tax planning Archives - Ullrich Delevati

For federal income tax purposes, the general rule is that rental real estate losses are passive activity losses (PALs). An individual taxpayer can generally deduct PALs only to the extent of passive income from other sources, if any. For example, if you have positive taxable income from other rental properties, that generally counts as passive income. You can use PALs to offset passive income from other sources, which amounts to being able to currently deduct them.

Unfortunately, many rental property owners have little or no passive income in most years. Excess rental real estate PALs for the year (PALs that you cannot currently deduct because you don’t have enough passive income) are suspended and carried forward to future years. You can deduct suspended PALs when you finally have enough passive income or when you sell the properties that generated the PALs.

Exception for professionals

Thankfully, there’s a big exception to the general rule that you must have positive passive income to currently deduct rental losses. If you qualify for the exception, a rental real estate loss can be classified as a non-passive loss that can usually be deducted currently.

This exception allows qualifying individual taxpayers to currently deduct rental losses even if they have no passive income. To be eligible for the real estate professional exception:

You must spend more than 750 hours during the year delivering personal services in real estate activities in which you materially participate, and
Those hours must be more than half the time you spend delivering personal services (in other words, working) during the year.

If you can clear these hurdles, you qualify as a real estate professional. The next step is determining if you have one or more rental properties in which you materially participate. If you do, losses from those properties are treated as non-passive losses that you can generally deduct in the current year. Here’s how to pass the three easiest material participation tests for a rental real estate activity:

Spend more than 500 hours on the activity during the year.
Spend more than 100 hours on the activity during the year and make sure no other individual spends more time than you.
Make sure the time you spend on the activity during the year constitutes substantially all the time spent by all individuals.

If you don’t qualify

Obviously, not everyone can pass the tests to be a real estate professional. Thankfully, some other exceptions may potentially allow you to treat rental real estate losses as currently deductible non-passive losses. These include the:

Small landlord exception. If you qualify for this exception, you can treat up to $25,000 of rental real estate loses as non-passive. You must own at least 10% of the property generating the loss and actively participate with respect to that property. Properties owned via limited partnerships don’t qualify for this exception. To pass the active participation test, you don’t need to do anything more than exercise management control over the property in question. This could include approving tenants and leases or authorizing maintenance and repairs. Be aware that this exception is phased out between adjusted gross incomes (AGIs) of $100,000 and $150,000.

Seven-day average rental period exception. When the average rental period for a property is seven days or less, the activity is treated as a business activity. If you can pass one of the material participation tests, losses from the activity are non-passive.

30-day average rental period exception. The activity is treated as a business activity when the average rental period for a property is 30 days or less and significant personal services are provided to customers by or on behalf of you as the property owner. If you can pass one of the material participation tests, losses from the activity are non-passive.

Utilize all tax breaks

As you can see, various taxpayer-friendly rules apply to owners of rental real estate, including the exceptions to the PAL rules covered here. We can help you take advantage of all available rental real estate tax breaks.

Staying compliant with payroll tax laws is crucial for small businesses. Mistakes can lead to fines, strained employee relationships and even legal consequences. Below are six quick tips to help you stay on track.

1. Maintain organized records

Accurate recordkeeping is the backbone of payroll tax compliance. Track the hours worked, wages paid and all taxes withheld. Organizing your documentation makes it easier to verify that you’re withholding and remitting the correct amounts. If you ever face an IRS or state tax inquiry, having clear, detailed records will save time and reduce stress.

2. Understand federal withholding

Federal income tax. Employees complete Form W-4 so you can determine how much federal income tax to withhold. The amounts can be calculated using IRS tax tables.
FICA taxes (Social Security and Medicare). Your business is responsible for withholding a set percentage from each employee’s wages for Social Security and Medicare, and you must match that amount as an employer. The current tax rate for Social Security is 6.2% for the employer and 6.2% for the employee (12.4% total). Taxpayers only pay Social Security tax up to a wage base limit. For 2025, the wage base limit is $176,100. The current rate for Medicare tax is 1.45% for the employer and 1.45% for the employee (2.9% total). There’s no wage base limit for Medicare tax. All wages are subject to it.

