Transportation and logistics companies always have their work cut out for them when it comes to tax planning. It can be tempting to stick to rote industry tax-mitigation practices, like buying equipment for write-off and limiting strategies almost exclusively to income taxes. But it’s generally much smarter to look at the entirety of your business, take the long view, and balance taxes with operations for the greatest money-saving benefits overall.
As you consider your approach, pay special attention to equipment, property improvements, accounting methods, and other available credits and deductions, without defaulting to old tax habits.
Equipment: Don’t let the tax tail wag the dog
When tax time rolls around, many transportation company owners have been conditioned to reflexively ask, “I’ve bought enough equipment, haven’t I?” Under the generous Section 179 or bonus depreciation rules, you’re often able to completely write off equipment purchases. But if you look more closely, you may find you’re making unnecessary business purchases just because you don’t want to pay taxes.
For example, let’s say you bought three trucks (all of which are now sitting idle) because you thought you needed the depreciation expense to sidestep your income tax, but it turns out you don’t have the drivers to operate them. Let’s assume you’ve spent $480,000 on those three trucks to get the write-off. You had $480,000 of taxable income prior to the depreciation expense, and — poof! — you eliminated your income and tax liability with the purchase. But now there are payments to make on that equipment, which is just sitting in your lot, not making you any money. You’ve spent $1 to save 40 cents. Or perhaps you traded in older assets rather than just add new ones, and the equipment is in service and being used. But did you trade it in too soon and not fully utilize the value of the old equipment? That can be costly, too. The point is, tax strategy should be based on managing taxes, not simply eliminating them. Too often equipment investment is the main strategy companies use to decrease their tax liability. We call this letting the tax tail wag the dog.
It’s true that the transportation industry is extremely capital-intensive, and in a normal trade cycle, there is likely a large dollar amount of new equipment available for depreciation each year. With 100% bonus depreciation and a Section 179 limit of $1.02 million (dollar-for-dollar phase-out for purchases over $2.55 million), you can likely write off most, if not all, of your equipment purchases. Be cautious, though, because you will have effectively expensed the equipment so you receive no benefit for these purchases in the future. You will need to buy more equipment next year to get the benefit again. Be aware that you can elect out of bonus depreciation, not take Section 179, and get a reduced expense each year over the tax life of the equipment. Sure, this means higher taxable income in the current year, but a sound tax strategy considers the entire business over both the short and long terms and looks beyond mere tax reduction.
Many transportation companies utilize trades to acquire new equipment, which in the tax world is called a like-kind exchange. Under prior law, you could defer the gain on the asset traded in and essentially reduce the amount you capitalize on the new equipment. Unfortunately, that is now only allowed for real property. Effective January 1, 2018, any equipment trade-in is treated as a sale of that equipment for the trade value received, and the gain or loss must be recognized. If sold at a gain, the gain can be offset by taking Section 179 or bonus depreciation on the new piece of equipment, but this generally only works for federal tax purposes. Many states do not follow bonus depreciation and have reduced Section 179 limits, so the entire gain likely can’t be offset for state tax purposes.
This brings up the conflict between operations and taxes. It’s quite possible that you will receive more for your used equipment by selling it outright instead of trading it in. Dealerships have to make a profit on the used equipment they take in, so you aren’t getting top dollar. Selling equipment yourself generally means more gain, which equals more tax, but ultimately more cash will go to your business to fund future purchases and operations.
Equipment repairs and maintenance can be daunting. New tangible property regulations, generally effective for tax years beginning on or after January 1, 2014, provide significant opportunities for many items to be expensed rather than capitalized and depreciated. Again, many states do not follow bonus depreciation and have reduced Section 179 limits, so if you can expense an item or repair you can get both federal and state benefits.
Property improvements: Be aware of Section 179 benefits
Do you own a building? On top of the tangible property regulations providing more opportunities to expense items, the Tax Cuts and Jobs Act expanded Section 179-eligible property to include roofs, HVAC property, security systems, and fire protection and alarm systems if they are improvements to nonresidential real property and placed in service after the date the original building was first placed in service. In most cases, in order to take Section 179 on items of real property the building needs to be owned through the operating entity.
