The following are links to our blog articles on the new 20% Qualified Business Income Deduction (QBID):
The Tax Cuts and Jobs Act (TCJA) didn’t change the federal tax credit for “increasing research activities,” but several TCJA provisions have an indirect impact on the credit. As a result, the research credit may be available to some businesses for the first time.
What types of expenses qualify for the Research Credit?
Qualified research expenses (QREs) eligible for the research expense credit are amounts the taxpayer, or a startup company, pays or incurs during the tax year for in-house and contract research expenses while carrying on a trade or business. QREs have to be eligible for treatment as research and experimental expenses, undertaken to discover information that is technological in nature, intended to develop a new or improved business component, and elements in a process of experimentation. Expenses do not qualify as QREs if they are for research conducted outside the U.S.; research in the social sciences, arts, or humanities; and research to the extent funded by any grant, contract, or otherwise by another person.
Previously, corporations subject to alternative minimum tax (AMT) couldn’t offset the research credit against their AMT liability, which erased the benefits of the credit (although they could carry unused research credits forward for up to 20 years and use them in non-AMT years). By eliminating corporate AMT for tax years beginning after 2017, the TCJA removed this obstacle.
Now that the corporate AMT is gone, unused research credits from prior tax years can be offset against a corporation’s regular tax liability and may even generate a refund (subject to certain restrictions). Therefore, it is a good idea for corporations to review their research activities in recent years and amend prior returns if necessary to ensure the corporation claims all the research credits that they are entitled to.
The TCJA didn’t eliminate individual AMT, but it did increase individuals’ exemption amounts and exemption phaseout thresholds. As a result, fewer owners of sole proprietorships and pass-through businesses are subject to AMT, allowing more of them to reap the benefits of the research credit as well.
More to consider
By reducing corporate and individual tax rates, the TCJA will also increase research credits for many businesses. Why? Because a portion of the tax code that prevents double tax benefits requires businesses to reduce their deductible research expenses by the amount of the credit.
To avoid this result (which increases taxable income), businesses can elect to eliminate the double benefit by reducing the credit by an amount calculated at the highest corporate rate. The highest corporate rate has been reduced from 35% to 21% with the TCJA, so with this election, a higher percentage of the research credit remains.
Keep in mind that the TCJA didn’t affect certain research credit benefits for smaller businesses. Pass-through businesses can still claim research credits against AMT if their average gross receipts are $50 million or less. Qualifying start-ups without taxable income can also still claim research credits against a maximum of $250,000 in payroll taxes.
Do your research
If your company engages in qualified research activities, now is a good time to revisit the credit to be sure you’re taking full advantage of its benefits.
The Tax Cuts and Jobs Act (TCJA) introduces two elections: one to defer gain from the sale of property that is reinvested in a Qualified Opportunity (QO) Fund and another to permanently exclude gain from the sale or exchange of the investment in the QO Fund. These elections can provide substantial tax benefits for taxpayers who can satisfy the detailed and quite complex set of rules. We go over some of these rules here, however, if you decide this is something you might want to pursue further, be sure to reach out to us for more information and to make certain the proper planning is in place to take full advantage of the tax savings.
This is an entirely new set of rules included in TCJA, but the rules sound somewhat similar to rules of a Like Kind Exchange. One difference in this new section of the law is that gain deferrals are not limited to gains on real estate. Instead, gains from the sale of any property can be deferred if reinvested properly under the new law. This could bring some major tax savings and may be something that you want to consider, especially if you are expecting a large capital gain and you wish to invest that gain in one of the Qualified Opportunity Zones.
Designation of a QO Zone. Under the TCJA, a state's chief executive officer (generally, a governor or the mayor of the District of Columbia) can designate certain census tracts that are low-income communities as Qualified Opportunity Zones (QO Zones). The designations are already in place (deadline was June 21, 2018) and will remain in effect for ten calendar years. A complete listing of all certified and designated QO Zones can be found here:
QO Funds. A QO Fund is an investment vehicle organized as a corporation or a partnership for the purpose of investing in a QO Zone. The QO Fund can't invest in another QO Fund and has to hold at least 90% of its assets in QO Zone property (i.e., any QO Zone stock, any QO Zone partnership interest, and any QO Zone business property). A QO Zone property has to meet many requirements, including that substantially all of the entity's business property must be used in a QO Zone. A penalty can apply to the QO Fund if it fails to meet the 90% requirement.
