Despite all the thunder, lightning and tumult that surround the federal government in this election year, taxpayers are catching a break as they develop their tax-reduction strategies. At the end of 2015, Congress moved to make 20 tax-relief provisions permanent, which removes the year-end guessing games that bedeviled taxpayers and their advisors in recent years.
“We’re not waiting for anything this year,” said Bernadette Mashas, a partner who specializes in taxes at Fair, Anderson & Langerman in Las Vegas. However, that doesn’t mean that life is necessarily simple for business owners and managers as they position themselves for the end of the tax year.
For one thing, the state’s new Commerce Tax created a new batch of paperwork for every business entity in Nevada, even the tiniest of home-based businesses or the smallest owner of rental properties. At the federal level, both parties continue to float tax proposals that might complicate matters after voters go to the polls.
“In an election year, I would not anticipate any changes in tax law before the election,” said Eric Johnson, a certified public accountant and partner at Stewart Archibald & Barney in Las Vegas. “However, businesses and individuals will want to pay attention to what happens after the general election in November. There could be a flurry of activity after the election.”
Mark Bailey, a CPA and managing partner of Excelsis Accounting Group in Reno, noted it’s impossible to predict what is likely to happen. Business owners need to plan what is known — the situation right now. “Be proactive about what’s in place right now,” he said. “Don’t try to out guess Congress.”
Plenty of opportunities exist in the current environment for business owners and managers to find significant tax savings, both for their businesses and themselves.
As business owners and managers think through their strategies for the remainder of this year, they should remember that bonus depreciation remains in place for property that’s acquired and placed into service through 2019, Mashas said. The bonus depreciation amount remains at 50 percent in 2016 and 2017, but then steps down to 40 percent in 2018 and 30 percent in 2019.
Business owners may want to time their capital investments to take full advantage of the bonus depreciation, said Stewart Archibald & Barney’s Johnson. In fact, Johnson suggested that business owners should meet with their tax advisors before they take any significant step — even the remodeling of an office or the opening of a new branch location — to ensure the transaction is structured in a tax-friendly way that captures bonus depreciation or other tax advantages.
Cost-segregation studies also present significant opportunities for businesses that buy or build buildings, said Bailey. Non-residential buildings, he explained, generally are depreciated over a 39-year tax life, but some non-structural items such as wall coverings, accent lighting and landscaping often can be depreciated more quickly over five, seven or 15-year periods.
Savvy building owners contract with an expert such as a construction engineer to segregate the long-depreciation portions of the building’s cost from the short-depreciation elements. The savings can be substantial.
“People have a tendency to overlook those studies,” said Bailey. “At the end of the year, it’s too late.”
Another often-overlooked opportunity for businesses to reduce tax liabilities is the federal research-and-development (R&D) tax credit, Bailey said. The credit is especially valuable because it can extend over three years, and earlier tax returns can be amended to capture a refund for the R&D credit.
The studies that support these credits generally are conducted by CPAs or other specialists. Many business owners aren’t willing to make the investment in the study for a one-year tax credit that may not amount to much more than the cost of the study. But once the credit is applied over three years, it becomes much more valuable. “This can be a huge number,” added Bailey.
Mashas said tried-and-true tax strategies still provide effective tools for many business owners and high-income taxpayers. The accounting maxim, “delay receipt of income, accelerate deductions” remains applicable in 2016. Small business owners, for instance, can use credit cards to pre-pay business expenses and claim the deduction against their 2016 income.
Other strategies, include:
• Use of the so-called 1031 Exchange strategy to defer capital gains on a sale of property.
• Employment of owner’s children in a small business to reduce taxable profits. It should be noted the employment must be legitimate and not a sham.
• Review of investment portfolios with financial advisors to identify possible losses that can be harvested in 2016 to offset income.
• Use of the gift exclusion to transfer up to $14,000 a year to family members or others, a step that can help reduce the size of a taxable estate.
• Use of a 529 Plan to build college savings. Although contributions aren’t deductible, the accounts build value tax-free until they’re used to pay educational expenses for children (or grandchildren).
As the economy recovers and employers build their staff, the federal Work Opportunity Tax Credit is worth a closer look as well, Bailey said. The tax credit is available when an employer hires a new worker from a group that traditionally has had trouble finding jobs — an unemployed veteran, for example, or an individual referred by the state’s Bureau of Vocational Rehabilitation. The tax credit, which is based on a percentage of the worker’s income, can total as much as $9,600 for an employer who hires a veteran who has been unemployed for six months or more.
One seemingly modest change in the IRS reporting requirements may trip up some unwary businesses, Johnson said. Employers who distribute W2 forms to workers and 1099 forms to contractors now need to file them with the IRS at the end of January, the same time that they are distributed to workers and contractors. In the past, companies weren’t required to file the reports until the end of February.
This is particularly noteworthy for individual taxpayers who may not be aware that they need to file a 1099 form covering payments to a contractor. For instance, Johnson noted investors who are renovating and flipping residential properties need to remember to file 1099 forms for the contract workers. The penalty for failure to file can pinch $100 for each taxpayer who isn’t provided a 1099.
Meanwhile, many individual Nevada taxpayers who dealt with a short sale of their home during the recession face an important tax-related deadline this year. Historically, any debt that was forgiven by a lender as part of a short sale would have been treated as taxable ordinary income for the former homeowner. Relief is available through the end of this year for up to $2 million in forgiven mortgage debt. There’s no promise the relief will continue, and Mashas advised taxpayers should resolve the situation this year.
Business owners and managers who are getting serious about their retirement planning, meanwhile, should take a close look at possible conversion of traditional IRA assets into Roth IRAs. The conversion may be particularly attractive to older taxpayers who are developing a strategy to deal with the required minimum distributions from an IRA, Mashas said.
