Technology Companies: Act Now on Year-End Tax Planning

This blog post was previously published on November 15, 2018. It was updated on November 15, 2019.

While 2019 didn’t see any major new tax laws put into place, that doesn’t mean you can put your tax planning on auto-pilot. To fully benefit from the Tax Cuts and Jobs Act and other provisions, you should be proactive in finalizing year-end tax planning for your technology business.

Maximize your deduction for qualified business income (QBI)

Owners of certain pass-through entities may be able to receive a 20% deduction on qualified business income, which may reduce their maximum effective tax rate for 2019. Pass-through entities, which include subchapter S corporations, partnerships and some limited liability companies. There’s another plus for pass-throughs: they keep the deduction on entity-level state and local taxes.  

The deduction may be limited to 50% of the W-2 wages paid, or the sum of 25% of the wages plus 2.5% of certain depreciable basis. Research whether you have paid enough wages to use this deduction – if you’re close, now may be the time to pay bonus wages to employees. Smaller, more closely held businesses, where the owner is also the most highly-compensated employee, should particularly pay attention to this.

The QBI deduction limitations and restrictions are set at the owner level.  Planning for year-end 2019 should include discussion of salaries, timing and distribution of income.

Also, be aware that filers who claim the QBI deduction must now show how they calculated QBI, by using Form 8995. Each business must stand separately and will require its own Form 8995.

If you aren’t sure whether your business qualifies for the QBI deduction, now is the time to discuss it with your tax advisor. It’s important that he or she have a deep understanding of your business in order to make a recommendation. This is also a good time of year to consider if you want to make any change to your business entity type, or carve out a segment into a separate entity, which might help you to qualify for the QBI deduction. Consult with your tax advisor and attorney before making any major changes.

Calculate your potential R&D tax credit

If your business spends a considerable amount of time and money on innovation, consider claiming the research and development (R&D) tax credit. In addition to enabling companies to write off certain costs incurred when developing new and improved products, the credit makes it possible for companies to offset an income tax liability dollar-for-dollar.

The Tax Cuts and Jobs Act, which went into effect for tax year 2018, also indirectly increased the R&D tax credit’s after-tax benefit when it reduced the corporate tax rate to 21%. Additionally, the tax law’s removal of the corporate alternative minimum tax (AMT) gave more companies the opportunity to take advantage of the R&D tax credit.

The Tax Cuts and Jobs Act also limited the deductibility of net operating losses generated after December 31, 2017. Businesses can offset up to 80% of their taxable income using net operating losses occurring after 2017. Technology companies expecting substantial revenue growth may consider taking advantage of the R&D tax credit now and applying it against the balance of taxable income that cannot be offset by their net operating losses.

Startups with less than $5 million in revenue (and no revenue for the period of five years ending with the credit year) can, in the absence of a tax liability, instead apply the R&D tax credit to offset up to $250,000 in payroll taxes each year for up to five years. To do this, you need to keep at least a minimum of documentation of your activities and eligibility. A qualified professional with R&D tax experience can help you assess your eligibility, calculate the amount you could expect from this credit, as well as advise and assist you with proper documentation for claiming the credit.

Finally, keep in mind that, for taxable years beginning after Dec. 31, 2021, taxpayers will be required to capitalize and amortize research or experimental expenditures (which will include all software development costs) over a period of five years. Those costs are currently immediately deductible as expenses.

Depreciate new assets placed into service this year

The Tax Cuts and Jobs Act increased Bonus Depreciation, allowing businesses to fully depreciate property placed in service on their federal tax return. This aims to incentivize companies, especially in the technology, manufacturing, and construction sectors, to invest in their business and purchase new assets. It is important to note that some states have decoupled and disallowed this bonus depreciation, so you will need to consider whether your state is following federal or state tax laws as it relates to bonus depreciation when filing your 2019 tax return.

Speak with your tax advisor about the potential tax implications of any asset acquisitions you are contemplating, and whether it is better to acquire them at the end of this year or to wait until early 2020.

Consider how Wayfair ruling may affect your tax liability

The Wayfair Supreme Court ruling in June 2018 shifted the tax liability for online purchases from consumers to businesses. Instead of consumers paying a use tax, retailers now must collect the sales tax.

The court’s decision effectively eliminated the need to have a physical presence in a particular jurisdiction in order to be subjected to that state’s laws, register as a business entity, and collect sales tax. States have established different sales volume thresholds, which determine a business’ liability. If you are a technology company selling software as a service, apps, or tangible goods, you need to understand how the states where your customers reside are interpreting and following these Wayfair-related laws.

Make sure that your tax professional knows where you are doing business and analyzes the sales tax requirements in each state.

Startup employees may want to delay tax on qualified equity grants

Startup employees paid in restricted stock can now postpone paying taxes on this stock. Section 83(i) of the Tax Cuts and Jobs Act gives startup employees the opportunity to delay paying income taxes on restricted stock for up to five years.

Note that startup employees taking this approach would be relying on the startup’s financial success, and the impact of this new provision might be limited by its real-world application and reliance on guidance from the IRS. Startups are a major component of the technology industry, so many professionals in the tech space could potentially benefit.

Some of your investors may be eligible for tax break

If your company has assets of $50 million or less and is a C corporation, individuals who buy stock directly from the company and hold it for more than five years can exclude all of their gain when they sell; this gain is also exempt from the Alternative Minimum Tax.

This exclusion applies to any purchases after September 27, 2010. It is capped at the greater of $10 million or 10 times share basis, and only applies to certain industries – of which technology is one.

Self-created IP sale can no longer benefit from capital gains rate

Inventors with self-made intellectual property such as inventions, patents and designs may not enjoy lower tax rates like before. The Tax Cuts and Jobs Act eliminated the ability to consider self-made property as capital assets, which are subject to the lower capital gains rate of 20%. Rather, self-made property is now taxed as ordinary income. You may want to consider how patented assets are sold and the impact that would have on your business’ deals across the technology industry.

Contact a Kaufman Rossin tax advisor to learn more about how these and other tax provisions may affect your technology company and how you can get ahead now with tax planning.