To become a Qualified Opportunity Fund, an eligible corporation or partnership self certifies. To self certify, a corporation or partnership completes a form and attaches that form to its federal income tax return. The return with the attached form must be filed timely, taking extensions into account.
Temporary gain deferral election. A taxpayer can elect to defer the gain from a sale or exchange of property with an unrelated person if the taxpayer invests the gain in a QO Fund within the 180-day period beginning on the date of the sale or exchange.
By making the election and investing within the time period, the taxpayer defers the gain until the earlier of December 31, 2026 or the date on which the investment is sold or exchanged. If the QO Fund investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain at the time the investment is sold. If the investment is held for more than 7 years, the 10% becomes 15%.
For example, T sells property and realizes a gain of $1 million on December 1, 2021. On December 31, 2021, T invests all of the $1 million gain in a QO Fund. T makes the temporary deferral election and therefore does not include the $1 million of realized gain in his gross income for the 2021 tax year. If T still holds the QO Fund investment at December 31, 2026, T will recognize the deferred gain on his 2026 tax return, but T will exclude 10% of the gain entirely as T would have held the investment for 5 years.
If T had invested all of the $1 million gain in a QO Fund on January 31, 2022, T would still make a temporary deferral election and exclude the $1 million of realized gain in his gross income for the 2021 tax year. However, if T still held the QO Fund investment at December 31, 2026, T would be required to recognize the entire deferred gain on his 2026 tax return.
Permanent gain exclusion election. If the investor holds the investment in the QO Fund for at least ten years, the investor is eligible for an increase in basis of the QO Fund investment equal to its fair market value on the date that the QO Fund investment is sold or exchanged. As explained above, taxpayers who make the temporary deferral election have to recognize any deferred gain on December 31, 2026 (unless a sale or exchange causes the period to end before December 31, 2026). Because the end of the deferral period on December 31, 2026 will occur before any taxpayer will be able to hold the investment for ten years, the permanent exclusion election will not protect a taxpayer from recognizing at least some of the deferred gain. Thus, if a taxpayer holds the investment for ten years, the permanent exclusion election presumably will only exclude gain in excess of the deferred gain (that would already have been recognized).
As you can see, if you are looking to invest in one of the Qualified Opportunity Zones, you could defer the recognition of gain and potentially save a lot of tax in the process, but only if you do it the right way. Let us know if you might be interested in this opportunity, so we can help you succeed.
Tax Act Tuesday: How did the Tax Cuts and Jobs Act (TCJA) impact depreciation of automobiles used in a business?
When it comes to an automobile used in your business, special limitations apply which may result in it taking longer for you to depreciate a car than it would other business property. If you are using the actual expense method in calculating the depreciation allowance, an automobile is treated as an asset with a 5-year recovery period. Under the regular depreciation tables, the cost of an automobile is actually depreciated over a 6-year span according to the following percentages: Year 1 - 20%, Year 2 - 32%, Year 3 - 19.2%, Years 4 and 5 - 11.52%, and Year 6 - 5.76%. Six years are involved because depreciation is deemed to start in the middle of Year 1 and end in the middle of Year 6. (These percentages are not available for cars used 50% or less for business purposes. For those, straight-line depreciation is required.)
However, under additional limitations applicable to cars, you are limited to specified depreciation ceilings, under “luxury automobile” rules. These ceilings operate to extend depreciation beyond the sixth year for cars costing more than what the total depreciation allowance would be over the six years. You cannot avoid these limitations via an election to “expense” the car (a Section 179 election). With these limitations applying, it may take longer than the regular six years to depreciate the entire cost of the car, if it is not disposed of sooner.
Prior to the Tax Cuts and Jobs Act, the annual depreciation limit amounts for a passenger automobile were:
The Tax Cuts and Jobs Act increased the base limitation amounts for depreciation allowed on passenger automobiles and also changed how the index for inflation adjustments will be handled for future years. For passenger automobiles placed in service during 2018, the annual depreciation limits will be:
What about Bonus Depreciation?
