Year-End Tax Planning for Businesses

2021 brought a wave of new tax changes for businesses, and 2022 could bring yet another surge. With the end of the year in sight, there’s a window of opportunity in the fourth quarter to make strategic tax planning moves that will reduce the amount of taxes owed come tax time.

Potential tax increases continue to brew on many different levels, including corporate rates, individual rates, and capital gains, among others. This means that it’s important to look for ways to reduce your overall tax burden in anticipation of rate increases. Is your business prepared for what’s to come?

In addition to anticipated tax hikes, outlined below are some key changes resulting from expiring COVID relief legislation, as well as sunsetting provisions coming out of the Tax Cuts and Jobs Act (TCJA).

Pending Tax Increases and Additional Tax Planning Considerations

At this point, it’s difficult to predict what tax changes will come before year-end, with widely varying proposals coming sometimes every other month from the same branch of Congress. We do anticipate tax legislation prior to year-end, which may alter the way your business implements year-end strategies.

If you anticipate enactment of tax legislation that is unfavorable to your business, you may be looking for ways to accelerate income into 2021 and defer expenses to 2022, counter to our most traditional year-end approach. This reverse approach could include electing out of 2021 bonus depreciation to defer deductions to later years. You can also focus on accelerating income by faster billings close to year-end. If individual income tax rates increase and the TCJA qualified business deduction is eliminated for your business, you may be looking at entity restructuring to significantly minimize your taxes heading into 2022.

Pass-Through Entity Taxes – “SALT Workaround”

As part of the TCJA, which eliminated certain deductions in favor of lower tax rates, a $10,000 maximum was placed on the deduction for state and local tax (SALT) available to individuals with itemized deductions on their personal returns. California joined a list of 20 other states to enact an elective state level income tax on pass-through entity income for Partnerships and S Corporations. These entities generally do not pay state income taxes since the activity is taxable directly on the owners’ tax returns. Under current law, the owners can only deduct a maximum of $10,000 of state taxes on their federal returns; however, if the entity elects to pay this tax, the entity can take the state tax deduction without any limitations.

This can be a significant tax benefit for high earners in high tax states. At this time, there are ongoing discussions at the federal level whether the SALT deduction limitation will be increased or eliminated all together. Business owners should be having these discussions with their tax advisors to determine eligibility and if they will benefit from paying elective pass-through entity state taxes prior to the end of 2021 or in 2022.

State Tax Issues with a Permanent Remote Workforce

Businesses reacted quickly at the onset of the pandemic, and for a host of reasons, many workplaces expanded to a virtual environment. These hybrid workforce models have become normalized, and more companies than ever have increased their footprint across multiple states. If a business has employees in another state, that business will likely be considered doing business in that state and have new tax filing requirements.

Unrelated to the pandemic, recent federal and Supreme Court decisions have provided additional opportunity for states to tax businesses making online sales to customers in other states. Therefore, even without increased physical presence in other states, companies have seen their multi-state tax requirements continue to increase.

Tax, legal, and human resources functions need to work together to review the increase in risks and compliance. In addition to the increased compliance, each state offers its own credits and incentives that the company may be eligible to receive. A notable benefit for companies operating in high tax states like California is that sourcing income to other states may provide an overall reduction in taxes paid in some cases.

Employee Retention Credit

While this credit opportunity ends with the 2021 third quarter, eligible small businesses that paid qualified wages in 2021 are able to claim a credit up to $7,000 per employee per quarter on current or amended payroll tax filings. This is an increase from $5,000 per employee in total for 2020. For example, if a business employs 20 people, it can claim up to a $420,000 credit in 2021 and $100,000 in 2020. Businesses must meet certain eligibility requirements to qualify.

Please keep in mind that a business cannot use the same qualified wages for both the Paycheck Protection Program loan forgiveness application and the Employee Retention Credit; however, your advisor can help develop strategies to leverage the benefits of each incentive and find ways to enhance the benefits of both.

Net Operating Losses

For years 2018 through 2020, the CARES Act suspended the 80 percent net operating loss (NOL) carry forward rule and allowed for these NOLs to be carried back five years. This means that business taxpayers who experienced an excess of deductions over taxable income from business operations in 2021 can carry 80 percent of the excess amount forward indefinitely but cannot carry it back. Exceptions apply to qualified farming losses and NOLs of non-life insurance companies.

California’s Assembly Bill 85 suspended the use of NOLs for tax years beginning in 2020, 2021, and 2022 for corporations and individuals with over $1 million of taxable income. AB 85 extends the NOL carryover periods to allow for their use in 2022.

Excess Business Loss Limitations

Excess business loss (EBLs) limitations are back for 2021. After being suspended in the CARES Act for tax years 2018, 2019, and 2020, noncorporate taxpayers are now subject to EBL threshold amounts of $262,000 for individuals ($524,000 for joint returns). Any business losses in excess of the taxable year’s deduction convert to NOLs and are eligible to offset income in future tax years.

Research and Development (R&D) Credit

Businesses with research expenditures, such as technology and life sciences companies, will no longer be able to deduct R&D expenses as they occur. Businesses will be required to amortize qualifying research expenses or “QREs” over multiple years instead of deducting them in the year incurred unless the provision in the TCJA changes before Dec. 31, 2021.

Through 2021, businesses could choose whether to deduct Section 174 expenses in the year in which they were incurred or capitalize and amortize the costs over period of time not less than five years. But this new provision eliminates the former option.

Starting in 2022, Section 174 expenses associated with research conducted:

• within the U.S. will be capitalized and amortized over a five-year period.
• outside the U.S. will be capitalized and amortized over a 15-year period.

Charitable Contributions

In an effort to incentivize corporations to heighten their charitable contributions to nonprofits during the pandemic, the CARES Act temporarily increases the deduction limitation for charitable contributions from 10% to 25% of taxable income for 2021.

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

Meal Deductions

In 2021 and 2022, businesses can claim 100 percent of food and beverage expenses, provided that the meals were paid from restaurants and the activity meets qualifications for a business meal that would ordinarily be subject to a 50% deduction. This temporary deduction was created to assist restaurants during the pandemic.

Sick and Family Leave Credit

Small and midsized businesses with less than 500 employees are eligible to claim tax credits related to wages paid for providing paid sick and family leave related to COVID. After March 31, 2021, companies were not required to provide the paid family and sick leave, but if wages were paid voluntarily through September 30, 2021, they are eligible for the same fully refundable tax credits.

Bonus Depreciation

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

Looking Ahead

The last two years have been filled with policy changes, and next year is no exception. Connecting with an advisor will help you identify ways for the legislation to work for you. Contact me at (805) 963-7811 or jsheffield@bpw.com to discuss your business’ year-end tax planning opportunities.