Now that the corporate tax rate has been reduced to 21% permanently, is it a good time to incorporate your business? There is no one-size-fits-all answer to this question but there are some general guidelines to consider.
The primary nontax advantage of incorporating a small business is personal asset protection. Both corporations and LLCs allow owners to separate and protect their personal assets. In a properly structured and managed corporation or LLC, owners should have limited liability for business debts and obligations. Another nontax reason business owners incorporate is perpetual existence. Corporations and LLCs can continue to exist even if ownership or management changes. Sole proprietorships simply end if an owner dies or leaves the business.
If you file a Schedule C, E or F and your only concern is a loss of deductions because of the new tax changes, there is likely little benefit to incorporating your business. None of the deductions for expenses have been eliminated or suspended if you are a business owner, landlord or farmer. In fact, certain noncorporate businesses are considered pass-through entities and may qualify for a 20% qualified business income (QBI) deduction.
Other considerations to incorporating include the type of business you operate, your gross income, the type of assets you use in your business, and whether you have employees and wish to provide benefits. One final point: Regular C corporations are subject to double taxation. This means the income is taxed once at the corporate level and again at the shareholder level when income is distributed in the form of dividends. Pass-through entities pass the income through to the owners, and it is taxed only once on their return.
Be sure to consult with us first before making any decisions on how you should structure your business.
There are many costs associated with the start-up of a business that can be deducted once your business opens. To qualify as a start-up cost, the expense must be one that you could deduct if you were already in business. Examples include travel to suppliers, training for your new employees, advertising, utilities and other pre-opening expenses. If start-up costs are less than $50,000, you are allowed to deduct up to the first $5,000 of expenses you incur in the current year. Any additional start-up expenses are deducted over a remaining period of not less than 180 months.
For many of you, finding the money to pay for a new car, boat or dream vacation was as easy as tapping the equity in your home. Prior to 2018, you could use the equity in your home to make large purchases, pay expenses or consolidate debt and deduct the interest on up to $100,000 of debt.
After 2017 and before 2026, this tax savings strategy is gone. While you can still use the equity in your home to borrow needed funds, the interest is no longer deductible unless you use the money to buy, construct or improve your home. The elimination of this deduction applies regardless of when the home equity debt was incurred.
Are you an employee who incurs unreimbursed expenses? Beginning in 2018 and continuing through 2025, some expenses you could previously claim as itemized deductions won’t be allowed. Here’s a list of the more common items that are no longer deductible:
- Uniforms and certain work clothes
- Safety shoes and other safety equipment
- Tools needed for your job
- Union dues
- Job-seeking expenses
- Professional dues and licenses
- Home office deductions
- Subscriptions to professional journals
- Continuing education
- Work-related travel, meals and lodging
- Rural mail carrier vehicle expenses
- Passport for a business trip
Now may be a great opportunity to negotiate an accountable plan with your employer.
As a business owner, you most likely provide health benefits for you and your employees. Even if you do not have employees, having a health insurance policy in your business may save you money.
As a self-employed taxpayer, you are allowed to deduct from your adjusted gross income, 100% of the cost of the health insurance policy. While this may not save in self-employment tax, the deduction will reduce your overall tax liability. You can title the policy in your name or in the name of your business.
If your business is a C corporation, the policy must be established by the business and in the business name. C corporations are allowed to deduct the cost of health insurance provided to the shareholders while remaining tax-free to the shareholder.
If your business is an S corporation, the policy must be established by the business, but not necessarily in the business name. A plan providing medical care coverage for the 2% shareholder in an S corporation is established by the S corporation if: (1) the S corporation makes the premium payments for the policy covering the shareholder (including a spouse or dependents, if applicable); or (2) the 2% shareholder makes the premium payments and furnishes proof of payment to the S corporation, and then the S corporation reimburses the shareholder for the premium payments in the current taxable year. If the insurance premiums are not paid or reimbursed by the S corporation and included in the shareholder’s income, a plan providing medical care coverage for the shareholder is not established by the S corporation and the shareholder is not allowed the deduction. Provided these two conditions are met, and the payment for the premiums is included as wages to the shareholder, the shareholder is allowed a deduction on Form 1040, line 29, against income.
