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Year-End Tax Planning for Small Business

As year-end approaches, each business should consider the many opportunities that might be lost if year-end tax planning is not explored. A business may want to consider several general strategies, such as the use of traditional timing techniques for delaying income recognition and accelerating deductions. A business should also consider customized strategies tailored to its […]

As year-end approaches, each business should consider the many opportunities that might be lost if year-end tax planning is not explored. A business may want to consider several general strategies, such as the use of traditional timing techniques for delaying income recognition and accelerating deductions. A business should also consider customized strategies tailored to its particular situations.

For the 2018 tax year, taxpayers have relative clarity with respect to available credits and deductions. With the exception of a handful of industry-specific tax credits and deductions that expired at the end of 2017, most temporary credits and deductions were permanently extended several years ago. A few others were extended for 5-years through 2019.

Clarity is a new concept for federal taxes, as several years’ worth of promises of impending tax reform finally resulted in the Tax Cuts and Jobs Act (TCJA). The Act made several high profile changes to the tax code, notably reducing tax rates for businesses and individuals, but also created new tax benefits and made several other business-friendly tax benefits even friendlier.

The last few months of the year provide an important “last chance” to change the final course of your business’s tax year before it closes for good. Among the reasons why year-end tax planning toward the end of 2018 may be particularly fruitful are the following:

Business credits and deductions. Many business-related tax credits and deductions that were periodically scheduled to expire were permanently extended in 2015. Others were twice extended one year for both 2016 and 2017, and are not available for the 2018 filing season unless extender legislation is enacted. A few were extended for a five-year period. Some others were modified and extended by TCJA. Taking inventory of what deductions and credits your business has been using and whether they remain available or will be removed in the near future can significantly impact your bottom line. Many of the provisions now periodically extended relate to energy-related activities or specific industries, but it is important to make sure that any credits are considered in light of their availability.

Depreciation and expensing. TCJA made some significant changes to encourage business to expand and invest in new property. First-year depreciation allowances on certain business property, or bonus depreciation, has fluctuated over the last few years, but TCJA provides for 100 percent bonus depreciation for property placed in service before 2023. Additionally, the limitation on expensing certain depreciable assets has been increased to $1 million, with a $2.5 million investment limitation. While 2018 is not necessarily the last time these benefits will be available, there has been no better time than 2018 to take advantage of them

Qualified business income deduction. Beginning in 2018, business owners to deduct up to 20 percent of their qualified business income (QBI) from sole proprietorships, partnerships, trusts and S corporations. This is one of the centerpieces of TCJA and broadly applies to many taxpayers. The IRS has released comprehensive guidance on the deduction, which provides a great deal of clarification on the requirements of the deduction. This is an entirely new deduction, with new documentation requirements, which may require a year-end review of records.

Cash method of accounting. Another provision arising from TCJA was a more permissive adoption of the cash method of accounting. Beginning in 2018, corporations with gross receipts up to $25 million can use the method, which is up from $1 million in prior years. Many of the traditional end-of-year planning techniques relating to timing, such as income deferral or income acceleration, are made easier where the cash method of accounting is used.

Employee benefits. TCJA made a large number of changes on the individual side relating to benefits that could impact employers. Employees can no longer claim miscellaneous itemized deductions, cannot generally exclude moving expense reimbursements, and the deduction for business meals and entertainment was also impacted. Employers should review their internal policies to determine if they need to be changed to reflect the changes.

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Using Single-Member LLCs to Own Real Estate

Single-member LLCs (SMLLCs) are LLCs with only one member (owner). Thanks to the taxpayer-friendly “check-the-box” entity classification regulations, SMLLCs have become a popular entity choice for various business and investment activities. Because of its unique attributes, SMLLCs are also ideal for real estate holdings. Why, Because they provide liability protection along with tax simplification, while […]

Single-member LLCs (SMLLCs) are LLCs with only one member (owner). Thanks to the taxpayer-friendly “check-the-box” entity classification regulations, SMLLCs have become a popular entity choice for various business and investment activities.

