The date part of that? Easy. You can read a calendar.

The tangible property part? Mostly easy, too. The main rule is anything with a class life of 20 years or less? You can bonus depreciate.

But that “purchase” requirement? Trickier that you might guess.

The Technical Purchase Requirement

So, the Section 168(k) statute says we look to Section 179(d)(2) to determine what a purchase is. And that chunk of the law says this:

For purposes of paragraph (1), the term “purchase” means any acquisition of property, but only if—

(A) the property is not acquired from a person whose relationship to the person acquiring it would result in the disallowance of losses under section 267 or 707(b) (but, in applying section 267(b) and (c) for purposes of this section, paragraph (4) of section 267(c) shall be treated as providing that the family of an individual shall include only his spouse, ancestors, and lineal descendants),

(B) the property is not acquired by one component member of a controlled group from another component member of the same controlled group, and

(C) the basis of the property in the hands of the person acquiring it is not determined—

(i) in whole or in part by reference to the adjusted basis of such property in the hands of the person from whom acquired, or

(ii) under section 1014(a) (relating to property acquired from a decedent).

Which provides most but not all the rules you need… so let’s just step through this.

No Bonus Depreciation for Related Party Acquisitions

A first observation? Someone can’t purchase property from a related party.

That simple rule makes sense just from a loophole prevention context. Without that prohibition, families and family-owned businesses could manipulate bonus depreciation deductions at will.

No Bonus Depreciation for Purchaser Contributed Property

A more subtle requirement. If you purchase some property and then contribute it to a partnership or corporation? No bonus depreciation.

This wrinkle may matter more than you think. For example, if you and your spouse buy a short-term rental thinking you should be able to get giant bonus depreciation deductions? That may work, sure.

But then if you contribute that property to an LLC which you and your spouse both own and then treat that LLC as a partnership? Okay, now we got a problem. The reason? The bonus depreciation deduction would need to go on a partnership tax return. Except the partnership didn’t purchase. You and your spouse did.

No Bonus Depreciation on Inherited Property

Bonus depreciation doesn’t apply to inherited property someone acquires from a decedent and for which tax law (specifically Section 1014) resets the basis to the fair market value usually at time of death.

You can read this rule right in the statute I quoted above. But so you understand and so this makes sense, assume you and your spouse own property—maybe it’s an income rental—and you’ve already depreciated it fully. Maybe you bought the property for $200,000 decades ago and have long since deducted all the available depreciation meaning the adjusted for depreciation “cost basis” now seats at $50,000.

In a community property state, the death of one spouse resets the basis to the fair market value. If the above property at the date of death of the first spouse is now worth $1,000,000? The surviving spouse can again begin depreciating the property. And based on that new $1,000,000 basis. But he or she can’t use bonus depreciation. Rather, the surviving spouse uses regular old MACRS depreciation.

Note: Bonus depreciation would not apply to much of an income rental. Only the parts of the property that represents tangible personal property with of 20 years or less.

No Bonus Depreciation for Section 754 Elections

A sort of related issue: If someone buys into a partnership with tangible property or inherits an interest in a partnership with tangible property? Their purchase price or the Section 1014 basis adjustment can, if a Section 754 election has been made, cause the partnership to adjust the basis and depreciation numbers for that partner’s share of, say, the machinery.

However, the regulations for Section 168(k) specifically exclude taking bonus deprecation on this amount created via the Section 754 election. (Let me cite the actual regulation in case you’re a tax practitioner and want to read this: Reg 1.168(k)(f)(9).)

Yes Bonus Depreciation on Section 1031 Like-Kind Exchanges

So, you might guess that the statute quoted earlier prevents you from deducting bonus depreciation on a least some of the basis you count after a like-kind exchange. But that’s not exactly right. In general, if you want, you can take bonus depreciation on the new property you acquire via a like kind exchange.

Example: You trade land worth $1,000,000 but with a basis equal to $100,000 for a building worth $1,000,000. You can use Section 1031 to avoid paying taxes on the $900,000 realized gain. And the probably you can bonus depreciate the part of the new building that counts as tangible personal property. If 20% of the new building is tangible personal property and your basis is only that $100,000, probably you can deduct $20,000 of bonus depreciation.

If you trade the $1,000,000 piece of land and use a $2,000,000 mortgage to acquire a $3,000,000 building and 20% of that building counts as tangible personal property, you can probably bonus depreciate 20% of the $2,000,000 and the $100,000 so roughly a $420,000 bonus depreciation deduction.

Yes Bonus Depreciation on Section 1033 Involuntary Conversions

A quick final point: If you use Section 1033 to handle an involuntary conversion? Roughly, the accounting for a Section 1033 involuntary conversion works like the accounting for a Section 1031 like-kind exchange.

In other words, if the involuntary conversion causes you to lose one property (a vehicle, a building, or whatever) and you replace that property, you can potentially use bonus depreciation on the carryover basis and the new property’s excess basis.

A fire destroys equipment with basis $400,000 and FMV $1,000,000. The taxpayer receives $1,000,000 insurance and reinvests it all in similar equipment (qualifying under §1033). Basis in replacement equipment = $400,000 (carryover). Under the §168(k) regs, that $400,000 basis qualifies for bonus depreciation (since equipment has a recovery period <20 years)

The post The Section 168(k) Bonus Depreciation Purchased Requirement appeared first on Evergreen Small Business.

Given the questions I get from friends and colleagues about this, especially about using ChatGPT in a small business, I thought it’d make sense to share how I’ve or we’ve been using this new tool.

Organizing This Discussion

Using ChatGPT in a small business though? A big topic. Thus, I’m going to break this discussion into two parts.

In this part, which I consider part 1, I’m going to list and briefly describe all the examples of how we’re probably productively been using ChatGPT in our small business. (The CPA firm in other words.) But I’m hoping you can use my ideas to begin incorporating something like ChatGPT into your work.

In the second part, “Small Business ChatGPT Tips and Tricks,” I share some basic tips and techniques I found work well and get you or me good or better results.

And one other comment as I start: This is going to be a bit of a laundry list. But that’s not just because lists provide an easy structure for writing. I think you and I approach an AI like ChatGPT with the idea that we’re going to build a laundry list of tasks it can help us do better. That, I think, should be our immediate goal.

So, here’s my current laundry list…

General Help with Writing Emails

A quick first task. And this is pretty general. But if you need some help getting your emails “just right?” ChatGPT is your friend. And in a potpourri of ways. Some examples.

If you need to write emails in other than your native language? That’s obviously often a struggle. But here’s what you can do. Write in your native language—and then have ChatGPT translate that message into the appropriate language for the email. This works great.

Another example: If you need to, let me just say this politely, if you need to be a little less angry and a little more composed? Have ChatGPT soften the language of your first draft.

Finally, another example: If you’re struggling with grammar, punctuation, typos or other silly mistakes for whatever reason? Get ChatGPT to proof your writing.

By the way, a possible side effect of this approach? I’m guessing it will over time allow the people to polish their writing skills.

Writing Awkward Emails

A related example: writing those awkward emails that take too much time. Often because the subject matter is potentially hurtful or emotionally charged: declining to interview a job applicant, rejecting a candidate for some position, or disengaging from a client. Also any other communication where you or I may struggle with writer’s block. Or where we may procrastinate as we worry about the wording.

ChatGPT suffers from no emotional block about writing, for example, an awkward email. What it writes? Surely good enough. Always nice enough. Almost surely “legally” safe. And absolutely massively faster at this work than you or I are.

Thus, use ChatGPT to write an adequate email. Then click Send. Done.

The “Quick Question” Emails

You know what I’m talking about here if you’re in a service business. The “I just have a quick question” trap: So, your or my client or customer has a question or set of questions, wants a quick, free answer, and assumes you or I can dash off a quick response. Ideally this afternoon.

Reality: Rarely do these “quick questions” take only a minute or two to draft and then send. It’s a half hour. Or longer.

Thus, I think, if you or I attribute the email to ChatGPT, we have ChatGPT write these. This approach converts a maybe 45-minute task into that five-minute task. One you or I can provide for free.

And two subtle benefits of this approach. First, when you’re sharing bad news or awkward truths, you may find it useful to be quoting something ChatGPT says. (You aren’t the one telling them some idea doesn’t work. ChatGPT tells them.) Second, and maybe unfairly, ChatGPT can be a more authoritative source than you or I are delivering personalized information. (If you want another source? Here’s what ChatGPT says…)

A sidebar comment about all these email-related tasks: I don’t think this stuff is merely nibbling around the edges. CPAs for example basically get paid for half the hours they work. Your business may experience something similar. Thus, if you or I can dial down the minutes we spend here and there communicating with clients and vendors, colleagues and coworkers, we should save hours each week.

Writing Software Code

I want to talk now about some of the new work an AI like ChatGPT can do. And the obvious first example here? Programming. You and I, even if we’re not experienced or trained programmers, can use ChatGPT to write source code. And at extremely low cost.

We can then use this software to automate bits of our businesses. Or to increase the value of the products or services we provide. Or to cut the costs of those products and services.

