Recent changes to federal tax law and accounting rules could affect whether you decide to lease or buy equipment or other fixed assets. Although there’s no universal “right” choice, many businesses that formerly leased assets are now deciding to buy them.
Pros and cons of leasing
From a cash flow perspective, leasing can be more attractive than buying. And leasing does provide some tax benefits: Lease payments generally are tax deductible as “ordinary and necessary” business expenses. (Annual deduction limits may apply.)
Leasing used to be advantageous from a financial reporting standpoint. But new accounting rules that bring leases to the lessee’s balance sheet go into effect in 2020 for calendar-year private companies. So, lease obligations will show up as liabilities, similar to purchased assets that are financed with traditional bank loans.
Leasing also has some potential drawbacks. Over the long run, leasing an asset may cost you more than buying it, and leasing doesn’t provide any buildup of equity. What’s more, you’re generally locked in for the entire lease term. So, you’re obligated to keep making lease payments even if you stop using the equipment. If the lease allows you to opt out before the term expires, you may have to pay an early-termination fee.
Pros and cons of buying
Historically, the primary advantage of buying over leasing has been that you’re free to use the assets as you see fit. But an advantage that has now come to the forefront is that Section 179 expensing and first-year bonus depreciation can provide big tax savings in the first year an asset is placed in service.
These two tax breaks were dramatically enhanced by the Tax Cuts and Jobs Act (TCJA) — enough so that you may be convinced to buy assets that your business might have leased in the past. Many businesses will be able to write off the full cost of most equipment in the year it’s purchased. Any remainder is eligible for regular depreciation deductions over IRS-prescribed schedules.
The primary downside of buying fixed assets is that you’re generally required to pay the full cost upfront or in installments, although the Sec. 179 and bonus depreciation tax benefits are still available for property that’s financed. If you finance a purchase through a bank, a down payment of at least 20% of the cost is usually required. This could tie up funds and affect your credit rating. If you decide to finance fixed asset purchases, be aware that the TCJA limits interest expense deductions (for businesses with more than $25 million in average annual gross receipts) to 30% of adjusted taxable income.
When deciding whether to lease or buy a fixed asset, there are a multitude of factors to consider, including tax implications. We can help you determine the approach that best suits your circumstances. © 2019
Shakespeare’s words don’t apply just to Julius Caesar; they also apply to calendar-year partnerships, S corporations and limited liability companies (LLCs) treated as partnerships or S corporations for tax purposes. Why? The Ides of March, more commonly known as March 15, is the federal income tax filing deadline for these “pass-through” entities.
Until the 2016 tax year, the filing deadline for partnerships was the same as that for individual taxpayers: April 15 (or shortly thereafter if April 15 fell on a weekend or holiday). One of the primary reasons for moving up the partnership filing deadline was to make it easier for owners to file their personal returns by the April filing deadline. After all, partnership (and S corporation) income passes through to the owners. The earlier date allows owners to use the information contained in the pass-through entity forms to file their personal returns.
For partnerships with fiscal year ends, tax returns are now due the 15th day of the third month after the close of the tax year. The same deadline applies to fiscal-year S corporations. Under prior law, returns for fiscal-year partnerships were due the 15th day of the fourth month after the close of the fiscal tax year.
Avoiding a tragedy
If you haven’t filed your calendar-year partnership or S corporation return yet and are worried about having sufficient time to complete it, you can avoid the tragedy of a late return by filing for an extension. Under the current law, the maximum extension for calendar-year partnerships is six months (until September 16, 2019, for 2018 returns). This is up from five months under the old law. So the extension deadline is the same — only the length of the extension has changed. The extension deadline for calendar-year S corporations also is September 16, 2019, for 2018 returns.
Whether you’ll be filing a partnership or an S corporation return, you must file for the extension by March 15 if it’s a calendar-year entity.
Extending the drama
Filing for an extension can be tax-smart if you’re missing critical documents or you face unexpected life events that prevent you from devoting sufficient time to your return right now.
But to avoid potential interest and penalties, you still must (with a few exceptions) pay any tax due by the unextended deadline. There probably won’t be any tax liability from the partnership or S corporation return. But, if filing for an extension for the entity return causes you to also have to file an extension for your personal return, it could cause you to owe interest and penalties in relation to your personal return.
