Part five of our Tax Planning series is all about small businesses! Keep reading for some great tips on how to minimize your 2020 tax bill. Are you an individual looking for tax advice? Click here for those tips.
Year-end Planning Moves for Small Businesses
Tax Tip #7: Net Operating Losses (NOLs)
The CARES Act temporarily relaxed many of the NOL limitations that were implemented under the Tax Cuts and Jobs Act (TCJA). If your small business expects a loss in 2020, know that you’ll be able to carry back 100% of that loss to the prior five tax years!
If you had an NOL carried into 2020, you can claim a deduction equal to 100% of your 2020 taxable income.
Tax Tip #8: Establish a Tax-favored Retirement Plan
If your business doesn’t already have a retirement plan, now might be the time to take the plunge!
Current retirement plan rules allow for significant deductible contributions. For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings—with a maximum contribution of $57,000 for 2020. If you’re employed by your own corporation, up to 25% of your salary can be contributed with a maximum contribution of $57,000.
Other small business retirement plan options include the 401(k) plan (which can be set up for just one person), the defined benefit pension plan, and the SIMPLE-IRA. Depending on your circumstances, these other types of plans may allow bigger deductible contributions.
The SECURE Act offers an additional incentive for establishing a retirement plan in 2020. The credit for employers that adopt a new eligible plan is increased from $500 to a maximum of $5,000, and a $500 credit has been added for new small employer plans with an auto-enrollment feature.
Tax Tip #9: Take Advantage of Generous Depreciation Tax Breaks
100% first-year bonus depreciation is available for qualified new and used property that’s acquired and placed in service in calendar-year 2020. That means your business might be able to write off the entire cost of some, or all, of your 2020 asset additions on this year’s return. So, consider making additional acquisitions between now and year-end.
Also, the CARES Act made a technical correction to the TCJA that retroactively treats a wide variety of interior, non-load-bearing building improvements (known as Qualified Improvement Property (QIP)) as eligible for bonus depreciation (and hence a 100% write-off).
Alternatively, if you elect out of bonus depreciation, you can depreciate QIP over 15 years (rather than the 39 years provided by the TCJA). Small businesses can take advantage of this provision by filing for a change in accounting method or by amending the applicable return.
For example, let’s say in 2020 you renovated the interior of your building or your offices. You didn’t increase the size, alter structural components, or add an elevator or escalator. The improvements would likely qualify as Qualified Improvement Property and be eligible for 100% bonus depreciation.
Tax Tip #10: Time Business Income and Deductions for Tax Savings
If you conduct your business using a pass-through entity (sole proprietorship, S corporation, LLC, or partnership), your shares of the business’s income and deductions are passed through to you and taxed at your personal rates. If you assume next year’s individual federal income tax rate brackets will be roughly the same as this year’s, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. Deferring income and accelerating deductions will—at a minimum—postpone part of your tax bill from 2020 until 2021.
However, it’s quite likely that 2020 was a comparatively bad year thanks to COVID-19. Hopefully, you expect to be in a higher tax bracket in 2021. If so, take the opposite approach! Accelerate income into this year (if possible) and postpone deductible expenditures until 2021. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate.
Contact us for more information on timing strategies.
Tax Tip #11: Watch out for Business Interest Expense Limit
The CARES Act temporarily relaxed the unfavorable TCJA limitation on a taxpayer’s deduction for business interest expense. Under the TCJA, the deduction was limited to the sum of (1) business interest income, (2) 30% of adjusted taxable income, and (3) floor plan financing interest paid by certain vehicle dealers. For 2020, the 30% limit has been increased to 50% of adjusted taxable income. Barring additional legislation, the limit will go back to 30% in 2021. The rules for businesses conducted as partnerships, LLCs treated as partnerships for tax purposes, and S corporations are especially complicated.
Fortunately, many businesses are exempt from the interest expense limit rules under the small business exception. Under this exception, a taxpayer is generally exempt from the limit if average annual gross receipts are $26 million (the inflation-adjusted amount for 2020) or less for the three-tax-year period ending with the preceding tax year.
Need Some More Help?
If you’re a small business, you need a strong financial partner in your corner. That’s where Dent Moses comes in. We’re all about providing you with high-quality financial management services and an exceptional level of compassion. If you have any questions about our 2020 Tax Planning Tips series, or if you need general tax planning advice, you’ve come to the right place. Get in touch with us today.