Here’s what you and your tax professional can discuss in order to help reduce your tax liability for 2020 and beyond
SMALL BUSINESS OWNERS ARE OFTEN LOOKING FOR ways to minimize their companies' tax liability. This year’s conversation with your tax professional could be especially important, says accountant Vinay Navani of WilkinGuttenplan, as accountants fully grasp the tax implications of the Coronavirus Aid, Relief and Economic Security (CARES) Act for small business owners. Plus, the Tax Cuts and Jobs Act continues to affect the way business income is calculated, the deductions you can take, and more.
As a CPA and shareholder at WilkinGuttenplan P.C., Mr. Navani is not affiliated with Merrill. Opinions provided are his, do not necessarily reflect those of Merrill, and may be subject to change. Merrill, its affiliates and financial advisors do not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
As you work with your tax advisor, be aware of these changes—along with the possibility that additional changes may emerge in coming months—and consider whether the 9 strategies below could help you in the 2020 tax year and potentially farther into the future.
1. Determine whether your business may qualify for different tax treatment
Many small business owners can deduct 20% of qualified business income in calculating their federal taxes—“but it’s not automatic,” Navani says. The deduction generally applies to income from “pass-throughs” (when owners pay taxes on business income themselves, rather than the business itself paying tax). However, the law limits the deduction for certain service businesses. For tax year 2020, owners of businesses such as legal, medical or accounting practices begin to see a reduced deduction if their taxable income surpasses $326,600 for joint filers ($163,300 for all other filers). Owners of service businesses with taxable income in excess of $426,600 for joint filers ($213,300 for all other filers) get no deduction.
Looking ahead to the 2021 tax year, you may want to consider changing your status from a pass-through business to a C-corporation in spite of the 20% deduction, Navani says. While pass-throughs may still have advantages, the 2017 Tax Cuts and Jobs Act reduced income tax rates from 35% to a flat 21% for all C-corporations.
Whether the switch makes sense for you is something your tax specialist can help you understand.
2. Create a smart plan for paying taxes
The sooner you have an idea of your business’s general outlook for the tax year, the better prepared you are to prevent cash flow disruptions—either by putting money aside or arranging for a line of credit to pay the IRS. Ask your accountant whether you’d be better off paying quarterly estimated taxes next year, allowing you to distribute the tax burden throughout the year instead of having to find the cash for a large tax payment in April. (You may need to pay estimated taxes throughout the year to avoid interest and possibly penalties levied by the IRS.)
Small businesses may get a tax credit to help defray the cost of starting certain retirement plans.
3. Set up—or add to—a retirement savings plan
In addition to personal IRA contributions, small business owners have several options for employer-sponsored retirement savings plans, including SIMPLE IRA, SEP IRA, 401(k), and profit-sharing plans. They differ in the amount the employer and employee can contribute, the investment options available, and the ease and expense of setting them up, among other factors.
With any plan, contributions you make for yourself and your employees may be tax-deductible. Small businesses may also get a tax credit to help defray the cost of starting certain retirement plans. For calendar year taxpayers, you generally have until the due date, including extensions, of the small business’s tax return in 2021 (for the 2020 tax year) to contribute funds to a retirement plan for the 2020 tax year. But some types of plans must be established before the end of this year, or earlier during this year, to get the tax deduction for 2020. Ask your tax advisor. (This provision may or may not apply beyond the 2020 tax year. To learn how much you can contribute to your retirement plan, refer to our Contribution Limits and Tax Reference Guide.)
4. Take advantage of larger deductions for equipment
If you buy new or used equipment for your company and place it in service before the end of the year, you could be entitled to a federal tax deduction of up to $1.04 million. Because the deductions are intended for small businesses, they start to phase out at spending amounts starting at $2,590,000, ending above $3,630,000. In addition, businesses can take a 100% bonus depreciation deduction on certain kinds of equipment bought and placed in service after Sept. 27, 2017 (up from 50%). That deduction applies to purchases of certain used as well as new equipment.
5. Defer expenses and accelerate income—or vice versa
If your company operates on a cash basis for tax purposes and your profits seem likely to be lower in 2020—and you expect your business to be more profitable in 2021—consider accelerating cash collection before Dec. 31 and delaying deductible expenses until after the new year. Income you realize in 2020 may be taxed at a lower rate, and deductions will be more valuable when your income recovers. To bring in more income, Navani suggests trying to invoice customers early and encourage them to pay early. To delay deductions, you could pay staff bonuses in January instead of December.
Alternatively, if you expect your profits to be high in 2020, you may want to defer revenue during the last part of the year as a way of reducing your 2020 taxable income, and move up deductions by paying some 2021 costs in advance.
6. Contribute to charity
Giving can not only help you fulfill your goals as a socially responsible business and engage your employees in a meaningful activity—it can also provide your business with a tax deduction, usually equal to the fair market value of the property donated. However, if you own a pass-through business, be aware that your ability to deduct charitable gifts made by the business could be limited in 2020. The Tax Cuts and Jobs Act capped personal itemized deductions for state and local taxes. The standard deduction for 2020 is $24,800 for married couples filing jointly and $12,400 for individuals1. If you claim the standard deduction, you generally can’t write off charitable gifts, though in 2020 non-itemizers can deduct up to $300 in cash contributions to certain charities. Be sure to review your giving strategy with your tax specialist, advises Navani.
You may have heard that forgiven PPP loans are not taxable. That’s true, but the full tax picture is far more complicated.
7. Understand how PPP loans will be taxed
The CARES Act created the Paycheck Protection Program (PPP), which authorized small businesses loans to cover employee salaries and certain other expenses. Assuming certain conditions are met, businesses can apply to have those loans forgiven. You may have heard that forgiven PPP loans are not taxable. That’s true, but the full tax picture is far more complicated. That’s because the IRS has stated that otherwise deductible expenses, such as payroll costs, will not be tax-deductible if they are funded with PPP loan proceeds. “For tax planning purposes, you may have taxable income that you’re not expecting,” Navani says. Consult with your tax advisor about this and other important tax issues raised by PPP loans.
8. Consider when to pay back payroll taxes
The CARES Act allowed businesses to defer paying their 6.2% share of Social Security payroll taxes incurred between March 27, 2020 and the end of 2020. However, half of the deferred funds will have to be paid by December 31, 2021, and the other half of the deferred funds by December 31, 2022. So now’s the time to talk to your tax advisor about how to plan for this liability.
9. Make the most of this year’s losses
If 2020 was a tough year for your small business, you may be able to find a silver lining. Thanks to the CARES Act, certain small businesses can apply a net operating loss generated in 2018, 2019 or 2020 to income from the past five years for a potential immediate refund. This rule change could even be an incentive to take steps to increase your losses in 2020 by incurring more expenses. You’ll have the option to amend past returns or carry losses forward for future tax years, which is yet another reason to talk to your tax advisor about this issue. Navani points out that if you don’t tell the IRS what you’re doing on your 2020 return, the law specifies that these losses will first be carried back to previous years. If you want your refund quickly, the best way to do that may be to file a tentative refund claim.
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Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.