Important Tax Questions Every Business Owner Should Ask Before Heading Into 2021
2020 has been a humbling year. More than any other year in recent history, we’ve learned that expectations can change on a dime. At the beginning of the year, the assumptions we held are likely far different from those we hold now, making year-end tax planning for businesses – regardless of size – more crucial than ever. As we head into 2021, ask yourself some of the following questions and see if you took full advantage of the available tax breaks or if your tax strategy needs adjusting.
Will I be able to use an NOL?
The net operating loss (NOL) rules were overhauled a few years ago when Congress passed the Tax Cuts and Jobs Act (TCJA). The TCJA limited the availability of NOLs by (1) only permitting them to offset 80% of income, and (2) repealing the use of NOL carrybacks altogether. But when the COVID-19 pandemic hit, Congress stepped back these changes. With the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, losses occurring in 2018, 2019, and 2020 can now be carried back up to five years and can offset up to 100% of incomes on carrybacks or on carryforwards through the end of 2020. Because corporate tax rates are so low, carrying back NOLs to years when tax rates were higher may help your business lower its effective tax rate and put much-needed cashback in your bank.
Did I have any qualified improvement property?
With a glitch in the tax code, qualified improvement property (QIP) was ineligible for bonus depreciation until recently. With the passage of the CARES Act, nonstructural interior building components like alarm systems, drywall, and plumbing are depreciated over 15 years and are therefore eligible for bonus depreciation. Because this change is retroactive to 2018, you can amend prior year returns to claim bonus depreciation on QIP assets, reducing your tax liability or generating losses that you can use to bolster your financial position in 2021.
Am I eligible for the Employee Retention Credit?
The Employee Retention Credit created as part of the CARES Act incentivized employers to retain employees when operations were suspended for government-mandated shutdowns or when businesses saw their revenues significantly decline, and the employer did not receive PPP funding. The refundable credit is worth 50% of qualifying wages up to $5,000 per employee for pay periods through the end of the year. If you haven’t taken advantage of this credit yet, you still have time.
Can I claim any paid leave credits?
Like the employee retention credit, paid leave credits are available for pay periods through the end of the year. There are two significant COVID-19 related credits: paid sick leave and paid family leave, which fully reimburses employers for wages paid to employees while on qualifying leave. Paid leave wages used to claim the credit cannot also be deducted, so you should have your advisor run scenarios to see if a deduction or a credit is better for your bottom line.
Should I defer payroll taxes?
The CARES Act allows all employers, regardless of need, to defer the employer portion of Social Security tax deposits – 6.2% of wages – for payroll periods that end between March 27, 2020, and December 31, 2020. Half of the deferred deposits will be due on December 31, 2021, and the remainder will be due on December 31, 2022. No penalty or interest will accrue during this time, so you can use this cash to shore up operational deficiencies – guilt-free – over the next year or two.
A similar deferral is offered for the employee portion of the Social Security tax. But unlike the deferral of the employer portion, the employee portion must be repaid in early 2021. Employers are required to withhold ratably from employee’s paychecks these deferred amounts between January 1, 2021, and April 30, 2021. Employers unable to collect wages from employees’ paychecks will be responsible for paying those deferred taxes, and those that fail to do so will be subject to interest and penalties.
Did my child work for the business this year?
If you paid your minor child a reasonable salary to work in your business, you might see some tax breaks if your business is a sole proprietorship or a partnership in which the only partners are the parents. First, by paying your child to perform work duties, you are effectively shifting a portion of your income onto your child, lowering your tax burden. Second, earned income is not subject to kiddie tax rules. If you instead chose to shift unearned income (like dividends, interest, and capital gains) to your child, this income would be subject to an additional tax under the kiddie tax rules. Your child’s earned income is free from this obligation. Third, the amount you pay to your minor child is not subject to Social Security tax; this will save your business 6.2% of wages. Your child would also be eligible to contribute to a Roth IRA now that they have earned income.
Am I optimizing officer salaries for the QBI deduction?
When individuals’ and couples’ taxable incomes exceed certain thresholds – $163,300 and $326,600 in 2020, respectively – their 20% qualified business income (QBI) deductions may be limited based on W-2 wages. This applies to all owners of pass-through business entities but is especially meaningful for owners engaged in specified services businesses like doctors, consultants, actors, and financial planners. Owners of specified service trades or businesses will lose their deductions altogether if their W-2 wages aren’t high enough. At the same time, if salaries are too high, the QBI deduction won’t be maximized.
Even though the QBI deduction affects individual income taxes, businesses can help their owners increase their deductions by adjusting officer salaries. Increasing or decreasing officer wages can potentially make room for a larger QBI deduction. Officer/owners will need to tow this line carefully; additional wages will increase taxable income. The extra tax may offset the benefits of a larger QBI deduction, and for certain business structures, officer compensation has to be deemed reasonable. Your tax advisor can help you determine optimal officer wages.
Is my choice of business entity serving us?
The entity type you selected at the onset of your business may no longer be serving you. Take a close look at your business structure before the year ends and see if a change in entity type is warranted. Some changes, like moving from a C corporation to an S corporation, are simple. Still, others will have legal and tax consequences, so talk to your advisor to see if a business entity change is warranted.
Change isn’t necessarily bad, but it does require you to stay alert and be open to shifting business strategies to accommodate those changes. Fortunately, many of the tax planning tools we discussed above are simple mechanisms you can use to help control taxable incomes as we head into what will most likely be another unpredictable year. If you have questions about your business’s year-end tax strategy or need assistance with another tax-planning issue, a Klatzkin advisor can help. For additional information, click here to contact us. We look forward to speaking with you soon.
©2020 Klatzkin & Company LLP. The above represents our best understanding and interpretation of the material covered as of this post’s date and should not be construed as accounting, tax, or financial advice. Please consult your tax advisor concerning your specific situation.