As the end of the year approaches, we review a few year-end tax planning ideas for business owners below.
Under current law, a business may benefit from a combination of three depreciation-based tax breaks: (1) The Section 179 deduction, (2) “bonus” depreciation and (3) regular depreciation.
YEAR-END MOVE: Place qualified property in service before the end of the year. Typically, a small business can write off most, if not all, of the cost in 2020 as shown below.
- Section 179 deductions: This tax code section allows you to “expense” (i.e., currently deduct) the cost of qualified property placed in service anytime during the year. The maximum annual deduction is phased out on a dollar-for-dollar basis above a specified threshold.
The maximum Section 179 allowance has been gradually raised over the last decade since it was doubled to $500,000 in 2010. As shown below, the TCJA increased the amount again in 2018.
|Tax year||Deduction limit||Phase-out threshold|
|2018||$1 million||$2.50 million|
|2019||$1.02 million||$2.55 million|
|2020||$1.04 million||$2.59 million|
However, be aware that the Section 179 deduction cannot exceed the taxable income from all your business activities this year. This could limit your deduction for 2020.
- Bonus depreciation: The TCJA doubled the 50% first-year bonus depreciation deduction to 100% for property placed in service after September 27, 2017 and expanded the definition of qualified property to include used, not just new, property. However, the TCJA gradually phases out bonus depreciation from 2022 through 2026.
- Regular depreciation: Finally, if there is any remaining acquisition cost, the balance may be deducted over time under the Modified Accelerated Cost Recovery System (MACRS).
Note: The CARES Act fixes a glitch in the TCJA relating to qualified improvement property (“QIP”). Under the new law, QIP is eligible for bonus depreciation, retroactive to 2018.
Paycheck Protection Program (PPP) loans
Under the CARES Act, businesses that obtained PPP loans may have these loans fully or partially forgiven, based upon the business using the funds for qualifying expenses and retaining employees and salary levels. The forgiveness calculations are complex, so businesses may need to consult with their lender, CPA, or other professional advisors for assistance.
Although the CARES Act specified that forgiveness of PPP loans would not create taxable income, the IRS stated its position in Notice 2020-32 that because the forgiven loans are not taxable income, the expenditures giving rise to the loan forgiveness are not tax deductible. Some members of Congress have indicated that the IRS position on expense deduction is at odds with the Congressional intent in passing the CARES Act. Legislation has been introduced that would clarify that PPP loan forgiveness would not impact the tax deductibility of the related expenditures; however, this legislation is still pending.
Furthermore, with many PPP forgiveness applications stretching into 2021, businesses are faced with the question of when to take the impact of lost tax deductions into account for their taxable income. As of this writing, for purposes of 2020 tax estimates, we are generally recommending that businesses assume the tax deductions will be lost for 2020, to the extent forgiveness is relatively certain. It is anticipated that additional guidance regarding the timing and overall deductibility of these expenses will be provided before 2020 income tax returns must be filed.
Payroll Tax Deferral
Normally, employers must deposit payroll taxes with the IRS under a schedule based on the size of the company revenue. Most small businesses are on a monthly schedule.
YEAR-END MOVE: Take advantage of a payroll tax deferral break. Under the CARES Act, an employer can defer payment of the 6.2% Social Security tax portion of payroll taxes for the period spanning March 27, 2020, through December 31, 2020.
Half of the deferred amount is due at the end of 2021. The employer must pay the other half by the end of 2022. If you choose this approach, make sure you will have the funds needed to meet your company’s obligations in the future.
Note: Don’t confuse the payroll tax deferral with the “payroll tax holiday” for employees created by an executive order in August. The payroll tax deferral discussed above refers to a separate provision in the CARES Act applying to employers.
Prior to 2018, business interest was fully deductible. The TCJA generally limited the deduction for business interest to the sum of the taxpayer’s business interest income, the taxpayer’s floor plan financing interest expense, and 30% of adjusted taxable income (ATI). The CARES Act adjusts the limitation calculation to use 50% of ATI for 2019 and 2020 (but only 2020 for partnerships). Taxpayers may also elect to use 2019 ATI rather than 2020 ATI for purposes of calculating their interest limitation.
YEAR-END MOVE: Determine if you qualify for a special exception. The limitation on business interest does not apply to a business with average gross receipts of $25 million (indexed for inflation) or less for the three prior years. The threshold for 2020 is $26 million.
For these purposes, ATI is defined as your business income without regard to any income, deduction, gain or loss not properly allocable to a business; business interest income and expense; net operating losses (NOLs); the 20% qualified business income (QBI) deduction; and, for tax years beginning before 2022, depreciation, amortization or depletion.
