Last Minute Tax Planning for 2017

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Year-end tax planning is going to be more difficult this year, in view of the uncertainty surrounding the tax reform currently proposed in the House and the Senate. Nevertheless, there are still a number of things you can do to reduce your tax bill for 2017.

There are major changes in the proposed tax legislation for 2018, so we need to think about both 2017 and 2018.

Itemized Deductions vs Standard Deduction

Most taxpayers are entitled to the Standard Deduction, so unless your deductible items add up to more than the Standard Deduction there is no need to keep track of them. A single person, for example, gets an automatic deduction of $6,350, and a married couple filing jointly gets $12,700. Under the proposed tax legislation, these amounts will be increased to $12,200 and $24,400 respectively. That’s the good news. The bad news is that expenses that were previously deductible may not do you any good if they fall below the new levels. The other bad news is that even if your itemized expenses are greater than these new amounts, many of the expenses that are currently deductible may either be eliminated or severely limited in the future. These include:

Medical expenses – You can currently deduct medical expenses that exceed 10% of your income (7.5% if you are 65 or older). This deduction is scheduled to be eliminated, so it would be wise to take care of any medical issues before the end of the year, and be sure to pay for them before December 31.

State and local income taxes – Your state tax is currently deductible, but the deduction will be eliminated under the current plans. If it looks as if you will owe state tax for 2017, it would be wise to make an estimated payment before December 31.

Property taxes – This deduction would be limited to $10,000 in 2018. Property taxes are typically paid in two installments – in Los Angeles, they are due on November 1 and February 1 – so why not pay both installments before year-end.

Mortgage interest – Deductibility of new mortgages will be limited, but existing loans will be unchanged. If you make your January payment in December, you could get a deduction this year that may not help you if you wait until next year.

Charitable donations – If you can deduct itemized expenses in 2017, but not in 2018, it would be advisable to make next year’s donations in 2017.

Unreimbursed employment expenses – Business expenses for employees (NOT self-employed or 1099 workers) will not be allowed under the proposed rules. These include union and professional dues, education expenses, home office expense, mileage, travel and meals, and other usual and necessary expenses incurred for the convenience of your employer, but which the employer will not reimburse.
You may find it appropriate to change your status from employee to independent contractor, if you meet the criteria, as many of these expenses will still be deductible from self-employment income. This can be a complex decision, so consult a tax specialist before making the change.

Be sure to pay for any such expenses before December 31, while they are still deductible. You could also purchase required equipment and supplies that you expect to need next year.

Defer Income / Accelerate Deductions

There are opportunities to defer income items that would be taxable this year, and move them into next year. You may also be able to pay certain deductible expenses this year that you might have waited to pay next year. This strategy only makes sense, of course, if you are not expecting to be in a higher tax bracket next year.

If you have business income – self-employed, partnership, etc. – you can delay billing your customers or clients, so you don’t receive payment until after December 31. Similarly, you can speed up payment of some of your expenses to get a deduction this year. Pass through income, such as partnership and S Corp income, may be taxed at lower rates under the new legislation, depending on your situation. If this is the case, then it would be wise to defer as much income as possible to next year. Speak with a tax specialist about this.

If you have a rental property, and your income is under $100,000, you may be eligible to deduct up to $25,000 of rental losses against your regular income. The deduction phases out completely when your income goes over $150,000. It is a good incentive to defer income or accelerate expenses if you are in this range.

Talk to your employer about receiving any year-end bonus after December 31, so you don’t pay tax on it until next year.

Alimony under current divorce agreements may continue to be deductible, but will be eliminated for future separation agreements. It may be wise to finalize your agreements before the end of the year.

Alternative Minimum Tax (AMT)

For many taxpayers, particularly those with higher incomes, there is currently a limit to the benefit you can get from certain deductible expenses. There are phase-outs as your income rises, but another very important consideration is the Alternative Minimum Tax (AMT). The expenses most likely to be affected are state and local income taxes (especially in California, New York and other high-tax states) and office and employment expenses. If you are subject to the AMT, accelerating payment of these expenses will not do you any good. You should speak with your tax advisor about other possible strategies for 2017.

The AMT will be eliminated under both the House and Senate proposals. This will reduce the complexity of your return, and very possibly result in a lower tax bill. Important – if you plan to exercise Incentive Stock Options (ISOs) and you do not plan to sell them immediately, you may be wise to wait until next year, when they will not result in an AMT expense.

Take Losses Before Year-End

If you have losses on taxable investments, think about selling them this year. They will offset any capital gains you may have, but even if your losses are more than your gains, you can use up to $3,000 to reduce other income, and you can carry any excess losses forward to future years.

