Year-End Planning Tips for Retailers in Light of Pending Tax Reform
As each year draws to a close, we advise retailers to revisit their tax management strategies and plan as judiciously as possible for the remainder of the year and, in some cases, the years ahead.
However, with proposed tax reform legislation making its way through Congress, things are a little more complicated this time around. The Tax Cuts and Jobs Act contains some favorable tax rate cuts, but there’s still not much clarity on other possible provisions that could limit or eliminate certain deductions and credits. In any case, the final package, if enacted, will very likely bring changes that could affect both your business and personal tax planning. Until we have final legislation, taxpayers are generally left with making some educated projections when it comes to tax planning this year.
So, this year’s tax-planning checklist is offered in light of pending tax reform. You can still craft an advantageous and compliant strategy for 2017 and beyond — just remember that some items are tentative. And, of course, this is not meant to be an all-inclusive list, but these items are the most common strategies we recommend retailers implement to manage their overall tax burden.
S corporation or partnership losses
If you own an interest in an S corporation, you may need to increase your tax basis in the entity so you can deduct a current-year tax loss against other income. If you are reporting losses, you should review the tax basis in your entity’s stock, as well as the tax basis in loans to the entity, to ensure that you have sufficient tax basis to deduct the loss on this year’s personal income tax returns. These strategies may require adjustment prior to the end of 2017.
S corporation owner’s health insurance deduction
Based on a directive from the IRS, it is important that the corporation pay the health insurance premiums of an S corporation shareholder or reimburse the shareholder for premiums paid personally, in accordance with a corporate plan. Those premium payments must be added to the owner’s Form W-2 as taxable wages. This allows the individual owner to claim a deduction for the health insurance costs. The income added on Forms W-2 is not subject to FICA or Medicare.
Section 179 expense and bonus depreciation
The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) was passed by Congress late in 2015 and had more long-term implications than prior end-of-year tax laws. For 2017, the Section 179 first-year expense deduction is $510,000. This allows a retailer to purchase up to $510,000 of new or used equipment, furniture, or fixtures by year-end and expense the entire purchase price to the extent of taxable income. Once total expenditures for such assets exceed $2,030,000, the amount of available Section 179 expense begins to phase out. At $2,540,000 of expenditures, it is completely phased out. Additionally, 50 percent bonus depreciation is still in effect for tax year 2017. This is not subject to taxable income limitations, unlike Section 179 depreciation.
Do you lease real estate to your own business entity? If so, the passive activity loss rules present a significant threat. If your Form 1040 has a mix of positive and negative net income amounts among your rental activities, the passive loss risk needs to be carefully assessed. Grouping rules may allow you to offset your rental losses with your retail profits to avoid disallowance of the losses.
Officer note payable repayments
If your entity or another business has generated tax losses in the past, review current-year loan repayments made to shareholders. If prior-year losses have been deducted based on money borrowed from shareholders, the repayment of such loans may create taxable income to the shareholder in the year of repayment. Review your loan activity in 2017 and consult with a tax advisor to determine if an unwelcome tax surprise may result.
Joint taxpayers with combined earned income in excess of $250,000 will be subject to an additional 0.9 percent Medicare tax in 2017. Consider your wages for 2017 to determine if it is possible to reduce your wages to below this amount. For many S corporation retail owners who are planning on receiving wages more than a reasonably-low amount, it may be worthwhile to determine whether you can reduce wage payments and instead take S corporation distributions to avoid this additional tax. Wages, however, must be reasonable for the services provided.
Recognize income in 2017 or 2018
Consider postponing income to the following year for tax deferral, if possible. Taxpayers with taxable income in excess of $400,000 should review current-year income compared to expected income for 2018 to see if taxable income should be maximized in 2017 or deferred. Married taxpayers with taxable income over $470,700 will be subject to the highest federal tax rate of 39.6 percent. The effective rate, due to phase-outs of deductions for high-income individuals, may be higher. For singles, the threshold for taxable income is $418,400. If tax reform reduces tax rates as promised, it may be advantageous to defer income where possible, as it could be subject to lower rates in 2018.
Cost segregation of buildings or improvements
Any building acquisition, construction project, or renovation which costs more than $500,000 can usually defer tax liabilities and provide a cash flow benefit through some form of a cost segregation study. These studies separate the various costs of the structures and land improvements into different depreciation methods and shorten the depreciable life categories, which accelerate your tax deduction for depreciation. The tax depreciation may be greater than the book depreciation methods used for your financial statements.
Capitalize or expense store repairs?
