With tax year 2021 coming to a close, we need to consider what can be done to help lower your tax bill for this year and next. With the uncertainty of pending legislation, here are some tax planning ideas for Businesses.
Review your accounting method
Businesses typically use either an accrual method of accounting or the cash basis. Under an accrual method, income and expense is recognized when: 1) All events have occurred to deduct the cost or recognize the income and 2) the amount can be determined with reasonable accuracy. Under the cash basis, income is recognized when actually or constructively received and expenses are generally deducted in the year paid. Many businesses were prohibited from using the cash basis of accounting due to restrictions on gross income levels or the required use of inventories. The Tax Cuts and Jobs Act of 2017 (TCJA) has expanded the definition of who qualifies to use the cash basis of accounting. Businesses with average annual gross receipts (3-year average) under $26 million can now qualify to use the cash method of accounting. Is the cash method right for your business?
Cost Segregation Analysis
A Cost Segregation Analysis is a commonly used strategic tax planning tool that allows companies and individuals who have constructed, purchased, expanded or remodeled any kind of real estate to accelerate depreciation deductions. When a property is purchased, not only does it include a building structure, but it also includes all of its interior and exterior components. Many of those components fall into tax categories that can be written off much quicker than the building structure. A Cost Segregation Analysis dissects the construction cost or purchase price of the property that would otherwise be depreciated over 27 ½ or 39 years. The primary goal of a Cost Segregation Analysis is to identify all property-related costs that can be depreciated over 5, 7 and 15 years.
Qualified Improvement Property
Qualified improvement property (QIP) is an improvement made to the interior of an existing nonresidential building (enlargements, elevators/escalators, or internal structural framework do not qualify). The Coronavirus Aid, Relief and Economic Security Act (CARES Act) shortened the depreciable life of QIP from 39 years to 15 years. This change is retroactive to property placed in service in 2018. QIP is also eligible for immediate deduction by electing to take 100% bonus depreciation or a section 179 deduction in the year the property is placed in service. However, New York (and many other states) have decoupled from the CARES Act, and the depreciable life for QIP in New York remains at 39 years.
Bonus depreciation allows for the accelerated depreciation of capitalized assets with depreciable lives of 20 years or less. The allowable bonus depreciation is typically 100% of the cost of the property, with the exception of certain passenger automobiles that are subject to dollar limits on a per vehicle basis. Placing bonus-eligible assets in service before year end can be an effective way to reduce your Federal tax liability. Caution: New York, and many other states, don’t accept bonus depreciation. Bonus depreciation claimed on the Federal return must be added back in full to NY taxable income, and the bonus eligible property is depreciated over the normal recovery period.
Expensing Business Property (Section 179)
For 2021, the expensing limit is $1,050,000 and is generally available for most depreciable property (other than buildings) and off the shelf computer software.
The Research and Development (R&D) Tax Credit remains one of the best opportunities for businesses to substantially reduce their tax liability. Large and small companies from a wide-range of industries can qualify for federal and state tax savings. The R&D Tax Credit may be claimed by taxpaying businesses that develop, design or improve products, processes, formulas or software. Research activities no longer have to be new to the industry; instead activities need to be new to the company – a standard that is much more favorable to taxpayers.
Planning with Year-End Bonuses
If a business is having a successful year consider making bonuses to employees. An accrual basis taxpayer can accrue bonuses, and get a deduction in 2021 as long as they make the payments by March 15, 2022. Please note that bonuses accrued to owners do not qualify.
If an owner believes they are underpaid for estimated taxes, a year-end bonus paid by December 31, 2021 can be used to withhold additional federal and state taxes.
Another bonus strategy relates to an existing C corporation that is making an election to be treated as an S corporation. An existing C corporation that makes this election is subject to built-in-gains (BIG) tax for a 60-month period after electing S status. Any asset sold during the 60-month period that has a BIG attached is subject to C corporation tax rates. An accrued bonus to an owner that is paid in the following year is considered a built-in-loss that can be used to reduce BIG tax in the future.
Other Miscellaneous items
Consider moving income into 2021 from 2022 if you anticipate a small net operating loss this year. By creating a small amount of net income, a C corporation can base their 2022 estimated tax payments on the 2021 safe-harbor tax rather than calculating estimates on a quarterly basis.
If you have a passive activity with suspended losses, consider disposing of the activity to free up those losses.
Pending legislation may adjust the state and local tax (SALT) limit for individuals. Keep in mind that New York State recently created a workaround – the Pass Through Entity Tax (PTET) credit. Please see “NY PTET Tax – Update” posted on August 27, 2021 to the TBC Web page.
These are just a few planning ideas to consider for 2021 or 2022 and are general in nature. If you have any questions or need further information please contact your TBC advisor.