Tax Tips - Business Posts - Page 3 of 10

Understanding Taxes on Real Estate Gains

August 15, 2024/in News, Tax Tips - Business/by Encore Partners Team

Let’s say you own real estate that has been held for more than one year and is sold for a taxable gain. Perhaps this gain comes from indirect ownership of real estate via a pass-through entity such as an LLC, partnership or S corporation. You may expect to pay Uncle Sam the standard 15% or 20% federal income tax rate that usually applies to long-term capital gains from assets held for more than one year.

However, some real estate gains can be taxed at higher rates due to depreciation deductions. Here’s a rundown of the federal income tax issues that might be involved in real estate gains.

Vacant land

The current maximum federal long-term capital gain tax rate for a sale of vacant land is 20%. The 20% rate only hits those with high incomes. Specifically, if you’re a single filer in 2024, the 20% rate kicks in when your taxable income, including any land sale gain and any other long-term capital gains, exceeds $518,900. For a married joint-filing couple, the 20% rate kicks in when taxable income exceeds $583,750. For a head of household, the 20% rate kicks when your taxable income exceeds $551,350. If your income is below the applicable threshold, you won’t owe more than 15% federal tax on a land sale gain. However, you may also owe the 3.8% net investment income tax (NIIT) on some or all of the gain.

Gains from depreciation

Gain attributable to real estate depreciation calculated using the applicable straight-line method is called unrecaptured Section 1250 gain. This category of gain generally is taxed at a flat 25% federal rate, unless the gain would be taxed at a lower rate if it was simply included in your taxable income with no special treatment. You may also owe the 3.8% NIIT on some or all of the unrecaptured Section 1250 gain.

Gains from depreciable qualified improvement property

Qualified improvement property (QIP) generally means any improvement to an interior portion of a nonresidential building that’s placed in service after the date the building is placed in service. However, QIP does not include expenditures for the enlargement of the building, elevators, escalators or the building’s internal structural framework.

You can claim first-year Section 179 deductions or first-year bonus depreciation for QIP. When you sell QIP for which first-year Section 179 deductions have been claimed, gain up to the amount of the Section 179 deductions will be high-taxed Section 1245 ordinary income recapture. In other words, the gain will be taxed at your regular rate rather than at lower long-term gain rates. You may also owe the 3.8% NIIT on some or all of the Section 1245 recapture gain.

What if you sell QIP for which first-year bonus depreciation has been claimed? In this case, gain up to the excess of the bonus depreciation deduction over depreciation calculated using the applicable straight-line method will be high-taxed Section 1250 ordinary income recapture. Once again, the gain will be taxed at your regular rate rather than at lower long-term gain rates, and you may also owe the 3.8% NIIT on some or all of the recapture gain.

Tax planning point: If you opt for straight-line depreciation for real property, including QIP (in other words, you don’t claim first-year Section 179 or first-year bonus depreciation deductions), there won’t be any Section 1245 ordinary income recapture. There also won’t be any Section 1250 ordinary income recapture. Instead, you’ll only have unrecaptured Section 1250 gain from the depreciation, and that gain will be taxed at a federal rate of no more than 25%. However, you may also owe the 3.8% NIIT on all or part of the gain.

Plenty to consider

As you can see, the federal income tax rules for gains from sales of real estate may be more complicated than you thought. Different tax rates can apply to different categories of gain. And you may also owe the 3.8% NIIT and possibly state income tax, too. We will handle the details when we prepare your tax return. Contact us with questions about your situation.

Closing a business involves a number of tax responsibilities

July 24, 2024/in News, Tax Tips - Business/by Encore Partners Team

While many facets of the economy have improved this year, the rising cost of living and other economic factors have caused many businesses to close their doors. If this is your situation, we can help you, including taking care of various tax responsibilities.

To start with, a business must file a final federal income tax return and some other related forms for the year it closes its doors. The type of return that must be filed depends on the type of business you have. For example:

Sole Proprietors will need to file the usual Schedule C, “Profit or Loss from Business,” with their individual returns for the year they close their businesses. They may also need to report self-employment tax.
Partnerships must file Form 1065, “U.S. Return of Partnership Income,” for the year they close. They also must report capital gains and losses on Schedule D. They indicate that this is the final return and do the same on Schedule K-1, “Partner’s Share of Income, Deductions, Credits, etc.”
All Corporations need to file Form 966, “Corporate Dissolution or Liquidation,” if they adopt a resolution or plan to dissolve an entity or liquidate any of its stock.
C Corporations must file Form 1120, “U.S. Corporate Income Tax Return,” for the year they close. They report capital gains and losses on Schedule D and indicate this is the final return.
S Corporations need to file Form 1120-S, “U.S. Income Tax Return for an S Corporation,” for the year of closing. They report capital gains and losses on Schedule D. The “final return” box must be checked on Schedule K-1.
All Businesses may need to be filed other tax forms to report sales of business property and asset acquisitions if they sell the business.

