With two weeks to go until the New Year, now is the time for businesses and individuals to reach for low-hanging fruit in end-of-year tax planning.
While the new tax law reduced the corporate tax rate from 35 to 21 percent, many small- and mid-size businesses still benefit from pass-through entity status. The tax ramifications for businesses in this category are closely linked to the tax returns of individuals. Both should consider the following strategies now to maximize benefits for the year under the new tax law.
Rethink Timing for Charitable Donations
Even as state and local tax deductions are now limited to $10,000, and married couples, filing jointly, receive a $24,000 standard deduction, planning opportunities exist around other itemized deductions. But it’s a matter of timing. Unless a couple makes charitable donations this year that, in combination with other deductions, exceeds the $24,000 threshold, the charitable deduction is essentially wasted. Rather than taking, for example, a $5,000 deduction this year, consider saving up for a larger charitable deduction in a future year.
Maximize Excludible Gifting and Minimize Tax Liability on Required Distributions
Individuals are now allowed an annual gift tax exclusion of $15,000, per donee. There’s something else to act on swiftly. Individuals 70½ or older who are required to take the minimum distribution from tax-deferred retirement accounts, should consider a qualified charitable distribution before the year ends. By making a donation directly from their account, individuals can reduce income while possibly benefitting from the $24,000 standard deduction.
Consider Equipment Purchases
Businesses considering the acquisition of equipment, and other assets subject to depreciation, should accelerate the purchase so the deduction can be taken this year. Purchases may include a truck for a distribution company, manufacturing equipment, or other business assets. Also, while the old tax law required equipment purchases to be new, the current law states the equipment need only be new to the purchaser to qualify for immediate expensing.
Finalize Divorce Proceedings
Individuals who find themselves in this situation, yet near the end of proceedings, may avail themselves of tax-planning benefits by finalizing the matter this year. The new tax law grandfathered in an old provision, under which the alimony payer is allowed a deduction, and the recipient picks up the income. But the provision expires Dec. 31. Oftentimes, the individual paying the alimony is in a higher income tax bracket than the recipient, creating the urgency to act on this provision while still possible.
Match Up Capital Losses with Capital Gains
If an investor has an asset with significant value that’s less than its adjusted basis, and that loss hasn’t yet been recognized, he should consider recognizing the loss this year if—here’s the proviso—he has capital gains in 2018 that he’s also recognized. Capital losses can only be carried forward and deducted at $3,000 a year unless there is a capital gain. So, if an individual sells a business this year, and doesn’t see future prospects for capital gains, he would be wise to consider taking capital losses in the same year in which a capital gain occurs.
Then, Reinvest the Gains
Individuals with significant capital gains can also take advantage of a new tax law provision that allows them to reinvest money in a qualified opportunity fund, and defer taxes on the gains until 2026. If the investment is held for five years, the taxpayer gets a 10 percent step-up in basis. If held an additional two years, it’s an additional 5 percent. When the tax is then triggered on the deferred gain, the investor pays tax on 85 percent of the gain. Further, if an investor holds the investment for 10 years, he does not pay tax on any appreciation on the investment in the fund from the time it was originally made.
Maximize the QBI Deduction
S corporation owners who have been paying themselves a high salary may wish to consider reducing it and taking the cash out as a distribution instead. The new tax law includes a provision that allows pass-through entities (except specified service, trades, or businesses) to take a 20 percent deduction on qualified business income. But it’s generally limited to 50 percent of wages. Where the S corporation has sufficient wages, owners can increase the QBI deduction by having the shareholder reduce his wages, and increase his business income from the corporation. The caveat is that business owners must take a reasonable salary. Conversely, if the company is caught by the 50 percent wage limit, it may want to increase the salary to shareholders, again within the reasonable compensation range. With either approach, it’s important to analyze the impact, particularly as shareholders and companies consider significant year-end bonuses.
Start with Projections
First, project taxable income for the remaining portion of the year, and provide a best guess for next year. Projections should account for income variance from one year to the next. This will allow businesses and individuals to make informed decisions about whether to take deductions or pick up income in the appropriate year to maximize tax benefits.
There is no substitute in any analysis for putting pencil to paper or inputting this data into a spreadsheet. If the exercise is too daunting, a qualified tax professional can help.