Every change in the tax law presents an opportunity to enhance your business’ tax optimization strategy, and the massive tax law passed last December (the Tax Cuts and Jobs Act) is certainly no exception. Its scale exceeds that of any tax law in the last 30 years, and while it will take entrepreneurs time to fully unpack and adopt changes, we’ve compiled some strategies below you should consider depending on your tax profile.
As always, we advise that tax strategy should never undermine business strategy, so always apply our principle that ‘value creation will supersede tax savings’ at every turn.
- Aggregate multiple businesses to maximize your “qualified business income deduction”. One of the biggest benefits in the new tax law was the creation of a new deduction: the qualified business income deduction. In its simplest form, it allows entrepreneurs to take 20% of their business income as a straight up deduction. But there are a number of caveats that can limit the amount, like income level, W-2 wages paid to employees, industry, and the fact that it’s determined on a per-business basis. A strategy that can get you back in the gravy, however, is to combine figures from businesses with common ownership to maximize the deduction you’re eligible for. And a special version of this strategy permits you to even claim the deduction on income from a property you rent to your own business (which otherwise would not qualify at all).
- Manage income for the years in which you expect to recognize capital gains. As of a few years ago, there’s effectively three long-term capital gains rates: 0%, 15%, and 20% — which one applies depends on what your income is that year. What’s changed under the new law is that each rate is no longer tied to your tax bracket, but to its own separately defined income levels. So now if you’re income is under around $38k single/$77k joint you pay 0%, if it’s between that and $425 single/$479k joint you pay 15%, and if it’s higher you pay 20%. Combine that with the additional 3.8% “net investment income tax” for folks with income over $200k single/$250k joint, and a little advance planning can translate into $5k, $10k, or more in tax savings.
- Limit or stop entertainment expenses altogether. On the negative side, you can no longer deduct costs generally considered “amusement, entertainment, or recreation”, including membership dues to related facilities. It used to be that if business was discussed, you could at least deduct things like sport tickets, concerts, and the like at 50%, but this is now completely gone, meaning you either choose to spend the money recognizing there’ll be no deduction, or simply not spend the money altogether.
- Write-off furnishings and other components for non-residential real estate. So if you own an apartment, you can now fully deduct personal property in the year of purchase like beds, refrigerators, ranges and more (instead of depreciating them over 7 or more years). And if you own commercial buildings, you can now likewise write off in year one components like roofs, HVAC, alarm systems and more (instead of spreading it over multiple years into the future).
- Purchase vehicles and equipment. Historically, buying a consumer vehicle for business use came with lots of ridiculous limitations intended to prevent claiming luxury vehicles as business deductions (e.g., you definitely can’t get a luxury vehicle for anywhere near $15k nowadays). While the limits weren’t altogether eliminated, they were effectively tripled, and when combined with the new bonus depreciation rules, translate into deducting more around $20k – $25k, instead of the around $8k – $10k previously allowed. And the variety of ways to deduct other new and used equipment purchases was also expanded, effectively leading to any of these types of purchases being 100% deductible in the year of purchase. Translation: it’s a good time to buy personal property.
- Reduce your quarterly estimated tax payments and reinvest in your business instead. In addition to the qualified business income deduction above, there’s two other big changes that could mean lower overall taxes for business owners. First, the Alternative Minimum Tax (AMT) was severely weakened. Those with incomes approaching or exceeding $200k were often used to seeing this specter appear on the bottom of their return, adding to their overall tax bill. But the exemption was increased, and the triggering income thresholds were raised, meaning many fewer taxpayers will see this tax draining their bottom line. Second, overall personal deductions no longer get trimmed if your income is too high. Combine all three of these changes together, and there’s a good chance you can redirect a nice amount of those quarterly payments towards other uses in your business.
- Change business tax structures. It used to be a more straight-forward analysis on what tax structures were best for which business models. But the new rules (especially those around the qualified business income deduction) are up-ending traditional wisdom. For instance, we’re seeing businesses for which S-corp elections used to be a no-brainer, now warrant to a second look and sometimes opt for Sole Proprietorships instead. And Partnerships who had little reason to convert to S-corps, in some cases can now significantly benefit from doing so. It’s all driven by the interaction and character of business and personal income, so there’s no across-the-board answer, and different owners will benefit from different choices. But running the numbers will confirm or disprove whether your current tax structure is still the best for you under the new law.
Apply a Design Mentality
The tax component of every business’ financial model is worth periodically revisiting and updating, especially in light of landmark legislation changes like the one that took effect this year. Our team’s approach is to view taxes through a design lens, which considers the context of your business model and personal goals, and takes into account related trade offs before making a final decision. By properly weighing these elements together in conversation with one of our Tax Designers, you can have the comfort of knowing that each piece connects to your bigger picture, and advances rather than hampers your end result.