The best choice of entity can affect your business in several ways, including the amount of your tax bill. In some cases, businesses decide to switch from one entity type to another. Although S corporations can provide substantial tax benefits over C corporations in some circumstances, there are potentially costly tax issues that you should assess before making the decision to convert from a C corporation to an S corporation.
Here are four issues to consider:
1. LIFO inventories. C corporations that use last-in, first-out (LIFO) inventories must pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.
2. Built-in gains tax. Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within five years after the conversion. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.
3. Passive income. S corporations that were formerly C corporations are subject to a special tax. It kicks in if their passive investment income (including dividends, interest, rents, royalties, and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.
4. Unused losses. If your C corporation has unused net operating losses, they can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.
When a business switches from C to S status, these are only some of the factors to consider. For example, shareholder-employees of S corporations can’t get all of the tax-free fringe benefits that are available with a C corporation. And there may be issues for shareholders who have outstanding loans from their qualified plans. These factors have to be taken into account in order to understand the implications of converting from C to S status.
If you’re interested in an entity conversion, contact us. We can explain what your options are, how they’ll affect your tax bill and some possible strategies you can use to minimize taxes.
Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2021. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
February 1 (The usual deadline of January 31 is a Sunday)
March 1 (The usual deadline of February 28 is a Sunday)
Are you considering replacing a car that you’re using in your business? There are several tax implications to keep in mind.
A cap on deductions
Cars are subject to more restrictive tax depreciation rules than those that apply to other depreciable assets. Under so-called “luxury auto” rules, depreciation deductions are artificially “capped.” So is the alternative Section 179 deduction that you can claim if you elect to expense (write-off in the year placed in service) all or part of the cost of a business car under the tax provision that for some assets allows expensing instead of depreciation. For example, for most cars that are subject to the caps and that are first placed in service in calendar year 2020 (including smaller trucks or vans built on a truck chassis that are treated as cars), the maximum depreciation and/or expensing deductions are:
The effect is generally to extend the number of years it takes to fully depreciate the vehicle.
The heavy SUV strategy
Because of the restrictions for cars, you might be better off from a tax standpoint if you replace your business car with a heavy sport utility vehicle (SUV), pickup or van. That’s because the caps on annual depreciation and expensing deductions for passenger automobiles don’t apply to trucks or vans (and that includes SUVs). What type of SUVs qualify? Those that are rated at more than 6,000 pounds gross (loaded) vehicle weight.
This means that in most cases you’ll be able to write off the entire cost of a new heavy SUV used entirely for business purposes as 100% bonus depreciation in the year you place it into service. And even if you elect out of bonus depreciation for the heavy SUV (which generally would apply to the entire depreciation class the SUV belongs in), you can elect to expense under Section 179 (subject to an aggregate dollar limit for all expensed assets), the cost of an SUV up to an inflation-adjusted limit ($25,900 for an SUV placed in service in tax years beginning in 2020). You’d then depreciate the remainder of the cost under the usual rules without regard to the annual caps.
The tax benefits described above are all subject to adjustment for non-business use. Also, if business use of an SUV doesn’t exceed 50% of total use, the SUV won’t be eligible for the expensing election, and would have to be depreciated on a straight-line method over a six-tax-year period.
Contact us if you’d like more information about tax breaks when you buy a heavy SUV for business.
When it comes to taxes, December 31 is more than just New Year’s Eve. That date will affect the filing status box that will be checked on your 2020 tax return. When filing a return, you do so with one of five tax filing statuses. In part, they depend on whether you’re married or unmarried on December 31.
More than one filing status may apply, and you can use the one that saves the most tax. It’s also possible that your status could change during the year.
Here are the filing statuses and who can claim them:
How to qualify as “head of household”
In general, head of household status is more favorable than filing as a single taxpayer. To qualify, you must “maintain a household” that, for more than half the year, is the principal home of a “qualifying child” or other relative that you can claim as your dependent.
A “qualifying child” is defined as one who:
If a child’s parents are divorced, different rules may apply. Also, a child isn’t eligible to be a “qualifying child” if he or she is married and files a joint tax return or isn’t a U.S. citizen or resident.
There are other head of household requirements. You’re considered to maintain a household if you live in it for the tax year and pay more than half the cost. This includes property taxes, mortgage interest, rent, utilities, property insurance, repairs, upkeep, and food consumed in the home. Don’t include medical care, clothing, education, life insurance or transportation.
