Plan now, save later

No less a body than the U.S. Supreme Court has ruled that striving for the lowest possible tax bill is perfectly legal. Thus, planning to produce the lowest possible tax bill possible should be the goal of every green industry business. Accomplishing that goal year after year usually involves shifting income and deductions around to tax years where they will be the most productive.

For those nurseries whose tax rates will potentially be lower in 2018, end-of-the-year tax planning is simple: defer any income possible, pushing it into the lower tax rate of next year. In addition to deferring income until next year, looming tax reform might make it more valuable to accelerate deductions into the current tax year offsetting the current tax rates that will, no doubt, be higher than next year’s.

Major maneuvers before and after

Under any new law, depreciation could largely be a concept of the past. Most of the reforms proposed would allow nurseries to immediately write-off (i.e., expense) the cost of new investments in depreciable assets other than structures, for at least five years – if this reform proposal becomes a reality.

In the meantime, Section 179, the first-year expensing allowance continues as an option. Under the Section 179 first-year expensing option, a nursery business is allowed to expense $500,000 in new equipment purchases. The write-off is reduced if Section 179 property in excess of the $2 million (increased by inflation) limit. Making this election accelerates the write-off, creating an immediate tax benefit for outlays.

Don’t forget the Section 179 deduction for “single purpose horticultural structures,” those buildings designed, constructed and used strictly for horticulture purposes. The result: a Section 179 deduction of up to $500,000.

A grower also has the option of claiming a first-year “bonus” depreciation allowance for purchases of qualifying new (not used) equipment, software – and single purpose horticultural buildings -- put to use before year-end. The 50 percent bonus depreciation is on top of any allowable Section 179 deduction. In 2018, the bonus phases down to 40 percent and 30 percent in 2019.

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 been increased from $500 to $2,500 for businesses that don’t have an applicable financial statement. With a financial statement the nursery can label costs up to $5,000 per invoice as materials or supplies without questions from the IRS.

When it comes to the 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). Those businesses 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.

Property that has no value to the nursery could be abandoned rather than sold for a nominal amount. The resulting ordinary loss on the abandoned property or equipment, is fully deductible rather than treated as a capital loss.

Moving income and deductions — legally

Many small nurseries are permitted to use the cash-method of accounting for tax purposes. Those that do can micromanage the operation’s taxable income to minimize taxes this year and in 2018. Expecting a lower tax bill next year? Consider these strategies:

• Pre-payments So long as the economic benefit does not extend beyond one-year, pre-paid expenses are usually acceptable. The complex rules allow a grower to claim 2017 deductions for prepaying the first three months of next year’s rent or prepaying the premium for property insurance coverage for the first half of next year.
• Bonuses If possible, year-end bonsuess should be paid prior to the operation’s last payroll. Paying bonuses early or creating a separate bonus payroll will make is easier on the bookkeeper or the payroll processing company.
• 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. Net operating losses (NOLs) or non-capital losses occur when the growing or nursery business’s expenses exceed its income.

NOLs can be used to offset income in any given tax year, can be carried back three years or carried forward for up to seven years. It may make 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).

Proposals and pass-throughs

Under most proposals for reforming our tax laws, the estate tax would be eliminated — a boon to wealthy individuals who inherit businesses, investments and real estate. As mentioned, deductions and credits would be repealed under the latest proposal, the domestic production activities deduction would no longer be necessary but the research tax credit would be retained.

Closer to home, incorporated nurseries would see their top tax rate cut from 35 percent to as low as 20 percent under the president’s proposal. The taxation of the roughly 95 percent of American businesses that are not incorporated but, rather, so-called “pass-through” businesses, such as sole proprietorships, limited liability companies and partnerships, is more questionable.

President Trump’s plan proposes a new tax rate of 25 percent for the pass-through income of “small and family-owned businesses” currently claimed on individual returns — that is, income “passes through” to the owners and is taxed at their individual tax rate (the same rates applying to wages and salaries). These businesses already have the advantage of being exempt from the corporate tax on profits and taxes on dividends.

The problem, according to the critics, is that financial entities such as private equity, venture-capital and hedge funds are all partnerships whose wealthy partners would see substantial tax savings on large portions of their income unless, as is hoped, lawmakers find a way to exclude them.

More proposed “reforms”

The Trump-proposed tax “reform” for individuals would nearly double the standard deduction to $12,000 for individuals and $24,000 for families, thus increasing the amount of personal income that is tax free. It also collapses the number of personal tax brackets from seven to three. The individual tax rates would be 12 percent, 25 percent and 35 percent with possibly a surcharge for the very wealthy.

The latest proposal calls for an increased child tax credit and opening it to families with higher incomes. Also proposed is a new $500 tax credit to help pay for the care of the elderly and the sick who are claimed as dependents.

Deductions for mortgage interest and charitable giving would remain under this latest proposal but most itemized deductions, along with the estate tax, would be eliminated.

For businesses, the president’s reforms would:

• Reduce regular, “C” corporation tax rates to 20 percent.
• Eliminate the net investment income tax which is an additional 3.8 percent tax on high-income shareholders pay on distributions.
• Create a new 25 percent tax rate for income passed through from a business for all but “service” pass-throughs.

Under some of the earlier proposals, 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 proposals become a reality it could mean significantly lower taxes on regular corporations and their shareholders leaving many seriously thinking about changing the type of entity they do business as.

While good tax planning is based on current versus future tax rates, the significance of looming tax reform can’t be ignored. The potential of tax reform next year makes tax deferral even more valuable, especially for really profitable nurseries 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. If next year’s tax rates will be lower than this year’s rates, then tax deductions will be less valuable next year than in this year.

In the category of “be careful of what you wish for,” tax rate reductions mean revenue lost by the government. Not too surprisingly, they usually make up for that lost revenue by closing loopholes, exemptions and favorable treatment of one type of income over another.

Decisions, decisions. 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 the tax returns are being prepared.

Mark E. Battersby is a financial writer based in Ardmore, Pa.