New twists in year-end tax planning
If suggested end-of-year strategies are a little different this year, it’s because the year itself was different. What began as a normal filing season was extended to July 15, 2020, and other ramifications of the COVID-19 pandemic — quarantine in place, working from home, CARES Act legislative issues, social turmoil, all with a hugely meaningful election on the horizon — saw to that. And that’s without mentioning the election that we’re on the cusp of.
Because COVID-19 has made this a bad year for many businesses, the traditional year-end tax planning strategies may not make sense, according to tax attorney Barbara Weltman, author of “J.K. Lasser’s Small Business Taxes 2021.”
“For example, many small businesses are on the cash basis and so they have flexibility in terms of income and deductions at year end when traditionally they would try to defer income and accelerate deductions,” she said. “But that may not make sense this year because the taxpayer is likely in a lower tax bracket this year than in the future. They might also have concerns about collections, because their customers are experiencing their own difficulties.”
The same thing is true for deductions, Weltman advised: “Where you typically would say to stock up on supplies and pay outstanding debts, you may instead want to have the deductions next year because they might be more valuable then, if you’re in a higher tax bracket. The bottom line is for a business owner to sit down with their CPA and know where the business stands to date and then decide on a year-end strategy.”
Another issue is to take advantage of expiring provisions, Weltman suggested. "Several tax provisions are set to expire at the end of 2020,” she noted. "The Work Opportunity Tax Credit could be useful to businesses that are rehiring. As businesses start getting back to the ‘new normal,’ they will start to hire more employees. If they hire from a targeted group, they may get this tax credit.”
One of the targeted groups is the long-term unemployed, with 26 consecutive weeks or more of unemployment. Other targeted groups include veterans, ex-felons, vocational rehabilitation referrals, summer youth employees, Supplemental Nutrition Assistance Program recipients, and Supplemental Social Security recipients.
“The WOTC is a use-it or lose-it credit — it expires at the end of the year. Congress could extend it but we don’t have any assurance of that, so now is the time to use it,” she said. “An employer can hire more than one member of a targeted group, and get the credit for each one. There are different credit amounts for different targeted groups.”
As we get close to the end of the year, businesses that expect to have a loss can get ready to file for a quick refund, according to Weltman. “For losses in 2020, taxpayers have a five-year carryback, so conceivably they could recoup a lot of cash.”
A taxpayer with an NOL from 2018, 2019 or 2020 taxable years can carry that loss back to each of the five preceding years unless they elect to waive the carryback.
Ed Zollars agreed: “And using bonus depreciation will create a larger NOL,” observed Zollars, a partner at CPA firm Thomas, Zollars & Lynch, and an instructor for Kaplan Financial Education. “If someone has a loss, the obvious plan would be to maximize the loss if they can. Unlike a Section 179 deduction, bonus depreciation will create a larger NOL.”
“Also, there’s no [required minimum distribution] this year, so the taxpayer might be in a lower tax bracket this year. It might be a good idea to accelerate some income and thereby use up what might be an opened-up lower bracket.”
The business interest limitation is another area to consider, according to Zollars. The deduction for net business interest is limited to 50 percent of adjusted gross taxable income for 2020, but reverts back to 30 percent of adjusted gross taxable income for 2021.
“Make sure you’re paid up for business interest in 2020,” he cautioned. “You don’t want interest to drop into 2021 when it might be limited — 50 percent is not a problem, but 30 percent would be a problem.”
Keep your eyes open
In addition to existing planning opportunities, it should be kept in mind that we might not be done with developments for the 2020 tax year, observed Vincent O’Brien, of Vincent O’Brien, a CPA and instructor at M+O=CPE.
“There could be additional legislation that affects this tax year,” he said. “It could be in a lame duck session after the election, or early next year with a retroactive application to 2020. Practitioners need to be ready for this if it does happen.”
O’Brien agreed with both Weltman and Zollars on the importance of the CARES Act five-year carryback for NOLs. “It’s important to look at clients that had NOLs in 2018 and 2019, as well as 2020,” he noted. “For clients that do not want to carry back an NOL for five years, they need to elect out of that, and it’s done on the 2020 return,” he said. “Generally speaking, they will want to use the carryback, but if they had a lower income level five years ago, they may get better tax savings using an NOL going forward. If there was no income available for the carryback, it doesn’t require an election, but if the taxpayer had income in a prior year, it’s carried back unless they elect out.”
O’Brien expects many entities that are applying for Paycheck Protection Program loan forgiveness to put their 2020 returns on extension. “They will be waiting to get their forgiveness processed, and to see what the final rules are,” he said.
The coronavirus has affected bottom lines this year, so that not every employer that previously gave their employees a bonus will do so this year. But for those who will receive one, it makes sense to decide after the election whether to receive it in December or January.
“If Biden wins the presidency, the decision would be to receive it in December before any legislative rate increase,” said Ryan Losi, executive vice president of CPA firm Piascik.
“If the taxpayer hasn’t maxed out their 401(k) for deferral, they might want to bump it up,” he advised. “Most will have three to five payments left, so if they haven’t hit the cap, they can put in additional dollars and reduce this year’s taxes.
Losi recommends holding off on paying state and local taxes to the extent possible and pushing them into 2021 if Biden wins the presidency, since he has favored repealing the state and local tax limitation. “This wouldn’t apply to those who use the standard deduction or don’t have a lot of income, but a couple making $150,000 that lives in a high-tax state might want to push out their state and local taxes,” he said.
“And don’t forget to fund your 529 plan,” he said. “Many states allow a state deduction if you fund it. It’s another bucket where you may or may not get a deduction on your return, but the earnings go untaxed for a certain length of time, giving the advantage of the time value of money.”
Since this is the last year that the five-year carryback created by the CARES Act is operative, Losi suggested that if a business will break even, it can create a loss by pushing receivables out to 2021, prepaying expenditures in 2020 and maximizing bonus depreciation.
“A lot of owners will be looking at their situation right after the election to decide whether they want to accelerate income into 2020 or push it out to 2021,” he said. “If it’s a big enough loss, they might want to carry it forward, but if they carry it back they can get a cash refund now. They have to know the rules — the tax software won’t do these automatically.”
Ready for forgiveness
With the deadline for extensions over, the focus is on loan forgiveness for clients that received PPP loans, according to Roger Harris, president of Padgett Business Services. "Given the fact that we have a ruling that says that forgiven expenses aren’t deductible, the question becomes whether it is in our clients’ best interest to rush the process and get it done by the end of the year, or to not be in such a rush and have the loans forgiven in 2021. We need guidance from the IRS to know if this is even a planning opportunity.”
“We assume we have to deal with forgiveness in the year the loan is actually forgiven and the amount of forgiveness is known,” he said. "If that’s the rule, it can be a big difference as to when it’s best to have that event occur. We have to know that to know if one way is clearly better than the other.”