3. Don’t overlook employer contributions

Depending on your state and industry, you may need to contribute additional taxes beyond those withheld from employee paychecks.

Federal Unemployment Tax Act (FUTA) tax. Employers pay FUTA tax to fund unemployment benefits.
State unemployment insurance. Requirements vary by state, so consult your state’s labor department for details. You can also find more resources at the U.S. Department of Labor.

4. Adhere to filing and deposit deadlines

Deposit schedules. Your deposit frequency for federal taxes (monthly or semi-weekly) depends on the total amount of taxes withheld. Missing a deadline can lead to penalties and interest charges.
Quarterly and annual filings. You must submit forms like the 941 (filed quarterly) and the 940 (filed annually for FUTA tax) on time, with any tax due.

Under the Trust Fund Recovery Penalty, a “responsible person” who willfully fails to withhold or deposit employment taxes can be held personally liable for a steep penalty. The penalty is equal to the full amount of the unpaid trust fund tax, plus interest. For this purpose, a responsible person can be an owner, officer, partner or employee with authority over the funds of the business.

5. Stay current with regulatory changes

Tax laws are never static. The IRS and state agencies update requirements frequently, and new legislation can introduce additional obligations. A proactive approach helps you adjust payroll systems or processes in anticipation of changes, rather than scrambling at the last minute.

6. Seek professional advice

No matter how meticulous your business is, payroll taxes can be complex. We can provide guidance specific to your industry and location. We can help you select the right payroll system, calculate employee tax withholding, navigate multi-state filing requirements and more. In short, we can help ensure that every aspect of your payroll is set up correctly.

When it’s time to consider your business’s future, succession planning can protect your legacy and successfully set up the next generation of leaders or owners. Whether you’re ready to retire, you wish to step back your involvement or you want a solid contingency plan should you unexpectedly be unable to run the business, exploring different succession strategies is key. Here are five options to consider, along with some of the tax implications.

1. Transfer directly to family with a sale or gifts

One of the most common approaches to succession is transferring ownership to a family member (or members). This can be done by gifting interests, selling interests or a combination. Parents often pass the business to children, but family succession plans can also involve siblings or other relatives.

Tax implications:

Gift tax considerations. You may trigger the federal gift tax if you gift the business (or part of it) to a family member or if you sell it to him or her for less than its fair market value. The annual gift tax exclusion (currently $19,000 per recipient) can help mitigate or avoid immediate gift tax in small, incremental transfers. Plus, every individual has a lifetime gift tax exemption. So depending on the value of the business and your use of the exemption, you might not owe gift taxes on the transfer. Keep in mind that when gifting partial interests in a closely held business, discounts for lack of marketability or control may be appropriate and help reduce gift taxes.

Estate planning. If the owner dies before transferring the business, there may be estate tax implications. Proper planning can help minimize estate tax liabilities through trusts or other estate planning tools.

Capital gains tax. If you sell the business to family members, you could owe capital gains tax. (See “5. Sell to an outside buyer” for more information.)

2. Transfer ownership through a trust

Suppose you want to keep long-term control of the business within your family. In that case, you might place ownership interests in a trust (such as a grantor-retained annuity trust or another specialized vehicle).

Tax implications:

Estate and gift tax mitigation. Properly structured trusts can help transfer assets to the next generation with minimized gift and estate tax exposure. Trust-based strategies can be particularly effective for business owners with significant assets.

Complex legal framework. Because trusts involve legal documents and strict rules, working with us and an attorney is crucial to ensure compliance and optimize tax benefits.

3. Engage in an employee or management buyout

Another option is to sell to a group of key employees or current managers. This path often ensures business continuity because the new owners already understand the business and its culture.