Because of its unique attributes, SMLLCs are also ideal for real estate holdings. Why, Because they provide liability protection along with tax simplification, while also setting the table for tax-deferred transactions under both the Section 1031 like-kind exchange rules.

Under the check-the-box regulations, the existence of an SMLLC is generally ignored for federal tax purposes (the exception is when the member treats the SMLLC as a corporation, which is relatively unusual). This disregarded entity status means that the business or investment activity carried on by the SMLLC is considered to be conducted directly by the SMLLC’s member for federal tax purposes. When an individual uses an SMLLC to operate a business, the tax results are reported on the individual’s Schedule C, just as if the business were a sole proprietorship. No additional federal tax forms need be filed. When an individual’s SMLLC is used to own and operate rental real estate, the tax results show up on the member’s Schedule E. When a corporation owns an SMLLC; the SMLLC is considered to be an unincorporated branch or division. When an SMLLC is owned by an entity treated as a partnership, the SMLLC’s activities are directly reflected on the member’s Form 1065 with no additional federal tax forms required.

Real estate investors are rightly concerned about exposure to all the various and sundry liabilities that property ownership can entail. These can range from environmental liabilities to personal injury claims when tenants slip and fall on the sidewalk. Setting up an SMLLC to own real estate addresses the liability exposure problem without adding tax complexity since no additional federal tax forms are required. Of course, the SMLLC’s member will often be required to guarantee any mortgages against the SMLLC’s property personally, but that’s par for the course.

Here’s where it gets interesting. As explained earlier, the SMLLC’s member is considered to directly own, for federal tax purposes, any real estate that is owned by the SMLLC. Therefore, an exchange of property owned by the SMLLC will be treated as an exchange by the member for purposes of the Section 1031 like-kind exchange rules. Meanwhile, the relinquished property given up in the exchange and the replacement property received in the exchange can at all times be held within the liability-limiting confines of the SMLLC.

If the property to be relinquished in an upcoming Section 1031 exchange is currently owned directly by an individual, he or she can set up a new SMLLC to receive the replacement property. The exchange will still qualify for Section 1031 tax-deferred treatment because both the relinquished and replacement properties will be considered owned directly by the individual for federal tax purposes. However, under applicable state law, the SMLLC will protect the individual from liabilities associated with the replacement property because he or she will never appear in the chain of title.
Single member LLCs are excellent entities to own real estate.

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Maximizing Depreciation Deductions For Business Real Estate

When buying business real estate, for your personal occupancy or rental to others-you should take steps that maximize the income tax depreciation deductions that you can claim for the property. Here are a few suggestions. Separating improvements from land. Not all of the cost of acquiring real estate is depreciable. Specifically, the cost of improvements […]

When buying business real estate, for your personal occupancy or rental to others-you should take steps that maximize the income tax depreciation deductions that you can claim for the property. Here are a few suggestions.

Separating improvements from land.

Not all of the cost of acquiring real estate is depreciable. Specifically, the cost of improvements to land is depreciable, but the cost of the land itself is not. Clearly, then, it is desirable to identify and document, at the time that you acquire real estate, the part of your overall acquisition cost allocable to improvements. Thus, when you buy a property, you should either retain a qualified real estate appraiser to make an allocation between land and improvements based on a detailed written analysis, or, if you have enough valuation expertise and knowledge of the locality, write your own detailed analysis and allocation. In either case, I will be happy to review the analysis to determine whether it is in accordance with valuation techniques that are respected by the tax law. Also, regarding the allocation, you should be aware that the cost of improvements includes not only the cost of buildings, but also the cost of items such as landscaping and roads, and even some costs of grading and clearing. I can assist an appraiser (or you) in identifying which of these seemingly land-related costs are, actually, costs of improvements, and should, therefore, be reflected in the improvements portion of the allocation.

Turning land into a deductible asset.

