Acuity Blog

Maximize the QBI deduction before it’s gone

The qualified business income (QBI) deduction is available to eligible businesses through 2025. After that, it’s scheduled to disappear. So if you’re eligible, you want to make the most of the deduction while it’s still on the books because it can potentially be a big tax saver.

Deduction basics

The QBI deduction is written off at the owner level. It can be up to 20% of:

  • QBI earned from a sole proprietorship or single-member LLC that’s treated as a sole proprietorship for tax purposes, plus
  • QBI from a pass-through entity, meaning a partnership, LLC that’s treated as a partnership for tax purposes or S corporation.

How is QBI defined? It’s qualified income and gains from an eligible business, reduced by related deductions. QBI is reduced by: 1) deductible contributions to a self-employed retirement plan, 2) the deduction for 50% of self-employment tax, and 3) the deduction for self-employed health insurance premiums.

Unfortunately, the QBI deduction doesn’t reduce net earnings for purposes of the self-employment tax, nor does it reduce investment income for purposes of the 3.8% net investment income tax (NIIT) imposed on higher-income individuals.

Limitations

At higher income levels, QBI deduction limitations come into play. For 2024, these begin to phase in when taxable income before any QBI deduction exceeds $191,950 ($383,900 for married joint filers). The limitations are fully phased in once taxable income exceeds $241,950 or $483,900, respectively.

If your income exceeds the applicable fully-phased-in number, your QBI deduction is limited to the greater of: 1) your share of 50% of W-2 wages paid to employees during the year and properly allocable to QBI, or 2) the sum of your share of 25% of such W-2 wages plus your share of 2.5% of the unadjusted basis immediately upon acquisition (UBIA) of qualified property.

The limitation based on qualified property is intended to benefit capital-intensive businesses such as hotels and manufacturing operations. Qualified property means depreciable tangible property, including real estate, that’s owned and used to produce QBI. The UBIA of qualified property generally equals its original cost when first put to use in the business.

Finally, your QBI deduction can’t exceed 20% of your taxable income calculated before any QBI deduction and before any net capital gain (net long-term capital gains in excess of net short-term capital losses plus qualified dividends).

Unfavorable rules for certain businesses 

For a specified service trade or business (SSTB), the QBI deduction begins to be phased out when your taxable income before any QBI deduction exceeds $191,950 ($383,900 for married joint filers). Phaseout is complete if taxable income exceeds $241,950 or $483,900, respectively. If your taxable income exceeds the applicable phaseout amount, you’re not allowed to claim any QBI deduction based on income from a SSTB.

Other factors

Other rules apply to this tax break. For example, you can elect to aggregate several businesses for purposes of the deduction. It may allow someone with taxable income high enough to be affected by the limitations described above to claim a bigger QBI deduction than if the businesses were considered separately.

There also may be an impact for claiming or forgoing certain deductions. For example, in 2024, you can potentially claim first-year Section 179 depreciation deductions of up to $1.22 million for eligible asset additions (subject to various limitations). For 2024, 60% first-year bonus depreciation is also available. However, first-year depreciation deductions reduce QBI and taxable income, which can reduce your QBI deduction. So, you may have to thread the needle with depreciation write-offs to get the best overall tax result.

Use it or potentially lose it

The QBI deduction is scheduled to disappear after 2025. Congress could extend it, but don’t count on it. So, maximizing the deduction for 2024 and 2025 is a worthy goal. We can help.

© 2024


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Tax-wise ways to take cash from your corporation while avoiding dividend treatment

If you want to withdraw cash from your closely held corporation at a low tax cost, the easiest way is to distribute cash as a dividend. However, a dividend distribution isn’t tax efficient since it’s taxable to you to the extent of your corporation’s “earnings and profits,” but it’s not deductible by the corporation.

