Year-End Tax Planning for Businesses Ahead of Biden’s Tax Plan
Year-end tax planning has always been critical for businesses, but it’s no more critical than in a year when prior tax legislation may be giving way to new tax legislation. The proposed tax changes by President Biden are enough to turn tax planning on its head as businesses look to next year and beyond. But equally important is the expiration of existing tax rules that can still make a significant difference for many small businesses in 2021. Specifically, businesses need to consider the following in their year-end tax planning:
Barring any legislative action to extend them, important tax rules affecting businesses will change or expire at the end of 2021. COVID relief programs are expected to expire this year, but there is still time for businesses to benefit significantly if they act in time. New tax proposals are on the table that will impact businesses starting next year.
There’s a standard caveat when working with existing and proposed tax rules: everything is subject to change. There’s a chance that Biden’s proposed tax changes don’t make it through Congress in their current form. That makes tax planning challenging at best. However, businesses should first focus on what is known before concentrating on the “what if” planning for potential changes under the Biden proposal.
Taking Advantage of Existing Tax Rules
Some of the more widely used COVID-related relief programs, such as the Paycheck Protection Program are no more. But opportunities continue to exist to claim COVID-related tax credits through the end of the year and even retroactively for prior quarters.
Employee Retention Credit
The employee retention credit (ERC) was initially enacted in March 2020 to assist employers and encourage them to maintain their workforces. The program was modified late last year to expand the available credit from 50% to 70% of qualified wages through December 31, 2021.
The ERC was one of several pandemic-related relief measures designed to assist employers and encourage them to maintain their workforces. The ERC was enacted under the CARES ACT as a fully refundable tax credit that could be claimed by employers who managed to keep employees on their payroll. The changes also expanded eligibility to companies with 500 Full-Time Equivalent (FTE employees up from 100.
New ERC rules also make it easier for businesses to qualify. Any business that suffered a 20% reduction or greater in quarterly gross receipts for any reason compared to the same quarter in 2019 is eligible to file a claim.
All eligible employers can claim the ERC through December 31, 2021, on qualifying wages paid after June 30, 2021, and before January 2022.
Family and Sick Leave Credits
Although federal requirements that employers provide enhanced paid family and sick leave ended last year, payroll tax credits are still available in 2021 for certain employers who chose to continue the benefit. Qualifying paid leave is also available for employees when getting the vaccine or to recover from the vaccine’s side effects.
Playing Catch Up with Credits
Businesses that did not claim available tax credits from any program on their original returns can still amend prior quarterly filings to claim them.
What If Planning for Biden’s Proposed Tax Plan
This is where year-end planning gets tricky because we can’t know with any degree of certainty how the final changes will look. But, because some of the changes may be significant for many business owners, it’s still worthwhile to do some contingency planning, starting with the elimination of the qualified business income (QBI) tax deduction for high earners.
Elimination of the Qualified Business Income Tax Deduction
Currently, the QBI deduction allows certain types of “pass-through” entities (particularly LLCs, S corporations, and some sole proprietorships) to deduct 20% of their business income so that only 80% of their remaining income is taxable. The deduction for high-earning business owners of specified service or trade businesses (i.e., doctors, lawyers, consultants, financial advisors) is completely phased out if their earnings exceed $429,000 in 2021.
Under the proposed rules, the QBI is to be phased out for all businesses where business owner earnings (from all sources) exceed 400,000. That is especially significant because he also wants to raise the top individual tax rate to 39.6% on those same individuals.
This might be one of those times it makes sense for business owners to do what they can to accelerate earnings into this year and push deductions into next year. That’s between each individual and their tax advisor.
Research and Development Expenses
This change won’t affect as many businesses as the elimination of the QBI deduction, but even businesses with modest R&D expenses will feel the pinch. Currently, businesses have some flexibility in determining whether to deduct R&D expenses in the current year or capitalize and amortize them over a number of years. Under the proposed changes, the IRS will require R&D costs to be capitalized and amortized over five years for costs incurred in the U.S. The effect on cash flow will be significant for many businesses. To comply with the new rule, businesses will need to track their R&D costs with a much higher level of specificity.
While there is an outside chance this provision gets removed from the final bill, businesses should take steps now to put procedures in place to begin documenting their R& D costs.
Business Interest Expense Limitations
Under the proposed rule, depreciation, amortization, and depletion will no longer be added back to calculate adjustable taxable income (ATI). Businesses will be limited to an annual interest expense equal to 30% of ATI, effectively reducing the maximum deductible interest expense by 30% of annual depreciation, amortization, and depletion. Limiting allowable interest expenses will have a significant impact on cash flows for many businesses.
Again, there is uncertainty whether this rule change will make it into law, but it is definitely on Congress’s radar.
Yearend Planning for the Known and Unknown
It has always been hard to make predictions about the future of taxes under a new administration. But we do know for sure that tax planning will not be any less complicated between now and year-end. This year it will be especially critical to plan for what is known—the expiration of beneficial tax credits—and unknown—the possible provisions that could raise taxes or hurt cash flow.
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