Tag: Tax Planning

Posted on Dec 1, 2016

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. After President Obama hands over the baton to President-elect Trump and new members of Congress are sworn into office in January, the tax laws could change. But here’s what we know now.

Take Advantage of Net Operating Losses (NOLs)

NOLs received some bad press during the 2016 election season. But they can be an effective — and perfectly legal — way for small business owners to lower taxes in the future. NOLs happen when a business’s deductible expenses exceed its income for the year.

With the exception of the Section 179 depreciation deduction, the business tax breaks and strategies discussed in the main article can be used to create or increase a 2016 NOL. You can then choose to carry a 2016 NOL back for up to two years in order to recover taxes paid in those earlier years. Or you can choose to carry the NOL forward for up to 20 years if you think your business tax rates will go up.

Juggle Pass-Through Income and Deductible Expenditures

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.

Important note: 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 Corporate Income and Accelerate Deductible Expenditures (or Vice Versa)

If your business operates as a regular C corporation, corporate tax rates for 2017 are scheduled to be the same — again, assuming the new Congress makes no tax law changes. So, if you expect your corporation to pay the same or lower rate in 2017, you should plan to defer income into next year and accelerate deductible expenditures into this year. If you expect the opposite, accelerate income into this year, while postponing deductible expenditures until next year.

Looking for easy ways to defer income and accelerate deductible expenditures? 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:

  1. 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.
  2. 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.
  3. Prepay some expenses for next year, as long as the economic benefit from the prepayment doesn’t extend beyond the earlier of: 1) 12 months after the first date on which your business realizes the benefit, or 2) the end of 2017 (the tax year following the year in which the payment is made). For example, this rule allows you to claim 2016 deductions for prepaying the first three months of next year’s office rent or prepaying the premium for property insurance coverage for the first half of next year.
  4. 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.

When should you take the opposite approach? 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 gas-guzzling SUV, pickup or van for your business may be seen by some as bad for the environment. But these vehicles can be useful if you need to haul people, equipment and other things around as part of your day-to-day business operations. They also have major tax advantages.

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.

To cash in on this favorable tax treatment, you must buy a “heavy” vehicle, which means 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 much skimpier. You can usually find a vehicle’s GVWR specification on a label on the inside edge of the driver’s side door where the hinges meet the frame.

Example 1: New Heavy Vehicle

Your business uses the calendar year for tax purposes. You buy a new $65,000 Cadillac Escalade and use it 100% for business between now and December 31. On your 2016 business tax return or form, you can elect to write off $25,000 under Sec. 179.

Then you can use the 50% first-year bonus depreciation break to write off another $20,000 (half the remaining cost of $40,000 after subtracting the $25,000 Sec. 179 deduction).

Finally, you can follow the regular depreciation rules to depreciate the remaining cost of $20,000. (That’s the amount left after subtracting the Sec. 179 deduction and the 50% bonus depreciation deduction.) For this asset, regular depreciation will generally result in a $4,000 deduction (20% x $20,000) in the first year.

When all is said and done, your first-year depreciation write-offs amount to $49,000 ($25,000 + $20,000 + $4,000). That represents a whopping 75.4% of the vehicle’s total cost.

In contrast, if you spend the same $65,000 on a new sedan that you use 100% for business between now and year end, your 2016 depreciation write-off will be only $11,160.

Example 2: Used Heavy Vehicle

Your business uses the calendar year for tax purposes. You buy a used $40,000 Cadillac Escalade and use it 100% for business between now and December 31. On your 2016 business tax return or form, you can elect to write off $25,000 under Sec. 179. Bonus depreciation isn’t allowed on used vehicles.

But you can generally write off another $3,000 under the normal depreciation rules. That’s equal to 20% of the remaining cost of $15,000 ($40,000 – $25,000).

Your first-year depreciation deductions add up to $28,000 ($25,000 + $3,000).

In contrast, if you spend the same $40,000 on a used passenger car and use it 100% for business, your 2016 depreciation write-off will be only $3,160.

You may not be eligible to claim Sec. 179 deductions if you have a tax loss for the year (or close to it). Sec. 179 can’t be used to create an overall business tax loss. This is the so-called business taxable income limitation.

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 deduction is $500,000. This amount will be adjusted for inflation in future years.

Thanks to this tax break, many small and medium-size businesses can immediately deduct most (or all) of their new and used fixed asset purchases in the current tax year. This can be especially beneficial if you buy a new or used heavy long-bed pickup and/or heavy van to be used over 50% in your business. Unlike heavy SUVs, these heavy vehicles aren’t subject to the $25,000 Sec. 179 deduction limitation. That means you can probably deduct the full business percentage of the cost on this year’s federal income tax return.

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.

Important note: Deductions claimed for qualified real property costs count against the overall $500,000 maximum for Sec. 179 deductions.

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.

Important note: 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.

Sell Qualified Small Business Corporation (QSBC) Stock

For QSBC stock that was acquired after September 27, 2010, a 100% federal gain exclusion break is potentially available when the stock is eventually sold. That equates to a 0% federal income tax rate if you sell the shares for a gain.

To qualify for this break, you must hold the shares for more than five years. In addition, this deal isn’t available to C corporations that own QSBC stock. Finally, many companies won’t meet the definition of a QSBC in the first place, and the gain exclusion break could be on the chopping block when the new Congress convenes early next year.