There’s a rule in the tax code that allows you to exchange property you hold for business use or investment for other like-kind property and defer any tax on the gain. This was a popular strategy for business owners who wished to acquire new property without incurring a large tax liability from selling similar property.
For tax years beginning after 2017 and before 2026, the rules for exchanging property have tightened. While you are still permitted to defer tax on the gain by acquiring like property, exchanges are limited to real property only. While you can still exchange unimproved real property for improved property and vice versa, you cannot exchange machinery, equipment or vehicles for like property.
Many of you are already aware that contributing to a qualified tuition plan, commonly referred to as a 529 plan, can be a tax-free way to save for your child’s college education. But did you know that the Tax Cuts and Jobs Act added a provision that also allows you to use a 529 plan to pay for the enrollment costs for your child to attend an elementary or secondary public, private or religious school?
There is one catch, however. While distributions from a 529 plan for college expenses are unlimited provided they are used to pay for qualified educational expenses, distributions for elementary or secondary education expenses are limited to $10,000 per year per designated beneficiary.
Have you ever thought of your home as a source of untapped income? Consider this: Your home is located in an area that has a lot of tourism or large events that attract many people. Sometimes hotel space is limited or fills quickly. You prefer to be out of town while these events are taking place. If you rent your home for less than 15 days during the year, you just earned some tax-free income.
If you itemize deductions, your mortgage interest and real estate taxes are deducted on your Schedule A. None of the income you collect is taxable, nor is it reported on your tax return. The key to keeping the income tax-free is the number of days you rent your home. You must keep it to less than 15 days during the year. If you rent your home for 15 days or more, tax reporting becomes a bit more complex. Since you also use your home for personal purposes—meaning you live there—you must divide your expenses between the rental use and the personal use based on the number of days used for each purpose. If, after you reduce your rental income by allowed expenses, you have a profit, that profit is taxable. Deductions are limited to rental income.
If you are considering renting your home to others, regardless of the number of days, consult with me first so we can discuss all potential tax consequences.
The Tax Cuts and Jobs Act made some significant changes to how business owners deduct the cost of certain property. In the past, the cost of business assets was recovered through bonus depreciation, by regular depreciation or by expensing it under §179, depending on the type of property.
Prior to the change in the law, taxpayers were allowed to deduct 50% of the cost of most new tangible property (other than buildings and some building improvements) and most new computer software in the year placed in service. This was referred to as 50% bonus depreciation. Currently, for property placed in service and acquired after Sept. 27, 2017, the 50% bonus rate increases to 100%, appropriately called 100% bonus depreciation. Additionally, property eligible for bonus depreciation can be new or used.
Beginning in 2018, taxpayers can immediately deduct the entire cost of qualifying §179 property up to an annual limit of $1 million. Qualifying property for §179 expensing has been expanded to include certain depreciable tangible property used in connection with lodging, such as appliances and furniture in a residential rental activity and improvements to non-residential real property such as roofs, heating, ventilation, air conditioning, and fire and alarm protection systems.
While on the surface it may not look like there is much of a difference between 100% bonus depreciation or §179 expensing, which method you choose depends on several factors such as your income, the type of property you purchase and when it is placed in service.
A business doesn’t have to own all its operating assets. Leasing your personally owned property, such as a building, vehicle, or equipment, to your incorporated business may be a good tax-savings strategy. Similarly, another corporation, a partnership, or a family business in which you have an ownership interest may lease assets to your corporation. In addition to possible tax savings, you may not want your corporation to own a lot of assets if you are in a business where lawsuits are common. Leasing instead of owning is one way to insulate assets from potential creditors.
To avoid potential problems with the IRS, lease terms between you and your corporation must be fair to both sides. The contract should be legally binding and the payments should be set at the same rate you would charge anyone else. Lease payments are deductible expenses to the corporation, while lease income is taxable to you. In turn, you’ll get to deduct costs of ownership, such as mortgage interest, maintenance, repairs, depreciation, acquisition interest, insurance and administrative costs.