Top 10 Year-End 2020 Tax Planning Ideas for Businesses and Business Owners
Year-end tax planning for 2020 takes place against the backdrop of legislative changes that occurred in late 2017 from The Tax Cuts and Jobs Act (TCJA) and a number of tax provisions for small businesses under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act").
For businesses, the Tax Cuts and Jobs Act (TCJA) cut the corporate tax rate to 21%, the corporate alternative minimum tax (AMT) is now gone, there are new limits on business interest deductions, and the law significantly liberalized expensing and depreciation rules. The TCJA also introduced a new deduction for non-corporate taxpayers with qualified business income from pass-throughs. This year, we’ve seen loan assistance programs to get cash into businesses and under the CARES Act, new tax credits to offset the costs to retain employees.
Going into year-end, business owners will need to consider flexibility in being able to change their tax planning course if there is a change in administration with the coming election followed by tax policy changes ultimately passed by Congress. We could see an increase in the corporate tax rate to 28% and a new corporate minimum tax for large corporations based upon a company’s book income. Pass-through entities could be impacted by any future changes to individual income taxes.
Here are a few ideas that business owners can implement before 2020 winds down:
1. Review retirement plan options
Qualified retirement plans can be a powerful way to defer business income and lower current tax liabilities. Individuals who already have these plans should use the end of the year as an opportunity to fully fund their contributions, while business owners who do not should consider implementing a plan after a review of the potential benefits and tax savings. Along with defined contribution plans, small business owners might consider defined benefit plans, cash balance plans, or combinations of the two. For self-employed individuals, a Keogh plan must be set up before the end of the year. However, a self-employed individual may establish a simplified employee pension (SEP) plan up to the extended due date of his or her income tax return. A self-employed individual may make contributions to either plan up to the filing date of a timely filed income tax return.
2. Take advantage of the business expensing election (Section 179 election)
For qualified property placed in service in tax years beginning in 2020, the maximum amount that may be expensed under the Code Sec. 179 dollar limitation is $1,040,000, and the beginning-of-phaseout amount is $2,590,000. These limits will be adjusted for inflation in 2021. The expensing deduction can be claimed regardless of how long the property is held during the year. Therefore, property acquired and placed in service in the last days of the tax year, rather than at the beginning of the following year, can result in a full expensing deduction for the earlier year. Also, recall that the TCJA expanded the definition of section 179 property to include qualified improvements to nonresidential real property, which means certain improvement to a building’s interior and for improvements such as roofs, HVACs, fire protection systems, alarm systems, and security systems.
3. Take advantage of "bonus" depreciation
Most new, as well as used, machinery and equipment bought and placed in service in 2020 qualifies for a 100% bonus first-year depreciation deduction. Additionally, as a result of the TCJA, the additional first-year depreciation deduction may be claimed for used as well as new property. Bonus depreciation deduction is permitted without any proration based on the length of time that an asset is in service during the tax year. As a result, a 100% write-off may be claimed even if qualifying assets are in service for only a few days in 2020. The limit on annual depreciation deductions for passenger autos (including trucks, vans, and electric automobiles) acquired by the taxpayer and placed in service by the taxpayer during calendar year 2020, for which bonus first-year depreciation deduction applies are extra-generous now. Heavy vehicles, such as SUVs, pickup trucks, or vans—those that are built on a truck chassis and are rated at more than 6,000 pounds gross (loaded) vehicle weight—are exempt from the luxury-auto dollar caps because they fall outside of the definition of a passenger auto. Thus, thanks to 100% bonus depreciation under Code Sec. 168(k), the entire cost of a heavy vehicle bought in 2020 and used 100% for business may be deducted this year.
4. Maximize the pass-through business income deduction (Section 199A deduction)
Through 2025 a new deduction is available equal to 20% of qualified business income from partnerships, S corporations, and sole proprietorships. The heart of planning for this deduction is managing taxable income and for those in a non-specified service trade or business, managing the wage/capital limitation. To reduce taxable income below the threshold amount, a few ideas to consider are making pension plan contributions, increasing payroll, accelerating business expenses, recognizing losses, avoiding recognizing gains, and making charitable contributions. If you are in a non-specified service trade or business, but you exceed the income limitations and thus are subject to the additional W-2 wage and capital (qualified property) limitation, you should consider making additional qualified capital purchases or increasing wages to increase your available QBI deduction. Future tax changes could have this deduction phase out for higher earners. Those that are pass-through entities that would be impacted by a phase-out may consider starting conversations regarding whether C corporation status would be more beneficial if they weren’t eligible for the business income deduction.
