The “manufacturers’ deduction” isn’t just for manufacturers
The Section 199 deduction is intended to encourage domestic manufacturing. In fact, it’s often referred to as the “manufacturers’ deduction.” But this potentially valuable tax break can be used by many other types of businesses besides manufacturing companies.
Sec. 199 deduction 101
The Sec. 199 deduction, also called the “domestic production activities deduction,” is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts.
Yes, the deduction is available to traditional manufacturers. But businesses engaged in activities such as construction, engineering, architecture, computer software production and agricultural processing also may be eligible.
The deduction isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the alternative minimum tax.
How income is calculated
To determine a company’s Sec. 199 deduction, its qualified production activities income must be calculated. This is the amount of domestic production gross receipts (DPGR) exceeding the cost of goods sold and other expenses allocable to that DPGR. Most companies will need to allocate receipts between those that qualify as DPGR and those that don’t — unless less than 5% of receipts aren’t attributable to DPGR.
DPGR can come from a number of activities, including the construction of real property in the United States, as well as engineering or architectural services performed stateside to construct real property. It also can result from the lease, rental, licensing or sale of qualifying production property, such as:
- Tangible personal property (for example, machinery and office equipment),
- Computer software, and
- Master copies of sound recordings.
The property must have been manufactured, produced, grown or extracted in whole or “significantly” within the United States. While each situation is assessed on its merits, the IRS has said that, if the labor and overhead incurred in the United States accounted for at least 20% of the total cost of goods sold, the activity typically qualifies.
Contact your tax advisor to learn whether this potentially powerful deduction could reduce your business’s tax liability when you file your 2016 return.
Why 2016 may be an especially good year to take bonus depreciation
Bonus depreciation allows businesses to recover the costs of depreciable property more quickly by claiming additional first-year depreciation for qualified assets. The PATH Act, signed into law a little over a year ago, extended 50% bonus depreciation through 2017.
Claiming this break is generally beneficial, though in some cases a business might save more tax in the long run if they forgo it. However, 2016 may be an especially good year to take bonus depreciation. Keep this in mind when you’re filing your 2016 tax return.
New tangible property with a recovery period of 20 years or less (such as office furniture and equipment) qualifies for bonus depreciation. So does off-the-shelf computer software, water utility property and qualified improvement property. And beginning in 2016, the qualified improvement property doesn’t have to be leased
It isn’t enough, however, to have acquired the property in 2016. You must also have placed the property in service in 2016.
Now vs. later
If you’re eligible for bonus depreciation and you expect to be in the same or a lower tax bracket in future years, taking bonus depreciation (to the extent you’ve exhausted any Section 179 expensing available to you) is likely a good tax strategy. It will defer tax, which generally is beneficial.
But if your business is growing and you expect to be in a higher tax bracket in the near future, you may be better off forgoing bonus depreciation. Why? Even though you’ll pay more tax for 2016, you’ll preserve larger depreciation deductions on the property for future years, when they may be more powerful — deductions save more tax when you’re paying a higher tax rate.
Making a decision for 2016
The greater tax-saving power of deductions when rates are higher is why 2016 may be a particularly good year to take bonus depreciation. With both President Trump and the Republican-controlled Congress wishing to reduce tax rates, there’s a good chance that such legislation could be signed into law.
This means your tax rate could be lower for 2017 (if changes go into effect for 2017) and future years. If that happens, there’s a greater likelihood that taking bonus depreciation for 2016 would save you more tax than taking all of your deduction under normal depreciation schedules over a period of years.
Also keep in mind that, under the PATH Act, bonus depreciation is scheduled to drop to 40% for 2018, drop to 30% for 2019, and expire Dec. 31, 2019. Of course, Congress could pass legislation extending 50% bonus depreciation or making it permanent — or it could eliminate it or reduce the bonus depreciation percentage sooner.
If you’re unsure whether you should take bonus depreciation on your 2016 return — or you have questions about other depreciation-related breaks, such as Sec. 179 expensing — contact your tax advisor.
Deduction for state and local sales tax benefits some, but not all, taxpayers
The break allowing taxpayers to take an itemized deduction for state and local sales taxes in lieu of state and local income taxes was made “permanent” a little over a year ago. This break can be valuable to those residing in states with no or low income taxes or who purchase major items, such as a car or boat.
