Archives for March 2024

Strategic Coordination of Sec. 179 Tax Deductions and Bonus Depreciation

Ken Botwinick, CPA | 03/26/2024

To optimize tax savings, businesses should prioritize maximizing depreciation write-offs for newly acquired assets within the current tax year. Two key federal tax incentives facilitate this strategy: first-year Section 179 depreciation deductions and first-year bonus depreciation deductions. These provisions enable businesses to potentially deduct a significant portion or all of their qualifying asset costs in the first year of use. However, these deductions are subject to annual inflation adjustments and evolving tax laws that may phase out bonus depreciation.

Here’s how to strategically coordinate these deductions for optimal tax-saving outcomes:

Section 179 deduction overview:
Most tangible depreciable business assets qualify, including equipment, computer hardware, vehicles (with limitations), furniture, most software, and fixtures.
Depreciable real property generally does not qualify unless it meets the criteria for qualified improvement property (QIP).
For tax year 2024, the maximum Section 179 deduction is $1.22 million, with a phase-out beginning at $3.05 million in qualified asset additions.

Bonus depreciation overview:
Most tangible depreciable business assets, as well as software and QIP, generally qualify.
Used assets must be new to the taxpayer to be eligible.
For assets placed in service in 2024, the first-year bonus depreciation rate is 60%, reduced from 80% in 2023.

Comparison of Section 179 vs. bonus depreciation:
Section 179 deductions have generous rules but are subject to limitations such as phase-out thresholds, business taxable income constraints, and specific rules for certain types of assets and ownership structures.
First-year bonus depreciation deductions are not subject to complex limitations but are subject to declining percentage rates, with 60% applicable for assets placed in service in 2024.

Tax-saving strategy:
Maximize Section 179 deductions up to allowable limits.
Utilize first-year bonus depreciation for any remaining qualifying asset costs.
Example scenario:
In 2024, a calendar-tax-year C corporation places $500,000 of qualifying assets in service. Due to taxable income limitations, the corporation’s Section 179 deduction is capped at $300,000. The corporation can deduct $300,000 on its 2024 federal income tax return. Additionally, it can deduct 60% of the remaining $200,000 ($500,000 – $300,000) through first-year bonus depreciation, totaling a $420,000 deduction for the year.

Managing tax incentives:
Effective coordination of Section 179 and bonus depreciation deductions is crucial for maximizing tax benefits. We can provide detailed guidance on these strategies and address any specific queries you may have regarding tax rules and implications.

Bartering Is A Taxable Transaction Even If No Cash Is Exchanged

Ken Botwinick, CPA | 03/20/2024

If your small business is seeking to conserve cash or reduce expenses, engaging in barter or trade for goods and services can be advantageous. While bartering dates back to ancient times, modern technology, particularly the internet, has facilitated easier exchanges between businesses.

Tax Considerations

Bartering transactions involve taxable income based on the fair market value of goods or services received. Exchanging services with another business also results in taxable income for both parties.

Fair Market Value Examples

A computer consultant provides tech support to an advertising agency in exchange for free advertising.
An electrical contractor performs repairs for a dentist in exchange for dental services.
Both parties are taxed on the fair market value of the services exchanged, typically the amount they would charge for the same services.
If services are exchanged for property:
- A construction firm doing work for a retail business in exchange for unsold inventory realizes income equal to the inventory’s fair market value.
- An architectural firm performing services for a corporation in exchange for shares incurs income based on the fair market value of the received stock.

Joining Barter Clubs

Many businesses join barter clubs that utilize “credit units” awarded to members providing goods and services. These credits can be redeemed within the club’s network.
Taxation of bartering occurs in the year of transaction. If participating in a club, taxation may apply when credits are credited to your account, regardless of redemption timing.
Provide your Social Security number or Employer Identification Number and certify non-existence of backup withholding when joining a club; otherwise, a 24% tax rate will be applied to bartering income.

Tax Reporting

Barter clubs issue Form 1099-B by January 31 annually, summarizing cash, property, services, and credit values received during the prior year for IRS reporting.

Exchanging Without Currency

Bartering enables businesses to trade excess inventory or provide services during slow periods, conserving cash flow. It also offers solutions when customers lack immediate funds for transactions.
Understanding federal and state tax implications is crucial for optimizing benefits from bartering transactions.

For further guidance or detailed information on navigating tax implications related to bartering, feel free to contact us.

Optimize Your QBI Deduction Before Its Expiration

Ken Botwinick, CPA | 03/18/2024

The qualified business income (QBI) deduction offers significant tax advantages to eligible businesses until its scheduled expiration in 2025. Therefore, it’s crucial for eligible businesses to capitalize on this deduction while it remains in effect, as it can lead to substantial tax savings.