Tying up loose ends with workers

If you have employees, you must pay them final wages and compensation owed, make final federal tax deposits and report employment taxes. Failure to withhold or deposit employee income, Social Security and Medicare taxes can result in full personal liability for what’s known as the Trust Fund Recovery Penalty.

If you’ve paid any contractors at least $600 during the calendar year in which you close your business, you must report those payments on Form 1099-NEC, “Nonemployee Compensation.”

You may face more obligations

If your business has a retirement plan for employees, you’ll generally need to terminate the plan and distribute benefits to participants. There are detailed notice, funding, timing and filing requirements that must be met when terminating a plan. There are also complex requirements related to flexible spending accounts, Health Savings Accounts, and other programs for employees.

We can assist you with many other complicated tax issues related to closing your business, including debt cancellation, use of net operating losses, freeing up any remaining passive activity losses, depreciation recapture, and possible bankruptcy issues.

You also must cancel your Employer Identification Number (EIN) and close your IRS business account. In addition, you need to keep business records for a certain amount of time.

If your business is unable to pay all the taxes it owes, we can explain the available payment options to you. Contact us to discuss these responsibilities and get answers to any questions.

Be aware of the tax consequences of selling business property

July 15, 2024/in News, Tax Tips - Business/by Encore Partners Team

Looking for some guidance when it comes to dealing with real estate transactions! Our team at Encore Partners, LLP has over 40 combined years of expertise and experience in complex real estate transactions consistently providing guidance to our clients on the best strategies possible to optimize their portfolios. With our robust tax knowledge and understanding, we implement expert business and personal tax strategies for acquisitions, transfers, and transaction tax appeals and abatements. We are able to advise in areas of budget, accruals, and pre-purchase due diligence while implementing strategies to lessen the burden of your real estate transaction taxes.

If you are selling property used in your trade or business, trust the Encore team to assist you with understanding the tax implications. There are many complex rules that can potentially apply. To simplify this discussion, let’s assume that the property you want to sell is land or depreciable property used in your business, and has been held by you for more than a year.

Note: There are different rules for property held primarily for sale to customers in the ordinary course of business, intellectual property, low-income housing, property that involves farming or livestock, and other types of property.

Basic rules

Under tax law, your gains and losses from sales of business property are netted against each other. The tax treatment is as follows:

If the netting of gains and losses results in a net gain, then long-term capital gain treatment results, subject to “recapture” rules discussed below. Long-term capital gain treatment is generally more favorable than ordinary income treatment.
If the netting of gains and losses results in a net loss, that loss is fully deductible against ordinary income. (In other words, none of the rules that limit the deductibility of capital losses apply.)

The availability of long-term capital gain treatment for business property net gain is limited by “recapture” rules. Under these rules, amounts are treated as ordinary income, rather than capital gain, because of previous ordinary loss or deduction treatment.

There’s a special recapture rule that applies only to business property. Under this rule, to the extent you’ve had a business property net loss within the previous five years, any business property net gain is treated as ordinary income instead of long-term capital gain.

Different types of property

Under the Internal Revenue Code, different provisions address different types of property. For example:

Section 1245 property. This consists of all depreciable personal property, whether tangible or intangible, and certain depreciable real property (usually real property that performs specific functions). If you sell Section 1245 property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset.
Section 1250 property. In general, this consists of buildings and their structural components. If you sell Section 1250 property that’s placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to depreciation recapture. However, for most noncorporate taxpayers, the gain attributable to depreciation deductions, to the extent it doesn’t exceed business property net gain, will (as reduced by the business property recapture rule above) be taxed at a rate of no more than 28.8% (25% plus the 3.8% net investment income tax) rather than the maximum 23.8% rate (20% plus the 3.8% net investment income tax) that generally applies to long-term capital gains of noncorporate taxpayers.

