Legal Updates

Still Time for Business Tax Planning

As 2015 draws to a close, there is still time to reduce your 2015 tax bill and plan ahead for 2016. This memo highlights several potential tax-saving opportunities for business owners to consider.

• Defer Income into 2016. Deferring income to the next taxable year is sometimes a useful year-end planning tool. If you expect your taxable income to be higher in 2015 than in 2016, or if you anticipate being in the same or a higher tax bracket in 2015 than in 2016, you may benefit by deferring income into 2016. Of course, in the case of an individual taxpayer, exposure to the alternative minimum tax could reverse the standard planning. Some ways to defer income include:

o Use of Cash Method of Accounting: By adopting the cash method of accounting rather than the accrual method, you can put yourself in a better position to accelerate deductions and defer income. Because an automatic change to the cash method can be made by the due date of the return, including any filing extensions, there is still time to implement this planning idea. The following three types of businesses can make an automatic change to the cash method:
      small businesses with average annual gross receipts of $1 million or less (including those with inventories that are a material income producing factor);
      C corporations with average annual gross receipts of $5 million or less in which inventories are not a material income producing factor; and
      taxpayers with average annual gross receipts of $10 million or less.

Provided inventories are not a material income producing factor, sole proprietors, limited liability companies (LLCs), partnerships, and S corporations can change to the cash method of accounting without regard to their average annual gross receipts.

If you are already on the cash method or if you qualify for a change and elect to change to the cash method, delay year-end billing to clients so that payments are not received until 2016.

o Installment Sales: Generally, a sale occurs when you transfer property. If a gain will be realized on the sale, the installment method permits income recognition to normally be deferred until payments are received. Consequently, if you sell property prior to the end of 2015 and will receive one or more payments in future years, you should consider reporting the gain on the property using the installment method to defer payments (and tax) until next year or later.

o Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year. Unless you have constructive receipt of dividends before year-end, they will not be taxed to you in 2015.

• Accelerating Income into 2015. You may benefit from accelerating income into 2015. For example, if you anticipate being in a higher tax bracket in 2016, or perhaps you need additional income in 2015 to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. However, accelerating income into 2015 could be disadvantageous if you expect to be in the same or lower tax bracket for 2016.

If you report your business income and expenses on a cash basis, send bills and pursue collection before the end of 2015. Inquire as to whether some of your clients or customers are willing to pay for January 2016 goods or services in advance. Any income received using these steps will shift income from 2016 to 2015.

o Qualifying Dividends: Qualified dividends are subject to rates similar to the capital gains rates. That is, for taxpayers below the 39.6% tax bracket, qualified dividend income is subject to a 15% rate. For taxpayers in the 39.6% bracket, the rate is 20%. However, qualified dividends may be subject to an additional 3.8% net investment income tax as well. Qualified dividends are typically dividends from domestic and certain foreign corporations. If you are not in the highest bracket for 2015, but you expect to be in 2016, consideration should be made as to authorizing any dividend payment prior to the end of 2015 to utilize the 15% favorable tax rate vs. the 20% rate at higher income levels.

• Business Deductions.

o Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses, and their dependents as an above-the-line deduction, without regard to the general 10%-of-adjusted gross income floor. Self Employed Health Insurance includes eligible long term health care premiums.

o Equipment Purchases: If you purchase equipment, you may make a “Section 179 election,” which allows you to expense otherwise depreciable business property. For 2015, you may elect to expense up to $25,000 of equipment costs (with a phase-out for purchases in excess of $200,000) if the asset was placed in service during 2015.

Even though the Section 179 expense amount and phase-out have been much higher in the past, if Congress acts soon it could raise the 2015 Section 179 amounts. As of this writing, however, the recently enacted Bipartisan Budget Act of 2015 did not include any increase which makes it less likely that such legislation will be passed and if so whether that legislation would have retroactive application.

