Top Ten Tax Planning Strategies to Consider Before Year-End
1. Cost Segregation and Repairs and Maintenance Benefits. If you own or lease real estate used in your business operations, consider securing a “Cost Segregation” study in order to determine the proper tax classification and tax depreciation period for each component – such as the building shell, hardscape/ landscape, special electrical, lighting, plumbing, docks, manufacturing-specific, etc. On average, over 30% of a building can be classified to useful lives much shorter than the statutory 39-year building life. To the extent past deductions were missed, taxpayers can often report the cumulative amount of under-reported tax depreciation amounts in the year identified.
A Cost Segregation study also provides important details to take advantage of the liberalized “Repairs & Maintenance” Regulations, which allow options for expensing (vs. capitalizing) certain routine repairs and costs to keep buildings and equipment in good operating condition.
2. Evaluate the Legal Structure of Your Business Entities. Oftentimes facts change and the legal structure you opted for at formation may not be optimal now and into the future. This can be particularly important if you plan on selling the business in the future, or transferring the business interests to future generations. LLCs and S Corps are often the most appropriate for the majority of operations; however, the rules for operating each entity and the short-term and long-term income, estate and gift tax consequences can be dramatically different. Payroll taxes, qualified plan funding, taxability of distributions and debt allocations are also significantly different between various entities.
3. Maximize Your 2015 Qualified Retirement Plan Deductions. Review the various qualified retirement plan options you have within your business, or that you can choose on a personal level. Again, personal and business entity facts change from year-to-year. You may have set up an IRA years ago and are still funding it, even though another qualified plan such as a SEP, 401K or pension or profit sharing plan will often yield much higher annual tax deductions – in some cases in the hundreds of thousands of dollars. The employee demographics and salaries will determine the total contribution amounts – and more importantly, the amounts allocable to the equity owner(s)/ employees. Many plans can be set-up and funded after year-end. However, pension and profit-sharing plans must be established prior to year-end in order to claim a 2015 deduction – but funding for calendar 2015 can take place as late as September 15th 2016, if returns are extended. Fiscal year businesses may have later deadlines.
4. Employee Bonuses and Other Awards. Accelerating payment by year-end (for cash-basis taxpayers) or accruing bonuses by year-end (for accrual basis taxpayers) can produce 2015 deductions if paid by year end for cash-basis taxpayers. This can also produce more cash for employees who may have already maxed out on the Social Security payroll taxes. Calendar-year accrual-basis taxpayers generally have up until March 15th to pay out bonuses. Bonuses payable to equity owners have more restrictive rules and must generally be paid by calendar year-end – even for accrual basis taxpayers.
5. Tax Deductions With No Cash Outflow. Employee-related deductions are not limited to traditional cash wage and bonus amounts. If an employer is short of cash, the employer may want to award key employees (or key advisors) with property ranging from vehicles to land to a percentage of the business. Internal Revenue Code Section 83 (Property in Exchange for Services) controls the tax implications. Generally, such property awards result in significant tax deductions to the business equal to the fair market value at the time the property is transferred to the employee or advisor. On the other hand, the employee picks up additional compensation at the same level. There are many ways to spread the taxable income over a period of years and plan for future increases and decreases in the value of the property received.
6. Capital Expenditures Before Year-End. Asset purchases can yield material tax benefits, even those purchased towards year-end. Both cash and accrual basis taxpayers can generally claim depreciation on business assets. Regardless of whether a taxpayer pays cash, or finances the asset, the depreciation is calculated based on the total purchase price. Therefore, the tax benefit can often exceed the first year’s cash outlay. A lease generally only produces deductions equal to the cash expended during the year. Federal and/or state tax credits may also be available for certain assets, including energy efficient/ green assets.
While the current 179 limit has dropped to a paltry $25,000, it is likely that Congress will increase this amount prior to year-end – most likely to $250,000 or more. However, to take advantage of the 179 expensing provisions, taxpayers must have adequate taxable income to absorb the asset expensing.
In addition to the 179 deductions, late last month, the IRS announced that beginning in 2016, the threshold for deductibility of certain asset acquisitions by companies that do not secure audited financial statements will be raised from the current $500 amount to $2,500. This will allow many companies to further lower their taxable incomes via asset acquisitions.
7. Investment Loss Harvesting. Loss Harvesting involves the sale of devalued stocks, bonds and other investments prior to year-end in order to allow such losses to offset realized gains on other investments already sold this year. This strategy can save both income tax, as well as the 3.8% federal Net Investment Income Tax. Taxpayers need to watch the “Wash Sale” rules, which can disallow losses on publicly traded investments which are sold at a loss and re-purchased on the open market within 30-days of the original sale date.
8. Bad Debts/ Good Tax Benefits. Uncollectable loans made in a business or non-business context may offer year-end deductibility. Business bad debts generally generate “ordinary” tax deductions which can offset both ordinary and capital gain income, while non-business bad debts generally generate short-term capital losses, which can only be used to offset capital gains.
The timing of the bad debt deduction also varies depending on whether the bad debt claimed is a wholly worthless bad debt or a partially worthless bad debt. A partially worthless bad debt is easier to support since this generally requires documenting unsuccessful collection efforts and a book entry to write-off the estimated uncollectible amount. The balance may be deductible in a future year when the taxpayer can prove that there is no possibility of collecting the balance. A wholly worthless bad debt requires documentation that the lender cannot collect ANY amounts on the remaining loan balance. Bad debts associated with family loans are much more difficult to document, but with proper fact patterns and documentation, it is possible.
9. Medical Prepayments. Health Savings Accounts can allow “above-the-line” (Page 1. vs. Sch. A) tax deductibility of up to $6,650 ($6,750 for individuals 55 and older) for wages directed to such a medical account. These monies can be paid out for medical services in a post-year-end period.
10. Estate and Gift Tax Planning. Even if your net assets are less than the $5.43 million per spouse exemption, year-end is a great time to review your estate structure. Income tax transfers, probate fee savings and longer-term estate tax savings may be realized by transferring all or a partial interest in various investments, including closely held businesses. “Discounting” of minority interest (e.g. less than 50%) transfers are a concern of the IRS and Congress, so such transfers should be considered sooner rather than later. Also review how key assets are titled – e.g. home, insurance policies, investment accounts, LLCs, corporations, etc., as this can impact probate fees and impact what the tax basis of inherited assets will be in the hands of your heirs.
Blake and Trish work in the Park City Office of HCVT LLP, a Top 40 CPA Firm in the U.S.