TAX PLANNING FOR BUSINESS OWNERS

​"The power to tax involves the power to destroy."
- Chief Justice John Marshall

​I love Steve Carell's face in that picture....and it works beautifully for the message, doesn't it? Almost $1 million dollars lost due to the impact of taxes. I'm always amazed at how much taxes affect our financial affairs over the long term. 

With the tax bill that was just passed into law a few weeks ago and given that many of us are agonizing over the soon to be here tax day (which is on April 17, 2018, by the way), let's talk about a few ideas that may help you reduce your current and/or future tax bill. 

This time though, let's do it from a business owner's perspective. 

Business Owners - 2018 and Beyond

​Here are two ideas that come right out of the the new tax law that was just passed. These can only be applied to 2018 and beyond taxes.

Idea #1 - Cash Stuffing a Business:
As you've probably heard, C-corporation tax rates have fallen from a high of nearly 35% in 2017 to 21% in 2018. That 14 point difference is a 40% reduction in taxes and clearly that's a nice change if your business is a C-corporation. Here's the thing though: Only 5% of businesses in America are C-corporations. Most businesses are structured as "pass-throughs" - think sole proprietors, partnerships, limited liability companies, and S-corporations - which means that business profits are taxed at the owner's personal income tax rate and not a separate business tax rate. 

Why did most owners choose business entities that are taxed this way? The answer was because the personal income tax rate of owners of small businesses was - and "was" is the key word - smaller than the C-corporation tax rate.

What if that is no longer true? What if you're a high income business owner with $500,000 of profits being taxed at a 37% personal income tax rate because your business is a pass-through entity, but you see that you could push a lot of that money (profit) to a C-corp where it would be taxed at 21%, instead? That $80,000 reduction in your tax bill could go a long way to help you buy that new building you've been eyeing. 

Nice idea, isn't it. There are pros and cons with this, but the pros are definitely there. Consider it. 

Idea #2 - Create Separate Business Entities:
The new tax bill has a great new 20% deduction for pass-through entities and it's a big deal. It's also super complicated (I've just read 42 pages on this one subject). To give you a taste of the positive benefits of this deduction, imagine you have a business that's generating $1,000,000 of Qualified Business Income (for simplicity's sake, think of this as your normal taxable profit AFTER paying yourself a salary). With this new deduction, you might have as much as $200,000 shaved off of your taxable income as a result of this new 20% deduction. At a 37% tax rate, that $200,000 deduction just saved you $74,000 in federal income taxes. 

There's a problem though: The law places some significant limitations that can effectively eliminate this benefit for a significant portion of business owners in the country. Who is among this unfortunate group? Well, the law generally applies limitations to.....

​"any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees"

​While the above is legal-speak, you can generally count yourself unlucky if you are a doctor, lawyer, accountant, actuary, or consultant. So what can you do if you're the owner of one of these types of businesses? Well, you can identify those functions in your existing business that DO NOT relate to your individual expertise, break them out, and create a separate business entity for those activities. By doing so, the new entity can qualify for the 20% deduction without any limitation. To give you a few examples, think about a doctor's office or a law firm. They both bill clients and track receivables, right? Neither of those two activities are related to their expertise though. As a result, create separate business entities to handle those tasks! As another example, consider a veterinarian group that also boards cats and dogs. By breaking out the revenue that comes from the boarding activity, given that boarding animals is not related to a unique expertise (at least according to the IRS), the profit coming from that revenue is eligible for the 20% deduction without limitation!

Business Owners - 2017 and Beyond

Here are a few ideas that you may be able to apply to your 2017 tax bill!

Cost Segregation - If you own commercial real estate or have made significant improvements on commercial property, you know that you can depreciate many of those expenses. What many people don't know is that you can identify specific items and depreciate them faster than others....giving you more depreciation expenses in the current year....thus further reducing your taxable income. In our experience, there is a 15% average increase in current depreciation when this method is employed. 

Property Tax Mitigation - Because commercial property taxes are so large, it often makes sense to "audit" your property tax liabilities to make sure you are not being overcharged. Basically, this means having a valuation done on the property and making a solid case to your tax assessor that you're paying too much because the valuation the assessor is using is too high. A lot of tax money may be saved or recovered in this process. 

Work Opportunity Tax Credit - This is a broadly misunderstood tax credit available to employers who hire qualifying employees. While many errantly believe it applies only to people with criminal records and the like, the qualifications for this category of credits is actually quite broad. Given that the average tax credit is $2,400 per newly hired employee, it's definitely an area to look for savings!

Research & Development Tax Credit - This is a tax credit available to small and mid-sized businesses who are involved in technology, manufacturing, and engineering whereby new products and/or processes are created. In our experience, the credit is worth $25,000 per $1,000,000 of payroll. 

Payroll R&D Tax Credit - If you have a company that is currently not profitable, but you have employees and are paying payroll taxes, this tax credit may be available if you've been involved in research and development work. Up to $250,000 of tax credits can be used as an offset against payroll taxes. ​

Closing Thoughts

If you're a high income tax-payer and want to look at another way to create deductions, take a look at the Restricted Property Trust. The fit is narrow, but where it works, it works very well. By the way, we've passed the window for this to be used for 2017 taxes, but it's always smart to plan ahead for 2018!

As always, let us know how we can help.

Learn more about the Restricted Property Trust

Author

Bruce Wing is the president of Strategic Wealth, LLC, a Registered Investment Adviser located on the north side of Atlanta.