Consult a Tax Pro

These are just some of the tax-planning strategies available to help small business owners lower their taxes. Before implementing any of these strategies, consult your tax advisor to discuss the details and limitations, as well as other creative tax-saving alternatives. Your tax advisor is closely monitoring any tax law changes and will let you know when (and if) circumstances change.

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Posted on Aug 1, 2016
Tax forms 1065
Tax forms 1065

Unless you’ve extended the due date for filing last year’s individual federal income tax return to October 17, the filing deadline passed you by in April. What if you didn’t extend and you haven’t yet filed your Form 1040? And what if you can’t pay your tax bill? This article explains how to handle these situations.

“I Didn’t File but I Don’t Owe”

Let’s say you’re certain that you don’t owe any federal income tax for last year. Maybe you had negative taxable income or paid your fair share via withholding or estimated tax payments. But you didn’t file or extend the deadline because you were missing some records, were too busy, or had some other convincing reason (to you) for not meeting the deadline.

No problem, since you don’t owe — right? Wrong.

While it’s true there won’t be IRS interest or penalties (these are based on your unpaid liability, which you don’t have), blowing off filing is still a bad idea. For example:

You may be due a refund. Filing a return gets your money back. Without a return, there is no refund.
Until a return is filed, the three-year statute-of-limitations period for the commencement of an IRS audit never gets started. The IRS could then decide to audit your 2015 tax situation five years (or more) from now and hit you with a tax bill plus interest and penalties. By then, you may not be able to prove that you actually owed nothing. In contrast, when you do the smart thing and file a 2015 return showing zero tax due, the government must generally begin any audit within three years. Once the three-year window closes, your 2015 tax year is generally safe from audit, even if the return had problems.
If you had a tax loss in 2015, you may be able to carry it back as far as your 2013 tax year and claim refunds for taxes paid in 2013 and/or 2014. However, until you file a 2015 return, your tax loss doesn’t officially exist, and no loss carryback refund claims are possible.
There are other more esoteric reasons that apply to taxpayers in specific situations.

The bottom line is, you should file a 2015 return, even though you’ve missed the deadline and believe you don’t owe.

“I Owe but Don’t Have the Dough”

In this situation, there’s no excuse for not filing your 2015 return, especially if you obtained a filing extension to October 17.

If you did extend, filing your return by October 17 will avoid the 5%-per-month “failure-to-file” penalty. The only cost for failing to pay what you owe is an interest charge. The current rate is a relatively reasonable 0.83% per month, which amounts to a 10% annual rate. This rate can change quarterly, and you’ll continue to incur it until you pay up. If you still can’t pay when you file by the extended October 17 due date, relax. You can arrange for an installment arrangement (see below).

If you didn’t extend, you’ll continue to incur the 5%-per-month failure-to-file penalty until it cuts off:

Five months after the April 19 due date for filing your 2015 return or
When you file, whichever occurs sooner.
While the penalty can’t be assessed for more than five months, it can amount to up to 25% of your unpaid tax bill (5 times 5% per month equals 25%). So you can still save some money by filing your 2015 return as soon as possible to cut off the 5%-per-month penalty. Then you’ll continue to be charged only the IRS interest rate — currently 0.83% per month — until you pay.

If you still don’t file your 2015 return, the IRS will collect the resulting penalty and interest. You’ll be charged the failure-to-file penalty until it hits 25% of what you owe. For example, if your unpaid balance is $10,000, you’ll rack up monthly failure-to-file penalties of $500 until you max out at $2,500. After that, you’ll be charged interest until you settle your account (at the current monthly rate of 0.83%).

Save Money with an Installment Agreement

By now you understand why filing your 2015 return is crucial even if you don’t have the money to pay what you owe. But you may ask: When do I have to come up with the balance due? The answer: As soon as possible, if you want to halt the IRS interest charge. If you can borrow at a reasonable rate, you may want to do so and pay off the government, hopefully at the same time you file your return or even sooner if possible.

Alternatively, you can usually request permission from the IRS to pay off your bill in installments. This is done by filing a form with your 2015 return. On the form, you suggest your own terms. For example, if you owe $5,000, you might offer to pay $250 on the first of each month. You’re supposed to get an answer to your installment payment application within 31 days of filing the form, but it sometimes takes a bit longer. Upon approval, you’ll be charged a $120 setup fee or $52 if you agree to automatic withdrawals from your bank account.

As long as you have an unpaid balance, you’ll be charged interest (currently at 0.583% a month, which equates to a 7% annual rate), but this may be much lower than you could arrange with a commercial lender. Other details:

Approval of your installment payment request is automatic if you owe $10,000 or less (not counting interest or penalties), propose a repayment period of 36 months or less, haven’t entered into an earlier installment agreement within the preceding five years, and have filed returns and paid taxes for the preceding five tax years.
A streamlined installment payment approval process is available if you owe between $10,001 and $25,000 (including any assessed interest and penalties) and propose a repayment period of 72 months or less.
Another streamlined process is available if you owe between $25,001 and $50,000 and propose a repayment period of 72 months or less. However, you must agree to automatic bank withdrawals, and you may have to supply financial information.
If you owe $50,000 or less, you can apply for an installment payment arrangement online instead of filing an IRS form.
Finally, if you can pay what you owe within 120 days, you can arrange for an agreement with the IRS and avoid any setup fee.
Warning: When you enter into an installment agreement, you must pledge to stay current on your future taxes. The government is willing to help with your 2015 unpaid liability, but it won’t agree to defer payments for later years while you’re still paying the 2015 tab.

