Now that we are one year into the most sweeping tax changes since 1986 (The Tax Cuts and Jobs Act), we can re-evaluate how these changes affected you and your business for complete 2019 tax planning.
We think it’s important to review these items before year end to see if there are any measures you can take to minimize your 2019 tax liability. Below are just some of the items to consider before the end of the year.
2019 VERSUS 2020 MARGINAL TAX RATES
One question that everyone has is: Do I accelerate taxable income into 2019 or defer income to 2020?
With tax rates holding steady between 2019 and 2020, it really depends on your overall tax situation. Generally, unless your 2019 marginal tax rate will be significantly lower than your 2020 marginal tax rate, you should defer income and accelerate deductions to reduce your 2019 taxable income.
In addition, the circumstances of an individual taxpayer may cause the marginal or effective tax rate to be higher in one year than in the other year. While the maximum marginal federal tax rate is 21 percent for C corporations, the maximum marginal federal tax rate for individuals is 37 percent.
Moreover, the effect of the additional 3.8 percent tax on net investment income could push the effective marginal tax rate on high-income individuals to almost 41 percent.
If the relevant tax rate is expected to be approximately the same for 2019 and 2020, consider taking advantage of various tax rules that allow taxable income or gain to be deferred, such as sales of stock to an employee stock ownership plan, like-kind exchanges, involuntary conversions and tax-free merger and acquisition transactions.
TOP ITEMS TO CONSIDER FOR BUSINESSES
Bonus Depreciation and Section 179 Expensing
As part of tax reform, Congress expanded the “bonus” depreciation provisions that allow businesses to accelerate the deduction of asset purchases through additional first-year depreciation deductions.
For qualifying property placed into service prior to 2023, a business can immediately deduct 100 percent of the cost of the assets. Bonus depreciation is eligible for both new and used property acquired by purchase, provided the property was not used by the taxpayer or related party prior to acquisition. Generally speaking, eligible property is property depreciated under MACRS with a recovery period or 20 years or less. Cost segregation studies can help maximize the applicability of bonus depreciation.
One thing to note is that tax reform eliminated the categories of qualified leasehold improvement, qualified restaurant property and qualified retail improvement property and replaced them with a new category called qualified improvement property (QIP).
The intent of Congress was to give QIP a 15-year depreciable life, making it eligible for bonus depreciation. However, a drafting error does not assign this class of property a 15-year depreciable life; therefore, it has a 39-year depreciable life and is not eligible for bonus depreciation. This will remain in place unless a technical corrections bill is passed.
Another expensing option is Section 179 expensing. If you purchase certain depreciable property, you may elect to treat a specified dollar amount as a deduction for property placed in service during the taxable year. However, the benefits of this election are phased out if more than a specified dollar amount of qualifying property is placed in service.
Tax reform increased the maximum deduction and phase-out threshold for Section 179 property. For 2019, the maximum amount that can be expensed is $1,020,000 and is reduced on a dollar-for-dollar basis for eligible property placed in service in excess of $2,550,000. Both amounts are indexed for inflation annually.
The election is available for tangible personal property (including a new provision for assets used in lodging), qualified real property and off-the-shelf computer software. Further, the 2017 Tax Cuts and Jobs Act expands the definition of Section 179 property to include qualified improvements made to nonresidential real property and improvements to roofs, HVAC, fire protection systems, alarm systems and security systems.
You can combine the usage of Section 179 expensing and bonus depreciation, but you should consult your tax advisor for further information about how each provision will affect your business.
Federal Research Credit
The Research and Development Tax Credit (R&D Tax Credit) applies to a wide array of businesses. A common misconception is that it only applies to high-tech companies. However, if you have undertaken efforts to improve processes, etc. in your company, or even if you tried and were unsuccessful in your efforts, you could be eligible for the credit.
Understanding qualified research expenses (QREs) and qualified research activities (QRAs) as outlined by the IRS can help to clarify what qualifies for the R&D Tax Credit.
QREs are the costs a company pays in association with conducting research activities that will fit within the stipulations of the R&D credit, though these expenses may not be covered in full by the Research and Development Tax Credit. Certain expenses, such as contracted employee wages, may only return a percentage of their cost through the credit, though savings can still be exponential.