Generally, most retailers’ fixed assets are capitalized and depreciated over a number of years. The regulations in place now may allow retailers to expense items that you would have depreciated in past years. Effectively implementing these capitalization policies will allow your store to expense items that cost less than $2,500, and may allow for expensing items up to $5,000. This can benefit a retailer and should be looked at closely. You should also consider identifying previously capitalized expenditures that now may be deductible as repairs and maintenance under the new guidance.
Make sure to reconcile your inventory balances on your books with your store inventory count. This is normally done if a physical inventory is taken, but it doesn’t require one. Reconciling the two inventory balances often results in decreased taxable income due to various issues related to shrinkage. Consider writing off obsolete inventories or donating them before year-end to establish a deduction.
Net investment income tax
The net investment income tax is 3.8 percent again for 2017. Individuals at the top marginal tax rate will have an effective rate of at least 43.4 percent. This is a tax on interest, dividends, rental income, capital gains, and passive income. Through the use of grouping elections, changing interest rates on shareholder loans and other planning to reduce capital gains, it may be possible to reduce your income subject to this 3.8 percent additional tax. The additional 3.8 percent tax does not apply to net rental income generated from the retailer renting its building from the retailer’s owner.
Harvest capital gains or losses
If you have unrealized gains or losses in your stock portfolio, there is a potential to use them for 2017. If your income is low for 2017, it might make sense to recognize gains, pay the tax at a lower rate, and then repurchase similar holdings. If your income is already quite high for 2017, consider recognizing losses to reduce your tax liability and then repurchase similar holdings. Because of the wash sale rules, you have to be careful. However, there are ways to harvest losses without triggering the wash sale rules. If this is applicable to you, please let your tax advisor know, as the sale has to occur in 2017. Likewise, if you already have carryover capital losses from previous years, you could harvest gains in order to offset those losses, as you can only deduct a net loss of $3,000 per year.
Meals and entertainment expenses
Many retailers lump all meal and entertainment expenses into one account. As a result, most of these expenses will only be deductible at 50 percent of their value on your company’s tax return. Under current tax law, there are some instances when these expenses could be deductible at 100 percent. Therefore, these expense accounts should be carefully reviewed to determine if there are any meals and entertainment that could be 100 percent deductible. Cash method taxpayers should pay accounts payable for meal and entertainment expenses prior to the end of the year. Pending tax reform proposals eliminate entertainment deductions and may reduce deductions for meals.
Review January expenses and other chargebacks
Taxpayers are usually encouraged to review their expenses paid in January of 2018 to determine if they are properly deductible in 2017. With the significant tax rates many retailers may face this year, you will want to review all January and February invoices to find those that can be deducted in 2017.
Maximize contributions to your 401(k) and other retirement plans
Many retailers have instituted retirement plans so employees can make contributions to reduce the employees’ wages. Most of these plans have limits on the amounts that officers and owners of the retail store may contribute (and sometimes require that such contributions are returned at year end). However, owners frequently do not contribute the maximum amount. After the year ends, the opportunity to contribute more is missed. Contact your retirement plan administrator to determine if you can contribute additional funds to these accounts.
Compensate your children for work
If your children provide, or could provide, services to your store, consider the benefits of paying them for their services. This may introduce them to the idea of working to earn compensation. At the same time, it may reduce your overall family tax burden based on tax rate differences. The wages earned by your children could be contributed to a Roth IRA for lifetime tax-free growth.
Tax transcript review
The end of the year is usually a good time to review all tax account transcripts from the IRS and any applicable states. These reports contain information that allow you to confirm payments, credits, and audit adjustments, for example. They can also contain other items that you might not be aware of, such as penalty/interest assessments or simple posting errors made by the agency. Identifying these errors and addressing them prior to year-end allows taxpayers to “clean up” the year and start 2018 on the right foot.
Resale certificate review and use tax
In states where sales tax applies, it is critical that you provide a resale certificate to your supplier in order to purchase goods acquired for resale sales tax-exempt. Failure to provide a properly completed exemption certificate to your supplier could create some unexpected issues for you and/or your supplier if examined by the state. As such, we recommend you take a proactive approach and review your supplier resale certificates to make sure they have been provided or, in some cases, have not expired.
If you have purchased any items from out-of-state vendors, we recommend you review these purchases to ensure the proper sales tax (if applicable) has been added. Where sales tax has not been added, you may be liable for use tax in your state. Retailers have exposure in instances where they have purchased equipment, supplies, fixtures, and generally any other form of tangible personal property for use in their stores, especially if the assets have been acquired out-of-state or through the internet. As such, these accounts should be carefully examined to ensure your company is in compliance.
How we can help
Our retail industry tax practitioners can help you both comply and optimize tax savings for your business and yourself. We can also work with you to develop a strategic tax plan and make sense of the complex regulations and rules.