New tax law gives pass-through businesses a valuable deduction

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Although the drop of the corporate tax rate from a top rate of 35% to a flat rate of 21% may be one of the most talked about provisions of the Tax Cuts and Jobs Act (TCJA), C corporations aren’t the only type of entity significantly benefiting from the new law. Owners of noncorporate “pass-through” entities may see some major — albeit temporary — relief in the form of a new deduction for a portion of qualified business income (QBI).

A 20% deduction

For tax years beginning after December 31, 2017, and before January 1, 2026, the new deduction is available to individuals, estates and trusts that own interests in pass-through business entities. Such entities include sole proprietorships, partnerships, S corporations and, typically, limited liability companies (LLCs). The deduction generally equals 20% of QBI, subject to restrictions that can apply if taxable income exceeds the applicable threshold — $157,500 or, if married filing jointly, $315,000.

QBI is generally defined as the net amount of qualified items of income, gain, deduction and loss from any qualified business of the noncorporate owner. For this purpose, qualified items are income, gain, deduction and loss that are effectively connected with the conduct of a U.S. business. QBI doesn’t include certain investment items, reasonable compensation paid to an owner for services rendered to the business or any guaranteed payments to a partner or LLC member treated as a partner for services rendered to the partnership or LLC.

The QBI deduction isn’t allowed in calculating the owner’s adjusted gross income (AGI), but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction.

The limitations

For pass-through entities other than sole proprietorships, the QBI deduction generally can’t exceed the greater of the owner’s share of:

  • 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year, or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.

Qualified property is the depreciable tangible property (including real estate) owned by a qualified business as of year end and used by the business at any point during the tax year for the production of qualified business income.

Another restriction is that the QBI deduction generally isn’t available for income from specified service businesses. Examples include businesses that involve investment-type services and most professional practices (other than engineering and architecture).

The W-2 wage limitation and the service business limitation don’t apply as long as your taxable income is under the applicable threshold. In that case, you should qualify for the full 20% QBI deduction.

Careful planning required

Additional rules and limits apply to the QBI deduction, and careful planning will be necessary to gain maximum benefit. Please contact us for more details.

 

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The IRS announces standard mileage rates for 2018

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The optional mileage allowance for owned or leased vehicles (including autos, vans or pickups) will climb 1 cent to 54.5 cents per mile for business travel. Employers also can use this rate for reimbursements to employees who supply their own autos for business use, and to value personal use of certain low-cost employer-provided vehicles. The rates for using a car to get medical care and in connection with a move that qualifies for the moving expense deduction also increase by 1 cent, to 18 cents. (Notice 2018-3)

Even if your income is high, your family may be able to benefit from the 0% long-term capital gains rate

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We’re entering the giving season, and if making financial gifts to your loved ones is part of your plans — or if you’d simply like to reduce your capital gains tax — consider giving appreciated stock instead of cash this year. Doing so might allow you to eliminate all federal tax liability on the appreciation, or at least significantly reduce it.

Leveraging lower rates

Investors generally are subject to a 15% tax rate on their long-term capital gains (20% if they’re in the top ordinary income tax bracket of 39.6%). But the long-term capital gains rate is 0% for gain that would be taxed at 10% or 15% based on the taxpayer’s ordinary-income rate.

In addition, taxpayers with modified adjusted gross income (MAGI) over $200,000 per year ($250,000 for joint filers and $125,000 for married filing separately) may owe the net investment income tax (NIIT). The NIIT equals 3.8% of the lesser of your net investment income or the amount by which your MAGI exceeds the applicable threshold.

If you have loved ones in the 0% bracket, you may be able to take advantage of it by transferring appreciated assets to them. The recipients can then sell the assets at no or a low federal tax cost.

The strategy in action

Faced with a long-term capital gains tax rate of 23.8% (20% for the top tax bracket, plus the 3.8% NIIT), Rick and Sara decide to transfer some appreciated stock to their adult daughter, Maia. Just out of college and making only enough from her entry-level job to leave her with $25,000 in taxable income, Maia falls into the 15% income tax bracket. Therefore, she qualifies for the 0% long-term capital gains rate.

However, the 0% rate applies only to the extent that capital gains “fill up” the gap between Maia’s taxable income and the top end of the 15% bracket. In 2017, the 15% bracket for singles tops out at $37,950.

When Maia sells the stock her parents transferred to her, her capital gains are $20,000. Of that amount $12,950 qualifies for the 0% rate and the remaining $7,050 is taxed at 15%. Maia pays only $1,057.50 of federal tax on the sale vs. the $4,760 her parents would have owed had they sold the stock themselves.

Additional considerations

Before acting, make sure the recipients won’t be subject to the “kiddie tax.” Also consider any gift and generation-skipping transfer (GST) tax consequences.

For more information on transfer taxes, the kiddie tax or capital gains planning, please contact us. We can help you find the strategies that will best achieve your goals.

Accrual-basis taxpayers: These year-end tips could save you tax

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With the possibility that tax law changes could go into effect next year that would significantly reduce income tax rates for many businesses, 2017 may be an especially good year to accelerate deductible expenses. Why? Deductions save more tax when rates are higher.

Timing income and expenses can be a little more challenging for accrual-basis taxpayers than for cash-basis ones. But being an accrual-basis taxpayer also offers valuable year-end tax planning opportunities when it comes to deductions.

Tracking incurred expenses

The key to saving tax as an accrual-basis taxpayer is to properly record and recognize expenses that were incurred this year but won’t be paid until 2018. This will enable you to deduct those expenses on your 2017 federal tax return. Common examples of such expenses include:

Commissions, salaries and wages,
Payroll taxes,
Advertising,
Interest,
Utilities,
Insurance, and
Property taxes.
You can also accelerate deductions into 2017 without actually paying for the expenses in 2017 by charging them on a credit card. (This works for cash-basis taxpayers, too.)

As noted, accelerating deductible expenses into 2017 may be especially beneficial if tax rates go down for 2018.

Prepaid expenses

Also review all prepaid expense accounts. Then write off any items that have been used up before the end of the year.

If you prepay insurance for a period of time beginning in 2017, you can expense the entire amount this year rather than spreading it between 2017 and 2018, as long as a proper method election is made. This is treated as a tax expense and thus won’t affect your internal financials.

And there’s more …

Here are a few more year-end tax tips to consider:

Review your outstanding receivables and write off any receivables you can establish as uncollectible.
Pay interest on all shareholder loans to or from the company.
Update your corporate record book to record decisions and be better prepared for an audit.
To learn more about how these and other year-end tax strategies may help your business reduce its 2017 tax bill, contact us.