Under a special rule, you can qualify as head of household if you maintain a home for a parent even if you don’t live with him or her. To qualify, you must claim the parent as your dependent.
Determining marital status
You must generally be unmarried to claim head of household status. If you’re married, you must generally file as either married filing jointly or married filing separately — not as head of household. However, if you’ve lived apart from your spouse for the last six months of the year, a qualifying child lives with you and you “maintain” the household, you’re treated as unmarried. In this case, you may qualify as head of household.
Contact us if you have questions about your filing status. Or ask us when we prepare your return.
You may be able to deduct some of your medical expenses, including prescription drugs, on your federal tax return. However, the rules make it hard for many people to qualify. But with proper planning, you may be able to time discretionary medical expenses to your advantage for tax purposes.
Itemizers must meet a threshold
For 2020, the medical expense deduction can only be claimed to the extent your unreimbursed costs exceed 7.5% of your adjusted gross income (AGI). This threshold amount is scheduled to increase to 10% of AGI for 2021. You also must itemize deductions on your return in order to claim a deduction.
If your total itemized deductions for 2020 will exceed your standard deduction, moving or “bunching” nonurgent medical procedures and other controllable expenses into 2020 may allow you to exceed the 7.5% floor and benefit from the medical expense deduction. Controllable expenses include refilling prescription drugs, buying eyeglasses and contact lenses, going to the dentist and getting elective surgery.
In addition to hospital and doctor expenses, here are some items to take into account when determining your allowable costs:
Costs for dependents
You can deduct the medical costs that you pay for dependents, such as your children. Additionally, you may be able to deduct medical costs you pay for other individuals, such as an elderly parent. Contact us if you have questions about medical expense deductions.
If you’re self-employed and don’t have withholding from paychecks, you probably have to make estimated tax payments. These payments must be sent to the IRS on a quarterly basis. The fourth 2020 estimated tax payment deadline for individuals is Friday, January 15, 2021. Even if you do have some withholding from paychecks or payments you receive, you may still have to make estimated payments if you receive other types of income such as Social Security, prizes, rent, interest, and dividends.
You must make sufficient federal income tax payments long before the April filing deadline through withholding, estimated tax payments, or a combination of the two. If you fail to make the required payments, you may be subject to an underpayment penalty, as well as interest.
In general, you must make estimated tax payments for 2020 if both of these statements apply:
If you’re a sole proprietor, partner or S corporation shareholder, you generally have to make estimated tax payments if you expect to owe $1,000 or more in tax when you file your return.
Quarterly due dates
Estimated tax payments are spread out through the year. The due dates are April 15, June 15, September 15 and January 15 of the following year. However, if the date falls on a weekend or holiday, the deadline is the next business day.
Estimated tax is calculated by factoring in expected gross income, taxable income, deductions and credits for the year. The easiest way to pay estimated tax is electronically through the Electronic Federal Tax Payment System. You can also pay estimated tax by check or money order using the Estimated Tax Payment Voucher or by credit or debit card.
Most individuals make estimated tax payments in four installments. In other words, you can determine the required annual payment, divide the number by four and make four equal payments by the due dates. But you may be able to make smaller payments under an “annualized income method.” This can be useful to people whose income isn’t uniform over the year, perhaps because of a seasonal business. You may also want to use the annualized income method if a large portion of your income comes from capital gains on the sale of securities that you sell at various times during the year.
Determining the correct amount
Contact us if you think you may be eligible to determine your estimated tax payments under the annualized income method, or you have any other questions about how the estimated tax rules apply to you.
It’s been estimated that there are roughly 5 million family-owned businesses in the United States. Annually, these companies make substantial contributions to both employment figures and the gross domestic product. If you own a family business, one important issue to address is how to best weave together your succession plan with your estate plan.
Rise to the challenge
Transferring ownership of a family business is often difficult because of the distinction between ownership and management succession. From an estate planning perspective, transferring assets to the younger generation as early as possible allows you to remove future appreciation from your estate, minimizing any estate taxes. However, you may not be ready to hand over control of your business or you may feel that your children aren’t yet ready to run the company.
There are various ways to address this quandary. You could set up a family limited partnership, transfer nonvoting stock to heirs or establish an employee stock ownership plan.
Another reason to separate ownership and management succession is to deal with family members who aren’t involved in the business. Providing such heirs with nonvoting stock or other equity interests that don’t confer control can be an effective way to share the wealth with them while allowing those who work in the business to take over management.