Pay With a Credit Card

You can also pay your federal tax bill with Visa, MasterCard, Discover or American Express. But before pursuing this option, ask about the one-time fee your credit card company will charge and the interest rate. You may find the IRS installment payment program is a better deal.

Act Soon

Filing a 2015 federal income return is important even if you believe you don’t owe anything or can’t pay right now. If you need assistance or want more information, contact your tax adviser.

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Posted on Jun 29, 2016

Safety First

“Safety First” should be your corporate mantra. Focusing on the safety of your products as you make them can help avoid complaints and litigation, give you a marketing edge and raise the bar for other manufacturers, according to the Consumer Product Safety Commission.

10 Quick Manufacturing Safety Tips

1. Build safety into product design.

2. Test products for all foreseeable hazards.

3. Stay up to date on manufacturing safety developments.

4. Educate consumers about product safety.

5. Track and address your product’s safety performance.

6. Fully investigate safety incidents.

7. Report product defects promptly.

8. If a defect occurs, quickly start a recall.

9. Work with the Consumer Product Safety Commission on any recall.

10. Learn from your mistakes — and others.

The two companies took a proactive approach rather than waiting for an industry standard to address the problem. They developed a method to “pinch-proof” the hinged joints between the doors’ panels. Their leadership challenged other manufacturers to meet the same high standards.You don’t have to be a huge corporation to come up with safety innovations. For example, Martin Door Mfg., a small Salt Lake City firm, and Wayne-Dalton, a larger company in Mt. Hope, OH, were both confronted with a safety issue in the garage doors they made — a large number of crushed or amputated fingers were reported after using their products.

Taking the lead is the key to improving manufacturing safety. There are several steps you can take — even before a problem develops:

Investigate your customer base. Who will use your product? For example, will a ladder hold a 300-pound person painting a house? How about a 350-pound person? If the ladder could collapse under a certain amount of weight, warn the consumer.

Study how customers will use your product. Back to the ladder. Although it may be intended as a means to climb, some people are apt to use two ladders and a plank for makeshift scaffolding. Warn the consumer if a product isn’t safe when it is used in ways you didn’t intend.

Stay informed about product safety developments. For example, stronger materials may become available for the ladder.

Keep up with safety regulations, as well as safety precautions taken by other companies. When the garage door manufacturers realized they had a problem, there were no state or federal regulations regarding it. But both firms recognized that safety made good business sense.

Fully investigate reports of injuries and accidents. A problem could stem from unintended use, but it could also result from a manufacturing or design flaw. An inquiry can help you determine the cause, guide you toward fixing any defect, and let you know whether a product recall of the lot or the entire line is necessary. If a recall is needed, the Consumer Product and Safety Commission will work with you to ensure the plan is effective.

An added benefit: Consumers and the media tend to go easier on companies that police themselves and promptly deal with problems. The media can also get safety warnings out quickly, helping you to avoid future incidents and potential lawsuits.

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Posted on Jun 17, 2016

MD Blog PicManufacturers may get an additional boost from a beneficial program that helps small and medium-sized companies.

The Hollings Manufacturing Extension Partnership (MEP), a program run by the U.S. Department of Commerce, would be expanded and strengthened by the MEP Improvement Act. This legislation was recently introduced in Congress and is widely thought to have a good shot of enactment. If passed, the bipartisan act would:

  • Permanently adjust the federal MEP cost share to one-to-one,
  • Strengthen and clarify the review process MEP centers use,
  • Authorize centers to support the development of manufacturing-related apprenticeships, internships and industry-recognized certification programs,
  • Increase the program’s funding level to $260 million a year through 2020, and
  • Require the program to develop open-access resources describing best practices for small manufacturers.

Top Shelf Endorsements

The bill has been endorsed by some high-visibility entities, including:

  • Information Technology and Innovation Foundation
  • American Small Manufacturers Coalition
  • Alliance for American Manufacturing
  • Honda North America
  • Association for Manufacturing Technology
  • National Council for Advanced Manufacturing
  • Manufacturing Skill Standards Council.

MEP is built on a nationwide system of service centers that are partnerships between the federal government and a variety of public or private entities, including state, university and not-for-profit organizations.Since its inception in 1988, MEP has focused on strengthening the U.S. manufacturing sector. The program’s power lies in its partnerships. Through collaborations with federal, state and local entities, it puts manufacturers in position to develop products and customers, expand globally and adopt new technology.

Return on Investment

Although MEP’s strategic objective is to create value for all manufacturers, it concentrates on small and mid-sized enterprises (SMEs). These account for nearly 99% of manufacturing firms in the United States.

The program has delivered a high return on investment (ROI) to taxpayers. For every dollar of federal investment, MEP generates $17 in new sales growth and $24 in new client investment, according to the program’s website.

