2020 Tax Planning Considerations for Businesses
Written by Jessica M. Dorsett, CPA
It goes without saying, 2020 has been a year unlike any other. Within our client base, some Companies are stronger than ever, while others are facing difficult decisions regarding downsizing, or even closing the doors. No matter where your business falls on the spectrum, tax planning is important to help reduce unnecessary financial burdens.
This article, which focuses on tax planning for closely-held businesses and their owners, addresses both new and old tax planning strategies to consider for 2020 and the future. With the nation’s political environment still volatile, we must move forward while keeping our eye on the future. There are very different tax plans from the 2 primary political parties, which should be considered in making decisions. If only I had a crystal ball…
Reminders for all businesses:
- As discussed in our article here, we now know the PPP loan increases taxable income in 2020, to the extent the Company has reasonable expectation of forgiveness. We have spent hundreds of hours in researching, planning and assisting with the PPP loans for our clients. There are very few situations where 100% forgiveness is not achieved.
- Local grants are taxable income.
- EIDL grant (not the loan) does not require an application, and should be reported into income right away.
- Deferral of payroll taxes – if you are taking advantage of this option to provide additional cash flow, it must be reported as a liability on the balance sheet and is paid back 50% by 12/31/21 and the remainder by 12/31/22. However, this expense will not be deducted until paid.
- As previously mentioned, Republicans and Democrats have very different opinions when it comes to taxes. In my personal opinion, with the national debt increasing as much as it has this year, tax increases are inevitable. Corporate tax rates are an easy target from a political standpoint, as are the “wealthy”. There is a balance we strive for, weighing the present value of cash now (by virtue of tax savings) vs paying more later in taxes.
Profitable Companies: If your business is having a profitable year, consider the following strategies.
- Oldies but goodies – planning strategies
- Qualified Business Income Deduction (not available for C-corporations) – make sure you understand how this deduction works and, more specifically, how it applies to your business. It is a complicated deduction, with limitations, phase-outs and several calculations. If you are unsure how this has played out on your returns the last few years, sit down with your tax professional and have the conversation.
- Accrual to cash conversion: If your company’s gross receipts (revenues) are usually less than $26 million a year, and you are reporting taxes on an accrual basis, analyze you balance sheet and normal operational cycle to determine if converting to cash basis is a good strategy. Generally speaking, if accounts receivable are usually much larger than accounts payable at year end, converting to a cash basis reporting will result in a significant ONE TIME tax savings. Then going forward, there is more control and planning opportunity for taxable profits. As a cash basis payer, you pay taxes on the income once received (not earned) and you take the deduction for expenses once paid (not incurred). Annual tax planning is highly recommended to avoid tax surprises.
- Bonus depreciation & 179 deductions: We finally received a technical correction with regards to qualified improvement property. If you had substantial property in prior years, but were not able to take full depreciation, you can go back and claim it. Consideration should be made to the lost deductions for the future (especially if you think your profits and taxes will increase in the future).
- Maximize retirement savings: review your plan and make sure the strategy is still appropriate for your business. Are business owners able to save as much as they’d like towards retirement? Should you have a “safe harbor” plan, if not already? Should you consider a profit-sharing contribution this year (if the plan permits)? Can your retirement plans be improved?
- Yearend bonuses: if an accrual basis business, you can accrue bonuses for non-owners and still deduct as long as it’s paid within 75 days of year-end. Some employees may like the payment in 2021 for tax planning purposes.
- New(ish) considerations:
- Increase charitable contributions: For 2020 only, C-corporations may deduct charitable contributions up to 20% adjusted taxable income (usually limited to 10%), and individuals (contributions pass to the individual in passthrough entities) can deduct up to 100% of modified adjusted gross income (was 60%). There are certain limitations to be aware of, which are outside the scope of this article.
- Research & Development credits: The requirements for the research and development credit are fairly broad, but also very complicated. According to the Internal Revenue Service, “Qualifying Research” is defined as, “Research undertaken for discovering information that is technological in nature and its application must be intended for use in developing a new or improved business component of the taxpayer” (IRS). The critical component to take away from this statement is the “new or improved business component” aspect. Covid-19 has changed the manner of business for nearly everyone, so there was extraordinary R&D carried out in 2020. Your “pivot” to survive might generate a tax credit!
- Net operating loss (NOL) rules have changed several times in the last year and have become pretty confusing to say the least. Here are just a few of the things to consider with NOLs:
- NOLs generated in 2020 can be carried back 5 years, or carried forward indefinitely.
- If the Company has prior year NOLs carrying forward, consider reviewing the 2018 & 2019 NOL generating returns to amend and carryback 5 years in order to retrieve prior year taxes (should be reviewed in light of any 2020 losses as well).
- Caution 1 – if there are skeletons in the closet, you may want to forego the carryback. Amended returns are reviewed by an actual IRS agent (not a computer) for red flags and issues.
- Caution 2 – consider the effective tax rates of the prior years, versus future years (see earlier comments in this article regarding the likelihood of increased tax rates).
- Caution 3 – receiving those refunds could take up to 6 months, or longer.
- Amending returns is expensive. Have a conversation regarding all these items with your tax professional.
- NOL limitations – the TCJA Act limited NOL carryforwards to only offset 80% of current year taxable income, meaning you still have to pay taxes on at least 20% of your income. However, the same Act changed NOLs to carryforward indefinitely. The CARES Act temporarily suspended the 80% limitation for 2020 returns, while leaving the indefinite carryforward attribute intact.
- Employee Retention Credit – if your Company did NOT obtain a PPP loan, and you experienced a decline in business this year, you may be eligible for the Employee Retention Credit.
This article only scratches the surface of tax planning. Contact our office to discuss your planning needs before it’s too late.