As a business owner, you’re no stranger to high tax burdens.
Expenses, including both the employer and employee FICA payroll taxes (for Social Security, Medicare, and Medicaid funding), directly affect the growth of your business and personal income. But you don’t have to be part of the 1 percent to utilize advanced tax strategies and significantly reduce your taxable income.
Practically everyone takes the basic tax deductions: mileage, a home office, and mortgage interest. That’s a good start. However, you should be aware of all strategic tax credit and tax planning opportunities that are relevant and appropriate for your business.
Here are 10 advanced tax planning strategies — including updates from the 2017 Tax Cut and Jobs Act (TCJA) — to explore with your Tax Advisor.
Strategy #1: Cost Segregation
If you have constructed, purchased, expanded or remodeled any kind of real estate, you can increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes.
When you purchase real estate, your property includes a building structure and all of its interior and exterior components.
On average, 20 to 40 percent of a property’s components fall into tax categories that can be written off much quicker than the building structure.
Cost segregation is a tax strategy that includes breaking down and reclassifying those certain interior and exterior components of a building.
A cost segregation study reclassifies certain parts of a building into their most tax-efficient, useful, life-depreciation categories.
Using a standard schedule, a building structure generally depreciates over either 27 ½ years (residential) or 39 years (commercial).
However, there are many items included with the building that depreciate more quickly than the structure—including tenant improvements, electrical and lighting, carpeting, parking lots, equipment, and fixtures.
Cost segregation separates out items that depreciate at a faster rate, allowing them to be expensed sooner. The study seeks to identify all property-related costs that can be depreciated over 5, 7 and 15 years.
For leased property, you may also separate tenant leasehold improvements.
A cost segregation study is usually conducted by a team of qualified engineers and/or CPAs. You can commission a study at any point after purchasing a building.
Because you can claim more deductions sooner, cost segregation can reduce taxes, resulting in more cash available upfront. This can be crucial to operations, especially in the early years.
In addition, you’ll gain valuable information about business assets. For example, before replacing your windows, the previous cost segregation report would reveal the important details needed to write off the cost of the purchase.
Anyone can have a cost segregation done.
And thanks to the Tax Cuts and Jobs Act, used personal property placed into service after 9/27/17 is eligible for 100 percent bonus depreciation. That means real estate investors can deduct 10 percent of 5, 7, and 15 year property all in the first year.
Consider doing it if you have spent $500,000 or more to construct, purchase, expand, or remodel your property. Owners of larger multifamily or commercial properties will benefit the most from a cost segregation study.
Ask your Financial Advisor and Tax Advisor about combining 1031 exchanges with cost segregation for maximum tax savings. |
Strategy #2: Hiring Credits
The federal government offers tax credits for small and medium businesses to hire and retain talent.
The most commonly known hiring credits fall under the Work Opportunity Tax Credit. These credits offset some of a business’ tax or Social Security liability.
The $9,600 (per employee) credit is aimed to help targeted groups, who have had significant barriers to employment, reenter the workforce.
- Qualified IV-A Recipient
- Qualified Veteran
- Ex-Felon
- Designated Community Resident (DCR)
- Vocational Rehabilitation Referral
- Summer Youth Employee
- Supplemental Nutrition Assistance Program (SNAP) Recipient
- Supplemental Security Income (SSI) Recipient
- Long-Term Family Assistance Recipient
- Qualified Long-Term Unemployment Recipient
You must obtain certification that an individual is a member of the targeted group, before claiming the credit.
The ERTC was introduced in the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 to support workplaces in keeping employees on payroll and prevent layoffs and furlough during the COVID-19 pandemic.
Taxpayer Certainty and Disaster Tax Relief Act (TCDTR) Update
The Taxpayer Certainty and Disaster Tax Relief Act (TCDTR) of 2020, enacted December 27, 2020, made a number of changes to the employee retention tax credits previously made available under the CARES Act, including modifying and extending the ERC, for six months through June 30, 2021. Several of the changes apply only to 2021, while others apply to both 2020 and 2021.
