With a new president taking office, 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 individuals and attempt to forecast a future tax landscape to best position your financial situation.
Looking ahead, many anticipate inevitable tax increases on the horizon due to a host of moving parts. While election results confirm that Democrats will take office in 2021, we’re still in a state of uncertainty on who will win control of the Senate. This means that predicting future tax law remains a guessing game. Depending on the balance of power, 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.
In President-elect Biden’s tax plan, he outlines a number of policies to enact tax hikes for both high-net-worth individuals and corporations, flipping the tax strategies of the Trump administration and reshaping the tax code. Biden plans to raise taxes on individuals with income above $400,000, as well as increase capital gains taxes, payroll taxes, and the corporate income tax rate. He also proposes lowering the exemption amount of estate and gift tax to $3.5 million and increasing the top rate for the estate tax to 45 percent. This plan, however, could be in for a bumpy road ahead should Republicans gain majority control of the Senate.
Without knowing the outcome of the Senate majority or what bills will be passed in the future, we can only be certain on what changes have already happened—and there’s been a number of them this year.
While many businesses remain steeped in financial and operational challenges related to the COVID-19 crisis, 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.
Payroll Protection Program (PPP) Loan Forgiveness and Repayment Strategies
Some businesses are eager to apply for forgiveness in an effort to unrig the burden of the PPP loan, but there’s still two areas of uncertainty that need resolution.
The first area relates to the deductibility of expenses and a potential “double-dipping” scenario. The IRS states 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.
Congress has also proposed legislation that would allow blanket forgiveness under a $150,000 PPP loan threshold, making loan forgiveness a much simpler, more streamlined process. Again, this proposal is still pending.
Net Operating Losses
One the biggest changes seen in the CARES Act was the re-established five-year net operating loss (NOL) carryback provision for losses occurring in taxable years after 2017 and before 2021. This means that taxpayers can opt to take NOLs incurred in 2018, 2019, or 2020 and carry back those losses five years to offset taxable income. The CARES Act also suspends current law and lifts 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.
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.
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, such as taxpayers who have annual gross receipts of $25 million or less for the three previous tax years are not 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
Bonus Depreciation
The IRS issued final regulations on first-year 100% bonus depreciation, clarifying (and correcting a drafting error in the TCJA) the general eligibility of qualified improvement property. 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 after Dec. 31, 2017 and before Jan. 1, 2023. The TCJA also broadened eligibility to include used property and qualified film, televisions, 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
Section 179
Rather than depreciating the cost of qualifying assets, Section 179 allows you to deduct the cost of eligible new or used assets and qualified improvement property. The 2020 deduction limit is $1,040,00. The maximum amount that a business can spend on equipment purchases in 2020 is $2,590,000 before the Section 179 deduction is reduced on a dollar for dollar basis.
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 deferral is a four-month 6.2% pay increase, using the employee’s portion of Social Security withholdings 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 immediately in their first four paychecks. This means they will need to double their withholdings to 12.4% to recoup the total benefit. Many companies and employees have opted out of this deferral program due to the strain it may have on employee paychecks down the road.
The Cares Act also introduced a similar option 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.
In addition, 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 corporations to heighten their charitable contributions during this time of need, the CARES Act temporarily increases the federal deduction limitation for charitable contributions from 10% to 25% of taxable income for 2020. 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 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 in a higher tax bracket 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. Contact us at (781) 247-5569 or email Stu at stu@erocktax.com to talk tax planning.
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About Stu: With more than 30 years of experience as a tax professional, Stu Steinberg brings a broad depth of knowledge to his work with his clients. Stu founded Erock Tax to help provide tax and financial planning strategies to individuals, families and small businesses and is passionate about empowering his clients through education about their money health. Stu is highly energetic and brings a sense of optimism, creative problem-solving and a deep level of commitment to every Erock client.