5. Accelerate and pay 2020 employee bonuses
Generally, accrual basis employers want to incur the liability for bonuses and have it deductible for the current year and then pay the bonuses to employees the following year, so that employees report the income the following year if they are cash method taxpayers. However, with the possibility of future tax rate increases, employees may be wanting their bonuses paid in 2020, instead of in 2021. Bonuses paid to sole proprietors, LLC members, and partners aren’t deductible, because the owners of these types of businesses are considered self-employed.
6. Splitting business income with family members
A business owner can split business income by gifting family members an interest in the business. An S-corporation business owner can gift non-voting shares without giving up control. A C corporation business owner can gift common stock, preferred stock, or debt securities if the capital structure of the corporation permits. If the business is a partnership or an LLC taxed as a partnership, a partner can gift a portion of a partnership interest.
Children can work for the family business. Placing the child on the business payroll enables the child to make deductible IRA contributions. Putting children to work may also help avoid the kiddie tax, which has now been restored back to the parent’s individual marginal income tax rate. (The TCJA had previously changed the kiddie tax rules to use the trust and estate tax income tax rates.) The kiddie tax only applies to children whose earned income does not exceed one-half the amount of their support. Putting children on the family payroll may increase their earned income to an amount more than one-half their total support, thus, exempting their unearned income from the kiddie tax.
7. Review structure of business
It’s always a good idea to revisit whether your business structure (sole proprietorship, partnership, LLC, S corporation, or C corporation) is still the best fit. Future tax rate changes can impact this decision. The potential for an increase in the corporate tax rate, an increase in the individual tax rate for high earners, and the potential change in the preferential rate for qualified dividends all could have an impact. Of course, tax savings aren’t the only factor to consider in structuring a business. Before changing your tax status, consult your tax advisor and perform a thorough analysis.
8. Time business income and deductions
With the potential for the individual income tax rates to increase for high earners, for businesses that are pass-through entities whose business income and deductions get passed-through to owners such as sole proprietorships, S corporations, partnerships and LLCs, recognizing income and deductions will be all about timing. If you expect to be in a higher tax bracket in 2021, accelerate income into 2020 if possible and postpone expenses until 2021.
9. Revisit exit planning strategy and wealth transfer strategies
Considering the low current interest rate environment, revisit your exit planning strategy and wealth transfer strategies. Strategies such as Grantor Retained Annuity Trusts (GRATs), Charitable Lead Annuity Trusts (CLATs), the use of Intra-Family lending, and the use of loans or sales to grantor trusts work well in the low interest rate environment. With the federal estate and gift exemption amount nearly doubled now to $11.58 million per person, those with taxable estates should make use of the increased exemptions with the use of lifetime gifts.
10. Review how the SECURE Act impacts your business
The Setting Every Community Up for Retirement Enhancement Act of 2019 (the "SECURE" Act) affects the rules for creating and maintaining employer-provided retirement plans. Whether you currently offer your employees a retirement plan (or are planning to do so), you should consider how these new rules may affect your current retirement plan (or your decision to create a new one). The changes in the law apply to both large employers and small employers, but some of the changes are especially beneficial to small employers. Unrelated small businesses are more easily allowed to band together to create a single retirement plan or Multiple Employer Plan (MEP). There are also several provisions to encourage employers to offer lifetime income annuities as options within retirement plans and new tax credits for small employers to maintain retirement plans. These are just a few of the provisions intended to make it simpler, easier, and less costly for more businesses to sponsor retirement plans for their employees.
The CARES Act provided several significant tax-savings opportunities. Don’t forget to take advantage of previous tax provisions of the TCJA and the SECURE Act that could provide additional cash needed for businesses. These are just a few options businesses have to consider in year-end planning. Your Key Private Bank advisor can work with your tax advisor so you are well-positioned to take action before the end of the year.
If you have any questions or need more information, please contact your Key Private Bank Advisor.