Tax implications:

Financing arrangements. In many cases, employees or managers may not have the funds to buy the business outright. Often, the seller finances part of the transaction. While this can provide ongoing income for the departing owner, interest on installment payments has tax consequences for both parties.

Deferred payments. Spreading payments over time can soften your overall tax burden by distributing capital gains across multiple years, which might help you avoid being subject to top tax rates or the net investment income tax. But each payment received is still taxed.

4. Establish an Employee Stock Ownership Plan (ESOP)

An ESOP is a qualified retirement plan created primarily to own your company’s stock, and thus it allows employees to own shares in the business. It may be an appealing choice for owners interested in rewarding and retaining staff. However, administering an ESOP involves complex rules.

Tax implications:

Owner benefits. Selling to an ESOP can offer potential tax deferrals, especially if the company is structured as a C corporation and the transaction meets specific requirements.

Corporate deductions. Contributions to an ESOP are usually tax-deductible, which can reduce the company’s taxable income.

5. Sell to an outside buyer

Sometimes, the best fit is outside the family or current employees or management team. You might decide to sell to an external buyer — for example, a competitor or private equity group. If you can find the right buyer, you may even be able to sell the business at a premium.

If your business is structured as a corporation, you may sell the business’s assets or the stock. Sellers generally prefer stock (or ownership interest) sales because they minimize the tax bill from a sale.

Tax implications:

Capital gains tax. Business owners typically pay capital gains tax on the difference between their original investment in the business (their “basis”) and the sale price. The capital gains rate depends in part on how long you’ve held the business. Usually, if you’ve owned it for more than one year, you’re taxed at the applicable long-term capital gains rate.

Allocation of purchase price. If you sell the assets, you and the buyer must decide how to allocate the purchase price among assets (including equipment and intellectual property). This allocation affects tax liabilities for both parties.

Focus on your unique situation

Succession planning isn’t a one-size-fits-all process. Each option has unique benefits and pitfalls, especially regarding taxes. The best approach for you depends on factors including your retirement timeline, personal financial goals and family or employee involvement. Consult with us to ensure you choose a path that preserves your financial well-being and protects the business. We can advise on tax implications and work with you and your attorney to structure the deal advantageously. After all, a clear succession plan can safeguard the company you worked hard to build.

Prior to the enactment of the Tax Cuts and Jobs Act (TCJA), businesses were able to claim a tax deduction for most business-related interest expense. The TCJA created Section 163(j), which generally limits deductions of business interest, with certain exceptions.

If your business has significant interest expense, it’s important to understand the impact of the deduction limit on your tax bill. The good news is there may be ways to soften the tax bite in 2025.

The nuts and bolts

Unless your company is exempt from Sec. 163(j), your maximum business interest deduction for the tax year equals the sum of:

30% of your company’s adjusted taxable income (ATI),
Your company’s business interest income, if any, and
Your company’s floor plan financing interest, if any.

Assuming your company doesn’t have significant business interest income or floor plan financing interest expense, the deduction limitation is roughly equal to 30% of ATI.

Your company’s ATI is its taxable income, excluding:

Nonbusiness income, gain, deduction or loss,
Business interest income or expense,
Net operating loss deductions, and
The 20% qualified business income deduction for pass-through entities.

When Sec. 163(j) first became law, ATI was computed without regard to depreciation, amortization or depletion. But for tax years beginning after 2021, those items are subtracted in calculating ATI, shrinking business interest deductions for companies with significant depreciable assets.

Deductions disallowed under Sec. 163(j) may be carried forward indefinitely and treated as business interest expense paid or accrued in future tax years. In subsequent tax years, the carryforward amount is applied as if it were incurred in that year, and the limitation for that year will determine how much of the disallowed interest can be deducted. There are special rules for applying the deduction limit to pass-through entities, such as partnerships, S corporations and limited liability companies that are treated as partnerships for tax purposes.

