It's not too late to take steps to significantly reduce your 2016 business income tax bill and lay the groundwork for tax savings in future years. Here's a summary of some of the most effective year-end tax-saving moves for small businesses under the existing Internal Revenue Code.
Pass-Through Entity Income and Expenses
If your business operates as a sole proprietorship, S corporation, limited liability company (LLC) or partnership, your share of the net income generated by the business will be reported on your Form 1040 and taxed at your personal rates. If the new Congress maintains the status quo, individual federal income tax rate brackets for 2017 will be about the same as this year's brackets (with modest increases for inflation).
Under that assumption, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2016 until 2017.
On the other hand, if your business is healthy, and you expect to be in a significantly higher tax bracket in 2017 (say, 35% vs. 28%), take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2017. That way, more income will be taxed at this year's lower rate instead of next year's higher rate. The results of the election could affect tax rates and regulations in the future. Individual tax rates in 2017 and beyond could be higher or lower than under current law.
Defer Income and Accelerate Deductible Expenses (Or Vice Versa)
If your small business uses cash-method accounting for tax purposes, it can provide flexibility to manage your 2016 and 2017 taxable income to minimize taxes over the two-year period. Here are four specific cash-method moves if you expect business income to be taxed at the same or lower rates next year:
- Before year end, charge on your credit cards recurring expenses that you would otherwise pay early next year. You can claim 2016 deductions even though the credit card bills won't be paid until next year. However, this favorable treatment doesn't apply to store revolving charge accounts. For example, you can't deduct business expenses charged to your Sears or Home Depot account until you actually pay the bill.
- Pay expenses with checks and mail them a few days before year end. The tax rules say you can deduct the expenses in the year you mail the checks, even though they won't be cashed or deposited until early next year. For big-ticket expenses, send checks via registered or certified mail. That way, you can prove they were mailed this year.
- Prepay some expenses for next year, as long as the economic benefit from the prepayment doesn't extend beyond the earlier of:
- 12 months after the first date on which your business realizes the benefit, or
- the end of 2017 (the tax year following the year in which the payment is made).
- On the income side, the general rule for cash-basis taxpayers is that you don't have to report income until the year you receive cash or checks in hand or through the mail. To take advantage of this rule, hold off sending out some invoices at year end. That way, you won't get paid until early next year. Of course, you should never do this if it raises the risk of not collecting the cash.
If you expect to pay a significantly higher tax rate on next year's business income, try to use the opposite strategies to raise this year's taxable income and lower next year's. Be sure to factor into the equation your expectations about how the election results will affect taxes in future years.
Buy Heavy Vehicles
Purchasing a SUV, pickup or van for your business can be useful as part of your day-to-day business operations and they also have major tax advantages. A "heavy" vehicle, is one with a manufacturer's gross vehicle weight rating (GVWR) above 6,000 pounds. First-year depreciation deductions for lighter SUVs, light trucks, light vans and passenger cars are substantial less due to depreciation law limitations.
Under the Section 179 election, you can elect to immediately write off up to $25,000 of the cost of a new or used heavy SUV that's:
1) placed in service by the end of your business tax year that begins in 2016, and
2) used over 50% for business during that year.
If the vehicle is new, 50% first-year bonus depreciation allows you to write off half of the remaining business-use portion of the cost of a heavy SUV, pickup or van that's:
1) placed in service in calendar year 2016, and
2) used over 50% for business during the year.
After taking advantage of the preceding two breaks, you can follow the "regular" tax depreciation rules to write off whatever is left of the business portion of the heavy SUV's, pickup's or van's cost over six years, starting with 2016.
Elect Sec. 179 on Other Fixed Asset Purchases
Sec. 179 is even more generous for other types of fixed assets, such as equipment, software and leasehold improvements. For tax years that begin in 2016, the maximum Sec. 179 first-year depreciation overall deduction is $500,000. This amount will be adjusted for inflation in future years.
Businesses can immediately deduct most (or all) of their new and used fixed asset purchases in the current tax year.
Real property improvements have traditionally been ineligible for the Sec. 179 deduction. However, an exception that started in 2010 has been made permanent for tax years beginning in 2016. Under the exception, you can claim a first-year Sec. 179 deduction of up to $500,000 (adjusted for inflation in future years) for the following qualified real property improvement costs:
Certain improvements to interiors of leased nonresidential buildings,
Certain restaurant buildings or improvements to such buildings, and
Certain improvements to interiors of retail buildings.
Take Advantage of 50% First-Year Bonus Depreciation
For qualified new assets (including software) that your business places in service in calendar year 2016, you can claim 50% first-year bonus depreciation. (Used assets don't qualify.) This break is available for the cost of new computer systems, purchased software, machinery and equipment, and office furniture.
Additionally, 50% bonus depreciation can be claimed for qualified improvement property, which means any qualified improvement to the interior portion of a nonresidential building if the improvement is placed in service after the date the building was first placed in service. However, qualified improvement costs don't include expenditures for the enlargement of a building, any elevator or escalator, or the internal structural framework of a building.
Under the current rules, 50% bonus depreciation will also be available for qualified assets that are placed in service in 2017. In 2018 and 2019, bonus depreciation rates will fall to 40% and 30%, respectively. The bonus depreciation program is set to expire in 2020, unless Congress revives it.