2020 Business Planning Guide
Business tax planning is complex. Careful planning involves more than just focusing on lowering taxes for the current and future years. How each potential tax saving opportunity affects the entire business must also be considered. In addition, planning for closely-held business entities requires a delicate balance between planning for the business and planning for its owners. As the end of the year approaches, it is a good time to think of planning strategies that will possibly help lower your tax bill for this year and possibly the next.
Listed below are some year-end steps that can be taken to possibly reduce taxes. Again, by contacting us, we can provide a comprehensive review of the tax-savings opportunities appropriate to your particular situation.
Qualified Business Income Deduction
Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2020, if taxable income exceeds $326,600 for a married couple filing jointly, $163,300 for singles, marrieds filing separately, and heads of household, 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 trade or business; and/or
- The unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business.
The limitations are phased in. For example, the phase-in applies to joint filers with taxable income between $326,600 and $426,600, and to all other filers with taxable income between $163,300 and $213,300.
Taxpayers may be able to achieve significant savings through this deduction by deferring income or accelerating deductions to fall within the dollar thresholds for 2020. Depending on their business model, taxpayers may be able to increase the new deduction by increasing W-2 wages before year-end. The rules are quite complex, so don’t make a change without consulting your tax adviser.
More small businesses are able to use the cash (as opposed to accrual) method of accounting than were allowed to do so in earlier years. To qualify as a small business a taxpayer must, among other things, satisfy a gross receipts test. For 2020, the gross-receipts test is satisfied if, during a three-year testing period, average annual gross receipts don’t exceed $26 million (the dollar amount was $25 million for 2018, and for earlier years it was $1 million for most businesses). Cash method taxpayers may find it a lot easier to shift income or accelerate expenses.
Business Property Expensing
Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2020, the expensing limit is $1,040,000, and the investment ceiling limit is $2,590,000.
- Expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software.
- It is also available for qualified improvement property, such as:
- Any interior improvement to a building’s interior (but not for enlargement of a building, elevators or escalators, or the internal structural framework),
- Roofs, and
- HVAC, fire protection, alarm, and security systems.
The generous dollar ceilings mean that many small and medium sized businesses that make timely purchases will be able to 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.
- The expensing deduction may be claimed in full (if you are otherwise eligible to take it) regardless of how long the property is in service during the year can be a useful tool for year-end tax planning.
- Property acquired and placed in service in the last days of 2020, rather than at the beginning of 2021, can result in a full expensing deduction for 2020.
- Please note that there are some additional limits to expensing vehicles that may prevent a full write-off in the year of purchase.
Businesses can claim a 100% first year bonus 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 100% write-off is permitted without any proration based on the length of time that an asset is in service during the tax year.
- The 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2020.
Safe Harbor Election
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 don’t have to be capitalized under the Code Sec. 263A uniform capitalization (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 (AFS; e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500. Where the UNICAP rules aren’t an issue, consider purchasing qualifying items before the end of 2020.
Net Operating Loss
A corporation that anticipates a small net operating loss (NOL) for 2020 and substantial net income in 2021 may find it worthwhile to accelerate enough of its 2021 income or defer enough of its 2020 deductions to create a small amount of net income for 2020. This will permit the corporation to base its 2021 estimated tax installments on the relatively small amount of income shown on its 2020 return, rather than having to pay estimated taxes based on 100% of its much larger 2021 taxable income.
While the Tax Cuts and Jobs Act of 2017 cancelled this provision, the CARES Act reintroduced the NOL carryback provisions previously in place. If you have a net operating loss from your business that arose in 2018 through 2020 it can be carried back five years to a year where you had taxable income for a quick tax refund. Additionally, the 80% income limitation put in place by the Tax Cuts and Jobs Act of 2017 has been similarly cancelled, allowing you to use a net operating loss to fully offset taxable income.
Miscellaneous Tax Saving Strategies
To reduce 2020 taxable income, consider deferring a debt-cancellation event until 2021. However, because the forgiveness of a Payroll Protection Program loan is not considered income by the IRS, there is no tax effect to deferring that application.
To reduce 2020 taxable income, consider disposing of a passive activity in 2020 if doing so will allow you to deduct suspended passive activity losses.
Consider using the Employee Retention Credit, which allows for a refundable payroll tax credit for eligible employers harmed by COVID-19. The credit is equal to 50% of up to $10,000 in qualified wages per employee (i.e., a total of $5,000 per employee). Employers generally are not eligible for the Employee Retention Credit if any member of their controlled or affiliated service group obtained a loan under the Payroll Protection Program.
Multi-state Tax Reporting
With many employees working from home as a result of COVID-19 restrictions, your business may be required to file income tax returns in additional states. If you have an employee who began working from home during the year in a different state than your office location, their home office may constitute physical presence in that state and trigger a requirement to file and pay income taxes. This is a very complex area of taxation and the determination of whether filing a tax return is required depends on the state, the number of employees working in that state, the role and importance of the employees to the organization’s function, and many other factors. Please reach out to your tax advisor if you find yourself in this situation to determine your filing requirements.
In 2018, the Supreme Court of the United States issued its widely anticipated decision in Wayfair, allowing states to impose a tax payment or tax collection obligation on out-of-state business, regardless of whether the business has a physical presence in the state. While Wayfair dealt with remote seller sales and use tax collection obligations, states may now tax a business even if the business has no in-state physical presence. Overnight, remote sellers, licensors of software, financial services, franchisors, and other businesses that provide services or deliver their products to customers from a remote location must start complying with state and local taxes. Left unchecked, these state and local tax obligations and correlated liabilities from tax, interest, and penalties will grow over time. A business is likely impacted by Wayfair if any of the following apply:
- The business makes sales into states in which it is not registered or filing sales/use tax returns.
- The business ships goods or provides services to customers located in states where it has little or no in-state physical presence.
- The business makes retail sales of tangible goods.
- The company provides online services or makes sales of digital goods.
- The business licenses software or provides access to software.
- The business received a “nexus questionnaire” or received audit or tax notices from any state where it is not currently registered for sales/use taxes.
Businesses for which any of the above apply should take steps to minimize potential exposures from tax, interest, and penalties that may arise from Wayfair, and plan around the very fluid state changes that are happening and will occur in the near future. Please contact us to discuss if you do business with customers in more than one state.