BUSINESSES – 2025 Year-End Update & Planning Considerations

Qualified Business Income (QBI) Deduction

• In 2025, new tax law makes the Sec. 199A qualified business income (QBI) deduction permanent and keeps the deduction rate at 20%.
• Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2025, if taxable income exceeds $394,600 for a married couple filing jointly, (about half that for others), the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the business.
• The limitations are phased in; for example, the phase-in applies to joint filers with taxable income up to $100,000 above the threshold, and to other filers with taxable income up to $50,000 above their threshold.

Deferring Income & Accelerating Deductions

• Taxpayers may be able to salvage at least some of the QBI deduction, by deferring income or accelerating deductions to keep income under the dollar thresholds (or be subject to a smaller deduction phaseout) for 2025. Depending on their business model, taxpayers also may be able increase the deduction by increasing W-2 wages before year-end. The rules are quite complex, so don't make a move in this area without a consulting discussion.

Section 179 Deduction

• Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2025, the expensing limit is $2,500,000, and the investment ceiling limit is $4,000,000. Expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software. It is also available for interior improvements to a building (but not for its enlargement), elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems.
• Generous dollar ceilings mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What's more, the expensing deduction is not prorated for the time that the asset is in service during the year. So, expensing eligible items acquired and placed in service in the last days of 2024, rather than at the beginning of 2025, can result in a full expensing deduction for the current year.
• Instead of taking full Section 179, consider normalizing depreciation deductions over the life of the asset. This provides a depreciation smoothing effect and avoids a whipsaw impact by taking large deductions in one year and having no depreciation left over for future years.

Bonus Depreciation

• 100% bonus depreciation has now been made permanent for qualified property acquired after January 19, 2025. Businesses can immediately expense the full cost of these available assets in the year they are placed in service rather than depreciating them over several years.
• Note: For property placed in service between January 1, 2025 and January 19, 2025, the 40% bonus rate still applies.
• Businesses also can claim bonus first year depreciation deduction for machinery and equipment bought used (with some exceptions) or new if purchased and placed in service this year, and for qualified improvement property, described above as related to the expensing deduction. The write-off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2025.
• Qualifying property includes tangible property depreciated under MACRS with a recovery period of 20 years or less, most computer software, qualified film, television, and live theatrical productions, and water utility property.

De Minimis Safe Harbor

• Consider taking advantage of the de minimis safe harbor election to expense the lower costs assets, material and supplies. Under this safe harbor you can expense the amount if each item cost does not exceed $2,500.

• Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book- tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs aren’t required to be capitalized under the UNICAP rules. To qualify for the election, the cost of a unit of property can't exceed $5,000 if the taxpayer has an applicable financial statement.

Year-End Bonuses

• Year-end bonuses can be timed for maximum tax effect by both cash- and accrual-basis employers. Cash- basis employers deduct bonuses in the year paid, so they can time the payment for maximum tax effect. Accrual-basis employers deduct bonuses in the accrual year when all events related to them are established with reasonable certainty.
• However, the bonus must be paid within 2 1⁄2 months after the end of the employer’s tax year for the deduction to be allowed in the earlier accrual year. Accrual employers looking to defer deductions to a higher-taxed future year should consider changing their bonus plans before year-end to set the payment date later than the 2.5-month window or change the bonus plan’s terms to make the bonus amount not determinable at year end.

Rental Real Estate 

• If you have any rental real estate activities, it's important to determine if the activity will be considered a passive activity by the IRS. Generally, losses from passive activities are only deductible against passive activity income. However, a deduction of up to $25,000 ($12,500 if married filing separately) may be allowed against nonpassive income to the extent you actively participate in the rental real estate activities.
• This deduction is subject to a phaseout for individuals with modified adjusted gross income above $100,000 (or $50,000 if married filing separately).
• Additionally, you may be eligible for a qualified business income deduction if certain criteria are met, such as the rental activity qualifying as a Section 162 trade or business.

Substantiation of Vehicle-Related Deductions 

• Vehicle expenses, if not properly substantiated, such deductions are disallowed. Thus, if vehicles are used in any part of your business or business-related activities, your tax records with respect to each vehicle should include the following:

         (1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance, etc.); 

         (2) the amount of mileage for each business or investment use and the total miles for the tax period; 

         (3) the date of the expenditure; and 

         (4) the business purpose for the expenditure. 

• The IRS will consider the following as adequate substantiation for such expenses:
  • (1) records such as a notebook, diary, log, statement of expense, or trip sheets; and
  • (2) documentary evidence such as receipts, canceled checks, bills, or similar evidence.
• It's important to note that records are considered adequate to substantiate the element of a vehicle expense only if they are prepared or maintained in such a manner that each recording of an element of the expense is made at or near the time the expense is incurred.