MEP’s partnerships are expanding in response to rapidly changing global dynamics. The program has established relationships with diverse organizations. MEP centers also increasingly support government initiatives launched to strengthen U.S. manufacturing. Some of the program’s specific objectives are:

  • Educate local and regional partners on SME needs and causes of behavior,
  • Connect manufacturers to other programs and services offered by partner organization,
  • Identify firms that are interested in a particular technology, as well as informing information technology developers about manufacturer’s technology needs, and
  • Support workforce development programs.

Examples of Success

Here are two examples of how MEP has worked in action:

The exporter. One family-owned business in Wisconsin made standard products for metal fabricators and produced custom products, primarily for handrails. The organization exported some of its products and was able to increase export sales by connecting with the local MEP center and participating in three monthly training sessions, as well as coaching and assistance between the sessions.

Through this program, the exporter joined a group of noncompeting firms that worked together to create an exporting strategy to tap into new markets. The company was able to increase export sales 40% a year and expanded its reach from two to 16 countries.

The device maker. A North Carolina company designed and made high-performance radio frequency systems and solutions for applications that drive wireless and broadband communications. It enlisted the help of an MEP center to provide onsite training on Six Sigma and lean manufacturing principles. Participants were given real-world projects to continue working on after training was complete. The training helped management improve inventory controls and final product test efficiency, resulting in multi-million dollar cost savings.

Continued Challenges

Manufacturers face constant pressure to cut costs, improve quality, meet environmental and international standards, and “go to market” faster with new and improved products. At the same time, new opportunities are constantly beckoning.

As you try to keep pace with accelerating and emerging changes, consider taking advantage of the valuable resources MEP offers. If the MEP Improvement Act passes, the program’s role in the American manufacturing sector is likely to become even more critical.

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Posted on Jun 7, 2016

conveyor line

It’s a build-to-order manufacturing environment and that means frequent changeovers in your production line. And each time you make changes to produce a new item, you suffer significant downtime. But there may be ways to shave time off those non-productive periods. These four suggestions have proven to buy manufacturers time and keep production lines efficient:

1. Measure setup time. It should be a key metric in batch-driven processes. If you’re not establishing goals and monitoring setup time, it can get away from you.

2. Mimic NASCAR. One company occasionally stops production to hold a contest, putting together “pit crews” to see who can set up a machine the fastest. The winning team’s time becomes the new goal. Winners get bragging rights.

3. Think Japanese. Manufacturers in Japan are known for their efficiency and ability to make quick changes. One of the techniques they use is Kaizen. Assemble a team that cuts across disciplines and spend three to five days tackling a process improvement problem. For example, one company had a team reconfigure work and storage areas. It reduced setup time from 6 hours to 40 minutes.

Several factors contribute to Kaizen success:

  • Holding the event elevates the problem to priority level.
  • Include people on the team who have no production experience, along with those who do. This improves the problem-solving process.
  • Follow the Kaizen event outline.
  • Set the expectation that the team will make a major achievement in a very short time.

4. Consider another Japanese method.Japanese industrial engineer Shigeo Shingo developed the “Single Minute Exchange of Dies” process for Toyota as an essential component of just-in-time manufacturing. He maintained that most approaches to reducing setup time limit their success by focusing on improving employee skills rather than on making changes in the process that lower the skills needed. Shingo describes how to implement SMED in his book, A Revolution in Manufacturing:

  • Analyze the production system thoroughly and the role setup plays in that system.
  • Study the internal setup, or those processes that can be carried out only when the machine is idle, for example, changing dies.
  • Study external setup, or those processes that can be carried out while the machine is running, such as transporting dies or checking availability of materials.
  • Determine how internal setup can be converted to external setup, thus streamlining the entire process.

Lean Material Stocking

Instead of trying to trim retooling time, try eliminating it with a lean material stocking system.

An established principle of time management is to handle each piece of paper just once. It’s rare to achieve that efficiency, but aiming for it makes you think about unnecessary steps. Applying that principle to parts and maintenance, compare these two scenarios of the typical route from delivery to production:

Before the lean method:

  • Shipment arrives.
  • Parts are stocked until needed for production.
  • Parts are assembled into kits and sent to production.
  • The parts are ready for production when needed.

After the lean method:

  • Shipment arrives.
  • Parts are sorted and sent to carts holding bins labeled for each part number.
  • When production is ready, the cart is moved to the job.

What the lean material stock system does:

  • Eliminates the labor-intensive steps of storing, locating and retrieving materials and assembling kits.
  • Provides visual inventory control, because by looking at a bin, you can see if a part is in short supply.
  • Offers just-in-time capabilities. Almost as soon as materials are received, they are ready to be used in production.

The best changeover is no changeover. Look at ways products can be redesigned to share more of the same parts. Moreover, if you’re running small batches of similar products, you might be able to avoid changeover by taking some processes offline.

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Posted on Apr 27, 2016

Alternative Minimum Tax

Congress originally devised the alternative minimum tax (AMT) rules to ensure that high-income individuals who take advantage of multiple tax breaks will owe something to Uncle Sam each year. In recent years, however, that concept has eroded. Now, even upper-middle-income taxpayers are likely to owe the AMT. Here’s an overview of how the AMT works and possible ways to minimize it.

Don’t Overlook the AMT Credit

If you owed the AMT last year, you may have earned an AMT credit that will reduce your regular federal income tax bill in the current tax year. Many taxpayers who pay the AMT fail (or forget) to claim their rightful AMT credits the following year.

