Good tax planning is based on a car wash operation’s current versus its potential future earnings or profits. For those car wash businesses whose taxable earnings will potentially be lower next year, end-of-the-year tax planning is very simple: defer any income possible, pushing it onto next year’s lower tax bill.
Car wash operators may find that deferring income until next year when the tax bill, if not the tax rates, may be lower, less practical than accelerating deductions into the computation of the tax bill for the current tax year. However, while many approaches either don’t work or only result in a deferral of taxes, tax bills can be reduced using timing, making a few key moves, and by spending money on specific things. Consider, as one example, pre-paying some deductible expenses.
Those in need of extra business deductions before the end of the year can prepay some expenses, such as business insurance, rent on business property or equipment, and lease payments on business vehicles. There are, of course, a number of tricky rules that must be followed.
The general rule is that expenses for a future year can only be deducted in the year to which it applies. A good example is when a two-year lease is paid in advance, only the portion of the payment that applies to the current year can be currently deducted.
Fortunately, there is an exception, the so-called “12-month” rule, that allows the car wash operation to deduct prepaid future expenses in the current year if the expense is for a right or benefit that extends no longer than 12 months or until the end of the tax year after the tax year in which the payment is made.
The 12-month rule can apply to business insurance premiums, licenses, rents and leases, as well as to payments for terminating business contracts. It may not, however, be used for payments for interest; loans and other financial interests; or purchases of furniture, fixtures, equipment, or other long-term capital assets.
Bottom-line, whether prepaying expenses makes sense depends on the expected tax bill for this year compared to future years, as well as future changes predicted for our tax laws that might raise the car care operation’s taxes. If income is expected to go up substantially next year, not prepaying expenses but instead maximizing deductions next year, might be the best option.
CREATING LARGER DEDUCTIONS
The 2017 Tax Cuts and Jobs Act (TCJA) increased the write-offs for certain types of business equipment. These accelerated depreciation deductions allow the car wash business to expense and immediately write-off more of the cost of business equipment purchased during the year for a lower bill when tax returns are filed.
The TCA created a tax deduction for the entire cost of new purchases with 100 percent bonus depreciation. With bonus depreciation, the cost of computers, equipment, vehicles, and furniture acquired in the 2019 tax year can be written-off.
Section 179 Expensing
There is also the increased Section 179, first-year expensing write-off that has been doubled from $500,000 to $1,000,000. Section 179 property now includes fire protection, alarm systems, and security systems.
Every car care business can get a tax credit, a direct reduction of the tax bill rather than a deduction from the amount that tax bill is based on, for investing in specific energy-saving improvements and projects. These investments must be in “investment credit property” that can be depreciated or amortized. The amount of the tax credit is: • 30 percent for solar, fuel cells, small wind turbines, etc. • 10 percent for geothermal, microturbines, and combined heat and power.
Both residential and commercial solar projects may qualify for the full 30 percent investment tax credit through 2019 — so long as the project is placed in service before 2024. Under the current rules, projects that start construction in 2019 will receive the 30 percent credit for four years, 2020 construction-start projects will receive the 26 percent credit for three years with 2021 construction-start projects receiving the 21 percent tax credit for two years.
Once again, this might be a good time to weigh the bottom-line benefit of an immediate write-off against depreciation deductions in later, perhaps more profitable, years.
Earlier IRS regulations that kicked in during the 2016 tax year impacted every business with fixed assets. Today, the so-called “de minimis” safe harbor deduction for materials and supplies has been increased from $500 to $2,500, at least for those businesses without an applicable financial statement.
It is not too late to update the car wash operation’s policy for differentiating repairs from capital expenditures to comply with the updated regulation.
OBSOLETE AND EXTRANEOUS
Writing off and/or writing down obsolete, damaged, or worthless equipment increases the operation’s expenses and lowers the tax bill for the year. Under the tax rules, abandonment losses from business or investment property are generally deductible as ordinary losses — so long as the abandonment is not treated as a sale or exchange.
While tangible property can be physically relinquished, abandonment of intangible property should be established with detailed documentation. In order for a car wash business to claim a deduction for the abandonment of property, particularly intangible assets such as partnership interests, a three-prong test must be met: • Ownership of the property prior to abandonment. • An intent to abandon the property. • Affirmative action to abandon the property.
The purpose of records is two-fold: First, they provide a reminder of income and expenditures, plus they serve as proof should the vigilant IRS demand it. Yes, good records will help monitor the progress of the car care business, prepare its financial statements, identify sources of income, keep track of deductible expenses, and aid in preparation of the annual tax returns. And, the time to assemble those records is now, before the end of the tax year.
With few exceptions, the tax laws don’t require any special kind of records. So, identifying the business records that should be kept is the first step. Proving income is pretty straightforward, keeping in mind that if there is any doubt, the IRS can go with the operation’s bank deposits.
Expense records are important for deductions and lowering taxable income. Here, cancelled checks may not always do the trick as IRS auditors want invoices, bills, and contracts explaining those cancelled checks. Expenditures for business assets such as equipment, office furniture, and other big-ticket items should be documented with contemporaneous documentation.
GIVING IT AWAY FOR TAX SAVINGS
The end of the year is a traditional time for employee bonuses, gift-giving, and parties. In addition to receiving a tax deduction for these expenses, a car wash business can benefit from employees’ goodwill, especially around the holidays.
Employee bonuses are usually considered deductible business expenses. However, bonuses to sole proprietors, partners, and limited liability (LLC) members are not deductible because the IRS considers them to be self-employed.
Employee/owner bonuses are an expense and can be deducted, at least in some cases. For instance: • S corporations can deduct shareholder and owner bonuses as long as they own their shares at the time the bonus is paid. • Regular corporations, so-called “C” corporations, can only deduct bonuses for shareholder/owners who have a 50 percent or higher ownership at the time the bonus is paid. In general, having a corporation and being an employee of that corporation might result in a larger tax deduction.
Holiday gifts as well as parties are often tax deductible so long as they are not routinely/frequently given and are for the purpose of promoting goodwill.
PLANNING BEFORE YEAR-END
As the end of the car wash operation’s tax year approaches, several general rules can guide it to real tax savings — savings that will be consistent, year-after-year: • Don’t spend money simply to reduce that tax bill. After all, $1 spent does not equal $1 worth of tax saved nor create a $1 deduction. Also, keep in mind that if those accelerated deductions result in a net operating loss (NOL), it can now only be used to offset tax bills down the road — there is no longer a NOL carryback. • Know thy accounting method. Most year-end tax strategies work best for cash-basis taxpayers. Accrual-basis car wash businesses report all income in the year it is earned and all expenses in the year they are incurred. So, just because the business is paying for a 2019 expense in 2019 doesn’t always result in a deduction on the 2019 tax return. • Worker classification matters. Every car care business must correctly determine whether workers are employees or independent contractors. Independent contractors are not, of course, subject to withholding, making them responsible for paying their own taxes and reducing the car wash operation’s payroll tax liability.
Today, few car wash operators get their tax professionals involved before the end of the tax year. But, how can anyone hope to know whether income deferral or accelerated write-offs will be of the most help in reducing this year’s tax bill — and the tax bills in future years?
Mark E. Battersby is an Ardmore, PA-based freelance writer, specializing in finance and tax issues.