This should make sense, right? Because you and I have work we do where some software would help… Software that no software development company will ever produce. So, the answer: We do it ourselves.

This step requires a bit of set-up time. It took me about a day to figure out what to do with the JavaScript ChatGPT has been writing for our blog posts recently. Getting Python running on my computer? That took a few hours too. (I had not really programmed for decades.) Roughly speaking, I can now write a blog post that includes a JavaScript calculator in about the same time as a blog post that doesn’t.

This has been a meaningful improvement for us. One example to illustrate. We use our blog to market our niche services across the US. And ChatGPT gives me the ability to bump the value of our blog’s posts by adding JavaScript calculators to some of those posts.

We’ve got “calculators” that estimate the tax savings from an S corporation, that estimate reasonable S corporation shareholder-employee compensation, that calculate the depreciation deductions from cost segregation studies, that answer some of those perennial Roth IRA questions, and a bunch more.

You may be able to do something similar in your operation. Or even something identical.

One-on-one Mentoring and Personalized Education

Another example and in a sense something the programming stuff I just mentioned illustrates. ChatGPT will teach you and me stuff. Complicated stuff.

You can start by having it write a short overview of some subject you in your job or people in your industry struggle with. You can then ask detailed questions. Repeatedly. You can provide examples that explain your current understanding throughout this process using specific client details. (“So let me get this straight, ChatGPT. For my client named Steve, in this situation, it works like this?”) ChatGPT shows endless patience. It works day or night. You can in effect torture it with dumb questions. The sort no one would ever ask in a classroom or seminar.

Seriously, the next time you have a question in the past you’d ask a knowledgeable colleague or mentor? Ask ChatGPT. (I participate as an admin in a couple of online social media networks for CPAs. And most of the questions folks ask? They should probably ask ChatGPT.)

Reasonable-cost Research Reports and Management Consultant Studies

Small businesses often don’t get to do the same sorts of research that larger firms do. Or get to regularly consult with industry or management experts.

For example, the big guys may have economists on staff who look at the likely scenarios the near future holds. They may also either employ or engage with true experts to plan for and think about the challenges and opportunities their business and industry face.

And then what about pursuing or ignoring the strategy or tactic de jour? (In public accounting right now, firms of all sizes wonder whether private equity funds owning a firm makes sense.) The small guys don’t have people (typically) they can ask about stuff like this.

However, now? With ChatGPT? In all of the above cases, you and I can get lengthy written analyses customized to our firm’s specific situation. Concerned about how new tariffs will affect your business or your clients? Or about how inflation may affect you or your clients? Worried about the compensation levels needed to fully staff your firm with great talent? Struggling to understand how something like private equity ownership of firms in your industry impacts your business plan?

ChatGPT will do all this research and analysis for you. And extremely quickly. You can get insights and commentary about the range of economic outcomes from new government policy for your firm this morning as you have your coffee. Actionable insights about current and future salary levels and labor shortages within the profession tomorrow morning–again with your coffee. The private equity thing? Again, with your morning coffee. But maybe two cups for that.

By the way this thought: Will these ChatGPT reports and analysis be perfect? Full of bulletproof analysis? Will the actions they suggest be guaranteed to deliver great or at least good results?

I think not. But getting pretty good research and pretty good analysis surely beats the option of not looking at and considering this stuff. (And I’m not sure what you’d get from an expensive expert is that much better.)

Monte Carlo Simulations and Scenario Planning

A quick thing to point out. You and I can get ChatGPT to do Monte Carlo analysis for our investment planning. And scenario planning for our business plans and forecasts.

I think ChatGPT is particularly useful for doing Monte Carlo simulations. To start, get ChatGPT to explain what a Monte Carlo is and how it works. You can then get its help to collect the handful of inputs needed. And you can then ask it to make the calculations. And then ask it redo the calculations for an alternative set of assumptions.

The same reality occurs with scenario planning. Say you were thinking about selling out to a private equity firm. You can easily get ChatGPT to model the financial outcomes of continuing to operate independently, selling out to a private equity, and any other option too.

For what it’s worth? When I asked ChatGPT to analyze for fun our firm selling out to a private equity firm, it estimated we would simply be converting ordinary income to capital gains and would probably, even if CPA firm valuations deflated, end up with much better outcomes by staying “partner owned.” That analysis also acknowledged but didn’t quantify the benefits of autonomy by working for ourselves versus (and here I quote ChatGPT) working for “MBAs with spreadsheets.” I intuitively knew in our situation all this was true. But I found it interesting and useful to get another, neutral, objective point of view.

Critiquing Business Strategies and Tactics

Okay, a subtle point but an important one. I don’t feel like a ChatGPT-style AI does a good job at business planning, strategy, or tactics. For one thing, it “thinks” or “does what it does” too linearly. For another thing, probably you and I can’t prompt it with enough of the right information to come out with innovative, highly personalized strategies and tactics.

But you know what ChatGPT is really good at? Looking at some plan, strategy or tactic that you or I or a consultant or client develops and then critiquing it. There? It often will spot errors or bugs or holes.

Sorry for falling down the rabbit hole for a paragraph. (Just this paragraph.) And I’m not sure about exact error rate percentages here. But here’s what I think happens when you have ChatGPT “check your work.” If when we’re on our game our error rate is five percent and ChatGPT’s error rate is twenty percent? (And those percentages feel about right actually.) A compounding benefit occurs. And the overall effective error rate drops to maybe one percent. (The actual math maybe looks like this: 20% times 5% equals 1%.)

Three Final Thoughts

Let me close with three final thoughts.

First, I don’t think something like ChatGPT replaces a good knowledge worker any more than a nail gun and air compressor replace a master carpenter. After more than a year, though, I do think you and I will use ChatGPT for work we can’t affordably or efficiently do now. For a reasonable price.

Tip: To put this into dollars? I think we pay OpenAI $20 a month per person right now for a subscription to ChatGPT 4o. Paying $200 a month per person for ChatGPT o1? Yeah, that’s probably okay. But at some point, say the price was $2,000 a month per person, I don’t know if that would make economic sense. At least not given how we’re able to use the technology.

Second thought: I feel like ChatGPT amplifies worker productivity and performance. You boost someone’s performance by maybe—this is a fermi number guess—by maybe 20 to 30 percent. That means a couple of things, I suggest. First, you and I don’t become less valuable with AI we become more valuable. (For $20 a month, you or I maybe become like 20 percent smarter.) Second, the most important people to get up to speed with an AI tool like ChatGPT? Your most skilled and experienced team members.

Here’s my third and final thought. An AI like ChatGPT should allow you or me to dramatically boost the performance of our small businesses rather quickly. So not at some point in the future like three years from now. But today. Or maybe tomorrow. The trick though? And this gets back to the laundry list comment I made earlier. We need to experiment and explore and ultimately build a list of tasks where ChatGPT lets us do more work and new useful work.

The post Using ChatGPT in a Small Business appeared first on Evergreen Small Business.

Additional Information and Instructions

The S corporation reasonable compensation calculator suggests possible S corporation salary amounts based on shareholder distributions, shareholder wages, the highest paid nonshareholder’s wages, and the Bureau of Labor Statistics data for the job.

The distributions a shareholder-employee receives matter for a simple reason. The Internal Revenue Service can reclassify distributions as wages if an S corporation pays unreasonably low wages to a shareholder-employee.

The amount the highest non-shareholder-employee earns also matters. In most situations, a shareholder-employee would need to be paid more than a non-shareholder employee.

The calculator also considers the most up-to-date Bureau of Labor Statistics annual wages data for more than 800 occupations. More specifically, if available, the calculator grabs the 10th, 25th, 50th, 75th and 90th percentile annual wage amounts.

Adjusting for Inflation

The data used in this 2025 version of the calculator reflects May 2024 annual wages which means roughly a year or more of inflation has occurred since the data were collected. (The BLS published the data in Spring 2025 which means at least a two percent adjustment is probably appropriate.) However, keep in mind that salary amounts don’t always move up even if there is inflation. (We noticed that many salary amounts didn’t change or slightly decreased between the May 2023 and May 2024.)

Understanding the S Corporation Reasonable Compensation Amounts

The S corporation reasonable compensation calculator estimates three amounts or ranges: an “aggressive”salary, a “pretty safe” range, and a “very safe” salary.

“Aggressive” Salary Amount

The calculator estimates the lowest possible, or “Aggressive,” S corporation reasonable compensation amount by identifying the smallest of the following three amounts: the S coporation distributions and wages the shareholder-employee will receive during the year, the annual wages paid to the highest-paid non-shareholder employee, and the 10th percentile annual wages number available from the Bureau of Labor Statistics. The calculator suggests the smallest of these values is probably as aggressive as one should be.

Example: An S corporation pays its shareholder $15,000 in wages and another $45,000 in distributions. (That totals $60,000.) Say the S corporation employs another non-shareholder employee and pays that person $50,000. Also say that the tenth percentile annual wage for the job equals $70,000. In this case, the calculator looks at those three numbers ($60,000, $50,000 and $70,000) and suggests that probably $50,000 is as low as the S corporation should pay its shareholder.