While the election to expense under Section 179 does not impact the limitations above, the same is not true of bonus depreciation. The TCJA modified Code Section 168(k) to extend the additional (bonus) first-year depreciation deduction for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2027.
Under the TCJA, a 100% bonus first-year deduction of the adjusted basis is generally allowed for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023 (for certain property with longer production periods, the end date is increased by one year). Used passenger automobiles will be eligible for bonus depreciation under the expanded bonus rules, and thus eligible for the increase as well. In later years, the first-year bonus depreciation deduction phases down, as follows:
In the case of a passenger automobile, for qualified property acquired and placed in service after September 27, 2017, the first-year depreciation allowed under Code Section 280F is increased by $8,000. The depreciation limits for passenger automobiles acquired by the taxpayer after September 27, 2017, and placed in service by the taxpayer during calendar year 2018, for which the Code Section 168(k) bonus first year depreciation deduction applies, are:
SUVs and Other Large Vehicles
Because of the restrictions for cars, you may be better off tax-wise (if not gasoline mileage-wise) if you buy a sport utility vehicle (SUV) instead of a car. That's because the regular annual depreciation and expensing caps for passenger automobiles don't apply to trucks or vans (and that includes SUVs) that are rated at more than 6,000 pounds gross (loaded) vehicle weight. You may also be eligible to elect to expense (see above) up to $25,000 of the cost of the SUV and then depreciate the remainder of the cost. These tax benefits are subject to adjustment for non-business use (and the more-than-50% business use rule discussed below). Even better, if you haven’t elected out of bonus depreciation on 5 year property, you may be able to expense the entire cost of the vehicle in the first year.
One of the provisions of the Tax Cuts & Jobs Act (TCJA) that made an impact very soon after the bill was passed is the reduction in individual income tax rates. On January 11, 2018, the IRS released new federal income tax withholding tables for 2018. These new withholding tables resulted in less federal withholding and larger paychecks for most Americans. You can read more about that here.
However, the new withholding tables are based on the old Form W-4, which gives details about the number of exemptions an employee claims. Personal exemptions were eliminated as a deduction by the TCJA beginning in 2018, so the new withholding levels might not produce an accurate estimate of the federal tax an employee will owe for the year. This could be especially true for taxpayers who have not reviewed their new withholding or done a tax projection for the year to determine how all of the new TCJA provisions will impact them.
A recent report by the Government Accountability Office (GAO) estimates that 1 in 5 taxpayers will under-withhold federal income taxes throughout 2018 as a result of the new withholding tables. The large change in withholding for 2018 could cause some taxpayers to have a lower refund than they are used to or even owe tax and underpayment penalties when filing their tax returns in 2019. Additionally, the IRS has recently warned taxpayers to check their withholdings using the IRS online calculator to make sure they have enough withheld to avoid penalties and a balance due at the end of the year.
If your federal withholding was reduced during 2018 as a result of the federal withholding table changes, we recommend reviewing a tax projection or using the IRS online calculator before the end of the year to ensure that you have withheld enough during 2018 to cover your tax liability. If you have under-withheld, reviewing this information before the end of the year is a great idea while there is still time to withhold more to make up for a short fall.
Tax Act Tuesday blog posts for September focused on changes to the Alternative Minimum Tax (AMT), the home office deduction for employees, and IRS clarifications about the new 20% Qualified Business Income Deduction regarding specified service businesses and how to calculate the deduction if you own multiple businesses. Links to all of our September articles follow:
Every business with more than one owner needs a buy-sell agreement to handle both expected and unexpected ownership changes. When creating or updating yours, be sure you’re prepared for the valuation issues that will come into play.
Issues, what issues?
Emotions tend to run high when owners face a “triggering event” that activates the buy-sell. Such events include the death of an owner, the divorce of married owners or an owner dispute.
The departing owner (or his or her estate) suddenly is in the position of a seller who wants to maximize buyout proceeds. The buyer’s role is played by either the other owners or the business itself — and it’s in the buyer’s financial interest to pay as little as possible. A comprehensive buy-sell agreement takes away the guesswork and helps ensure that all parties are treated equitably.