Consider an installment sale
An additional challenge to family businesses is that older and younger generations may have conflicting financial needs. Fortunately, strategies are available to generate cash flow for the owner while minimizing the burden on the next generation.
For example, consider an installment sale. These transactions provide liquidity for the owner while improving the chances that the younger generation’s purchase can be funded by cash flows from the business. Plus, so long as the price and terms are comparable to arm’s-length transactions between unrelated parties, the sale shouldn’t trigger gift or estate taxes.
Explore trust types
Or, you might want to create a trust. By transferring business interests to a grantor retained annuity trust (GRAT), for instance, the owner obtains a variety of gift and estate tax benefits (provided he or she survives the trust term) while enjoying a fixed income stream for a period of years. At the end of the term, the business is transferred to the owner’s children or other beneficiaries. GRATs are typically designed to be gift-tax-free.
There are other options as well, such as an installment sale to an intentionally defective grantor trust (IDGT). Essentially a properly structured IDGT allows an owner to sell the business on a tax-advantaged basis while enjoying an income stream and retaining control during the trust term. Once the installment payments are complete, the business passes to the owner’s beneficiaries free of gift taxes.
Protect your legacy
Family-owned businesses play an important role in the U.S. economy. We can help you integrate your succession plan with your estate plan to protect both the company itself and your financial legacy.
Hinkle Richter & Rhine, LLP is proud to be an environmentally certified sustainable company.
What does this mean? It means that when we say “Guiding Clients Down the Right Path”, we walk the talk.
The Edenark Group ISO 14001 environmental sustainability certification program is the world’s premier sustainability standard, used by organizations around the world, that care about all current, and future, stakeholders.
The program helps the organization define how it interacts internally, externally, and with the environment. It incorporates energy/waste/water/materials management and reduction, employee health and performance enhancement, community involvement, procurement and suppliers, compliance and regulations, emergency/security, and stakeholder engagement. Benefits include creating a culture of continual improvement, stakeholder engagement, lower costs, higher revenues and profits, improved employee performance, and, most importantly,...... doing something good for current and future generations.
“When you have served a community for forty years, you have deep roots and a perspective that only comes from experience. We want our organization to be the best it can be; and we care about our team, our clients, the community, and future generations,” said Darryl Hinkle, Managing Partner of Hinkle, Richter & Rhine. “As accountants and business advisors, we are always looking for ways to improve an organization, be it ours or our clients’. This program is designed to accomplish our financial goals of lower costs, higher revenues and profits, and improved team health and performance. But, we look beyond that and see this program being consistent with how we choose to lead by example; and how we wish to be viewed, in our community, by our clients and by our peers,” added Hinkle.
“When an organization pursues, and attains, the Edenark Group ISO 14001 sustainability certification, they are not just doing it to see their costs go down and revenues and profits go up. They are setting a higher bar for their organization and sending a signal to all those around them,” says David Goodman, CEO of Edenark Group. “They are not just changing out a few light bulbs and calling it a day. They are agreeing to adhere to the world’s Gold standard for sustainability certification and are joining an elite fraternity of over 300,000 organizations, in over 150 countries, that have committed to continually improving in every way, for the benefit of all of us today, and all of us tomorrow.”
S corporations can provide tax advantages over C corporations in the right circumstances. This is true if you expect that the business will incur losses in its early years because shareholders in a C corporation generally get no tax benefit from such losses. Conversely, as an S corporation shareholder, you can deduct your percentage share of these losses on your personal tax return to the extent of your basis in the stock and any loans you personally make to the entity.
Losses that can’t be deducted because they exceed your basis are carried forward and can be deducted by you when there’s sufficient basis.
Therefore, your ability to use losses that pass through from an S corporation depends on your basis in the corporation’s stock and debt. And, basis is important for other purposes such as determining the amount of gain or loss you recognize if you sell the stock. Your basis in the corporation is adjusted to reflect various events such as distributions from the corporation, contributions you make to the corporation and the corporation’s income or loss.
Adjustments to basis
However, you may not be aware that several elections are available to an S corporation or its shareholders that can affect the basis adjustments caused by distributions and other events. Here is some information about four elections:
Contact us if you would like to go over how these elections, as well as other S corporation planning strategies, can help maximize the tax benefits of operating as an S corporation.