We can help you file your tax returns on a timely basis or determine whether filing for an extension is appropriate. Contact us today. © 2019
If you run your business from your home or perform certain functions at home that are related to your business, you might be able to claim a home office deduction against your business income on your 2018 income tax return. Thanks to a tax law change back in 2013, there are now two methods for claiming this deduction: the actual expenses method and the simplified method.
Basics of the deduction
In general, you’ll qualify for a home office deduction if part of your home is used “regularly and exclusively” as your principal place of business. If your home isn’t your principal place of business, you may still be able to deduct home office expenses if 1) you physically meet with patients, clients or customers on your premises, or 2) you use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for your business.
Traditionally, taxpayers have deducted actual expenses when they claim a home office deduction. Deductible home office expenses may include:
- Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
- A proportionate share of indirect expenses, such as mortgage interest, property taxes, -utilities, repairs and insurance, and
- A depreciation allowance.
But keeping track of actual expenses can be time consuming.
The simplified method
Fortunately, there’s a simplified method that’s been available since 2013: You can deduct $5 for each square foot of home office space, up to a maximum total of $1,500.
For example, if you’ve converted a 300-square-foot bedroom to an office you use exclusively and regularly for business, you can write off $1,500 under the simplified method (300 square feet x $5). However, if your business is located in a 600-square-foot finished basement, the deduction will still be only $1,500 because of the cap on the deduction under this method.
As you can see, the cap can make the simplified method less beneficial for larger home office spaces. But even for spaces of 300 square feet or less, taxpayers may qualify for a bigger deduction using the actual expense method. So, tracking your actual expenses can be worth the extra hassle.
Flexibility in filing
When claiming the home office deduction, you’re not locked into a particular method. For instance, you might choose the actual expense method on your 2018 return, use the simplified method when you file your 2019 return next year and then switch back to the actual expense method thereafter. The choice is yours.
Unsure whether you qualify for the home office deduction? Or wondering whether you should deduct actual expenses or use the simplified method? Contact us. We can help you determine what’s right for your specific situation. © 2019
Limited liability company (LLC) members commonly claim that their distributive shares of LLC income — after deducting compensation for services in the form of guaranteed payments — aren’t subject to self-employment (SE) tax. But the IRS has been cracking down on LLC members it claims have underreported SE income, with some success in court.
SE tax background
Self-employment income is subject to a 12.4% Social Security tax (up to the wage base) and a 2.9% Medicare tax. Generally, if you’re a member of a partnership — including an LLC taxed as a partnership — that conducts a trade or business, you’re considered self-employed.
General partners pay SE tax on all their business income from the partnership, whether it’s distributed or not. Limited partners, however, are subject to SE tax only on any guaranteed payments for services they provide to the partnership. The rationale is that limited partners, who have no management authority, are more akin to passive investors.
(Note, however, that “service partners” in service partnerships, such as law firms, medical practices, and architecture and engineering firms, generally may not claim limited partner status regardless of their level of participation.)
Over the years, many LLC members have taken the position that they’re equivalent to limited partners and, therefore, exempt from SE tax (except on guaranteed payments for services). But there’s a big difference between limited partners and LLC members. Both enjoy limited personal liability, but, unlike limited partners, LLC members can actively participate in management without jeopardizing their liability protection.
Arguably, LLC members who are active in management or perform substantial services related to the LLC’s business are subject to SE tax, while those who more closely resemble passive investors should be treated like limited partners. The IRS issued proposed regulations to that effect in 1997, but hasn’t finalized them — although it follows them as a matter of internal policy.
Some LLC members have argued that the IRS’s failure to finalize the regulations supports the claim that their distributive shares aren’t subject to SE tax. But the IRS routinely rejects this argument and has successfully litigated its position. The courts generally have imposed SE tax on LLC members unless, like traditional limited partners, they lack management authority and don’t provide significant services to the business.
Review your situation
The law in this area remains uncertain, particularly with regard to capital-intensive businesses. But given the IRS’s aggressiveness in collecting SE taxes from LLCs, LLC members should assess whether the IRS might claim that they’ve underpaid SE taxes.
Those who wish to avoid or reduce these taxes in the future may have some options, including converting to an S corporation or limited partnership, or restructuring their ownership interests. When evaluating these strategies, there are issues to consider beyond taxes. Contact us to discuss your specific situation. © 2019
Depreciation-related breaks on business real estate: What you need to know when you file your 2018 return
Commercial buildings and improvements generally are depreciated over 39 years, which essentially means you can deduct a portion of the cost every year over the depreciation period. (Land isn’t depreciable.) But special tax breaks that allow deductions to be taken more quickly are available for certain real estate investments. Some of these were enhanced by the Tax Cuts and Jobs Act (TCJA) and may provide a bigger benefit when you file your 2018 tax return. But there are two breaks you might not be able to enjoy due to a drafting error in the TCJA.