Key Points:

Overview of the QBI Deduction: The QBI deduction allows owners to deduct up to 20% of qualified business income from sole proprietorships, single-member LLCs treated as sole proprietorships, partnerships, LLCs treated as partnerships, or S corporations.
Definition of QBI: Qualified income and gains from eligible businesses are considered QBI, adjusted for specific deductions such as contributions to self-employed retirement plans, self-employment tax deductions, and self-employed health insurance premiums.
Limitations: Higher income levels trigger limitations on the QBI deduction. For 2024, these limitations begin to apply when taxable income exceeds $191,950 ($383,900 for married joint filers) and are fully phased in at $241,950 or $483,900, respectively.
Calculation of Limitations: If taxable income exceeds the fully-phased-in threshold, the QBI deduction is limited to the greater of 1) 50% of W-2 wages allocated to QBI or 2) a combination of wages and 2.5% of the unadjusted basis immediately upon acquisition (UBIA) of qualified property.
Qualified Property Consideration: The UBIA of qualified property, which includes depreciable tangible property used to generate QBI, generally equals its original cost when placed in service.
Impact on SSTBs: Specified service trade or businesses (SSTBs) face stricter rules, with phaseouts beginning at lower income thresholds and complete phaseouts at higher thresholds, potentially disqualifying income from SSTBs from the QBI deduction.
Additional Considerations: Aggregating multiple businesses for the deduction may optimize benefits, particularly for businesses approaching the income limitations. Furthermore, decisions regarding depreciation deductions, such as Section 179 and bonus depreciation, can affect QBI and overall taxable income.
Use It or Lose It: With the QBI deduction set to expire after 2025, businesses are advised to maximize utilization of this tax benefit for the 2024 and 2025 tax years to benefit from potential tax savings.

For expert guidance on navigating the complexities of the QBI deduction and strategizing for optimal tax outcomes, please reach out to us. We are here to assist you in maximizing your QBI deduction and achieving your tax planning goals.

Q&A:

What is qualified business income (QBI)?

Qualified business income refers to income generated by an eligible business, which is then reduced by specific deductions. These deductions include contributions to a self-employed retirement plan, 50% of self-employment tax, and self-employed health insurance premiums.

What are some qualified business income (QBI) limitations?

Qualified business income limitations encompass several factors:

Specified Service Trade or Business (SSTB) Limitation: Certain professional services (e.g., health, law, accounting, consulting) may face restrictions on QBI deductions based on income thresholds.
W-2 Wage and Capital Limitations: Businesses with higher incomes may have their QBI deduction limited by the W-2 wages paid by the business and the unadjusted basis of qualified property held by the business.
Overall QBI Deduction Limitation: The QBI deduction is subject to an overall limitation based on taxable income levels and can be further restricted for certain SSTBs once income thresholds are exceeded.

Why should I maximize my qualified business income (QBI) deductions now rather than later?

The QBI deduction is currently set to expire after 2025. While there is a possibility of extension by Congress, this is uncertain. Therefore, maximizing your QBI deductions now allows you to take advantage of potential tax savings before the deduction is scheduled to disappear.

Better Tax Break When Applying The Research Credit Against Payroll Taxes

Ken Botwinick, CPA | 03/08/2024

The credit for increasing research activities, often referred to as the research and development (R&D) credit, is a valuable tax break available to certain eligible small businesses.

But in addition to the credit itself, be aware that there are two additional features that are especially favorable to small businesses:

Eligible small businesses ($50 million or less in gross receipts for the three prior tax years) may claim the credit against alternative minimum tax (AMT) liability.
The credit can be used by certain smaller startup businesses against their Social Security payroll and Medicare tax liability.

Let’s take a look at the second feature. The Inflation Reduction Act (IRA) has doubled the amount of the payroll tax credit election for qualified businesses and made a change to the eligible types of payroll taxes it can be applied to, making it better than it was before the law changes kicked in.

Election basics

Subject to limits, your business can elect to apply all or some of any research tax credit that you earn against your payroll taxes instead of your income tax. This payroll tax election may influence you to undertake or increase your research activities. On the other hand, if you’re engaged in — or are planning to undertake — research activities without regard to tax consequences, you could receive some tax relief.

Many new businesses, even if they have some cash flow, or even net positive cash flow and/or a book profit, pay no income taxes and won’t for some time. Thus, there’s no amount against which business credits, including the research credit, can be applied. On the other hand, any wage-paying business, even a new one, has payroll tax liabilities. Therefore, the payroll tax election is an opportunity to get immediate use out of the research credits that you earn. Because every dollar of credit-eligible expenditure can result in as much as a 10-cent tax credit, that’s a big help in the start-up phase of a business — the time when help is most needed.

