You still have time to significantly reduce this year’s business income tax bill — even with all the uncertainty about which proposed federal income tax changes, if any, will become reality. Here are some moves for business owners to consider, but stay tuned for developments.
Claim 100% first-year bonus depreciation for late-breaking asset additions
Thanks to the 2017 Tax Cuts and Jobs Act (TCJA), 100% first-year bonus depreciation is available for qualified new and used assets that are placed in service (put into business use) in calendar year 2021. That means your business might be able to write off the entire cost of some or all of your 2021 asset additions on this year’s federal income tax return and maybe on the state return too.
So, consider making additional acquisitions between now and December 31. Contact your tax pro for details on the 100% first-year bonus depreciation break and exactly which assets qualify.
Caveat: If significant tax-rate increases are enacted for 2022 and beyond, you could be better off forgoing 100% first-year bonus depreciation and instead depreciating newly acquired assets over a number of years. If tax rates go up, those future depreciation write-offs could be worth more than a current-year 100% write-off. Fortunately, you have until the deadline for filing your current-year federal income tax return, including any extension, to decide which course to take. If your business uses the calendar year for tax purposes, the extended filing deadline is 10/17/22 for a sole proprietorship’s Form 1040 or a C corporation’s Form 1120. The extended deadline is 9/15/22 for a partnership’s Form 1065, an LLC taxed as a partnership’s Form 1065, or an S corporations’ Form 1120-S. So, I recommend extending your return to have maximum flexibility to react to developments.
Claim 100% first-year bonus depreciation for late-breaking real estate qualified improvement property (QIP) expenditures
The 100% first-year bonus depreciation break is also available for commercial real estate qualified improvement property (QIP) that’s placed in service this year. QIP is defined as an improvement to an interior portion of a non-residential building that’s installed after the date the building was placed in service. However, QIP does not include expenditures: (1) to enlarge a building, (2) for any elevator or escalator, or (3) for any internal structural framework of a building.
Caveat: Same as above.
Write off new or used heavy SUV, pickup, or van
The 100% first-year bonus depreciation break can have a big tax-saving impact for new and used heavy vehicles used over 50% for business. That’s because heavy SUVs, pickups, and vans are treated for federal income tax purposes as transportation equipment. In turn, that means they qualify for 100% first-year bonus depreciation. Specifically, 100% bonus depreciation is available when the SUV, pickup, or van has a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds. You can verify a vehicle’s GVWR by looking at the manufacturer’s label, which is usually found on the inside edge of the driver’s side door where the door hinges meet the frame. If you’re considering buying a heavy vehicle, placing it in service before yearend could deliver a big write-off on this year’s return.
Micromanage business income and deductions for multi-year tax savings
If you conduct your business using a pass-through entity — meaning a sole proprietorship, S corporation, partnership, or LLC taxed as a partnership — your shares of the business’s tax items are passed through to you and reflected on your personal Form 1040. So, any passed-through net income will be taxed at your personal federal income tax rates. Those rates may or may not be higher next year, and you may or may not know the answer by the end of this year. So, for 2021 yearend tax planning purposes, you can only place your bets, act accordingly, and hope for the best.
If, as yearend approaches, you optimistically believe you will be in the same or lower federal income tax bracket in 2022, the traditional strategy of deferring taxable income into next year while accelerating deductible expenditures into this year makes sense. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2021 until 2022. See below for some ways to defer income.
On the other hand, if you expect to be in a higher tax bracket in 2022, take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2022. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate.
Advice: As yearend draws nigh, we may still not know about next year’s tax rates. So be ready to make last-minute tax planning moves right up until the big ball begins its descent. If we know next year’s tax rates sooner, great. But don’t count on it.
Maximize deduction for pass-through business income
The deduction based on an individual’s qualified business income (QBI) from pass-through entities was a major element of the TCJA. The deduction can be up to 20% of a pass-through entity owner’s QBI, subject to restrictions that can apply at higher income levels and another restriction based on your taxable income. For QBI deduction purposes, pass-through entities are defined as sole proprietorships, single-member LLCs that are treated as sole proprietorships for tax purposes, partnerships, LLCs that are treated as partnerships for tax purposes, and S corporations.
You can also claim the QBI deduction for up to 20% of qualified REIT dividends and up to 20% of qualified income from publicly-traded partnerships.