There are two reasons you earn an AMT credit for a tax year:

1. If you owed the AMT from exercising in-the-money incentive stock options, or

2. If your AMT bill was caused by claiming accelerated depreciation write-offs.

The first situation is common, especially with employees of start-ups and high-tech firms. The second typically happens only if you own an interest in a business with significant investments in depreciable assets.

Ask your tax adviser if you earned an AMT credit. But, be advised that you can claim it only if your regular federal income tax liability exceeds your AMT liability for the tax year. That’s because you’re allowed to use the credit to reduce only regular federal income taxes (not the AMT). Put another way, you can’t claim the AMT credit on your current return if you owe the AMT again this year.

So, you still must calculate your AMT liability for the current year. The difference between your AMT liability and your regular federal income tax liability is the maximum amount of AMT credit you can claim on your current-year return. In other words, you can use the AMT credit to equalize your regular federal income tax and the AMT for the current year, but that’s it. After taking this limitation into account, any leftover AMT credit is carried forward to next year.

AMT Basics

Think of the AMT as an alternate set of tax rules that are similar to the regular federal income tax system. But there are key differences. For example, under the AMT rules, certain types of income that are tax-free under the regular federal income tax system are taxable. The AMT rules also disallow certain deductions and credits that are allowed under the regular federal income tax system. And the maximum AMT rate is only 28% compared to the 39.6% maximum rate that applies under the regular federal income tax system.

In addition, taxpayers are allowed a relatively large inflation-adjusted AMT exemption, which is deducted when you calculate AMT income. Unfortunately, the exemption is phased out when your AMT income surpasses certain levels.

If your AMT liability exceeds your regular federal income tax liability for the tax year, you must pay the higher AMT amount.

Why Upper-Middle-Income Taxpayers Get Hit

After repetitive tax law changes, the AMT often doesn’t apply to the wealthiest taxpayers in the highest tax bracket. That’s because many of their tax breaks are already cut back or eliminated under the regular federal income tax rules before getting to the AMT calculation.

For instance, the passive activity loss rules greatly restrict the tax benefits that can be reaped from “shelter” investments, including rental real estate and limited partnerships. And, if your income exceeds certain levels, phaseout rules are likely to reduce or eliminate various tax breaks, such as personal and dependent exemption deductions, itemized deductions, higher-education tax credits and deductions for college loan interest.

Moreover, individuals in the 35% or 39.6% tax brackets are less likely to be hit with the AMT, which has a maximum tax rate of 28%. Finally, the AMT exemption — which is deducted when you calculate AMT income — is phased out as income goes up. This phaseout has little or no impact on individuals with the highest incomes, but it increases the likelihood that upper-middle-income taxpayers will owe the AMT.

AMT Risk Indicators

Various inter-related factors make it hard to pinpoint who will be hit by the AMT. But taxpayers are generally more at risk if they have:

    • Substantial (but not necessarily huge) salary income (more than $250,000 per year).
    • Significant long-term capital gains and/or dividends.
    • Large deductions for state and local income and property taxes.
    • A spouse and several children (e.g., at least four) who provide personal and dependent exemption deductions for regular federal income tax purposes. (These deductions are disallowed under the AMT rules.)
    • Significant miscellaneous itemized deductions, such as investment expenses, fees for tax advice and unreimbursed employee business expenses.
    • Interest from private activity bonds. This income is tax-free for regular federal income tax purposes, but it’s taxable under the AMT rules.
  • Significant depreciation write-offs for personal property assets, such as machinery, equipment, computers, furniture, and fixtures from your own business or from investments in S corporations, LLCs or partnerships. These assets must be depreciated over longer periods under the AMT rules.

Another noteworthy factor that’s likely to trigger the AMT is exercising in-the-money incentive stock options (ISOs) during the tax year. The so-called “bargain element” — the difference between the market value of the shares on the exercise date and the exercise price — doesn’t count as income under regular federal income tax rules, but it counts as income under the AMT rules.

A significant spread between a stock’s current market value and an ISO’s exercise price can result in an unexpected AMT liability. Consult your tax professional before exercising your options. Depending on current and anticipated market conditions, it may be advantageous to exercise them over several years to minimize the adverse AMT effects.

Possible Ways to Minimize the AMT

Any strategy that reduces your adjusted gross income (AGI) might help to reduce or avoid the AMT. AGI includes all taxable income items and certain non-itemized deductions, such as moving expenses and alimony paid.

By lowering AGI, you may be able to claim a higher AMT exemption. Here are some considerations that may help reduce your AGI:

    • Contribute as much as you can to your tax-favored retirement plan, such as a 401(k) plan, profit-sharing plan or SEP.
    • Contribute to your cafeteria benefit plan at work. Contributions lower your taxable salary and AGI. Most cafeteria plans include healthcare and dependent care flexible spending account arrangements.
    • Harvest losses from investments held in taxable brokerage firm accounts. Then use the capital losses to offset any capital gains. Any leftover capital losses up to $3,000 are deductible against income from salary, interest, dividends, self-employment and other sources.
    • Defer the sale of appreciated investments held in taxable brokerage firm accounts until next year. Doing so will defer the resulting taxable gains.
  • Prepay deductible business expenses near year end if you run a business as a sole proprietorship, limited liability company, partnership or S corporation. The resulting business deductions will be “passed through” to you, thereby lowering AGI. Similarly, postpone the receipt of business income until next year to reduce your AGI in the current tax year.

