RENO, Nev. — With the end of the year upon us, it's time to think strategically about tax planning. Tax reform added new opportunities and modified a few tried-and-true planning techniques.
Here are 10 year-end tax considerations for businesses and individuals, with an emphasis on new planning, in light of tax reform.
Business Tax Considerations
1: Take advantage of the 20% business income deduction
Following tax reform, business owners can deduct up to 20% of certain income from pass-through businesses such as partnerships and S corps. There are a few limitations that may have prevented taxpayers from fully benefiting from the new deduction in 2018, such as the limitation on service businesses and limitation based on wages and assets. Careful planning may permit taxpayers to qualify for or increase the amount of the deduction for 2019.
2: Plan for rental properties
Rental activities can be considered business activities or investment activities for tax purposes, depending on the nature and extent of the rental activities. Following tax reform, the distinction between a rental business and rental investment is significant because of the 20% section 199A deduction, the business interest limitation, and other items. Thus, taxpayers should consider whether to modify rental activities.
3: Evaluate tax accounting methods
There may be more than one method to determine when taking an item of income or deduction into account for tax purposes. For example, some businesses can choose to use either the cash or the accrual method of accounting. Tax reform greatly expanded the methods of accounting available to businesses with less than $25 million in average annual gross receipts, allowing for additional ways to defer income and accelerate deductions. Taxpayers should consider if they are using the most favorable methods of accounting for their particular circumstances. They may also need to evaluate their tax accounting methods in light of the new GAAP revenue recognition standards, which private companies are generally required to adopt starting with their 2019 statements.
4: Accelerate equipment purchases
Business taxpayers can immediately write off the cost of new/used equipment purchases following tax reform. Just because a deduction is available doesn't mean a taxpayer should buy equipment; but if you are planning to invest in equipment, you may consider buying equipment before year end to get the benefit on the 2019 tax return.
5: Create formal loan agreements and charge interest on related party loans
At times, taxpayers may lend money to their business, or vice versa. Year end is a great time to make sure advances made that year have been memorialized in a formal loan agreement with interest charged. A loan agreement calling for interest reduces the risk the IRS and courts will treat the loan as a contribution or distribution rather than a loan.
6: Update partnership agreements for the new partnership audit rules
Starting in 2018, procedures applied by the IRS in conducting partnership audits changed significantly. New rules allow the IRS to assess and collect tax on understatements of income at the partnership level and grant a partnership representative sole authority to act on behalf of the partnership in an audit. If an agreement was in effect pre-2018, it might refer to a “tax matters partner” and include other language that should be updated to reflect the new rules. For example, the agreement should designate a partnership representative and specify the duties of the representative (e.g., notify partners of developments in an IRS audit), among other things.
7: Bring tax reporting for owner compensation into compliance
There are several nuances associated with tax reporting for owner compensation, including reporting of compensation paid to partners and S corp shareholder health insurance. Now is a great time to bring tax reporting for owner compensation into compliance to avoid potential additional tax, penalties and interest. Partners are not employees, so their compensation is reported as a guaranteed payment for services on Schedule K-1, not as wages or salaries on Form W-2.
Individual Tax Considerations
8: Defer capital gains by investing in an opportunity zone fund
Tax reform added three incentives for reinvesting capital gains in economically distressed areas (opportunity zones) through a qualified opportunity fund:
• Deferral of gain invested in the QOF until the earlier of either the day the QOF is sold or exchanged; or Dec. 31, 2026.
• Permanent exclusion of up to 15% of the deferred gain if the QOF is held for at least seven years.
• Permanent exclusion of post-investment appreciation in the QOF if the investment is held at least 10 years.
If a taxpayer generated capital or net section 1231 gains during the year, for example by selling stocks or a rental property, we should consult with the client to evaluate if a QOF investment is available and right for the client.
9: Max out retirement contributions
Taxpayers may consider increasing retirement plan contributions as a way to obtain a tax deduction and set aside money for the future. In some cases, retirement plan contributions must be made by year end (e.g., a 401k plan) and in other cases the contributions can be made after year end (e.g., IRA contributions). If a business owner has not yet established a plan or would like to revisit their plan structure, now is a great time to do so. You may also want to consider converting your IRA to a Roth IRA if you have a low income year.
10: Adopt a bunching strategy for itemized deductions
Tax reform doubled the standard deduction to $12k (single)/18k (head of household)/24k (married filing joint), cutting the number of taxpayers who itemize by more than half. If you don't itemize — or can time deductions so they itemize in some years and take the standard deduction in others — a bunching strategy may be optimal.
Example: Anna and Ryan are married and pay $10k per year in state taxes and make $10k per year in charitable contributions. Their total itemized deductions, $20k, are less than the standard deduction, $24k, so they end up claiming the standard deduction. If they bunch their charitable contributions by making the $10k contribution they would otherwise make during 2020 before year end, they can claim $30k in itemized deductions for 2019 and the $24k standard deduction in 2020, providing $54k in total deductions over two years versus $48k.
In conclusion, there are many “to-do's” that need to get “to-done” by Dec. 31, 2019, to proactively manage your tax burden. Please note, this article gives a general overview, and does not offer specific tax advice. We recommend talking to a qualified tax professional about your specific situation.
Michael Bosma, CPA, is Principal-in-Charge of the Reno office of CliftonLarsonAllen LLP. Reach him for comment at firstname.lastname@example.org.