2021 brought a multitude of changes affecting businesses and with additional legislation being debated in Congress, it looks like 2022 will be no different. As the proposed legislation is still evolving, we will focus on the existing laws to assist your year-end tax planning. Below are a few strategies to help minimize your tax burden.
Qualified Business Income Deduction
Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income (QBI). For 2021, if taxable income exceeds $329,800 for a married couple filing jointly; $164,900 for singles and heads of household; and $164,925 for married filing separately, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. The limitations are phased in and apply to joint filers with taxable income between $329,800 and $429,800 and to single and head of household taxpayers with taxable income between $164,900 and $214,900 and to married filing separately taxpayers with taxable income between $164,925 and 214,925. Taxpayers may achieve significant savings with respect to the QBI deduction by deferring income or accelerating deductions to come under the dollar thresholds (or be subject to a smaller phaseout of the deduction) for 2021. Depending on their business model, taxpayers also may increase the new deduction by increasing W-2 wages before year-end.
Defer or Accelerate Income
Income deferral or acceleration remains an essential consideration in business tax planning. If you expect taxable income to be higher in 2021 than 2022, or you anticipate being taxed at a higher rate in 2021 than 2022, you may benefit by deferring income into 2022. If you anticipate being taxed at a higher rate in 2022, or perhaps you need additional income this year to take advantage of an offsetting deduction or credit that will not be available in a future tax year, accelerating income may be beneficial. If the proposed legislation were to pass, the top rates for C corporations and individuals could increase, possibly making it beneficial to accelerate income and delay deductions. The below points are made with the current tax law in place and not regarding the proposed legislation.
- Cash Method of Accounting: By adopting the cash method of accounting instead of the accrual method, you can generally put yourself in a better position for accelerating deductions and deferring income. Cash method taxpayers may find it a lot easier to shift income, for example, by holding off billings until next year, accelerating expenses, or paying bills early. Any entity other than a tax shelter that meets an inflation-adjusted average annual gross receipts test ($26 Million for tax years beginning 2021; $27 million for 2022) can use the cash method of accounting.
- Installment Sales: Generally, if gain will be realized on the sale of property, income recognition will typically be deferred under the installment method until payments are received, as long as one payment is received in the year after the sale. Consider selling the property and reporting the gain under the installment method to defer income. Suppose you determine it would be beneficial to move income from future years to 2021, and you made a sale of property using an installment note. In that case, you could make the election on the 2021 tax return to not treat the sale as an installment sale recognizing all the gain in 2021.
- Early Collection: Businesses reporting on the cash basis should consider issuing bills and pursuing collection before the end of 2021. Also, you could check to see if customers are willing to pay for 2022 goods or services in advance. Any income received using these steps will shift income from 2022 into 2021.
Section 179 and Bonus Depreciation
For 2021, the Section 179 expensing limit is $1,050,000, with a phase-out for purchases more than $2,620,000 (complete phase-out at $3,670,000 of expense-eligible property placed in service). The deduction is subject to a business income limit. Expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software. It is also available for qualified improvement property (generally, improvement to a building’s interior), roofs, HVAC systems, fire protection systems, alarm systems, and security systems. These deductions are not prorated for when the asset is in service during the year; therefore, property acquired and placed in service in the last days of the year can result in a full deduction for 2021. A 100% first-year deduction (bonus depreciation) for the adjusted basis of depreciable property is still allowed for qualified property acquired and placed in service during the year. Qualifying property includes tangible property depreciated under MACRS with a recovery period of 20 years or less and most computer software. The CARES Act also assigned a recovery period to qualified improvement property (QIP), thus making such property eligible for bonus depreciation. Bonus depreciation is not subject to a business income limit.
Net Operating Loss (NOL)
Post-2020 NOLs can no longer be carried back (except for farm losses, which may be carried back two years) but may be carried forward indefinitely. Taxpayers should be aware that, under the Tax Cuts and Jobs Act, deductions for losses arising after 2017 and carried forward to 2021 are limited to 80% of taxable income (not counting the NOL or qualified business income deduction).
For tax years beginning after 2020, taxpayers will be eligible for: (1) a 100% deduction of NOLs arising in tax years before 2018, and (2) a deduction limited to 80% of taxable income for NOLs arising in tax years after 2017.
Paycheck Protection Program (PPP)
The forgiveness of the PPP loan was deemed nontaxable by the CARES Act. Although initially, the guidance from the IRS regarding the deductibility of expenses used to document and earn forgiveness for the PPP loan indicated these expenses would be nondeductible for tax purposes, part of the Consolidated Appropriations Act 2021 provided clarity on the issue that ordinary and necessary business expenses paid with a forgiven or forgivable PPP loan are fully deductible.
Employee Retention Credit (ERC)
The ERC was established to encourage businesses to keep employees on their payroll during the pandemic. It is a refundable payroll tax credit that may be claimed by eligible employers who pay qualified wages to qualifying employees. For 2021, the credit is available for the first three quarters of the year. The ERC can be claimed even if the taxpayer has PPP loans that are forgiven. However, the taxpayer cannot use the same wages used for PPP loan forgiveness in calculating the ERC.
With the proposed legislation (Build Back Better Plan) currently being considered by Congress, we would like our clients to know that Sciarabba Walker is evaluating the possibility of changes to tax policy and will inform our clients if and when changes occur. As always, please stay tuned to our website and follow us on social media for the most up-to-date tips and guidance as it becomes available. Click here to read our individual year-end planning guidance.
We would be happy to assist you with your year-end tax planning or answer any questions you have. Please reach out to your personal Sciarabba Walker contact or email us at email@example.com at your earliest convenience.