Eligible employers can now claim a refundable tax credit against the employer share of Social Security tax equal to 70 percent of the qualified wages they pay to employees after December 31, 2020, through June 30, 2021. Qualified wages are limited to $10,000 per employee per calendar quarter in 2021. The maximum ERTC amount available is $7,000 per employee per calendar quarter, for a total of $14,000 in 2021.
To claim the ERTC, your business must be in the private sector or a tax-exempt organization that carries on a trade or business during the 2020 calendar year, and either:
- Has operations that were fully or partially suspended during any calendar quarter in 2020 due to orders from an appropriate governmental authority limiting commerce, travel or group meetings (for commercial, social, religious or other purposes) due to COVID-19.
- Or experienced a significant decline in gross receipts during the calendar quarter.
This credit provides businesses with an incentive to hire individuals who live and work in a federally-designated “empowerment zone,” or a designated distressed community.
Businesses may be credited 20 percent of the first $15,000 in wages (up to $3,000) earned in a taxable year if the employee both lives and works in an empowerment zone. Subject to the statute of limitations, businesses can retroactively claim this credit on their federal income tax return.
Depending on the state you live in, you may access a variety of credits with the goal of incentivizing job creation and bolstering the local economy.
For instance, in California, Main Street Small Business Tax Credit. This bill provides financial relief to qualified small businesses for the economic disruptions in 2020 that have resulted in unprecedented job losses.
Each credit comes with its own qualifying criteria. Private companies, C Corps, S Corps, LLCs, and 501(c)s all qualify for various credits at the federal and/or state level.
Your business can reduce its overall total tax burden by subtracting the total amount of any tax credits for which you file. These savings can be used for other business objectives, like recruiting, onboarding, and training new employees or investing back into the business.
Hiring credits are also important for their contributions to the local and national economy. They encourage business owners to hire historically disadvantaged employees. This leads to greater diversity in the workplace, as well as helping employees develop self-sufficiency and become contributing taxpayers themselves.
Strategy #3: Insurance Captives
A captive insurance company is a type of risk-financing tool. (“Captive” refers to the fact that it is wholly owned and controlled by its insureds.)
The captive provides risk-mitigation services for its parent company or a group of related companies; it evaluates risks, writes policies, manages claims, and sets premium levels. It primarily insures the risks of its owners, and not outside parties.
Captive management companies assist the insured business in identifying the benefits, costs and burdens of forming the captive insurance company.
This captive manager guides the captive and the insured through the highly complex and challenging regulatory environment, while staying current in an ever-changing tax environment.
The captive entity is a standalone legal entity, generally formed using Internal Revenue Code § 831(b). This can provide substantial income tax benefits for the captive while still giving rise to deductible insurance premiums for the insured business.
Some risks insurable under a captive arrangement may generally be unavailable through the commercial insurance marketplace or otherwise fill “gaps” in a commercial insurance policy.
These risks can include:
- General liability
- E & O liability
- Employee benefits
- Workers compensation
- Product liability
- Cyber risk
- Environmental
- Property
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As an owner of a small- or medium-sized business that excels at risk management, is ready to make a long-term commitment, is financially sound, and has a reasonably predictable insurance risk, captives are a viable and productive tool for you.
Strategy #4: IC-DISC
An Interest Charge Domestic International Sales Corporation, or IC-DISC, offers significant federal income tax savings for making or distributing U.S. products for export.
The exporter—an S corp, LLC, partnership, or closely held C corp—pays commissions to the IC-DISC, which is owned by the exporter’s shareholders or partners. The commissions are deductible by the exporter for US federal income tax purposes. The IC-DISC is treated as a federally exempt entity.
Changes due to the TCJA:
Prior to the TCJA, taxpayers could reduce their tax rate by as much as 19.6 percent. Following the passage of TCJA, the benefit has been limited due to the reduction in tax rates and the potential 20 percent deduction for pass-through entities—resulting in an effective reduction of only 5.8 percent.
However, the new potential pass-through income reduction is limited to taxable income of less than $157,500 for individuals and $315,000 for married taxpayers—and it only relates to certain types of income. This means the reduction may not be as significant as first thought.
Unlike our previous tax-planning strategies that result in deferred tax payments, an IC-DISC can provide tax savings that are permanent.
The operating company pays a (deductible) commission to the IC-DISC, thereby reducing the operating company’s ordinary taxable income.