Small businesses are exempt from the business interest deduction limit. These are businesses whose average annual gross receipts for the preceding three tax years don’t exceed a certain threshold. (There’s an exception if the business is treated as a “tax shelter.”) To prevent larger businesses from splitting themselves into small entities to qualify for the exemption, certain related businesses must aggregate their gross receipts for purposes of the threshold.

Ways to avoid the limit

Some real estate and farming businesses can opt out of the business interest deduction limit and therefore avoid it or at least reduce its impact. Real estate businesses include those that engage in real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing or brokerage.

Remember that opting out of the interest deduction limit comes at a cost. If you do so, you must reduce depreciation deductions for certain business property by using longer recovery periods. To determine whether opting out will benefit your business, you’ll need to weigh the tax benefit of unlimited interest deductions against the tax cost of lower depreciation deductions.

Another tax-reduction strategy is capitalizing interest expense. Capitalized interest isn’t treated as interest for purposes of the Sec. 163(j) deduction limit. The tax code allows businesses to capitalize certain overhead costs, including interest, related to the acquisition or production of property.

Interest capitalized to equipment or other fixed assets can be recovered over time through depreciation, while interest capitalized to inventory can be deducted as part of the cost of goods sold. We can crunch the numbers to determine which strategy would provide a better tax advantage for your business.

You also may be able to mitigate the impact of the deduction limit by reducing your interest expense. For example, you might rely more on equity than debt to finance your business or pay down debts when possible. Or you could generate interest income (for example, by extending credit to customers) to offset some interest expense.

Weigh your options

Unfortunately, the business interest deduction limitation isn’t one of the many provisions of the Tax Cuts and Jobs Act scheduled to expire at the end of 2025. But it’s possible Congress could act to repeal the limitation or alleviate its impact. If your company is affected by the business interest deduction limitation, contact us to discuss the impact on your tax bill. We can help assess what’s right for your situation.

As a business owner, you may be eligible to claim home office tax deductions that will reduce your taxable income. However, it’s crucial to understand the IRS rules to ensure compliance and avoid potential IRS audit risks. There are two methods for claiming this tax break: the actual expense method and the simplified method. Here are answers to frequently asked questions about the tax break.

Who qualifies?

In general, you qualify for home office deductions if part of your home is used “regularly and exclusively” as your principal place of business.

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if:

You physically meet with patients, clients or customers on your premises, or
You use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for business.

What expenses can you deduct?

Many eligible taxpayers deduct actual expenses when they claim home office deductions. Deductible home office expenses may include:

Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
A proportionate share of indirect expenses, including mortgage interest, rent, property taxes, utilities, repairs, maintenance and insurance,
Security system if applicable to your business, and
Depreciation.

But keeping track of actual expenses can take time and requires organized recordkeeping.

How does the simplified method work?

Fortunately, there’s a simplified method: You can deduct $5 for each square foot of home office space, up to a maximum of $1,500.

The cap can make the simplified method less valuable for larger home office spaces. Even for small spaces, taxpayers may qualify for larger deductions using the actual expense method. So, tracking your actual expenses can be worth it.

Can you change methods?

You’re not stuck with a particular method when claiming home office deductions. For instance, you might choose the actual expense method on your 2024 return, use the simplified method when you file your 2025 return next year and then switch back to the actual expense method for 2026. The choice is yours.

What if you sell your home?

If you sell — at a profit — a home on which you claimed home office deductions, there may be tax implications. We can explain them to you.

Also, be aware that the amount of your home office deductions is subject to limitations based on the income attributable to your use of the office. Other rules and limits may apply. However, any home office expenses that you can’t deduct because of these limitations can be carried over and deducted in later years.

Do employees qualify?

The Tax Cuts and Jobs Act suspended the business use of home office deductions through the end of 2025 for employees. Those who receive paychecks or Form W-2s aren’t eligible for deductions, even if they’re currently working from home because their employers require them to and don’t provide office space.

