Good news! Business taxpayers may still be able to take actions to lower their federal income tax liabilities for 2020, as well as for future years. Consider these ideas before you file last year's return.
Claim 100% First-Year Bonus Depreciation — Or Maybe Not
For qualifying assets placed in service in 2020, business taxpayers can deduct 100% of the cost in the first year. The 100% immediate write-off is allowed for both new and used qualifying assets, which include most categories of tangible depreciable assets.
Claiming 100% first-year bonus depreciation whenever it's allowed is usually considered a tax-smart move. But you should think twice about claiming it for 2020 additions if you anticipate higher tax rates in future years. In that case, consider forgoing bonus depreciation on last year's return and, instead, depreciate the assets in question over a number of years. That way, the depreciation write-offs will offset future income that you suspect might be taxed at higher rates. The choice to claim 100% first-year bonus depreciation for 2020 asset additions (or not) is made on last year's return.
Important: Factor the net operating loss (NOL) issue into your decision. The CARES Act allows a five-year carryback privilege for a NOL that arises in a tax year beginning in 2020. Claiming 100% first-year bonus depreciation can potentially create or increase an NOL for the year. If so, the NOL can be carried back, and you can recover some or all of the federal income tax paid for the carryback year. This factor argues in favor of claiming 100% first-year bonus depreciation on last year's return. Talk with your tax advisor about what makes the most sense for your specific situation.
Take Advantage of COVID-19 Relief Provisions
The CARES Act included various tax relief provisions for business taxpayers. These provisions can impact last year's business return. Here are four examples.
1. Liberalized NOL deduction rules.
Under the law, business NOLs that arose in tax years beginning in 2020 can be carried back up to five tax years. So, an NOL that's reported on last year's return can be carried back to an earlier year and allow you to recover some or all of the income tax paid in the carryback year. Because federal income tax rates were generally higher in years before the Tax Cuts and Jobs Act (TCJA) took effect, NOLs carried back to those years can be especially beneficial.
2. Faster depreciation for real estate QIP.
Qualified Improvement Property (QIP) is generally defined as an improvement to an interior portion of a nonresidential building that's placed in service after the date the building was first placed in service. The CARES Act provision allows 100% first-year bonus depreciation for QIP that was placed in service in 2020. Alternatively, you can depreciate QIP placed in service in 2020 over 15 years using the straight-line method.
3. Suspension of excess business losses.
An unfavorable TCJA provision disallowed current deductions for so-called "excess business losses" incurred by individuals in tax years beginning in 2018 through 2025. An excess business loss is one that exceeds $250,000 or $500,000 for a married couple that files a joint tax return. The CARES Act suspended the excess business loss disallowance rule for losses that arose in tax years beginning in 2020.
4. Increased limit on business interest expense deductions.
Under the TCJA, the deduction for business interest expense was generally limited to 30% of adjusted taxable income (ATI) for tax years beginning in 2020. Business interest expense that's disallowed under this limitation is carried over to the following tax year. In general, the CARES Act increased the taxable income limitation to 50% of ATI for tax years beginning in 2020. Special complicated rules apply to partnerships and limited liability companies (LLCs) that are treated as partnerships for tax purposes.
Important: Businesses with average annual gross receipts of $25 million or less (adjusted for inflation) for the three previous tax years are exempt from the business interest expense deduction limitation. Certain real property businesses and farming businesses are also exempt if they choose to use slower depreciation methods for specified types of assets.
Establish SEP for Big Tax Savings
If you work for your own small business and haven't yet set up a tax-favored retirement plan for yourself, consider creating a simplified employee pension (SEP). Unlike other types of small business retirement plans, a SEP can be created this year and still generate a deduction on last year's return. In fact, if you're self-employed and extend your 2020 Form 1040 to October 15, 2021, you'll have until then to establish a SEP and make a contribution for last year.
The deductible contribution can be up to:
20% of your 2020 self-employment income, or
25% of your 2020 salary if you work for your own corporation.
The absolute maximum amount you can contribute for the 2020 tax year is $57,000. Beware: You may not want a SEP if your business has employees, because you might have to cover them and make contributions to their accounts, which could make this option cost-prohibitive.
Extend Your Business Return
2020 was a crazy year. COVID-19-related tax relief measures and the election outcome have created lots of moving parts. Business owners have much to consider before filing their last year's income tax returns.
Moreover, what you choose to do on last year's return can affect your tax bills for later years. All things considered, extending last year's return might be a wise move. That would give you more time to evaluate all the relevant factors in your specific situation. Here's an overview of the due dates for different types of businesses.
For sole proprietorships or single-member LLCs that are treated as sole proprietorships for tax purposes, the filing deadline for the 2020 Form 1040 is April 15, 2021. Those returns can be extended for six months, to October 15, 2021.
For the calendar-year partnerships, LLCs treated as partnerships for tax purposes and S corporations, the filing deadline is March 15, 2021. Those returns can be extended for six months, to September 15, 2021.
For calendar-year C corporations, the filing deadline for the 2020 Form 1120 is April 15, 2021. Those returns can be extended for six months, to October 15, 2021.
Important: While you can extend the deadline for filing your return, you can't extend the deadline for paying what you owe without penalty.
Consult with a Tax Pro
These are just some of the last-minute tax-saving maneuvers that business owners can take before Tax Day. As always, contact us and we can advise you on the optimal strategies for your specific situation!
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