Did you remodel a building? The owners may shy away from investing too much into a building that they have to write off over 39 years, but don’t forget about the designation of qualified improvement property (QIP). QIP is eligible for Section 179 as is any improvement to an interior portion of nonresidential real property if placed in service after the date the original building was first placed in service. QIP does not include any enlargement of a building, elevators, escalators, or internal structural framework.
Employees: Reward your people in a tax-savvy way
Your employees are more important than your equipment, and with the industry’s driver shortage, you want to make sure you are taking care of your people so they don’t go elsewhere. Is your tax projection showing a high taxable income? Bring down the tax liability by rewarding those employees who helped create that good situation by paying or accruing bonuses before year-end.
Employer contributions to retirement plans are another great option. Whether you file your tax return on a cash or accrual basis, you can accrue an employer retirement plan contribution, receive the benefit of the expense in the current year to lower taxable income, and not have to pay the contribution until the due date of the return, including extension.
Tax reform: Take advantage of cash-basis accounting
Do you remember all that talk of tax reform? You should still be hearing about it. One large piece of it was the expansion of the ability to use the cash method of accounting. Many companies were previously required to be accrual-basis taxpayers. Under tax reform, C corporations and partnerships with C corporation partners (other than tax shelters) that average less than $25 million in gross receipts are eligible to be cash-basis taxpayers.
Qualified personal service corporations, partnerships without C corporation partners, and other pass-through entities are generally allowed to use the cash basis, regardless of whether they meet the gross receipts test. The gross receipts threshold will be adjusted for inflation for years beginning after December 31, 2018. By electing the cash basis, you will be taxed on revenue when cash is collected and deduct expenses when paid. Under normal accrual accounting, you are taxed on income when you earn it or when it is due, even if it’s not collected, and get a deduction for expenses even if you haven’t paid them yet.
The cash-basis accounting method is ideal for those companies that typically have accounts receivable greater than their accounts payable and accrued expenses. For smaller companies, the cash method is often much easier to administer and a simpler concept to understand.
Fuel credits: Claim this easy money saver
Are you using fuel that you paid an excise tax on in your auxiliary power units, reefer trailers, yard trucks, forklifts, and other equipment? You may be eligible to claim a fuel tax credit on Form 4136. The credit is refundable but must be included in income if you claimed an expense for the purchase of the fuel. For 2018, the credit was $.183 per gallon for off-highway business use of gasoline and $.243 per gallon for nontaxable use of undyed diesel fuel. Many states also offer a fuel tax credit, but it may require filing a form separate from your income tax return.
WOTC: Plan ahead for this lucrative credit
Another tax credit often talked about but rarely taken is the Work Opportunity Tax Credit (WOTC). It requires better communication and a little more legwork but can be lucrative. If you hire individuals from certain targeted groups, such as unemployed veterans or food stamp recipients, you may be eligible. The credit can be as high as $9,600. It requires up-front work when you are going through the hiring process, so don’t wait until you are giving your year-end information to your accountant to discuss WOTC. The credit is nonrefundable, but in the event, you have an excess credit over your tax liability, it can be carried back one year or forward for 20 years.
Sales tax: Don’t forget to plan for it
Transportation companies often benefit from many sales tax exemptions that can be overlooked in the whirlwind of daily duties and the greater pursuit of income tax strategy. For just a flavor or the tax savings that can be had: Wisconsin offers a sales tax exemption on tractors and trailers along with accessories, supplies, parts, and related repair services if used exclusively as a common or contract carrier; Minnesota provides a partial exemption for the same types of items for companies whose vehicles incur mileage outside of the state’s borders. A reverse sales tax audit can help uncover savings.
How we can help
All too often, tax planning is a rushed conversation in December about what the books look like and what your company may owe. Instead, it should be a year-round strategy. CLA’s transportation and logistics professionals work with business owners year-round to devise tax-advantaged plans that consider the whole business — including its owners —in the immediate future and over the long haul.