Section 179 expensing
This allows you to deduct (rather than depreciate over a number of years) qualified improvement property — a definition expanded by the TCJA from qualified leasehold-improvement, restaurant, and retail-improvement property. The TCJA also allows Sec. 179 expensing for certain depreciable tangible personal property used predominantly to furnish lodging and for the following improvements to nonresidential real property: roofs, HVAC equipment, fire protection and alarm systems, and security systems. Under the TCJA, for qualifying property placed in service in tax years starting in 2018, the expensing limit increases to $1 million (from $510,000 for 2017), subject to a phaseout if your qualified asset purchases for the year exceed $2.5 million (compared to $2.03 million for 2017). These amounts will be adjusted annually for inflation, and for 2019 they’re $1.02 million and $2.55 million, respectively.
This break historically allowed a shortened recovery period of 15 years for property that qualified. Before the TCJA, the break was available for qualified leasehold-improvement, restaurant, and retail-improvement property. Again, the TCJA expanded the definition to “qualified improvement property.” But, due to a drafting error, no recovery period was given to such property, so it defaults to 39-year property. For accelerated depreciation to be available for qualified improvement property, a technical correction must be issued.
This additional first-year depreciation allowance is available for qualified assets, which before the TCJA included qualified improvement property. But due to the drafting error noted above, qualified improvement property will be eligible for bonus depreciation only if a technical correction is issued. When available, bonus depreciation is increased to 100% (up from 50%) for qualified property placed in service after Sept. 27, 2017, but before Jan. 1, 2023. For 2023 through 2026, bonus depreciation is scheduled to be gradually reduced.
Warning: Under the TCJA, real estate businesses that elect to deduct 100% of their business interest will be ineligible for bonus depreciation starting in 2018.
Can you benefit?
Although the enhanced depreciation-related breaks may offer substantial savings on your 2018 tax bill, it’s possible they won’t prove beneficial over the long term. Taking these deductions now means forgoing deductions that could otherwise be taken later, over a period of years under normal depreciation schedules. In some situations — such as if in the future your business could be in a higher tax bracket or tax rates go up — the normal depreciation deductions could be more valuable long-term. For more information on these breaks or advice on whether you should take advantage of them, please contact us. © 2019
A variety of tax-related limits affecting businesses are annually indexed for inflation, and many have gone up for 2019. Here’s a look at some that may affect you and your business:
Section 179 expensing:
Limit: $1.02 million (up from $1 million)
Phaseout: $2.55 million (up from $2.5 million)
Income-based phase-ins for certain limits on the Sec. 199A qualified business income deduction:
Married filing jointly: $321,400-$421,400 (up from $315,000-$415,000)
Married filing separately: $160,725-$210,725 (up from $157,500-$207,500)
Other filers: $160,700-$210,700 (up from $157,500-$207,500)
Employee contributions to 401(k) plans: $19,000 (up from $18,500)
Catch-up contributions to 401(k) plans: $6,000 (no change)
Employee contributions to SIMPLEs: $13,000 (up from $12,500)
Catch-up contributions to SIMPLEs: $3,000 (no change)
Combined employer/employee contributions to defined contribution plans (not including catch-ups): $56,000 (up from $55,000)
Maximum compensation used to determine contributions: $280,000 (up from $275,000)
Annual benefit for defined benefit plans: $225,000 (up from $220,000)
Compensation defining “highly compensated employee”: $125,000 (up from $120,000) Compensation defining “key employee”: $180,000 (up from $175,000)
Other employee benefits
Qualified transportation fringe-benefits employee income exclusion: $265 per month (up from $260)
Health Savings Account contributions:
Individual coverage: $3,500 (up from $3,450)
Family coverage: $7,000 (up from $6,900)
Catch-up contribution: $1,000 (no change)
Flexible Spending Account contributions:
Health care: $2,700 (up from $2,650)
Dependent care: $5,000 (no change)
Additional rules apply to these limits, and they are only some of the limits that may affect your business. Please contact us for more information. © 2019
This year, the optional standard mileage rate used to calculate the deductible costs of operating an automobile for business increased by 3.5 cents, to the highest level since 2008. As a result, you might be able to claim a larger deduction for vehicle-related expense for 2019 than you can for 2018.