Even if expensing equipment purchases is not available under Section 179, careful timing of equipment purchases can result in favorable depreciation deductions in 2015. Generally, under the “half-year convention,” one may deduct six months’ worth of depreciation for equipment that is placed in service on or before the last day of the tax year (if more than 40% of the cost of all personal property placed in service occurs during the last quarter of the year, however, a “mid-quarter convention” applies, which lowers your depreciation deduction.)

o Home Office Deduction: Expenses attributable to using the home office as a business office are deductible if the home office is used regularly and exclusively: (i) as a taxpayer’s principal place of business for any trade or business; (ii) as a place where patients, clients, or customers regularly meet or deal with the taxpayer in the normal course of business; or (iii) in the case of a separate structure not attached to the residence, in connection with a trade or business. If you have been using part of your home as a business office, you should consider the amount of any deduction you should take because an IRS safe harbor could be used to minimize audit risk.

o NOL Carryback Period: If your business suffers net operating losses for 2015, you generally apply those losses against taxable income going back two tax years. For example, the loss could be used to reduce taxable income (i.e., generate tax refunds) for tax years as far back as 2013. Certain “eligible losses” can be carried back three years; farming losses can be carried back five years.

o Bad Debts: If you use the accrual method, you can accelerate deductions into 2015 by looking at the business’ accounts receivable and writing off those receivables that are totally or partially worthless. By identifying specific bad debts, you should be entitled to a deduction. You may be able to complete this process after year-end if the write-off is reflected in the 2015 year-end financial statements. For non-business bad debts (such as uncollectible loans), the debts must be wholly worthless to be deductible, and will probably only be deductible as a capital loss.

• Planning for 2015 Tax Increases and Potential Expiration of Tax Relief Provisions.

o Built-In Gains Tax for S Corporations (that previously were C corporations: An S corporation generally is not subject to tax; instead, it passes through its income or loss items to its shareholders, who are taxed on their pro-rata shares of the S corporation’s income. However, if a business that was formed as a C corporation elects to become an S corporation, the S corporation is taxed at the highest corporate rate on all unrealized gains that were built in at the time of the election if the gains are recognized during a special look back period which is generally 10 years. In recent years, this special period was significantly shorter (most recently, it was five years). However, it is uncertain whether legislation will be passed to shorten the special holding period for 2015 or subsequent years and, if passed, whether that legislation would have retroactive application.

o Basis Adjustment to Stock of S Corporations Making Charitable Contributions of Property: The rule that the basis of an S corporation shareholder’s stock is decreased by charitable contributions of property by the S corporation in an amount equal to the shareholder’s pro rata share of the adjusted basis of the contributed property expired for contributions made in taxable years beginning after December 31, 2014. As a result, absent congressional action retroactively extending the prior rule for charitable contributions made in 2015, your stock basis will be reduced by your pro rata share of the S corporation’s charitable contributions (at fair market value rather than adjusted basis). For example, if your S corporation contributed property with a $200 adjusted basis and $500 fair market value to a charity, your stock basis will be reduced by $500 instead of $200 unless Congress enacts legislation extending the prior rule.

o Exclusion of Gain Attributable to Certain Small Business Stock: Stock acquisitions that qualify as “small business stock” under § 1202 are subject to special exclusion rules upon their sale as long as a five-year holding period is satisfied. For qualified small business stock sold in 2015, the five-year look-back period is to 2010. A 50% exclusion applies for qualified small business stock acquired before February 18, 2009, and after December 31, 2014. A 75% exclusion applies for qualified small business stock acquired after February 17, 2009, and before September 28, 2010. A 100% exclusion applies for qualified small business stock acquired after September 27, 2010, and on or before December 31, 2014. For qualified small business stock acquired in 2015, only 50% of the gain is excluded from gross income (after the five-year holding period is met). Unless Congress acts before the end of 2015 to reinstate the 100% exclusion for stock acquired in 2015 (and held for at least five years), gain on the sale of such stock acquired in 2015 may be subject to the 50% exclusion rate.

The foregoing is general in nature and may or may not apply to your circumstances. Because every business is unique, you should review your situation with your tax advisers prior to implementing any strategy or making decisions concerning taxes as the year-end approaches.

If you have any questions, please do not hesitate to call.