We would all like our tax law to be simple and straightforward. If an expenditure is an expense, we think it should be deductible. Simple as that. Unfortunately, the reality is quite different. Many of the expenses we incur in our businesses require additional calculations to determine the deductible amount or additional documentation or filings to qualify for the deduction. Knowing these rules and requirements may preserve a deduction to which you might be entitled. Below is a summary of some items that have unique treatment for 2017. Most of these items will not change with the new tax law but there are a few that will, so it is important to review as more information becomes available.
Domestic Production Activities Deduction
Like the idea of getting a “double dip” deduction? Well, here you go. This is a deduction for qualified production by taxpayers. Qualifying activities include:
* The manufacture, production, growth or extraction of tangible personal property (e.g. clothing, goods and food)
* Software development
* Sound recordings
* Qualified film production
* U.S. production of electricity, natural gas or potable water
* Construction or substantial renovation of real property in the U.S.
* Qualified engineering and architectural services
The deduction is equal to 9% of the lesser of Qualified Production Activities Income (QPAI) or taxable income. The deduction is further limited to 50% of the qualified production activity W-2 wages paid by the taxpayer.
QPAI is equal to the domestic production gross receipts reduced by the sum of: (1) cost of goods sold that is allocable to the receipts; (2) other deductions, expenses and losses that are allocable to the receipts; and (3) a ratable portion of other deductions, expenses and losses that are not directly allocable to these or other receipts.
Repealed for tax years beginning after December 31, 2017.
Life insurance premiums paid by the corporation for policies that are owned by the shareholders or are payable to the shareholders are wages and should be included on their W-2’s and are deducted by the company as compensation.
Group-term life insurance premiums paid by the business on policies for the employees are deductible to the business. If the benefits are for more than $50,000 for any employee a portion of the premiums (as determined by an IRS table) must be included as wages and separately disclosed on the W-2.
Disability insurance premiums can be deductible to the employer. However, it may not be a good idea. If the employer deducts the premiums any benefits from the policy that the employee receives will be taxable. If the employer includes the premiums on the employee’s W-2 as additional wages any benefits from the policy that the employee receives will NOT be taxable.
Health insurance premiums paid on behalf of employees for an employer-sponsored plan are deductible to the employer. These premiums must be separately disclosed on the W-2.
Special rules apply to more-than-2%-owners of S corporation. These premiums are deductible by the corporation and must be included in Federal and State wages (but not Social Security or MediCare wages. They must be paid (or reimbursed) out of company funds. They are deductible by the S corporation shareholder on that shareholder’s individual income tax return. The deductible premiums cannot be more than the amount of other wages paid to the shareholder. If it is not handled perfectly, the deduction is denied.
Meals and entertainment expense
All deductions for any expense require documentation. Meal and entertainment expense require more comprehensive documentation than most other deductions. In addition to the normal “when, where and how much” documentation the taxpayer is required to document “who you were with and how this applies to business”. Most meal and entertainment expenses are only 50% deductible for 2017.
Meals provided to the employee by the employer are deductible to the employer IF the meals are provided on or near the employer’s business premises and are provided for the convenience of the employer. Such meals are not taxable to the employee. Employers can also deduct de minimis meals such as coffee, doughnuts or soft drinks; occasional meals that enable an employee to work overtime; or occasional parties or picnics for employees and their guests. Beginning in 2018, the 50% deductible limitation will apply to these items.
Special documentation is required for vehicle expense. Generally speaking, a log is required which documents the business miles driven. The IRS has taken the position (and has been upheld by the courts) that if there is no log they will allow no deduction. If there is a log the taxpayer has the choice of calculating the deduction using the standard mileage rate (53.5 cents per mile in 2017) or a portion of actual expenses or deducting a pro-rata share (business miles/total miles) of actual expenses. The actual expenses include fuel, repairs, lease cost and depreciation. Pro-rata taxes and interest expense may be deducted using either method. The employee is required to submit and the employer is required to obtain documentation of the business miles driven. This is generally done via an expense report. The expense is deductible by the employer and not taxable to the employee.
If the employer pays the employee a flat amount (such as $50 per month) for mileage this must be treated as wages and is subject to payroll taxes.
If the vehicle is owned by the company the company is required to have documentation regarding the business miles driven. If the employee is allowed to drive personal miles using the vehicle the employee is required to report those to the employer. The employer is required (using an IRS table and computation) to add to the employee’s W-2 an amount calculated to represent the employee’s personal use of the company vehicle.
Membership dues for professional organizations and those organizations you can demonstrate are necessary or useful for conducting business are deductible.
Membership dues for entertainment facilities, recreation or fitness clubs, airline clubs or social clubs are not deductible. However, if you are a member of, say, a golf club any out of pocket expenses you have for client entertainment would be deductible as detailed above.
Health Savings Accounts
Contributions to Health Savings Accounts by the employer are deductible. Non-discrimination rules apply. These contributions must be separately disclosed on the W-2.
De Minimis fringe benefits
Certain fringe benefits are deductible to the employer and not includable in the employee’s wages. These are generally benefits or services provided to employees that have so little value that accounting for it would be unreasonable. These can include personal use of employer-provided cell phones, occasional personal use of a company copy machine, holiday or birthday gifts with a low value, flowers or similar items for special occasions, occasional parties or picnics for employees and their guests, occasional tickets for theater or sporting events and certain meals (see above).
The IRS issued very complicated regulations dictating the definition of repairs vs. improvements. If the company has made the appropriate elections, the company may be able to deduct repair expenses of less than $2,500 each. If the appropriate elections are NOT made the deduction may be limited to amounts less than $500 each.
The IRS has issued very complicated regulations dictating the period in which the deduction for supplies can be taken. Generally speaking any supplies that are unused at the end of the tax year must be capitalized as inventory and not deducted until they are used. There is a de minimis rule that allows the deduction of units of property that cost less than $200 each. If the appropriate election is made, that limitation increases to $2,500.
First-year write-off and bonus depreciation
For 2017, taxpayers are allowed, in some cases, to deduct the full cost of assets in the year the asset is placed in service. This deduction faces a couple of limitations. First, if your total assets place in service during the year exceeds $2,010,000 the amount you can write off is limited. Additionally, the allowable deduction is limited to the amount of net income of the company before the deduction.
Taxpayers can also deduct up to 50% of the cost of new assets in the year of acquisition under the bonus depreciation rules. This deduction cannot be used on the purchase of used assets.
Keep in mind that it is not always in your best interest to use these deductions. If the current-year tax bracket is lower than you expect future brackets to be, using these deductions could result in a higher total tax.
Payments for services, rents or interest
Payments the company makes for services or rents of $600 or more to a recipient or for interest expense of $10 or more require the company to issue form 1099-MISC or 1099-INT to the recipients.