.

For property tax prepayment to make sense, two things must happen:

1. You must itemize (that is, your itemized deductions must exceed the standard deduction), and

2. Your other SALT expenses for the year must be less than $10,000.

If you don’t itemize, or you’ve already used up your $10,000 limit (on income or sales taxes or on previous property tax installments), accelerating your next property tax installment will provide no benefit.

Example

Joe and Mary, a married couple filing jointly, have incurred $5,000 in state income taxes, $5,000 in property taxes, $18,000 in qualified mortgage interest, and $4,000 in charitable donations, for itemized deductions totaling $32,000. Their next installment of 2018 property taxes, $5,000, is due in the spring of 2019. They’ve already reached the $10,000 SALT limit, so prepaying property taxes won’t reduce their tax bill.

Now suppose they live in a state with no income tax. In that case, prepayment would potentially make sense because it would be within the SALT limit and would increase their 2018 itemized deductions.

Look before you leap

Before you prepay property taxes, review your situation carefully to be sure it will provide a tax benefit. And keep in mind that, just because prepayment will increase your 2018 itemized deductions, it doesn’t necessarily mean that’s the best strategy. For example, if you expect to be in a higher tax bracket in 2019, paying property taxes when due will likely produce a greater benefit over the two-year period.

For help determining whether prepaying property taxes makes sense for you this year, contact us. We can also suggest other year-end tips for reducing your taxes.

© 2018

You May Be Able To Save More for Retirement in 2019

Retirement plan contribution limits are indexed for inflation, and many have gone up for 2019, giving you opportunities to increase your retirement savings:

  • Elective deferrals to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans: $19,000 (up from $18,500)
  • Contributions to defined contribution plans: $56,000 (up from $55,000)
  • Contributions to SIMPLEs: $13,000 (up from $12,500)
  • Contributions to IRAs: $6,000 (up from $5,500)

One exception is catch-up contributions for taxpayers age 50 or older, which remain at the same levels as for 2018:

  • Catch-up contributions to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans: $6,000
  • Catch-up contributions to SIMPLEs: $3,000
  • Catch-up contributions to IRAs: $1,000

Keep in mind that additional factors may affect how much you’re allowed to contribute (or how much your employer can contribute on your behalf). For example, income-based limits may reduce or eliminate your ability to make Roth IRA contributions or to make deductible traditional IRA contributions.

For more on how to make the most of your tax-advantaged retirement-saving opportunities in 2019, please contact us.

© 2018

A Refresher on Major Tax Law Changes for Small-Business Owners

The dawning of 2019 means the 2018 income tax filing season will soon be upon us. After year end, it’s generally too late to take action to reduce 2018 taxes. Business owners may, therefore, want to shift their focus to assessing whether they’ll likely owe taxes or get a refund when they file their returns this spring, so they can plan accordingly.

With the biggest tax law changes in decades — under the Tax Cuts and Jobs Act (TCJA) — generally going into effect beginning in 2018, most businesses and their owners will be significantly impacted. So, refreshing yourself on the major changes is a good idea.

Taxation of pass-through entities

These changes generally affect owners of S corporations, partnerships and limited liability companies (LLCs) treated as partnerships, as well as sole proprietors:

  • Drops of individual income tax rates ranging from 0 to 4 percentage points (depending on the bracket) to 10%, 12%, 22%, 24%, 32%, 35% and 37%
  • A new 20% qualified business income deduction for eligible owners (the Section 199A deduction)
  • Changes to many other tax breaks for individuals that will impact owners’ overall tax liability

Taxation of corporations

These changes generally affect C corporations, personal service corporations (PSCs) and LLCs treated as C corporations:

  • Replacement of graduated corporate rates ranging from 15% to 35% with a flat corporate rate of 21%
  • Replacement of the flat PSC rate of 35% with a flat rate of 21%
  • Repeal of the 20% corporate alternative minimum tax (AMT)

Tax break positives

These changes generally apply to both pass-through entities and corporations:

  • Doubling of bonus depreciation to 100% and expansion of qualified assets to include used assets
  • Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phaseout threshold to $2.5 million
  • A new tax credit for employer-paid family and medical leave

Tax break negatives

These changes generally also apply to both pass-through entities and corporations:

  • A new disallowance of deductions for net interest expense in excess of 30% of the business’s adjusted taxable income (exceptions apply)
  • New limits on net operating loss (NOL) deductions
  • Elimination of the Section 199 deduction (not to be confused with the new Sec.199A deduction), which was for qualified domestic production activities and commonly referred to as the “manufacturers’ deduction”
  • A new rule limiting like-kind exchanges to real property that is not held primarily for sale (generally no more like-kind exchanges for personal property)
  • New limitations on deductions for certain employee fringe benefits, such as entertainment and, in certain circumstances, meals and transportation

Preparing for 2018 filing

Keep in mind that additional rules and limits apply to the rates and breaks covered here. Also, these are only some of the most significant and widely applicable TCJA changes; you and your business could be affected by other changes as well. Contact us to learn precisely how you might be affected and for help preparing for your 2018 tax return filing — and beginning to plan for 2019, too.