Small business owners are well aware of the increasing cost of employee health care benefits. As a result, your business may be interested in providing some of these benefits through an employer-sponsored Health Savings Account (HSA). Or perhaps you already have an HSA. It’s a good time to review how these accounts work since the IRS recently announced the relevant inflation-adjusted amounts for 2021.
The basics of HSAs
For eligible individuals, HSAs offer a tax-advantaged way to set aside funds (or have their employers do so) to meet future medical needs. Here are the key tax benefits:
Key 2020 and 2021 amounts
To be eligible for an HSA, an individual must be covered by a “high deductible health plan.” For 2020, a “high deductible health plan” is one with an annual deductible of at least $1,400 for self-only coverage, or at least $2,800 for family coverage. For 2021, these amounts are staying the same.
For self-only coverage, the 2020 limit on deductible contributions is $3,550. For family coverage, the 2020 limit on deductible contributions is $7,100. For 2021, these amounts are increasing to $3,600 and $7,200, respectively. Additionally, for 2020, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $6,900 for self-only coverage or $13,800 for family coverage. For 2021, these amounts are increasing to $7,000 and $14,000.
An individual (and the individual’s covered spouse, as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2020 and 2021 of up to $1,000.
Contributing on an employee’s behalf
If an employer contributes to the HSA of an eligible individual, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from an employee’s gross income up to the deduction limitation. There’s no “use-it-or-lose-it” provision, so funds can be built up for years. An employer that decides to make contributions on its employees’ behalf must generally make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer doesn’t make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.
Paying for eligible expenses
HSA distributions can be made to pay for qualified medical expenses. This generally means those expenses that would qualify for the medical expense itemized deduction. They include expenses such as doctors’ visits, prescriptions, chiropractic care and premiums for long-term care insurance.
If funds are withdrawn from the HSA for any other reason, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it’s made after reaching age 65, or in the event of death or disability.
As you can see, HSAs offer a flexible option for providing health care coverage, but the rules are somewhat complex. Contact us with questions or if you’d like to discuss offering this benefit to your employees.
Contributing to a tax-advantaged retirement plan can help you reduce taxes and save for retirement. If your employer offers a 401(k) or Roth 401(k) plan, contributing to it is a smart way to build a substantial sum of money.
If you’re not already contributing the maximum allowed, consider increasing your contribution rate. Because of tax-deferred compounding (tax-free in the case of Roth accounts), boosting contributions can have a major impact on the size of your nest egg at retirement.
With a 401(k), an employee makes an election to have a certain amount of pay deferred and contributed by an employer on his or her behalf to the plan. The contribution limit for 2020 is $19,500. Employees age 50 or older by year end are also permitted to make additional “catch-up” contributions of $6,500, for a total limit of $26,000 in 2020.
The IRS recently announced that the 401(k) contribution limits for 2021 will remain the same as for 2020.
If you contribute to a traditional 401(k)
A traditional 401(k) offers many benefits, including:
If you already have a 401(k) plan, take a look at your contributions. Try to increase your contribution rate to get as close to the $19,500 limit (with an extra $6,500 if you’re age 50 or older) as you can afford. Keep in mind that your paycheck will be reduced by less than the dollar amount of the contribution, because the contributions are pretax — so, income tax isn’t withheld.
If you contribute to a Roth 401(k)
Employers may also include a Roth option in their 401(k) plans. If your employer offers this, you can designate some or all of your contributions as Roth contributions. While such contributions don’t reduce your current MAGI, qualified distributions will be tax-free.
Roth 401(k) contributions may be especially beneficial for higher-income earners, because they don’t have the option to contribute to a Roth IRA. Your ability to make a Roth IRA contribution for 2021 will be reduced if your adjusted gross income (AGI) in 2021 exceeds:
Your ability to contribute to a Roth IRA in 2021 will be eliminated entirely if you’re a married joint filer and your 2021 AGI equals or exceeds $208,000 (up from $206,000 for 2020). The 2021 cutoff for single filers is $140,000 or more (up from $139,000 for 2020).
The best mix
Contact us if you have questions about how much to contribute or the best mix between traditional and Roth 401(k) contributions. We can discuss the tax and retirement-saving strategies in your situation.