Johnson noted that look-back provisions in the conversion provide a chance for a do-over if the conversion doesn’t work out. Executives should check with their CPA for details on this complex device.
Johnson also suggested that business owners and managers whose earnings place them in higher-income brackets need to pay careful attention to avoiding the Alternative Minimum Tax, which can add 5 to 8 percent to a tax bill. High-bracket individuals also need to plan carefully to avoid the federal net investment income tax. The 3.8 percent investment tax kicks in at $200,000 of investment income for a single taxpayer and $250,000 for a married couple filing jointly.
State tax law provided some of the biggest change for businesses this year due to the large tax package that was passed by the Nevada legislature in 2015. The state’s Commerce Tax took effect this year with an August 15 deadline for the first returns, which many business owners may not be aware of. The tax year corresponds to the state’s fiscal year, which begins on July 1, and returns are due six weeks later.
While the tax is levied only on companies with gross revenue of $4 million or more, Bailey said many business people haven’t realized that a return must be filed by all businesses in the state no matter how small or how far they fall from the $4 million threshold to pay.
Mashas noted, for instance, that taxpayers who file a Schedule E covering income from a rental property or Schedule C for business income on their federal taxes are required to file a return for the Commerce Tax, even though the gross income from those ventures may fall far short of the $4 million threshold.
Johnson added that the structure of the tax (based on revenues, not profits) gives business owners a powerful incentive to double-check their philosophy about invoices. Many companies, he explained, routinely include pass-through costs on their invoices.
The Commerce Tax exempts pass-through costs from the tax meaning pass-through costs need to be broken out separately so that they’re not part of the regular invoice. CPA firms have needed to get themselves up to speed on the new state law quickly, said Anna Durst, chief executive officer of the Nevada Society of CPAs.
“The Commerce Tax will be a challenge for firms because many clients will look to their CPAs to help fill out the forms and compute the tax. CPA firms will have to be proficient on the tax requirements and filing deadlines,” Durst said.
The Commerce Tax law established 26 different NAICS (North American Industry Classification System) categories within the tax structure. Each category pays a different tax rate. Manufacturers, for instance, pay a tax rate of .091 percent of their gross revenues while hotel owners pay .20 percent.
Even with the addition of the Commerce Tax, Nevada’s overall tax environment ranks fifth best in the nation, said The Tax Foundation, an independent think tank in Washington, D.C. A year ago, the state ranked third.
Nevada ranks as the fourth best environment for corporate taxpayers and tops for individual income taxes (the state doesn’t have an individual income tax). However, it ranks 42nd in unemployment insurance taxes, 39th in sales taxes and seventh in property tax rates.
Across the nation, risks appear to be rising for over-aggressive strategies to reduce federal income taxes.
After a couple of years in which budget cuts limited IRS enforcement, Mashas said the agency now has larger financial resources. That’s translating into an increase in audits and more “correspondence audits,” in which taxpayers receive letters asking them to explain items on their returns.
The agency appears to be particularly focused on deductions for money-losing small businesses, especially if the business has lost money for several consecutive years and may be an expensive hobby rather than a profit-oriented business. “They’re really hot on that topic,” said Mashas.
The IRS has also indicated it’s looking closely at several areas of individual and business returns, Johnson said, including:
• The tuition credit that’s claimed by
parents of college students.
• Amended returns.
• “Reasonable compensation” questions on small business returns.
So does all this mean it’s time for business owners and managers to get together with their CPA to map out tax strategy for the rest of the year? Yes.
“Too often, we don’t see business owners until March of the next year,” said Bailey. “I call that ‘post-mortem tax planning.’ When that happens, you’re toast.”
Mashas suggested that Jan. 2 of the current year is a good date to begin planning. “A tax strategy should be a 365-day process,” she said. “Everything you do should involve tax planning.”
Even as they work with their clients on tax planning year-round — or at least for half the year — CPA firms around the state face their own challenges with the economic recovery.
Durst noted that CPAs’ bread-and-butter work of tax-preparation and audits stayed solid with the recession, but their clients now are asking for more ancillary services such as consulting, bookkeeping and planning.
Many CPA firms are increasing their staff, and mergers-and-acquisitions among accounting firms are on the rise as partners retire or firms look to expand into new geographic markets.
While the number of students majoring in accounting at colleges in this region is rising, demand for CPAs outstrips the supply as baby boomers continue to retire from CPA positions.
“Many students are choosing to go directly into industry accounting roles instead of public accounting which in turn challenges the pipeline of new CPAs,” Durst said. “There are many qualified accounting professionals in Nevada but not all of them are CPAs. This is a national trend not unique to Nevada.”
As of June, some 3,246 CPAs held Nevada licenses, and 2,448 lived in the state. Those figures, Durst said, are slightly higher than pre-recession levels.
A growth area for many CPA firms, especially those with some expertise in information technology, is assurance that business clients adequately address cybersecurity issues.
Those issues, always in the news as one retailer after another reports a breach, struck at the tax system, too. The IRS reported earlier this year that hackers got access to about 700,000 of its files.
Mashas noted that identity thieves continue to target individual and business taxpayers. Telephone callers who say they represent the IRS certainly are perpetrating a scam, she said. “The IRS will contact you only by mail. They won’t call,” Mashas added.
Businesses as well as individuals should take care that they routinely back up the files on their computers to protect themselves against thieves who can take over computers remotely and demand ransom to allow access to files. Such simple maneuvers will go a long way to protecting businesses in this increasingly at-risk world.
While new filings and security challenges may plague both accountants and business alike, there are some positive things happening in the industry. And, smart business owners will leverage the opportunities available in regards to taxes with a solid strategy and a trusted accounting advisor.