Actual costs vs. mileage rate
Businesses can generally deduct the actual expenses attributable to business use of vehicles. This includes gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you can claim a depreciation allowance for the vehicle. However, in many cases depreciation write-offs on vehicles are subject to certain limits that don’t apply to other types of business assets.
The mileage rate comes into play when taxpayers don’t want to keep track of actual vehicle-related expenses. With this approach, you don’t have to account for all your actual expenses, although you still must record certain information, such as the mileage for each business trip, the date, and the destination.
The mileage rate approach also is popular with businesses that reimburse employees for business use of their personal automobiles. Such reimbursements can help attract and retain employees who’re expected to drive their personal vehicle extensively for business purposes. Why? Under the Tax Cuts and Jobs Act, employees can no longer deduct unreimbursed employee business expenses, such as business mileage, on their individual income tax returns.
But be aware that you must comply with various rules. If you don’t, you risk having the reimbursements considered taxable wages to the employees.
The 2019 rate
Beginning on January 1, 2019, the standard mileage rate for the business use of a car (van, pickup or panel truck) is 58 cents per mile. For 2018, the rate was 54.5 cents per mile. The business cents-per-mile rate is adjusted annually. It is based on an annual study commissioned by the IRS about the fixed and variable costs of operating a vehicle, such as gas, maintenance, repair and depreciation. Occasionally, if there is a substantial change in average gas prices, the IRS will change the mileage rate midyear.
There are certain situations where you can’t use the cents-per-mile rate. It depends in part on how you’ve claimed deductions for the same vehicle in the past or, if the vehicle is new to your business this year, whether you want to take advantage of certain first-year depreciation breaks on it.
As you can see, there are many variables to consider in determining whether to use the mileage rate to deduct vehicle expenses. Contact us if you have questions about tracking and claiming such expenses in 2019 — or claiming them on your 2018 income tax return. © 2019
The dawning of 2019 means the 2018 income tax filing season will soon be upon us. After year end, it’s generally too late to take action to reduce 2018 taxes. Business owners may, therefore, want to shift their focus to assessing whether they’ll likely owe taxes or get a refund when they file their returns this spring, so they can plan accordingly. With the biggest tax law changes in decades — under the Tax Cuts and Jobs Act (TCJA) — generally going into effect beginning in 2018, most businesses and their owners will be significantly impacted. So, refreshing yourself on the major changes is a good idea.
Taxation of pass-through entities
These changes generally affect owners of S corporations, partnerships and limited liability companies (LLCs) treated as partnerships, as well as sole proprietors:
- Drops of individual income tax rates ranging from 0 to 4 percentage points (depending on the bracket) to 10%, 12%, 22%, 24%, 32%, 35% and 37%
- A new 20% qualified business income deduction for eligible owners (the Section 199A deduction)
- Changes to many other tax breaks for individuals that will impact owners’ overall tax liability
Taxation of corporations
These changes generally affect C corporations, personal service corporations (PSCs) and LLCs treated as C corporations:
- Replacement of graduated corporate rates ranging from 15% to 35% with a flat corporate rate of 21%
- Replacement of the flat PSC rate of 35% with a flat rate of 21%
- Repeal of the 20% corporate alternative minimum tax (AMT)
Tax break positives
These changes generally apply to both pass-through entities and corporations:
- Doubling of bonus depreciation to 100% and expansion of qualified assets to include used assets
- Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phaseout threshold to $2.5 million
- A new tax credit for employer-paid family and medical leave
Tax break negatives
These changes generally also apply to both pass-through entities and corporations:
- A new disallowance of deductions for net interest expense in excess of 30% of the business’s adjusted taxable income (exceptions apply)
- New limits on net operating loss (NOL) deductions
- Elimination of the Section 199 deduction (not to be confused with the new Sec.199A deduction), which was for qualified domestic production activities and commonly referred to as the “manufacturers’ deduction”
- A new rule limiting like-kind exchanges to real property that is not held primarily for sale (generally no more like-kind exchanges for personal property)
- New limitations on deductions for certain employee fringe benefits, such as entertainment and, in certain circumstances, meals and transportation
Preparing for 2018 filing
Keep in mind that additional rules and limits apply to the rates and breaks covered here. Also, these are only some of the most significant and widely applicable TCJA changes; you and your business could be affected by other changes as well. Contact us to learn precisely how you might be affected and for help preparing for your 2018 tax return filing — and beginning to plan for 2019, too. © 2018
Tax planning is a juggling act for business owners. You have to keep your eye on your company’s income and expenses and applicable tax breaks (especially if you own a pass-through entity). But you also must look out for your own financial future. For example, you need to develop an exit strategy so that taxes don’t trip you up when you retire or leave the business for some other reason. An exit strategy is a plan for passing on responsibility for running the company, transferring ownership, and extracting your money from the business.