Note: If the S corporation leaves the highest paid non-shareholder employee salary input blank, the calculator assumes the only employee is the shareholder. In that case, if the S corporation pays its shareholder $15,000 in wages and another $45,000 in distributions (again $60,000 in total) and the tenth percentile annual equal equals $70,000, the calculator looks at those two numbers ($60,000 versus $70,000) and suggests that the S corporation should pay $60,000 in wages. (This would mean the S corporation should pay zero distributions.)

“Pretty Safe” Salary Range

The calculator estimates the “Pretty Safe Salary Rage” as any amount falling between the 25th and 75th percentiles assuming those values are available.

The idea here is that if a shareholder’s compensation sits at a level where one in four people in the same job make more or make less, probably the shareholder-employee’s compensation falls within the range of “reasonable.” Note that if a particular annual earnings percentile is unavailable, the calculator displays “Unknown.”

“Very Safe” Salary Amount

The calculator estimates a “Very Safe Salary” as the greatest of the following values: The highest annual wages value available from the Bureau of Labor Statistics for an occupation or the wages paid to the highest non-shareholder employee.

In other words, if an S corporation pays its shareholder-employee the highest annual wages value reported by the Bureau of Labor Statistics? Or, if even higher, the wages paid the highest paid non-shareholder-employee working for the S corporation? That’s a pretty safe number in terms of the Internal Revenue Service arguing an S corporation should have paid a shareholder-employee an even larger salary amount.

Tips for Using the Calculator

A handful of tips. First, the calculator uses national averages. If an S corporation shareholder-employee works in a locality with salaries vastly different than the national average, that difference may undermine the usefulness of the calculator’s estimates. Employers may want to nudge the calculated value up or down to adjust for this.

Second, some small corporations employ shareholders in “more than one hat” roles where the worker does two or three jobs on a part-time basis. Thus, some situations will require the S corporation to average salaries from multiple positions to get to a reasonable compensation estimate.

A third and related tip: You probably want to experiment with different Bureau of Labor Statistics’ occupations. The list the calculator looks at is long. And your job may fit well into more than one category.

Fourth finally, this note from a tax accountant who reviewed the earliest version of this calculator: If a small business corporation’s profits are very modest, the calculator’s “Pretty Safe Salary Range” may be impractically high. A firm generating, say, $20,000 in profits before paying shareholder-employees their wages may not be able to pay anything close to the 25th percentile. Thus apply common sense. And understand that for very small (and probably for very large) S corporations, you may need to take the calculator’s suggestions with a grain of salt.

Related Resources for S Corporations

If you’re working to really maximize your S corproation’s tax savings, you might be interested in this recent blog post: Advanced S Corporation Tax Planning Secrets.

You’ve maybe already seen this other calculator, but you can estimate the payroll tax savings your S corporation produces using the S Corporation Payroll Tax Savings Calculator.

If you’ve got access to ChatGPT, you may also want to get its rather useful input on the appropriate salary to pay an S corporation shareholder-employee. We’ve got more information about that here: Using ChatGPT to Determine S Corporation Reasonable Compensation for Shareholders.

The post S Corporation Reasonable Compensation Calculator appeared first on Evergreen Small Business.

Some folks can also prudently buy the home or apartment where they reside. But after those obvious options? I’m pretty agnostic. Except, that is, for the real estate investment every entrepreneur should consider: Self-rental property your business occupies.

Why Self-rental Property is So Attractive to Entrepreneurs

Self-rental property works great for entrepreneurs for a simple reason. As long as they follow the rules, they can pretty effectively unlock depreciation deductions that normally other real estate investors can’t unlock. Or unlock without spending tons of time or doing lots of fiddling.

A real estate professional by the way can unlock depreciation deductions. But to do that, she or he will need to spend more than 750 hours and more than 50 percent of their time working in a real estate trade or business. They will also need to materially participate in the properties they own if they want to deduct the depreciation—and this can be problematic.

And by the way? Short-term-rental investors? Yes, they can get giant deductions on their return too. And they may be able to materially participate with very modest hours. But they also need to manage the average rental interval of guests. Because in order to qualify as a short-term-rental investor? Your average rental interval needs to equal 7 days or less.

A self-rental property, however? Easy for entrepreneurs if they do it right.

The Self-rental Property Depreciation Deduction Estimator

Take a peek at the simple JavaScript Calculator below. It shows the depreciation deductions you can probably get from a owner-occupied commercial property that cost $1,000,000. The calculator defaults to 100% bonus depreciation (the right percentage for property placed into service on or after January 1, 2025), and it assumes a cost segregation engineer has broken down the price into real property and personal property.

To summarize, once you click the Calculate button, the Self-rental Property Depreciation Deduction Estimator calculates depreciation deductions for the first year through seventh years. These calculations assume a $1,000,000 price broken down into 25% land, 15% five -year property, 30% fifteen-year property, 0% 27.5-year property, and 55% 39-year property. But what’s unique here? As compared to most real etate investors who will not get to use those gian depreciation deductions? An entrepreneur very probably will.

Tip: Replace the percentages, or decimal values, for your potential real estate investment to estimate actual depreciation you might deduct on your return. And then click Calculate again.

Note: The seventh year’s depreciation is also roughly the depreciation deduction for years that follow the seventh year.

The Usual Problems with Real Estate Depreciation and Other Deductions

The problem with those big deductions however? In many, perhaps most cases, you can’t actually use them. Section 469 of the Internal Revenue Code limits your deductions on a passive investment like real estate to the income you earn from other passive investments. (This is the usual rule for real estate investments, by the way.)

Something special happens with self-rental property that the entrepreneur correctly sets up, however. First, if the entrepreneur groups the rental property with the operating trade or business? That grouping causes Section 469 rules to see the grouped rental property and active trade or business as not a real estate rental activity.

The second thing to happen? The entrepreneur looks at the hours she or she spends on both the rental property and the other active trade or business to determine whether they materially participate. If they spend more than 500 hours on the grouped activities? Bingo.

The First Requirement for Grouping the Rental with the Active Trade or Business

You have two requirements to get a grouping to work. First, the ownership of the rental property needs to perfectly match the ownership of the other operating trade or business. For example, if two shareholders own 60 percent and 40 percent of say an engineering firm? They would also need to own those same percentages—so 60 percent and 40 percent—of the building the engineering firm rents.

Note: You typically would put the real estate into one entity, like a limited liability company. And treat that entity as a partnership. And then the other operating trade or business might be a different partnership. Or a corporation.

The Second Requirement for Grouping

You need to make the grouping in the first year you own the property or operate the trade or business. For example, if this year, you buy a building to house the engineering firm you and your partner have operated for decades? You need to make the grouping election on this year’s tax return.

Note: Not all grouping and aggregation elections need to be made in the first year an activity or trade or business exists. With Section 469 grouping elections like a self-rental, however, the decision not to group the first year is treated as a default grouping. And then the problem that creates? You can’t regroup later on except in special circumstances. And then only with the Internal Revenue Service’s permission.

A Predictable Caveat

Let me end with a predictable caution. One you really don’t even need me to give. (Sorry. But accountants have pretty conservative, compulsive personalties.)

The tax deductions you generate by buying a building and renting it to your business? Very high impact. You may be able to in effect save hundreds of thousands of dollars pretax by using this gambit. (In comparison, remember something like a Section 401(k) plan in the absolutely best case scenario maybe lets you save $70,000-ish of pre-tax money.)

But the tax savings? Not so good an entrepreneur can ignore the return on investment. Thus, we want to treat a prospective real estate investment that same way we’d treat any other business investment. We probably want to calculate the anticipated return on investment. Consider whether and how we can safely use borrowed funds for some of the purchase price. Stuff like that.

The post The Real Estate Investment Every Entrepreneur Should Consider appeared first on Evergreen Small Business.

You will probably need your tax accountant’s help to do this. And you need to plan now for making this change. Or setting up the initial fiscal year correctly. But the extra year Section 199A deduction tax savings? Pretty substantial if you have a successful small business. And definitely worth considering…

Section 199A Deduction Ends for Most Taxpayers in 2025

Some quick background to start. Section 199A ends for most people at the end of 2025. But that’s because most small businesses and investors use a calendar year for their accounting.

Two things to know here. First, the actual law doesn’t say the deduction ends at the end of 2025. Rather, the law says the deduction ends for taxable years beginning after 2025. That’s why using the calendar year for your accounting—a calendar year starts on January 1—works.

Second thing to know: Most partnerships and S corporation can use or change to using another accounting, or fiscal, year. For example, most new partnerships and S corporations can use a fiscal year that starts on December 1 and ends on November 30. And many existing partnerships and S corporations can get the IRS’s permission to change to a fiscal year if the business shows seasonality in its gross receipts.

Extra Year Section 199A Deduction: Big Picture

Thus, the obvious tactic: You start a new partnership or S corporation and adopt a fiscal year. Or if possible, you change the fiscal year of an existing partnership or S corporation.

