2021 Year-end Tax Planning Tips for Businesses
If you're in business, you know that year-end is the time to start pondering moves you can make to lower your businesses taxes, both for this year and next. Tax planning is challenging enough, but this year may be even more so than usual due to the uncertainty surrounding legislation pending in Congress that could have enormous impact on the situation.
Even so, the standard year-end approach of deferring income and accelerating deductions to minimize taxes will continue to produce the best results for most small businesses, as will the bunching of deductible expenses into this year or next to maximize their tax value.
That said, if new legislation is passed that contains tax increases, the highest income businesses and owners may find that the opposite strategies are better. In other words, it may be wise to pull income into 2021 to be taxed at current rates, and to defer deductible expenses until 2022, when they can be taken to offset what could be higher-taxed income.
With that caveat, here are some actions based on the way things are now that could save you tax dollars. Not all will apply to everyone, but likely every business can find one gem on the list.
- Taxpayers, other than C corporations, may be entitled to a deduction of up to 20% of their qualified business income. For 2021, if taxable income exceeds $329,800 for a married couple filing jointly, (about half that for others), the deduction may be limited if you are engaged in a service-type trade or business (such as law, accounting, health, or consulting), by the amount of W-2 wages paid by the business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the business.
The limitations are phased in; for example, the phase-in applies to joint filers with taxable income up to $100,000 above the threshold, and to other filers with taxable income up to $50,000 above their threshold.
If the threshold applies to your business, you may be able to salvage some or all of this deduction, by deferring income or accelerating deductions to keep income under the dollar thresholds (or be subject to a smaller deduction phaseout) for 2021.
- More small businesses are able to use the cash (as opposed to accrual) method of accounting than were allowed to do so in earlier years. To qualify as a small business a taxpayer must, among other things, satisfy a gross receipts test, which is satisfied for 2021 if, during a three-year testing period, average annual gross receipts don't exceed $26 million (next year this dollar amount is estimated to increase to $27 million). Not that many years ago it was $1 million.
Cash method taxpayers may find it easier to shift income, for example by holding off billings till next year, or by accelerating expenses by paying bills early or making certain prepayments.
- Businesses should consider making expenditures that qualify for the "section 179" business property expensing option. For 2021 tax years, the federal expensing limit is $1,050,000, and the investment ceiling limit is $2,620,000.
Expensing is generally available for most depreciable property, other than buildings, and for off-the-shelf computer software. It is also available for interior improvements to a building (but not for its enlargement, elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems.
Because this deduction is not prorated like normal depreciation based on the time the asset is in service during the year, this means that eligible acquisitions even in the last few days of the year can be fully expensed within the limits. By the way, most states have different and far lower expense limits. Arkansas, for instance, only allows up to $25,000 to be deducted under section 179.
- Businesses also can claim the federal 100% bonus first-year depreciation deduction for machinery and equipment bought used (with some exceptions) or new if purchased and placed in service this year, and for qualified improvement property, described above as related to the 179 deduction. The 100% bonus deduction is also available even if qualifying assets are in service for only a few days in 2021. Again, most states, including Arkansas, do not offer this liberal deduction.
- Businesses may be able to take advantage of the "de minimis safe harbor election" to expense the costs of lower-cost assets and materials and supplies, assuming the costs aren't required to be capitalized under the UNICAP rules.
To qualify for the election, the cost of a unit of property can't exceed $5,000 if the taxpayer has an applicable financial statement (AFS, e.g., a certified audited financial statement along with an independent CPA's report). If there's no AFS, the cost of a unit of property can't exceed $2,500. Where the UNICAP rules aren't an issue, and where potentially increasing tax rates for 2022 aren't a concern, consider purchasing qualifying items before the end of 2021.
- A corporation (other than a large corporation) that anticipates a small net operating loss (NOL) for 2021 (and substantial net income in 2022) may find it worthwhile to accelerate just enough of its 2022 income (or to defer just enough of its 2021 deductions) to create a small amount of net income for 2021. This allows the corporation to base its 2022 estimated tax installments on the relatively small amount of income shown on its 2021 return, rather than having to pay estimated taxes based on 100% of its much larger 2022 taxable income.
- Year-end bonuses can be timed for maximum tax effect by both cash- and accrual-basis employers.
Cash basis employers deduct bonuses in the year paid, so they can be timed for maximum tax effect. Accrual-basis employers deduct bonuses in the accrual year, when all events related to them are established with reasonable certainty. However, the bonus must be paid within 2½ months after the end of the employer's tax year for the deduction to be allowed in the earlier accrual year.
Accrual employers looking to defer deductions to a higher-taxed future year should consider changing their bonus plans before year-end to set the payment date later than the 2.5-month window or change the bonus plan's terms to make the bonus amount not determinable at year-end.
- Sometimes the disposition of a passive activity can be timed to make best use of its freed-up suspended losses. Where reduction of 2021 income is desired, consider disposing of a passive activity before year-end to take the suspended losses against 2021 income. If possible 2022 top rate increases are a concern, holding off on disposing of the activity until 2022 might save more in future taxes.
So, there you have it! Here's hoping we soon get some clarity from Congress as to what our tax laws are actually going to look like going forward. Happy tax planning!