#TaxTipTuesday-The “manufacturers’ deduction” isn’t just for manufacturers

The Section 199 deduction is intended to encourage domestic manufacturing. In fact, it’s often referred to as the “manufacturers’ deduction.” But this potentially valuable tax break can be used by many other types of businesses besides manufacturing companies.

Sec. 199 deduction 101

The Sec. 199 deduction, also called the “domestic production activities deduction,” is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts.

Yes, the deduction is available to traditional manufacturers. But businesses engaged in activities such as construction, engineering, architecture, computer software production and agricultural processing also may be eligible.

The deduction isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the alternative minimum tax.

How income is calculated

To determine a company’s Sec. 199 deduction, its qualified production activities income must be calculated. This is the amount of domestic production gross receipts (DPGR) exceeding the cost of goods sold and other expenses allocable to that DPGR. Most companies will need to allocate receipts between those that qualify as DPGR and those that don’t — unless less than 5% of receipts aren’t attributable to DPGR.

DPGR can come from a number of activities, including the construction of real property in the United States, as well as engineering or architectural services performed stateside to construct real property. It also can result from the lease, rental, licensing or sale of qualifying production property, such as:

• Tangible personal property (for example, machinery and office equipment),
• Computer software, and
• Master copies of sound recordings.

The property must have been manufactured, produced, grown or extracted in whole or “significantly” within the United States. While each situation is assessed on its merits, the IRS has said that, if the labor and overhead incurred in the United States accounted for at least 20% of the total cost of goods sold, the activity typically qualifies.

Contact us to learn whether this potentially powerful deduction could reduce your business’s tax liability when you file your 2016 return.

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Tax bracket, tax rate, what’s the difference?

 

The difference between your tax bracket and your tax rate is more than a trick question. For example, knowing your tax rate gives you an accurate reflection of your tax liability in relation to your total income. Knowing your tax bracket is useful for planning purposes. For instance, you may want to spread a Roth conversion over several years in order to stay within the income limits of a particular tax bracket.

So, what’s the difference between the two? The main difference is that a tax bracket is a range of income to which a specific tax rate applies, while your effective tax rate is the percentage of your income that you actually pay in tax. Put another way, not every dollar is taxed at the same rate. Your tax bracket shows the rate of tax on the last dollar you made during the tax year. Your effective tax rate reflects the actual amount you paid on all your taxable income.

For example, say you’re single and in the 25% bracket for 2016. That means your taxable income is between $37,650 and $91,150.

Yet the tax you pay is less than 25% of your income.

Why? Because the 25% tax rate only applies to the amount of taxable income within the 25% bracket. The tax on income below $37,650 is calculated using the rate that applies to income in the 10% and 15% brackets.

So, if your 2016 taxable income is $40,000, only $2,350 is taxed at 25%. The remainder is taxed at 10% and 15%, leading to a “blended” overall rate. The result: a tax bracket of 25%, and an effective tax rate of less than that.

Good tax advice can affect both your bracket and your rate. Want to know how? Contact us.

#TaxTipTuesday- There’s Still Time to Benefit on Your 2016 Tax Bill by Buying Business Assets

In order to take advantage of two important depreciation tax breaks for business assets, you must place the assets in service by the end of the tax year. So you still have time to act for 2016.

 
Section 179 deduction
The Sec. 179 deduction is valuable because it allows businesses to deduct as depreciation up to 100% of the cost of qualifying assets in year 1 instead of depreciating the cost over a number of years. Sec. 179 can be used for fixed assets, such as equipment, software and leasehold improvements. Beginning in 2016, air conditioning and heating units were added to the list.

 
The maximum Sec. 179 deduction for 2016 is $500,000. The deduction begins to phase out dollar-for-dollar for 2016 when total asset acquisitions for the tax year exceed $200,010,000.

 
Real property improvements used to be ineligible. However, an exception that began in 2010 was made permanent for tax years beginning in 2016. Under the exception, you can claim a Sec. 179 deduction of up to $500,000 for certain qualified real property improvement costs.

 
Note: You can use Sec. 179 to buy an eligible heavy SUV for business use, but the rules are different from buying other assets. Heavy SUVs are subject to a $25,000 deduction limitation.

 
First-year bonus depreciation
For qualified new assets (including software) that your business places in service in 2016, you can claim 50% first-year bonus depreciation. (Used assets don’t qualify.) This break is available when buying computer systems, software, machinery, equipment, and office furniture.

 
Additionally, 50% bonus depreciation can be claimed for qualified improvement property, which means any eligible improvement to the interior of a nonresidential building if the improvement is made after the date the building was first placed in service. However, certain improvements aren’t eligible, such as enlarging a building and installing an elevator or escalator.

 
Contemplate what your business needs now
If you’ve been thinking about buying business assets, consider doing it before year end. This article explains only some of the rules involved with the Sec. 179 and bonus depreciation tax breaks. Contact us for ideas on how you can maximize your depreciation deductions.

Should you make a “charitable IRA rollover” in 2016?

Last year a break valued by many charitably inclined retirees was made permanent: the charitable IRA rollover. If you’re age 70½ or older, you can make direct contributions — up to $100,000 annually — from your IRA to qualified charitable organizations without owing any income tax on the distributions.

 
Satisfy your RMD
A charitable IRA rollover can be used to satisfy required minimum distributions (RMDs). You must begin to take annual RMDs from your traditional IRAs in the year in which you reach age 70½. If you don’t comply, you can owe a penalty equal to 50% of the amount you should have withdrawn but didn’t. (An RMD deferral is allowed for the initial year, but you’ll have to take two RMDs the next year.)
So if you don’t need the RMD for your living expenses, a charitable IRA rollover can be a great way to comply with the RMD requirement without triggering the tax liability that would occur if the RMD were paid out to you.

 
Additional benefits
You might be able to achieve a similar tax result from taking the RMD payout and then contributing that amount to charity. But it’s more complex because you must report the RMD as income and then take an itemized deduction for the donation. This has two more possible downsides:

 
• The reported RMD income might increase your income to the point that you’re pushed into a higher tax bracket, certain additional taxes are triggered and/or the benefits of certain tax breaks are reduced or eliminated. It could even cause Social Security payments to become taxable or increase income-based Medicare premiums and prescription drug charges.

• If your donation would equal a large portion of your income for the year, your deduction might be reduced due to the percentage-of-income limit. You generally can’t deduct cash donations that exceed 50% of your adjusted gross income for the year. (Lower limits apply to donations of long-term appreciated securities or made to private foundations.) You can carry forward the excess up to five years, but if you make large donations every year, that won’t help you.

 
A charitable IRA rollover avoids these potential negative tax consequences.

 
Have questions about charitable IRA rollovers or other giving strategies? Please contact us. We can help you create a giving plan that will meet your charitable goals and maximize your tax savings.