During the COVID-19 crisis, some key tax deadlines were postponed until July 15, 2020. If your business and/or personal federal income tax return is still awaiting completion, you may have significant retroactive tax-planning flexibility. The same holds true for individuals who own interests in pass-through business entities and haven’t yet filed their personal tax returns. Here’s what business owners need to know.
Postponed Deadlines for Business Entities
The IRS has postponed until July 15 deadlines for federal income tax. This includes payment obligations and filing obligations that would otherwise fall on or after April 1, 2020, and before July 15, 2020. The crisis-relief measures depend on how your business is structured:
For calendar-year C corporations. The normal deadline for calendar-year corporations to remit unpaid federal income tax for the 2019 tax year was April 15, 2020. However, the IRS extended that deadline until July 15. Likewise, the deadline for calendar-year corporations to file a 2019 federal income tax return (Form 1120) has been deferred from April 15 to July 15.
In addition, the deadlines for making the corporation’s first and second estimated federal income tax installments for the 2020 tax year, which would normally be due on April 15 and June 15, are postponed to July 15.
These deferrals are automatic. You didn’t have to file an extension with the IRS to take advantage, and your corporation won’t owe any interest or penalty if you defer payment or filing.
For individuals who own calendar-year, pass-through businesses. The IRS has also postponed the deadlines for federal income tax payment obligations and federal income tax return filing obligations of individuals who own interests in so-called “pass-through” business entities, including:
- Sole proprietorships,
- Single-member limited liability companies (LLCs) treated as sole proprietorships for tax purposes,
- Multi-member LLCs treated as partnerships for tax purposes, and
- S corporations.
Income from an ownership interest in a pass-through business is generally reported on the individual owners’ personal tax returns. The normal deadline for individuals to remit unpaid federal income tax (including any self-employment tax) for the 2019 tax year was April 15, 2020. However, the IRS extended that deadline until July 15. Likewise, the deadline for individuals to file their personal 2019 federal income tax return (Form 1040) has been deferred from April 15 to July 15.
In addition, the deadlines for making an individual’s first and second estimated federal income tax installments for the 2020 tax year that would normally be due on April 15 and June 15, are postponed to July 15.
The deferred deadlines are also automatic. You didn’t have to file an extension with the IRS to take advantage, and you won’t owe any interest or penalty if you defer payment or filing.
These deferrals are intended to help businesses that are struggling during business interruptions caused by COVID-19. Until your return is filed, here are some last-minute strategies for businesses to consider.
Fiscal-Year Business Entities
Business entities that use fiscal tax years (years not ending on December 31) may have still-unfiled federal income returns for tax years that started in 2018. The July 15 deadline relief applies to these entities for federal income tax payments and federal income tax returns that would otherwise be due on or after April 1 and before July 15.
The Bonus Depreciation Conundrum
With bonus depreciation, business taxpayers can deduct 100% of the first-year cost of qualifying assets placed in service between September 28, 2017, and December 31, 2022 (or December 31, 2023 for certain assets with longer production periods and aircraft). The 100% first-year write-off is allowed for both new and used qualifying assets. This includes most categories of tangible depreciable assets, off-the-shelf software and real estate qualified improvement property (QIP).
When it’s allowed, claiming 100% first-year bonus depreciation is usually a tax-smart move. But, if you anticipate higher tax rates in future years, consider forgoing bonus depreciation and, instead, depreciating assets over several years. That way, the depreciation write-offs would offset future income that you’re expecting to be taxed at higher rates. The decision to claim 100% first-year bonus depreciation (or not) is made on your still-unfiled business tax return.
Important: The Coronavirus Aid, Relief, and Economic Security (CARES) Act allows a five-year carryback privilege for a business net operating loss (NOL) that arises in a tax year beginning in 2018 through 2020. Claiming 100% first-year bonus depreciation on an affected year’s return can potentially create or increase an NOL for that year. If so, the NOL can be carried back, and you can recover some or all of the federal income tax paid for the carryback year. This factor could cause you to favor claiming 100% first-year bonus depreciation on a still unfiled return.
However, creating an NOL for the year would eliminate the qualified business income (QBI) deduction for owners of pass-through businesses. (See “QBI Deductions” below.) Ask your tax pro what makes the most sense in your situation.