When a business has more than one owner, a buy-sell agreement can be a powerful tool. The agreement controls what happens to the business when a specified event occurs, such as an owner’s retirement, disability or death.
Among other benefits, a well-drafted agreement:
- Provides a ready market for the departing owner’s shares,
- Prescribes a method for setting a price for the shares, and
- Allows business continuity by preventing disagreements caused by new owners.
A key issue with any buy-sell agreement is providing the buyer(s) with a means of funding the purchase. Life or disability insurance often helps fulfill this need and can give rise to several tax issues and opportunities. One of the biggest advantages of life insurance as a funding method is that proceeds generally are excluded from the beneficiary’s taxable income.
Succession within the family
You can pass your business on to family members by giving them interests, selling them interests, or doing some of each. Be sure to consider your income needs, the tax consequences, and how family members will feel about your choice.
Under the annual gift tax exclusion, you can gift up to $15,000 of ownership interests without using up any of your lifetime gift and estate tax exemption. Valuation discounts may further reduce the taxable value of the gift. With the gift and estate tax exemption approximately doubled through 2025 ($11.4 million for 2019), gift and estate taxes may be less of a concern for some business owners. But others may want to make substantial transfers now to take maximum advantage of the high exemption. What’s right for you will depend on the value of your business and your timeline for transferring ownership.
If you don’t have co-owners or want to pass the business to family members, other options include a management buyout, an employee stock ownership plan (ESOP) or a sale to an outsider. Each involves a variety of tax and nontax considerations. Please contact us to discuss your exit strategy. To be successful, your strategy will require planning well in advance of the transition. © 2018
The holiday season is a great time for businesses to show their appreciation for employees and customers by giving them gifts or hosting holiday parties.
Before you begin shopping or sending out invitations, though, it’s a good idea to find out whether the expense is tax deductible and whether it’s taxable to the recipient. Here’s a brief review of the rules:
Gifts to customers
When you make gifts to customers, the gifts are deductible up to $25 per recipient per year. For purposes of the $25 limit, you need not include “incidental” costs that don’t substantially add to the gift’s value, such as engraving, gift-wrapping, packaging or shipping. Also excluded from the $25 limit is branded marketing collateral — such as pens or stress balls imprinted with your company’s name and logo — provided they’re widely distributed and cost less than $4. The $25 limit is for gifts to individuals. There’s no set limit on gifts to a company (a gift basket for all to share, for example) as long as they’re “reasonable.”
Gifts to employees
Generally, anything of value that you transfer to an employee is included in the employee’s taxable income (and, therefore, subject to income and payroll taxes) and deductible by you. But there’s an exception for noncash gifts that constitute “de minimis fringe benefits.” These are items so small in value and given so infrequently that it would be administratively impracticable to account for them. Common examples include holiday turkeys or hams, gift baskets, occasional sports or theater tickets (but not season tickets), and other low-cost merchandise.
De minimis fringe benefits are not included in an employee’s taxable income and yet are still deductible by you. Unlike gifts to customers, there’s no specific dollar threshold for de minimis gifts. However, many businesses use an informal cutoff of $75. Keep in mind that cash gifts — as well as cash equivalents, such as gift cards — are included in an employee’s income and subject to payroll tax withholding, regardless of how small and infrequent.
The Tax Cuts and Jobs Act reduced certain deductions for business-related meals and eliminated the deduction for business entertainment altogether. There’s an exception, however, for certain recreational activities, including holiday parties. Holiday parties are fully deductible (and excludible from recipients’ income), provided they’re primarily for the benefit of non-highly-compensated employees and their families. If customers also attend, holiday parties may be partially deductible.
Gifts that give back
If you’re thinking about giving holiday gifts to employees or customers or throwing a holiday party, contact us. With a little tax planning, you may receive a gift of your own from Uncle Sam. © 2018