RENO, Nev. — Most every CPA and Enrolled Agent I run into agrees — 2020 is the “wonkiest” tax season on record.
While most taxpayers were celebrating the change of the official tax filing date from April 15th to July 15th of this year, the preparers of these tax returns issued a collective groan.
Basically, their “busy season” had been extended 3 months. Wahoo! As the team wrapped up this “filing” season, I thought it would be prudent to list the Top 10 mistakes that cost you a buck or ten. Drumroll please:
10. Not taking losses from self-rental. Generally, losses from rental of real estate is, per se, passive as it relates to the passive activity loss rules under IRC section 469. If your partnership or S corporation business rents from your related entity, generally you can deduct any loss from the rental against other active income.
9. Not making aggregation election for a real estate professional. Real estate professionals get to deduct losses against active income (i.e. the holy grail of tax planning). The be considered a real estate professional, you must spend more than half of your time in a real estate trade or business, with a minimum of 750 hours. If you elect to aggregate your real estate activities, it is easier to meet this hurdle. Often more importantly, is how this can treat the income from these endeavors as being subject to the 3.8% Net Investment Income Tax.
8. Not putting enough into a front door or back door Roth IRA. If you can contribute into a Roth IRA, do. If you cannot, contribute to a non-deductible IRA, then do an immediate Roth conversion for zero tax. Make sure you don’t have other pre-tax IRAs to make sure you don’t get surprised on how the conversion rules work.
7. Not changing your method of accounting. With tax reform, many methods of accounting that you were required to adopt because your average income exceeds 10 million have now been relaxed. This basically allows most mortal businesses to decide if cash or accrual is better for them. In tax planning, less tax is “more better.”
6. Not putting your children to work. Employing your minor children for real work allows them to have income that is not subject to the kiddy tax; it also escapes FICA and Medicare Tax. In order to take advantage of this benefit, they must generally be employed by your sole proprietorship or wholly owned partnership.
5. Supporting your college age children. Most business owners get no benefit for paying for their children to go to college because the college credit, etc., are phased out. Pointing self-employment income at them, however, is a very good way to have them support themselves, so they claim themselves as a dependent and take advantage of the credits. You can gift a portion of your company to make this magic happen. If the gift is over the threshold, you will reduce your lifetime exemption. Most mortal taxpayers are not close to having a taxable estate, so this is not a big deal.
4. Having your S corporation borrow from your related businesses. Some business make money, some lose money. In S corporation world, you will not be able to deduct losses from the S corporation if you don’t lend the money directly to the company.
3. Not paying wages from the correct entity and losing the cool 20% 199A deduction. Many business owners get sloppy when it comes to getting correct expenses in the correct entity, especially if they own all of both. Be sensitive to the wage limitation in the income companies so as to not limit your ability to take the 20% percent deduction against the income. Note that you can reallocate wages if you are using a common paymaster.
2. Making too much taxable income. Let face it, business is cyclical. Make sure you have a handle on your expected average income tax rate and strive to not pay tax at a higher rate, ever. There are myriad planning ideas in these high-income years. Generally, you pay the highest tax rate (37%) because you did not plan adequately.
1. Making too little. Perhaps the largest misunderstood problem in all of tax land — many itemized deductions are lost if you do not have sufficient income to offset. Generally getting deductions in one year will preclude their deduction in the next. Savvy taxpayers find the “just right” amount of income. Many times, business will elect bonus depreciation and lose the benefit. You could have opted out of bonus, paid the same amount of tax this year, and get the depreciation deduction later.
In the end, planning is everything. The above-mentioned ideas are general in nature. Speak to a qualified CPA to ensure how your facts align with the relevant laws.
Michael Bosma, CPA, is Principal-in-Charge of the Reno office of CliftonLarsonAllen LLP. His NNBW column, “Covering Your Assets,” focuses on effective planning strategies for every business owner. Reach him for comment at firstname.lastname@example.org.