Important note: Lowering AGI will also slash your state and local income taxes, which are disallowed for AMT purposes and, therefore, increase your AMT exposure. Likewise, if you’re likely to be hit with the AMT, the traditional tax year-end strategy of prepaying state and local income and property taxes that are due early next year won’t help you. Those taxes aren’t deductible under the AMT rules. So prepay them in a year when you have a chance of not being in the AMT mode.

Address the AMT Head-On

Taxpayers can’t automatically assume they’re exempt from the AMT. Most individuals in the higher tax brackets probably have some risk factors. The IRS has trained auditors to find unsuspecting folks who owe the AMT. If you’re not careful, you could owe back taxes, interest and potential penalties under the AMT rules.

Consult with your tax adviser about your specific situation. Cornwell Jackson’s tax team can identify whether you’re at risk and help find ways to reduce your exposure to the AMT that also factor in current market conditions and other personal investment goals.

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Posted on Jan 22, 2016

At the end of last year, the Protecting Americans from Tax Hikes Act of 2015 was signed into law. Known as the PATH Act, it does more than just extend expired and expiring tax provisions for another year. The new law makes many temporary tax breaks permanent.

This provides some stability in planning. When it comes to certain deductions and credits, taxpayers will no longer have to wait for Congress to pass a temporary tax extenders law — often at the end of the year — in order to plan tax-saving strategies.

Here’s an overview of how individuals and businesses can benefit from the latest tax package.

Tax Breaks for Individuals

American Opportunity education credit. Eligible taxpayers can take an annual credit of up to $2,500 for various tuition and related expenses for each of the first four years of postsecondary education. The credit phases out based on modified adjusted gross income (MAGI) beginning at $80,000 for single filers and $160,000 for joint filers, indexed for inflation. The new law makes this credit permanent.

Tuition and fees deduction. The new law extends through 2016 the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction is capped at $4,000 for taxpayers whose adjusted gross income (AGI) doesn’t exceed $65,000 ($130,000 for joint filers) or, for those beyond those amounts, $2,000 for taxpayers whose AGI doesn’t exceed $80,000 ($160,000 for joint filers).

Small business stock gains exclusion. The PATH Act makes permanent the exclusion of 100% of the gain on the sale or exchange of qualified small business (QSB) stock acquired and held for more than five years. The 100% exclusion is available for QSB stock acquired after September 27, 2010.

A QSB is generally a domestic C corporation that has gross assets of no more than $50 million at any time (including when the stock is issued) and uses at least 80% of its assets in an active trade or business. The law also permanently extends the rule that eliminates QSB stock gain as a preference item for alternative minimum tax (AMT) purposes.

Charitable giving from IRAs. The PATH Act makes permanent the provision that allows taxpayers who are age 70½ or older to make direct contributions from their IRAs to qualified charitable organizations up to $100,000 per tax year. If you take advantage of this opportunity, you can’t claim a charitable or other deduction for the contributions, but the amounts aren’t considered taxable income and can be used to satisfy your required minimum distributions.

To qualify for the exclusion from income for IRA contributions for a tax year, you need to arrange a direct transfer by the IRA trustee to an eligible charity by December 31. Donor-advised funds and supporting organizations aren’t eligible recipients.

Transit benefits. Do you commute to work via a van pool or public transportation? The law makes permanent the requirement that limits on the amounts that can be excluded from an employee’s wages for income and payroll tax purposes be the same for parking benefits and van pooling / mass transit benefits.

For 2015, the monthly limit is $250. Before the PATH Act, the 2015 monthly limit was only $130 for van pooling / mass transit benefits. (The $250 limit increases to $255 for 2016.)

State and local sales tax deduction. Taxpayers can take an itemized deduction for state and local sales taxes, instead of for state and local income taxes. This tax break is now permanent. The deduction is especially valuable for individuals who live in states without income taxes and those who purchase major items, such as a car or boat.

Energy tax credit. The PATH Act extends through 2016 the credit for purchases of residential energy property. Examples include new high-efficiency heating and air conditioning systems, insulation, energy-efficient exterior windows and doors, high-efficiency water heaters and stoves that burn biomass fuel.

The provision allows a credit of 10% of expenditures for qualified energy improvements, up to a lifetime limit of $500.

Mortgage-related tax breaks. Under the new law, you can treat qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction through 2016. However, the deduction phases out for taxpayers with AGI of $100,000 to $110,000.

In addition, the PATH Act extends through 2016 the exclusion from gross income for mortgage loan forgiveness. It also modifies the exclusion to apply to mortgage forgiveness that occurs in 2017 as long as it’s granted pursuant to a written agreement entered into in 2016.

Educator expense deductions. Qualifying elementary and secondary school teachers can claim an above-the-line deduction for up to $250 per year of expenses paid or incurred for books, certain supplies, computer and other equipment, and supplementary materials used in the classroom. Under the new law, beginning in 2016, the deduction is indexed for inflation and includes professional development expenses.

Tax Breaks for Businesses

Section 179 deduction. Tax law allows businesses to elect to immediately deduct — or expense — the cost of certain tangible personal property acquired and placed in service during the tax year. The Section 179 deduction is in lieu of recovering the costs more slowly through depreciation deductions. Keep in mind the election can only offset net income — it can’t reduce it below $0 to create a net operating loss. There are also other restrictions.