© 2018

6 Last-Minute Tax Moves for Your Business

 

Tax planning is a year-round activity, but there are still some year-end strategies you can use to lower your 2018 tax bill. Here are six last-minute tax moves business owners should consider:

  1. Postpone invoices. If your business uses the cash method of accounting, and it would benefit from deferring income to next year, wait until early 2019 to send invoices. Accrual-basis businesses can defer recognition of certain advance payments for products to be delivered or services to be provided next year.
  2. Prepay expenses. A cash-basis business may be able to reduce its 2018 taxes by prepaying certain expenses — such as lease payments, insurance premiums, utility bills, office supplies and taxes — before the end of the year. Many expenses can be deducted up to 12 months in advance.
  3. Buy equipment. Take advantage of 100% bonus depreciation and Section 179 expensing to deduct the full cost of qualifying equipment or other fixed assets. Under the Tax Cuts and Jobs Act, bonus depreciation, like Sec. 179 expensing, is now available for both new and used assets. Keep in mind that, to deduct the expense on your 2018 return, the assets must be placed in service — not just purchased — by the end of the year.
  4. Use credit cards. What if you’d like to prepay expenses or buy equipment before the end of the year, but you don’t have the cash? Consider using your business credit card. Generally, expenses paid by credit card are deductible when charged, even if you don’t pay the credit card bill until next year.
  5. Contribute to retirement plans. If you’re self-employed or own a pass-through business — such as a partnership, limited liability company or S corporation — one of the best ways to reduce your 2018 tax bill is to increase deductible contributions to retirement plans. Usually, these contributions must be made by year-end. But certain plans — such as SEP IRAs — allow your business to make 2018 contributions up until its tax return due date (including extensions).
  6. Qualify for the pass-through deduction. If your business is a sole proprietorship or pass-through entity, you may qualify for the new pass-through deduction of up to 20% of qualified business income. But if your taxable income exceeds $157,500 ($315,000 for joint filers), certain limitations kick in that can reduce or even eliminate the deduction. One way to avoid these limitations is to reduce your income below the threshold — for example, by having your business increase its retirement plan contributions.

Most of these strategies are subject to various limitations and restrictions beyond what we’ve covered here, so please consult us before you implement them. We can also offer more ideas for reducing your taxes this year and next.

© 2018

2019 Q1 tax calendar: Key deadlines for businesses and other employers

Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2019. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

January 31

  • File 2018 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
  • Provide copies of 2018 Forms 1099-MISC, “Miscellaneous Income,” to recipients of income from your business where required.
  • File 2018 Forms 1099-MISC reporting nonemployee compensation payments in Box 7 with the IRS.
  • File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2018. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 11 to file the return.
  • File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2018. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 11 to file the return. (Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944,“Employer’s Annual Federal Tax Return.”)
  • File Form 945, “Annual Return of Withheld Federal Income Tax,” for 2018 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities and IRAs. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 11 to file the return.

February 28

  • File 2018 Forms 1099-MISC with the IRS if 1) they’re not required to be filed earlier and 2) you’re filing paper copies. (Otherwise, the filing deadline is April 1.)

March 15

  • If a calendar-year partnership or S corporation, file or extend your 2018 tax return and pay any tax due. If the return isn’t extended, this is also the last day to make 2018 contributions to pension and profit-sharing plans.

© 2018

Real estate investor vs. professional: Why it matters

Income and losses from investment real estate or rental property are passive by definition — unless you’re a real estate professional. Why does this matter? Passive income may be subject to the 3.8% net investment income tax (NIIT), and passive losses generally are deductible only against passive income, with the excess being carried forward.

Of course the NIIT is part of the Affordable Care Act (ACA) and might be eliminated under ACA repeal and replace legislation or tax reform legislation. But if/when such legislation will be passed and signed into law is uncertain. Even if the NIIT is eliminated, the passive loss issue will still be an important one for many taxpayers investing in real estate.

“Professional” requirements

To qualify as a real estate professional, you must annually perform:

  • More than 50% of your personal services in real property trades or businesses in which you materially participate, and
  • More than 750 hours of service in these businesses.

Each year stands on its own, and there are other nuances. (Special rules for spouses may help you meet the 750-hour test.)

Tax strategies

If you’re concerned you’ll fail either test and be subject to the 3.8% NIIT or stuck with passive losses, consider doing one of the following:

Increasing your involvement in the real estate activity. If you can pass the real estate professional tests, the activity no longer will be subject to passive activity rules.

Looking at other activities. If you have passive losses from your real estate investment, consider investing in another income-producing trade or business that will be passive to you. That way, you’ll have passive income that can absorb some or all of your passive losses.

