Tips for navigating 2018 tax season
Business owners need every advantage to help save the most on their taxes. Qualified experts can help entrepreneurs save thousands in deductions, point out advantageous incentives and demystify changes to the tax codes. We reached out to two experts for a few tips to see how to best prepare for tax season this year.
William Stein, of Melanson Heath & Company, in Manchester. melansonheath.com
Muriel Schadee, of Nathan Wechsler Accountants & Business Advisors, in Concord. nathanwechsler.com
Q. If you are in the process of starting a business, what should you be aware of relating to the tax treatment of some of your initial expenses?
Schadee: “Generally, expenses incurred before a business begins do not generate current tax deductions. However, there are certain elections allowed for startup costs and organization costs. Taxpayers, including individuals, corporations and partnerships, are permitted to elect to deduct $5,000 of startup expenses in the year the business begins, and the rest of the startup expenses can be deducted ratably over a period of 180 months, beginning with the month the business starts. The $5,000 initial deduction is reduced by the excess of total startup costs over $50,000.
Startup expenses include expenses incurred to investigate creating or acquiring a business, or to actually create the business. To be eligible for the startup expense election, an expense must also be one that would be a deductible business expense if it were incurred after the business actually begins. A similar $5,000 deduction is available to corporations and partnerships for their organization costs. The rest of the organization expenses can be deducted ratably over 180 months, and the initial $5,000 deduction is reduced by the excess of total organization costs over $50,000. To qualify as an organization expense, the expense must be for the creation of the corporation or partnership. An example of an organization expense is the legal fee for drafting the corporate charter or partnership agreement.
It is important to keep a record of startup and organization costs, and to make the appropriate decision regarding the write-off election. An election either to deduct or to amortize start-up expenditures, once made, is irrevocable.”
Q. What documents or records should I prepare or have ready when I meet with my accountant?
Stein: “The answer will vary, depending upon the complexity of your situation, including whether you are working with your accountant for the first time, but there are several types of common documentation that should be gathered and provided to your accountant. In general, it is always helpful to provide as much information as possible to your accountant so that they can be as efficient as possible and provide you with every benefit you are entitled to take. Some types of documentation that should be made available include the following:
Form W-2 (Wage and Tax Statement).
Forms 1099. There are several types, but here are some examples:
1099-B (Proceeds From Broker and Barter Exchange Transactions) For property sold that does not include cost basis, documentation should be provided to support the cost basis to be claimed.
1099-INT (Interest Income)
1099-DIV (Dividends and Distributions)
1099-MISC (Miscellaneous Income)
1099-S (Proceeds From Real Estate Transactions)
Schedule K-1 (S Corporations, Partnerships, Trusts – Federal and State)
Copy of prior year returns (if first time with new accountant)
For sole proprietorships, a summary of annual income and expenses for the business. Additional documentation may be needed for certain expenditures, including the purchase of vehicles and equipment.
For rental activities, a summary of annual rental income and expenses for each property rented.
Form 1098 for mortgage interest
Form 1098-T for qualified tuition
Child care expenses summarized by provider and amount. Include provider’s social security number or employer identification number.”
Q. How will green and energy efficient initiatives affect my taxes?
Stein: “The federal government still offers tax credits for certain green and energy efficient purchases. The benefit of the credit is that it reduces your tax liability directly, dollar for dollar. However, these credits are limited to your total tax liability for the year, although some credits that have been limited are available for carryover to the following year’s return. Some of the credits available for 2018 returns include the following:
Qualified Plug-In Electric Drive Motor Vehicle Tax Credit – This is an incentive program for the purchase of electric cars. The credit ranges between $2,500 and $7,500 depending on the capacity of the battery. It also is subject to a phase out (reduction) when the manufacturer sells 200,000 qualified vehicles. The credit has no carryover provision.
Residential Energy Efficient Property Credit – A credit of 30 percent is available for the purchase of qualified solar electric property (for example, solar panel systems), solar water heating property, small wind energy property, geothermal heat pump property and fuel cell property. The credit has a carryover provision to the following year’s return.
Prior to 2018, the Nonbusiness Energy Property Credit was also available. Unfortunately, this credit was retired for property placed in service after December 31, 2017. The credit was 10 percent for the purchase of eligible home improvements (excluding labor/installation fees) for qualified improvements such as insulation, exterior windows and doors, metal and certain asphalt roofs, electric heat pumps and various boilers, stoves and furnaces.”
Q. How are C corporations taxed under the 2017 Tax Cuts and Jobs Act?
Schadee: “For tax periods after 2017, a flat 21 percent tax rate applies to C corporation taxable income. This tax rate replaces graduated tax rates that ranged from 15 percent to 35 percent prior to 2018. For tax years beginning before 2018, some C corporations were also subject to an alternative minimum tax. For tax years beginning after 2017, the corporate alternative minimum tax has been repealed.”
Q. What can I deduct for my new business and startup expenses?
Stein: “Generally, a trade or business can deduct the ordinary and necessary expenses it pays or incurs beginning at the point in which the trade or business becomes active, subject to the various limitations provided in the Internal Revenue Code. With regard to startup expenses, these costs are not generally immediately deductible. However, a business can elect to deduct a limited amount of startup expenses in the tax year in which the trade or business begins. The amount of startup expenses that may be deducted is the lesser of:
The startup expenses with respect to the active trade or business, or
$5,000 reduced by the amount by which the startup expenses with respect to the active trade or business exceed $50,000.
