An aggregate producer’s guide to tax planning

Good tax planning is based on an aggregate business’ current tax rate versus its future tax rates.

Federal tax reform continues to loom on the horizon. So long as every owner and operator is aware that there is some likelihood that tax rates – and perhaps the rules – will change next year, now is an excellent opportunity for effective tax planning, as well as savings.

In addition to deferring income until next year when tax rates may be lower, looming tax reform would also make it more valuable to accelerate deductions into the current tax year. This would offset the current tax rates that will, no doubt, be higher than next year’s.

But, tax reform or not, the following areas warrant consideration when planning to reduce tax bills and avoid potential pitfalls:

> Year-end purchases: Under the Section 179 first-year expensing option, an aggregate business is allowed to expense up to $500,000 in new equipment purchases. Of course, the write-off is reduced if Section 179 property in excess of $2 million (increased by inflation) is acquired during the tax year. Making this election accelerates the write-off, creating an immediate tax benefit for outlays.

> Bonus depreciation: A pit or quarry operation can claim a first-year bonus depreciation for purchases of qualifying new, unused equipment and software put to use before the year’s end. The 50 percent bonus depreciation is on top of any allowable Section 179 deduction. The bonus phases down to 40 percent in 2018 and 30 percent in 2019.

> Abandon: Unwanted, unneeded equipment or property that has no value to a crushed stone, sand or gravel business could be abandoned rather than sold for a nominal amount. The resulting ordinary loss on the abandoned property, equipment or business asset is fully deductible rather than treated as a capital loss.

Depending on the property it may be classed as Section 1231 property, a loss that may be either ordinary or capital depending on other transactions for the year.

> Repairs: New guidelines for differentiating depreciable capital improvements from the immediately deductible repairs kicked in last year. Today, thanks to a de minimis safe harbor, deduction for material and supplies has increased from $500 to $2,500 for aggregate businesses that don’t have an applicable financial statement.

With a financial statement, an aggregate business can label costs up to $5,000 per invoice as materials or supplies without questions from the IRS.

> Business use of vehicles: The standard mileage allowed in 2017 for automobiles and light trucks used in the operation is 53.5 cents per mile – down from 54 cents in 2016.

> Vehicle depreciation: Those using the actual expense method, rather than the standard mileage rate, are limited to a maximum depreciation deduction for automobiles placed in service during 2017 of $11,160, including bonus depreciation and $3,160 if bonus depreciation does not apply.

For trucks and vans, the limit is $11,560 for the first tax year if bonus depreciation applies and $3,560 if it does not apply.

> Off-road vehicles: Calculating the write-offs for off-road equipment is a difficult task. Some aggregate operations may be liable for the federal highway vehicle use tax.

Obviously, off-road equipment is depreciated differently than cars or pickups. Everything is different, including insurance costs, because these vehicles are not driven on public roads or highways.

A number of quarries overlook the refund or credit available for federal excise taxes paid for motor fuels and similar state purchases. The taxes are on fuels used to power vehicles and equipment on roads and highways. Taxes paid for fuel to power vehicles and equipment used off-road may qualify for a refund or credit.

> Reasonable compensation: The IRS can, and will, challenge salary amounts they deem to be “unreasonable.” While the factors used by the IRS and the courts to determine reasonable compensation vary, the IRS typically looks at training and experience, duties and responsibilities, time and effort devoted to the business and more.

The courts generally look at amounts paid by comparable businesses for similar services, the use of a bonus formula and the importance of the role played by the compensated individual.

> Carryovers and carryforwards: Certain credits and deductions have limits that prevent them from being used in full in the current tax year, but could be carried over to future years. Think:
■ Capital losses
■ General business credits
■ Home office deductions

> Net operating losses: Net operating losses (NOLs), or non-capital losses, occur when the aggregate business’ expenses exceed its income. NOLs can be used to offset income in any given tax year, as well as carried back three years or carried forward for up to seven years.

It may make more sense to carry any NOL back to recover income taxes already paid. Or, it can be carried forward to offset an anticipated larger tax bill down the line. But remember the possibility of lower tax rates.

> New deadlines: In an attempt to stagger filing deadlines so tax returns of entities that “pass through” income and losses, such as partnerships and S corporations, tax returns are now due by March 15 as opposed to April 15. Regular C corporation tax returns are now due by April 15 as opposed to March 15.

> Form 1099 and W-2 deadlines: The IRS is no longer granting automatic extensions for filing Form W-2. To stop the increase of identity theft, lawmakers require employers to file Forms W-2, W-3 and 1099-MISC statements to the IRS and the Social Security Administration by Jan. 31, 2018.

Proposed tax rates and pass-through businesses

Income from aggregate businesses such as partnerships, S corporations and sole proprietorships claimed on individual tax returns – that is, “passed through” to the business owners – is taxed at the owners’ individual tax rate. These businesses already have the advantage of being exempt from the corporate tax on profits and taxes on dividends.

The proposed reductions in the federal tax rate are expected to significantly reduce the tax bills of aggregates businesses incorporated as regular C corporations. However, this reduction would give closely held businesses a significant reason to consider converting their pass-through entities, which are currently taxed at the owner level, to regular corporations.

The Trump-proposed tax “reform” would:

■ Reduce regular, C corporation tax rates to 15 percent.

■ Eliminate the net investment income tax, which is an additional 3.8 percent tax on high-income shareholders’ pay on distributions.

■ Further complicating matters, the tax rate on income passed through from S corporations and other entities would be lowered, but only if the earnings are retained in the business. Earnings distributed to shareholders would, potentially, be taxed at a higher rate.

If these, or other tax rate reduction proposals, become a reality it could mean significantly lower taxes on regular corporations and their shareholders, with many businesses seriously thinking about changing the type of entity they do business as. The pros and cons to think about:

■ Changing from a pass-through entity or a regular corporation is usually not complicated. An LLC or another entity taxed as a partnership files Form 8832, Entity Classification Election. In most cases, the transformation is tax-free.

■ The downside of converting to a regular corporation is primarily the double tax that will ultimately be paid on the liquidation of the corporation or the sale of its assets followed by a distribution of the sale proceeds to the owner. The tax rules allow a partial exclusion of gain from the sale of some small business stock.

■ The relief of liabilities upon conversion may exceed the owners’ adjusted tax basis in the entity. Fortunately, the tax-free transition door swings just one way, so owners and producers should analyze both the potential benefit and pitfalls of changing the form of entity because conversion back to a pass-through could carry a significant tax cost.

■ Further costs could include self-employment tax on partners and accelerated phaseouts from the increase in the owner’s adjusted gross income.

Making plans to plan

While good tax planning is commonly based on current versus future tax rates, the significance of looming tax reform can’t be ignored. In fact, the potential of tax reform next year makes tax deferral even more valuable, especially for really profitable aggregate businesses or those subject to the highest marginal tax rate.

In addition to deferring income until next year when tax rates may be lower, the possibility of tax reform would also make it more valuable to accelerate deductions into the current year. After all, if next year’s tax rates will be lower than this year’s rates, then tax deductions will be less valuable next year than this year.

There are a number of decisions to make. Will profits be greater next year? Will tax rates finally come down? Will deductions be limited? Making these decisions and more, as well as planning to reap tax savings year after year, requires professional assistance now – not just as tax returns are being prepared.

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Mark E. Battersby is a freelance writer who has specialized in taxes and finance for the last 25 years.