President-elect Trump has proposed substantial tax changes for businesses, including taxing all business income of a taxpayer at 15%. This 15% rate replaces the top rate of 35% for C corporations. Even bigger news is that the 15% rate also applies to S corporation shareholders and partners in a partnership or LLCs on their flow-through income at the individual level. The 15% rate would also be applicable to sole proprietors on Schedule C in their individual income tax returns. Retained profits in flow-through entities will be subject to a 20% tax upon distribution similar to current treatment of C corporation dividend.
Given the probability of lower business taxes in the future, as well as lower prospective individual income taxes, here are some suggestions for business owners and their advisors to consider:
Accelerate business expenses. If your business utilizes the cash method, pay now for services, supplies, bonuses (to unrelated employees), sales or procurement incentives, and consider moving repairs and maintenance in to the current year. If the phone bill is due January 5, 2017, don’t wait. Pay the bills you can before year-end. It is worth mentioning that charging expenses on a credit card before year-end is treated the same as paying by check, even if you pay the credit card bill the following year. If your business is on the accrual method then look at deducting prepaid expenses like insurance or taking a hard look at repairs and other capitalized expenditures. The benefit from the prepayment cannot extend beyond the end of the following tax return (December 31, 2017 for calendar year taxpayers).
Defer income. If cash method, consider delaying late year invoicing to ensure payment is received in the following year. If accrual method, then consider delaying shipment until 2017 or providing services in 2017, and pay 2016 bonuses by March 15, 2017. Be careful, for any accrued bonus to be deductible this year it must be fixed and determined by this year-end. (Sorry, cash basis taxpayers but if you want to deduct employee bonuses then you must pay them within the tax year.) Homebuilders or smaller construction companies should consider the completed-contract method to defer income until jobs are completely finished.
LIFO or last-in-first-out inventory. The US offers a unique opportunity for businesses with inventory, the ability to match current inventory purchases to current revenues received from customers. LIFO makes exceptionally good sense during times of inflation. To illustrate: If your business normally keeps 5,000 tons of steel on hand that costs $500 per ton today then you have $2.5 million of inventory. If prices rose to $600 per ton you would have $3.0 million of inventory (using first-in-first-out or FIFO) and you would have $500,000 more taxable income. Worse yet, business tax rates are anticipated to go down, so under FIFO you would be deferring your tax deduction to a time period likely to provide a lower tax benefit.
Set up a 401(k), SIMPLE or SEP if you don’t have one. Not only is this a good idea but the tax benefit will never be greater if tax rates go down. Smaller employers may also be eligible for federal tax credits for setting up new plans in 2016. Employee contributions (yours) have to be withheld by December 31, 2016.
Deduct Pension/Profit sharing contributions. Employer contributions to Pension/Profit sharing 401(k) plans can still be deducted in 2017 for 2016, and deadlines vary depending on entity and plan types. Some plans offer deferral until the tax filing deadline of April 15, 2017 or October 15, 2017, if extended.
Get your money back on equipment and software. Maximize the Section 179 deduction for investments in depreciable property, like equipment, but don’t go over $500,000 if you can help it. Purchases of new equipment, furniture, software and some leasehold improvements will qualify.
Accrual basis strategies. If you are on the accrual basis, scrub your receivables and deduct uncollectible debts, and consider any business disputes like shipment of non-conforming goods, and partially filled orders or contracts.
Perks for domestic producers. The Domestic Producers deduction is still around, and worth looking at again, given that business tax rates are anticipated to decrease, meaning the value of this deduction will never be worth more. Only businesses that manufacture, produce, grow or extract (MPGE) are eligible, and whether you qualify can be an interesting conversation.
The current prospective secretary of Treasury, Steven Mnuchin, has indicated he may change some elements of the president-elect’s individual tax plan. However, so far he has supported the tax cuts for businesses. Given the environment, business income tax planning can result in some permanent savings to business owners. Get with your CPA or advisor and go over your plan, but do it quickly: December 31, 2016 may be a milestone!
For our interactive tax tool for individuals, see http://ljpr.com/1040-tip-sheet/, and especially note line 17 for business owners.
Contact us at LJPR Financial Advisors: 248-641-7400. LJPR.com or firstname.lastname@example.org.