Eligible businesses

To qualify for the election a taxpayer must:

Have gross receipts for the election year of less than $5 million, and
Be no more than five years past the period for which it had no receipts (the start-up period).

In making these determinations, the only gross receipts that an individual taxpayer considers are from the individual’s businesses. An individual’s salary, investment income or other income aren’t taken into account. Also, note that an entity or individual can’t make the election for more than six years in a row.

Limits on the election

The research credit for which the taxpayer makes the payroll tax election can be applied against the employer portion of Social Security and Medicare. It can’t be used to lower the FICA taxes that an employer withholds and remits to the government on behalf of employees. Before a provision in the IRA became effective for 2023 and later years, taxpayers were only allowed to use the payroll tax offset against Social Security, not Medicare.

The amount of research credit for which the election can be made can’t annually exceed $500,000. Prior to the IRA, the maximum credit amount allowed to offset payroll tax before 2023 was only $250,000. Note, too, that an individual or C corporation can make the election only for those research credits which, in the absence of an election, would have to be carried forward. In other words, a C corporation can’t make the election for the research credit to reduce current or past income tax liabilities.

These are just the basics of the payroll tax election. Keep in mind that identifying and substantiating expenses eligible for the research credit itself is a complex task. Contact us about whether you can benefit from the payroll tax election and the research tax credit.

Tax-Wise Ways To Take Cash From Your Corporation While Avoiding Dividend Treatment

Ken Botwinick, CPA | 03/04/2024

If you want to withdraw cash from your closely held corporation at a low tax cost, the easiest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax efficient since it’s taxable to you to the extent of your corporation’s “earnings and profits,” but it’s not deductible by the corporation.

5 different approaches

Thankfully, there are some alternative methods that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Here are five possible options:

1. Salary. Reasonable compensation that you, or family members, receive for services rendered to the corporation is deductible by the business. However, it’s also taxable to the recipient(s). The same rule applies to any compensation (in the form of rent) that you receive from the corporation for the use of property. In either case, the amount of compensation must be reasonable in relation to the services rendered or the value of the property provided. If it’s excessive, the excess will be nondeductible and treated as a corporate distribution.

2. Fringe benefits. Consider obtaining the equivalent of a cash withdrawal in fringe benefits that are deductible by the corporation and not taxable to you. Examples are life insurance, certain medical benefits, disability insurance and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other employees of the corporation. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.

3. Capital repayments. To the extent that you’ve capitalized the corporation with debt, including amounts that you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, interest paid on the debt can be deducted by the corporation. This assumes that the debt has been properly documented with terms that characterize debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If not, the “debt” repayment may be taxed as a dividend. If you make cash contributions to the corporation in the future, consider structuring them as debt to facilitate later withdrawals on a tax-advantaged basis.

4. Loans. You may withdraw cash from the corporation tax-free by borrowing money from it. However, to avoid having the loan characterized as a corporate distribution, it should be properly documented in a loan agreement or a note and be made on terms that are comparable to those on which an unrelated third party would lend money to you. This should include a provision for interest and principal. All interest and principal payments should be made when required under the loan terms. Also, consider the effect of the corporation’s receipt of interest income.

5. Property sales. You can withdraw cash from the corporation by selling property to it. However, certain sales should be avoided. For example, you shouldn’t sell property to a more than 50% owned corporation at a loss, since the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50% owned corporation at a gain, since the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those on which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.

Minimize taxes

If you’re interested in discussing any of these ideas, contact us. We can help you get the maximum out of your corporation at the minimum tax cost.

Q&A

How can I withdraw cash from my corporation without it being treated as a dividend?

Some alternative methods that can allow you to withdraw cash from your corporation while avoiding dividend treatment include paying yourself a reasonable salary, obtaining the equivalent of a cash withdrawal in fringe benefits, structuring cash contributions to the corporation as debt so that the subsequent repayment to you from the corporation can be treated as debt repayment rather than a dividend, withdrawing cash as a loan, and selling property to the corporation.

Strategic Coordination of Sec. 179 Tax Deductions and Bonus Depreciation

Bartering Is A Taxable Transaction Even If No Cash Is Exchanged

Optimize Your QBI Deduction Before Its Expiration

Better Tax Break When Applying The Research Credit Against Payroll Taxes

Tax-Wise Ways To Take Cash From Your Corporation While Avoiding Dividend Treatment

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