This has been a year full of uncertainties. Both businesses and individuals have faced their own unique struggles that at one time would have been considered unimaginable. With the election tomorrow, along with navigating through ongoing COVID-19 challenges, year-end tax planning is at the forefront and is more important now than ever before.
Below are some of the key tax considerations for year-end tax planning for both businesses and individuals.
Business year-end tax planning considerations:
1. Projecting income - Projecting business income for this year and next can allow the business to time income and deductions to its advantage. It’s generally — but not always — better to defer tax, so consider:
a. Deferring income to next year. If your business uses the cash method of accounting, you can defer billing for products or services at year-end. If you use the accrual method, you can delay shipping products or delivering services.
b. Accelerating deductible expenses into the current year. If you’re a cash-basis taxpayer, you may pay business expenses by Dec. 31, so you can deduct them this year rather than next. Both cash and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid.
2. Using current year losses for quick refunds - Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, taxpayers are now eligible to carry back Net Operating Losses (NOLs) arising in 2018 through 2020 tax years to the previous five tax years. The CARES Act also allows taxpayers to potentially claim an NOL deduction equal to 100 percent of taxable income for prior-year NOLs carried forward into tax years beginning before 2021. In this situation, accelerating deductible expenses into the current year as mentioned in 1b (above) would be ideal.
3. Accelerate corporate alternative minimum tax (AMT) refunds – In 2018 the Tax Cuts and Jobs Act (TCJA) repealed the corporate AMT, which allowed corporations to claim all of their unused AMT credits in the tax years beginning in 2018 - 2021. The CARES Act accelerates this timeline, allowing corporations to claim all remaining credits in either 2018 or 2019. As a result, companies have several options available to file for quick refunds. The fastest method for many companies will be filing a tentative refund claim on Form 1139, but corporations must file by December 31, 2020 to claim an AMT credit this way.
4. Interest expense deduction - Generally, under the TCJA, interest paid or accrued by a business is deductible up to 30 percent of adjusted taxable income (ATI). Taxpayers (other than tax shelters) with average annual gross receipts of $25 million or less for the three previous tax years are exempt from the interest deduction limitation. The CARES Act generally increases the limit to 50 percent for 2019 and 2020. (Special partnership rules apply for 2019.) It also permits businesses to elect to use 2019 ATI for the 2020 calculation, which may increase the deduction.
5. Retroactive refunds for bonus depreciation – The CARES Act fixed a drafting error in the TCJA, by allowing a 100 percent write-off of qualified improvement property by using the bonus depreciation provisions. This amendment is retroactive to property placed in service after December 31, 2017, which could allow businesses to receive refunds by either amending their 2017, 2018 and 2019 (if filed) returns to deduct the cost of qualified improvement property; or they can choose to reflect the additional retroactive deduction entirely in the 2020 year with an accounting method change.
6. PPP Loan Forgiveness – Based on current guidance, we know that expenses associated with forgiveness are nondeductible. What isn’t clear is if they’re non-deductible for 2020 tax returns or not until 2021 when forgiveness is determined. Depending on timing of further guidance, Taxpayers may need to consider filing extensions for their 2020 tax returns to hold off on filing until forgiveness is determined or if/when Congress acts to address this issue. It’s important to note that a business may have to file a tax return before knowing the forgiveness amount depending on the timeline of the application and other factors including fiscal year-end. In this case, there’s limited guidance available on the tax return reporting requirements.
7. Consider the timing of payroll tax deduction - The CARES Act allows employers to defer the payment of the employer share of FICA taxes (6.2 percent) for the rest of 2020. The amount of the employer share of FICA taxes due for the period beginning on March 27, 2020, and ending December 31. 2020, can be deferred. The deferred amounts will then be paid as follows:
a. 50 percent of the deferred amount will be paid December 31, 2021
b. Remaining 50 percent of the deferred amount will be paid December 31, 2022
This provides a great liquidity benefit, but taxpayers should consider the impact on deductions before the end of the year.
Individual year-end tax planning considerations:
1. Charitable contributions move “above the line”- One important limit to keep in mind is that, traditionally, charitable contributions can be deducted only if an individual itemizes deductions. However, the CARES Act generally allows nonitemizers to deduct up to $300 of cash contributions to public charities in 2020 “above the line.” This means the deduction reduces adjusted gross income (AGI) and individuals don't have to itemize deductions to claim it.
2. Penalty free early retirement distributions - The CARES Act provided relief for individuals that must use funds from their retirement fund; that is a coronavirus related distribution. This exempts coronavirus related distributions of up to $100,000 from the 10 percent early distribution penalty. The distribution will be taxable, but will be taxable over a three-year period. However, the individual has an opportunity to repay the distributions within a three-year period, beginning on the day after the distribution, to avoid taxability of the distribution. If the coronavirus has caused a cash-flow bind, this may be a viable option.
3. Make up a tax shortfall with increased withholding – With COVID-19 creating cash flow problems for many, individuals need to make sure withholding and estimated taxes align with end of year tax expectations while there is time to fix a problem. Rather than being penalized for underpaying taxes, the shortfall can be made up before the end of the year through increased withholding on salary or bonuses. Increasing fourth quarter estimated tax payment due Jan. 15, 2021 can still leave individuals vulnerable to penalties for underpayments in previous quarters. However, withholdings are considered to have been paid ratably throughout the year, so increasing it for year-end wages can save taxpayers from penalties.