In addition, the IC-DISC pays dividends to its shareholders, which are taxed at a favorable rate of 20 percent.
If your business produces or distributes U.S.-made products, you can qualify to form an IC-DISC.
Good candidates include, but are not limited to:
- Traditional manufacturers, including both those that directly export their products and those that sell products that are destined for use overseas
- Producers of agriculture products, minerals, and/or software
- Distributors of U.S.-made goods
- Architectural and engineering firms who work on projects that will be constructed abroad
- Pass-through entities and privately-held corporations
Strategy #5: Section 199A Pass-Through Deductions
Section 199A provides tax relief for small and medium businesses by allowing non-corporate taxpayers to deduct up to 20% of their qualified business income (QBI), plus up to 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.
The Section 199A deduction for pass-through businesses was signed into law as part of the TCJA.
The deduction is calculated off specific income thresholds. If the your taxable income for the year is less than the following thresholds:
For taxable year 2018:
- Joint filers: $315,000
- Single filers: $157,500
For taxable year 2019:
- Joint filers: $321,400
- Single filers: $160,725
For taxable year 2020:
- Joint filers: $326,600
- Single filers: $163,300
Then the new deduction is calculated by the lesser of:
- 20% of qualified business income (QBI) or20% of the overall taxable income of the individual
The qualified business income deduction (QBID) allows eligible self-employed and small-business owners to deduct up to 20% of their qualified business income on their taxes.
Qualified business income (QBI) is the net amount of qualified items of income, gain, deduction, and loss connected to a qualified U.S. trade or business. It is the regular, non-investment income brought in by a business. Only items included in taxable income are counted.
QBI excludes:
- Capital gains or losses
- Dividends
- Interest income
- Income earned outside the U.S.
- Certain wage and guaranteed payments made to partners and shareholders
Section 199A allows for a deduction, up to 20 percent, from passthrough income for a domestic business that operates as either a:
- Sole proprietorship
- Partnership
- S corporation
Individuals and some trusts and estates with QBI, qualified real estate investment trust (REIT) dividends, or qualified publicly traded partnership (PTP) income may qualify for the deduction.
The business must not be considered a “specified service trade or business” (SSTB) and must either pay wages or own property.
What Is a Specified Service Trade or Business (SSTB) under the TCJA?
A specified service trade or business (SSTB) is a trade or business involving the performance of services in the following fields dealing in certain assets or any trade or business principal asset is the reputation or skill of one or more of its employees or owners:
- Health
- Law
- Accounting
- Actuarial science
- Performing arts
- Consulting
- Athletics
- Financial services
- Investing and investment management
- Trading
Strategy #6: Bonus Depreciation
Bonus depreciation (also referred to as the additional first-year depreciation deduction) allows your business to take an immediate first-year deduction on the purchase of eligible business property, in addition to other depreciation.
Take advantage of the more generous Section 179 deduction rules
For qualifying property placed in service in tax years beginning in 2018, the TCJA almost doubled the maximum Section 179 deduction to $1 million (up from $510,000 for tax years beginning in 2017).
The TJCA also added more favorable treatment for property used for lodging, as well as other qualifying real property.
Be sure to consult with your Tax Advisor on the various limitations of Section 179 deductions given your corporate structure.
Bonus depreciation is a method of accelerated depreciation.
Your business can make an additional deduction of 100 percent of the cost (through January 1, 2023) of qualifying property in the first year in which it is put into service. Bonus depreciation is for new—or new-to-you—Section 179 property. Eligible property includes some building improvements, computers, software, machinery, equipment, and office furniture.
The 100 percent bonus depreciation provision can be used towards first-year deductions for new and used heavy vehicles that are used over 50 percent for business. Any SUV, pick-up truck, or van that weighs between 6,000 and 14,000 pounds will qualify for a Section 179 deduction.
Whether or not you will benefit from claiming bonus depreciation depends upon the specifics of your business and tax situation.
Your Tax Advisor may advise you not to take the bonus depreciation allowance for any class of property, such as for vehicles. To make this election, you'll need to attach a statement to your tax return. If you’ve already filed a return without making the election to opt out, you have six months from the original filing deadline to submit an amended return.