Other rules apply to, respectively, Section 1250 property that you placed in service before 1987 but after 1980 and Section 1250 property that you placed in service before 1981.

As you can see, even with the simple assumptions in this article, the tax treatment of the sale of business assets can be complex. Contact us if you’d like to determine the tax implications of transactions, or if you have any additional questions.

Hiring your child to work at your business this summer

July 1, 2024/in News, Tax Tips - Business/by Encore Partners Team

With school out, you might be hiring your child to work at your company. In addition to giving your son or daughter some business knowledge, you and your child could reap some tax advantages.

Benefits for your child

There are special tax breaks for hiring your offspring if you operate your business as one of the following:

A sole proprietorship,
A partnership owned by both spouses,
A single-member LLC that’s treated as a sole proprietorship for tax purposes, or
An LLC that’s treated as a partnership owned by both spouses.

These entities can hire an owner’s under-age-18 children as full- or part-time employees. The children’s wages then will be exempt from the following federal payroll taxes:

Social Security tax,
Medicare tax, and
Federal unemployment (FUTA) tax (until an employee-child reaches age 21).

In addition, your dependent employee-child’s standard deduction can shelter from federal income tax up to $14,600 of 2024 wages from your business.

Benefits for your business

When hiring your child, you get a business tax deduction for employee wage expense. The deduction reduces your federal income tax bill, your self-employment tax bill and your state income tax bill, if applicable.

Note: There are different rules for corporations. If you operate as a C or S corporation, your child’s wages are subject to Social Security, Medicare and FUTA taxes, like any other employee’s. However, you can deduct your child’s wages as a business expense on your corporation’s tax return, and your child can shelter the wages from federal income tax with the $14,600 standard deduction for single filers.

Traditional and Roth IRAs

No matter what type of business you operate, your child can contribute to an IRA or Roth IRA. With a Roth IRA, contributions are made with after-tax dollars. So, taxes are paid on the front end. After age 59½, the contributions and earnings that have accumulated in the account can be withdrawn free from federal income tax if the account has been open for more than five years.

In contrast, contributions to a traditional IRA are deductible, subject to income limits. So, unlike Roth contributions, deductible contributions to a traditional IRA lower the employee-child’s taxable income.

However, contributing to a Roth IRA is usually a much better idea for a young person than contributing to a traditional IRA for several reasons. Notably, your child probably won’t get any meaningful write-offs from contributing to a traditional IRA because the child’s standard deduction will shelter up to $14,600 of 2024 earned income. Any additional income will likely be taxed at very low rates.

In addition, your child can withdraw all or part of the annual Roth contributions — without any federal income tax or penalty — to pay for college or for any other reason. Of course, even though your child can withdraw Roth contributions without adverse tax consequences, the best strategy is to leave as much of the Roth balance as possible untouched until retirement to accumulate a larger tax-free sum.

The only tax law requirement for your child when making an annual Roth IRA contribution is having earned income for the year that at least equals what’s contributed for that year. There’s no age restriction. For the 2024 tax year, your child can contribute to an IRA or Roth IRA the lesser of:

His or her earned income, or
$7,000.

Making modest Roth contributions can add up over time. For example, suppose your child contributes $1,000 to a Roth IRA each year for four years. The Roth account would be worth about $32,000 in 45 years when he or she is ready to retire, assuming a 5% annual rate of return. If you assume an 8% return, the account would be worth more than three times that amount.

Caveats

Hiring your child can be a tax-smart idea. However, your child’s wages must be reasonable for the work performed. Be sure to maintain the same records as you would for other employees to substantiate the hours worked and duties performed. These include timesheets, job descriptions and W-2 forms. Contact us with any questions you have about employing your child at your small business.

Consider borrowing from your corporation but structure the deal carefully

July 1, 2024/in News, Tax Tips - Business/by Encore Partners Team

If you own a closely held corporation, you can borrow funds from your business at rates that are lower than those charged by a bank. But it’s important to avoid certain risks and charge an adequate interest rate.

Basics of this strategy

Interest rates have increased over the last couple years. As a result, shareholders may decide to take loans from their corporations rather than pay higher interest rates on bank loans. In general, the IRS expects closely held corporations to charge interest on related-party loans, including loans to shareholders, at rates that at least equal applicable federal rates (AFRs). Otherwise, adverse tax results can be triggered. Fortunately, the AFRs are lower than the rates charged by commercial lenders.

