Small Business Tax Briefs- Year End Edition
How to maximize deductions for business real estate
Currently, a valuable income tax deduction related to real estate is for depreciation, but the depreciation period for such property is long and land itself isn’t depreciable. Whether real estate is occupied by your business or rented out, here’s how you can maximize your deductions.
Segregate personal property from buildings. Generally, buildings and improvements to them must be depreciated over 39 years (27.5 years for residential rental real estate and certain other types of buildings or improvements). But personal property, such as furniture and equipment, generally can be depreciated over much shorter periods. Plus, for the tax year such assets are acquired and put into service, they may qualify for 50% bonus depreciation or Section 179 expensing (up to $510,000 for 2017, subject to a phase out if total asset acquisitions for the tax year exceed $2.03 million).
If you can identify and document the items that are personal property, the depreciation deductions for those items generally can be taken more quickly. In some cases, items you’d expect to be considered parts of the building actually can qualify as personal property. For example, depending on the circumstances, lighting, wall and floor coverings, and even plumbing and electrical systems, may qualify.
Carve out improvements from land. As noted above, the cost of land isn’t depreciable. But the cost of improvements to land is depreciable. Separating out land improvement costs from the land itself by identifying and documenting those improvements can provide depreciation deductions. Common examples include landscaping, roads, and, in some cases, grading and clearing.
Convert land into a deductible asset. Because land isn’t depreciable, you may want to consider real estate investment alternatives that don’t involve traditional ownership. Such options can allow you to enjoy tax deductions for land costs that provide a similar tax benefit to depreciation deductions. For example, you can lease land long-term. Rent you pay under such a "ground lease" is deductible.
Another option is to purchase an "estate-for-years," under which you own the land for a set period and an unrelated party owns the interest in the land that begins when your estate-for-years ends. You can deduct the cost of the estate-for-years over its duration.
More limits and considerations. There are additional limits and considerations involved in these strategies. Also keep in mind that tax reform legislation could affect these techniques. For example, immediate deductions could become more widely available for many costs that currently must be depreciated. If you’d like to learn more about saving income taxes with business real estate, please contact us.
Research credit can offset a small business’s payroll taxes
Does your small business engage in qualified research activities? If so, you may be eligible for a research tax credit that you can use to offset your federal payroll tax bill.
This relatively new privilege allows the research credit to benefit small businesses that may not generate enough taxable income to use the credit to offset their federal income tax bills, such as those that are still in the unprofitable start-up phase where they owe little or no federal income tax.
QSB status. Under the Protecting Americans from Tax Hikes Act of 2015, a qualified small business (QSB) can elect to use up to $250,000 of its research credit to reduce the Social Security tax portion of its federal payroll tax bills. Under the old rules, businesses could use the credit to offset only their federal income tax bills. However, many small businesses owe little or no federal income tax, especially small start-ups that tend to incur significant research expenses.
For the purposes of the research credit, a QSB is generally defined as a business with:
- Gross receipts of less than $5 million for the current tax year, and
- No gross receipts for any taxable year preceding the five-taxable-year period ending with the current tax year.
The allowable payroll tax reduction credit can’t exceed the employer portion of the Social Security tax liability imposed for any calendar quarter. Any excess credit can be carried forward to the next calendar quarter, subject to the Social Security tax limitation for that quarter.
Research activities that qualify. To be eligible for the research credit, a business must have engaged in "qualified" research activities. To be considered "qualified," activities must meet the following four-factor test:
- The purpose must be to create new (or improve existing) functionality, performance, reliability or quality of a product, process, technique, invention, formula or computer software that will be sold or used in your trade or business.
- There must be an intention to eliminate uncertainty.
- There must be a process of experimentation. In other words, there must be a trial-and-error process.
- The process of experimentation must fundamentally rely on principles of physical or biological science, engineering or computer science.
Expenses that qualify for the credit include wages for time spent engaging in supporting, supervising or performing qualified research, supplies consumed in the process of experimentation, and 65% of any contracted outside research expenses.
Complex rules. The ability to use the research credit to reduce payroll tax is a welcome change for eligible small businesses, but the rules are complex and we’ve only touched on the basics here. We can help you determine whether you qualify and, if you do, assist you with making the election for your business and filing payroll tax returns to take advantage of the new privilege.
2017 might be your last chance to hire veterans and claim a tax credit
With the recent observance of Veterans Day, it’s an especially good time to think about the sacrifices veterans have made for us and how we can support them. One way businesses can support veterans is to hire them. The Work Opportunity tax credit (WOTC) can help businesses do just that, but it may not be available for hires made after this year.