Because of the limitations on the QBI deduction, tax planning moves (or non-moves) can unexpectedly increase or decrease your allowable QBI deduction. For example, yearend moves that reduce this year’s taxable income can have the negative side effect of reducing this year’s QBI deduction. Work with your tax pro to optimize your tax outcome.
Advice: Once again, be ready to make last-minute moves right up until December 31.
Establish a tax-favored retirement plan
If your business doesn’t already have a retirement plan set up to benefit you, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions. For example, if you’re self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $58,000 for 2021. If you’re employed by your own corporation, up to 25% of your salary can be contributed to your account, with a maximum contribution of $58,000. If you’re in the 32% federal income tax bracket, making a maximum contribution could cut what you owe Uncle Sam for 2021 by a whopping $18,560.
Other small business retirement plan options include the 401(k) plan which can even be set up for just one person (a so-called solo 401(k)), the defined benefit pension plan, and the SIMPLE-IRA. Depending on your circumstances, these other types of plans may allow bigger deductible contributions.
Thanks to a change made by the 2019 SECURE Act, tax-favored qualified employee retirement plans, except for SIMPLE-IRA plans, can now be adopted by the due date (including any extension) of the employer’s federal income tax return for the adoption year. The plan can then receive deductible employer contributions that are made by the due date (including any extension), and the employer can deduct those contributions on the return for the adoption year.
Key Point: This SECURE Act does not change the deadline to establish a SIMPLE-IRA plan. It remains October 1 of the year for which the plan is to take effect. Also, this SECURE Act change does not override rules that require certain plan provisions to be in effect during the plan year, such as the provisions that cover employee elective deferral contributions (salary-reduction contributions) under a 401(k) plan. The plan must be in existence before such employee elective deferral contributions can be made.
Example: The deadline for setting up a SEP-IRA for a sole proprietorship business that uses the calendar year for tax purposes and making the initial deductible contribution for the 2021 tax year is 10/17/22 if you extend your 2021 Form 1040 to that date. The deadline for the deadline contribution for your 2021 tax year is also 10/17/22. However, to make a SIMPLE-IRA contribution for the 2021 tax year, you must have set up the plan by October 1. So, you might have to wait until next year if the SIMPLE-IRA option is appealing.
Advice: While you have until next year to establish a tax-favored retirement plan (except for a SIMPLE-IRA), why not just get it done this year as part of your yearend tax planning drill? Contact your tax pro for more information on small business retirement plan alternatives, and be aware that if your business has employees, you may have to make contributions for them too.
The bottom line
The yearend tax planning moves outlined here could turn out to be better or worse ideas, depending on what happens in DC. I’m guessing there won’t be any negative retroactive tax changes that take effect this year, and that any negative changes scheduled for future years won’t be as expensive as some folks think. In other words, I’m semi-optimistic. Am I nuts? Time will tell. Stay tuned.
Sidebar: How to defer business taxable income
Most small businesses are allowed to use cash-method accounting for tax purposes. Assuming your business is eligible, cash-method accounting allows you to micro-manage your 2021 and 2022 business taxable income in order to, hopefully, minimize taxes over the two-year period. Say you expect your business income will be taxed at the same or lower rate next year. I hope you’re right. With that big assumption in place, here are specific cash-method moves to defer some taxable income until 2022.
Charge recurring expenses that you would normally pay early next year on credit cards. You can claim 2021 deductions even though the credit card bills won’t actually be paid until 2022.
Pay expenses with checks and mail them a few days before yearend. The tax rules say you can deduct the expenses in the year you mail the checks, even though they won’t be cashed or deposited until early next year. For big-ticket expenses, consider sending checks via registered or certified mail, so you can prove they were mailed this year.
Before yearend, prepay some expenses. As long as the economic benefit from the prepayment does not extend beyond the earlier of: (1) 12 months after the first date on which your business realizes the benefit of the expenditure or (2) the end of the next tax year. For example, this rule allows you to claim 2021 deductions for prepaying the first three months of next year’s office rent or prepaying the premium for property insurance coverage for the first half of next year.
On the income side, the general rule for cash-basis businesses is that you don’t have to report income until the year you receive cash or checks in hand or through the mail. To take advantage of this rule, consider waiting until near yearend to send out some invoices to customers. That will defer some income until 2022, because you won’t collect the money until early next year. Of course, this idea only makes sense for your best-paying customers.