Year-End Tax Planning for Businesses

Many businesses remain steeped in financial, operational, and HR challenges related to the COVID-19 crisis, but businesses cannot afford to neglect proper tax planning this year. With only a few months remaining in 2020, now is the time to evaluate your tax position, take full advantage of tax breaks, and plan out strategies to manage your taxable income.

Looking Ahead

With an election coming up, an ongoing pandemic, and unprecedented tax law changes over the past few years, this could be the most important tax planning year yet. This article will review 2020 legislative tax changes affecting businesses and forecast future tax landscapes to best position your financial situation.

Looking ahead, many anticipate inevitable tax increases on the horizon due to a host of moving parts. Depending on who wins the presidency, the administration could establish another tax overhaul or institute a general tax increase due to the impact COVID-19 has had on the economy. We also know that the TCJA provisions sunset in 2025, so long-term tax planning may present opportunities to accelerate income into this year or next. 

Without knowing the outcome of the election or what bills will be passed, we can only be certain on what changes have already happened—and there’s been a number of them this year.

Paycheck Protection Program (PPP) Loan Forgiveness and Planning Strategies

Many consider the Paycheck Protection Program (PPP) loans to be the most significant piece of any of the 2020 stimulus packages. Almost 5 million loans resulted in over $500 billion dollars distributed to businesses across the country. While many businesses did not make the first round of funding, subsequent funding and additional time allowed businesses to evaluate and apply for these loans. Similarly, at the time of the first applications, there were many unknowns with respect to forgiveness qualifications. However, numerous taxpayer-friendly modifications followed to help taxpayers achieve forgiveness for all or most of their loans.

At the time of writing, businesses have already submitted their applications for forgiveness. In order to maximize loan forgiveness, it’s critical that businesses review the forgiveness application instructions, the potential limitations and how they may affect their loan forgiveness amounts under the different options available.

For tax planning purposes, it’s important that businesses consider the impacts of loan forgiveness to their net taxable income. The issue relates to the deductibility of expenses and a potential “double-dipping” scenario. The IRS has stated that forgiven PPP loans are not taxable income, but taxpayers whose loans are forgiven cannot deduct the business expenses that are associated with the forgiven loan proceeds. While many have voiced in favor of the deductibility of expenses due to the severity of the current state of affairs and impact on the business community, it’s advised to move forward with estimated taxes on the belief that Congress will not act, for now. 

Net Operating Losses

One the biggest changes seen in the CARES Act was the re-established net operating loss (NOL) carryback provision for losses occurring in taxable years after 2017 and before 2021 and expanded the carryback period to five years. This means that taxpayers can opt to take NOLs incurred in 2018, 2019, or 2020 and carry back those losses to offset taxable income in the previous five years. The CARES Act also suspends the NOL limit of 80 percent of taxable income through 2021. Additional losses can be carried forward.

This provision of the CARES Act will provide much-needed cash flow and liquidity for companies to utilize their losses and amend previous years’ returns.

California did not adopt the carryback provision enacted in the CARES Act and temporarily suspends NOL deductions for certain businesses. This suspension begins January 1, 2020 and ends December 21, 2022, affecting business entities with net business income of at least $1 million as well as individual taxpayers with modified adjusted gross income $1 million or more, which accounts for many businesses operating as pass-through entities. The state also creates a $5M cap on business income tax credits for tax years 2020, 2021, and 2022.

Alternative Minimum Tax Credit

Under current law, the TCJA eliminated the corporate alternative minimum tax (AMT) starting in 2018 which allowed companies to claim a refundable portion of unused credits over a four-year period between 2018 and 2021. However, in an effort to increase cash flow for businesses disrupted by COVID-19, the CARES Act accelerates the availability of these credits, and either allows a company to claim the remaining of its credits in 2019 or elect to use all the credits in 2018.

Business Interest Expense Deduction

The CARES Act also increases (in general) the deduction amount from 30% to 50% of adjusted taxable income (ATI) on interest paid or accrued by a business in 2019 and 2020. It also allows businesses to elect to use 2019 ATI for the 2020 calculation, which could potentially increase their deduction amount.

