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Planning for Business Owners

  1. Flow-through planning. The activities, income, and deductions of partnerships, S corporations, and sole proprietorships flow through to their owners and impact the owners’ individual tax returns. In addition to planning related to incurring expenses or deferring income, the new tax law creates a new deduction for certain qualified business income (“QBI”) from a pass-through business. As we approach the end of the year, business owners can engage in planning to maximize their ability to benefit from the new deduction.
    1. Planning with taxable income for purposes of the new pass-through tax deduction. The new tax law allows owners of a flow-through business to deduct up to 20% of QBI earned from the business. The deduction is in effect for tax years 2018 through 2025. The deduction cannot exceed 20% of the taxpayer’s “taxable income” and is subject to other limitations based on a taxpayer’s taxable income. For example, in 2018, if a taxpayer has taxable income of over $415,000 (married, filing joint), then any QBI from a specified service trade or business engaged in by the taxpayer is not eligible for the deduction. Also, any QBI from a non-service business of the taxpayer would be subject to limits based on the amount of W-2 wages paid by the business and the cost of property owned by the business.
    2. Because taxable income plays a large role in both determining eligibility for the QBI deduction and the limitations on the amount deductible, lowering taxable income can have a big impact. For service businesses or businesses with few employees or property, it could be critical for taxable income to be below threshold amounts to be able to benefit from the deduction. For other business owners, it may be more important to have taxable income high so that the overall limit of 20% of taxable income doesn’t apply to the deductible amount. Note that reductions to gross income that alter QBI will affect the calculation of the QBI deduction.
    3. For these purposes, “taxable income” is defined as gross income minus permissible deductions, including itemized deductions if the standard deduction isn’t taken. Making changes to any of the items that make up taxable income could significantly impact the benefit of the pass-through tax deduction for a taxpayer.
  2. Free up suspended partnership losses. The ability to use partnership losses can be limited for several reasons, such as the lack of tax basis in the partnership interest, or because of the passive loss rules of Section 469. The unused losses are “suspended” until they can be used. Suspended losses can be freed up either when the reason they were suspended no longer exists (e.g., the basis increases) or when the interest in the partnership is fully terminated.
  3. Accelerated deductions for acquired property. The new tax law allows businesses to fast-track depreciation deductions, which can lower a flow-through business owner’s overall tax burden.
    1. Bonus depreciation. Buying qualified property allows a business to take a 100% depreciation deduction. The qualified property must be placed into service between September 27, 2017 and December 31, 2022.
    2. Section 179. The maximum that can be expensed under Code Section 179 is increased to $1 million and it does not phase out until the cost of qualifying property acquired in a year exceeds $2.5 million.
  4. Benefit planning for entities. Owners of businesses that are not C corporations are unable to use many of the common tax-free employee benefits that companies provide to employees. There are, however, some strategies available to business owners that should be considered before the end of the year.
    1. Qualified retirement plans. The individual contribution limit for an IRA is $5,500 (plus catch-up if over 50), but employers can contribute up to $55,000 (2018 figure) on a pre-tax basis for employees under a qualified defined contribution plan. There are many qualified plan options that an owner-employee could use to maximize pre-tax contributions for retirement funding. Typical plan options for small business owners or self-employed individuals include SEP and SIMPLE IRAs and qualified plans (both defined benefit and defined contribution plans). While a SIMPLE plan must be established by October 1 of a calendar year, other plans have until December 31 to be set up.16
    2. Consider obtaining long-term care insurance. Self-employed individuals can pay for long-term care (LTC) insurance premiums for themselves and their spouse and deduct up to the “eligible long-term care premium amount.”17 This amount is often not as large as the actual premium paid, but self-employed taxpayers can deduct the eligible LTC premium amount without having to exceed the 7.5% AGI threshold that applies to individuals purchasing LTC insurance without the involvement of a trade or business.
    3. What’s more, if the employer is a C Corporation and provides the LTC insurance benefit to an owner-employee due to employee status, or if any employer provides LTC insurance coverage to a non-owner employee, the premium paid – rather than the eligible LTC premium amount – is generally deductible for the business and altogether excluded from the employee’s income.