5 different approaches

Thankfully, there are some alternative methods that may allow you to withdraw cash from a corporation while avoiding dividend treatment. Here are five possible options:

1. Salary. Reasonable compensation that you, or family members, receive for services rendered to the corporation is deductible by the business. However, it’s also taxable to the recipient(s). The same rule applies to any compensation (in the form of rent) that you receive from the corporation for the use of property. In either case, the amount of compensation must be reasonable in relation to the services rendered or the value of the property provided. If it’s excessive, the excess will be nondeductible and treated as a corporate distribution.

2. Fringe benefits. Consider obtaining the equivalent of a cash withdrawal in fringe benefits that are deductible by the corporation and not taxable to you. Examples are life insurance, certain medical benefits, disability insurance and dependent care. Most of these benefits are tax-free only if provided on a nondiscriminatory basis to other employees of the corporation. You can also establish a salary reduction plan that allows you (and other employees) to take a portion of your compensation as nontaxable benefits, rather than as taxable compensation.

3. Capital repayments. To the extent that you’ve capitalized the corporation with debt, including amounts that you’ve advanced to the business, the corporation can repay the debt without the repayment being treated as a dividend. Additionally, interest paid on the debt can be deducted by the corporation. This assumes that the debt has been properly documented with terms that characterize debt and that the corporation doesn’t have an excessively high debt-to-equity ratio. If not, the “debt” repayment may be taxed as a dividend. If you make cash contributions to the corporation in the future, consider structuring them as debt to facilitate later withdrawals on a tax-advantaged basis.

4. Loans. You may withdraw cash from the corporation tax-free by borrowing money from it. However, to avoid having the loan characterized as a corporate distribution, it should be properly documented in a loan agreement or a note and be made on terms that are comparable to those on which an unrelated third party would lend money to you. This should include a provision for interest and principal. All interest and principal payments should be made when required under the loan terms. Also, consider the effect of the corporation’s receipt of interest income.

5. Property sales. You can withdraw cash from the corporation by selling property to it. However, certain sales should be avoided. For example, you shouldn’t sell property to a more than 50% owned corporation at a loss, since the loss will be disallowed. And you shouldn’t sell depreciable property to a more than 50% owned corporation at a gain, since the gain will be treated as ordinary income, rather than capital gain. A sale should be on terms that are comparable to those on which an unrelated third party would purchase the property. You may need to obtain an independent appraisal to establish the property’s value.

Minimize taxes

If you’re interested in discussing any of these ideas, contact us. We can help you get the maximum out of your corporation at the minimum tax cost.

© 2024


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Applying for a commercial loan with confidence

Few and far between are businesses that can either launch or grow without an infusion of outside capital. In some cases, that capital comes in the form of a commercial loan from a bank or some other type of lender.

If you and your company’s leadership team believe a loan will soon be necessary, it’s important to approach the endeavor with confidence. That starts with having valid, well-considered strategic reasons for borrowing. From there, you need to engage your bank or a prospective lender with a strong air of professionalism and certainty.

Essential questions

First, familiarize yourself with how the process works. It’s essentially built on four basic questions:

  1. How much money do you want?
  2. How do you plan to use the loan proceeds?
  3. When do you need the funds?
  4. How soon can you repay the loan?

Your loan officer will also likely ask about your business’s previous sources of financing. So, be ready to explain how you’ve financed your company to date. Methods may include personal cash infusions, forgone salaries and sweat equity, as well as any equity contributions from friends, family members and outside investors.

Loan products

As you’re probably aware, banks and lenders offer a variety of commercial loan products. Another way of expressing confidence is to know what you want. Common options include:

Lines of credit. One of these gives you access to an agreed-upon amount of funds that you can draw on as needed. As is the case with a credit card, you pay interest only on the outstanding balance.

Traditional term loans. These are what most people likely envision when they see the term “commercial loan.” You receive a lump sum with repayment terms, which include a payment schedule and interest rate.

