Year-end planning for tax savings

Last December’s Tax Cuts & Jobs Act (TCJA) presents a challenge, both because of its wide-ranging scope and the opportunity to reap a share of that law’s much-touted tax savings.

Small businesses, especially those in the aggregate industry, should begin to see the promised tax savings when tax returns for the 2018 tax year are filed, but the full potential of tax savings can be realized only by planning now.

Quarry operators and aggregate business owners undertaking tax planning should be aware that the federal corporate tax rate streamlined to a flat 21 percent. The new 20 percent deduction for “qualified” income from pass-through businesses may, however, have some people thinking about changing the entity of their business as they face a tax rate as high as 29.6 percent. More about that later, though.

Profits from change

Among the areas every owner, operator and manager should think about before the end of the tax year are:

• Write-offs. An aggregate business is now allowed to fully write off the entire cost of new purchases, utilizing 100 percent bonus depreciation. Thanks to bonus depreciation, the cost of equipment, computers, vehicles and other business property can be written off in the year placed in service – in lieu of depreciating the cost over a number of years.

There is also the increased Section 179 first-year expensing write-off that doubled from $500,000 to $1 million. Section 179 now also includes fire protection, alarm systems and security systems.

• Repairs. New regulations that kicked in during the 2016 tax year today impact every aggregate producer that has fixed assets. The so-called “de minimis” safe harbor deduction for materials and supplies increased from $500 to $2,500, at least for those businesses without an applicable financial statement. Fortunately, it is not too late to update the crushed stone, sand or gravel operation’s policy for differentiating repairs from capital expenditures to comply with the updated regulation.
• Abandon, don’t sell. If equipment or other assets have no value to the business, the benefits of abandoning it before the end of the tax year – rather than selling – might be rewarding. Abandonment generates an ordinary, fully deductible loss, rather than a capital loss, which is subject to limitations. Of course, abandonment must be documented and the property really abandoned.
• Writing off entertainment. Business-related entertainment, amusement or recreational expenses are no longer deductible after the TCJA. Business meals, of course, remain 50 percent deductible.
• Family and medical leave tax credits. As part of the TCJA, employers are now able to claim a tax credit, which is a reduction in the crushed stone, sand and gravel operation’s tax bill (as opposed to a deduction in the income that tax bill is based on) on wages paid to qualifying employees while they are on family or medical leave.

In order to claim the credit, there must be a written policy that provides at least two weeks of paid leave annually to all qualifying employees who work full time. What’s more, the paid leave must be no less than 50 percent of the wages normally paid to the employee.

• Limiting the deduction for business interest. The TCJA placed new limits on the deduction for business interest, restricting the deduction to 30 percent of the operation’s adjusted gross income. Questions remain about what constitutes investment rather than business interest and how the limits apply to pass-through entities and consolidated groups. Note: Corporate debt is considered to be business interest rather than investment interest.

Fortunately, an exception exists for small aggregate businesses, those with gross receipts that have not exceeded a $25 million threshold for a three-year period, designed to protect their ability to write off interest on loans for starting or expanding the business, hiring workers or increasing paychecks.

• Vehicle expenses. What percentage of a car, light truck or SUV used in or by the aggregate business constitutes business usage? Whatever the percentage, that amount may qualify as an auto expense.

The IRS allows two ways to calculate the deduction. First, there is the actual expense to which the percentage is applied to create the business auto expense deduction. Second, tracking the actual mileage for business purposes and using the 54.5-cents-per-mile standard write-off.

• Don’t forget those carryovers. Deductions for capital losses, net operating losses, home office deductions and even large charitable donations that cannot be fully used in one year may be carried forward to future years. Because these items have a way of slipping through the cracks, every aggregate business should record and closely track these deductions, as well as note carryovers from the current tax year’s return. Net operating loss (NOL) carrybacks, of course, are no longer permitted.

Reasonable compensation and bonuses

Paying bonuses and ensuring the operation doesn’t overpay an owner, manager or key employee can be quite complicated. Paying bonuses early or creating a separate payroll strictly for bonus payments might simplify things for both tax and accounting purposes.

The owner of an incorporated aggregate business who works in the operation might want to carefully consider his or her salary. S corporation owners benefit from a low salary because amounts that aren’t salary escape payroll taxes.

On the other hand, owners of regular C corporations generally benefit from a higher salary and lower distributions. While employment taxes are paid on the salary, the earnings paid as salary are only taxed once. Earnings that are distributed as dividends are taxed twice – once at the corporate level and a second time at the individual level.

The IRS frequently challenges salaries they deem “unreasonable.” While factors used by 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; dividend history; employee payments and bonuses; compensation agreements; the amount paid by comparable businesses for similar services; and the use of a written bonus formula.

The pass-through conundrum

To even the playing field between incorporated businesses and their new 21 percent corporate tax rate, the TCJA created a 20 percent deduction for income earned from pass-through entities such as sole proprietorships, partnerships and S corporations. While eligible taxpayers may be entitled to the deduction of up to 20 percent of qualified business income, for those with taxable income that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all others, the deduction is subject to limitations.

Pass-through owners will also need to pay close attention to some of the personal income tax deductions removed under the TCJA (including personal exemptions and the deduction for state and local income tax) and, of course, the increased amount of the standard deduction.

Planning before year’s end

As the end of the aggregate producer’s tax year approaches, several general rules might help guide the business to real tax savings that will be consistent year-after-year:

• Don’t spend money simply to reduce that tax bill. After all, a dollar spent does not equal a dollar worth of taxes saved or create a one-dollar deduction. Also, keep in mind that if those accelerated deductions result in an NOL, it can now only be used to offset tax bills down the road, as there is no longer an NOL carryback.
• Know thy accounting method. Most, but not all, year-end tax strategies work best for cash-basis taxpayers. Accrual-basis aggregate producers report all income in the year it is earned and all expenses in the year they are incurred. So, just because a crushed stone, sand or gravel operation is paying for a 2019 expense in 2018 doesn’t always result in an immediate deduction on the 2018 tax return.
• Chart a “pro forma” analysis of the aggregate operation’s tax liabilities. Do this for 2018 using the new rules, deductions and credits. By using estimated income and expense figures, this should not be too difficult. Otherwise, the true impact of reform will not be known until the tax return is prepared – when it may be too late to make any moves to reduce it.

Putting it together

Don’t forget the type of entity the aggregate business operates as. Depending on whether the crushed stone, sand or gravel business files as a “pass-through” entity such as an S corporation or partnership, or as a regular C corporation, significant tax savings might be achieved by changing how the operation files. Obviously, the numbers should be run now and possible changes considered early next year, or, in some cases, right on the annual tax return.

Once the work is done and the alternatives have been tested, would the aggregate business profit from a series of aggressive year-end tax strategies? Or, would a more conservative approach produce lower tax bills in the years ahead? Above all, ensure the business is actually spending money and not just moving it around.

Finally, if the business’ tax professionals are not already involved in the planning process, now might be a good time to enlist their aid.

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