Home office tax deductions can provide valuable tax savings for business owners, but they must be claimed correctly. We can help you determine if you’re eligible and how to proceed.

Businesses in certain industries employ service workers who receive tips as a large part of their compensation. These businesses include restaurants, hotels and salons. Compliance with federal and state tax regulations is vital if your business has employees who receive tips.

Are tips becoming tax-free?

During the campaign, President Trump promised to end taxes on tips. While the proposal created buzz among employees and some business owners, no legislation eliminating taxes on tips has been passed. For now, employers should continue to follow the existing IRS rules until the law changes — if it does. Unless legal changes are enacted, the status quo remains in effect.

With that in mind, here are answers to questions about the current rules.

How are tips defined?

Tips are optional and can be cash or noncash. Cash tips are received directly from customers. They can also be electronically paid tips distributed to employees by employers and tips received from other employees in tip-sharing arrangements. Workers must generally report cash tips to their employers. Noncash tips are items of value other than cash. They can include tickets, passes or other items that employees receive from customers. Workers don’t have to report noncash tips to employers.

Four factors determine whether a payment qualifies as a tip for tax purposes:

The customer voluntarily makes a payment,
The customer has an unrestricted right to determine the amount,
The payment isn’t negotiated with, or dictated by, employer policy, and
The customer generally has a right to determine who receives the payment.

There are more relevant definitions. A direct tip occurs when an employee receives it directly from a customer (even as part of a tip pool). Directly tipped employees include wait staff, bartenders and hairstylists. An indirect tip occurs when an employee who normally doesn’t receive tips receives one. Indirectly tipped employees can include bussers, service bartenders, cooks and salon shampooers.

What records need to be kept?

Tipped workers must keep daily records of the cash tips they receive. To do so, they can use Form 4070A, Employee’s Daily Record of Tips. It’s found in IRS Publication 1244.

Workers should also keep records of the dates and values of noncash tips. The IRS doesn’t require workers to report noncash tips to employers, but they must report them on their tax returns.

How must employees report tips to employers?

Employees must report tips to employers by the 10th of the month after the month they were received. The IRS doesn’t require workers to use a particular form to report tips. However, a worker’s tip report generally should include the:

Employee’s name, address, Social Security number and signature,
Employer’s name and address,
Month or period covered, and
Total tips received during the period.

Note: If an employee’s monthly tips are less than $20, there’s no requirement to report them to his or her employer. However, they must be included as income on his or her tax return.

Are there other employer requirements?

Yes. Send each employee a Form W-2 that includes reported tips. In addition, employers must:

Keep employees’ tip reports.
Withhold taxes, including income taxes and the employee’s share of Social Security and Medicare taxes, based on employees’ wages and reported tip income.
Pay the employer share of Social Security and Medicare taxes based on the total wages paid to tipped employees as well as reported tip income.
Report this information to the IRS on Form 941, Employer’s Quarterly Federal Tax Return.
Deposit withheld taxes in accordance with federal tax deposit requirements.

In addition, “large” food or beverage establishments must file another annual report. Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, discloses receipts and tips.

What’s the tip tax credit?

Suppose you’re an employer with tipped workers providing food and beverages. In that case, you may qualify for a valuable federal tax credit involving the Social Security and Medicare taxes you pay on employees’ tip income.

How should employers proceed?

Running a business with tipped employees involves more than just providing good service. It requires careful adherence to wage and hour laws, thorough recordkeeping, accurate reporting and an awareness of changing requirements. While President Trump’s pledge to end taxes on tips hasn’t yet materialized into law, stay alert for potential changes. In the meantime, continue meeting all current requirements to ensure compliance. Contact us for guidance about your situation.

