BUSINESS TAX ISSUES
Prepay Expenses Using the IRS Safe Harbor You just have to thank the IRS for its tax-deduction safe harbors. IRS regulations contain a safe-harbor rule that allows cash-basis taxpayers to prepay and deduct qualifying expenses up to 12 months in advance without challenge, adjustment, or change by the IRS, (IRS Reg. 1.263(a)-4(f). Under this safe harbor, your 2019 prepayments cannot go into 2021. This makes sense, because you can prepay only 12 months of qualifying expenses under the safe-harbor rule.
For a cash-basis taxpayer, qualifying expenses include, among others; lease payments on business vehicles, rent payments on offices and machinery, and business and malpractice insurance premiums.
Example. You pay $3,000 a month in rent and would like a $36,000 deduction this year. So on Tuesday, December 31, 2019, you mail a rent check for $36,000 to cover all of your 2020 rent. Your landlord does not receive the payment in the mail until Thursday, January 2, 2020. Here are the results:
- You deduct $36,000 in 2019 (the year you paid the money).
- The landlord reports $36,000 in 2020 (the year he received the money).
The landlord gets what he wants – next year’s entire rent in advance, eliminating any collection problems while keeping the rent taxable in the year he expects it to be taxable.
Don’t surprise your landlord: if he had received the $36,000 of rent paid in advance in 2019, he would have had to pay taxes on the rent money in 2019.
Before sending a big rent check to your landlord, make sure the landlord understands the strategy. Otherwise, he might not deposit the rent check (thinking your payment was a mistake) and instead might return the check to you. This could put a crimp in the strategy, because you operate on a cash basis.
Also, think “proof”. Remember, the burden of proof is on you. How do you prove that you mailed the check by December 31st ? Think like the IRS auditor or, better yet, a prosecuting attorney.
Answer: Send the check using one of the postal service’s tracking delivery methods, such as priority mail with tracking and possibly signature required , or one of the old standards, such as certified or registered mail. With these types of mailings, you have proof of the date that you mailed the rent check. You also have proof of the day the landlord received the check.
Stop Billing Customers, clients, and Patients Here is one rock-solid, time-tested, easy strategy to reduce your taxable income for this year: stop billing your customers, clients, and patients until after December 31, 2020. (We assume here that you or your corporation is on a cash basis and operates on the calendar year.)
Customers, clients, and patients, and insurance companies generally don’t pay until billed. Not billing customers and patients is a time-tested tax-planning strategy that business owners have used successfully for years. Example. Will Maket, a dentist, usually bills his patients and the insurance companies at the end of each week; however, in December , he sends no bills. Instead, he gathers up those bills and mails them the first week in January. Presto! He just postponed paying taxes on his December 2020 income by moving that income to 2021.
Buy Office Equipment With bonus depreciation now at 100 percent along with increased limits for Section 179 expensing, buy your equipment or machinery and place it in service by December 31, and get a deduction for 100 percent of the cost in 2020.
Qualifying bonus depreciation and Section 179 purchases include, among others; new and used personal property such as machinery, equipment, computers, desk, furniture, and chairs (and certain qualifying vehicles).
PLANNING TIP: Remember, the equipment need only be placed in service prior to the end of the year, it does not have to be completely paid for. That’s right, you could pay a minimum down
payment yet get a 100% deduction.
Use Your Credit Cards If you are a single-member LLC or sole proprietor filing Schedule C for your business, the day you charge a purchase to your business or personal credit card is the day you deduct the expense, (Rev. Rul. 78-38). Therefore, as a Schedule C taxpayer, you should consider using your credit cards for last minute purchases of office supplies and other business necessities.
If you operate your business as a corporation, and if the corporation has a credit card in the corporate name, the same rule applies: the date of the charge is the date of the deduction for the corporation, (Ibid).
But if you operate your business as a corporation and you are the personal owner of the card, the corporation must reimburse you if you want the corporation to realize the tax deduction, and that happens on the date of reimbursement. You should use an Accountable Plan to accomplish this. Thus, submit your expense report and have the corporation on the Cash Method Of Accounting make its reimbursement to you before midnight on December 31st .
Retirement Plans Owners of companies should consider putting retirement plans into service before December 31st . They may be funded in 2021 for 2020 if started by year-end.
Dividend VS. Salary Owners of regular corporations should consider taking a dividend as opposed to salary. If the corporation is in a lower tax bracket than the owner’s personal income tax bracket the owner gets a preferential tax advantage on the dividend and the corporation avoids payroll taxes. This only works with C -Corporations.
