Keys to Year-End Tax Savings for Businesses

Source: BDO

Whatever
2021 holds, these tips can help lower your tax liability

2020 has been an unpredictable year. Businesses have faced all-encompassing challenges ranging from protecting employee health and safety to managing unexpected costs to dealing with severe fluctuations in supply and demand for products and services. Some businesses were able to enter new markets and achieve fresh levels of growth, while others had to make tough choices just to endure.

The outlook for 2021 is uncertain. While COVID-19 continues to surge through the U.S., a new administration is preparing to take office, and control of the Senate—which will have major implications for the future of tax reform—remains undecided. In this environment, many businesses are left wondering which strategies will be effective to help lower their tax liability and increase savings.

Regardless of which stage of recovery your business is in, or what is on the horizon, consider whether any of the year-end tax strategies outlined below could help your business start off 2021 on the right track.

When determining which strategies to leverage, a business should consider whether it expects one of the following scenarios to occur:2020 has been an unpredictable year. Businesses have faced all-encompassing challenges ranging from protecting employee health and safety to managing unexpected costs to dealing with severe fluctuations in supply and demand for products and services. Some businesses were able to enter new markets and achieve fresh levels of growth, while others had to make tough choices just to endure.2020 has been an unpredictable year. Businesses have faced all-encompassing challenges ranging from protecting employee health and safety to managing unexpected costs to dealing with severe fluctuations in supply and demand for products and services. Some businesses were able to enter new markets and achieve fresh levels of growth, while others had to make tough choices just to endure.

The outlook for 2021 is uncertain. While COVID-19 continues to surge through the U.S., a new administration is preparing to take office, and control of the Senate—which will have major implications for the future of tax reform—remains undecided. In this environment, many businesses are left wondering which strategies will be effective to help lower their tax liability and increase savings.

Regardless of which stage of recovery your business is in, or what is on the horizon, consider whether any of the year-end tax strategies outlined below could help your business start off 2021 on the right track.

When determining which strategies to leverage, a business should consider whether it expects one of the following scenarios to occur:

1. Income is constant or lower in
   2021 than in 2020, or tax rates are expected to remain constant or
   decrease as compared to 2020.
2. Income is higher in 2021 than in
   2020, or income tax rates are expected to increase as compared to 2020.

Scenario 1: Income or income tax rates are expected to be
constant or decrease in 2021

Defer Income: If
income or tax rates are expected to remain the same or drop in 2021, businesses
may wish to defer income to 2021, given the time value of money or given that
the income would be taxed at a lower rate than it would if the income were
recognized in 2020. For cash-basis taxpayers, which recognize revenue and
expenses at the time money is actually exchanged, deferring income is fairly
easy as taxpayers can delay sending bills until 2021. For accrual-basis
taxpayers—where revenue and expenses are recognized when earned or
incurred—deferral of income can be more complex. However, the 2017 tax reform
bill known as the Tax Cuts and Jobs Act (TCJA) amended the rules governing when
an accrual-basis taxpayer should recognize income, i.e., such taxpayers can
choose an accounting method that allows the business to report the advance
payment amount as gross income as of the time that amount is reflected as
revenue on the taxpayer’s applicable financial statements. This provision
effectively allows for a one-year deferral for the reporting of advance
payments.



Accelerate
Deductions: Companies may
wish to make payments on expenses that would be deductible in 2020 rather than
2021. For cash-basis taxpayers, paying their bills quickly and using credit to
cover deductible expenses is one way to ensure those purchases take place
before the end of 2020. Again, for accrual-basis taxpayers, this is more
complicated, but not impossible with the right accounting strategies.



Expense
Capital Assets: Taxpayers
should consider reviewing their capitalized costs on their balance sheets such
as prepaid expenses or software development costs and consider possible changes
to accounting methods. Also, given the new liberalized bonus deprecation rules,
businesses could look to place tangible assets in service by December 31, 2020
that could secure an immediate deduction for 2020.



Close
on Taxable Business Acquisitions: Taxpayers
looking to make business acquisitions that would result in part of the purchase
price being allocated to tangible personal property, such as machinery,
computers or other equipment, may wish to try to do so before the end of 2020
so they can expense the purchase immediately and claim a deduction on their
tangible personal property tax in 2020 rather than in 2021. The TCJA amended
the rules to allow bonus depreciation for used property with a MACRS life of 20
years or less.

 

Scenario 2: Taxable income or the income tax rate is expected to
increase in 2021

Accelerate Income: When a
taxpayer expects to be taxed at a higher rate in the next year, the strategies
discussed in Scenario 1 are reversed. In this case, rather than deferring
income to 2021, a taxpayer may wish to recognize income before 2020 ends, so that
it is taxed at the presumed lower rate. Accrual-basis taxpayers might be able
to accelerate income by completing work contracts and billing clients or
customers before the end of 2020. Cash-basis businesses simply need
constructive receipt (i.e., the funds are under their control) of payment
before year end to recognize income in 2020.  