There are a few exemptions to be aware of, however. Some taxpayers who have annual gross receipts of $25 million or less for the three previous tax years may not be subject to the interest deduction limitation. Real property businesses can opt to fully deduct their interest as well, but keep in mind, they would be required to use the alternative depreciation system for real property used in the business 

Qualified Improvement Property and Bonus Depreciation 

The CARES Act provided a technical correction to the TCJA that could be extremely beneficial to certain taxpayers. Qualified Improvement Property (QIP)—certain improvements to the interior of a nonresidential building—is once again categorized as 15-year property, and perhaps more importantly, eligible for bonus depreciation. This is retroactive to years beginning after December 31, 2017, and therefore, taxpayers should consider amending 2018 and 2019 tax returns to claim the additional deductions for QIP.

100% bonus depreciation is allowed for qualifying assets (such as machinery, equipment, computers, appliances, and furniture) with a recovery period of 20 years or less if placed in service before Jan. 1, 2023. The TCJA also broadened eligibility to include used property and qualified film, television, and live theatrical productions. 

Bonus depreciation is set to be reduced in the subsequent years as follows:

• 80% for 2023
• 60% for 2024
• 40% for 2025
• 20% for 2026

Payroll Taxes

Companies and eligible employees may take advantage of a recent payroll tax deferral program to temporarily boost paychecks during the current health crisis. The CARES Act introduced a payroll tax deferral for businesses. Employers may opt to delay their 6.2% portion of the Social Security payroll tax and repay it over the next two years, requiring the first half due by Dec. 31, 2021 and the second half due by Dec. 31, 2022.

A similar option was issued for employees: the optional deferral is a four-month net pay increase, using the employee’s portion of Social Security withholdings (6.2%) to infuse more income until the end of 2020. However, there’s a catch. Beginning on Jan. 1, 2021, employees will need to start paying back the money in their paychecks between January 1, 2021 and April 30, 2021. Many companies and employees have opted out of this deferral program due to the strain it may have on employee paychecks down the road.

Many employers making payments to employees under the mandatory paid sick leave or paid family leave will be eligible to claim a credit against their 2020 payroll taxes. In addition, some employers who did not receive Paycheck Protection Program loans may qualify for an employee retention credit if an employer’s business has been fully or partially suspended because of a COVID-19-related shutdown order or if their gross receipts have fallen below more than 50% in comparison to the same quarter of the previous year, then the business may be eligible for a payroll tax credit. The credit equals 50% of up to $10,000 in compensation, including health care benefits, paid to an eligible employee after March 12, 2020, through Dec. 31, 2020.

Increased Charitable Contributions

In an effort to incentivize taxpayers to maintain their charitable contributions during this time of need, the CARES Act temporarily increases the 2020 federal deduction limitation for charitable contributions from 10% to 25% of taxable income for corporations and from 60% to 100% for individuals who itemize deductions. Similarly, the limitation on donated food inventory is also increased from 15% to 25% of taxable income. 

These changes only relate to cash donations and will not be eligible for stocks, real estate, or other non-cash donations. The food inventory donation increase only applies to public charities and will not pertain to certain private foundations or donor-advised funds.

Deferring or Accelerating Projected Income

A traditional year-end tax planning strategy—deferring or accelerating income into the current or next tax year—indicates an opportunity to time income and deductions to your tax advantage.

If you anticipate being taxed at a higher tax rate next year, you may consider accelerating income and deferring deductible expenses so you can save more money over a two-year period. Businesses affected by COVID-19 may find this option is the best strategy in a financially challenging year.

Depending on your situation and accounting method, your business may choose to do the opposite—to postpone income into next year by deferring billing for products or services at year end with the cash method of accounting or choose to delay shipping products or delivering services through the accrual method.

Lastly, you can opt to accelerate deductible expenses into the current year and pay business expenses by the end of the year. If you use a credit card to pay these expenses, both cash and accrual-basis taxpayers can deduct the expenses in the year that they’re charged, even if the credit card bill is paid in the new year.

Next Steps

This year has presented surmountable change, but the best way to overcome challenge is to seek out opportunity. Schedule an appointment to review tax planning strategies that will help your business recover and thrive in the months ahead. You can also visit our digital year-end tax planning guide with more detailed information at www.bpw.com/resources/client-tools.

Contact me with questions at jsheffield@bpw.com or (805) 963-7811. I look forward to helping you.