Don’t Assume You Are Taking Too Many Deductions If your business deductions exceed your business income, you have a tax loss for the year. With a few modifications to the loss, tax law calls this a “net operating loss,” or NOL, (IRS Section 172(d)2018).
If you are just starting your business, you could very possibly have an NOL. You could have a loss year even with an ongoing and successful business.
Net Operating Loss Deduction (NOL):
The Coronavirus Aid, Relief, and Economic Security (CARES) Act made two changes to the TCMJ. Under TCMJ NOLs were no longer able to be carried back to priors years and must have been carried forward offsetting only 80% of taxable income. The CARES Act new changes:
- The CARES Act allows NOLs arising in tax years beginning in 2018, 2019, and 2020 to be carried back five (5) years for refunds against prior taxes. IRC 172(a)
- The CARES Act allows application of 100 percent of NOL to carry back years. IRC 172(b)(1)(D)
If you have an NOL for 2018 or 2019 you can file an amended tax return, for 2019 only you file for a quick refund, file a tentative refund claim before December 31, 2020 or file an amended return later.
Small Business New Rule IRC Section 199A was added to the Code for years after 2017. Taxpayers other than C-corporations may be entitled to a deduction of up to 20% of their qualified business income. If taxable income does not exceed $321,480 for a married couple filing jointly, $160,700 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law; accounting, health, actuarial science, consulting services, performing arts, athletics, financial services, investment management, trading services, dealing in securities, partnership interests, commodities, or any business where principal asset is the reputation or skill of one or of its employees), 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 phase out for joint filers with taxable income between $315,000 and $415,000 and for all other taxpayers with taxable income between $157,500 and $207,500.
PLANNING TIP: Taxpayers may be able to achieve significant savings by deferring income or accelerating deductions so as to come under the dollar thresholds (or be subject to a smaller phase out of the deduction) for 2020. Depending on their business model, taxpayers also may be able to increase the new deduction by increasing W-2 wages before year-end.
Cash Method Of Accounting More “Small Business” are able to use the cash method of accounting in 2018 and later years than were allowed to do so in the past. To qualify as a “Small Business” a taxpayer must, among other things, satisfy a gross receipts test. Effective for tax years beginning after December 31, 2017, the gross receipts test is satisfied if, during a three year test period, average annual gross-receipts don’t exceed $25 million (the dollar amount use be $5 million). Cash method taxpayer may find it a lot easier to shift income, for example, by holding off billing till next year or by accelerating expenses, paying bills early or by making certain prepayments.
Bonus Depreciation Finally a deduction for business that makes sense. A business can claim a 100% bonus first-year depreciation for machinery and equipment – bought and placed in service, new or used (with some exceptions) after September 17, 2017 and before January 1, 2023. That means 100% of cost whether paid off or not placed in service this year is fully deductible. As a result, the 100% bonus first-year write off is available even if the qualifying asset is in service even one day in the year. The bonus reduces to 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026 and no bonus after 2026.
Expensing 179 Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2018, the expensing limit is $1,020,000 and the investment ceiling is $2,550,000. Expensing is generally available for most depreciable property (other than buildings), and off-the-shelf computer software. Expensing is also available for qualified improvement property (generally, any interior improvement to a building’s interior, but not enlargement of a building, elevators or escalators, or the internal structural framework), for roofs, and HVAC, fire protection, alarm, and security systems. Expensing deduction is available (provided you are otherwise eligible to take it) regardless of how long the property is held during the year. This can be a powerful planning tool, thus property placed in service even the last day of 2019 gets the deduction if elected. The election is made when filing your 2020 tax return in 2021 by the due date of your return including extension.
De Minimis Safe Harbor Election Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the cost of lower-cost assets, materials and supplies, assuming the cost does not have to be capitalized under Code Sec. 263A uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if taxpayer has 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, consider purchasing such qualified items before the end of 2020.
PLANNING TIP: The purpose of this election is to reduce the depreciation of small asset acquisitions used in your trade or business. This is another form of expensing, and there is no recapture of depreciation when the asset is disposed of later.
Employee Meals: IRC Sec 274(n) Employee meals were 100 percent deductible. Now meals are limited to 50 percent deductible, unless they are staff meals and meetings which are 100% deductible.
Entertainment Expense: IRC Sec 274(a); 274(e) Entertainment directly related to a trade or business was 50 percent deductible. Now, entertainment is no longer deductible.
Increased Employers Deduction: (IRC 127 as amended by The CARES Act) Effective for payments made after March 27, 2020 and before January 1, 2021, employers can pay the principal or interest of an employee’s qualified education loan and exclude the benefit from the employee’s taxable income.