Although planning is needed to help build the biggest possible nest egg in your traditional IRA (including a SEP-IRA and SIMPLE-IRA), it’s even more critical that you plan for withdrawals from these tax-deferred retirement vehicles. There are three areas where knowing the fine points of the IRA distribution rules can make a big difference in how much you and your family will keep after taxes:
Early distributions. What if you need to take money out of a traditional IRA before age 59½? For example, you may need money to pay your child’s education expenses, make a down payment on a new home or meet necessary living expenses if you retire early. In these cases, any distribution to you will be fully taxable (unless nondeductible contributions were made, in which case part of each payout will be tax-free). In addition, distributions before age 59½ may also be subject to a 10% penalty tax. However, there are several ways that the penalty tax (but not the regular income tax) can be avoided, including a method that’s tailor-made for individuals who retire early and need to draw cash from their traditional IRAs to supplement other income.
Naming beneficiaries. The decision concerning who you want to designate as the beneficiary of your traditional IRA is critically important. This decision affects the minimum amounts you must generally withdraw from the IRA when you reach age 72, who will get what remains in the account at your death, and how that IRA balance can be paid out. What’s more, a periodic review of the individual(s) you’ve named as IRA beneficiaries is vital. This helps assure that your overall estate planning objectives will be achieved in light of changes in the performance of your IRAs, as well as in your personal, financial and family situation.
Required minimum distributions (RMDs). Once you attain age 72, distributions from your traditional IRAs must begin. If you don’t withdraw the minimum amount each year, you may have to pay a 50% penalty tax on what should have been paid out — but wasn’t. However, for 2020, the CARES Act suspended the RMD rules — including those for inherited accounts — so you don’t have to take distributions this year if you don’t want to. Beginning in 2021, the RMD rules will kick back in unless Congress takes further action. In planning for required distributions, your income needs must be weighed against the desirable goal of keeping the tax shelter of the IRA going for as long as possible for both yourself and your beneficiaries.
Traditional versus Roth
It may seem easier to put money into a traditional IRA than to take it out. This is one area where guidance is essential, and we can assist you and your family. Contact us to conduct a review of your traditional IRAs and to analyze other aspects of your retirement planning. We can also discuss whether you can benefit from a Roth IRA, which operate under a different set of rules than traditional IRAs.
If you own a business, you may wonder if you’re eligible to take the qualified business income (QBI) deduction. Sometimes this is referred to as the pass-through deduction or the Section 199A deduction.
The QBI deduction:
Taxpayers other than corporations may be entitled to a deduction of up to 20% of their QBI. For 2020, if taxable income exceeds $163,300 for single taxpayers, or $326,600 for a married couple filing jointly, the QBI deduction may be limited based on different scenarios. These include whether the taxpayer is engaged in a service-type of 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. For example, the phase-in for 2020 applies to single filers with taxable income between $163,300 and $213,300 and joint filers with taxable income between $326,600 and $426,600.
For tax years beginning in 2021, the inflation-adjusted threshold amounts will be $164,900 for single taxpayers, and $329,800 for married couples filing jointly.
Year-end planning tip
Some taxpayers may be able to achieve significant savings with respect to this deduction, by deferring income or accelerating deductions at year end so that they come under the dollar thresholds (or be subject to a smaller phaseout of the deduction) for 2020. Depending on your business model, you also may be able to increase the deduction by increasing W-2 wages before year end. The rules are quite complex, so contact us with questions and consult with us before taking steps.
Many employees take advantage of the opportunity to save taxes by placing funds in their employer’s health or dependent care flexible spending arrangements (FSAs). As the end of 2020 nears, here are some rules and reminders to keep in mind.
A pre-tax contribution of $2,750 to a health FSA is permitted in both 2020 and 2021. You save taxes because you use pre-tax dollars to pay for medical expenses that might not be deductible. For example, they wouldn’t be deductible if you don’t itemize deductions on your tax return. Even if you do itemize, medical expenses must exceed a certain percentage of your adjusted gross income in order to be deductible. Additionally, the amounts that you contribute to a health FSA aren’t subject to FICA taxes.
Your plan should have a listing of qualifying items and any documentation from a medical provider that may be needed to get a reimbursement for these items.
To avoid any forfeiture of your health FSA funds because of the “use-it-or-lose-it” rule, you must incur qualifying medical expenditures by the last day of the plan year (Dec. 31 for a calendar year plan), unless the plan allows an optional grace period. A grace period can’t extend beyond the 15th day of the third month following the close of the plan year (March 15 for a calendar year plan).