It can be advantageous to borrow money from your closely held corporation to pay personal expenses. These expenses may include your child’s college tuition, home improvements, a new car or high-interest credit card debt. But avoid these two key risks:

1. Not creating a legitimate loan. When borrowing money from your corporation, it’s important to establish a bona fide borrower-lender relationship. Otherwise, the IRS could reclassify the loan proceeds as additional compensation. This reclassification would result in an income tax bill for you and payroll tax for you and your corporation. (However, the business would be allowed to deduct the amount treated as compensation and the corporation’s share of related payroll taxes.)

Alternatively, the IRS might claim that you received a taxable dividend if your company is a C corporation. That would trigger taxable income for you with no offsetting deduction for your business.

Draft a formal written loan agreement that establishes your unconditional promise to repay the corporation a fixed amount under an installment repayment schedule or on demand by the corporation. Take other steps such as documenting the terms of the loan in your corporate minutes.

2. Not charging adequate interest. The minimum interest rate your business should charge to avoid triggering the complicated and generally unfavorable “below-market loan rules” is the IRS-approved AFR. (There’s an exception to the below-market loan rules if the aggregate loans from a corporation to a shareholder are $10,000 or less.)

Current AFRs

The IRS publishes AFRs monthly based on market conditions. For loans made in July 2024, the AFRs are:

4.95% for short-term loans of up to three years,
4.40% for mid-term loans of more than three years but not more than nine years, and
4.52% for long-term loans of over nine years.

These annual rates assume monthly compounding of interest. The AFR that applies to a loan depends on whether it’s a demand or term loan. The distinction is important. A demand loan is payable in full at any time upon notice and demand by the corporation. A term loan is any borrowing arrangement that isn’t a demand loan. The AFR for a term loan depends on the term of the loan, and the same rate applies for the entire term.

An example

Suppose you borrow $100,000 from your corporation with the principal to be repaid in installments over 10 years. This is a term loan of over nine years, so the AFR in July would be 4.52% compounded monthly for 10 years. The corporation must report the loan interest as taxable income.

On the other hand, if the loan document gives your corporation the right to demand full repayment at any time, it’s a demand loan. Then, the AFR is based on a blended average of monthly short-term AFRs for the year. If rates go up, you must pay more interest to stay clear of the below-market loan rules. If rates go down, you’ll pay a lower interest rate.

Term loans for more than nine years are smarter from a tax perspective than short-term or demand loans because they lock in current AFRs. If rates drop, a high-rate term loan can be repaid early and your corporation can enter into a new loan agreement at the lower rate.

Avoid adverse consequences

Shareholder loans can be complicated, especially if the loan charges interest below the AFR, the shareholder stops making payments or the corporation has more than one shareholder. Contact us about how to proceed in your situation.

Growing your business with a new partner

May 23, 2024/in News, Tax Tips - Business/by Encore Partners Team

There are several financial and legal implications when adding a new partner to a partnership. Here’s an example to illustrate: You and your partners are planning to admit a new partner. The new partner will acquire a one-third interest in the partnership by making a cash contribution to the business. Assume that your basis in your partnership interests is sufficient so that the decrease in your portions of the partnership’s liabilities because of the new partner’s entry won’t reduce your basis to zero.

More complex than it seems

Although adding a new partner may appear to be simple, it’s important to plan the new person’s entry properly to avoid various tax problems. Here are two issues to consider:

1. If there’s a change in the partners’ interests in unrealized receivables and substantially appreciated inventory items, the change will be treated as a sale of those items, with the result that the current partners will recognize gain. For this purpose, unrealized receivables include not only accounts receivable, but also depreciation recapture and certain other ordinary income items. To avoid gain recognition on those items, it’s necessary that they be allocated to the current partners even after the entry of the new partner.

2. The tax code requires that the “built-in gain or loss” on assets that were held by the partnership before the new partner was admitted be allocated to the current partners and not to the entering partner. In general, “built-in gain or loss” is the difference between the fair market value and basis of the partnership property at the time the new partner is admitted.

The upshot of these rules is that the new partner must be allocated a portion of the depreciation equal to his or her share of the depreciable property, based on current fair market value. This will reduce the amount of depreciation that can be taken by the current partners. The other outcome is that the built-in gain or loss on the partnership assets must be allocated to the current partners when the partnership assets are sold. The rules that apply in this area are complex, and the partnership may have to adopt special accounting procedures to cope with the relevant requirements.

