Here’s what you and your tax professional may want to discuss in order to help reduce your tax liability for 2021 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, given the ongoing 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 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 nine strategies below could help you in the 2021 tax year and potentially farther into the future.
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 2021, owners of businesses such as legal, medical or accounting practices may see a reduced deduction if their taxable income surpasses $329,800 for joint filers ($164,900 for all other filers). Owners of service businesses with taxable income in excess of $429,800 for joint filers ($214,900 for all other filers) get no deduction.
You may also want to consider changing your status from a pass-through business to a C-corporation in spite of the potential 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.
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.)
One possibility you may want to consider if you qualify: Estimated taxes can generally be based on the prior year, so if 2020 was a down year, you can pay a relatively low amount of estimated tax for 2021 to preserve cash flow. Of course, the full remaining amount would be due on April 15, 2022. You can work with your accountant to estimate the tax due in 2022, so you can invest the difference and potentially be better prepared for the eventual payment.
Many states have enacted Pass Through Entity (PTE) taxes as an IRS-approved work-around to state and local tax deductions.1 Here’s an example of how it can work: If an S corporation has $100,000 worth of income and the ultimate state tax is $10,000, that amount is considered an expense, so that the
S corporation’s income for federal tax purposes becomes $90,000. Ask your tax professional whether your state has a PTE provision.2
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 2022 (for the 2021 tax year) to contribute funds to a retirement plan for the 2021 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 2021. Ask your tax advisor.
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 $1.05 million. Because the deductions are intended for small businesses, they start to phase out at spending amounts starting at $2,620,000, ending above $3,670,000. 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.
If your company operates on a cash basis for tax purposes and your profits seem likely to be lower in 2021—and you expect your business to be more profitable in 2022—consider accelerating cash collection before Dec. 31 and delaying deductible expenses until after the new year. Income you realize in 2021 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 2021, you may want to defer revenue during the last part of the year as a way of reducing your 2021 taxable income, and move up deductions by paying some 2022 costs in advance.
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 2021. The Tax Cuts and Jobs Act capped personal itemized deductions for state and local taxes. The standard deduction for 2021 is $25,100 for married couples filing jointly and $12,550 for individuals.³ If you claim the standard deduction, you generally can’t write off charitable gifts, though in 2021 non-itemizers can deduct up to $300 ($600 for joint returns) in cash contributions to qualifying charities. Be sure to review your giving strategy with your tax specialist, advises Navani.
The CARES Act created the Paycheck Protection Program (PPP), which authorized small businesses loans to cover employee salaries and certain other expenses. As a result of year-end 2020 tax legislation, the expenses funded with PPP loans are deductible and the loan forgiveness is tax-free. Consult with your tax advisor about any other tax issues raised by PPP loans.
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. Talk to your tax advisor about how to plan for this liability.
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