Strategy #7: Establish or expand a retirement plan
You can significantly reduce your taxable income by contributing to a retirement plan.
For instance, almost any small business can establish a Simplified Employee Pension, or SEP IRA. You can contribute up to 25 percent of your earnings, or $58,000 for 2021 ($57,000 for 2020).
If you’re employed by your own corporation, you can establish a Solo 401(k) and contribute up to 25 percent of your salary, up to $58,000 for 2021 ($57,000 for 2020). If you have employees you can increase the annual savings amount to $62,000 by including a profit-sharing plan with your 401(k).
By combining various retirement plans, you can save significant amounts each year.
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Strategy #8: Offer fringe benefit plans for employees
Fringe benefits are perks that go beyond an employee’s annual salary or other wages. These benefits help attract and retain the best talent.
Additional wages trigger employment tax costs for businesses, but if the business pays for some fringe benefits for employees these taxes can be mitigated, which is another way to reduce your taxable income.
Tax-exempt benefits you can consider offering to employees include:
- Health benefits
- Long-term care insurance
- Group term life insurance
- Disability insurance
- Educational assistance
- Dependent care assistance
- Transportation benefits
- Meals provided for employee convenience
Strategy #9: Make multi-year charitable gifts in one year
The standard deduction provides a simple way for taxpayers to reduce their taxes.
TCJA Updates
The TCJA nearly doubled the standard deduction, from:
- $6,500 to $12,000 for individual filers
- $13,000 to $24,000 for joint returns
- $9,550 to $18,000 for heads of household in 2018.
Unfortunately, the TCJA also eliminated the deduction for miscellaneous itemized deductions for tax years 2018 through 2026.
Because charitable deductions are only deductible as itemized deductions, you’ll now need combined itemized expenses for the tax year to be greater than your standard deduction amount.
One way to get around this? Make multi-year charitable gifts.
If you and your spouse generally make charitable gifts of $15,000 per year, you could make a $45,000 charitable gift in one year and itemize it on your taxes (because it’s over your standard deduction—assuming no other itemized deductions). Then, simply refrain from making charitable gifts over the following two years and take the standard deduction.
You can make multi-year charitable gifts through a Donor-Advised Fund.
Interested in gifting through a donor-advised fund? We can help.
Strategy #10: Take advantage of all State incentives and credits
Your state likely offers a long list of business incentives and credits to encourage economic growth, as well as specific business growth and activity.
While these programs can be challenging to find and understand they can provide access to low-cost financing, tax credits, and grants.
California State Incentives
The California Competes Tax Credit is an income tax credit available to businesses that want to come to California or stay and grow in California.
The New Employment Credit (NEC) is available for each taxable year beginning on or after January 1, 2014, and before January 1, 2021, to a qualified taxpayer that hires a qualified full-time employee on or after January 1, 2014, and pays or incurs qualified wages attributable to work performed by the qualified full-time employee in a designated census tract or economic development area, and that receives a tentative credit reservation for that qualified full-time employee.
Manufacturing and research & development in “biotechnology, physical, engineering, and life science” may qualify for partial sales and use tax exemption on purchases and leases of manufacturing and research & development equipment.
A sales tax exclusion from both state and local sales tax collection on equipment purchases for qualifying businesses that conduct qualifying activities. Sales tax rates vary by jurisdiction (typically 7.5% to 10%).
Companies may qualify for corporate tax income credits for R&D expenses experienced in the business, the credits could be up to 15%, plus 24% of the basic research expenses.
Film and television productions featuring California are eligible to apply for the tax incentive, which encourages still-image and entertainment programs to shoot in California. The program offers a variety of amounts of tax credit to different types and scales of productions.
A cash reimbursement for training cost incurred by employers set by a pre-determined two-year performance based contract. Contracts vary based on number of employees enrolled, hours of training, training material and employee wages.
The California Small Business Loan Guarantee Program (SBLGP) assists businesses with the creation and retention of jobs while encouraging investment into low- to moderate-income communities.
The California Capital Access Program (CalCAP) encourages participating banks and lending institutions to provide loans to small businesses that fall outside of conventional underwriting standards.
Visit the California Business Portal to learn more about incentive programs that your business may be eligible for.
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