Tax Planning: A "Perfect" Ending to 2020 Part 2

Melissa Lanigan, CPA (Dec, 2020)

As we continue to wind down 2020, we continue our Part 2 of 2020 year-end tax planning: Tax Planning Strategies for Businesses.

Businesses still have time to take advantage of tax saving opportunities to lower 2020 Federal income tax liabilities and set yourself up to help save tax for future years.

Below are several tax planning strategies for businesses to consider for 2020:

1.     Maximize Qualified Business Income (QBI) tax deduction for pass-through entities

The deduction can be up to 20% of qualified business income for pass-through entities, which include S corporations, partnerships, single member LLC's and sole proprietors.  The calculation for the deduction is complicated and is limited when high income earners reach certain thresholds, but can still have a major tax saving impact on your tax bill.  The deduction is calculated and reported on the individual owner's personal income tax return (Form 1040).  This is in addition to the itemized or standard deduction. 

2.     Net Operating Loss Deduction

The 80% net operating loss (NOL) deduction limitation does not apply for 2020.  If you have losses carrying forward from prior tax years and plan to have taxable income for 2020, you can eliminate your taxable income for 2020 up to your total NOL carryforward balance.  Also, the CARES Act allows NOL's generated in 2018, 2019 and 2020 to be carried back five years.  Carrying back the NOL will allow for a refund of tax paid in prior years. 

3.     Bonus Depreciation on 2020 Asset Additions

One of the major benefits of the 2017 Tax Cuts and Jobs Act (TCJA) was the enactment of 100% bonus depreciation.  This allows an immediate 100% write-off of an asset's cost that is purchased and placed in-service in 2020.  For an asset to be eligible, the asset must be tangible, have a class life of less than 20 years, and must be in service to qualify for the write off.  The asset can be purchased new or used.  The entity is not limited to taxable income in order to write off an asset's cost.  In other words, the bonus depreciation deduction can contribute to or create a net operating loss (NOL) to be carried forward to future tax years indefinitely.  One thing to keep in mind when considering using bonus depreciation is that various states do not follow Federal bonus deprecation rules (called decoupling).  This means you may not be able to deduct 100% of the asset's cost in the year of purchase on your State tax return. For states that decouple you will need to follow their specific tax depreciation expense rules.

4.     Bonus Depreciation on Qualified Improvement Property

The CARES Act passed March 2020, included a technical correction from the TCJA on the treatment of Qualified Improvement Property (QIP).  The correction defines QIP to be depreciated as 15-year property.  Since the class life is less than 20 years, QIP placed in service in the current tax year now qualifies for 100% first year bonus depreciation. (Note: QIP is defined as an improvement to an interior portion of a non-residential building that is placed in service after the building is placed in service).

5.     Section 179 Expensing

Section 179 allows businesses to fully expense the cost of qualified assets the year placed in service.  For 2020, Section 179 expensing is limited to $1,040,000. This limit is reduced dollar for dollar when qualifying asset purchases are over $2,590,000 (in other words the whole deduction goes away once $3,630,000 of qualified asset purchases is reached). Section 179 expensing is limited to taxable income.  A benefit to taking advantage of Section 179 expense is many states allow Section 179 expense. Therefore, not only will you receive the benefit for Federal, you may also receive the accelerated depreciation benefit for the state. However, states rules need to be confirmed before claiming the deduction on your state tax return, as some states have their own rules.

6.     Timing of Income and Expenses

A tax accountant's general rule of thumb is to defer income and accelerate expenses, but sometimes the opposite is true.  With this in mind, consider the timing of income and expenses, especially if your business uses the cash method of accounting.

  • Prepay expenses now instead of paying in January of next year.  If you are a cash basis taxpayer and your cash flow allows, prepay upcoming invoices (do not wait until the January due date to pay an invoice you have received).  Prepaid expenses can be deducted when paid.  
  • Charge expenses on a credit card.  Expenses paid by credit card can be expensed when charged even though the credit card bill may not be paid until the following year.
  • Accelerate Income.  If you think income tax rates are going to increase, consider accelerating income and sales into 2020 while corporate tax rates still remain at a flat 21% rate.
  • Depreciation.  Consider accelerating asset purchases in 2020 to take advantage of bonus or Section 179 depreciation deductions.  There may be good reasons to forgo bonus and Section 179 depreciation deductions.  If you feel tax rates are going to increase in the future and you anticipate higher taxable income in future tax years, it may be of more benefit to forego accelerated depreciation all in one year. Rather, you can spread out the depreciation deduction over the tax life of the asset.

7.      Other Planning Tips

  • Review accounts receivable aging reports for uncollectable accounts that may be written off as bad debt expense in the current year.
  • Maximize tax deductible retirement plan contributions for yourself and for employees.
  • Consider a tax deductible Section 139 Disaster Relief payment to your employees.  Because the COVID-19 pandemic was declared a natural disaster in March 2020 by President Trump, tax-free payments can be made to employees to pay for or reimburse the employee with expenses as a result of the natural disaster.
  • Hire your child to do legitimate work for your business and pay reasonable wages.  The business can deduct the wages and payroll tax expense while your child can set up a ROTH IRA for retirement savings.  Refer to the September 2020 Focus article for more information.
  • There are a number of federal tax credits available for 2020.  Here is a list of the common tax credits available that your business may qualify for:
    • FICA Tip Credit
    • R&D Tax credit
    • Work Opportunity Credit
    • Credit for Small Employer Pension Plan Startup Costs

The items above are just a sample of tax strategies that businesses can pursue.  There are many scenarios to consider while tax planning in order to take advantage of all tax saving opportunities.  Often, more than one tax planning scenario will need to be prepared and analyzed in order to properly manage your tax liability as well as cash flow. As always, please contact your Dermody, Burke & Brown tax advisor if you want to discuss any year-end tax planning ideas or if you have any questions.

 

The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.

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