CARES Act Tax Planning June 5, 2020: A Year of Disruptions

Tax Planning in 2020: A Year of Disruptions
June 5, 2020
Written by Paul M. Polito, CPA

Clearly the COVID 19 virus, or, at least, the world’s reaction to it, has created a “Black Swan event” that impacts virtually every citizen and every organization.

In this article I will discuss the tax planning dynamics that fall out of this very unusual year.

Very shortly (July 15, 2020 for most taxpayers) half of the estimated income taxes for 2020 will be due.

Generally, in order to be “penalty proof” taxpayers will pay about the same tax as they paid in 2019. This is a good strategy when your income is higher or the same in 2020. However, very few will be close to the same taxable income as in 2019. We expect that most will be way down, but some will be way up over last year.

I will break this down by categories of taxpayers:
1. Taxpayers whose income was relatively unaffected by the economic pause:
a. Assuming there was no PPP loan to be forgiven:
Estimates can usually be based on 2019 income tax
b. Assuming there was a PPP loan and will be used for forgivable purposes, add the projected forgiven amount to the estimated taxable income for 2020 to calculate the estimated tax liability. You may still be able to make “penalty proof” estimates based on 2019, but if the additional income is substantial, the amount may need to be increased. Also, plan for a tax liability in 2021.
2. Taxpayers whose income has been reduced by the economic pause:
a. Assuming there was no PPP loan forgiveness, re-calculate estimates based on estimated taxable income for 2020.
b. Assuming there was a PPP loan and 100% was or will be used for forgivable purposes, add the forgiven debt amount to the estimated taxable income. If the result is less than 2019 taxable income, base 2020 estimates on 2020 estimated taxable income; if greater, base the estimates on 2019 income but plan for a tax liability in 2021.

Typically, estimated taxes are paid in four quarterly installments due in April, June, September and January, or a similar timeframe for fiscal filers.
In 2020, estimates for the first two quarters are both due on July 15th. Most of the time the estimates are equal in amount, but there is a provision for unequal payments when your taxable income is not evenly distributed throughout the year.

Consider this example:
A corporation typically nets approximately $500,000 in taxable income. Normally, federal tax at 21% would be $105,000. Normal estimated tax would be $26,250 per quarter, thus $52,500 would be due on July 15, 2020. Suppose for 2020, due to the “economic pause” income is down $300,000 but the corporation projects that its $1 million PPP loan will be fully forgiven. Taxable income would be $1.2 million, tax would be $252,000 or $63,000 each quarter; $126,000 due on July 15, 2020. Estimated taxes are based on cumulative taxable income measured at the month-end preceding the estimate due dates of 4-15,6-15,9-15 and 1-15. For convenience, the annual tax is usually divided by 4 and quarterly estimated payments are paid in four equal quarterly installments

Given all the changes with the PPP program and the 60 days that SBA has to approve the forgiveness applications, we project that the loan forgiveness will occur after August 31, 2020. By using the “annualization method”, the estimated taxes can be “back end loaded” to the last estimate due in January without incurring an estimated tax penalty.
Here’s how this works:
Measurement period: Cumulative estimated tax
taxable income on increase

1/1/20-3/31/20 (3mo.) ($200,000/12×3)= $50,000 $10,500
1/1/20-5-31-20 (5mo) ($200,000/12×5)= $83,333 $ 7,000
1/1/20-8/31/20 (8mo) ($200,000/12×8)=$133,333 $10,500
1/1/20-12/31/20 (12mo) ($1,200,000/12×12)=$1.2million $224,000
Total tax on $1.2 million @21%= $252,000

Given the pressure on cash for most businesses, at a time when some or many customers cannot pay their bills timely, accrual basis taxpayers could find themselves short of cash to make estimated tax payments throughout the year even though they received PPP funds. Use of this annualization method, though time consuming, pushes the estimated tax requirements into the last quarterly payment. If you ask your preparer to use this method to avoid an estimated tax penalty, understand that it could require an extra hour or two to prepare and check.

See our client letter dated March 30th (found here) with additional tax changes for 2020 that came out of the CARES Act.

Bottom line, this is not a year to pass on tax planning.

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