The election is also subject to annual dollar limits. For 2014, businesses could expense up to $500,000 in qualified new or used assets, subject to a dollar-for-dollar phaseout once the cost of all qualifying property placed in service during the tax year exceeded $2 million. Without the PATH Act, the expensing limit and the phaseout amounts for 2015 would have sunk to $25,000 and $200,000, respectively.

The new law makes the higher limits permanent and indexes them for inflation beginning in 2016. It also makes permanent the ability to apply Sec. 179 expensing to qualified real property, reviving the 2014 limit of $250,000 on such property for 2015 but raising it to the full Sec. 179 limit beginning in 2016. Qualified real property includes qualified leasehold-improvement, restaurant and retail-improvement property.

Finally, the new law permanently includes off-the-shelf computer software on the list of qualified property. And, beginning in 2016, it adds air conditioning and heating units.

Bonus depreciation. Bonus depreciation allows businesses to recover the costs of depreciable property more quickly by claiming bonus first-year depreciation for qualified assets. It’s been extended, but only through 2019 and with declining benefits in the later years. For property placed in service during 2015, 2016 and 2017, the bonus depreciation percentage is 50%. It drops to 40% for 2018 and 30% for 2019.

The provision continues to allow businesses to claim unused AMT credits in lieu of bonus depreciation. Beginning in 2016, the amount of unused AMT credits that may be claimed increases.

Qualified assets include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software, water utility property and qualified leasehold-improvement property. Beginning in 2016, qualified improvement property doesn’t have to be leased to be eligible for bonus depreciation.

Accelerated depreciation of qualified real property. The PATH Act permanently extends the 15-year straight-line cost recovery period for qualified leasehold improvements (building alterations to suit the needs of a tenant), qualified restaurant property and qualified retail-improvement property. These expenditures are now exempt from the normal 39-year depreciation period.

This is beneficial for restaurants and retailers because they tend to remodel periodically. If eligible, they may first apply Section 179 expensing and then enjoy this accelerated depreciation on qualified expenses in excess of the applicable Section 179 limit.

Research credit. This valuable credit provides an incentive for businesses to increase their investments in research. However, the temporary nature of the credit deterred some businesses from pursuing critical innovations.

The PATH Act permanently extends the credit. Additionally, beginning in 2016, businesses with $50 million or less in gross receipts can claim the credit against AMT liability, and certain start-ups (generally, those with less than $5 million in gross receipts) that haven’t yet incurred income tax liability can use the credit against their payroll tax.

Work Opportunity tax credit. Employers that hire individuals who are members of a “target group” can claim this credit, which has been extended through 2019. The new law also expands the credit beginning in 2016 to apply to employers that hire qualified individuals who have been unemployed for 27 weeks or more.

The credit amount varies depending on:

  • The target group of the individual hired;
  • Wages paid to the employee; and
  • Hours worked by the new hire during the first year of employment.

The maximum credit that can be earned for each qualified adult employee is generally $2,400. The credit can be as high as $9,600 per qualified veteran. Employers aren’t subject to a limit on the number of eligible individuals they can hire.

You must obtain certification that an employee is a member of a target group from the appropriate State Workforce Agency before claiming the credit. The certification must be requested within 28 days after the employee begins work. For 2015, the IRS may extend the deadline as it did for 2014, when legislation reviving the credit for that year wasn’t passed until late in the year — meaning that the 28-day period had already expired for many covered employees hired in 2014.

Food inventory donations. The PATH Act makes permanent the enhanced deduction for contributions of food inventory for non-corporate business taxpayers. Under the enhanced deduction (which is already permanently available to C corporations), the lesser of basis plus one-half of the item’s appreciation or two times basis can be deducted, rather than only the lesser of basis or fair market value. Beginning in 2016, the limit on deductible contributions of inventory increases from 10% to 15% of the business’s AGI per year.

S corporation recognition period for built-in gains tax. S corporation income generally is passed through to its shareholders, who pay tax on their pro-rata shares. If a C corporation elects to become an S corporation, the newly created S corporation is taxed at the highest corporate rate (currently 35%) on all gains that were built-in at the time of the election and recognized during the “recognition period.”

Generally, this period is 10 years. But, under the new law, it’s only five years, beginning on the first day of the first tax year for which the corporation was an S corporation.

Commuting benefits. The PATH Act makes permanent the provision that established equal limits for the amounts that can be excluded from an employee’s wages for income and payroll tax purposes for parking fringe benefits and van-pooling / mass transit benefits. The limits for both types of benefits are now $250 per month for 2015. Without the parity extension, the limit for van-pooling / mass transit would be only $130.

Tax Planning with More Certainty

Many of these tax breaks may seem familiar, because they’re continuations from previous years. Under the PATH Act, there are now significant tax planning opportunities for individuals and businesses. The permanent extensions of some valuable tax breaks will make it easier for taxpayers to plan ahead. Keep in mind that this article only touches on some of the new law’s provisions. There may be extensions and enhancements that can benefit you as an individual taxpayer and your company if you’re a business owner or executive.

 

Contact your Cornwell Jackson tax advisor to determine how you can make the most of this tax relief.

