As Mark Twain once observed, the only two things you can count on in life are death and taxes.
The good news: If your small business was clobbered by the COVID pandemic and government shutdowns, you shouldn’t have to pay a lot in taxes for 2021.
The bad news: Sometimes our income tax laws work in crazy ways.
I’m indebted to my good friend John D’Aquila, a certified public accountant and head of D’Aquila and Company LLP in Jacksonville, Florida (www.daquilallp.com), for sharing some of his year-end tax tips with me and allowing me to share them with you.
AMERICAN RESCUE PLAN ACT
As COVID has continued to impact businesses, Congress passed the Consolidated Appropriations Act, 2021 at the end of December 2020, and the American Rescue Plan Act this March. A major highlight of ARPA is a provision allowing businesses to fully deduct expenses paid with the proceeds of a forgiven Paycheck Protection Program loan, effectively overriding earlier guidance. The ARPA followed up by extending and modifying certain refundable payroll tax credits for both businesses and self-employed individuals, which are discussed in depth below.
As a result of this latter change, the IRS has revised Form 941-X to allow businesses to correct COVID-related employment tax credits reported on Form 941 earlier in the year. Reviewing your payroll tax returns to ensure that your business took full advantage of these credits, and filing any amended returns that may be necessary, “should be one of your top year-end tax planning priorities,” according to D’Aquila.
SECTION 179 EXPENSING AND DEPRECIATION DEDUCTIONS
Depending on what the income of your business looks like for 2021, there are two go-to deductions that generally take priority when trying to reduce income for tax purposes: the Section 179 deduction, where your business can elect to deduct the entire cost of certain property acquired and placed in service during the year, and the bonus depreciation deduction, where 100% of the cost of business property may be expensed. Under the Section 179 expensing option, your business can immediately expense the cost of up to $1,050,000 of “Section 179” property placed in service in 2021. This amount is reduced dollar for dollar (but not below zero) by the amount by which the cost of the Section 179 property placed in service during the year exceeds $2,620,000.
The bonus depreciation rules apply unless the business specifically elects out of those rules. Electing out might be preferable when a business expects a tax loss for the year and the bonus depreciation would just increase that loss, or where it might be advantageous to push depreciation deductions into future years. For example, where the owner of a pass-thru entity to whom these deductions would flow expects to be in a higher tax bracket in future years, such deductions might be of more use in those future years. If applying both the Section 179 deduction and the bonus depreciation deduction to an asset, the Section 179 deduction applies first.
If you are in the market for a vehicle, the purchase of a sport utility vehicle weighing more than 6,000 pounds can trigger a bigger deduction than if a smaller vehicle is purchased. This is because vehicles that weigh 6,000 pounds or less are considered listed property, and the related first-year deduction is limited to $18,200 for cars, trucks and vans acquired and placed in service in 2021. For vehicles weighing more than 6,000 pounds, however, up to $26,200 of the cost of the vehicle can be immediately expensed.
If you leased a passenger automobile in 2021 with a value of more than $51,000, the deduction available for that lease expense is reduced. In such cases, the lessee must include in gross income an amount determined by a formula the IRS issues each year.
ENERGY-EFFICIENT BUILDING DEDUCTION
If your business made any energy-efficient improvements to a building during 2021, such as installing property that is part of 1) an interior lighting system, 2) heating, cooling, ventilation and hot water systems or 3) the building envelope, an energy-efficient building deduction, which was made permanent in the CAA, may be available. The rules are pretty complicated, though, so talk to your accountant or tax professional about this.
MANIPULATING DEDUCTIONS AND INCOME
When it comes to year-end tax planning, two rules never change: You should try to 1) accelerate as many deductions as possible to December 2021 and 2) postpone as much income as possible to January 2022. If you know you will owe someone money early next year, ask them to submit their invoices now so you can mail payment before year-end. Better yet, if it’s a scheduled monthly payment, ask if it’s possible to pay the entire year in advance; they may even give you a discount for doing that. Wait until Jan. 1 to mail out your invoices, unless a client (having read this column) asks you to send it now, in which case you probably should do that in the interest of good customer service.