Say for purposes of illustration that a fiscal year starts on December 1 and ends on November 30. For the fiscal year that starts on December 1, 2025 and ends on November 30, 2026? Voila. You will get Section 199A deductions on essentially eleven months of business income earned in 2026.

Mechanically How This Works

You adopt an initial fiscal year or change your existing fiscal year by filing some paperwork with the IRS.

The paperwork you file depends on the method you use for establishing your fiscal year. But the simplest method, mechanically, requires you or your accountant to file a Form 8716 when you set up a new partnership or S corporation and as part of that process adopt an annual accounting period. A more complicated method works for some existing partnerships or S corporations and requires you or your accountant to file a Form 1128 and show your business’s gross receipts display seasonality.

You can and probably should file this paperwork soon. A Form 8716 that adopts a fiscal year needs to be filed for a new business before you establish another taxable year. A Form 1128 needs to be filed at the end of the first requested fiscal year.

Thus, talk to your accountant now. Adopting the initial fiscal year or making a change in a fiscal year of an existing partnership or S corporation will take time and require thinking. Given the shortages of accountants and the understaffing and processing delays at the Internal Revenue Service, you probably risk losing this opportunity if you wait.

Extra Year Section 199A Deduction Tax Savings

Roughly, you save from five to eight percent of the business income that appears on the K-1 you receive from a partnership or S corporation.

For example, a married partner or S corporation shareholder who receives $100,000 to $300,000 of business income from a partnership or S corporation probably saves between $5,000 and $15,000.

As another example, a married partner or S corporation shareholder who receives $300,000 to $600,000 of business income probably saves between $20,000 and $40,000.

Someone married with income above these amounts saves federal income taxes equal to roughly 8% of their income. At $1,000,000 of business income, the savings equal $80,000. At $10,000,000, the savings equal $800,000.

But note: The savings occur only for one year. And probably only on the income shown in box 1 of your K-1.

Thus, probably firms with business income falling under $100,000 shouldn’t do this. You and your accountant will go to extra work to “do” the fiscal year thing. The juice won’t be worth the squeeze if savings are modest.

Extra Year Section 199A Deduction Loophole Risks

The tactic described here really isn’t a loophole or “too clever by half” reading of the law.

The tactic described here relies on the last line of the Section 199A law. That chunk of the law says Section 199A “shall not apply to taxable years beginning after December 31, 2025.”

However, Congress could change that part of the law. For example, it could decide to terminate Section 199A earlier.

If Congress extends the termination date of Section 199A, you may not need to do the fiscal year thing to get a Section 199A deduction on 2026 business income. So that’s also a risk of pursuing this tactic.

Probably the biggest risks though: waiting so late that you lose the chance to adopt a fiscal year for a new partnership or S corporation. Or waiting so late that your tax accountant doesn’t have time to prepare your paperwork for changing your taxable year. Or finding you’ve waited so late that the IRS doesn’t have time to process your paperwork.

You should also know that if the IRS audits the partnership, the S corporation, or an owner? Or if the entity or an owner is involved in a appeals hearing or a tax court case—or anything like this—that may sabotage or blow up an entity’s ability to change the fiscal year in time to get an extra year of deductions.

Next Steps and Tips If You Need Help

If you’re a tax accountant exploring this tactic, you probably want to brush up on the ways Sections 199A, 442 and 444 work. Another blog post here, Section 199A(i) fiscal year change, and here, Section 199A(i) Fiscal Year Charge FAQ, may be useful as you start your refresh.

If you’re a taxpayer, again, you want to talk to your accountant ASAP. Get on her or his schedule to explore and possibly handle the paperwork.

If you’re a taxpayer but don’t have an accountant to do this work, you can reach out to our firm. We can do a consultation in many situations. And we also have time to do a limited number of fiscal year change engagements. And we might be able to do yours.

Note to people who may want our help: Please do not telephone. Please use the contact form. Also in your query indicate whether you’ve filed your first partnership or S corporation tax return or not, what accounting software you use (for example, QuickBooks, Xero, etc.), and whether your business generates most of its revenue during a two or three month “high season.” We should respond quickly with an indication of whether we can help.

The post How to Get Extra Year Section 199A Deductions appeared first on Evergreen Small Business.

For example, if you’re anticipating a big Section 199A deduction on your return? Like a $1,000,000 deduction say? Or even bigger? You can maybe save any extra $400,000, $500,000 or more in federal taxes by starting a new business using a fiscal year or by changing the fiscal year of your existing business.

Let me quickly go into the details. You can see if you agree. One comment to make up front. I didn’t always think this. When I wrote my book “Maximizing Section 199A Deductions” in 2017, I thought what I’m about to describe did not work. Now? Yeah, I do. But let’s step into the weeds.

The Statutory Language of Section 199A(i)

The first thing to look at is what the Section 199A(i) applicability “end” date language says in the actual statute. That language appears below:

(i)Termination

This section shall not apply to taxable years beginning after December 31, 2025.

You and I want to pay attention to the precise language. Section 199A doesn’t apply to taxable years that begin after December 31, 2025. So, obviously, a calendar taxable year that begins on January 1, 2025 works. We  all agree on that.

And it’s no big jump to realize, “Okay. Yeah. Starting on February 1, 2025? Or March 1, 2025? Or any other date within 2025? That works too. None of those dates begin after December 31, 2025.”

One other comment: If Congress, the writer of the law, wanted to prevent someone taking a Section 199A deduction on a fiscal year tax return that starts in 2025 but ends in 2026? It seems like it could and should have written Section 199A(i) differently. Something like this, to my mind, does the trick:

(i)Termination

This section shall not apply to taxable years beginning ending after December 31, 2025.

If you agree with what I’ve said or maybe always thought what I describe in the earlier paragraphs? You can stop reading. You know what you need to know. And you don’t need to spend any more time on this.

For people who vaguely remember reading something different? For accountants who maybe recall a training session where the presenter described things differently? Let me keep going. Because I maybe know where things went off the rails.

The Applicability Date Language of Regulation 1.199A-1(f)

The source of my initial confusion? And possibly your confusion too if you’re part of the brotherhood or sisterhood who fell down this rabbit hole? The applicability “starting” date language from the regulations works differently. And that language really triggered the fog here. That language says this:

(f) Applicability date—(1) General rule. Except as provided in paragraph (f)(2) of this section, the provisions of this section apply to taxable years ending after February 8, 2019.

(2) Exception for non-calendar year RPE. For purposes of determining QBI, W-2 wages, UBIA of qualified property, and the aggregate amount of qualified REIT dividends and qualified PTP income, if an individual receives any of these items from an RPE with a taxable year that begins before January 1, 2018, and ends after December 31, 2017, such items are treated as having been incurred by the individual during the individual’s taxable year in which or with which such RPE taxable year ends.

To summarize the general rule? The regulations apply to taxable years ending after February 8, 2019. (Not very relevant here. We’re only talking years ending after February 8, 2019 anyway.) But then the tweak that benefits taxpayers. For a non-calendar year RPE, or “relevant pass-through entity,” so a partnership or S corporation? If the fiscal year started in 2017 and ended in 2018? The Treasury gave the taxpayer a Section 199A deduction on his or her 2018 tax return.

In effect, even though the Section 199A only became effective for tax years beginning after December 31, 2017? Yeah. Christmas came early for fiscal year pass-through entities. They enjoyed the Section 199A deduction on qualified business income earned in calendar year 2017 but reported by the pass-through entity on the tax return that ended its fiscal year in 2018.

What a number of people did—me included—is apply this special rule about how Section 199A started in 2018 to how things work when it ends after 2025. Awkwardly, that reading is wrong.

A tangential note: Section 11011(e) of the Tax Cuts and Jobs Act set the applicable date of Section 199A as “taxable years beginning after December 31, 2017.”

The Obvious First Section 199A(i) Question

Let’s jump to the obvious first question: Can a relevant pass-through entity use a fiscal year or change its fiscal year and enjoy an extra year of Section 199A deduction? Answer: Maybe.

You just read what Section 199A(i) says. The section shall not apply to taxable years beginning after December 31, 2025. So that’s not a problem. But you need a way to wriggle into using a fiscal year. And two possible wriggles exist.

Wriggle #1: Section 442 says a partnership or S corporation—the two relevant pass-through entities that Section 199A applies to—can change from a calendar year to a natural year. (A natural year exists when a business generates at least 25 percent of its gross receipts in a two-month interval.)

Wriggle #2: Section 444 says a new partnership or S corporation can adopt a fiscal year that ends September 30, October 31, or November 30. (An existing calendar year partnership or S corporation probably cannot use Section 444 to change its fiscal year.)

Thus, theoretically any partnership or S corporation might be able to change its taxable year from a calendar year to a fiscal year that begins before December 31, 2025 using Section 442. New partnerships or S corporations can make a Section 444 election that begins their fiscal year on October 1, November 1, or December 1 of 2024 or 2025.

To adopt a fiscal year or make a fiscal year change, predictably, the entity must comply with requirements of Section 442 or 444. Some entities will surely fail to qualify for technical reasons. (Again, for example, note that it is not possible to move from an established calendar year S corporation to fiscal year using a Section 444 election.)