Note: If the business interest limit applies, you can carry forward the excess indefinitely until it is exhausted.
Employee Retention Credit
Many small businesses have been unable to continue regular operations during the COVID-19 pandemic. Frequently, they are facing difficult decisions concerning employment of workers.
YEAR-END MOVE: Consider whether your business qualifies to claim the Employee Retention Credit (“ERC”), which was authorized by the CARES Act to help offset the cost of retaining employees despite significant downturns in the business.
The ERC equals 50% of the qualified wages an employer pays to employees after March 12, 2020 and before January 1, 2021. For these purposes, “qualified wages” are limited to the first $10,000 of wages paid to each worker during this time period.
Your business qualifies for the credit if it fully or partially suspended operation during any calendar quarter in 2020 due to government orders relating to the COVID-19 outbreak or if it experienced a significant decline in gross receipts (i.e., gross receipts equal to less than 50% of the gross receipts for the same calendar quarter in 2019).
Note: The Families First Coronavirus Response Act (FFCRA), which was followed soon after by the CARES Act, also provides a tax credit to certain small businesses that have provided emergency paid leave due to the COVID-19 pandemic. The FFCRA provision initially offsets the Social Security tax component of payroll tax. Any excess credit is refundable.
There are limitations that apply when taking these credits in combination with each other and for businesses that also receive a Paycheck Protection Program (“PPP”) loan – the ERC and FFCRA credits may not be claimed for the same wages, PPP loan recipients are not eligible for the ERC, and wages for which a FFCRA credit is taken may not be included in the PPP forgiveness calculation.
Bad Debt Deduction
During this turbulent year, many small businesses are struggling to stay afloat, resulting in large numbers of outstanding receivables and collectibles.
YEAR-END MOVE: Increase your collection activities now. For instance, you may issue a series of dunning letters to debtors asking for payment. Then, if you are still unable to collect the unpaid amount, you can generally write off the debt as a business bad debt in 2020.
Generally, business bad debts are claimed in the year they become worthless. To qualify as a business bad debt, a loan or advance must have been created or acquired in connection with your business operation and result in a loss to the business entity if it cannot be repaid.
Note: Keep detailed records of all your collection activities—including letters, telephone calls, e-mails and efforts of collection agencies—in your files. This documentation can help support your position claiming worthlessness of the debt if the IRS ever challenges the bad debt deduction.
ASC 606, Revenue from Contracts with Customers, was effective in 2019 for non-public companies that issue GAAP financial statements. However, in May 2020, in response to the pandemic, the FASB provided for a one year extension on the required effective date for non-public companies which had not yet issued their financial statements. If your business elected to use this extension and will adopt ASC 606 in 2020, discuss impact of this adoption with your auditor and your tax advisor. The changes to revenue recognition for GAAP could result in additional tax filings to make the changes effective for tax purposes.
Net Operating Losses
The CARES Act provides for a five-year carryback for net operating losses incurred in 2018, 2019 or 2020. Starting again in 2021, net operating losses may only be carried forward, subject to limitation, as a result of the TCJA. In addition, the CARES Act suspends the disallowance of excess business losses for taxable years beginning before December 31, 2020 that was enacted by the TCJA. These loss relief provisions should be considered if you may incur a net operating loss in 2020 that could generate refunds of taxes paid in prior years.
* Maximize the QBI deduction that is available for pass-through entities and self-employed individuals. Be aware you must observe special rules if you’re in a “specified service trade or business” (SSTB).
* If you buy a heavy-duty SUV or van for business, you may claim bonus depreciation or a first-year Section 179 deduction of up to $25,000. The “luxury car” limits do not apply to certain heavy-duty vehicles.
* If you pay year-end bonuses to employees in 2020, the bonuses are generally deductible by your company and taxable to the employees in 2020. A calendar-year company operating on the accrual basis may be able to deduct bonuses paid as late as March 15, 2021, on its 2020 return. In order to deduct accrued bonuses in 2020, the bonuses must not be subject to any contingencies as of year-end. Related party rules also apply.
* Generally, repairs are currently deductible, while capital improvements must be depreciated over time. Therefore, make minor repairs before 2021 to increase your 2020 deduction.
* A corporation may deduct qualified contributions of up to 25% of modified taxable income in 2020 as a result of the CARES Act. The limitation will revert to 10% in 2021.
* Consider whether a switch to the cash method of accounting would provide an income tax benefit. Under a TCJA provision, a C corporation may use this simplified method if average gross receipts for last year did not exceed $26 million (up from $5 million).
* Hire disadvantaged workers eligible for the Work Opportunity Tax Credit (WOTC). The WOTC, which is generally a maximum of $2,400 per worker, is scheduled to expire after 2020.