It’s that time of year again; when firms begin projecting where they are going to end up at year end and determining which tax saving strategies they might utilize to help reduce or defer their taxes. Unlike this time last year, for 2016, firms can plan with more certainty due to a number of tax provisions being made permanent in December 2015. Some planning strategies need to be employed prior to December 31st, while others can be contemplated and executed after year end.
BEFORE DECEMBER 31ST
Fixed Asset Purchases
Firms making purchases of fixed assets (including qualified leasehold improvements) can expense up to $500,000 in 2016. However, there are limitations. Purchases are reduced dollar for dollar as the amount placed in service exceeds $2 million. Expensing these purchases cannot create or increase a firm’s loss. If a firm is projecting a loss, bonus depreciation of 50% of eligible purchases can be a better option. One caveat to be aware of is that states generally deviate from federal rules in determining depreciation. Reducing taxes by purchasing equipment should only be done if the fixed asset purchases are needed currently or in the near term. Making purchases of fixed assets purely for the tax benefits is not advisable if the fixed assets are not needed (don’t spend $1 to save 40 cents in taxes).
For Cash Basis Firms - Prepayment of Expenses
Firms that file their tax returns on a cash basis deduct expenses when paid, rather than when the cost is incurred. That being said, a firm can prepay 2017 expenses, such as rent, health insurance, and professional liability insurance and receive a deduction on its 2016 return. If cash flow is tight at year end, consider using an available line of credit or credit cards to pay or prepay expense, thereby generating a deduction temporarily delaying the cash outlay.
For Cash Basis Firms – Defer Revenue
When given the opportunity to do so, firms bill in advance under the theory that the cash is better in their pocket sooner rather than later (think time value of money). Firms that file on a cash basis should realize their advance billings receipts are taxable. By managing advance billings the last two to three months of the year, a cash basis firm can help reduce their receipts (revenue) thereby reducing their taxable income.
AFTER DECEMBER 31ST
Cost Segregation Study
If your firm recently purchased or developed a building or remodeled existing space, consider having a cost segregation (“Cost Seg”) study done. A Cost Seg study identifies the components of the property that can be depreciated faster, increasing current deductions in 2016 and in future years. Typical components that can be depreciated faster include decorative fixtures, security equipment, parking lots, and landscaping.
Research and Development Credit
A firm favorite. Having a research and development credit study done can help to generate a credit that can be used to offset taxes. A credit is generally better than a deduction as the benefit is dollar for dollar reduction in taxes, whereas a deduction’s benefit is limited to a tax paying entity’s effective tax rate. The large beneficial change for 2016 is that the research and development credit can also be used against alternative minimum tax (“AMT”) broadening its benefit to qualifying firms (generally those with gross receipts less than $50M over the past three years).
Profit Sharing and 401(k) Contributions
Firms, including those that file their returns on a cash basis, can deduct 401(k) matching and profit sharing contributions in the 2016 tax year even though the payment needs only to be made by the extended due date of the return. This gives a cash basis firm the ability to take a current year deduction without having to expend the cash until the subsequent year.
Domestic Production Activities Deduction
This federal deduction is intended to provide tax relief for firms that produce goods in the United States rather than producing it overseas. Firms generally qualify for the deduction, but there are limitations. Eligible services include consultation, planning, aesthetic and structural design, and supervision of construction. For 2016, the deduction equals 9% of the net income from eligible activities, with a limit of 50% of certain wages that are attributed to domestic production.
Energy Efficiency Tax Deduction
This deduction, which must be assigned to a firm by its government clients, provides a deduction of up to $1.80 per square foot for renovations or new construction where a building’s envelope, HVAC and/or lighting components surpass benchmarks for energy efficiency. It is good practice to discuss the assignment of the deduction with your client during the planning phase of the project as the client can assign the deduction to any of the major players in a project, including an architectural or engineering firm or contractor.
Using any, or a combination, of the above strategies can help a firm minimize its taxes. Some of the strategies also involve making a business decision (whether or not to make a profit sharing contribution), while by not exploring others (Cost Seg or Research and Development), a firm may be paying more in taxes than it needs to.