Any portion of the startup expenses that are not currently deducible are to be deducted ratably over 15 years (180 months) beginning with the month in which the active trade or business begins or is acquired.
Eligible startup expenses that qualify as startup expenses include the following items:
Investigative costs of creating or acquiring an active trade or business.
Business startup costs incurred after a decision to establish a particular business is made but before the business begins.
Pre-opening costs of the business that are related to activities engaged in for profit and for the production of income but incurred before the date the active trade or business begins in anticipation of the activity becoming an active trade or business.”
n What are some of the common pitfalls new business and startup owners encounter as they prepare their taxes for the first time?
Stein: “Due to the complexities that exist in the Federal tax code, there are several issues that any new business should consider but may get overlooked. Some examples include:
Selection of Entity Type – Should the new business form as a sole proprietorship, a limited liability company, a partnership, an S corporation or a C corporation? There are advantages and disadvantages to each type, including tax and non-tax considerations. New businesses should pay particular attention to this choice to ensure they are minimizing their effective tax liability and maximizing their tax benefits.
Accounting Method – A new business must decide with its first return the appropriate accounting method to use to recognize revenue and expenses. The method chosen will affect the timing of recognition and, therefore, the amount of taxable income or loss for the year. In general, most taxpayers use the cash or accrual method of accounting, but there are limitations based on gross receipts and certain industries may be required to use special types of revenue recognition methods.
Accounting System – This is a critical feature that every business needs to consider. The information that is reported on a tax return is based on the internal financial records of the business. All business returns will require the reporting of revenues and expenses. For some entity types, it will also require the reporting of a balance sheet. Therefore, it is very important that the data that forms the basis of the returns is accurate and provides the necessary details to complete the returns.”
Q. What is one of the major highlights of the 2017 Tax Cuts and Jobs Act?
Schadee: “The new 20 percent deduction for pass-through income is a major change in how taxes are calculated for owners of pass-through entities.
Prior to the 2017 Tax Cuts and Jobs Act , the net income of pass-through businesses, including sole proprietorships, partnerships, limited liability companies, and S corporations was reported by the owners on their income tax returns, and subject to the owners’ income tax rates.
For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the Tax Act adds Code Section 199A, Qualified Business Income, under which an individual, trust or estate, who has qualified business income from a partnership, S corporation or sole proprietorship, is allowed to deduct:
(1) the lesser of: (a) the combined qualified business income amount of the taxpayer, or (b) 20 percent of the excess, if any, of the taxable income of the taxpayer over the net capital gain of the taxpayer for the tax year. The combined qualified business income amount means an amount equal to: (i) the deductible amount for each qualified business of the taxpayer (defined as 20 percent of the taxpayer’s Qualified Business Income subject to the W-2 wage limit (explained below); plus (ii) 20 percent of the amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income of the taxpayer).
Qualified business income is generally defined as the net amount of qualified items of income, gain, deduction, and loss relating to any qualified business of the taxpayer conducted within the U.S. for the tax year. If the net amount for any tax year is less than zero, the amount is treated as a loss from a qualified business in the succeeding tax year. Qualified business income does not include reasonable compensation paid to the taxpayer by any qualified business for services with respect to the business and any guaranteed payment to a partner for services to the business.
The 20 percent deduction is not allowed in computing adjusted gross income, but rather is allowed as a deduction reducing taxable income. Except as provided below, the deduction cannot exceed the greater of: (1) 50 percent of the W-2 wages paid with respect to the qualified business, or (2) the sum of 25 percent of the W-2 wages paid with respect to the qualified business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified tangible depreciable property.
The above limit does not apply for taxpayers with taxable income below the threshold amounts ($315,000 for married individuals filing jointly, $157,500 for other individuals). The application of the limit is phased in for individuals with taxable income exceeding the threshold amount, over the next $100,000 of taxable income for married individuals filing jointly ($50,000 for other individuals). Thus, for 2018, the limit fully applies to married taxpayers with taxable income over $415,000 and other individuals with taxable income over $207,500.
For a partnership or S corporation, each partner or shareholder is treated as having W-2 wages for the tax year in an amount equal to his or her pro rata share of the W-2 wages of the entity for the tax year.
There is an exception for specified service businesses. The 20 percent deduction does not apply to specified service businesses (i.e., medical, legal, accounting, consulting, or businesses that involve services related to investment-type activities). However, the disallowance of the deduction for specified service businesses does not apply for taxpayers with income below the threshold amounts ($315,000 for married individuals filing jointly, $157,500 for other individuals). The benefit of the deduction for specified service businesses is phased out over the next $100,000 of taxable income for joint filers ($50,000 for other individuals). For 2018, the limit fully applies to married taxpayers with taxable income over $415,000 and other individuals with taxable income over $207,500.
The deduction does not apply to the business of being an employee. So, there is no 20 percent deduction on W-2 wages earned.