Each business should consider the unique challenges and possible opportunities that this year presents. Please see below a list of potential strategies and provisions that you may be able to utilize and should keep in mind as we approach year end.
Deferring Income and Accelerating Deductions
If you expect your taxable income to be higher in 2020 than in 2021, you may benefit by deferring income into 2021 or accelerating deductions into 2020.The following are methods for achieving this strategy.
- Use of Cash Method of Accounting: By adopting the cash method instead of the accrual method, you can generally put yourself in a better position for accelerating deductions and deferring income. An automatic change to the cash method can be made by the due date of the return including extensions.
- Installment Sales: If you are expecting to sell property prior to the end of 2020, and it makes economic sense, consider using the installment method to defer payments and tax until 2021 or later.
- Delay Billing: If you use the cash method, consider delaying year-end billing to clients so that payments are not received until 2021.
- Defer Interest and Dividends: To defer interest income, you could consider buying short-term bonds or certificates that will not mature until 2021. You will only be taxed in 2020 on dividends for which there is constructive receipt before year end.
- Bad Debts: If a business uses the accrual method, business accounts receivable should be analyzed and those receivables that are totally or partially worthless should be written off. By identifying specific bad debts, you should be entitled to a deduction. You may be able to complete this process after year’s end if the write-off is reflected in year-end financial statements.
- Current Year Bonuses: Accrual basis taxpayers may accelerate the bonus deduction into the current year while the employees will report the income in the following year if they are cash method taxpayers. Furthermore, any compensation arrangement that defers payment will be currently deductible only if paid within 2 ½ months after the employer’s year-end.
- Prepayment of Taxes: If you pay payroll taxes on a quarterly basis, consider accelerating 4th quarter payroll taxes at December 31 year-end and do not wait until January 15, 2021. Consider accelerating state income estimated taxes and property taxes if possible if you would benefit from a current year state income tax deduction. AMT should be considered for pass-through entities taxed at individual rates if accelerating state income and property taxes.
This strategy is somewhat complicated by the prospect of Biden’s tax proposal to increase the corporate tax rate from 21% to 28%, the highest individual rate from 37% and 39.6% and implement the 12.4% Social Security tax for self-employment earnings over $400,000. The probability of these tax increases hinge on the results of the two Georgia Senate seat run-off on January 5th. If you feel the changes are likely to occur, the next strategy may be a better option.
Accelerating Income into 2020
You may benefit from accelerating income into the current year. For example, you may anticipate being in a higher tax bracket in 2021, or perhaps you need additional income this year to take advantage of an offsetting deduction or credit that will not be available in a future tax year. Note, however, that accelerating income into 2020 could be disadvantageous if you expect to be in the same or lower tax bracket for 2021.
- Early Collection: A business that reports business income and expenses on a cash basis could issue bills and pursue collection before the end of 2020. Also, the taxpayer could check to see if clients or customers are willing to pay for January 2021 goods or services in advance. Any income received using these steps will shift income from 2021 into 2020.
- Qualifying Dividends: Qualified dividend income is generally subject to a 15% or 20% rate dependent upon statutory thresholds. The corporate board may consider the tax impact of declaring a dividend to its shareholders. If a controlling shareholder is not in the highest capital gains bracket for 2020 but expects to be in a higher bracket in 2021, consideration should be made as to authorizing any dividend payment prior to the end of 2020 to utilize the more favorable 15% tax rate.
Owners of closely held businesses may want to consider gifting an interest in the business (corporate stock or interests in family limited partnerships or LLCs). You may take advantage of valuation discounts (marketability and minority discounts) and the 2020 gift tax exclusion of $15,000 per donee ($30,000 when gift-splitting) when gifting family business interests before year end.
- Research and Development Tax Credit: Some business projects, such as those involving developments of new or more reliable products, processes, or techniques, may be eligible for the R&D tax credit. Eligible small businesses ($50 million or less in gross receipts) may claim the R&D tax credit against alternative minimum tax liability and the credit can be used by certain qualified small businesses against the employer’s payroll tax liability.
- Employer Wage Credit for Employees in the Uniformed Services: Some employers continue to pay all or a portion of the wages of employees who are called to active service. The amount of the credit is equal to 20% of the first $20,000 of differential wage payments to each employee for the taxable year. Employers of any size with a written plan for providing such differential wage payments are eligible for the credit.
- Work Opportunity Credit: The work opportunity credit is an incentive provided to employers who hire individuals in groups whose members historically have had difficulty obtaining employment. The credit gives a business an expanded opportunity to employ new workers and to be eligible for a tax credit based on the wages paid. The credit is available for first-year wages paid or incurred in the tax year for employees hired and who began work before December 31, 2020. Employers who hire members of targeted groups, including qualified long-term unemployed individuals, will be entitled to a credit equal to 40% of the first $6,000 of wages. Employers who hire qualified veterans will be entitled to a credit equal to 40% of a higher wage limit, with the wage limit dependent on the reason for qualification.
