Businesses have had a tough year amid the coronavirus crisis, facing fluctuating budgets, operational issues, access to customers and constantly changing market conditions, all while trying to manage remote employees and stay afloat.
As a small business owner, you may have incurred losses and experienced significant organizational change this year; however, in addition to regular tax deductions that are already allowed, the recent passage of the CARES Act offers a few possibilities for offsetting some of those losses. Tax code is a moving target with many complexities though, so business owners should consult with their financial advisors and tax professionals to ensure they stay within the proper guidelines. We offer potential standard and CARES-Act-based deductions that some corporations may benefit from below as they close out the year and look toward 2021.
CARES Act Tax Mitigation Provisions in 2020: Net Operating Loss, Charitable Contributions, Employee Retention Credit, and Deferral of Social Security Tax
The CARES Act offers several important provisions that can be possibly used by small business owners to offset costs for 2020, and we examine some of the more notable ones below. It is important to remember that some of these are temporary and deferment-based. Additionally, it is important that business owners ensure their company is properly classified. The Small Business Association defines "small businesses" as companies that are smaller in size and earn less revenue than corporations; however, depending on the industry, some companies in this category may have as many as 500 employees and earn up to $30 million+ in revenue.
Net Operating Loss
With the pandemic, it is possible that your losses exceeded your income in 2020. If so, you may be able to use the excess amount of losses to reduce your tax from prior years. While the Tax Cuts and Jobs Act (TCJA) adjusted these rules by disallowing them, the CARES Act revived the ability for businesses to take excess losses and carry back to previous years that were more profitable, so they can get a tax refund. As of today, losses from 2018, 2019, and 2020 may be carried back for up to five years, and business owners may make deductions for up to 100 percent of their taxable income.
Normally, qualified businesses can deduct charitable contributions from their taxable income for the year, if the contributions do not exceed 10 percent of that income. If the amount exceeds that 10 percent, companies can carry over the costs for up to five years, but the CARES Act raised this limit to 25 percent.
Employee Retention Credit
Employers who were severely hurt by the pandemic but still managed to retain their employees are eligible for this credit and can deduct up to $5,000 in wages per paid employee. An employer who was forced to close their business for an extended period or reduce operating hours as a result of government restrictions, between March 13-December 31, 2020, may qualify for this tax deduction. This is contingent upon continuing to retain and pay those workers, however, and it is important to note that employers who received a PPP loan, or payment protection program loan, are not eligible for this tax credit.
Deferral of Employer Social Security Tax
Employers normally pay a share of Social Security tax on employee wages of up to 6.2 percent, but the CARES Act now allows them to defer this amount for the 2020 tax year. Business owners can defer the entire amount for 2020 to be paid later, with 50 percent due by December 31, 2021, and the remaining 50 percent due by December 31, 2022.
Standard Tax Deductions for Small Businesses in 2020
There are several commonly-known tax deductions allowed for businesses known as "ordinary and necessary" business expenses, among them advertising, employee education, employee insurance and benefit programs, legal fees, accounting fees, and rent, travel and utilities, but whether these are all allowable for your business depends on several factors and circumstances that should be discussed with your tax preparer. In late 2017, the Tax Cuts and Jobs Act (TCJA) expanded some of these deductions, and business owners should be aware of them.
QTOB Deduction for Pass-Through Businesses: Qualified Business Income
A pass-through entity as defined by the Tax Policy Center is a business that is not subject to corporate income tax, because profits "flow through to owners or members and are taxed under the individual income tax rate." These types of businesses are not C-Corporations, and are normally sole proprietorships, partnerships, limited liability companies, or S-Corporations. Most U.S. businesses are organized this way, and size of pass-throughs can vary from small to global (e.g. law firms, accounting firms, and real estate companies are generally classified as pass-throughs).
The Tax Cuts and Jobs Act reduced corporate taxes from 35 to 21 percent at the end of 2017 for C-Corporations, but it also provided some tax breaks for pass-through businesses, if they qualify. Pass-through entities are allowed a deduction of up to 20 percent of the owner's combined qualified business income, and may also be eligible to deduct 20 percent of the excess of an owner's taxable income (this excludes capital net gains from investments and the like).
That said, eligibility is limited to Qualified Trades or Businesses (QTOB) that produce income but are not service businesses, like accounting firms, financial services companies, or law firms. While service businesses are excluded, several types of pass-through entities remain, and this is a significant provision that you should consider if your business qualifies.
Did you purchase some new industrial color printers this year? You may be able to mitigate the cost through Section 179 of the IRS Tax Code, which was created to encourage businesses to make self-improvements by allowing up-front tax deductions for qualifying equipment during their first year of service. Businesses may deduct the cost of this equipment from their gross income as long as it has been paid for, fully financed and put into use during the calendar year when the deduction is made. Of course, the cost of major improvements to a business can be substantial. The deduction amount for section 179 deduction started at $500k, and was raised to $1.04 million in late 2017 as part of the Tax Cuts and Jobs Act.
Qualifying equipment can range from small to large ticket items including IT equipment, appliances, machinery, vehicles between 6,000 and 14,000 pounds (e.g., passenger cars, vans or small trucks), certain types of property, alarm, fire and HVAC systems, and other types of improvements. Companies must also ensure that the purchased machinery is used more than half the time for actual business purposes. As an example, if a business owner purchased a van and used it 60 percent of the time for business trips, he or she would only be permitted to deduct 60 percent of the cost of the van from their 2020 gross income.
After the Section 179 cap is reached, business owners may also be allowed to make up-front tax deductions for certain equipment using what is called bonus depreciation. Since equipment, facilities improvements and things like furniture lose their value over time, companies may deduct the cost of these purchases over a period of several years (instead of one time, up-front). In 2020, bonus depreciation was changed so that businesses could deduct up to 100 percent of the cost of most "tangible depreciable assets" instead of having to depreciate those improvements over a several year period. Like section 179, there are limits on what can be used to meet this tax deduction, so check with your tax preparer.
Given the financial fallout of 2020, there are several tax considerations for businesses of all sizes, especially as it relates to the CARES Act. Maneuvering both standard and CARES Act tax deductions simultaneously can be tricky, however, and things get complicated quickly. It will take time and effort to understand the ramifications of the pandemic and the resulting tax breaks. Make sure you spend considerable time with tax preparer before you file your taxes in April 2021, and if you have additional questions, feel free to contact your financial advisor or reach out to us at www.brileywealth.com.
We know that your tax planning for 2020 may leave you with questions, and we welcome the opportunity to work with you and your legal and tax professionals to determine how recent legislative changes may affect your retirement and estate planning goals. This material is provided for informational purposes only. It is based on tax information and legislation as of March 2020. Investors need to make their own decisions based on their specific investment objectives, financial circumstances, and tolerance for risk. Our firm is not a tax or legal advisor. Investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences.