New laws and the rapidly changing environment brought on by the COVID-19 pandemic have presented new tax challenges this year. As 2020 draws to a close, there is still time to reduce your 2020 tax bill and plan ahead for 2021. This letter highlights several potential tax-saving opportunities for you to consider.
How Does Deferring Income Help?
Although C corporations enjoy a flat 21% statutory tax rate and pass-through entities are taxed at lower rates following the 2017 Tax Cuts and Jobs Act (TCJA), income deferral remains an important consideration in business tax planning. If a taxpayer expects taxable income to be higher in 2020 than 2021, or if the taxpayer anticipates being taxed at a higher rate in 2020 than 2021, the taxpayer may benefit by deferring income into 2021. Some ways to defer income are discussed below.
Use of Cash Method of Accounting: By adopting the cash method of accounting instead of the accrual method, a taxpayer generally can put itself 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. A business entity generally must obtain IRS consent to change either an overall method of accounting or the accounting treatment of any material item. To do so, the business generally must file Form 3115, Application for Change in Accounting Method.
Installment Sales: Generally, a sale occurs on the transfer of property. If gain will be realized on the sale, income recognition will normally be deferred under the installment method until payments are received, so long as one payment is received in the year after the sale. Therefore, if a business is expecting to sell property prior to the end of 2020, and it makes economic sense, consider selling the property and reporting the gain under the installment method to defer payments (and tax) until 2021 or later.
Delay Billing: If a taxpayer uses the cash method of accounting, the taxpayer may consider delaying year-end billing to clients so that payments are not received until 2021.
Should the Taxpayer Accelerate Income into The Current Year?
A business taxpayer may benefit from accelerating income into the current year. For example, the taxpayer may anticipate being taxed at a higher rate in 2021, or perhaps the taxpayer needs 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 the taxpayer expects 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.
Are There Business Deductions that Can Be Accelerated into The Current Year?
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, the taxpayer should be entitled to a deduction.
Current-Year Bonuses: In general, a taxpayer’s liability for employee bonuses accrues and is deductible for the current year even though the bonus is paid in the following year, if all the events are satisfied that fix the liability and the taxpayer does not have a unilateral right to cancel the bonus at any time prior to payment.
Suspended Passive Losses: Generally, a taxpayer may have passive losses that have been suspended and not yet allowed as a deduction. Determine what might be done to identify and absorb or release the suspended losses as part of the taxpayer’s overall tax planning.
Prepayment of Taxes: For taxpayers that 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 the taxpayer would benefit from a current year state income tax deduction.
What Business Deductions Are Available to the Entity?
Qualified Business Income: Individual taxpayers with qualified business income (QBI) from a pass-through entity (partnership or S corporation) or a sole proprietorship may be entitled to a deduction equal to the lesser of the deductible amount of the QBI or 20% of taxable income.
Excess Business Loss: The CARES Act postponed application of the limitation on excess business losses until tax years beginning in 2021.
Equipment Purchases: Taxpayers (individuals or corporations) purchasing equipment may make a “ §179 election,” which allows them to expense (i.e., currently deduct) otherwise depreciable business property, including computer software and qualified real property. Air conditioning and heating units placed in service since 2016 are eligible and continue to be eligible for this deduction. Certain improvements to nonresidential real property (roofs, heating, ventilation, and air-conditioning property, fire protection and alarm systems, and security systems), that may not be eligible for bonus depreciation, are eligible under §179. For 2020, taxpayers 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.
Bonus Depreciation: For property acquired after September 27, 2017, and placed in service during 2020, a taxpayer may deduct 100% of the cost of qualified property in 2020. The CARES Act assigned a recovery period to qualified improvement property (QIP), thus making such property eligible 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.
NOL Carryfoward 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. 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: A charitable contribution deduction is available to businesses. A corporation is generally allowed to deduct charitable contributions up to 10% of its taxable income. Under the CARES Act, the corporate limitation is increased to 25% of taxable income for contributions made in calendar year 2020. Contributions by pass-through entities are allocated to individual equity interest holders and are subject to the individual’s limitations. An individual is generally allowed to deduct charitable contributions up to 60% of adjusted gross income. Under the CARES Act, the individual limitation is increased to 100% of adjusted gross income for cash contributions made in calendar year 2020. Further, the CARES Act creates a temporary above-the-line deduction for up to $300 in cash contributions. Certain contributions of property are subject to additional limits as well as additional recordkeeping and substantiation requirements.
There is still time to implement the strategies discussed above to minimize your 2019 tax liability and plan for 2020. Please give us a call if we can help.