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Capture potential tax benefits from new federal tax legislation using end-of-year tax planning.
November 5, 2018
By Dan Childs
This year, taxpayers have more options to manage their income tax obligation than in the recent past, as the result of tax legislation passed in December 2017 by the U.S. Congress. Knowledge of the new legislation will allow taxpayers a better opportunity to manage their tax bill over the long term.
While some parts of the legislation are permanent, many of the changes expire at the end of 2025. Unless Congress acts before then, those changes will revert back to the old law. The House of Representatives passed a bill that would make the temporary changes permanent. It remains to be seen if the Senate will consider their bill, create one of its own or simply choose not to take up the issue.
In the meantime, the 2018 tax year looms. The first step in managing one’s tax obligation is to know the amount of taxable revenue that has been received to date, and the total of all deductible expenses. The difference provides an estimate of taxable income to date.
Knowing your present taxable income difference is the base information needed for a cash-basis, calendar-year taxpayer in making marketing and purchase decisions for the rest of the year. Situations where a taxpayer has more expenses to date than revenue provide an opportunity to generate tax-free income — up to the point where the additional revenue offsets the amount the expenses exceeded revenue.
Therefore, consider making additional sales of commodities, take payment of any custom work already completed or to be completed before the end of the year, or choose to depreciate any capital expenditures rather than expensing them this year.
Some examples of strategies a taxpayer may consider when year-to-date revenue is considerably more than expenses may be to expense all or a portion of capital expenditures, make needed business repairs that have been postponed, be sure all business accounts payable are paid before the end of the year, or maybe just defer any additional sales or revenue-generating transactions for the remainder of the year. Also, keep in mind that contributions to a 401(k) are tax-deductible up to certain limitations.
Some words of advice and caution are warranted when making end-of-year purchase decisions. First, a word of advice: Do not view paying income tax as a bad thing. Most entrepreneurs are in business to make a profit, and income tax is paid on profit.
A word of caution is that purchase decisions, whether capital or operating expenses, should not be made just to decrease a tax obligation. Oftentimes, these are not good business decisions. Ideally, purchases are made that reflect good business acumen as well as result in a reduction of the business’s income tax obligations.
Another consideration when developing strategies to manage taxable income is to look over multiple years rather than just one year at a time. Generally, taxes paid over time are minimized when taxable income does not change drastically from year to year.
This may be more difficult under the new tax legislation, since a business owner can now fully expense (deduct) all capital expenditures. The temptation exists to expense all capital purchases in the year of purchase, leaving no depreciation deduction for future years.
Unless a principled business approach is practiced where annual investments in capital assets remain somewhat constant, taxable income could fluctuate considerably from year to year, resulting in some years when the business is taxed in a much higher tax bracket.
Both the maximum tax rates and breakpoints that apply to net capital gain income are retained in the new law. The breakpoints are no longer tied to income tax brackets, as they were under previous law, and were indexed for inflation at the beginning of 2018.
The 0% tax rate applies to adjusted net capital gain up to $77,200 for joint filers and $38,600 for single filers. The 15% tax rate applies to adjusted net capital gain of more than the amount subject to the 0% rate, and up to $479,000 for joint filers and $425,800 for single filers. The 20% rate applies to the adjusted net capital gain of more than $479,000 for joint filers, and $425,800 for single filers.
These lower rates apply when assets that qualify are sold after the required holding period has been met. As an example, raised cattle held for breeding purposes qualify for these rates if sold after 24 months of age. If taxpayers are contemplating selling an asset where the gain would qualify as capital gain, then it would be prudent to check the amount of time they have owned the asset to make sure the required holding period is met.
Another important provision in the new tax legislation is referred to as the section 199A deduction. When calculating one’s estimated tax obligation based on taxable income to date, plus or minus projected income and expenses for the remainder of the year, a final adjustment to taxable income is available because of the section 199A deduction.
Eligible taxpayers may be entitled to deduct up to 20% of their qualified business income.
This applies to a taxpayer who owns a business that is operated as a sole proprietorship, or through a partnership, S corporation, trust or estate, with taxable income not exceeding $315,000 when filing a joint return as a married couple, or $157,000 for all other taxpayers; that taxpayer could be eligible for the 20% deduction.
If taxable income is higher than these thresholds, the deduction is subject to limitations.
There are still many questions surrounding how this provision will apply and what income is subject to the deduction; these questions should not be overlooked during one’s year-end tax planning.
Good income and expense records to date are very helpful in establishing a base taxable income. Decide if more revenue or deductions should be generated to achieve your end-of-the-year taxable income goal. Remember to apply the section 199A deduction if eligible. Also, be careful to take full advantage of the increased standard deduction for 2018. Personal exemption deductions have been eliminated.
One last piece of advice is to seek the council of a tax professional, especially if you do not feel comfortable doing the calculations yourself.
Childs is the Noble Research Institute senior agriculture economics consultant. Contact him at [email protected].
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