- Small Employer Pension Plan Startup Cost Credit: Certain small business employers that did not have a pension plan for the preceding three years may claim a nonrefundable income tax credit for expenses of establishing and administering a new retirement plan for employees. The credit applies to 50% of qualified administrative and retirement-education expenses for each of the first three plan years. The credit is limited to the greater of (a)$500; or (b) the lesser of (i) $250 for each eligible employee, or (ii) $5,000. Thus, the maximum available credit is limited to $5,000 per year.
- Small Employer Retirement Savings Auto-Enrollment Credit: Starting in 2020, certain small business employers that include an eligible automatic contribution arrangement in a qualified employer plan may claim a nonrefundable income tax credit of $500 for each of the first three plan years.
- Employer-Provided Child Care Credit: Employers may claim a credit of up to $150,000 for supporting employee child care or child care resource and referral services. The credit is allowed for a percentage of “qualified child care expenditures,” including for property to be used as part of a qualified child care facility, for operating costs of a qualified child care facility, and for resource and referral expenditures.
- Low-Income Housing Credit: The low-income housing credit is a tax credit which may be claimed over a 10-year period by owners of residential rental property used for low-income housing.
- Employer Credit for Family and Medical Leave Act Wages: An eligible employer may take a paid family and medical leave credit of between 12.5% and 25% of the wages paid to the employee, depending on what portion of the employee’s normal wages are paid during the leave (minimum 50% of wages).
- Employer Credit for sick and Family Leave under Families First Coronavirus Response Act: Businesses and tax-exempt organizations with fewer than 500 employees are required to pay sick leave to an employee who is unable to work or telework because they have affected by the pandemic. Such businesses are also required to pay family and medical leave to an employee who is unable to work or telework because the employee is caring for a child whose school is closed or whose child-care provider is unavailable due to COVID-19. Employers are entitled to fully refundable tax credits equal to the required paid sick or family leave wages.
- New Markets Credit: You may claim a new markets tax credit equal to 39% of any capital invested in a qualified community development entity. The credit is claimed in seven annual installments beginning in the year of the original investment.
- Energy Investment Credit: The energy investment credit is available for investments in certain alternative and renewable energy property and renewable electricity production facilities. The credit is either 10% or 30% of the basis of energy property placed in service during 2020.
- Accelerating AMT Refunds: The TCJA repealed the corporate AMT and allowed corporations to claim all their unused AMT credits in the tax years beginning 2018-2021. The CARES Act accelerates this timeline and allows corporations to claim all remaining credits in either 2018 or 2019. This gives companies options to file for quick refunds. The fastest method for many corporations is to file tentative refund claim on Form 1139, Corporation Application for Tentative Refund.
Qualified Small Business Stock: Stock acquisitions that qualify as “small business stock” under §1202 are subject to special exclusion rules upon their sale, as long as a five-year holding period is satisfied. S corporation stock does not qualify for the exclusion. A 100% gain exclusion applies for qualified small business stock acquired after September 27, 2010 and held for more than five years. A 75% exclusion applies for qualified small business stock acquired after February17, 2009 and before September 28, 2010 (and held for at least five years). A 50% exclusion applies for qualified small business stock acquired before February 18, 2009 (and held for at least five years).
Business Deductions Available
- Qualified Business Income (QBI): Individual taxpayers with QBI from a pass-through entity or sole proprietorship may be entitled to a deduction equal to the lesser of the deductible amount of the QBI or 20% of taxable income. However, if the taxpayer’s taxable income exceeds $326,600 (joint filers) or $163,300 (all other taxpayers), the deduction is subject to a limitation based on W-2 wages paid and qualified business assets owned by the business
- Limitation on Business Interest: The deduction for net interest expenses incurred by a taxpayer is limited to the sum of business interest income, 50% of the business’s adjusted taxable income (ATI), and floor plan financing interest, though taxpayers with average annual gross receipts of $26 million or less are exempt from the limit. Taxpayers may elect to substitute 2019 ATI for 2020 ATI. Further, taxpayers may elect out of the increase to 50% of ATI and use the standard 30% of ATI to determine their limitation.
- Excess Business Loss: The CARES Act postponed application of the limitation on excess business losses until tax years beginning in 2021.