But assuming an entity does get a fiscal year to work, if an entity calculates and reports a Section 199A deduction to its owners on its fiscal year tax return that starts in 2025 but ends in 2026? Owners include a Section 199A deduction on their 2026 1040 tax return.

The Obvious Second Section 199A(i) Question

Next question: Should new pass-through entities adopt a fiscal year and should existing entities change their fiscal year (when possible) to get an extra year of Section 199A deduction?

This question seems trickier. Sure, you probably can do this in many situations. But should you? My sense is the cost of adopting a fiscal year (for a new business) or of making a fiscal year change (for an existing business) exceeds the benefit for most pass-through entities.

I think our CPA firm’s rule of thumb might be something like “you need to anticipate getting a Section 199A deduction well into six figures to adopt a fiscal year or to make changing to a fiscal year worth considering.”

Someone who enjoys a $100,000 Section 199A deduction in 2025 might possibly save $30,000 to $40,000 in federal income taxes by getting one more year. Someone who enjoys a $200,000 Section 199A deduction in 2025 might save $80,000 with one more year. Grabbing that additional savings probably makes sense.

Furthermore, someone who makes ten times that much and enjoys a $1,000,000 or larger Section 199A deduction?  They maybe save $400,000 or more in federal income taxes by getting one more year of Section 199A treatment. Grabbing that additional savings absolutely makes sense.

But the typical successful small business owner who makes, say, $100,00o? So, that guy who currently gets a $20,000 Section 199A deduction? That size deduction may save $4000 or $5000. Which sounds good and is good. But that amount may not be enough to justify the fiddling. Or the costs of the accountants.

The Timeclock is Running Out

One other factor to consider here is timing. CPA firms and pass-through entities do not have much time to prepare and file the paperwork that effects a change in the accounting year assuming they even want to do so.

To change to a Section 442 natural year that ends on, for example, April 30, 2025 (if that’s possible), one files a Form 1128. That form’s due date would typically be July 15, 2025. But you probably want to file sooner. You can and probably should file the Form 1128 on January 1, 2025

To make a Section 444 election that adopts a taxable year ending on November 30, 2025 (if that’s possible), one files a Form 8716. That form’s due date would typically be February 15, 2025. But again, you can and probably should file the Form 8716 earlier on in that first fiscal year.

All in all, then, not much time considering that most of the time between now and then is tax season.

Not Everyone Agrees Yet

A final point. Some tax practitioners probably still think you in effect look at the Section 199A regulations’ instructions about how one handles fiscal year entities that start their taxable year in 2017 to determine how you should handle fiscal year entitites that start their taxable year in 2025. (This is the stuff I talked about in the preceding discussion of Regulation Section 1.199A-1(f).)

For example, here’s the relevant blurb from the Bloomberg BNA Tax Management Portfolio, “Portfolio 537-1st: Qualified Business Income Deduction,” that talks about how the fiscal year thing affects the Section 199A deduction:

However, the regulations do not provide a similarly favorable “mirror image” rule in the case of an RPE with a taxable year beginning on or before December 31, 2025, and ending after such date. As a result, a taxpayer that is a partner or shareholder in such an RPE would not be able to take a §199A deduction with respect to amounts allocable to such taxpayer even if realized by the RPE during 2025.

The authors then provide this example:

Example 9: Assume the same facts as Example 8, except that the S corporation’s taxable year begins on November 1, 2025, and ends on October 31, 2026. A is not entitled to a §199A deduction with respect to any portion of A’s share of QBI, W-2 wages, UBIA of qualified property, and the aggregate amount of qualified REIT dividends and qualified PTP income from the S corporation for the months of November and December 2025.

But I think that’s wrong.

Again, for the record, I was originally saying the same thing (and long before the BNA tax management portfolio said it.) But now? Now I think you don’t expand the regulation’s language that tweaks the applicability start date and then apply that language to the applicability end date. Rather you look at the statute’s termination date language. The rule Congress wrote.

Other Resources about Section 199A(i) Fiscal Year Charges

For an overview of changing an accounting year of a partnership or S corporation, you may want to refer to Revenue Procedure 2006-46. (It describes the mechanics of using Form 1128 to request an accounting year change based on a natural business year.)

For instructions for making a Section 444 election, you want to refer to the Form 8716 and its instructions as well as the Form 8752 and its instructions.

We also have a Section 199A(i) Fiscal Year Change FAQ available at our CPA firm website. That appears here: Section 199A(i) Fiscal Year Change FAQ.

The post Section 199A(i) Fiscal Year Change Extends Deduction appeared first on Evergreen Small Business.

They  don’t. Or at least not yet. And maybe never.

But if you’re an S corporation owner? And you’re struggling to set a shareholder-employee salary? Because ChatGPT does its work for free, and because it’ll often do an adequate job, I think you and I can use it. Its calculations and conclusions should often result in a reasonable compensation number.

But let me step you through the process I’d suggest.

The Trick is Your Prompt

You may already know this. But you ask an AI (artificial intelligence) model like ChatGPT questions.

You can for example ask a question like, “What is the average salary of a carpenter?” Or, “how much does a preschool teacher earn?”

These questions then prompt the AI. And then it returns your answer.

The trick to getting a usable S corporation reasonable compensation number? Providing a good prompt.

For example, a carpenter working as a small contractor in (say) Mount Vernon, Washington might ask, or prompt, the AI with a question like this:

I work as a carpenter and project manager for a small construction company in Mount Vernon, Washington. I have several years of experience. The firm’s total revenues fall between $500,000 and $1,000,000 a year usually. We do small home remodeling jobs. What would be the range of reasonable salaries for this position as well as common fringe benefits? Please cite your sources.

You want, as the above prompt does, to provide as much detail as you can. Also, ask the AI to provide citations for its sources.

When I asked ChatGPT this question in August of 2024, by the way, it provided the following answer—which seems good enough:

In your role as a carpenter and project manager for a small construction company in Mount Vernon, Washington, several factors influence salary expectations, including the size of the company, your level of experience, and regional economic conditions.

Salary Range

For a position combining carpentry and project management at a small firm, here’s a reasonable salary range:

• Salary Range: $60,000 to $90,000 annually.

Breakdown:

1. Carpenter with Project Management Duties: Given your extensive experience and dual role, your compensation would be on the higher end of the scale for similar positions in the area. In Washington state, the salary range for a carpenter typically falls between $50,000 and $75,000. Adding project management responsibilities increases this range.
2. Regional Factors: Salaries in Washington can be higher compared to other states due to the higher cost of living and strong demand for skilled trades. Mount Vernon, being a smaller city, might have slightly lower wages compared to larger urban centers like Seattle, but the difference isn’t substantial.

Sources:

• Bureau of Labor Statistics (BLS): Data on carpenters and construction managers provides baseline figures, with carpenters earning an average of around $60,000 annually, and project managers potentially earning significantly more, especially with specialized skills.
• Indeed & Glassdoor: These job sites provide salary insights specific to roles in the construction industry, with regional variations factored in.

Common Fringe Benefits

1. Health Insurance: Many companies offer health insurance as a standard benefit. This can vary in terms of coverage and the percentage of costs covered by the employer.
2. Retirement Plans: 401(k) plans are common, sometimes with employer matching contributions.
3. Paid Time Off (PTO): This includes vacation days, sick leave, and personal days. For your level of experience and role, around 10-15 days of PTO annually is typical.
4. Tool Allowance or Reimbursement: Given your role involves carpentry, some firms provide allowances or reimbursement for tools and equipment.
5. Professional Development: Some companies support continuing education or training relevant to your job.
6. Overtime Pay: If you work beyond standard hours, overtime pay is usually applicable, though this can depend on the company’s policy and your specific employment status (exempt or non-exempt).

Sources:

• Society for Human Resource Management (SHRM): Provides benchmarks for typical fringe benefits offered by employers.
• Industry Surveys and Reports: Various reports and surveys on construction industry compensation and benefits offer additional insights.

Additional Considerations

• Negotiation: Given your experience and dual role, you might have room to negotiate a higher salary or additional benefits.
• Company Size: Small companies often have less flexibility in salary but may offer other types of compensation or benefits.

These figures and benefits are approximate and can vary based on specific company policies and regional economic conditions.

Thus, I think a small construction company owner who works in Mount Vernon, Washington and who both manages profits and works on the job site as a carpenter might reasonably pay her or himself $60,000 to $90,000 in 2024.

Note: We don’t to my knowledge serve any construction companies operating out of Mount Vernon, Washington. I picked that location because it’s close to where I grew up.

Two Follow-Up Tips

Two follow-up tips if you want to use ChatGPT to set S corporation reasonable compensation.

First, you and I ought to be doing this every year, right? We can save money with an S corporation. But one of the most important rules is, you must set shareholder-employee compensation to some reasonable amount.

Second, save your prompt and the AI’s response as a document. Store it with your payroll records. This document can become something you reference if the Internal Revenue Service or an equivalent state agency ever questions you.