Retirement Plans

Make the maximum contributions to your retirement plans.
You can deduct contributions of $18,000 (more if you’re over 50) to your 401(k) plan – but at least make sure you contribute enough to get the full amount of your employer’s matching program.

You may be able to deduct up to $5,500 (more if you’re over 50) to a traditional IRA. If you don’t make a contribution before the end of the year, you have until April 15th. Contributions to a ROTH IRA are not deductible, but penalties are much less severe if you have to withdraw funds early.
If you’re self-employed or have an S Corporation, you can contribute to a SEP IRA or a similar plan. You can deduct approximately 20% of your self-employment income, up to $54,000. The good news is that you can make your contribution all the way up to the filing deadline, including extensions, which gives you plenty of time to calculate your income. If you have an S Corp, you can also take advantage of a SEP IRA.

Don’t take money out of your traditional IRA or 401(k) plan if you are under 59 ½ years old. There is a 10% penalty on top of the regular tax, and some states have an additional penalty. Before you take an early withdrawal, though, remember that you may be able to borrow from your 401(k). There are also penalties for early withdrawal from a ROTH, but your original contributions are not taxed a second time.

You can take a distribution from your IRA without a penalty if you are a first-time home buyer, if you make qualified tuition payments, and several other special situations. Remember that if you have a 401(k), and plan to make tuition payments, roll the 401(k) over into a traditional IRA first.

Consider rolling over your traditional IRA into a ROTH IRA. You will pay tax on the full amount when you roll it over, but if you expect to be in a low tax bracket this year, for any reason, this might be a good time to do it. Also, there is no required minimum distribution from a ROTH IRA after age 70 ½.
Start taking minimum required distributions from your traditional IRA if you turn 70 ½. There is a 50% tax if you don’t.

Charitable Donations

Charitable donations are a nice deduction, assuming your total deductions exceed the Standard Deduction. As suggested above, the standard deduction will probably increase next year, so it may be wise to make your 2018 donations this year to get a larger benefit from the deduction.

If you have shares of stock that have appreciated in value, consider donating the stock to charity. If you have owned the stock for more than one year, you can deduct the entire appreciated value of the stock, and avoid capital gains tax or Net Investment Income Tax (NIIT).

Gifts

You can make tax-free gifts of up to $14,000 ($28,000 for a married couple) per recipient. (Remember that gifts are not taxed to the recipient, but to the giver). Gifts in excess of this amount require filing a gift tax return, but you won’t actually pay tax until you go over your lifetime limit of $5,490,000.
Qualified payments for tuition or medical expenses are not considered a gift, as long as they are paid directly to the educational institution or the medical provider.

Avoid the “Kiddie Tax”

If your dependent children (under 19, or under 24 if they are full time students) have investment income over $2,100, it will be included in your income, and taxed at your full rate, including NIIT. So think carefully before you give them stocks to sell to pay for college.

Depreciation Opportunities

You can deduct 100% of qualifying asset purchases up to $500,000 (with phase-outs if your total purchases exceed $2 million) under Section 179. This is a tremendous incentive to buy capital assets which you would otherwise have to expense over several years. There are exclusions, but many of the excluded items are eligible for a 50% special depreciation allowance in the year of purchase.
These are terrific deductions. If you are planning to buy assets, buy them before year-end, and reduce your taxes for 2017.

Filing Deadlines

Individual tax returns for 2017 are due on April 17, 2018, or may be extended to October 15. Remember that it is an extension to file only, but taxes are still due on April 17. Form 1065 Partnership (including LLC) Returns are due on March 15, as are Form 1120S subchapter S corporation returns. Single member LLCs do not file Form 1065, so they are due with individual returns on April 17.

Form 1099-Misc and Form W-2 must be issued to employees and contractors, as well as to the IRS or Social Security Administration, by January 31. It’s a good idea to confirm all employee information and W-9 information before the end of the year. Remember that Form 1099-MISC must be issued to all individuals and partnerships to whom you paid over $600 during the year. There are penalties for not filing these forms.

Corporations and Partnerships

The proposed tax changes include a significant reduction in tax rates on business income. This includes income from C Corporations as well as S Corporations and partnerships. As the rules become clear, there will be a need to map out strategies to get the best benefit from the changes.
There are very specific rules related to S Corps and Partnerships, and now is a perfect time to be sure you in compliance before year-end. It would be a shame to lose out on the tax benefits of these business entities.

S Corp Salary – If you have a Subchapter S Corporation, don’t forget that you are required to pay yourself a reasonable salary. A major benefit of having an S Corp is that not all of your profits need to be subject to employment taxes, but you do need to pay yourself a salary, and issue yourself a W-2 as an employee. Issuing yourself a 1099 is not a substitute. Setting up W-2 payments after year-end is annoying, and there are stiff penalties for late payment of employment taxes, so take care of it before the end of the year.