Deduct
Deferrals: While
accelerating income, taxpayers should ascertain whether it is possible to defer
taxable expenses until 2021 or simply defer placing 2020 purchases in service
until 2021 when their overall income tax rate is higher, for example, by
delaying placing purchases in service for equipment or supplies that will
generate a deduction in the following year.



Capitalize
Assets: With respect to
capitalized assets, taxpayers may wish to consider waiting to place assets in
service until after December 31, 2020 to postpone any resulting deductions.



Delay
Business Acquisitions: Businesses
should consider delaying until 2021 the completion of any acquisitions that
could result in a tangible personal property deduction.

 

Other Year-End Tax Strategies to Consider

• R&D Tax Credit: A company that has dedicated
  resources to developing new or improving existing products, processes or
  software may qualify for the R&D tax credit, which could result in
  significant tax savings. Taxpayers seeking to maximize the benefit of
  immediately deducting R&D expenditures should consider the effective
  date of the required amortization rule (i.e., December 31, 2021) and, if
  possible, accelerate their R&D activities prior to 2022.   
• Section 199A: Certain non-corporate taxpayers
  may be entitled to a deduction of up to 20% of their qualified business
  income. Pass-through businesses may be able to increase the Section 199A
  deduction by increasing W-2 wages before the end of 2020.
• Bonus Planning: There may be opportunities for
  a business to claim deductions on bonuses or postpone them until 2021,
  depending on the individual taxpayer’s situation. An accrual basis
  corporation can take a deduction for its current tax year for a bonus not
  actually paid to its employee until the following tax year if:
  • The employee does not own more
    than 50% in value of the corporation’s stock,
  • The bonus is properly accrued on
    its books before the end of the current tax year,
  • The overall bonus pool is fixed
    at year-end, and
  • The bonus is actually paid
    within the first two and a half months of the following tax year (for a
    calendar year taxpayer, no later than the first half of March 2021).

For cash-basis employees, the bonus will not be taxable
income until the following year. 

• S Corporation Planning: Consider advancing funds to the
  business in the form of capital or a loan to increase the tax basis of the
  shareholder to allow for losses by creating sufficient tax basis before
  the end of 2020. Also, consider advising shareholders how much additional
  time needs to be spent before the end of the year working in the business
  to avoid application of the passive activity loss rules.
• Partnership Losses: A partner’s share of
  partnership losses is deductible only to the extent of his or her
  partnership basis at the end of the year in which the loss is incurred.
  The basis amount can be increased by a capital contribution, which
  increases the partner’s share of partnership liabilities, but a decrease
  in a partner’s share of the partnership liability will reduce basis. While
  all liability allocations increase basis for distribution purposes,
  recourse or at-risk liabilities increase tax basis for loss purposes.
• Timing Distributions of
  Appreciated Property: Delaying
  a distribution of appreciated property or a corporate liquidation into
  2021 can defer taxes on that distribution for an entire year.
• Increase Business Interest
  Deductions: Review
  the options for taking advantage of the benefits of the Coronavirus Aid,
  Relief, and Economic Security (CARES) Act, as well as regulations on the
  deduction of business interest expense. These options include
  increasing the percentage multiplied against adjusted taxable income from
  30% to 50% for most taxpayers in 2019 and all taxpayers in 2020.
• Section 382 Studies: Certain techniques are available
  to increase the annual limitation on net operating losses.
• Entity Simplification or
  Restructuring: In
  the context of closely held businesses, taxpayers can increase their tax
  basis for loss utilization and tax-free distributions and allow for
  additional interest expense by combining income in a closely held context.
  In the context of large corporate entity structures, entity simplification
  or restructuring could help to identify worthless stock deductions for a
  domestic subsidiary in a consolidated or affiliated group context, and for
  foreign subsidiaries.
• Transaction Cost Analysis: Most taxpayers incur many
  fees for all types of merger and acquisition transactions, as well as for
  the raising of capital and debt exchanges. Millions of dollars of
  otherwise capitalized and non-deductible losses could be freed up and
  utilized immediately to offset taxable income for the year or to create a
  net operating loss.
• Qualified Small Business Stock: Qualifying taxpayers can
  exclude gains of up to the greater of $10 million or 10 times their tax
  basis for stock that has been held for five years and that otherwise meets
  all the corporate qualifications.
• IRS Account and Interest Recovery
  Services: Consider
  undertaking a project to identify potential IRS errors in processes and
  posting payments and to recover misapplied payments and interest as tax
  savings in this area could offset other year-end tax costs.

This article outlines some—but not all—considerations for
year-end tax planning. A trusted advisor can help businesses determine which
strategies would be effective in helping them lower their total tax
liability for the year ahead.

For any questions regarding this article etc, kindly contact
Larry Miao (smiao@bdo.com)