Other Resources Related to S Corporation Reasonable Compensation

A handful of blog resources here you might find useful. First, we’ve got an S corporation tax savings calculator you can use to determine whether you save money with an S corporation. Use that if you’re still researching this idea of reorganizing your business as an S corporation. And then here’s a full list of our S corporation blog posts.

Second, we’ve got a blog post from a few years ago about how to set a safe reasonable salary for an S corporation shareholder-employee: S Corporation Reasonable Compensation. That’s worth reading for a little more detail on the bookkeeping.

And then the Internal Revenue Service provides a helpful summary here: IRS Fact Sheet on Wages for S Corporation Officers. That should be required reading.

The post Using ChatGPT to Determine S Corporation Reasonable Compensation appeared first on Evergreen Small Business.

Five million small businesses operate as S corporations. And surely most of those folks know the simple trick for saving money with an S corporation. You pay a low salary and avoid payroll taxes.

Too many S corporation owners, unfortunately, do not know about all the other more advanced S corporation tax planning tricks and tactics. Thus, this month’s blog post.

Basic S Corporation Trick: Avoid Payroll Taxes

To start, however, I want to review the standard, simple S corporation trick for saving taxes. Just to make sure we’re all on the same page.

And to do this, let me give a quick example where a business owner earns $100,000. I’m going to slightly round the numbers, by the way. That’ll keep this blog post more readable.

Tip: Use our free calculator to estimate S corporation tax savings for your situation: S Corporation Tax Savings Calculator

If the business operates as a sole proprietorship or a partnership and the owner realizes $100,000 of profit. He or she pays Social Security and Medicare payroll taxes on most of the $100,000. Those taxes run roughly 14%, which means about a $14,000 payroll tax. (The actual formula might work like this: a 15.3% tax on 92.35% of the $100,000. And now you see why I’m rounding numbers. And simplifying.)

If the business instead operates as an S corporation, however, tax law allows the business owner to split the $100,000 into regular employee wages and then a shareholder distributive share. The split, by the way, needs to be fair. The resulting shareholder-employee wages amount needs to be reasonable.

But if a business owner can reasonably split the $100,000 of profit into $50,000 of wages and $50,000 of distributive share, he or she halves the payroll taxes. The savings in this case run slightly more than $7,000 a year, which is great.

Too many S corporation shareholders stop there, however. Because a bunch of other powerful, more advanced S corporation tax planning tactics exist.

Trick #1: Optimize for Section 199A Deduction with Higher Wages

A first powerful technique: some business owners pay too little in W-2 wages by focusing just on the payroll tax savings. But if a business generates Section 199A qualified business income and earns its owners a high income, the owners need wages to support a full Section 199A deduction.

The Section 199A deduction, something we’ve talked about a lot through the years (see list here), allows a taxpayer to avoid paying income taxes on the last twenty percent of her or his taxable income. If a taxpayer’s income rises above a threshold amount—roughly $200,000 for a single filer and roughly $400,000 for a married filer in 2024—the Section 199A deduction can’t exceed more than 50 percent of the W-2 wages paid by the business.

Now to be clear, you can’t arbitrarily set your wages to some amount simply to optimize your 199A deduction. You need to pay yourself a reasonable salary. But in general, if you’re losing 199A deductions because you don’t have enough wages, you want to look at bumping your wages so you’re paying out 2/7ths of your profits as wages and 5/7ths as shareholder distributions.

Example: An S corporation makes $7,000,000 in profit for its owner. The owner pays herself $500,000 in W-2 wages, and those are the only wages. This approach limits her Section 199A to just $250,000. If she can reasonably bump her wages to $2,000,000, she increases her Section 199A deduction from $250,000 to $1,000,000. That bump should save her about $280,000 in income taxes.

Trick #2: Split a Specified Service Trade or Business to Requalify for Section 199A

Another 199A gambit: many high-income S corporations lose the Section 199A deduction because some part of the operation is a specified service trade or business (SSTB). These SSTBs include most of the traditional professions (but not all), performing artists, athletes, and celebrities.

But a tip? Many entrepreneurs operate multiple trades or businesses, some of which are SSTBs, and some of which are not. Often, the entrepreneurs hold these businesses in a single S corporation entity. The problem here: combining an SSTB and a non-SSTB disqualifies the entire business for purposes of Section 199A. This leads to an obvious idea: if the business owner can split one S corporation into two S corporations, that’ll often re-qualify some of the income for the Section 199A deduction.

Example: A physician owns a clinic and earns $400,000 practicing medicine. He also provides continuing medical education services in his specialty and earns $400,000 from that. If he combines those two activities in a single S corporation, he loses the 199A deduction on 100% of the $800,000 of income in all likelihood. Practicing medicine counts as an SSTB. And if half the taxpayer’s activity is SSTB-related, that taints everything. If, however, he separates the two activities into separate trades or businesses, probably using a couple of S corporations, he can get a big $80,000 199A deduction on the second non-SSTB business of providing continuing medical education. The savings here: close to $30,000 annually.

Trick #3: Elect to Pay Pass-through-entity Tax

A quick option for shareholders living in states with income taxes.

You can probably pay the state income taxes you individually owe on your S corporation profits directly from the S corporation. To do this, you make an election to pay a pass-through entity tax. And you want to do this.

Here’s why: if you personally pay the $30,000 in state income taxes on your S corporation profits, you almost surely don’t get a federal tax deduction for the payment. (Federal tax law limits the Schedule A tax deductions for state and local taxes to $10,000.) However, if your S corporation pays the $30,000 as a pass-through-entity tax, you almost surely will get a $30,000 federal tax deduction. If your federal tax rate is, say, 24%, that tweak to your tax accounting should save you about $7,200.

Trick #4: Use Tax-free Fringe Benefits

A simple gambit: you want to load as many tax-free fringe benefits onto your S corporation tax return as you can. These fringe benefits bump your shareholder-employee compensation without bumping your payroll taxes.

Example: Suppose an entrepreneur owns an S corporation that generates $100,000 of profit but wants to pay herself $50,000. That amount might be unreasonably low. But if she provides herself with $30,000 of health insurance (which counts as wages but isn’t subject to income or payroll taxes), that $80,000 of W-2 wages and fringe benefits might rise to the level of reasonable.

Trick #5: Set up a Generous Pension for Shareholder-employees

We think most small businesses want to set up good employee pension plans for rank-and-file employees. That step, especially when small firms compete for talent, makes good sense as a business practice in many situations.

But entrepreneurs also want to think about pensions as tax planning gambits they can use to not only save taxes but build wealth outside of their equity in the business.

Example: A Simplified Employee Pension (SEP) plan lets a business owner contribute up to 25 percent of their W-2 wages. Someone who pays herself $50,000 in base wages and then $30,000 in health insurance might be able to pay a $20,000 SEP contribution. This pension plan contribution in this situation probably saves payroll taxes. (With an S corporation, the SEP contribution saves both income taxes and payroll taxes.) And it also probably increases the reasonable compensation. Someone who receives $50,000 in base W-2 wages, $30,000 in health insurance benefits, and $20,000 of pension contributions arguably enjoys a $100,000 compensation package.

But higher-contribution options exist too. Inexpensive 401(k) plans in many cases not only allow for 25 percent employer contributions but let the shareholder-employee also add elective deferrals (from their W-2 wages) that in 2024 equal $23,000 for most individuals and $30,000 for folks aged 50 or older.

In special cases, an S corporation allows a shareholder-employee to set up a defined benefit plan that might allow an even larger employer contribution. Perhaps a low to mid six-figures deduction in some situations? Again, in this case, that pension benefit should count toward the reasonable compensation requirement. And as with SEP contributions and employer matching for 401(k) plans, a large defined benefit plan contribution saves not only income taxes but payroll taxes.

Trick #6: Own Partnership Interests Through an S Corporation

A partnership cannot own an interest in an S corporation. In essence, only U.S. citizens and permanent residents, and other taxpayers very similar to U.S. citizens and permanent residents can own interests in an S corporation. But this rule gets twisted and scrambled sometimes.

For example, the rule about eligible shareholders sometimes gets rephrased (incorrectly) as saying that an S corporation cannot own an interest in a partnership. But it can. Thus, if you own partnership interests in working trades or businesses and those partnerships generate self-employment income for you, you should explore with your tax advisor the possibility of setting up an S corporation and then having your S corporation own your partnership interests. That tiered structure—owning an S corporation that owns a partnership interest—will let you harvest many of the benefits of owning an S corporation already discussed on your partnership income.

A sidebar: Partnerships provide their own tax planning benefits including the ability flexibly allocate income and deductions. Thus, combining partnerships and S corporations in a tiered structure often lets you enjoy the best of both worlds.

Trick #7: Group Compatible Activities with an S Corporation

If you own an S corporation that operates an active trade or business generating strong profits and you start a new business, you need to consider making grouping elections that combine a loss-generating activity with the profitable S corporation’s activity.

Example: If you own two activities, materially participate in the one making $500,000 a year but don’t materially participate in the one losing $300,000 a year, you can’t use the $300,000 in losses to shelter any of the $500,000 of income. However, chances are good that you can find a way to group the two activities into a single activity. And that grouping will let you use your material participation in the one business for both businesses.