Follow your basis

When adding a partner or making other changes, a partner’s basis in his or her interest can undergo frequent adjustment. It’s important to keep proper track of your basis because it can have an impact on these areas:

Gain or loss on the sale of your interest,
How partnership distributions to you are taxed, and
The maximum amount of partnership loss you can deduct.

We can help

Contact us if you’d like assistance in dealing with these issues or any other issues that may arise in connection with your partnership.

When partners pay expenses related to the business

May 2, 2024/in News, Tax Tips - Business/by Encore Partners Team

It’s not unusual for a partner to incur expenses related to the partnership’s business. This is especially likely to occur in service partnerships such as an architecture or law firm. For example, partners in service partnerships may incur entertainment expenses in developing new client relationships. They may also incur expenses for: transportation to get to and from client meetings, professional publications, continuing education and home office. What’s the tax treatment of such expenses? Here are the answers.

Reimbursable or not

As long as the expenses are the type a partner is expected to pay without reimbursement under the partnership agreement or firm policy (written or unwritten), the partner can deduct the expenses on Schedule E of Form 1040. Conversely, a partner can’t deduct expenses if the partnership would have honored a request for reimbursement.

A partner’s unreimbursed partnership business expenses should also generally be included as deductions in arriving at the partner’s net income from self-employment on Schedule SE.

For example, let’s say you’re a partner in a local architecture firm. Under the firm’s partnership agreement, partners are expected to bear the costs of soliciting potential new business except in unusual cases where attracting a large potential new client is deemed to be a firm-wide goal. In attempting to attract new clients this year, you spend $4,500 of your own money on meal expenses. You receive no reimbursement from the firm. On your Schedule E, you should report a deductible item of $2,250 (50% of $4,500). You should also include the $2,250 as a deduction in calculating your net self-employment income on Schedule SE.

So far, so good, but here’s the issue: a partner can’t deduct expenses if they could have been reimbursed by the firm. In other words, no deduction is allowed for “voluntary” out-of-pocket expenses. The best way to eliminate any doubt about the proper tax treatment of unreimbursed partnership expenses is to install a written firm policy that clearly states what will and won’t be reimbursed. That way, the partners can deduct their unreimbursed firm-related business expenses without any problems from the IRS.

Office in a partner’s home

Subject to the normal deduction limits under the home office rules, a partner can deduct expenses allocable to the regular and exclusive use of a home office for partnership business. The partner’s deductible home office expenses should be reported on Schedule E in the same fashion as other unreimbursed partnership expenses.

If a partner has a deductible home office, the Schedule E home office deduction can deliver multiple tax-saving benefits because it’s effectively deducted for both federal income tax and self-employment tax purposes.

In addition, if the partner’s deductible home office qualifies as a principal place of business, commuting mileage from the home office to partnership business temporary work locations (such as client sites) and partnership permanent work locations (such as the partnership’s official office) count as business mileage.

The principal place of business test can be passed in two ways. First, the partner can conduct most of partnership income-earning activities in the home office. Second, the partner can pass the principal place of business test if he or she:

Uses the home office to conduct partnership administrative and management tasks and
Doesn’t make substantial use of any other fixed location (such as the partnership’s official office) for such administrative and management tasks.

To sum up

When a partner can be reimbursed for business expenses under a partnership agreement or standard operating procedures, the partner should turn them in. Otherwise, the partner can’t deduct the expenses. On the partnership side of the deal, the business should set forth a written firm policy that clearly states what will and won’t be reimbursed, including home office expenses if applicable. This applies equally to members of LLCs that are treated as partnerships for federal tax purposes because those members count as partners under tax law.

Scrupulous records and legitimate business expenses are the key to less painful IRS audits

April 11, 2024/in News, Tax Tips - Business/by Encore Partners Team

We have been emphasizing to our clients that maintaining accurate records and taking advantage of proper deductions not only makes tax season less stressful but also sets the stage for effective long-term financial planning. This proactive approach helps to minimize the risk of errors or audits enabling your efficient and strategic tax planning.

If you operate a business, or you’re starting a new one, you know records of income and expenses need to be kept. Specifically, you should carefully record expenses to claim all the tax deductions to which you’re entitled. And you want to make sure you can defend the amounts reported on your tax returns in case you’re ever audited by the IRS.

