The sooner convenience retailers start planning, the smaller impact the new proposed tax changes will have on their day-to-day operations—if and when they are implemented.
By Mark Battersby, Contributing Editor
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 should be the goal of every convenience store operator.
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 convenience store operations whose tax rates will potentially be lower next year, end of the year tax planning is very 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
Under any new law, depreciation could largely be a concept of the past. Most of the reforms proposed would allow convenience stores 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 convenience store is allowed to expense as much as $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 is exceeded. Making this election accelerates the write-off, creating an immediate tax benefit for outlays.
A convenience store business also has the option of claiming a first-year “bonus” depreciation allowance for purchases of qualifying new (not used) equipment and software put to use before year-end. The 50% bonus depreciation is on top of any allowable Section 179 deduction. In 2018, the bonus phases down to 40%, and 30% in 2019.
Real property expenditures now qualify for Section 179 deductions and, best of all, the exception is now permanent meaning that every convenience store business can expense up to $500,000 for expenditures for the following types of property:
1. Certain improvements to interiors of leased nonresidential buildings.
2. Certain restaurant buildings or improvements to such buildings.
3. Certain improvements to interiors of retail buildings.
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 to $2,500 from $500 for businesses that don’t have an applicable financial statement. Essentially, qualifying for the de minimis safe harbor deduction means your item can be entered as an expense and not an asset.
With a financial statement the convenience store business can label costs up to $5,000 per invoice as materials or supplies without questions from the IRS.
The IRS can, and will, challenge salary amounts they deem to be “unreasonable.” While the factors used by the IRS and the courts to determine reasonable compensation vary, the IRS typically looks at training and experience, duties and responsibilities, time and effort devoted to the business and more. The courts generally look at amounts paid by comparable businesses for similar services, the use of a bonus formula and the importance of the role played by the compensated individual.
MOVING INCOME
Many small convenience store operations 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:
• Prepayments: So long as the economic benefit does not extend beyond one year, pre-paid expenses are usually acceptable. The complex rules allow a convenience store 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 pay any year-end bonuses 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.
• Carry overs and Carry-forwards: 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 convenience store 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 convenience store businesses would see their top tax rate cut from 35% to as low as 20% under the president’s proposal. The taxation of the roughly 95% of American businesses that are not incorporated, but rather, 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% for the pass-through income of small and family-owned businesses currently claimed on individual returns. That is, it “passes through” to the business owners and is taxed at the owners’ 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 businesses would:
• Reduce regular, “C” corporation tax rates to 20%.
• Eliminate the net investment income tax, which is an additional 3.8% tax on high-income shareholders pay on distributions.
• Create a new 25% tax rate for income passed through from a business for all but “service” pass-throughs.
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 convenience store businesses 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. After all, 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.
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.