The IRS specifies which actions can be viewed as qualified research activities by providing criteria for individual projects that a company is completing in the form of a four-part test.
Choice of Entity Decision
The sweeping changes brought about by Tax Reform has caused many businesses to re-evaluate their tax status (such as C corporation vs. flow-through entity). Now is a good time for businesses to revisit their choice of entity decision with their client service professionals, especially considering the precipitous 40-percent drop in the overall corporate tax rate from 35 percent to 21 percent.
When considering a choice-of-entity conversion, businesses have much to consider, including but not limited to the following:
- Should corporate tax rates increase from the 2017 Tax Cuts and Job Act rates, the tax cost of a corporate structure will far exceed that of a pass-through structure when considering the two levels of tax. And, while a conversion to a corporate structure can generally be made tax-free, a conversion back into a partnership structure is a taxable event that could result in considerable tax liability.
- The new centralized partnership audit regime will increase the risk of an IRS examination. Given the complexity of the partnership structure, the heightened risk could lead to additional costs in managing a partnership.
- The gain exclusion on the sale of qualifying C corporation stock under Section 1202 could mitigate the impact of tax advantages of operating in a partnership form by allowing taxpayers to exclude a gain on exit equal to the greater of $10 million, or ten times the tax basis for qualifying corporations.
- A switch from S corporation status to C corporation status may entail a change in the overall method of accounting for tax purposes from cash to accrual if the average annual gross receipts in the business for the last three years is in excess of $26 million.
- International tax implications must be considered when making a choice of entity decision. For example, C corporations provide more favorable tax benefits when it comes to mitigating the tax impact of the new GILTI and FDII income regimes, as C corporations are entitled to a 50-percent exclusion on income, as well as a foreign tax credit of up to 80 percent, lowering the effective rate on that income to under 3 percent—versus an amount that can be in excess of 37 percent for partners or shareholders that are allocated that income from pass-through entities.
For many, the choice of entity analysis may be less about looking at current entities than about focusing on entity selection for new business ventures. Your tax advisor can help you navigate these complexities and run various projection scenarios to help your business further evaluate the long-term impact of any conversion considerations.
Accounting Method Changes
Cash flow continues to be an important focus for many companies in the current economy. Accounting method changes provide a valuable opportunity for taxpayers to reduce their current tax expense and increase cash flow by accelerating deductions, deferring income based on current tax law or both.
Accounting methods affect the timing of an item, or items, of income or expense reported for income tax purposes. Once an accounting method change for an item has been adopted or established on prior year tax returns, a taxpayer wishing to change the timing of reporting an item must generally file a Form 3115, Application for Change in Accounting Method, with the IRS to receive permission to change to a different method of accounting.
For the 2019 taxable year, businesses should be mindful of the following top accounting method changes:
- Revenue recognition conformity
- Deferral of advance payments
- Cash versus accrual method of accounting
- Uniform capitalization
- Deduction for unrelated party compensation
TOP ITEMS FOR INDIVIDUALS
Congress established the Opportunity Zones program in 2017 as part of the Tax Cuts and Jobs Act with the goal of spurring economic development by providing tax benefits for long-term private sector investments in low-income urban and rural communities across the country.
Taxpayers can invest their gain into an Opportunity Zone Fund and defer the tax on their gains until at least December 31, 2026. Additionally, if the investor holds his or her investment in an Opportunity Zone Fund for five or seven years, a portion of the original deferred gain will be permanently forgiven.
The final incentive is if an investor holds an investment in a Fund for 10 years, any appreciation on his or her initial investment gets added to the basis of the investment and is tax-free. Learn more about Opportunity Zones.
The phase-out of itemized deductions for high income individual taxpayers, called the “Pease” limitation, was suspended for tax years 2018 through 2025.
High-earning taxpayers will once again be able to take itemized deductions that were limited under Pease. However, with the increased standard deduction, a taxpayer’s amount of total deductions in 2020 must generally be greater than $12,400 ($12,200 for 2019) for single individuals and $24,800 ($24,400 in 2019) for married couples filing jointly before they incur the benefit of itemizing deductions.
The deduction for state, local and property taxes is now limited to $10,000 joint and $5,000 if single. We have seen this limitation significantly reduce the tax benefit from these deductions. If you are just over the limit, you might want to consider bunching your deductions between years in order to maximize the tax benefit.