Retroactive COVID-19 Business Tax Relief Measures
The CARES Act includes some retroactive tax relief for business taxpayers. The following provisions may affect a still-unfiled return:
Liberalized NOL rules. NOLs that arise in tax years beginning in 2018 through 2020 can be carried back five years. This means that an NOL that’s reported on a still-unfiled return can be carried back to an earlier tax year and allow you to recover federal income tax paid in the carry-back year. Because federal income tax rates were generally higher in years before the Tax Cuts and Jobs Act (TCJA) took effect, NOLs carried back to those years can be especially beneficial.
QIP technical corrections. QIP is generally defined as an improvement to an interior portion of a nonresidential building that’s placed in service after the date the building was first placed in service. The CARES Act includes a retroactive correction to the statutory language of the TCJA. The retroactive correction allows much faster depreciation for real estate QIP that’s placed in service after the TCJA became law.
Specifically, the correction allows 100% first-year bonus depreciation for QIP that’s placed in service in 2018 through 2022. Alternatively, you can depreciate QIP placed in service in 2018 and beyond over 15 years using the straight-line method.
Suspension of excess business loss disallowance rule. A so-called “excess business loss” is a loss that exceeds $250,000 or $500,000 for a married couple filing a joint tax return. An unfavorable TCJA provision disallowed current deductions for excess business losses incurred by individuals in tax years beginning in 2018 through 2025. The CARES Act suspends the excess business loss disallowance rule for losses that arise in tax years beginning in 2018 through 2020.
Liberalized business interest deduction rules. Another unfavorable TCJA provision generally limited a taxpayer’s deduction for business interest expense to 30% of adjusted taxable income (ATI) for tax years beginning in 2018 and beyond. Business interest expense that’s disallowed under this limitation is carried over to the following tax year.
In general, the CARES Act temporarily and retroactively increases the limitation from 30% of ATI to 50% of ATI for tax years beginning in 2019 and 2020. Special complicated rules apply to partnerships and LLCs that are treated as partnerships for tax purposes.
Important: Businesses with average annual gross receipts of $25 million or less (adjusted for inflation) for the three previous tax years are exempt from the business interest expense deduction limitation. Certain real property businesses and farming businesses are also exempt if they choose to use slower depreciation methods for specified types of assets.
Tax Break for Setting up a SEP
If you work for your own small business and haven’t yet set up a tax-favored retirement plan for yourself, you can establish a simplified employee pension (SEP). Unlike other types of small business retirement plans, a SEP can be created this year and still generate a deduction on last year’s return. In fact, if you’re self-employed and extend your 2019 Form 1040 to October 15, 2020, you’ll have until the extended deadline to establish a SEP and make a deductible contribution for last year.
Your deductible pay-in can be up to:
- 20% of your 2019 self-employment income, or
- 25% of your 2019 salary if you work for your own corporation.
The absolute maximum amount you can contribute for the 2019 tax year is $56,000. So, the tax savings can be significant.
Important: Cost is a major drawback to this strategy for small businesses with employees. A SEP might have to cover employees — and you might be required to contribute to their accounts. If your business has employees, consult a tax pro before setting up a SEP.
Before the Tax Cuts and Jobs Act (TCJA), net taxable income from pass-through business entities — sole proprietorships, partnerships, limited liability companies treated as sole proprietorships or partnerships for tax purposes, and S corporations — was simply passed through to the individual owners and taxed on Form 1040 at the owners’ personal rates.
For tax years beginning in 2018 through 2025, the TCJA allows a deduction for individual owners of those pass-through entities based on their share of qualified business income (QBI) from those entities. The deduction can be up to 20% of QBI, subject to restrictions that can apply at higher income levels.
If you qualify, the deduction is claimed on your 2019 Form 1040, which is now due on July 15 or October 15 if you extend your return. The IRS has issued lengthy, complex regulations on how to calculate the QBI deduction. Your tax advisor can interpret them and calculate your deduction.
If you haven’t already filed a federal income tax return for your business entity’s most recently ended tax year or your personal return for the 2019 tax year, the July 15 deadline for filing or extending (if applicable) is right around the corner. The ML&R tax team can discuss with you last-minute tax saving strategies in the context of today’s evolving tax rules. Contact us if you have any questions.