Asset-based loans. True to the name, asset-based loans typically fund equipment purchases or plant expansions. The length of the loan is usually tied to the life of the asset being financed, and that asset is usually pledged as collateral.

Supporting documents

No matter the product, banks and lenders want to work with serious borrowers who are deeply knowledgeable about the financial condition and projected performance of their businesses. To this end, don’t go into the initial meeting empty-handed. Prepare a comprehensive loan application package that includes:

  • A “statement of purpose” explaining your strategic plans for the funds,
  • Your business plan,
  • Three years of financial statements, if available,
  • Three years of business tax returns, if available,
  • Personal financial statements and tax returns for all owners,
  • Appraisals of any assets pledged as collateral, and
  • Carefully prepared, reasonable financial projections.

Remember that most loan officers have been around the block. They know how to critically evaluate financial documents and prospective borrowers’ underlying assumptions. As much as possible, support your case with market research and data. Be confident — but realistic — about your strengths and market opportunities, as well as forthcoming about the challenges you’ll likely face in accomplishing your strategic objectives.

If your bank or lender finds your business a viable borrower, your application will be given to an underwriting committee or department. Underwriters will have greater confidence in your financial statements if they’re prepared by a CPA and conform to U.S. Generally Accepted Accounting Principles. Professionally prepared financial projections are also recommended.

Shop around

Underwriters don’t approve every loan application, so don’t give up if a bank or lender turns you down. In fact, it’s a good idea to shop around. For help preparing to apply for a commercial loan and managing the approval process, contact us.

© 2024

 


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Small businesses can help employees save for retirement, too

Many small business owners run their companies as leanly as possible. This often means not offering what are considered standard fringe benefits for midsize or larger companies, such as a retirement plan.

If this is the case for your small business, don’t give up on the idea of helping your employees save for retirement in a tax-advantaged manner. When you’re ready, there are a couple account-based options that are relatively simple and inexpensive to launch and administrate.

SEP IRAs

Simplified Employee Pension IRAs (SEP IRAs) are individual accounts that small businesses establish on behalf of each participant. (Self-employed individuals can also establish SEP IRAs.) Participants own their accounts, so they’re immediately 100% vested. If a participant decides to leave your company, the account balance goes with them — most people roll it over into a new employer’s qualified plan or traditional IRA.

What are the advantages for you? SEP IRAs don’t require annual employer contributions. That means you can choose to contribute only when cash flow allows.

In addition, there are typically no setup fees for SEP IRAs, though participants generally must pay trading commissions and fund expense ratios (a fee typically set as a percentage of the fund’s average net assets). In 2024, the contribution limit is $69,000 (up from $66,000 in 2023) or up to 25% of a participant’s compensation. That amount is much higher than the 2024 limit for 401(k)s, which is $23,000 (up from $22,500 in 2023).

What’s more, employer contributions are tax-deductible. Meanwhile, participants won’t pay taxes on their SEP IRA funds until they’re withdrawn.

There are some disadvantages to consider. Although participants own their accounts, only employers can make SEP IRA contributions. And if you contribute sparsely or sporadically, participants may see little value in the accounts. Also, unlike many other qualified plans, SEP IRAs don’t permit participants age 50 or over to make additional “catch-up” contributions.

SIMPLE IRAs

Another strategy is to offer employees SIMPLE IRAs. (“SIMPLE” stands for “Savings Incentive Match Plan for Employees.”) As is the case with SEP IRAs, your business creates a SIMPLE IRA for each participant, who’s immediately 100% vested in the account. Unlike SEP IRAs, SIMPLE IRAs allow participants to contribute to their accounts if they so choose.

SIMPLE IRAs are indeed relatively simple to set up and administer. They don’t require the sponsoring business to file IRS Form 5500, “Annual Return/Report of Employee Benefit Plan.” Nor must you submit the plan to nondiscrimination testing, which is generally required for 401(k)s.