According to the U.S. Bureau of Labor Statistics, the unemployment rate continues to be historically low, ranging from 4.0% to 4.3% from May to November of 2024. With today’s hiring challenges, business owners should be aware that the Work Opportunity Tax Credit (WOTC) is available to employers that hire workers from targeted groups who face significant barriers to employment. The tax credit is generally worth as much as $2,400 for each eligible employee (higher for certain veterans and “long-term family assistance recipients”). It’s generally limited to eligible employees who begin working for the employer before January 1, 2026.

To satisfy a requirement of the WOTC, a pre-screening notice must be completed by the job applicant and the employer on or before the day a job offer is made. This is done by filing Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit.

The targeted groups

An employer is eligible for the credit only for qualified wages paid to a member of a targeted group. These groups are:

Qualified IV-A recipients who are members of families receiving assistance under the Temporary Assistance for Needy Families (TANF) program,
Qualified veterans,
Qualified ex-felons,
Designated community residents,
Vocational rehabilitation referrals,
Qualified summer youth employees,
Qualified members of families in the Supplemental Nutritional Assistance Program (SNAP),
Qualified Supplemental Security Income recipients,
Long-term family assistance recipients, and
Qualified long-term unemployed individuals.

Details to qualify

To qualify for the credit, there are a number of requirements. For example, each employee must have completed at least 120 hours of service in their first year of service for the employer. Also, the credit isn’t available for certain employees who are related to or who previously worked for the employer.

There are different rules and credit amounts for certain employees. The maximum credit available for first-year wages is generally $2,400 for each employee, $4,000 for long-term family assistance recipients, and $4,800, $5,600 or $9,600 for certain veterans. Additionally, for long-term family assistance recipients, there’s a 50% credit for up to $10,000 of second-year wages, resulting in a total maximum credit over two years of $9,000.

For summer youth employees, the wages must be paid for services performed during any 90-day period between May 1 and September 15. The maximum credit available for summer youth employees is $1,200 per employee.

A win for you and your employees

In some cases, employers may elect not to claim the WOTC. In limited circumstances, the rules may prohibit the credit or require allocating it. However, the credit can be advantageous for most employers hiring from targeted groups — and it can result in jobs for those who need them. Contact us with questions or for more information about your situation.

If you own a growing, unincorporated small business, you may be concerned about high self-employment (SE) tax bills. The SE tax is how Social Security and Medicare taxes are collected from self-employed individuals like you.

SE tax basics

The maximum 15.3% SE tax rate hits the first $168,600 of your 2024 net SE income. The 15.3% rate is comprised of the 12.4% rate for the Social Security tax component plus the 2.9% rate for the Medicare tax component. For 2025, the maximum 15.3% SE tax rate will hit the first $176,100 of your net SE income.

Above those thresholds, the SE tax’s 12.4% Social Security tax component goes away, but the 2.9% Medicare tax component continues for all income.

How high can your SE tax bill go? Maybe a lot higher than you think. The real culprit is the 12.4% Social Security tax component of the SE tax, because the Social Security tax ceiling keeps getting higher every year.

To calculate your SE tax bill, take the taxable income from your self-employed activity or activities (usually from Schedule C of Form 1040) and multiply by 0.9235. The result is your net SE income. If it’s $168,600 or less for 2024, multiply the amount by 15.3% to get your SE tax. If the total is more than $168,600 for 2024, multiply $168,600 by 12.4% and the total amount by 2.9% and add the results. This is your SE tax.

Example: For 2024, you expect your sole proprietorship to generate net SE income of $200,000. Your SE tax bill will be $26,706 (12.4% × $168,600) + (2.9% × $200,000). That’s a lot!

Projected tax ceilings for 2026–2033

The current Social Security tax on your net SE income is expensive enough, but it will only worsen in future years. That’s because your business income will likely grow, and the Social Security tax ceiling will continue to increase based on annual inflation adjustments.