Disposing of a Passive Activity

• Sometimes the disposition of a passive activity can be timed to make best use of its freed-up suspended losses. Where reduction of income is desired, consider disposing of a passive activity before year- end to take the suspended losses against current year income. If possible top rate increases are a concern, holding off on disposing of the activity until future years as this could save more in taxes.

Pass-Thru Entity Considerations 

• Basis - If you are operating a business through a pass-thru entity such as a partnership or S corporation, your basis in the entity must be high enough to allow for any loss deduction, if you have one for the year. In such a situation, we should consider the options available for increasing your basis in such entity.
• Reasonable Comp - If you are an S corporation shareholder it's important to ensure that you and other shareholders involved in running the business are paid an amount that is commensurate with the work being done. The IRS scrutinizes S corporations which distribute profits instead of paying compensation subject to employment taxes. Failing to pay arm's length salaries can lead to tax deficiencies, interest, and penalties. The key to establishing reasonable compensation is showing that the compensation paid for the type of work an owner-employee does for the S corporation is similar to what other entities would pay for similar work. An S corporation needs to adequately document the factors that support the salary an S corporation owner is being paid.

Pass-Through Entity (PTE) Tax at the Entity Level

• The pass-through state income tax deduction allows business owners to deduct state income tax on their business income without limit. This deduction allows a pass-through entity to elect to pay the state income tax due on the business income that would otherwise pass through and get paid on the owner’s personal tax returns.
• The federal itemized deduction cap for state and local taxes doesn’t apply when a pass-through entity pays state and local tax on its earnings at the entity level. Many states have passed legislation allowing the pass-through tax deduction work- around, and some states have even passed retroactive legislation.

• The owners of pass-through entities generally may either be allowed a credit for their share of the PTE tax or to exclude their share of the pass-through entity’s income from the taxing jurisdiction’s imposition of income tax on the owners. What further complicates this approach is that each state has adopted a different approach and rules for its PTE tax. 

Net Operating Losses

• NOLs from before 2018 could be carried back two years and carried forward only 20 years.
• 2018, 2019, and 2020 NOLs may be carried back five years and carried forward indefinitely
• Post-2020 NOLs may not be carried back (except for farm losses, which may be carried back two years), but may be carried forward indefinitely.
• Starting with the 2021 tax year, the NOL deduction is subject to an 80% of taxable income limitation (not counting the NOL or the qualified business income deduction)

• What this boils down to is that for earlier tax years, NOL carryovers and carrybacks could fully offset taxable income, but unused losses couldn’t be carried forward indefinitely.

Accountable Plan – Unreimbursed Expenses

The treatment of reimbursements and other expense allowance arrangements with employees depends on whether the arrangement is considered an “accountable plan.”

If the corporation's reimbursement or expense allowance plan meets the following criteria, it will be considered an accountable plan [IRC Sec. 62(c); Reg. 1.62-2(c)]:

1. The arrangement pays only deductible business-related expenses.
2. The arrangement requires the employee to substantiate the expenses to the corporation within a reasonable time. Reg. 1.62-2(g)(2)provides a 60-day safe harbor for the employee to substantiate the expenses.
3. The arrangement requires the employee to return any amount in excess of the substantiated expenses to the corporation within a reasonable time. Reg. 1.62-2(g)(2)provides a 120 day safe harbor for the employee to return any excess amounts.

• For S Corps –
  • Consider setting up an accountable plan for reimbursing home office expenses and other expenses paid personally for the corporation.
  • Unreimbursed employee expenses for an S Corp are not deductible unless an accountable plan is in place.
• For Partnerships –

• • The partnership agreement must state that the partner is required to pay those expenses (RR 70-253). Unreimbursed partnership expenses are based on what the partnership agreement states.
  • A partner cannot deduct expenses if the partnership would have honored the partners’ request for reimbursement.
  • If the partnership agreement does not include a discussion of unreimbursed expenses, then you may want to consider including provisions in the partnership agreement to address expenses incurred by the Partners incurred with respect to the partnership business.

Paying Kids (these rules apply to a Sole Prop and Partnership only)

• Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to Social Security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child.
• Payments for the services of a child under age 21 who works for his or her parent in a trade or business are not subject to FUTA tax. Payment for the services of a child are subject to income tax withholding, regardless of age.
• Minor’s wages are not subject to FICA or Medicare for either the child or the parent, and the child may then deposit money into a Roth IRA to utilize for future college or first-time home purchase needs. The child must be a legal employee, but there are no minimum age restrictions.
• CAUTION - Wages paid to a child must be reasonable in relation to the services rendered IRC Sec 162(a). Keep detailed records of the child’s employment including payroll records documenting hours worked and duties performed in case the Fed/State seeks verification as to the legitimacy of the wages.

Please call me at your convenience so we can set up an appointment to discuss your 2025 tax return and determine if any estimated tax payment may be due before year end. 

Sincerely, 

Ike Braden, CPA PLLC

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