Predictably, the IRS requires your grouping to follow common-sense rules. We discuss those in another blog post here: Grouping Activities to Achieve Material Participation. But the general concept? The grouping needs to be timely and reflect common sense.

Trick #8: Use the Self-rental Rules to Harvest Big Real Estate Deductions

A related trick: in theory, real estate investments should allow entrepreneurs to shelter other income. Say someone owns a business that generates $200,000 of taxable income and owns a real estate property that loses $100,000 on paper due to depreciation.

A taxpayer might think he or she can use the $100,000 loss to shelter half of the $200,000 in income. However, in many cases, tax law prevents you from doing this. A specific chunk of the law, Section 469, prevents you from taking the easy obvious deduction in most cases.

A handful of ways exist to dodge the Section 469 limitations on real estate-related losses, however. And one of the most powerful ways works for profitable S corporations. If you elect to group a self-rental property with the other active trade or business using the property, the Section 469 loss limitation rules don’t apply if you set things up right.

This gambit is a little tricky. The ownership percentages of the rental property and the S corporation need to match. Also, you need to make the grouping election when you acquire the property. But done right, you can use depreciation deductions from real estate you own and use in your business to shelter that business’s income.

One other note: normally nonresidential property results in a tiny trickle of real estate depreciation deductions over basically four decades. That doesn’t do much to help with a profitable business you’re running today. You can, however, frontload your depreciation deductions using accelerated depreciation. In some cases, you might be able to immediately deduct ten, twenty, or even thirty percent of the purchase price in the year you invest.

Trick #9: Put a “Hobby” Inside Your S Corporation

Okay, I want to be very careful here. I am not saying you can operate a hobby inside your S corporation and thereby deduct hobby losses or hobby expenses. Again, not saying that…

Furthermore, for you to deduct expenses on a business tax return, you must be engaged in the activity in pursuit of profit. That’s a requirement of a little chunk of tax law called Section 183 and popularly referred to as the “hobby losses rule.”

However, some activities you engage in for profit may look like a “hobby” or an “activity not engaged in for profit” if you operate the activity outside of an S corporation. In a worst-case scenario, you lose the deductions these activities generate. Putting the income and expenses inside your S corporation may work, however.

Example: Say you do barn design and home interiors design that reflect an owner’s interest in and love of horses and all things equine. Maybe you sell your work to horse folk who can’t normally be approached or marketed to using telephone calls, email blasts, or direct mail. But you can effectively market through personal one-on-one selling if you’re riding your own horse at dressage competitions, cross country events, or hunter jumper shows.

In this case, you very likely might lose your deductions if you conduct your horsemanship activities outside your business. But if you do all this stuff “inside” an S corporation that does barn and home design work, the deduction will probably work. (For an example of how this might work, take a peek at this Tax Advisor article: Aggregating Activities to Avoid the Hobby Loss Rules.)

Trick #10: Section 1202 Qualified Small Business Stock Inside an S Corporation

A final trick to mention: some stock in C corporations qualifies as Section 1202 Qualified Small Business Stock. The attraction of this qualification? When the stock is sold, capital gain is either partially or wholly avoided as long as the requirements are met. For stock acquired after Sept 28, 2010, the exclusion equals 100% of the gain if held more than five years. (A handful of other requirements exist too.)

Stock in an S corporation can’t “be” Section 1202 stock. But some taxpayers who own S corporations have a workaround on this. A taxpayer who owns an S corporation with a valuable activity that can be spun off into a separate C corporation can often get Section 1202 for that corporation.

We’ve got a longer discussion of how Section 1202 works here: Section 1202 Qualified Small Business Stock Exclusion. But know for now that you might be able to use the Section 1202 tax planning strategy even for some activity you start up inside an S corporation.

Example: A taxpayer does contract programming as an S corporation. A few years after starting this venture, the S corporation owner working weekends also develops a software program. The S corporation then “incorporates” a new C corporation owned by the S corporation and contributes the software program to that new C corporation. Thus, the S corporation owns a C corporation that owns and sells the software program. Assume at the point the software program is contributed to that new C corporation the software program and therefore the C corporation is worth $1,000,000. Further assume the S corporation sells the C corporation for $11,000,000 five years later. In this situation, the S corporation will treat $10,000,000 of the $11,000,000 of gain as Section 1202 qualified small business stock gain and pay zero income taxes.

A Final Comment about Advanced S Corporation Tax Planning

Your existing tax advisor probably knows about all this stuff. So, if you’ve got questions or ideas you want to run by an expert, talk to her or him. (I mention this because I see too many advertisements on social media sites where someone advertising “tax strategy consulting” suggests they know something your regular tax advisor doesn’t.)

But if you don’t have access to someone expert you can easily ask about these sorts of ideas? Sure. Go ahead and reach out to our CPA firm. Here’s how to contact us: Click here. We’d be happy to discuss working with you.

The post Advanced S Corporation Tax Planning Secrets appeared first on Evergreen Small Business.

This new bit of red tape stems from Congress’s concern about money laundering and other financial crimes. And it’ll cause some small business entrepreneurs and investors to go nuts.

Essentially a BOI report identifies the individuals who own 25 percent or larger chunks of the corporation or LLC and then also individuals who have substantial control (like corporate officers and directors, LLC members, LLC managers, and so on) over a corporation or LLC.

This information gets stored in a federal database so it’s available to law enforcement agencies. And also to financial institutions who need or want to check on their customers.

Why It’s Important to Handle this BOI Report Stuff

Yes, this is all a bit of a headache. I feel pretty sure both the politicians who cooked this up and the bureaucrats who designed the system haven’t thought through the compliance costs for you and your small business. But all of that? Pretty irrelevant. You (and I) want to get ahead of this BOI report stuff for a couple of reasons.

First reason? You may need to file the report yourself. We understand that many accountants and attorneys simply do not want to do this risky, random, hard-to-schedule work.

A second reason to learn and handle this new reporting requirement quickly and correctly? The penalties for failing to file? Pretty brutal. The daily penalty equals $500 (with a $10,000 maximum). And in a worst-case scenario? Willfully failing to file a report can lead to imprisonment.

Note: Presumably, the worst case scenarios should only occur when people willfully break the law. But innocent folks can find themselves targets of aggressive regulators and prosecutors too, as our office has personally observed.

Beneficial Ownership Information (BOI) Report Disclosures

FinCEN requires pretty basic information about corporations, LLCs and similar entities entrepreneurs and investors set up. Which is maybe the only good news here.

Reporting companies (so corporations, LLCs and similar entities) must provide their:

• Full legal name
• Trade names and “doing business as” (DBA) names
• Complete current U.S. address
• State, tribal or foreign jurisdiction where formed
• Internal Revenue Service taxpayer ID number (so probably your EIN)

Tip: If you now need to get an EIN, such as for a family LLC, refer to this blog post: Step-by-step Instructions for Applying for an EIN

Then for each beneficial owner owning 25 percent or more of the company or exercising substantial control, reporting entities must provide an individual’s:

• Full legal name
• Date of birth
• Complete current address
• Unique identification number and jurisdiction from an unexpired U.S. passport, unexpired state driver’s license, or unexpired identification card issued by a state, local or tribal government (Note that if none of these identification documents exist, an individual must use a foreign passport.)
• Image of identification document for the person

By the way, for corporations, limited liability companies and similar entities formed on or after January 1, 2024, the company must also name the applicant or applicants who filed the formation documents with the state, local or tribal government. (This might be the name of the attorney or paralegal who prepared and filed the articles of incorporation or formation.)

Some Organizations Exempt from BOI Reporting

Most small businesses need to file BOI reports, as noted earlier. The Corporate Transparency Act hits small businesses hard. Plan to file the report.

However, a list of about two dozen exempt entities exist. As a generalization, if some federal or state agency already regulates and monitors a firm (so like the Securities & Exchange Commission, the Federal Deposit Insurance Corporation, a state’s insurance commissioner, a public utilities regulator, and so on), the entity doesn’t need to file a BOI report.

Entities employing more than 20 full-time employees in the U.S., generating more than $5 million of revenue in the U.S., and maintaining a physical office don’t need to file. (So big small businesses dodge the bullet.)

Finally, inactive entities with less than a $1,000 of transactions and which own no assets don’t need to file.

Every other corporation, limited liability company or similar entity? Their ownership or management needs to file and provide the information listed in those earlier two sets of bulleted points.

Timing of BOI Reports

So the timing thing is sort of confusing.

You’ll file your BOI report online at www.fincen.gov sometime on or after January 1, 2024.

If your entity existed before January 1, 2024, you have until January 1, 2025.

If your entity formed on or after January 1, 2024 but during 2024, you need to file within ninety days of the date you receive confirmation of the filing or the date the information is publicly available. (Whichever date occurs first triggers the ninety-day countdown.) Thus, if you setup a new corporation, limited liability company, or some other entity from this point forward, be sure you plan to file the BOI report at the very start. (If you’re an attorney or accountant or incorporation service who files articles of incorporation or formation? Please do this. Please.)