Qualified Improvement Property (QIP): The CARES Act made changes to the qualified improvement property (QIP)error made by the Tax Cuts and Jobs Act (TCJA). QIP is any improvement made by the taxpayer to the interior portion of a building that is non-residential real property (think office buildings, retail stores, and shopping centers) if you place the improvement in service after the date you place the building in service. If you have such property on a already files 2018 or 2019 return, and it’s on that return as 39-year property. You now have to change it to 15-year property, eligible for both bonus depreciation and Section 179 expensing, therefore amended returns will be required.
INDIVIDUAL TAX ISSUES
Required Minimum Distribution (RMD) Rules: Under the SECURE ACT (Public Law 116-94), no minimum distribution is required for calendar year 2020 from an IRA, or from an employer-provided qualified retirement plan that is a defined contribution plan. The next RMDs will be for calendar year 2021. This provision waves the 2020 RMD rules for lifetime distributions to employees and IRA owners and for after-death distributions to beneficiaries. This Act also changes the 70 ½ age requirement for starting distributions to age 72.
PLANNING TIP: Take advantage of a charitable break for IRA owner’s that’s now perinate in the law. Individual’s 70 ½ and older can transfer as much as $100,00 annually from their IRAs directly to a qualifying charity. If married, you and your spouse can give up to $100,000 each from your separate IRAs. The benefits here are: 1) This distribution also qualifies toward your RMD requirements, 2) This distribution in not taxable to you, 3) This amount of IRA is forever removed from future income and estate tax, and 4) The charity of your choice benefits from your generosity. This planning is a WIN, WIN, WIN, when used properly, remember the distribution must go from the IRA directly to the charity, you cannot receive the funds and then write a check to the charity for this to work. All IRA account custodians will have the necessary forms. NOTE: This provision is just for IRAs, therefore, if you have 401Ks, 403Bs, 457 plans, pension, profiting sharing or qualified plans you must transfer the funds to an IRA rollover account first then directly transfer to the charity. This has not been changed by the SECURE ACT.
Higher-Income Earners remember the top marginal tax bracket is now 37%, however, the Tax Cuts and Jobs Act (TCJA) did not eliminate the surtax of 3.8% on certain unearned income. The surtax is the lesser of: 1) net investment income (NII), or 2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for married filing separate, and $200,000 in any other case). The IRS does not index these ACA thresholds for inflation. NII included capital gains and Section 475 ordinary income.
PLANNING TIP: Long-term Capital Gains are most likely the issue to get the surtax. Taxpayers that normally have adjusted gross income under $250,000 do not experience the surtax until they have a large long-term capital gain tax. One way to either reduce or eliminate the surtax is to consider an installment sale. Example: You sell a piece of real estate for $110,000 with a basis of $10,000, therefore, you have a gain of $100,000, you could spread the gain over two years by receiving half this year and half next year, this is especially good towards the end of the year. Now let’s further assume your adjusted gross income is $200,000, by spreading the $100,000 gain over two years you would not experience the surtax of 3.8% at all.
Estimated Tax And RMDs Individuals who must pay estimated tax and need to take RMD’s from retirement accounts or IRA distributions can elect to have up to 100% of the distribution go to income tax withholding, this possibility eliminates the need to pay estimated tax installments using Form 1040-ES. This is especially effective is you take the distribution near year end as the IRS considers the withholding as if it had been timely withheld throughout the year.
Take Advantage Of Capital Gains Rules Long-term capital gain from sale of asset held over one year and qualifying dividend is taxed at 0%, 15%, or 20%, depending on the taxpayer’s taxable income. The 2019 long-term capital gains rate are 0% for taxable income under $39,375 single, and $78,750 married filing jointly. The 15% capital gains rate applies to taxable income up to taxable income up to $434,550 for filing single and $488,850 married filing jointly. The top bracket rate of 20% applies to gains above those amounts.
PLANNING TIP: Zero-percentage-rate gains and dividends produce increased adjusted gross income (modified adjusted gross income) which can cause more of your social security to be subject to income tax.
ROTH IRA Conversion: Convert a traditional IRA into a ROTH IRA before year-end to accelerate income. The conversion income is taxable in 2019, but the 10% excise tax on early withdrawals before age 59 ½ is avoided providing, you pay the conversion taxes from outside the ROTH plan. One concern is that TCJA repealed the recharacterization option; you can no longer reverse it if the plan assets decline after conversion. There isn’t an income limit for making ROTH IRA conversions.
PLANNING TIP: When to use this type of planning:
- When income declines in the current year, due to reduction of income from salary.