The employment landscape has changed significantly since the beginning of the COVID pandemic. Many businesses are facing worker shortages and are reevaluating what it will take to get employees in the door. If your business is not already doing so, it may reap substantial tax benefits, as well as nontax benefits, by offering a retirement plan and/or other fringe benefits to employees. Businesses that offer such benefits have a better chance of attracting and retaining talented workers, which, in turn, reduces the costs of searching for and training new employees. Contributions made to retirement plans on behalf of employees are deductible, and your business may be eligible for a tax credit for setting up a qualified plan.
In addition, as a business owner you, and your spouse, can take advantage of a retirement plan yourselves. By adding your spouse as an employee and paying a salary up to the maximum amount that can be deferred into a retirement plan, you could realize significant tax savings.
Because health insurance is a much-sought-after employee benefit, you might consider setting up a high deductible health plan paired with a health savings account. The benefits to your business would include savings on health insurance premiums that would otherwise be paid to traditional health insurance companies and having employee wage contributions to the plan not being counted as wages. Thus, neither your business nor the employee would be subject to FICA taxes on the payroll contributions. As for the employee, he or she can reap a tax deduction for funds contributed to the HSA. Because there is no use-it-or-lose-it policy, the funds can grow tax free and be used in retirement.
PAYROLL TAX CREDITS
Refundable payroll tax credits are available for businesses with under 500 employers that offered paid sick or family leave through Sept. 30, 2021 (i.e., qualified leave wages) to employees who took leave due to COVID-19. The payroll tax credits are also available to self-employed individuals, who will recoup these credits by filing Form 1040 or Form 7202, “Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals.”
EMPLOYEE RETENTION TAX CREDIT
Your business may be eligible for an employee retention tax credit if your business either 1) had their operations fully or partially suspended under government orders in 2021 or 2) experienced a decline in gross receipts for a quarter in 2021 of 20% or more compared to the same quarter in 2019 (i.e., a “significant decline in gross receipts”). However, if the business did not exist as of the beginning of the same calendar quarter in calendar year 2019, then the same calendar quarter in 2020 is used. The ERTC generally equals 70% of the first $10,000 in wages, including certain health plan expenses, per employee in each quarter of 2021. For the third and fourth quarters of 2021, the credit amount is increased to $50,000 per quarter if the business is a “recovery startup business.”
A recovery startup business is any business that 1) began carrying on any trade or business after Feb. 15, 2020, 2) for which the average annual gross receipts for the three-tax year period ending with the tax year that precedes such quarter does not exceed $1,000,000 and 3) with respect to such quarter, the operation of the trade or business is not subject to a government-ordered suspension or a significant decline in gross receipts.
It’s worth noting that the infrastructure bill passed by the Senate would terminate the ERTC as of Sept. 30, 2021. That provision does not affect a recovery startup business, and its unknown whether this provision will survive in a final bill.
QUALIFIED BUSINESS INCOME DEDUCTION
If you are conducting your business as a sole proprietorship, a partner in a partnership, a member in an LLC taxed as a partnership or as a shareholder in an S corporation, the qualified business income deduction under Code Section 199A can significantly help reduce taxable income. The QBI deduction allows eligible taxpayers to deduct up to 20% of their QBI, plus 20% of qualified real estate investment trust dividends and qualified publicly traded partnership income. A W-2 wage limitation amount may apply to limit the amount of the deduction if your taxable income that exceeds a specific threshold amount. For any tax year beginning in 2021, the threshold amount is $329,800 for married filing joint returns, $164,925 for married filing separately and $164,900 for all other returns.
IMPACT OF FUTURE TAX LEGISLATION
Presently, Congress is engaged in negotiations on a huge tax and spending bill that will likely result in significant tax changes affecting businesses, beginning next year. As events unfold, this column will try, as always, to stay on top of them. Best wishes to all my readers for a happy, safe and successful 2022!