Year-end tax planning for businesses is especially difficult for 2021 because the Build Back Better Act has the potential to impact broad areas of taxation. Congress continues to negotiate a compromise. Unfortunately, it is difficult to know what is likely to emerge as the final version. In addition, although the effective date for most of the provisions in the Build Back Better plan are tied to the enactment date, January 1, 2022, or even later, a few proposals may be retroactive.
Based on current law, here are end-of-year tax planning strategies that are available to business owners to reduce their tax liability. Let’s take a look:
Businesses using the cash method of accounting can defer income into 2022 by delaying end-of-year invoices so that payment is not received until 2022. Businesses using the accrual method can defer income by postponing the delivery of goods or services until January 2022.
Companies that want to reduce their 2021 tax liability should consider traditional tax accounting method changes, tax elections and other actions for 2021 to defer recognizing income to a later taxable year and accelerate tax deductions to an earlier taxable year. Depending on their facts and circumstances, some businesses may instead want to accelerate taxable income into 2021 if, for example, they believe tax rates will increase in the near future or they want to optimize usage of net operating losses.
Purchase new business equipment
- Bonus Depreciation. Businesses are allowed to immediately deduct 100% of the cost of eligible property such as machinery and equipment that is placed in service after September 27, 2017, and before January 1, 2023, after which it will be phased downward over a four-year period: 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026. The first-year 100% bonus depreciation deduction is available for qualifying assets even if they are placed in service for only a few days in 2021.
- Section 179 Expensing. Businesses should take advantage of Section 179 expensing this year whenever possible. In 2021, businesses can elect to expense (deduct immediately) the entire cost of most new equipment up to a maximum of $1.05 million of the first $2.62 million of property placed in service by December 31, 2021. Keep in mind that the Section 179 deduction cannot exceed net taxable business income. The deduction is phased out dollar for dollar on amounts exceeding the $2.62 million threshold and eliminated above amounts exceeding $3.67 million.
Depreciation limitations on luxury, passenger automobiles, and heavy vehicles
As a reminder, tax reform changed depreciation limits for luxury passenger vehicles placed in service after December 31, 2017. If the taxpayer doesn’t claim bonus depreciation, the maximum allowable depreciation deduction for 2021 is $10,200 for the first year. Deductions are based on a percentage of business use. A business owner whose business use of the vehicle is 100 percent can take a larger deduction than one whose business use of a car is only 50 percent. For passenger autos eligible for the additional bonus first-year depreciation, the maximum first-year depreciation allowance remains at $8,000. It applies to new and used (“new to you”) vehicles acquired and placed in service after September 27, 2017, and remains in effect for tax years through December 31, 2022. When combined with the increased depreciation allowance above, the deduction amounts to as much as $18,200 in 2021. Heavy vehicles, including pickup trucks, vans, and SUVs whose gross vehicle weight rating (GVWR) is more than 6,000 pounds, are treated as transportation equipment instead of passenger vehicles. As such, heavy vehicles (new or used) placed into service after September 27, 2017, and before January 1, 2023, qualify for a 100 percent first-year bonus depreciation deduction as well.
Where possible, end-of-year repairs and expenses should be deducted immediately, rather than capitalized and depreciated. Small businesses lacking applicable financial statements (AFS) can take advantage of de minimis safe harbor by electing to deduct smaller purchases ($2,500 or less per purchase or invoice). Businesses with applicable financial statements can deduct $5,000. Small businesses with gross receipts of $10 million or less can also take advantage of safe harbor for repairs, maintenance, and improvements to eligible buildings. Please call if you would like more information on this topic.
Qualified business income deductions
Many business taxpayers – including owners of businesses operated through sole proprietorships, partnerships, and S corporations, as well as trusts and estates, may be eligible for the qualified business income deduction. This deduction is worth up to 20 percent of qualified business income (QBI) from a qualified trade or business for tax years 2018 through 2025. Limitations based on taxable income levels could apply. The QBI is complex, and tax planning strategies can directly affect the amount of deduction, i.e., increase or reduce the dollar amount. As such, it is important to speak with a tax professional before year’s end to determine the best way to maximize the deduction.