Your 2016 tax return
How do you determine whether you can save more by deducting sales tax on your 2016 return? Compare your potential deduction for state and local income tax to your potential deduction for state and local sales tax.
Don’t worry — you don’t have to have receipts documenting all of the sales tax you actually paid during the year to take full advantage of the deduction. Your deduction can be determined by using an IRS sales tax calculator that will base the deduction on your income and the sales tax rates in your locale plus the tax you actually paid on certain major purchases (for which you will need substantiation).
2017 and beyond
If you’re considering making a large purchase in 2017, you shouldn’t necessarily count on the sales tax deduction being available on your 2017 return. When the PATH Act made the break “permanent” in late 2015, that just meant that there’s no scheduled expiration date for it. Congress could pass legislation to eliminate the break (or reduce its benefit) at any time.
Recent Republican proposals have included elimination of many itemized deductions, and the new President has proposed putting a cap on itemized deductions. Which proposals will make it into tax legislation in 2017 and when various provisions will be signed into law and go into effect is still uncertain.
Questions about the sales tax deduction or other breaks that might help you save taxes on your 2016 tax return? Or about the impact of possible tax law changes on your 2017 tax planning? Contact us your tax advisor — they can help you maximize your 2016 savings and effectively plan for 2017.
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Can you defer taxes on advance payments?
Many businesses receive payment in advance for goods and services. Examples include magazine subscriptions, long-term supply contracts, organization memberships, computer software licenses and gift cards.
Generally, advance payments are included in taxable income in the year they’re received, even if you defer a portion of the income for financial reporting purposes. But there are exceptions that might provide you some savings when you file your 2016 income tax return.
The IRS allows limited deferral of income related to advance payments for:
- Goods or services,
- Intellectual property licenses or leases,
- Computer software sales, leases or licenses,
- Warranty contracts,
- Certain organization memberships,
- Eligible gift card sales, and
- Any combination of the above.
In the year you receive an advance payment (Year 1), you may defer the same amount of income you defer in an “applicable financial statement.” The remaining income must be recognized in the following year (Year 2), regardless of the amount of income you recognize in Year 2 for financial reporting purposes. Let’s look at an example.
Fred and Ginger are in the business of giving dance lessons. On November 1, 2016, they receive an advance payment from Gene for a two-year contract that provides up to 96 one-hour lessons. Gene takes eight lessons in 2016, 48 lessons in 2017 and 40 lessons in 2018.
In their applicable financial statements, Fred and Ginger recognize 1/12 of the advance payment in their 2016 revenues, 6/12 in their 2017 revenues and 5/12 in their 2018 revenues. For federal income tax purposes, they need to include only 1/12 of the advance payment in their 2016 gross income. But they must include the remaining 11/12 in their 2017 gross income.
The applicable financial statement
An applicable financial statement is one that’s audited by an independent CPA or filed with the SEC or certain other government agencies. If you don’t have this statement, it’s still possible to defer income; you simply need a reasonable method for determining the extent to which advance payments are earned in Year 1.
Suppose, for example, that a company issues gift certificates but doesn’t track their use and doesn’t have an applicable financial statement. The company may be able to defer income based on a statistical study that indicates the percentage of gift certificates expected to be redeemed in Year 1.
If your business receives advance payments, consult your tax advisor to determine whether you can reduce your 2016 tax bill by deferring some of this income to 2017. And make sure you abide by the IRS’s rules on these payments.
2017 Q1 tax calendar: Key deadlines for businesses and other employers
Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2017. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you.
- File 2016 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
- File 2016 Forms 1099-MISC, “Miscellaneous Income,” reporting nonemployee compensation payments in Box 7 with the IRS, and provide copies to recipients.
- File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2016. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 10 to file the return. Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944,“Employer’s Annual Federal Tax Return.”
- File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2016. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 10 to file the return.
- File 2016 Forms 1099-MISC with the IRS and provide copies to recipients. (Note that Forms 1099-MISC reporting nonemployee compensation in Box 7 must be filed by January 31, beginning with 2016 forms filed in 2017.)
If a calendar-year partnership or S corporation, file or extend your 2016 tax return. If the return isn’t extended, this is also the last day to make 2016 contributions to pension and profit-sharing plans.