Be aware that there’s no one way to keep business records. On its website, the IRS states: “You can choose any recordkeeping system suited to your business that clearly shows your income and expenses.” But there are strict rules when it comes to deducting legitimate expenses for tax purposes. And certain types of expenses, such as automobile, travel, meal and home office costs, require extra attention because they’re subject to special recordkeeping requirements or limitations on deductibility.

Ordinary and necessary

A business expense can be deducted if a taxpayer establishes that the primary objective of the activity is making a profit. To be deductible, a business expense must be “ordinary and necessary.” In one recent case, a married couple claimed business deductions that the IRS and the U.S. Tax Court mostly disallowed. The reasons: The expenses were found to be personal in nature and the taxpayers didn’t have adequate records for them.

In the case, the husband was a salaried executive. With his wife, he started a separate business as an S corporation. His sideline business identified new markets for chemical producers and connected them with potential customers. The couple’s two sons began working for the business when they were in high school.

The couple then formed a separate C corporation that engaged in marketing. For some of the years in question, the taxpayers reported the income and expenses of the businesses on their joint tax returns. The businesses conducted meetings at properties the family owned (and resided in) and paid the couple rent for the meetings.

The IRS selected the couple’s returns for audit. Among the deductions the IRS and the Tax Court disallowed:

Travel expenses. The couple submitted reconstructed travel logs to the court, rather than records kept contemporaneously. The court noted that the couple didn’t provide “any documentary evidence or other direct or circumstantial evidence of the time, location, and business purpose of each reported travel expense.”
Marketing fees paid by the S corporation to the C corporation. The court found that no marketing or promotion was done. Instead, the funds were used to pay several personal family expenses.
Rent paid to the couple for the business use of their homes. The court stated the amounts “were unreasonable and something other than rent.”

Retirement plan deductions allowed

The couple did prevail on deductions for contributions to 401(k) accounts for their sons. The IRS contended that the sons weren’t employees during one year in which contributions were made for them. However, the court found that 401(k) plan documents did mention the sons working in the business and the father “credibly recounted assigning them research tasks and overseeing their work while they were in school.” Thus, the court ruled the taxpayers were entitled to the retirement plan deductions. (TC Memo 2023-140)

Lessons learned

As this case illustrates, a business can’t deduct personal expenses, and scrupulous records are critical. Make sure to use your business bank account for business purposes only. In addition, maintain meticulous records to help prepare your tax returns and prove deductible business expenses in the event of an IRS audit.

Contact us if you have questions about retaining adequate business records.

Coordinating Sec. 179 tax deductions with bonus depreciation

March 29, 2024/in News, Tax Tips - Business/by Encore Partners Team

Your business should generally maximize current year depreciation write-offs for newly acquired assets. Two federal tax breaks can be a big help in achieving this goal: first-year Section 179 depreciation deductions and first-year bonus depreciation deductions. These two deductions can potentially allow businesses to write off some or all of their qualifying asset expenses in Year 1. However, they’re moving targets due to annual inflation adjustments and tax law changes that phase out bonus depreciation. With that in mind, here’s how to coordinate these write-offs for optimal tax-saving results.

Sec. 179 deduction basics

Most tangible depreciable business assets — including equipment, computer hardware, vehicles (subject to limits), furniture, most software and fixtures — qualify for the first-year Sec. 179 deduction.

Depreciable real property generally doesn’t qualify unless it’s qualified improvement property (QIP). QIP means any improvement to an interior portion of a nonresidential building that’s placed in service after the date the building is placed in service — except for any expenditures attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework. Sec. 179 deductions are also allowed for nonresidential building roofs, HVAC equipment, fire protection systems and security systems.

The inflation-adjusted maximum Sec. 179 deduction for tax years beginning in 2024 is $1.22 million. It begins to be phased out if 2024 qualified asset additions exceed $3.05 million. (These are up from $1.16 million and $2.89 million, respectively, in 2023.)

Bonus depreciation basics

Most tangible depreciable business assets also qualify for first-year bonus depreciation. In addition, software and QIP generally qualify. To be eligible, a used asset must be new to the taxpayer.

For qualifying assets placed in service in 2024, the first-year bonus depreciation percentage is 60%. This is down from 80% in 2023.

Sec. 179 vs. bonus depreciation

The current Sec. 179 deduction rules are generous, but there are several limitations:

The phase-out rule mentioned above,
A business taxable income limitation that disallows deductions that would result in an overall business taxable loss,
A limited deduction for SUVs with a gross vehicle weight rating of more than 6,000 pounds, and
Tricky limitation rules when assets are owned by pass-through entities such as LLCs, partnerships, and S corporations.