The latest Social Security Administration (SSA) projections (from May 2024) for the Social Security tax ceilings for 2026–2033 are:

2026 – $181,800
2027 – $188,100
2028 – $195,900
2029 – $204,000
2030 – $213,600
2031 – $222,900
2032 – $232,500
2033 – $242,700

Could these estimated ceilings get worse? Absolutely, because the SSA projections sometimes undershoot the actual final numbers. For instance, the 2025 ceiling was projected to be $174,900 just last May, but the final number turned out to be $176,100. But let’s say the projected numbers play out. If so, the 2033 SE tax hit on $242,700 of net SE income will be a whopping $37,133 (15.3% × $242,700).

Disconnect between tax ceiling and benefit increases

Don’t think that Social Security tax ceiling increases are linked to annual Social Security benefit increases. Common sense dictates that they should be connected, but they aren’t. For example, the 2024 Social Security tax ceiling is 5.24% higher than the 2023 ceiling, but benefits for Social Security recipients went up by only 3.2% in 2024 compared to 2023. The 2025 Social Security tax ceiling is 4.45% higher than the 2024 ceiling, but benefits are going up by only 2.5% for 2025 compared to 2024.

The reason is that different inflation measures are used for the two calculations. The increase in the Social Security tax ceiling is based on the increase in average wages, while the increase in benefits is based on a measure of general inflation.

S corporation strategy

While your SE tax bills can be high and will probably get even higher in future years, there may be potential ways to cut them to more manageable levels. For instance, you could start running your business as an S corporation. Then, you can pay yourself a reasonably modest salary while distributing most or all of the remaining corporate cash flow to yourself. That way, only your salary would be subject to Social Security and Medicare taxes. Contact us if you have questions or want more information about the SE tax and ways to manage it.

When drafting partnership and LLC operating agreements, various tax issues must be addressed. This is also true of multi-member LLCs that are treated as partnerships for tax purposes. Here are some critical issues to include in your agreement so your business remains in compliance with federal tax law.

Identify and describe guaranteed payments to partners

For income tax purposes, a guaranteed payment is one made by a partnership that’s: 1) to the partner acting in the capacity of a partner, 2) in exchange for services performed for the partnership or for the use of capital by the partnership, and 3) not dependent on partnership income.

Because special income tax rules apply to guaranteed payments, they should be identified and described in a partnership agreement. For instance:

The partnership generally deducts guaranteed payments under its accounting method at the time they’re paid or accrued.
If an individual partner receives a guaranteed payment, it’s treated as ordinary income — currently subject to a maximum income tax rate of 37%. The recipient partner must recognize a guaranteed payment as income in the partner’s tax year that includes the end of the partnership tax year in which the partnership deducted the payment. This is true even if the partner doesn’t receive the payment until after the end of his or her tax year.

Account for the tax basis from partnership liabilities

Under the partnership income taxation regime, a partner receives additional tax basis in his or her partnership interest from that partner’s share of the entity’s liabilities. This is a significant tax advantage because it allows a partner to deduct passed-through losses in excess of the partner’s actual investment in the partnership interest (subject to various income tax limitations such as the passive loss rules).

Different rules apply to recourse and nonrecourse liabilities to determine a partner’s share of the entity’s liabilities. Provisions in the partnership agreement can affect the classification of partnership liabilities as recourse or nonrecourse. It’s important to take this fact into account when drafting a partnership agreement.

Clarify how payments to retired partners are classified

Special income tax rules also apply to payments made in liquidation of a retired partner’s interest in a partnership. This includes any partner who exited the partnership for any reason.

In general, payments made in exchange for the retired partner’s share of partnership property are treated as ordinary partnership distributions. To the extent these payments exceed the partner’s tax basis in the partnership interest, the excess triggers taxable gain for the recipient partner.

All other payments made in liquidating a retired partner’s interest are either: 1) guaranteed payments if the amounts don’t depend on partnership income, or 2) ordinary distributive shares of partnership income if the amounts do depend on partnership income. These payments are generally subject to self-employment tax.

