2020 Year-End Tax Planning for Businesses
Few taxpayers could have predicted coming into 2020 that the Tax Cuts and Jobs Act (TCJA) and the guidance that followed during 2018 and 2019 would feel like just a warm-up for the flurry of tax legislation and guidance issued in 2020 in response to the COVID-19 crisis. As 2020 comes to a close, we will revisit several planning considerations to help businesses reduce their tax liabilities and create tax refunds using the provisions within the TCJA and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) signed into law on March 27, 2020. We’ll also consider how the upcoming presidential election may affect tax planning for businesses.
Income Tax Planning
Net Operating Loss (NOL) Carrybacks
The TCJA revoked the two-year NOL carryback and established an indefinite carryforward for NOLs created in taxable years beginning after December 31, 2017. The CARES Act retroactively allows taxpayers who generate NOLs for tax years beginning after December 31, 2017, and before January 1, 2021, i.e., 2018 through 2020, to carry back those NOLs up to five tax years. This is significant, as taxpayers who incurred NOLs in 2018 or 2019 can now carry those losses back and claim refunds now versus waiting to offset future income.
In addition, taxpayers may receive a permanent tax benefit to carrying back a tax loss should the effective rate in the prior year be higher than the effective rate in future years. For example, a C corporation subject to a 35 percent federal tax rate in 2015 that incurs a $100,000 loss in 2020 is eligible for a carryback to 2015 that could create a $35,000 tax benefit. On the other hand, if the $100,000 loss is carried forward, the taxpayer would only receive a $21,000 tax benefit based on the current corporate tax rate of 21 percent. In some cases, the prior-year effective tax rate could be lower than in future years, so taxpayers should evaluate the benefits before filing carryback claims. For 2020, taxpayers should consider whether creating a NOL or increasing a NOL in 2020 to carry back would be advantageous. The planning ideas below may help increase tax losses in 2020.
Accelerated Depreciation – Retail Glitch
Under the CARES Act, qualified improvement property has been assigned a 15-year MACRS recovery period (previously, 39-year MACRS) and is now eligible for bonus depreciation. Taxpayers may be eligible to file an accounting method change in 2020 to “catch up” missed depreciation in 2018 and 2019.
Accounting Method Changes
There are numerous accounting methods that taxpayers could consider for 2020 to accelerate deductions into 2020 or defer income to future tax years. We have included a few examples below:
- TCJA-related accounting methods for businesses with less than $26 million in average gross receipts:
- Consider converting from the accrual method to the cash basis method to defer income
- Consider electing out of the Section 263A uniform capitalization rules for inventory
- Consider a cost segregation study for a building placed in service in prior years (and in 2020 as well) to catch up missed depreciation in earlier years by identifying assets that may qualify for a shorter class life
- Consider electing to deduct qualified prepaid expenses, such as certain insurance and maintenance contracts that don’t extend beyond 12 months, rather than capitalizing
- Distributors and manufacturers currently valuing closing inventory at cost should consider valuing closing inventory at the lower of cost or market to write down potential loss in value of inventory items
Payroll Tax Deferral
The CARES Act allowed employers to defer the payment and deposit of the employer’s share of Social Security taxes due on or after March 27, 2020, and on or before December 31, 2020. Fifty percent of the deferred tax would be payable on December 31, 2021, and the remaining 50 percent would be payable on December 31, 2022. Should businesses follow this payment schedule, then cash basis and accrual basis taxpayers won’t be able to deduct the payroll taxes until the year of payment (2021 and 2022). Some taxpayers may receive more benefit than the time value of money of deferring by deducting the payroll taxes in 2020 if the deductions were to increase a NOL that would be carried back to a tax year with a higher effective rate than expected rates in the future. To deduct in 2020, cash basis taxpayers would need to pay the deferred amount of tax by December 31, 2020, while accrual basis taxpayers would need to pay the accrued tax within 8.5 months of year-end and prior to the filing of the 2020 return.
Trump & Biden Tax Position Comparison
Our recent BKD Thoughtware® article, “Tax Policy Under a Potential Biden Presidency” summarizes the potential policy changes to the current tax policies if former Vice President Joe Biden is elected president. There are significant differences between the two plans. After the election, businesses should monitor potential tax changes that may affect current tax planning.
While we’ve identified opportunities above to help reduce taxable income in 2020, if tax rates are expected to increase in the future, some businesses may consider taking a different approach and defer deductions to future years.
2020 has brought with it a significant amount of new tax legislation and guidance. The changes largely were favorable to taxpayers and provide a great opportunity for taxpayers to enact planning strategies to help decrease tax and increase cash flows. Each taxpayer’s facts and circumstances are different, and that may mean some strategies may not be appropriate for each taxpayer’s situation. With the uncertainties created by COVID-19 and potential effect of the upcoming election, it will be important for taxpayers to be diligent about tax planning during the remainder of 2020.
Please consult your BKD Trusted Advisor™ or submit the Contact Us form below for more information.