 

 

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Posted on Nov 19, 2015

If you are part of the plant production management team, you are always looking for ways to increase throughput and lower maintenance down times. Of course, one of the go-to year-end capital expenditures strategies is to utilize a CAPEX budget in Q4 to purchase machines, equipment, or do a significant retrofit of existing equipment.

In addition to the return on assets analysis requested by the CEO and CFO, you also have to predict an elusive variable of “the potential tax savings implication in 2015.”

Unfortunately, answering this question has become a variable that might be best handicapped by Vegas and not by a production manager.

 

The bad news.

There is no definite bright line that will allow you to know with a high degree of certainty if the Sec. 179 dollar limit for expensing will be $25,000 or $500,000 in 2015.

There is also not a definite way to know if 50% bonus depreciation is available or unavailable by the end of the year 2015.

 

The good news and current status.

In July 2015, the Senate Finance Committee voted to extend bonus depreciation and the enhanced section 179 deduction through 2016. The full Senate has not indicated if or when it will act on this legislation and the House is not scheduled to act on extender legislation until late 2015. However, if passed this will create planning certainty for 2 years.

In addition, in September, the House Ways and Means Committee passed HR 2510, a bill by Congressman Pat Tiberi (R-Ohio) that proposes to go a step further and make 50% bonus deprecation a permanent part of the tax law and not part of a sun setting extender that has to be renewed annually.

There is considerable support for this bill from a strong ally, Representative Paul Ryan. Ryan wields considerable influence in the house as both Chairman of the House Way and Means Committee and as the newly elected Speaker of the House. Ryan has publicly supported the bonus depreciation incentive and its impact on investing in making manufacturers and businesses more productive.

As House Ways and Means Chairman Paul Ryan (R-Wis.) put it at today’s markup, “H.R. 2510 is about small-business people refurbishing their store or manufacturers buying new equipment. They aren’t earning income. They’re investing in our country. They’re investing in our children. They’re creating jobs. This is exactly what our tax code should support.”

So staying fluid and flexible is the name of the game. We are advising our clients to not rely on bonus for 2015, but we give it our personal handicap score of somewhere north of 60% chance of passage over the next 30-40 days before Congress adjourns for the holidays.

 

Maximizing deductions for a year-end acquisition.

(This is an example from the Congressional Research Center using 2014 tax rules and regulations since we do not yet have the new regulations for 2015.)

In the case of assets that were eligible for both bonus and section 179 expensing allowances, a taxpayer may recover their cost in the following order. The Section 179 expensing allowance would be taken first, lowering the taxpayer’s basis in the asset by that amount. The taxpayer then could apply the bonus depreciation allowance to the remaining basis amount, further reducing their basis in the property. Finally, the taxpayer was allowed to claim a depreciation allowance under the MACRS for any remaining basis, using the double-declining balance method.

A simple example from a 2014 acquisition illustrates how this procedure might work. Assume that a company made an acquisition of a new CNC laser cutter system at a total cost of $700,000. Such a purchase qualified for both the Section 179 expensing and bonus depreciation allowances for that year. Therefore, it was permitted to recover that cost for federal tax purposes as follows:

  • First, the company could take a Section 179 expensing allowance of $500,000 on its federal tax return for that year, lowering its basis in the property to $200,000 ($700,000 -$500,000).
  • Then it could claim a bonus depreciation allowance of $100,000 ($200,000 x 0.5), further lowering its basis to $100,000 ($200,000 -$100,000).
  • Next, the company was allowed a deduction for depreciation under the MACRS on the remaining $100,000. Given that the MACRS recovery period for laser cutters is five years and five-year property is depreciated using the double-declining-balance method, the company could claim an additional depreciation allowance equal to 20% of $100,000, or $20,000, using the half-year convention. ( this presumes no mid-quarter convention issues)
  • The company could recover the remaining basis of $80,000 ($100,000 -$20,000) by taking MACRS depreciation deductions over each of the next five years at rates of 32%, 19.2%, 11.52%, 11.52%, and 5.76%, respectively. ( this presumes no mid-quarter convention issues)
  • Thus, the company was able to write off nearly 89% of the cost of the CNC laser cutter in the same year it was purchased and placed in service.

 

Key Points to Remember for Year-end Planning

This is not an all-inclusive list – instead key points to remember before pulling the trigger on any capital expenditure before year-end.

  • Only 50% of cost is eligible for bonus depreciation
  • Bonus is not available for USED equipment
  • Not all states acknowledge or utilize bonus depreciation or Sec. 179
  • Newly constructed or original use property with a recovery period of 20 years or less (real or personal), qualified leasehold improvements, certain computer software, and water utility property is eligible for bonus depreciation. The only new property is eligible for bonus depreciation; used property is not eligible.
  • Qualified leasehold improvements are generally bonus eligible if made under a lease to the interior portion of a building occupied by a tenant and placed in service more than three years after the building was first placed in service.

We generally advise our manufacturing clients during year-end tax planning to avoid making long-term decisions based on tax allowances, but it can be a strong incentive due to the significant cash flow savings in March when the final year-end tax bill is tabulated.

If your current tax advisor hasn’t talked to you this year about bonus deprecation, LIFO, cost segregation or R&D credits and how they could impact your business in 2015 and 2016, then let us help. We’re tax experts.

 

Blog post written by: Gary Jackson, CPA, Tax and Consulting Partner

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