Self-employed individuals who have not yet done so should set up self-employed retirement plans before the end of 2021. Call today if you need help setting up a retirement plan.
Reduce accumulated corporate profits and earnings by issuing corporate dividends to shareholders.
Write-off bad debts and worthless stocks
Given the economic challenges brought on by the COVID-19 pandemic, businesses should evaluate whether losses may be claimed on their 2021 returns related to worthless assets such as receivables, property, 80% owned subsidiaries or other investments.
- Bad debts can be wholly or partially written off for tax purposes. A partial write-off requires a conforming reduction of the debt on the books of the taxpayer; a complete write-off requires demonstration that the debt is wholly uncollectible as of the end of the year.
- Losses related to worthless, damaged or abandoned property can generate ordinary losses for specific assets.
Claim available tax credits
The U.S. offers a variety of tax credits and other incentives to encourage employment and investment, often in targeted industries or areas such as innovation and technology, renewable energy and low-income or distressed communities. Many states and localities also offer tax incentives. Businesses should make sure they are claiming all available tax credits for 2021 and begin exploring new tax credit opportunities for 2022.
- Employee Retention Credit (ERC). The ERC is a refundable payroll tax credit for qualifying employers that have been significantly impacted by COVID-19. Employers that received a Paycheck Protection Program (PPP) loan can claim the ERC but the same wages cannot be used for both programs. The Infrastructure Investment and Jobs Act signed by President Biden on November 15, 2021, retroactively ends the ERC on September 30, 2021, for most employers.
- Business Energy Investment Tax Credit (ITC). Business energy investment tax credits are still available, and businesses that want to take advantage of these tax credits can still do so. Business energy credits include geothermal electric, large wind (expires at the end of 2021), and solar energy systems used to generate electricity, heat, cool, or provide hot water for use in a structure, or to provide solar process heat. There is also a 30 percent tax credit for offshore wind facilities in inland or coastal waters if construction begins before 2026. Hybrid solar lighting systems, which use solar energy to illuminate the inside of a structure using fiber-optic distributed sunlight, are also eligible; excluded, however, are passive solar and solar pool heating systems. Utilities are allowed to use the credits as well.
- Paid Family and Medical Leave Credit. A business tax credit is available for employers providing paid family and medical leave to qualifying employees through 2025. Employers must have a written policy in place that meets certain requirements and meet other conditions. The credit, set to expire in 2020, was extended through 2025. It ranges from 12.5% to 25% of wages paid to qualifying employees for up to 12 weeks of family and medical leave per taxable year.
- Work Opportunity Tax Credit (WOTC). Extended through 2025 (The Consolidated Appropriations Act, 2021), the Work Opportunity Tax Credit is available for employers who hire long-term unemployed individuals (unemployed for 27 weeks or more) and is generally equal to 40 percent of the first $6,000 of wages paid to a new hire.
Begin planning for the future
Future tax planning will depend on final passage of the proposed Build Back Better Act and precisely what tax changes the final legislation contains. Regardless of legislation, businesses should consider actions that will put them on the best path forward for 2022 and beyond. Business can begin now to:
- Reevaluate choice of entity decisions while considering alternative legal entity structures to minimize total tax liability and enterprise risk.
- Evaluate global value chain and cross-border transactions to optimize transfer pricing and minimize global tax liabilities.
- Review available tax credits and incentives for relevancy to leverage within applicable business lines.
- Consider the benefits of an ESOP as an exit or liquidity strategy, which can provide tax benefits for both owners and the company.
- Perform a cost segregation study with respect to investments in buildings or renovation of real property to accelerate taxable deductions, and identify other discretionary incentives to reduce or defer various taxes.
- Perform a state-by-state analysis to ensure the business is properly charging sales taxes on taxable items, but not exempt or non-taxable items, and to determine whether the business needs to self-remit use taxes on any taxable purchases (including digital products or services).
Year-end tax planning could make a difference in your tax bill
If you’d like more information, please call to schedule a consultation to discuss your specific tax and financial needs and develop a plan that works for your business.