If your entity formed after 2024, you need to file with thirty-days of the date you receive confirmation of the filing or the date the information is publicly available. (Again, use whichever trigger occurs first.)

Also note this: If any of the information that goes on a report changes? (See those bulleted lists provided earlier.) You need to file an updated report within thirty days. Almost any change in the information reported on the BOI report triggers a requirement to update the BOI report within thirty days. For example, a new driver’s license triggers a new countdown. The two exceptions we’ve spotted: If a beneficial owner dies, you have until thirty days after the estate is settled. And then if a company dissolves, you don’t have to report that.

Next BOI Report Steps

First, if you want to yourself file the report, get and carefully read the Small Entity Compliance Guide the U.S. Treasury and Financial Crimes Enforcement Network have provided. It’s available here.  And, fortunately, the guide is well-written and thorough. Figure a two to three hour read.

Second, both individuals and reporting companies may apply for and, according to FinCEN, immediately get a FinCEN identifier, or identification number. An individual applies for a FinCEN identifier by supplying the same information as goes onto the BOI report. A reporting company applies by checking a box on the BOI report form. And the advantage of using a FinCEN identifier? Rather than enter all individual bits of information, the individual or company just provides the FinCEN identifier. Note too that using a FinCEN identifier should mean an individual needs to only make one update if some bit of information (like an address) changes. (The instructions don’t say this. But surely the FinCEN system will do this.)

Third, finally, if you get into this subject matter, and realize you just don’t feel comfortable and have too many questions about details? Go ahead and reach out to your accounting firm or attorney. Hopefully one of them will be able to help you. (We are, for example, providing this service to our corporation and partnership tax return clients. We plan to do this work in the spring after tax season ends)

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But let’s quickly get into the details. Because not only is the case groundbreaking, it produces actionable insights both for small business owners and individual taxpayers.

Issue #1: Due Process Violations

The Moores’ case, if you’re a layperson and you read their petition, brings up three issues related to a tax that appeared in 2017, the Section 965 transition tax. One of the easiest to understand is the “Due Process” clause in the U.S. Constitution.

You can read the Wikipedia definition here, but a quick analogy comparing your own taxes with the Moores’ makes the point clearest.

You probably have saved a bit of money using a 401(k) account. Or a traditional or Roth Individual Retirement Account. Hopefully you’ve been doing that for years. Maybe decades. And partly you’ve done that because tax law says (and has said for decades) you don’t pay income taxes on your profits until you withdraw the money.

That was the deal, right? And so, it would be really crummy, and pretty unfair, if Congress retroactively decided at this point to change the rules. In other words, to now say you need to pay—today—income taxes on the money earned inside your IRA or 401(k) account in the 1990s or the 2000s using a new tax law we cooked up last month.

And yet, that’s basically what the Section 965 transition tax did. It retroactively changed the tax law and rules. And it made previously earned income from earlier years and decades taxable in 2017.

The Moores explain the situation in their petition. They invested $40,000 in a friend’s small business in India. That decision reflected the fact that any income earned by the corporation would not be taxed as earned. But only later as it was distributed. Or when they sold shares. And then on December 22, 2017, President Trump signed the new law which said, ”Okay. Change of rules. Now we want to tax the income as far back as 1986.” The Moores’ resulting tax, apparently paid in 2018, but for an earlier decade’s worth of earnings, equaled $14,729.

Anyway, that’s the first issue—and one that’s largely been missed or ignored or misunderstood by journalists discussing the Moores’ case: Was this retroactive tax law a violation of due process?

Issue #2: Measurement of Income

A second issue the Moore v. United States case examines? When and how a taxpayer measures income.

This bit of the argument gets a little more complicated. As the news coverage of the case shows.

The common-sense income measurement method used for centuries looks at transactions summarized in income statements. That’s been the approach in the Western world since at least the Renaissance (as documented by the Italian monk, Luca Paccioli). And Indian and Arabic cultures have similar accounting traditions that predate the Europeans.

To illustrate how this works for investors, take the example of you owning stock in some U.S. corporation. Like Microsoft. Or Apple Computer.

You don’t owe taxes on the money the Microsoft or Apple shows on their income statements. And on which they pay taxes. You only owe taxes on dividend income you receive from Microsoft or Apple. Or on the capital gain you enjoy if you sell shares of Microsoft or Apple Computer. In other words, the income shown on your income statement. That’s the way the accounting works. Or always used to.

What the Section 965 “transition” tax, and then a related chunk of tax law the Section 951A “global intangible low-taxed income” tax, do? They say you pay taxes on a chunk of the income earned by a foreign corporation you’ve invested in. Even though you haven’t received, or realized, any income. Even though you wouldn’t show that income on your personal income statement. And even if you really don’t have a clean way to measure the income.

Note: Congress and IRS refer to the Section 951A “Global Intangible Low-Taxed Income” tax as the GILTI tax. And, yes, they pronounce it “guilty.”

A quick sidebar for any tax professionals in the audience. Because I want to make two technical points. First, GILTI and other sections of Subpart F do work similarly to how U.S. partnership accounting works. But one noteworthy difference between typical partnership accounting and the Section 965 transition tax is, with a partnership, the income attributed to the partners is earned in the same year the income is attributed—and notably, the attributed partnership income is earned after Congress enacted the law imposing the tax.

A second technical point: Some critics of the Moores’ petition say Subchapter S corporations already force shareholders to report and pay income taxes on corporation income. Thus, Sections 965 and 951A aren’t really a new way of doing the tax accounting. What those folks miss though? With an S corporation, shareholders unanimously consent to this tax accounting treatment before it occurs. Often because the tax accounting both simplifies a small business’s accounting and saves tax.

Summing up, the measurement issue seems more complicated to me. Presumably the Court will consider a bunch of issues as they look closely at how the mechanics need to work. Furthermore, the issue raises more unanswered questions than casual analysis might predict. One issue connected to the complexity, in fact, I discuss next.

Issue #3: Compliance Costs of the Section 965 and 951A Taxes

A third issue is missed in most of the reporting I’ve seen or read: The compliance costs. So let me explain.

In their petition, the Moores note that the Section 965 transition tax equaled, as noted, $14,729. That was the tax per their petition on a $40,000 investment made a decade or so earlier.

The Moores didn’t disclose what the tax accounting costs for determining this tax bill were. Mr. Moore said in an interview said the accountants were costly.

But know this: The costs to calculate Section 965 and 951A taxes in general? Astronomical for a small business investor.

The IRS Form 5471 forms used to calculate these taxes, for example, take roughly a week to prepare according to the IRS. That’s not counting the time to learn the law. Or the time to collect the needed data.

Furthermore, the preparer? She or he needs to be a tax specialist who understands both the federal tax laws for international taxpayers. And she or he needs to understand generally accepted accounting principles since the form incorporates GAAP financial statements.

Rough numbers, you’re probably talking $300 or $400 an hour for roughly 40 hours. That’s $12,000 to $16,000 for just a part of the annual 1040 tax return.

People haven’t thought or talked much about this issue. But it’s an important part of the story. And one small business owners and managers should understand.

Three Closing Comments

Our CPA firm publishes this blog to share actionable insights for small business entrepreneurs and investors. So, let me try to do that regarding the Moore v. United States tax law case.

First, a specific tactical insight. If you’ve invested in a small corporation or LLC in another country? Maybe a family business where your people came from? Or some friend’s foreign venture? Or, heaven forbid, you used a corporation or LLC  to hold some foreign rental property? Oh my gosh. You need to see if you should have been filing 5471s. And then if you should have been but haven’t? You want to get with a CPA firm who handles this to see how to bring yourself into compliance. The penalties for bungling the Section 965 and 951A taxes are brutal. (In general, the penalties are assessed in $10,000 increments.)

A second, more general insight. Whatever you or I may think of these sorts of increased regulatory burdens and compliance costs? The increases appear to reflect a trend or pattern entrepreneurs should plan for. And stay alert to.

As just another example, next year the Financial Crimes Enforcement Network (aka “FinCEN”) will require 30 to 40 million small businesses to file “Business Ownership Information” or BOI reports. Failing to file potentially triggers financial penalties that rise as high as $10,000 and, in a worst-case, results in up to two years in prison. (We blog on this topic next month, by the way.) The only practical response to this sort of stuff? Plan ahead. And budget time and dollars.

Finally, a third important takeaway from the Moores’ case for taxpayers. We all want to allow for the possibility that tax law changes—possibly even retroactive changes—may upset carefully laid plans.

Some Related Resources

We’ve got quite a bit of information about international taxes available here at the blog. And you might find other posts useful. For example, if you need to understand the basics of how one handles foreign business tax reporting? Check out this earlier blog post: Reporting Foreign Business Investment

And this related comment: The Section 965 transition tax is what the Moores’ case looks at but a companion tax is the Section 951A GILTI tax. Small businesses facing or dealing with that tax might be interested in either of these two posts too: Section 951A GILTI Tax Avoidance: Ten Tricks and Section 962 Election: An Answer to GILTI?.

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