An additional exception to the use-it-or lose-it rule permits health FSAs to allow a carryover of a participant’s unused health FSA funds of up to $550. Amounts carried forward under this rule are added to the up-to-$2,750 amount that you elect to contribute to the health FSA for 2021. An employer may allow a carryover or a grace period for an FSA, but not both features.
Examining your year-to-date expenditures now will also help you to determine how much to set aside for next year. Don’t forget to reflect any changed circumstances in making your calculation.
Dependent care FSAs
Some employers also allow employees to set aside funds on a pre-tax basis in dependent care FSAs. A $5,000 maximum annual contribution is permitted ($2,500 for a married couple filing separately).
These FSAs are for a dependent-qualifying child under age 13, or a dependent or spouse who is physically or mentally incapable of self-care and who has the same principal place of abode as the taxpayer for more than half of the tax year.
Like health FSAs, dependent care FSAs are subject to a use-it-or-lose-it rule, but only the grace period relief applies, not the up-to-$550 forfeiture exception. Thus, now is a good time to review expenditures to date and to project amounts to be set aside for next year.
Note: Because of COVID-19, the IRS has temporarily allowed employees to take certain actions in 2020 related to their health care and dependent care FSAs. For example, employees may be permitted to make prospective mid-year elections and changes. Ask your HR department if your plan allows these actions if you believe they would be beneficial in your situation. Other rules and exceptions may apply.
Contact us if you’d like to discuss FSAs in greater detail.
As we approach the end of the year, it’s a good time to think about whether your business needs to buy business equipment and other depreciable property. If so, you may benefit from the Section 179 depreciation tax deduction for business property. The election provides a tax windfall to businesses, enabling them to claim immediate deductions for qualified assets, instead of taking depreciation deductions over time.
Even better, the Sec. 179 deduction isn’t the only avenue for immediate tax write-offs for qualified assets. Under the 100% bonus depreciation tax break, the entire cost of eligible assets placed in service in 2020 can be written off this year.
But to benefit for this tax year, you need to buy and place qualifying assets in service by December 31.
The Sec. 179 deduction applies to tangible personal property such as machinery and equipment purchased for use in a trade or business, and, if the taxpayer elects, qualified real property. It’s generally available on a tax year basis and is subject to a dollar limit.
The annual deduction limit is $1.04 million for tax years beginning in 2020, subject to a phaseout rule. Under the rule, the deduction is phased out (reduced) if more than a specified amount of qualifying property is placed in service during the tax year. The amount is $2.59 million for tax years beginning in 2020. (Note: Different rules apply to heavy SUVs.)
There’s also a taxable income limit. If your taxable business income is less than the dollar limit for that year, the amount for which you can make the election is limited to that taxable income. However, any amount you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable dollar limit, the phaseout rule, and the taxable income limit).
In addition to significantly increasing the Sec. 179 deduction, the TCJA also expanded the definition of qualifying assets to include depreciable tangible personal property used mainly in the furnishing of lodging, such as furniture and appliances.
The TCJA also expanded the definition of qualified real property to include qualified improvement property and some improvements to nonresidential real property, such as roofs; heating, ventilation and air-conditioning equipment; fire protection and alarm systems; and security systems.
What about bonus depreciation?
With bonus depreciation, businesses are allowed to deduct 100% of the cost of certain assets in the first year, rather than capitalize them on their balance sheets and gradually depreciate them. (Before the Tax Cuts and Jobs Act, you could deduct only 50% of the cost of qualified new property.)
This tax break applies to qualifying assets placed in service between September 28, 2017, and December 31, 2022 (by December 31, 2023, for certain assets with longer production periods and for aircraft). After that, the bonus depreciation percentage is reduced by 20% per year, until it’s fully phased out after 2026 (or after 2027 for certain assets described above).
Bonus depreciation is allowed for both new and used qualifying assets, which include most categories of tangible depreciable assets other than real estate.
Important: When both 100% first-year bonus depreciation and the Sec. 179 deduction are available for the same asset, it’s generally more advantageous to claim 100% bonus depreciation, because there are no limitations on it.
These favorable depreciation deductions may deliver tax-saving benefits to your business on your 2020 return. Contact us if you have questions, or you want more information about how your business can maximize the deductions.
Unfortunately, the COVID-19 pandemic has forced many businesses to shut down. If this is your situation, we’re here to assist you in any way we can, including taking care of the various tax obligations that must be met.
Of course, a business must file a final income tax return and some other related forms for the year it closes. The type of return to be filed depends on the type of business you have. Here’s a rundown of the basic requirements.