Some owners decide to have the business valued annually to minimize surprises when a buyout occurs. This is often preferable to using a static valuation formula in the buy-sell agreement, because the value of the interest is likely to change as the business grows and market conditions evolve.
What are our protocols?
At minimum, the buy-sell agreement needs to prescribe various valuation protocols to follow when the agreement is triggered, including:
Are we ready?
Business owners tend to put planning issues on the back burner — especially when they’re young and healthy and owner relations are strong. But the more details that you put in place today, including a well-crafted buy-sell agreement with the right valuation components, the easier it will be to resolve buyout issues when they arise. Our firm would be happy to help.
To maintain their lifestyles in retirement, many top execs would like to set aside more dollars annually than is allowed under a qualified plan, such as a 401(k). One way an employer can help them do so is by setting up a nonqualified deferred compensation (NQDC) plan.
NQDC plans are contracts that defer a certain amount of compensation to a future point in time, such as retirement. They don’t have to comply with the nondiscrimination rules or contribution limits that apply to qualified plans.
Because the promised compensation hasn’t been transferred to your executives, it’s not yet counted as earned income — and therefore it isn’t currently taxed. This reduces current taxes and allows the compensation to grow tax-deferred.
There’s a catch
Although NQDC plans aren’t subject to many of the qualified plan requirements, they are subject to Internal Revenue Code Sections 409A and 451 — which don’t apply to qualified plans.
Sec. 451 sets the parameters for income taxation of NQDC, and Sec. 409A imposes strict requirements on the timing and form of NQDC payments and of any subsequent change in their timing or form.
3 points to remember
Here are three specific compliance points to keep in mind:
An effective way
Penalties for noncompliance with NQDC plan rules are harsh for the recipient. They may include taxation of any vested benefits at the time of the deferral plus a 20% excise tax and a “bump-up” in the tax underpayment interest rate.
When the rules are followed, however, these plans allow executives to amass greater savings for later in life, while their employers continue to benefit from their leadership skills. Our firm can provide more information and help you design and implement the right NQDC plan.
Financial statements help investors and lenders monitor a company’s performance. However, financial statements may not provide a full picture of financial health. What’s undisclosed could be just as significant as the disclosures. Here’s how a CPA can help stakeholders identify unrecorded items either through external auditing procedures or by conducting agreed upon procedures (AUPs) that target specific accounts.
Start with assets
Revealing undisclosed liabilities and risks begins with assets. For each asset, it’s important to evaluate what could cause the account to diminish. For example, accounts receivable may include bad debts, or inventory may include damaged goods. In addition, some fixed assets may be broken or in desperate need of repairs and maintenance. These items may signal financial distress and affect financial ratios just as much as unreported liabilities do.
Some of these problems may be uncovered by touring the company’s facilities or reviewing asset schedules for slow-moving items. Benchmarking can also help. For example, if receivables are growing much faster than sales, it could be a sign of aging, uncollectible accounts.
Next, external accountants can assess liabilities to determine whether the amount reported for each item seems accurate and complete. For example, a company may forget to accrue liabilities for salary or vacation time.
Alternatively, management might underreport payables by holding checks for weeks (or months) to make the company appear healthier than it really is. This ploy preserves the checking account while giving the impression that supplier invoices are being paid. It also mismatches revenues and expenses, understates liabilities and artificially enhances profits. Delayed payments can hurt the company’s reputation and cause suppliers to restrict their credit terms.
Identify unrecorded items
Finally, CPAs can investigate what isn’t showing on the balance sheet. Examples include warranties, pending lawsuits, IRS investigations and an underfunded pension. Such risks appear on the balance sheet only when they’re “reasonably estimable” and “more than likely” to be incurred.
These are subjective standards. In-house accounting personnel may claim that liabilities are too unpredictable or remote to warrant disclosure. Footnotes, when available, may shed additional light on the nature and extent of these contingent liabilities.
An external audit is your best line of defense against hidden risks and potential liabilities. Or, if funds are limited, an AUP engagement can target specific high-risk accounts or transactions. Contact our experienced CPAs to gain a clearer picture of your company’s financial well-being.
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