Small business tax planning is more important than ever this year because of COVID-19.
Here are our 10 top tax tips for 2020:
- Plan ahead to avoid penalties
- Choose your optimal tax structure
- Decide whether to accelerate or defer income
- Determine whether to accelerate or defer expenses
- Consider deferring payroll tax payments and deductions
- Turn losses into refunds
- Claim alternative minimum tax (AMT) refunds
- Claim retroactive bonus depreciation refunds
- Use a retirement account to reduce taxable income
Learn how to put these tax-planning strategies into effect to save you money this year.
1. Plan Ahead to Avoid Penalties
As part of the federal government’s coronavirus response, the Internal Revenue Service (IRS) postponed the deadline for individual and corporate quarterly estimated tax payments to July 15. Taxpayers who needed more time to file could request an extension to Oct. 15. These deadlines have now passed, so unless additional actions are taken by the federal government, normal quarterly deadlines now apply.
Filing your estimated taxes late or underpaying what you owe can result in penalties. Avoid these unnecessary expenses by planning ahead so you can pay your quarterly obligations on time. If you’re short on funding to make deadlines, consider whether short-term business financing might help you cover your payments so you can avoid penalties.
2. Choose Your Optimal Tax Structure
The Tax Cuts and Jobs Act (TCJA) of 2017 lowered the corporate tax rate to a flat 21% of taxable income for years after Dec. 31, 2017. This means that for some business owners in tax brackets with rates above 21%, you may be able to save money by changing the structure of your business.
Flow-Through Structures vs. C Corporations
Different business tax structures impose different tax rates on their owners. Flow-through entities, also known as pass-through entities, avoid paying corporate taxes by passing income on to business owners or investors, who are then taxed. Businesses classified as pass-through entities include sole proprietorships, partnerships, limited liability companies (LLCs) and S corporations.
In contrast, C corporations get taxed as businesses, and their owners must also pay taxes on any personal income received from the business.
Choosing Your Structure
Whether a pass-through structure or a C corporation will be more advantageous to you depends on the specifics of your situation. If you use a pass-through structure, the TCJA allows you to claim a 20% pass-through deduction. Whether this will benefit you more than filing as a C corporation depends partly on your income level. Under current tax brackets, a 22% tax rate kicks in at an income above $40,525 for individuals or $81,050 for married couples filing jointly.
However, other factors besides tax savings can go into choosing the structure of your business. Consult a professional experienced with tax planning for companies to help you determine your most prudent strategy.
3. Decide Whether to Accelerate or Defer Income
One important business tax planning decision can be deciding whether to collect outstanding payments now so you can pay taxes on them this year or delay collection and payment until next year. Businesses typically use the cash method of accounting, which requires you to report any income you actually receive during the year as part of your gross income for that year.
Under the cash method, collecting and reporting payments this year can be advantageous if you expect your tax bracket to go up next year. However, if you expect to be in a lower tax bracket next year, it might make sense to delay invoicing a customer until after Dec. 31.
4. Determine Whether to Accelerate or Defer Expenses
Similar considerations apply when deciding whether to pay for small business expenses this year or next year. Expenses paid for this year will lower your 2020 income, while those deferred until next year will reduce next year’s revenue.
If you expect your tax bracket to go up next year, it may be advantageous to hold off on paying for an expense until then so you can claim the deduction. On the other hand, if you expect your tax bracket to go down, you might wish to claim the deduction this year. Take this into account when deciding when to time tax-deductible purchases such as equipment or supplies.
5. Consider Deferring Payroll Tax Payments and Deductions
Under the Coronavirus Aid, Relief and Economic Security (CARES) Act, employers have the option of deferring employment tax deposits and payments through Dec. 31, 2020. For employers who take this option, half of the deferred deposits are due by Dec. 31, 2021, with the other half due by Dec. 31, 2022.
Taking advantage of these deferrals can provide you with cash in the short term, but will delay your ability to claim these items as deductions. Do a cost-benefit analysis with your tax-planning consultant to decide whether or not to go with these deferrals.
6. Turn Losses Into Refunds
The CARES Act includes a provision that allows businesses to claim recent losses for refunds against taxes paid in previous years. If you had a net operating loss (NOL) in 2018, 2019 or 2020, it can be carried back 5 years against taxes you previously paid, a tax strategy known as a loss carryback or NOL carryback. Applying this strategy allows you to put your loss towards reducing your tax liability for a previous year, which can result in a refund. Using this strategy involves special forms and deadlines, so get in touch with your tax professional promptly if you’re considering pursuing it.
If you’ve suffered losses because of the pandemic, you also can claim a disaster loss which applies towards a refund. Because COVID-19 has been declared a federal disaster eligible for disaster loans, you can claim losses due to the pandemic as disaster losses under Internal Revenue Code Section 165(i).
The loss can be claimed this year, or it can be applied as an amendment to your 2019 return for a refund. To be eligible, the loss must be due to the impact of COVID-19 as well as meeting other requirements. Consult a tax expert to assist you with details.
7. Claim AMT Refunds
The 2017 TCJA legislation repealed a corporate AMT which had previously been in effect. This made some businesses eligible for an AMT credit, which is a credit that can be used to lower your federal tax obligations when the amount you owe on taxes exceeds what it would have been under the AMT.
Following the passing of the TCJA, businesses could claim any used AMT credits over the years 2018 through 2021. The CARES Act sped up this timeline to allow businesses to claim all remaining credits fully starting in tax years beginning in 2018 or 2019 to obtain a quicker refund. The credit can be claimed by amending your prior return or by submitting a Form 1139 Corporation Application for a Tentative Refund. Consult your tax professional for assistance.
8. Claim Retroactive Bonus Depreciation Refunds
The CARES Act made it easier for businesses to claim refunds for bonus depreciation. Normal depreciation allows a company to spread deductions for eligible assets, such as machinery, over the life cycle of the asset. Bonus depreciation allows these deductions to be claimed during the immediate tax year rather than spread out over time.
Building on changes to bonus depreciation made under the TCJA, the CARES Act expanded the scope of eligible deductions to include a category known as qualified improvement property (QIP). QIP involves improvements to the interior of nonresidential real estate (for example, restaurants). Under CARES, you can retroactively deduct eligible QIP items dating back to 2018, electing whether to amend previous returns to apply the full deduction to your 2020 return.
9. Review Whether Employee Bonuses Are Deductible
Under Internal Revenue Code Section 461, you can claim deductions for certain eligible bonuses paid to employees. To qualify, bonuses must be paid to employees who aren’t considered self-employed, which excludes sole proprietors, LLC members and partners. You must withhold taxes on bonuses.
Bonus deductions are handled differently depending on whether you use the cash method of accounting or the accrual method, which records earnings and expenses when they occur even if cash hasn’t yet changed hands. Talk to your accounting professional about how to handle your bonus deductions.
10. Use a Retirement Account to Reduce Taxable Income
If you contribute to a retirement account or set one up for your employees, you may be eligible for deductions. For example, under Internal Revenue Code Section 404, you can deduct contributions you make to employee 401(k) plans, up to a specified limit. You also can claim tax credits for the costs of setting up certain types of retirement plans.
Regulations regarding setting up and managing retirement plans are complex. Get input from a qualified professional when claiming deductions.
Invest in Tax Preparation to Plan for a Profitable New Year
Tax preparation is never fun, but investing in year-end tax planning now can put you in a better financial position going into the new year. The tips outlined above can save you money, but a professional financial advisor may be able to help you identify other tax-saving strategies.