First-year bonus depreciation deductions aren’t subject to any complicated limitations. But, as mentioned earlier, the bonus depreciation percentages for 2024 and 2023 are only 60% and 80%, respectively.

So, the current tax-saving strategy is to write off as much of the cost of qualifying asset additions as you can with Sec. 179 deductions. Then claim as much first-year bonus depreciation as you can.

Example: In 2024, your calendar-tax-year C corporation places in service $500,000 of assets that qualify for both a Sec. 179 deduction and first-year bonus depreciation. However, due to the taxable income limitation, the company’s Sec. 179 deduction is limited to only $300,000. You can deduct the $300,000 on your corporation’s 2024 federal income tax return. You can then deduct 60% of the remaining $200,000 ($500,000 − $300,000), thanks to first-year bonus depreciation. So, your corporation can write off $420,000 in 2024 [$300,000 + (60% x $200,000) = $420,000]. That’s 84% of the cost! Note that the $200,000 bonus depreciation deduction will contribute to a corporate net operating loss that’s carried forward to your 2025 tax year.

Manage tax breaks

As you can see, coordinating Sec. 179 deductions with bonus depreciation deductions is a tax-wise idea. We can provide details on how the rules work or answer any questions you have.

Better tax break when applying the research credit against payroll taxes

March 7, 2024/in News, Tax Tips - Business/by Encore Partners Team

The credit for increasing research activities, often referred to as the research and development (R&D) credit, is a valuable tax break available to certain eligible small businesses. Claiming the credit involves complex calculations, which we’ll take care of for you.

But in addition to the credit itself, be aware that there are two additional features that are especially favorable to small businesses:

Eligible small businesses ($50 million or less in gross receipts for the three prior tax years) may claim the credit against alternative minimum tax (AMT) liability.
The credit can be used by certain smaller startup businesses against their Social Security payroll and Medicare tax liability.

Let’s take a look at the second feature. The Inflation Reduction Act (IRA) has doubled the amount of the payroll tax credit election for qualified businesses and made a change to the eligible types of payroll taxes it can be applied to, making it better than it was before the law changes kicked in.

Election basics

Subject to limits, your business can elect to apply all or some of any research tax credit that you earn against your payroll taxes instead of your income tax. This payroll tax election may influence you to undertake or increase your research activities. On the other hand, if you’re engaged in — or are planning to undertake — research activities without regard to tax consequences, you could receive some tax relief.

Many new businesses, even if they have some cash flow, or even net positive cash flow and/or a book profit, pay no income taxes and won’t for some time. Thus, there’s no amount against which business credits, including the research credit, can be applied. On the other hand, any wage-paying business, even a new one, has payroll tax liabilities. Therefore, the payroll tax election is an opportunity to get immediate use out of the research credits that you earn. Because every dollar of credit-eligible expenditure can result in as much as a 10-cent tax credit, that’s a big help in the start-up phase of a business — the time when help is most needed.

Eligible businesses

To qualify for the election a taxpayer must:

Have gross receipts for the election year of less than $5 million, and
Be no more than five years past the period for which it had no receipts (the start-up period).

In making these determinations, the only gross receipts that an individual taxpayer considers are from the individual’s businesses. An individual’s salary, investment income or other income aren’t taken into account. Also, note that an entity or individual can’t make the election for more than six years in a row.

Limits on the election

The research credit for which the taxpayer makes the payroll tax election can be applied against the employer portion of Social Security and Medicare. It can’t be used to lower the FICA taxes that an employer withholds and remits to the government on behalf of employees. Before a provision in the IRA became effective for 2023 and later years, taxpayers were only allowed to use the payroll tax offset against Social Security, not Medicare.

The amount of research credit for which the election can be made can’t annually exceed $500,000. Prior to the IRA, the maximum credit amount allowed to offset payroll tax before 2023 was only $250,000. Note, too, that an individual or C corporation can make the election only for those research credits which, in the absence of an election, would have to be carried forward. In other words, a C corporation can’t make the election for the research credit to reduce current or past income tax liabilities.

These are just the basics of the payroll tax election. Keep in mind that identifying and substantiating expenses eligible for the research credit itself is a complex task. Contact us about whether you can benefit from the payroll tax election and the research tax credit.

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