As released by the Ways and Means Committee of the U.S. House of Representatives on November 2, the Tax Cuts and Jobs Act would eliminate the WOTC for hires after December 31, 2017. So you may want to consider hiring qualifying veterans before year end.
The WOTC up close. You can claim the WOTC for a portion of wages paid to a new hire from a qualifying target group. Among the target groups are eligible veterans who receive benefits under the Supplemental Nutrition Assistance Program (commonly known as "food stamps"), who have a service-related disability or who have been unemployed for at least four weeks. The maximum credit depends in part on which of these factors apply:
- Food stamp recipient or short-term unemployed (at least 4 weeks but less than 6 months): $2,400
- Disabled: $4,800
- Long-term unemployed (at least 6 months): $5,600
- Disabled and long-term unemployed: $9,600
The amount of the credit also depends on the wages paid to the veteran and the number of hours the veteran worked during the first year of employment.
You aren’t subject to a limit on the number of eligible veterans you can hire. For example, if you hire 10 disabled long-term-unemployed veterans, the credit can be as much as $96,000.
Other considerations. Before claiming the WOTC, you generally must obtain certification from a "designated local agency" (DLA) that the hired individual is indeed a target group member. You must submit IRS Form 8850, "Pre-Screening Notice and Certification Request for the Work Opportunity Credit," to the DLA no later than the 28th day after the individual begins work for you.
Also be aware that veterans aren’t the only target groups from which you can hire and claim the WOTC. But in many cases hiring a veteran will provide the biggest credit. Plus, research assembled by the Institute for Veterans and Military Families at Syracuse University suggests that the skills and traits of people with a successful military employment track record make for particularly good civilian employees.
Looking ahead. It’s still uncertain whether the WOTC will be repealed. The House bill likely will be revised as lawmakers negotiate on tax reform, and it’s also possible Congress will be unable to pass tax legislation this year. Under current law, the WOTC is scheduled to be available through 2019.
But if you’re looking to hire this year, hiring veterans is worth considering for both tax and nontax reasons. Contact us for more information on the WOTC or on other year-end tax planning strategies in light of possible tax law changes.
Reduce your 2017 tax bill by buying business assets
Two valuable depreciation-related tax breaks can potentially reduce your 2017 taxes if you acquire and place in service qualifying assets by the end of the tax year. Tax reform could enhance these breaks, so you’ll want to keep an eye on legislative developments as you plan your asset purchases.
Section 179 expensing. Sec. 179 expensing allows businesses to deduct up to 100% of the cost of qualifying assets (new or used) in Year 1 instead of depreciating the cost over a number of years. Sec. 179 can be used for fixed assets, such as equipment, software and real property improvements.
The Sec. 179 expensing limit for 2017 is $510,000. The break begins to phase out dollar-for-dollar for 2017 when total asset acquisitions for the tax year exceed $2.03 million. Under current law, both limits are indexed for inflation annually.
Under the initial version of the House bill, the limit on Sec. 179 expensing would rise to $5 million, with the phase out threshold increasing to $20 million. These higher amounts would be adjusted for inflation, and the definition of qualifying assets would be expanded slightly. The higher limits generally would apply for 2018 through 2022.
The initial version of the Senate bill also would increase the Sec. 179 expensing limit, but only to $1 million, and would increase the phase out threshold, but only to $2.5 million. The higher limits would be indexed for inflation and generally apply beginning in 2018. Significantly, unlike under the House bill, the higher limits would be permanent under the Senate bill. There would also be some small differences in which assets would qualify under the Senate bill vs. the House bill.
First-year bonus depreciation. For qualified new assets (including software) that your business places in service in 2017, you can claim 50% first-year bonus depreciation. Examples of qualifying assets include computer systems, software, machinery, equipment, office furniture and qualified improvement property. Currently, bonus depreciation is scheduled to drop to 40% for 2018 and 30% for 2019 and then disappear for 2020.
The initial House bill would boost bonus depreciation to 100% for qualifying assets (which would be expanded to include certain used assets) acquired and placed in service after September 27, 2017, and before January 1, 2023 (with an additional year for certain property with a longer production period).
The initial Senate bill would allow 100% bonus depreciation for qualifying assets acquired and placed in service during the same period as under the House bill, though there would be some differences in which assets would qualify.
Year-end planning. If you’ve been thinking about buying business assets, consider doing it before year end to reduce your 2017 tax bill. If, however, you could save more taxes under tax reform legislation, for now you might want to limit your asset investments to the maximum Sec.179 expense election currently available to you, and then consider additional investments depending on what happens with tax reform. It’s still uncertain what the final legislation will contain and whether it will be passed and signed into law this year. Contact us to discuss the best strategy for your particular situation.