Meanwhile, participants face no setup fees and enjoy tax-deferred growth on their account funds. Best of all, they can contribute more to a SIMPLE IRA than they can to a self-owned traditional or Roth IRA. The 2024 contribution limit for SIMPLE IRAs is $16,000 (up from $15,500 in 2023), and participants age 50 or over can make catch-up contributions to the tune of $3,500 this year (unchanged from last year).

On the downside, that contribution limit is lower than the limit for 401(k)s. Also, because contributions are made pretax, participants can’t deduct them, nor can they take out plan loans. Then again, making pretax contributions does lower their taxable income.

Perhaps most important is that employer contributions to SIMPLE IRAs are mandatory — you can’t skip them if cash flow gets tight. However, generally, you may deduct contributions as a business expense.

Is now the time?

Overall, the job market remains somewhat tight and, in some industries, the competition for skilled labor is fierce. Offering one of these IRA types may enable you to attract and retain quality employees more readily. Some small businesses may even qualify for a tax credit if they start a SEP IRA, SIMPLE IRA or other eligible plan. We can help you decide whether now is the right time to do so.

© 2024


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Is it time to upgrade your business’s accounting software?

By now, just about every company uses some kind of accounting software to track, manage and report its financial transactions. Many businesses end up using several different types of software to handle different accounting-related functions. Others either immediately or eventually opt for a comprehensive solution that addresses all their needs.

Although there’s some truth to the old expression “if it ain’t broke, don’t fix it,” companies often soldier on for years with inefficient or outdated accounting software. How do you know when it’s time to upgrade? Look for certain telltale signs.

It’s slowing us down

Accounting software is intended to make your and your employees’ lives easier. Among its primary purposes are to automate repetitive tasks, save time and provide quicker access to financial insights. If you or your staff are spending an inordinate amount of time wrestling with your current software to garner such benefits, an upgrade may be in order.

There’s also the issue of whether and how your business has grown recently. While some software developers market their products as “scalable” — that is, able to expand functionality right along with users’ needs — your mileage may vary. Keep a running list of the accounting functions your company needs and use it to assess the viability of your software.

Some lack of functionality can be relatively obvious. For example, many employees today need mobile access to accounting data, whether because they’re working remotely or traveling for the business. If your software makes this difficult — or, more dangerously, lacks trustworthy cybersecurity — it may be time to upgrade.

In addition, think about integration. As mentioned, some companies wind up using several different kinds of accounting-related software, and these various products may not “play well” together. In such cases, upgrading to a broader solution is worth considering.

There are various products specifically designed for small businesses. Growing midsize companies might be ready for enterprise resource planning (ERP) software, which integrates accounting with other functions such as inventory, sales and marketing, and human resources.

It’s getting us in trouble

The accounting software needs of most businesses tend to gradually evolve over time, making it tough to decide when to invest in an upgrade. However, there are some glaring red flags that can make the decision much easier — though they can also pressure companies into making a rushed purchase of new technology.

For instance, though privately owned companies aren’t required to follow the same accounting standards as publicly held ones, they still need sound financial reporting for tax purposes and possibly to comply with state or local regulations. If you’ve run into trouble with tax authorities or other agencies because of accounting mistakes or inconsistencies, an upgrade could help.

And, of course, financial reporting isn’t only about taxes and compliance, it plays a huge role in obtaining loans, attracting investors, and perhaps winning bids or arranging joint ventures. If you and your leadership team believe you’re being outcompeted because you can’t make the right strategic moves, investing in better accounting software may be one of the steps you need to take.

Last but not least, we mentioned cybersecurity above, but it bears repeating: Any indication that your accounting software is vulnerable to hackers or internal fraud should be regarded as an immediate call to action. Fortify your existing software or find a more secure product.

Business imperative

Long gone are the days when companies could rely on a dusty ledger and ink to record their financial transactions. The right accounting software is a business imperative. We’d be happy to help you assess your current needs and decide whether now’s the time to upgrade.

© 2024


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