Will year-end tax plans look different this year? Absolutely.
“The future is uncertain” maxim holds true every election year, but the coronavirus has amplified the uncertainties inherent in this year’s election. Regardless of who controls the White House and Congress, we cannot avoid change; in the months that follow, government leaders will need to determine if COVID-era protections should be extended or allowed to expire, and those decisions will have a significant impact on businesses and business owners.
Even though this year’s tax planning is anything but straightforward, we can use a few tools in our toolkit to help us tackle these challenges.
Net Operating Losses
Now is the time to leverage your business losses. The Tax Cuts and Jobs Act (TCJA) initially repealed the two-year carryback rule for net operating losses (NOLs) beginning in 2018, but the Coronavirus Aid, Relief, and Economic Security (CARES) Act reversed this law — at least temporarily. Losses occurring in 2018, 2019, and 2020 can now be carried back up to five years.
NOL carrybacks can serve as cash infusions just when government assistance (like the Paycheck Protection Program loans and the Economic Injury Disaster Loans) runs out. By carrying these losses back to prior years when tax rates were higher, current-year losses can offset more tax liabilities than they would be able to offset in future years.
Qualified Improvement Property
Contrary to Congress’s intentions, qualified improvement property (QIP) became ineligible for bonus depreciation in 2018. A simple glitch in the tax law had dire consequences for businesses that reported a high number of QIP assets. QIP assets are non-structural interior building improvements like drywall, plumbing, and fire detection systems. Fortunately, the CARES Act fixed this glitch, and QIP is no longer considered a 39-year asset. Going forward (and retroactive to 2018 and 2019), QIP is a 15-year asset and once again eligible for 100% bonus depreciation.
Taxpayers can amend prior-year returns to apply bonus depreciation to QIP that was placed in service in 2018 or 2019. And with most of the fourth quarter of 2020 still ahead of us, it may make sense for some to initiate or accelerate building improvements at a time when they can receive full deductions for those expenditures.
163(j) Interest Deduction
Deductions for business interest expenses under Code Section 163(j) are limited to the sum of (1) the business’s interest income, (2) the business’s floor plan financing interest, and (3) 30% of the business adjusted taxable income. The CARES Act temporarily boosted this limitation from 30% to 50%, allowing businesses to take larger interest deductions in 2019 and 2020.
Because this limitation is based on taxable income, the benefits of Section 163(j) will vary for each business. Those that weathered the COVID-19 shutdowns well will certainly gain an advantage because their higher taxable income numbers will help them max out their interest deductions. But even struggling businesses may benefit from this law change. Because some government assistance payments and loan proceeds are includable in taxable income, less successful businesses may have enough taxable income to max out their interest deductions or at least see an improvement from the boosted limitation.
Paid Leave and Employee Retention Credits
The CARES Act established two workplace tax credits that reward small businesses for protecting their employees against COVID-19-related setbacks. The paid leave credit refunds employers up to 100% of the costs to provide sick or family leave to their employees. The employee retention credit refunds these employers 50% of the wages attributed to employees they were able to retain when there was an upset in normal business operations. Both credits are only valid for payroll periods through the end of the year.
Qualifying for these credits and understanding how they mesh with government assistance programs can be tricky, but using them when they’re available can give businesses a leg up as they head into 2021. It is possible Congress will extend these credits into the new year, but that’s not certain. Relying on any future employment-related credits would be premature.
Opportunities for Individual Taxpayers
The legislative and administrative response to the pandemic also included some tools that can help your individual tax situation:
- Penalty-free withdrawals from retirement accounts
For individuals impacted by COVID-19, the CARES Act allows individuals to pull up to $100,000 from their retirement accounts without paying the 10% early withdrawal penalty. The withdrawal will typically be taxable over a three-year period. Taxpayers also have the option to repay their withdrawal, in whole or in part, anytime over a three year period.
- Charitable deduction
In 2020, all individual taxpayers, whether they itemize deductions or take the standard deduction, can deduct up to $300 of charitable contributions on their tax returns.
- $1,200 recovery rebates
The one-time, non-taxable government rebates were distributed to taxpayers based on the earnings and dependents they reported on their returns. If their income dropped and/or if they gained additional dependents, the amount they are eligible for may have changed. These amounts will be reconciled once 2020 returns are filed.
There is no one optimal way to prepare for the tax deadline, and even after the election there will still be many unknowns. Your decisions will be influenced by many factors, including how optimistic you are for the future and how much risk you are willing to take on. If you want to discuss your options with one of our tax advisors, please reach out to us today.