- Equipment Purchases: For 2020, you may elect to expense up to $1,040,000 of equipment costs (with a phase-out for purchases in excess of $2,590,000). The deduction is subject to a business income limit. In addition, careful timing of equipment purchases can result in favorable depreciation deductions in 2020. In general, under the “half-year convention,” taxpayers may deduct six months’ worth of depreciation for equipment that is placed in service on or before the last day of the tax year.
- Bonus Depreciation: For property acquired after September 27, 2017 and placed in service before 2023, a 100% bonus depreciation rate applies. New or used property acquired after September 27, 2017 qualifies for bonus depreciation.
- Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses, and their dependents as an above-the-line deduction, without regard to the general 10%-of-AGI floor. Self-employed health insurance includes eligible long-term healthcare premiums.
- Home Office Deduction: For self-employed individuals, expenses attributable to using the home office as a business office are deductible if the home office is used regularly and exclusively: (1) as a taxpayer’s principal place of business for any trade or business; (2) as a place where patients, clients, or customers regularly meet or deal with the taxpayer in the normal course of business; or (3) in the case of a separate structure not attached to the residence, in connection with a trade or business. If a taxpayer uses part of the home as a business office, determining the amount of any deduction available can be tricky but an IRS-provided safe harbor could be used to minimize audit risk.
- NOL Carryforward and Carryback: If the taxpayer expects to suffer a net operating loss for 2020, it may generally carry the loss back five years or forward indefinitely. Non-life insurance companies with a net operating loss in 2020 may carry the loss back five years but may only carry the loss forward 20 years and REITs are not permitted a carryback but carry losses forward indefinitely. Taxpayers may elect to waive the carryback period and instead choose to only carry forward losses. Taxpayers should be aware that deductions for losses arising after 2017 and carried forward to 2021, are limited in 2021 and later years to 80% of taxable income.
- Charitable Contributions: Under the CARES Act, the corporate limitation is increased to 25% of taxable income for contributions made in 2020, and the individual limitation is increased to 100% of adjusted gross income for cash contributions made in 2020. Further, the CARES Act creates a temporary above-the-line deduction for up to $300 in cash contributions.
Health Care and Other Benefit Planning
- Pay or Play Excise Tax: For the 2020 plan year, if the taxpayer has 50 or more full-time equivalent employees, they could be subject to an excise tax, which could be as much as $2,570 per full-time employee, for failure to offer a health care plan that is minimum essential coverage to at least 95% of the full-time employees if at least one employee obtains subsidized coverage through a public health insurance exchange. The first 30 workers are excluded from this calculation. If the taxpayer does offer coverage but it is not adequate or is unaffordable, the excise tax could be $3,860 for each full-time employee who obtains subsidized coverage through an exchange.
- Health Reimbursement Arrangements: Some small employers that provide health coverage to their employees through a Small Business Health Options Program (SHOP) Exchange may be eligible to claim a credit in 2020 if they pay for at least half of the premiums for health insurance coverage for their employees. In 2020, the credit amount begins to phase out for employers with either 11 FTEs or an average annual per-employee wage of more than $27,600. The credit is phased out completely for employers with 25 or more FTEs or an average annual per-employee wage of $55,200 or more. The credit is available on a sliding scale for up to 50%of the employer’s contribution toward employee health insurance premiums. The credit is available only for two consecutive taxable years after 2013, so it is not available to a taxpayer if the taxpayer or a predecessor claimed it for 2018.
- Paycheck Protection Program: Under the CARES Act, a recipient of a covered loan can receive forgiveness of indebtedness on a PPP loan in an amount equal to the sum of payments made for qualified expenses. The IRS just released guidance this week (Rev. Rul. 2020-27) which says “A taxpayer that received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act may not deduct those expenses in the taxable year in which the expenses were paid or incurred if, at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.” This new guidance should be considered during yearend planning.
- Employee Retention Credit: Under the CARES Act, an employer may be eligible for the employee retention credit if, during an applicable calendar quarter, the employer’s business was fully or partially suspended due to orders from an appropriate government authority or suffered a significant decline in gross receipts. The credit applies to qualified wages paid to retained employees after March 12, 2020 and before January 1, 2021. The maximum credit with respect to any retained eligible employee is $5,000. Employers participating in the Paycheck Protection Program are not eligible for the credit.
- Deferred Payroll Tax Payments: Payroll Taxes due from the period beginning on March 27, 2020 and ending on December 31, 2020 can be deferred. The total payroll taxes incurred by employers, and 50 percent of payroll taxes incurred by self-employed persons qualify for the deferral. Half of the deferred payroll taxes are due on December 31, 2021, with the remainder due on December 31, 2022.
There is no one-size-fits-all for tax planning and any strategy may have unintended consequences if the taxpayer’s situation is not evaluated holistically considering the changing landscape. Please call our office to discuss all your options.