Even though the land isn’t depreciable, there are ways to obtain deductions, for your land cost, which provide a similar tax benefit. One technique is to enter into a long-term lease of the land rather than buy it. If you lease the land, the rents you pay under that “ground lease” are deductible. We can decide together, in the case of any specific acquisition, whether a ground lease can be made to work for you, your lender and the prospective landlord. A different technique, but one which also can turn the land into a deductible asset, is the acquisition of an interest in land known as an “estate-for-years.” Under an estate-for-years, you would own the land, but not forever, while an individual or entity “unrelated” to you would own the interest in land that begins when your estate-for-years ends. As the owner of the estate-for-years, you would be allowed to “amortize” (deduct ratably) the cost of the estate-for-years over its duration. Thus, for example, if your estate-for-years is for 50 years, you would be allowed to deduct each year 1/50th of the cost of the estate-for-years. I can identify for you which individuals or entities qualify as “unrelated”, and analyze with you the practicality of an estate-for-years as applied to a specific acquisition.

Separating personal property from buildings.

Most business buildings must be depreciated over a period of 39 years, with somewhat more favorable treatment for a residential rental real estate (27.5 years) and for certain other types of buildings or building improvements. On the other hand, most personal property (furniture, equipment, etc.) is depreciable over considerably shorter periods.

Furthermore, new personal property is eligible for additional first-year depreciation (bonus depreciation) equal to 50% of its cost, and for some taxpayers, up to $500,000 of immediate write-offs. In contrast, among buildings or building improvements, only certain building improvements are eligible for bonus depreciation and/or immediate write-offs. As you can see, if a specific item is classified as personal property rather than as a part of a building, the depreciation deductions for that item will generally be available sooner and thus, in economic terms, have a greater “present value” to the property owner.

Thus, in the same way that it is desirable to appropriately allocate between improvements and land, it is important to take steps to identify and document, at the time that you acquire real estate, the items that are personal property and the items that are building parts. For some items, the distinction follows “common sense” an ordinary chair is personal property, a weight-bearing brick wall is part of a building. However, for example, the distinctions between lighting fixtures, signs, floor coverings, wall coverings, plumbing, electrical systems and heating and cooling systems are governed by tax rules that can be complex and can involve projections as to the future use of the items. They may even necessitate consultation with engineers or other construction experts. Also, after the personal property and building items are separately identified, they must be separately valued, either by an appraisal, a breakdown of construction costs or both.

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Using S-Corporations to Reduce Self-Employment Income

As you are aware, income that you generate conducting your business as a sole proprietorship (or through a wholly-owned limited liability company (LLC)) is subject to both income tax and self-employment tax. The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for social security up to the social security maximum […]

As you are aware, income that you generate conducting your business as a sole proprietorship (or through a wholly-owned limited liability company (LLC)) is subject to both income tax and self-employment tax. The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for social security up to the social security maximum ($118,500 for 2015; $117,000 for 2014) and a 2.9% rate for Medicare, without any maximum. In addition, there is an additional 0.9% Medicare tax on income exceeding $250,000 for married couples ($125,000 for married persons filing separately) and $200,000 in all other cases. Similarly, if you conduct your business as a partnership in which you are a general partner, in addition to income tax you would be subject to the self-employment tax on your distributive share of the partnership’s income. On the other hand, if you conduct your business as an S corporation you will be subject to income tax, but not self-employment tax, on your share of the S corporation’s income.

An S corporation is not subject to tax at the corporate level. Instead, the corporation’s items of income, gain, loss, and deduction are passed through to the shareholders. However, the income passed through to the shareholder is not treated as self-employment income. Thus, by using an S corporation, you can avoid self-employment income tax.

There is a problem, however, in that IRS requires that the S corporation pay you reasonable compensation for your services to the S corporation. The compensation is treated as wages subject to employment tax (split evenly between the corporation and the employee), which is equivalent to the self-employment tax. If the S corporation does not pay you reasonable compensation for your services, IRS may treat a portion of the S corporation’s distributions to you as wages and impose social security taxes on the deemed wages. There is no simple formula regarding what is reasonable compensation. Presumably, reasonable compensation would be the amount that unrelated employers would pay for comparable services under like circumstances. There are many factors that would be taken into account in making this determination. These and other techniques can save businesses tax dollars.

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