Retirement plans – As discussed above, there are opportunities for S Corp shareholders and partners in partnerships and LLCs to make very substantial tax-deferred contributions to SEP and other retirement plans. The contributions are a percentage of your partnership income or your S Corp salary. It is important to remember that the retirement plans MUST be in the name of the S Corp or the partnership. Individual shareholders and partners cannot have their own SEP plans.

Health Insurance – Your health insurance payments may be deductible on your personal return if you are a shareholder in an S Corp or a partner in a partnership or LLC, and you meet certain requirements. Remember, though, that the payments must be made by the corporation or LLC – or reimbursed if you make the payments yourself.

Payments made by your S Corp must be included as compensation on your W-2, but are not subject to payroll taxes. Make this clear to your payroll processing company.

Payments by your partnership or LLC are treated as distributions.

If you have a single member LLC, you can make payments from your business or personal account.

Do you need your LLC or S Corp? – Are you getting any real benefit from it? If you are in a state that has a minimum LLC or S Corp tax, you may be paying for something you don’t really need. California’s minimum tax is $800, and you’re also paying for a relatively expensive tax return. If limited liability is a big concern, consider buying insurance that offers appropriate protection. Closing the LLC or S Corp before year-end won’t reduce your 2017 tax bill, but it will cut future costs… See the article I wrote earlier on this website.

Corporation and pass-through tax rates will be much lower under the proposed tax legislation, so it may be wise to revisit the decision to operate as an S Corp or a C Corp.

I would be pleased to discuss your tax planning issues.

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YOUR S CORPORATION – A CHECK-UP

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In my experience, a lot of people don’t pay enough attention to their Subchapter S Corporations until tax time, when it’s sometimes too late to correct errors or oversights.

You formed the S Corp because of the benefits you would get from it, so it would be a shame to operate it in such a sloppy way that you could miss out on some of those benefits. Please take a moment to be sure you are following these guidelines, and make any necessary changes before the end of the year.

Reasons for forming an S Corp generally include:

  • Reducing payroll taxes on a portion of your income
  • Retirement contributions in excess of the limits on IRAs and 401(k) plans
  • Deduction of health insurance costs
  • Limited liability

I will discuss these items briefly below, then move on to some other relevant thoughts.

W-2s and Payroll Taxes

Generally speaking, your S Corp does not pay tax, but rather the income “passes through” to your personal tax return. This pass-through income is taxed at your regular rates, but it is not subject to the federal and state payroll taxes you would pay if you were an employee.

It is important to note that a shareholder of an S Corp is not self-employed, but is actually an employee of the company. As such, you are required to pay yourself a reasonable salary, a term that is not clearly defined, but is intended to prevent shareholders from entirely avoiding Social Security, Medicare and other payroll taxes. One way to look at it is that you should pay yourself what it would cost to hire someone to do your job.

Your salary is treated as a deduction by the company, so you aren’t taxed twice. You pay payroll taxes on your salary, but you don’t pay payroll taxes on the remainder of the S Corp’s income after deducting your salary. That’s one of the benefits of an S Corp.

Action required:  Pay yourself a salary, and issue a W-2 at the end of the year. I suggest you use a payroll service to be sure you are in full compliance with the complex rules and regulations surrounding payroll. Do this before the end of the year.

Retirement Contributions

As an S Corp owner, you have a choice of retirement plans that you can establish. One of the most popular plans is a Simplified Employee Pension, or SEP. An advantage of a SEP plan is that the company can contribute a percentage of your salary, up to a maximum contribution of $54,000. This is substantially higher than the limits for IRAs and 401(k) plans. Do be aware, though, that you also have to offer the plan to your other eligible employees, and contribute the same percentage on their behalf. This is a specialized and complex area, so you should speak with a knowledgeable professional on the subject.

It is important to note again that as an S Corp shareholder, you are not self-employed, but rather an employee of the company. The retirement plan must be created in the name of the company, not yourself, and the contributions are made by the company. Contributions are deductible from the company’s income of course.

Action required: You can establish a SEP retirement plan any time during the year, or up to the date when the company’s tax return is due (even if you file for an extension). Other types of retirement plans may have different rules, so be sure to investigate before the end of the year.

Health Insurance

As an S Corp shareholder, you can deduct health insurance costs for yourself and your family directly on your tax return. But there is a special process for doing so, and it is important that you follow it. The company must pay for your health insurance. It is acceptable to have the insurance in your own name and make the payments yourself, but you need to have the company reimburse you, and deduct the expense.

Health insurance paid by the company is considered compensation to you, and must be added to your salary on your W-2 at the end of the year. You will not pay payroll tax on this amount, but it must be included in gross earnings. You then deduct the amount directly on your personal tax return.