- When retirement income in less than your prior working income.
- When your business (non-C Corporation) income produces a net-operating loss (NOL) for the year. Convert enough IRA income to reduce your taxable income to zero after considering the standard deduction.
- When the IRA investment suffers a large decline in value.
IRA Contribution Age Limit: In prior Law you could only contribute to an IRA until age 70 ½ if you otherwise qualified, now there is no age limit thanks to the SECURE Act.
Use Of FSA and HSA Plans: Consider increasing the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year. If you become eligible in December of 2020 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA contributions for 2020. The HSA 2020 limits are; $3,550 for self-only coverage and $7,100 for family coverage. People age 55 or older get $1,000 more.
(IRC 106, 220 and 223) Effective for distributions from HSAs and Archer MSAs for amounts paid after December 31, 2019, and reimbursements from Health FSAs and HSAs for expenses incurred after December 31, 2019, qualified medical expenses are no longer limited to those medicines and drugs that are prescribed by a physician. Thus all medicines and drugs can be reimbursed tax free without a prescription or recommendation by a physician. Over-the-counter medicines and drugs include amounts paid for menstrual care products.
Review Your Investment Portfolio For Possible Tax Savings Adjustments: If you are considering taking profits in your portfolio, then make sure that you balance gains and losses to reduce the tax. Now is the time to reduce underperforming investments as an offset against the winners. Remember losses offset gains dollar for dollar, any excess losses are deductible up to $3,000 any balance must be carried forward until used up or your death whichever comes first.
PLANNING TIPS: If you hold under performing stock positions and have an unrealized loss, you could sell the stock experiencing a capital loss and then repurchase the same stock after 31 days and avoid the WASH LOSS rules. If repurchased prior to 31 days, then your stock price gets adjusted and no loss is recognized.
Gifting To Avoid Gift Tax: Consider making gifts sheltered by the annual gift tax exclusion before the end of the year if doing so may save gift or estate taxes. The exclusion applies to gifts up to $15,000 made in 2020 to each of an unlimited number of individuals. There is an unlimited transfer directly to educational institutions for tuition (not considered a gift), or unlimited transfer to medical care providers (not considered a gift). You cannot carryover unused exclusions from one year to the next. Such transfers may save family income taxes where income earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
PLANNING TIP: Many may prefer CASH, however, consider appreciated stocks, mutual funds or other appreciated assets. Remember the transfer of these assets are transferred at FMV so keep the FMV at $15,000 or under. The basis of the asset transfers as well. Example; you own a stock position that has a market value of $15,000 with a cost basis of $5,000 for a gain of $10,000, and you transfer to an individual that is in a ZERO capital gains bracket then the $10,000 gain would not be taxable. Remember there are three capital gains brackets; 0%, 15%, and 20% depending upon your adjusted gross income. For 2020 Maximum Capital Gains/ Qualified Dividends Tax Rate Breakpoints:
MFJ or QW Maximum rate = 0% at $80,000 or less
MFJ or WQ Maximum rate = 15% at $496,600 or less
Single Maximum rate = 0% = at $40,000 or less
Single Maximum rate = 15% at $441,450 or less
HOH Maximum rate = 0% at 53,600 or less
HOH Maximum rate = 15% at $469,050 or less
NOTE: Capital gains/qualified dividends above the 15% breakpoint are taxed at 20%, unless the 25% or 29% rates apply.
Divorce Under The Tax Cuts and Jobs Act (TCJA): Tax reform changes the alimony game. TCJA eliminates tax deductions for alimony payments that are required under post 2018 divorce agreements. More specifically, the TCJA new denial of alimony tax deductions applies to payments required by divorce or separation agreements; 1,) Executed after December 31, 2018, or 2.) Modified after that date, if the modification specifically states that the new TCJA treatment of alimony payments now applies. When alimony payments are not deductible by the person paying them, they are not taxable to the one receiving the payments.
Education Planning Changes: There are two ways to help your kids or grandkids with their education.
- Contributing to a 529 plan is one option, you can shelter from gift tax as much as $75,000 in a single year per beneficiary ($150,000 if your spouse joins in). If you contribute the maximum, you will be treated as gifting $15,000 (or $30,000) per beneficiary in 2020 and in each of the next four years. Payments are excluded from your estate as long as you live through the fifth year. PLANNING TIP: Now the 529 Plans are not just for college, tax free distributions of up to $10,000 can now be taken each year to help pay for private parochial K-12 tuition. The $10,000 cap does not apply to 529 plan withdrawals to pay for college.
- Paying a person’s tuition directly to the school is tax-favored, too. The payment is not treated as gift for purposes of the gift tax rules.