Disposing of the activity. This generally allows you to deduct all passive losses — including any loss on disposition (subject to basis and capital loss limitations). But, again, the rules are complex.

Also be aware that the IRS frequently challenges claims of real estate professional status — and is often successful. One situation where the IRS commonly prevails is when the taxpayer didn’t keep adequate records of time spent on real estate activities.

If you’re not sure whether you qualify as a real estate professional, please contact us at (214) 696-1922. We can help you make this determination and guide you on how to properly document your hours.

© 2017

Are income taxes taking a bite out of your trusts?

If your estate plan includes one or more trusts, review them in light of income taxes. For trusts, the income threshold is very low for triggering the:

  • Top income tax rate of 39.6%,
  • Top long-term capital gains rate of 20%, and
  •  Net investment income tax (NIIT) of 3.8%.

The threshold is only $12,500 for 2017.

3 ways to soften the blow

Three strategies can help you soften the blow of higher taxes on trust income:

1. Use grantor trusts. An intentionally defective grantor trust (IDGT) is designed so that you, the grantor, are treated as the trust’s owner for income tax purposes — even though your contributions to the trust are considered “completed gifts” for estate- and gift-tax purposes.

IDGTs offer significant advantages. The trust’s income is taxed to you, so the trust itself avoids taxation. This allows trust assets to grow tax-free, leaving more for your beneficiaries. And it reduces the size of your estate. Further, as the owner, you can sell assets to the trust or engage in other transactions without tax consequences.

Keep in mind that, if your personal income exceeds the applicable thresholds for your filing status, using an IDGT won’t avoid the tax rates described above. Still, the other benefits of these trusts make them attractive.

2. Change your investment strategy. Despite the advantages of grantor trusts, nongrantor trusts are sometimes desirable or necessary. At some point, for example, you may decide to convert a grantor trust to a nongrantor trust to relieve yourself of the burden of paying the trust’s taxes. Also, grantor trusts become nongrantor trusts after the grantor’s death.

One strategy for easing the tax burden on nongrantor trusts is for the trustee to shift investments into tax-exempt or tax-deferred investments.

3. Distribute income. Generally, nongrantor trusts are subject to tax only to the extent they accumulate taxable income. When a trust makes distributions to a beneficiary, it passes along ordinary income (and, in some cases, capital gains), which are taxed at the beneficiary’s marginal rate.

Thus, one strategy for minimizing taxes on trust income is to distribute the income to beneficiaries in lower tax brackets. The trustee might also consider distributing appreciated assets, rather than cash, to take advantage of a beneficiary’s lower capital gains rate.

Of course, this strategy may conflict with a trust’s purposes, such as providing incentives to beneficiaries, preserving assets for future generations and shielding assets from beneficiaries’ creditors.

If you’re concerned about income taxes on your trusts, contact us. We can review your estate plan to uncover opportunities to reduce your family’s tax burden.

© 2017

Real Estate Investing Podcast with Mark Patten and Mandy Thiebaud

Mark Patten, CPA and Mandy Thiebaud, CPA  of McKinnon Patten & Associates discuss with Old Capital Podcast how earned income and passive income are treated by the IRS, capitalizing versus expensing replacements & repairs, and why owning real estate is more than just a return on your investment. Find out about 1031 exchanges, like-kind exchanges as well as cost segregation and how it can benefit your real estate investment. http://bit.ly/2rzqU8L

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Turning next year’s tax refund into cash in your pocket now

Each year, millions of taxpayers claim an income tax refund. To be sure, receiving a payment from the IRS for a few thousand dollars can be a pleasant influx of cash. But it means you were essentially giving the government an interest-free loan for close to a year, which isn’t the best use of your money.

Fortunately, there is a way to begin collecting your 2017 refund now: You can review the amounts you’re having withheld and/or what estimated tax payments you’re making, and adjust them to keep more money in your pocket during the year.

Reasons to modify amounts

It’s particularly important to check your withholding and/or estimated tax payments if:

  • You received an especially large 2016 refund,
  • You’ve gotten married or divorced or added a dependent,
  • You’ve purchased a home,
  • You’ve started or lost a job, or
  • Your investment income has changed significantly.

Even if you haven’t encountered any major life changes during the past year, changes in the tax law may affect withholding levels, making it worthwhile to double-check your withholding or estimated tax payments.

Making a change

You can modify your withholding at any time during the year, or even several times within a year. To do so, you simply submit a new Form W-4 to your employer. Changes typically will go into effect several weeks after the new Form W-4 is submitted. For estimated tax payments, you can make adjustments each time quarterly payments are due.

While reducing withholdings or estimated tax payments will, indeed, put more money in your pocket now, you also need to be careful that you don’t reduce them too much. If you don’t pay enough tax during the year, you could end up owing interest and penalties when you file your return, even if you pay your outstanding tax liability by the April 2018 deadline.

If you’d like help determining what your withholding or estimated tax payments should be for the rest of the year, please contact us.

© 2017