For many of us, 2020 has felt simultaneously like the quickest and yet longest year in recent history. At times, I felt like it was still Q1 and I was trying to figure out what I wanted to accomplish this year only to realize moments later that we were just weeks away from a new year. A global pandemic coupled with a subsequent economic downturn – combined with a presidential election – were just some of the many highlights of 2020. And now many individuals and business owners are left wondering what their taxes are going to look like this year and how to address them before December 31st comes around. As the end of the year rapidly approaches, there are a few things that you may want to consider as you prepare for tax season.
Individual Tax Season
This year, Congress had a field day introducing legislation designed to support individuals and families struggling through the pandemic. From stimulus checks to retirement planning, there were many tax adjustments this year that impacted individuals. With the end of the year upon us, here are a few planning considerations.
1) Retirement Planning
For 2020, the contribution limits for retirement planning have been increased from previous years. For individuals making contributions to a 401(k) plan, a maximum contribution of $19,500 (with an additional catch-up contribution of $6,500 available if 50 or over) can be made. If you are a self-employed/small business owner with a Simplified Employee Pension (SEP), then your maximum contribution is the lesser of 25% of the employee’s compensation, or $57,000 for 2020. Small business owners and individuals, if possible, should try to max out such contributions in order to reduce total taxable income; thereby reducing your taxes.
2) Charitable Contributions
At this time of year, many people are looking to donate to organizations to support those who are less fortunate. The great thing about such generosity is that you’re afforded a tax deduction. Normally, charitable contributions are only allowed up to 60% of your Adjusted Gross Income (AGI); however, for 2020, individuals may give up to 100% of their AGI in cash contributions, if made to a qualifying organization. In addition, under the CARES Act, an individual can take a maximum deduction of up to $300 of qualified charitable contributions as an “above-the-line” deduction. This means that you reduce your AGI by $300, thereby reducing your total tax liability.
3) State & Local Tax Deduction
Under the Tax Cuts and Jobs Act (TCJA), individuals are unable to take a state and local tax deduction (SALT deduction) that exceeds $10,000; limiting the ability to take a state and local tax payment deduction in excess of this limitation. The SALT deduction is usually associated with things like property tax payments or state and local income tax payments. This provision is currently being challenged in the Circuit Court (See Case Number 19-3962, State of New York et al. v. Steven T. Mnuchin et al, 2nd Cir.). However, the IRS recently published IRS Notice 2020-75 concerning proposed regulations related to the deductibility of certain state and local income taxes paid through a partnership or S-Corporation. Under the Notice, in jurisdictions in which tax laws have been enacted that impose a mandatory or elective entity-level income tax on a partnership or S-Corporation and a corresponding/offsetting owner-level tax benefit (i.e. credit or deduction), such entity-level taxes shall be deductible by the entity notwithstanding that the state may provide a credit or deduction against personal tax liability. Currently, about seven states have adopted a scheme that allows an entity-level tax and corresponding tax credit/deduction. Taxpayers who own small businesses should carefully review these proposed regulations and consult with their tax professional in order to take advantage of this SALT workaround.
4) Estate Planning
Under the TCJA, the lifetime exemption for gift transfers was temporarily increased from $5 million for individuals ($10 million for couples) to $11.58 million for individuals ($23.16 million for couples) for 2020. In addition, although the increase was temporarily increased from 2018 through 2025, Treasury regulations have provided that if the gift was made during the temporary increase period, such a gift would not be “clawed back” after 2025. With a new administration coming into office on Jan. 20, 2021, it is possible that the temporary increase might be cut short prior to the 2025 phase-out. Therefore, taxpayers should evaluate their estate gift planning before the end of the year if they plan to use the temporary lifetime exemption increase.
Business Tax Season
Businesses of all sizes have been significantly impacted by the coronavirus pandemic. From dealing with employees working from home to navigating the coronavirus restrictions, businesses have dealt with many changes. However, there are a number of tax provisions that can ease the pain of the COVID-19 impact on your bottom-line.
1) Net Operating Losses
As part of the TCJA, the Net-Operating Loss (NOL) deduction was limited to 80% of taxable income in that tax year with any remaining NOL being carried forward to future tax years. However, under the CARES Act, for tax years 2018, 2019 and 2020, a taxpayer may use 100% of its NOL for that tax year. In addition, taxpayers with NOL arising after Dec. 31, 2017 and before January 1, 2021 may carry-back any NOL to a previous tax year not to exceed five (5) years. Taxpayers should work with their tax team to review whether it would be more appropriate to carryback in NOL or carryforward such NOL into a future tax year.
2) Qualified Improvement Property
Under the TCJA, Congress had intended that Qualified Improvement Property (QIP) have a depreciation life of 15 years. However, a drafting error in the legislation neglected to provide for this 15-year depreciation schedule. The CARES Act corrected this technical error to provide a 15-year depreciation schedule, retroactive to Jan. 1, 2018. In addition, QIP is now eligible for 100% bonus depreciation. Therefore, since these provisions have been made retroactive, taxpayers should work to either file amended returns or request an administrative adjustment.
3) Employment Tax Deferral
Under the CARES Act and a Presidential Memorandum, employers (including self-employed persons) were able to defer the employee portion of Social Security tax through the end of the year. For payroll taxes deferred under the CARES Act, employers are only required to pay 50% of the deferral before Dec. 31, 2021, and the remaining deferral before Dec. 31, 2022. For payroll taxes deferred under the Presidential Memorandum, the deferral is limited to payment of taxable wages to an employee of less that $4,000 per bi-weekly pay period and employers are required to withhold and remit the unpaid portion before April 30, 2021. Therefore, employers should ensure that they document any deferrals that may have been made and ensure that such deferrals are repaid within the specified timeframe.
4) Loss Limitation Increase
As part of the TCJA, taxpayers, other than a corporation, could not deduct business losses in excess of $250,000 ($500,000 married filing jointly) against nonbusiness income. However, the CARES Act suspends this limitation until after Dec. 31, 2020. Therefore, a taxpayer, other than a corporation, may deduct excess business losses against nonbusiness income. This is helpful for taxpayers who may have been significantly impacted financially in their business to be able to offset those losses against income that may have been gained elsewhere.
5) Paycheck Protection Program
The Paycheck Protection Program (PPP) was implemented under the CARES Act in order to support businesses that were negatively impacted by the coronavirus pandemic. Under PPP, small businesses received forgivable loans to cover “eligible expenses” including payroll cost, mortgage interest, rent and utilities. However, under IRS guidance (See Notice 2020-32, Rev. Rul. 2020-27, and Rev. Proc. 2020-51), the IRS has indicated that taxpayers who received a PPP loan would not be able to also take a business deduction for any expenses that were paid using PPP funds. Therefore, businesses, who received PPP funds, and have either requested forgiveness or plan to request forgiveness, are prevented from deducting any of the expenses in which PPP funds were used. Unless Congress acts to resolve this issue, businesses should carefully consider the risk/benefit of just accepting the PPP funds as loans and take the deduction versus applying for forgiveness. In addition, businesses that received more than $2 million should carefully consider their PPP loan needs as these loans appear likely to be under a greater level of scrutiny going forward.
Should you have questions regarding this tax season or desire more information, please feel free to reach out to Demetrius Robinson (firstname.lastname@example.org; 614.427.5749).
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