With year-end approaching, it is time to start thinking about moves that may help lower your business’s taxes for this year and next. This year’s planning is more challenging than usual due to the uncertainty surrounding pending legislation that could increase corporate tax rates plus the top rates on both business owners’ ordinary income and capital gain starting next year.
Whether or not tax increases become effective next year, the standard year-end approach of deferring income and accelerating deductions to minimize taxes will continue to produce the best results for most small businesses, as will the bunching of deductible expenses into this year or next to maximize their tax value.
If proposed tax increases do pass, however, the highest income businesses and owners may find that the opposite strategies produce better results: Pulling income into 2021 to be taxed at currently lower rates, and deferring deductible expenses until 2022, when they can be taken to offset what would be higher-taxed income. This will require careful evaluation of all relevant factors.
Actions We Recommend for Business Tax Planning
We have compiled a list of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all of them will apply to you or your business, but you may benefit from many of them. We can narrow down specific actions when we meet to tailor a particular plan for your business. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves might be beneficial:
- Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2021, if taxable income exceeds $329,800 for a married couple filing jointly, (about half that for others), the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the business. The limitations are phased in; for example, the phase-in applies to joint filers with taxable income up to $100,000 above the threshold, and to other filers with taxable income up to $50,000 above their threshold.
- Taxpayers may be able to salvage some or all of this deduction, by deferring income or accelerating deductions to keep income under the dollar thresholds (or be subject to a smaller deduction phase out) for 2021. Depending on their business model, taxpayers also may be able increase the deduction by increasing W-2 wages before year-end. The rules are quite complex, so don’t make a move in this area without consulting your accountant.
- More small businesses are able to use the cash (as opposed to accrual) method of accounting than were allowed to do so in earlier years. To qualify as a small business a taxpayer must, among other things, satisfy a gross receipts test, which is satisfied for 2021 if, during a three-year testing period, average annual gross receipts don’t exceed $26 million (next year this dollar amount is estimated to increase to $27 million). Not that many years ago it was $1 million. Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings till next year or by accelerating expenses, for example, paying bills early or by making certain prepayments.
- Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2021, the expensing limit is $1,050,000, and the investment ceiling limit is $2,620,000. Expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software. It is also available for interior improvements to a building (but not for its enlargement), elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems.
- The generous dollar ceilings mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What’s more, the expensing deduction is not prorated for the time that the asset is in service during the year. So expensing eligible items acquired and placed in service in the last days of 2021, rather than at the beginning of 2022, can result in a full expensing deduction for 2021.
- Businesses also can claim 100% bonus first year depreciation deduction for machinery and equipment bought used (with some exceptions) or new if purchased and placed in service this year, and for qualified improvement property, described above as related to the expensing deduction. The 100% write-off is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2021.
- Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs aren’t required to be capitalized under the UNICAP rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS, e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500. Where the UNICAP rules aren’t an issue, and where potentially increasing tax rates for 2022 aren’t a concern, consider purchasing qualifying items before the end of 2021.
- A corporation (other than a large corporation) that anticipates a small net operating loss (NOL) for 2021 (and substantial net income in 2022) may find it worthwhile to accelerate just enough of its 2022 income (or to defer just enough of its 2021 deductions) to create a small amount of net income for 2021. This allows the corporation to base its 2022 estimated tax installments on the relatively small amount of income shown on its 2021 return, rather than having to pay estimated taxes based on 100% of its much larger 2022 taxable income.
- Year-end bonuses can be timed for maximum tax effect by both cash-basis and accrual-basis employers. Cash-basis employers deduct bonuses in the year paid, so they can time the payment for maximum tax effect. Accrual-basis employers deduct bonuses in the accrual year, when all events related to them are established with reasonable certainty. However, the bonus must be paid within 2½ months after the end of the employer’s tax year for the deduction to be allowed in the earlier accrual year. Accrual employers looking to defer deductions to a higher-taxed future year should consider changing their bonus plans before year-end to set the payment date later than the 2.5-month window or change the bonus plan’s terms to make the bonus amount not determinable at year end.
- To reduce 2021 taxable income, consider deferring a debt-cancellation event until 2022.
- Sometimes the disposition of a passive activity can be timed to make best use of its freed-up suspended losses. Where reduction of 2021 income is desired, consider disposing of a passive activity before year-end to take the suspended losses against 2021 income. If possible 2022 top rate increases are a concern, holding off on disposing of the activity until 2022 might save more in future taxes.
These are some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.