Remember The Sunset Rules for Gift and Estate Taxes: Continuing the planning conversation about gifting, the current increased estate, gift, and generation-skipping transfer tax exclusions under TCJA are scheduled to sunset effective January 1, 2026 (or potentially sooner, depending upon the outcome of the 2020 presidential election. If this law is not extended then it defaults to the rules in place in 2010 adjusted for inflation. Why is this important? Because currently the estate and gift tax exclusion is $11,580,000 and that drops back to $5,000,000 adjusted for inflation, therefore, gifting large amounts now may be very important for large estates.
Charitable Contribution Limits Changed: Prior to 2018 cash contributions were limited to 50% of your adjusted gross income, any excess got carried over for up to the next 5 years then lost if unused. The 50 % limit is now 60% for years after 2017, however, The CARES Act increased that to 100% for 2020.
Charitable Deduction Without Itemizing: (The CARES Act) Effective for 2020, up to $300 of qualified charitable contribution are deductible as above-the-line deduction in calculating AGI without the taxpayer having to itemize deductions.
Home Mortgage Interest: IRC Sec 163(h) prior to TCJA you could deduct interest payments on up to $1 million in acquisition indebtedness and up to $100,000 of home equity interest. Now, for tax years 2018 through 2026: 1,) You can deduct interest payments on up to $750,000 in acquisition indebtedness for homes purchased after December 14, 2017, 2,) You can deduct up to $100,000 of home equity interest, but only if funds are used to buy, build, or substantially improve the home.
Hobby Deductions: IRC Sec 183 Hobby expenses could be deducted as miscellaneous itemized deductions subject to the 2 percent-of-AGI threshold. Now, hobby expenses that don’t qualify as cost of sales are not deductible.
OTHER TAX ISSUES
Who Pays What Of Our Federal Income Tax: The IRS released the 2017 “share of income and share of Federal Income Taxes Paid” report: As of the date of this letter, I do not have the 2018 data.
Top 1% income earners with AGI of $515,371 or greater paid 38.47% of tax
Top 5% income earners with AGI of $208,053 or greater paid 59.14% of tax
Top 10% income earners with AGI of $145,135 or greater paid 70.08% of tax
Top 25% income earners with AGI of $83,682 or greater paid 86.1% of tax
Top 50% income earners with AGI of $41,740 or greater paid 96.89% of tax
Bottom 50% income earners with AGI of less than $41,740 paid 3.11% of tax
NOTE: In the 2016 report to be in the top 1% of income earners your AGI was $480,804 or above and to be in the bottom 50% your AGI had to be below $40,078.
The question is always in our “progressive system” of taxation, how much should someone that makes more than me be paying for the benefits that we all have? What is really fair? The percentage is relative, if the country needs more money to operate, then collect it from someone other than me, is how many feel.
If you wish to know where you fit into this system, just go to your 2017 income tax return and look at your Adjust Gross Income (AGI) then you will know.
The Tax Code’s Compliance Burden: According to an analysis of data reported by the Office of Information and Regulatory Affairs (OIRA), altogether, complying with the Tax Code in 2018 consumed 8.02 billion hours for recordkeeping, learning about the law, filling out the required forms and schedules, and submitting information to the Internal Revenue Service (IRS). The opportunity Cost of the Time Burden is estimated at $273.18 billion, the Out of Pocket Cost Associated with Tax Forms another $91.36 Billion for a total of $364.54 billion. That is approximately 18 cents for every dollar collected just on compliance. Source: National Taxpayers Union Foundation Analysis of OIRA and BLS Data
Social Security COLA Increase: Given that Social Security is our country’s most successful social program, and that 62% of retired workers are netting at least half of their income from their Social Security benefit, The increase (COLA) for 2021 is 1.3%. Enjoy the raise!
This letter will be posted on the Web Site: www.whalengroup.com. Please share with friends, that’s the greatest compliment I can receive.
I wish all my clients, friends and family a Very Happy Thanksgiving. We have so much to be thankful for here in America yet it is also a time to remember those less fortunate, those suffering from illness (especially COVID-19), storms, fires, and other issues. Happy Thanksgiving to all.
Al Whalen, EA, ATA, CFP®
The Tax Book Social Security COLA Increase
The Tax Cuts and Jobs Act of 2017
The CARES Act of 2020
The Secure Act of 2020
The Tax Foundation
Internal Revenue Code and Regulation
IRS, Statistics of Income, Individual Income Rates and Tax Shares (2019)
The Bradford Tax Institute
National Taxpayers Union Foundation
The Tax Book