Sole Proprietorships. You’ll need to file the usual Schedule C, “Profit or Loss from Business,” with your individual return for the year you close the business. You may also need to report self-employment tax.
Partnerships. A partnership must file Form 1065, “U.S. Return of Partnership Income,” for the year it closes. You also must report capital gains and losses on Schedule D. Indicate that this is the final return and do the same on Schedules K-1, “Partner’s Share of Income, Deductions, Credits, Etc.”
All Corporations. Form 966, “Corporate Dissolution or Liquidation,” must be filed if you adopt a resolution or plan to dissolve a corporation or liquidate any of its stock.
C Corporations. File Form 1120, “U.S. Corporate Income Tax Return,” for the year you close. Report capital gains and losses on Schedule D. Indicate this is the final return.
S Corporations. File Form 1120-S, “U.S. Income Tax Return for an S Corporation” for the year of closing. Report capital gains and losses on Schedule D. The “final return” box must be checked on Schedule K-1.
All Businesses. Other forms may need to be filed to report sales of business property and asset acquisitions if you sell your business.
Employees and contract workers
If you have employees, you must pay them final wages and compensation owed, make final federal tax deposits and report employment taxes. Failure to withhold or deposit employee income, Social Security and Medicare taxes can result in full personal liability for what’s known as the Trust Fund Recovery Penalty.
If you’ve paid any contractors at least $600 during the calendar year in which you close your business, you must report those payments on Form 1099-NEC, “Nonemployee Compensation.”
Other tax issues
If your business has a retirement plan for employees, you’ll want to terminate the plan and distribute benefits to participants. There are detailed notice, funding, timing and filing requirements that must be met by a terminating plan. There are also complex requirements related to flexible spending accounts, Health Savings Accounts, and other programs for your employees.
We can assist you with many other complicated tax issues related to closing your business, including Paycheck Protection Plan (PPP) loans, the COVID-19 employee retention tax credit, employment tax deferral, debt cancellation, use of net operating losses, freeing up any remaining passive activity losses, depreciation recapture, and possible bankruptcy issues.
We can advise you on the length of time you need to keep business records. You also must cancel your Employer Identification Number (EIN) and close your IRS business account.
If your business is unable to pay all the taxes it owes, we can explain the available payment options to you. Contact us to discuss these issues and get answers to any questions.
Are you thinking about selling stock shares at a loss to offset gains that you’ve realized during 2020? If so, it’s important not to run afoul of the “wash sale” rule.
IRS may disallow the loss
Under this rule, if you sell stock or securities for a loss and buy substantially identical stock or securities back within the 30-day period before or after the sale date, the loss can’t be claimed for tax purposes. The rule is designed to prevent taxpayers from using the tax benefit of a loss without parting with ownership in any significant way. Note that the rule applies to a 30-day period before or after the sale date to prevent “buying the stock back” before it’s even sold. (If you participate in any dividend reinvestment plans, it’s possible the wash sale rule may be inadvertently triggered when dividends are reinvested under the plan, if you’ve separately sold some of the same stock at a loss within the 30-day period.)
The rule even applies if you repurchase the security in a tax-advantaged retirement account, such as a traditional or Roth IRA.
Although the loss can’t be claimed on a wash sale, the disallowed amount is added to the cost of the new stock. So, the disallowed amount can be claimed when the new stock is finally disposed of in the future (other than in a wash sale).
An example to illustrate
Let’s say you bought 500 shares of ABC Inc. for $10,000 and sold them on November 5 for $3,000. On November 30, you buy 500 shares of ABC again for $3,200. Since the shares were “bought back” within 30 days of the sale, the wash sale rule applies. Therefore, you can’t claim a $7,000 loss. Your basis in the new 500 shares is $10,200: the actual cost plus the $7,000 disallowed loss.
If only a portion of the stock sold is bought back, only that portion of the loss is disallowed. So, in the above example, if you’d only bought back 300 of the 500 shares (60%), you’d be able to claim 40% of the loss on the sale ($2,800). The remaining $4,200 loss that’s disallowed under the wash sale rule would be added to your cost of the 300 shares.
If you’ve cashed in some big gains in 2020, you may be looking for unrealized losses in your portfolio so you can sell those investments before year end. By doing so, you can offset your gains with your losses and reduce your 2020 tax liability. But be careful of the wash sale rule. We can answer any questions you may have.