Charitable Contributions (Cash or Property)
You must obtain written substantiation from the charitable organization, in addition to a canceled check, for all charitable donations in excess of $250.
If you donate property and the value of contributed property exceeds $5,000, you must obtain a qualified written appraisal (prior to the due date of your tax return, including extensions), except for publicly-traded securities or non-publicly-traded stock of $10,000 or less.
If you have marketable securities or other long-term capital gain property that has appreciated in value, you should contribute the property in kind to the charity. By contributing the property in kind, you will avoid taxes on the appreciation and receive a charitable contribution deduction for the property’s full fair market value.
Tax reform increased the adjusted gross income limitation for cash contributions to a public charity beginning in 2018 from 50 percent of adjusted gross income to 60 percent of adjusted gross income.
In addition to medical expenses for doctors, hospitals, prescription medications and medical insurance premiums, you may be entitled to deduct certain related out-of-pocket expenses such as transportation, lodging (but not meals) and home healthcare expenses. If you used your car for trips to the doctor during 2019, you can deduct 20 cents per mile for travel that year.
Payments for programs to help you stop smoking and prescription medications to alleviate nicotine withdrawal problems are deductible medical expenses. Uncompensated costs of weight-loss programs to treat diseases diagnosed by a physician, including obesity, are also deductible medical expenses.
In 2019, the deduction is limited to the extent your medical expenses exceed 10 percent of your adjusted gross income.
Long-Term Care Insurance and Services
Premiums you pay on a qualified long-term care insurance policy are deductible as a medical expense. The maximum amount of your deduction is determined by your age. The following table sets forth the deductible limits for 2019:
|40 or less||$420|
|41 – 50||$790|
|51 – 60||$1,580|
|61 – 70||$4,220|
These limitations are per person, not per return. Thus, a married couple over 70 years old has a combined maximum deduction of $10,540, subject to the applicable AGI limit.
Generally, if your employer pays these premiums, they are not taxable income to you. However, if this benefit is provided as part of a flexible spending account or cafeteria plan arrangement, the premiums are taxable to you.
Medical payments for qualified long-term care services prescribed by a licensed healthcare professional for a chronically ill individual are also deductible as medical expenses.
Mortgage Interest and Points
Interest and points paid on a loan to purchase or improve a principal residence are generally deductible in the year paid. The mortgage loan must be secured by your principal residence.
Points paid in connection with refinancing an existing mortgage are not deductible currently, but rather must be amortized over the life of the new mortgage unless the loan proceeds are used to substantially improve the residence. However, if the mortgage is refinanced again, the unamortized points on the old mortgage can be deducted in full. Note also that the limit for deducting mortgage interest has been reduced to $75,000, and the deduction of up to $100,000 for non-real estate acquisition equity line of credit interest has been repealed.
Retirement Plan Contributions
If your employer (including a tax-exempt organization) has a 401(k) plan or 403(b) plan, consider making elective contributions up to the maximum amount of $19,000 ($25,000 if age 50 or over) in 2019. You should also consider making ROTH after-tax, nondeductible contributions to a 401(k) plan if the plan allows, as future earnings on those contributions will grow tax-deferred. A nondeductible contribution to a Roth IRA can also be considered.
The total allowable annual deduction for IRAs in 2019 is $6,000, subject to certain AGI limitations if you are an “active participant” in a qualified retirement plan. A non-working spouse may also make an IRA contribution based upon the earned income of his or her spouse. A catch-up provision for individuals age 50 or older applies, increasing the deductible limit by $1,000 for IRAs to a total deductible amount of $7,000.
2019 TAX PLANNING
Tax planning is very complex. Careful planning involves more than just focusing on lowering taxes for the current and future years. How each potential tax saving opportunity affects the entire business must also be considered. In addition, planning for closely-held entities requires a delicate balance between planning for the business and planning for its owners.
This information cannot cover every tax-saving opportunity that may be available to you and your business. Inasmuch as taxes are among your largest expenses, we urge you to meet with your Warren Averett Advisor who will work to provide you with a comprehensive review of the tax-saving opportunities appropriate to your particular situation.