Year-End Tax Planning for Businesses

With the release of the Trump administration’s tax reform proposal, new legislation and traditional year-end opportunities approaching, tax planning could be challenging, but there may be significant, tax-saving opportunities to plan for in the upcoming months.

Tax Reform Proposal
Released on September 27, 2017, the Trump administration published the first draft of potentially sweeping tax reform affecting both individuals and businesses alike. The proposal, while in its infancy, provided a general outline of anticipated changes. There is still much legislative discussion and review before implementation, so it is important to use this overview as a general guide, where significant changes may take place.

Below is an outline of the proposed business changes included in the Unified Framework for Fixing Our Broken Tax Code.

The plan proposes to:

• Reduce the corporate tax rate to 20%, down from the current federal rate of 35%.
• Create a new tax structure for pass-through businesses with a rate of 25% for small and family-owned businesses conducted as sole proprietorships, partnerships, and S corporations. In an effort to avert misuse of this lower rate, the changes may exclude personal services of an owner.
• Allow for the immediate expensing of the cost of new investments in depreciable assets, other than structures, made after September 27, 2017 (for at least five years).
• Limit the net interest expense by C corporations.
• Eliminate the manufacturing deduction.
• Preserve R&D credits, low-income housing credits and streamline rules for specific, undefined industries and sectors.
• Move towards a territorial tax system by removing taxes on foreign sourced income of US companies.
• Implement a one-time repatriation tax that applies to assets incurred overseas from US-owned companies, encouraging corporations to bring profits back into the US from abroad. The forecasted rate may be around 10%.

Other objectives include a plan that would “aim to eliminate” the alternative minimum tax for corporations and encourage “methods to reduce the double taxation of corporate earnings.”

New Legislation
Manufacturing and R&D Sales and Use Tax Expanded
Effective July 25, 2017, AB 398 expands California’s partial sales and use tax exemption for qualified manufacturing and R&D equipment. The bill also incorporates certain agricultural businesses and electric power generators within the legislation. In addition, AB 398 includes clarification on the definition of “useful life” for qualifying equipment and extends the sunset date of the partial sales and use tax exemption for all qualified taxpayers from 2022 to June 30, 2030.

New Precedent Set to Determine Land vs. Building Valuations
In a recent article published in August, we reviewed the precedent-setting court case Nielsen v. Commissioner that found the county assessor provided a more reliable appraisal of land and improvement values than that of the owner’s own assessment. This ruling is significant in determining depreciation deductions on the value of property between its land and improvements. While the court acknowledged that a taxpayer is qualified to provide a valuation of their entire property, it was decided that a taxpayer is not fit to offer a valuation of property with respect to allocation of value between land and improvements.

Read the full article: Court Decision Favors Assessor Over Owner in Land vs. Building Valuation

Bonus Depreciation Begins Gradual Reduction
Under current legislation, 2017 marks the last year businesses can qualify for the 50% bonus first-year depreciation deduction. Most new machinery and equipment bought and placed in service before 2019 is eligible for a depreciation deduction, but it includes a gradual reduction over the next few years, declining to 40% in 2018 and 30% in 2019.

Traditional Tax Planning Strategies
With the discussions of significant reform encircling with great uncertainty, there are traditional tax planning methods that businesses can utilize with certainty.

Timing of Income and Deductions
Deferring or accelerating income and deductions is one way businesses can manage effective tax planning strategies to reduce their tax burden. This impact increases if tax rates were to be reduced next year.

If your business is able to estimate income for this year and the next, one method to consider is to defer income into the next year, thus deferring the tax on that income. This strategy can be used by reducing year-end billing for goods and services if your business uses the cash method of accounting. On the other hand, if your business operates on the accrual method, then delaying the shipping of goods or delivery of services can be used to defer taxable income.

Considerations Based on Business Structure
Another reliable tax planning method is to consider the structure of your business when developing a year-end strategy. For example, if your business is taxable as a C corporation, you may think about distributing year-end bonuses instead of dividends, since salary is deductible and dividends are not.

For an S corporation, it may be beneficial for shareholders/employees to increase corporate distributions of company income and lower salaries (within reason) in an effort to lower the business’ payroll taxes. Distributions at the corporate level are not traditionally taxed and are not subject to the Medicare tax on net investment income. It is important that the salaries are at a reasonable level to avoid unnecessary further examination.

Moving Forward
As we near year end, it is essential to start your year-end tax planning to position your company for the best possible outcome. While the Trump administration’s tax reform proposal may take months to finalize, significant changes could be on the horizon, and it is recommended to look into how those changes might affect your business. Please contact me at jsheffield@bpw.com or (805)963-7811 if you have any questions or would like to further discuss a year-end tax plan for your business.