Last-Minute Strategies for Businesses that Deferred Filing Tax Returns
During the COVID-19 crisis, some key tax deadlines were postponed until July 15, 2020. If your business and/or personal federal income tax return is still awaiting completion, you may have significant retroactive tax-planning flexibility. The same holds true for individuals who own interests in pass-through business entities and haven’t yet filed their personal tax returns. Here are some last-minute strategies for businesses to consider.
Fiscal-Year Business Entities
Business entities that use fiscal tax years (years not ending on December 31) may have still-unfiled federal income returns for tax years that started in 2018. The July 15 deadline relief applies to these entities for federal income tax payments and federal income tax returns that would otherwise be due on or after April 1 and before July 15.
The Bonus Depreciation Conundrum
With bonus depreciation, business taxpayers can deduct 100% of the first-year cost of qualifying assets placed in service between September 28, 2017, and December 31, 2022 (or December 31, 2023 for certain assets with longer production periods and aircraft). The 100% first-year write-off is allowed for both new and used qualifying assets. This includes most categories of tangible depreciable assets, off-the-shelf software and real estate qualified improvement property (QIP).
When it’s allowed, claiming 100% first-year bonus depreciation is usually a tax-smart move. But, if you anticipate higher tax rates in future years, consider forgoing bonus depreciation and, instead, depreciating assets over several years. That way, the depreciation write-offs would offset future income that you’re expecting to be taxed at higher rates. The decision to claim 100% first-year bonus depreciation (or not) is made on your still-unfiled business tax return.
Important: The Coronavirus Aid, Relief, and Economic Security (CARES) Act allows a five-year carryback privilege for a business net operating loss (NOL) that arises in a tax year beginning in 2018 through 2020. Claiming 100% first-year bonus depreciation on an affected year’s return can potentially create or increase an NOL for that 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 could cause you to favor claiming 100% first-year bonus depreciation on a still unfiled return.
However, creating an NOL for the year would eliminate the qualified business income (QBI) deduction for owners of pass-through businesses. (See “QBI Deductions” below.) Ask your tax pro what makes the most sense in your situation.
Retroactive COVID-19 Business Tax Relief Measures
The CARES Act includes some retroactive tax relief for business taxpayers. The following provisions may affect a still-unfiled return:
Liberalized NOL rules. NOLs that arise in tax years beginning in 2018 through 2020 can be carried back five years. This means that an NOL that’s reported on a still-unfiled return can be carried back to an earlier tax year and allow you to recover federal income tax paid in the carry-back 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.
QIP technical corrections. 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 includes a retroactive correction to the statutory language of the TCJA. The retroactive correction allows much faster depreciation for real estate QIP that’s placed in service after the TCJA became law.
Specifically, the correction allows 100% first-year bonus depreciation for QIP that’s placed in service in 2018 through 2022. Alternatively, you can depreciate QIP placed in service in 2018 and beyond over 15 years using the straight-line method.
Suspension of excess business loss disallowance rule. A so-called “excess business loss” is a loss that exceeds $250,000 or $500,000 for a married couple filing a joint tax return. An unfavorable TCJA provision disallowed current deductions for excess business losses incurred by individuals in tax years beginning in 2018 through 2025. The CARES Act suspends the excess business loss disallowance rule for losses that arise in tax years beginning in 2018 through 2020.
Liberalized business interest deduction rules. Another unfavorable TCJA provision generally limited a taxpayer’s deduction for business interest expense to 30% of adjusted taxable income (ATI) for tax years beginning in 2018 and beyond. Business interest expense that’s disallowed under this limitation is carried over to the following tax year.
In general, the CARES Act temporarily and retroactively increases the limitation from 30% of ATI to 50% of ATI for tax years beginning in 2019 and 2020. Special complicated rules apply to partnerships and 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.
Tax Break for Setting up a SEP
If you work for your own small business and haven’t yet set up a tax-favored retirement plan for yourself, you can establish 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 2019 Form 1040 to October 15, 2020, you’ll have until the extended deadline to establish a SEP and make a deductible contribution for last year.
Your deductible pay-in can be up to:
- 20% of your 2019 self-employment income, or
- 25% of your 2019 salary if you work for your own corporation.
The absolute maximum amount you can contribute for the 2019 tax year is $56,000. So, the tax savings can be significant.
Important: Cost is a major drawback to this strategy for small businesses with employees. A SEP might have to cover employees — and you might be required to contribute to their accounts. If your business has employees, consult a tax pro before setting up a SEP.
If you haven’t already filed a federal income tax return for your business entity’s most recently ended tax year or your personal return for the 2019 tax year, the July 15 deadline for filing or extending (if applicable) is right around the corner. Contact Kirsch CPA Group at 513.858.6040 to discuss last-minute tax saving strategies in the context of today’s evolving tax rules.