The partnership agreement should clarify how payments to retired partners are classified so the proper tax rules can be applied by both the partnership and recipient retired partners.

Consider other partnership agreement provisions

Since your partnership may have multiple partners, various issues can come into play. You’ll need a carefully drafted partnership agreement to handle potential issues even if you don’t expect them to arise. For instance, you may want to include:

A partnership interest buy-sell agreement to cover partner exits.
A noncompete agreement.
How the partnership will handle the divorce, bankruptcy, or death of a partner. For instance, will the partnership buy out an interest that’s acquired by a partner’s ex-spouse in a divorce proceeding or inherited after a partner’s death? If so, how will the buyout payments be calculated and when will they be paid?

Minimize potential liabilities

Tax issues must be addressed when putting together a partnership deal. Contact us to be involved in the process.

As we look ahead to Q4 2024, it’s time to take proactive steps that may help lower your small business’s taxes for this year and next. The strategy of deferring income and accelerating deductions to minimize taxes can be effective for most businesses, as is the approach of bunching deductible expenses into this year or next to maximize their tax value.

Do you expect to be in a higher tax bracket next year? If so, then opposite strategies may produce better results. For example, you could pull income into 2024 to be taxed at lower rates, and defer deductible expenses until 2025, when they can be claimed to offset higher-taxed income.

Here are some other ideas that may help you save tax dollars if you act soon.

Estimated taxes

Make sure you make the last two estimated tax payments to avoid penalties. The third quarter payment for 2024 is due on September 16, 2024, and the fourth quarter payment is due on January 15, 2025.

QBI deduction

Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income (QBI). For 2024, if taxable income exceeds $383,900 for married couples filing jointly (half that amount for other taxpayers), the deduction may be limited based on whether the taxpayer is engaged in a service-type business (such as law, health or consulting), the amount of W-2 wages paid by the business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the business. The limitations are phased in.

Taxpayers may be able to salvage some or all of the QBI deduction (or be subject to a smaller deduction phaseout) by deferring income or accelerating deductions to keep income under the dollar thresholds. You also may be able increase the deduction by increasing W-2 wages before year end. The rules are complex, so consult us before acting.

Cash vs. accrual accounting

More small businesses are able to use the cash (rather than the accrual) method of accounting for federal tax purposes than were allowed to do so in previous years. To qualify as a small business under current law, a taxpayer must (among other requirements) satisfy a gross receipts test. For 2024, it’s satisfied if, during the three prior tax years, average annual gross receipts don’t exceed $30 million. Cash method taxpayers may find it easier to defer income by holding off on billing until next year, paying bills early or making certain prepayments.

Section 179 deduction

Consider making expenditures that qualify for the Section 179 expensing option. For 2024, the expensing limit is $1.22 million, and the investment ceiling limit is $3.05 million. Expensing is generally available for most depreciable property (other than buildings) including equipment, off-the-shelf computer software, interior improvements to a building, HVAC and security systems.

The high dollar ceilings mean that many small and midsize businesses will be able to currently deduct most or all of their outlays for machinery and equipment. What’s more, the deduction isn’t prorated for the time an asset is in service during the year. Even if you place eligible property in service by the last days of 2024, you can claim a full deduction for the year.

Bonus depreciation

For 2024, businesses also can generally claim a 60% bonus first-year depreciation deduction for qualified improvement property and machinery and equipment bought new or used, if purchased and placed in service this year. As with the Sec. 179 deduction, the write-off is available even if qualifying assets are only in service for a few days in 2024.

Upcoming tax law changes

These are just some year-end strategies that may help you save taxes. Contact us to customize a plan that works for you. In addition, it’s important to stay informed about any changes that could affect your business’s taxes. In the next couple years, tax laws will be changing. Many tax breaks, including the QBI deduction, are scheduled to expire at the end of 2025. Plus, the outcome of the presidential and congressional elections could result in new or repealed tax breaks.

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