It seems a bit convoluted, but those are the rules.

Action required:  Be sure to have the company reimburse you for medical insurance payments before the end of the year, and be sure to instruct your payroll service to include it on your W-2. If the payroll service gives you trouble, ask to speak to a supervisor… they do this for thousands of people every year.

Limited Liability

To ensure that your S Corp offers limited liability you need to be disciplined in the way you operate it. Without going into depth, you need to establish that it is a separate entity, and not just an extension of your own personal finances. That includes keeping a separate bank account and credit cards, maintaining careful accounting records and keeping up to date with your state’s filing requirements.

Action required: Check that you are following the appropriate discipline to ensure your company is a separate entity.

Estimated Tax Payments

We are required to make payments during the year of the amount of tax we estimate owing for the whole year. This is easy for the salary you pay yourself, because you are expected to withhold and pay federal and state tax from each paycheck.

The issue here is the tax you expect to pay on the company’s earnings that pass through to your personal return. Depending on your situation, these amounts can be substantial, and to add insult to injury, there are penalties for underpayment of estimated tax.

Action required:  Speak with your tax professional at least once during the year, to be sure you are making appropriate estimated tax payments.

State and Local Tax Registration

Many cities have tax filing requirements, and it can be annoying and expensive if you haven’t met their requirements. Los Angeles, for example, assesses tax on income above a specified level, but also has a requirement to register for a business license and renew it every year.

If you are operating outside the state in which you registered the company, you need to check on filing requirements. California, for example, is very aggressive about finding and taxing out-of-state businesses that do business there.

Action required: Learn the filing requirements, and follow them. They will find you if you don’t.

Auto Expense and Home Office

The S Corp can own a car, and deduct any allowable business expenses, but you may find it easier to keep the car in your own name, and submit for reimbursement any business mileage, documenting the locations, distances and business purpose of each trip. You would complete form 2106 on your personal return, and deduct the reimbursement. I often find it convenient and preferable to use the IRS standard mileage rate where eligible – it’s 53.5 cents per mile in 2017.

Similarly, assuming you meet the rigorous and very specific requirements, you can deduct an expense for the business use of your home office. Again, submit expense reports for reimbursement, detailing the square footage of your office space and the total size of your home, in addition to specific allocated costs such as rent, mortgage, utilities, etc.

Action required: Submit detailed expense reports, and have the company reimburse you. Do this before the end of the year.

An S Corporation can be a very useful business format, but there are rules that need to be followed to ensure you get all the appropriate benefits. And remember that an S Corp is not necessarily the best entity for you, depending on your situation and your objectives.

As always, speak to a tax professional before acting… and after!

Thinking About Year-End? … You Should Be

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Year-end is almost upon us again. Now is the time to get your house in order – it will take a huge amount of stress off the closing process a couple of months from now.

Being truly ready for the auditors can save audit time and fees, reduce stress on your staff during the audit, and maybe make your financials available for lenders and investors a little earlier. Equally importantly, audit-readiness is a good indication that your accounting department is organized and up to date. How many other ways do you really have to determine that? Here are a few things you should consider:

Preparation of Financial Statements

Do the auditors historically require that you make embarrassing changes to the financials? What has been done to avoid that this year?

–          Does your accounting department prepare the financials, including notes?

–          Have you questioned any balances or accounts that seem surprising or unusual?

–          Did you do anything different this year? Are you sure it is accounted for correctly? Now is the time to sort that out, not during the audit.

–          Have any changes in accounting rules affected your business? Are there any changes not yet required that you could implement early?

Reconciliations

Reconciliations provide explanations for changes in Balance Sheet and P&L accounts, and your accounting department should be able to show them to you every month.

–          Do you know exactly what is in every balance sheet account?

–          Can you explain every change in the balance sheet?

–          Have expenses been calculated consistently every month?

–          Can you show how cost of goods sold affected inventory every month?

If you can say yes to all of these items, updating to year-end should be a piece of cake.

Updated Estimates

Where your monthly accruals and amortization calculations are based on volume or other estimates, have they been updated to be sure the year-end balances are correct? Again, a 2 month update at the end of the year is a lot easier than doing it for the entire year.

Variance Analysis

Has there been a thorough analysis documenting all significant P&L and Balance Sheet variances from last year? Are the explanations reasonable, and the underlying facts correct?

Documentation of Procedures

–          Are the fundamental internal control procedures properly documented?

–          The auditors typically make recommendations for improvements in procedures and controls if they find any deficiencies. Were last year’s recommendations fully implemented?

–          Have changes in staffing or procedures resulted in changes to the control environment? Now is the time to correct them.

Not sure if you’re going to be ready for year-end? Do you know who to call?