Dollars and Sense
By Jim Moran, CPA
With 2021 drawing to a close, it is time for business owners to start thinking about year-end tax-planning opportunities to minimize 2021 taxable income and mitigate the impact of taxes prior to the start of the new year.
Planners are once again faced with the fact that tax reform is still unclear. Congress continues to debate President Biden’s Building Back Better legislation, and revenue raisers are still thinking carefully about how to fund this legislation.
This bill contains numerous tax provisions, but with a divided Congress, it is not known which provisions will end up in the final version. A prudent strategy would be to do year-end tax planning based on the status quo but be flexible based on any last-minute year-end legislation.
“A prudent strategy would be to do year-end tax planning based on the status quo but be flexible based on any last-minute year-end legislation.”
Here are items to consider as you proceed, taking into consideration current tax law, including provisions of the recent CARES Acts passed as a result of the pandemic:
Standard Mileage Rate
The standard mileage rate, for those taxpayers who can use it, is $0.56 for 2021. The IRS mileage rate for 2022 will be released sometime next month.
Meals and Entertainment
The CARES Act allows a 100% deduction in 2021 and 2022 for meals purchased from a restaurant. These meals must continue to meet the “ordinary and necessary” business requirements. Entertainment, amusement, and recreation-type events continue to remain 100% non-deductible.
Code Section 179 Expensing and Depreciation
The Code Section 179 expense deduction is $1,050,000 for 2021 with a total investment limitation of $2,620,000. Also, 100% bonus depreciation remains in effect in 2021 and 2022. After 2022, the bonus depreciation amount decreases by 20% each year until bonus depreciation is no longer allowed (beginning in 2027).
Corporate Limit Increased to 25% of Taxable Income
The COVID relief bills raised the limit to 25% of taxable income through 2021 for cash contributions to eligible charities. The increased deduction does not automatically apply. C-corporations must elect the increased limit on a contribution-by-contribution basis.
Increased Limits for Donated Food Inventory
Businesses that contribute food inventory for the care of the “ill, needy, or infants” get an enhanced deduction in 2021. The previous deduction limit was 15% of the taxpayer’s aggregate net income or taxable income. For 2021, business taxpayers may deduct contributions of up to 25% of their aggregate net income or taxable income.
For C-corporations, the 25% limit is based on their taxable income. For other businesses, including sole proprietorships, partnerships, and S-corporations, the limit is based on their aggregate net income for the year from the businesses from which the contributions are made.
Paycheck Protection Program
If your business had a PPP loan forgiven during 2021, the amount forgiven should be reported as debt-forgiveness income on your income statement. As a reminder, PPP loan forgiveness income is non-taxable federally.
Principal and interest payments on loan payments made by the SBA established by the CARES Act and revised by the Economic Aid Act are not taxable for federal income-tax purposes. The SBA is authorized to automatically pay up to six months of principal and interest.
Net Operating Losses
Generally, net operating losses (NOL) arising in 2021 or later cannot be carried back and must be carried forward indefinitely.
Net operating losses arising in tax years 2018 through 2020 can be caried back five years and then carried forward indefinitely. The NOL carryforwards beginning in 2018 can offset only 80% of taxable income for taxable years beginning in 2021.
NOL carryforwards arising in taxable years prior to 2018 can first offset 100% of 2021 taxable income. If all pre-2018 NOLs are used in 2021 and taxable income remains, any NOL carryovers from 2018-20 can offset only 80% of any remaining taxable income.
With the current improvement in the economy, and employees being harder to find and retain, a net-income-reduction measure (in turn tax reduction), businesses should consider bonuses for employees, whether through incentives or through setting work goals. Bonuses should also be contingent on cash flows and the current net income of the company.
For bonuses paid to a controlling shareholder (an individual who owns directly or indirectly greater than 50% of the value of a corporation’s stock), the bonus is considered paid in the year the controlling shareholder reports the income. Thus, in order to deduct the controlling shareholder’s 2021 bonus, it must be paid to the shareholder prior to the end of 2021.
Bonuses subject to a contingency cannot be accrued in 2021 and paid in 2022 even if paid within two and a half months of year-end. Therefore, if employees cannot receive their deferred bonuses for performance in 2021 unless they are still employed in the year 2022 bonus payment date, the company’s liability for the bonus is subject to a contingency and cannot be deducted for tax purposes in 2021, even if paid within two and a half months of year-end.
Similarly, the IRS has held that bonuses are not fixed in the year of service when the amount of individual awards are finalized but revert back to the company if an employee left before receiving the bonus, even though the forfeited amounts could be considered insignificant.
IRS rulings provide that an employer can establish the liability under the first prong of the all-events test for bonuses payable to a group of employees even though the employer does not know the identity of any particular bonus recipient, or the amount payable to that recipient, until after the end of the tax year if the amount of bonuses payable under the program is determinable through a formula that was fixed prior to the end of the year, or through other corporate action that fixed the amount payable to the employees as a group.
Any bonus amount allocable to an employee who was not employed on the date on which bonuses were paid and was reallocated among the other eligible employees and did not revert back to the company is deductible up to the amounts paid within two and a half months of year-end.
Having a well-thought-out tax-planning strategy for year-end is an important part of business decision-making processes. Contact your CPA to help you develop a plan specific to your goals and needs.
Jim Moran, CPA is an accountant in the Greenfield office of Melanson; (413) 773-5405.