Deferring Income into 2021
Deferring income to the next taxable year is a time-honored year-end planning tool. If you expect your AGI to be higher in 2021 than in 2022, or if you anticipate being in the same or a higher tax bracket in 2021 than in 2022, you may benefit by deferring income into 2022. Of course, in the case of an individual exposure to the alternative minimum tax could reverse the standard planning. Some ways to defer income include:
Use of Cash Method of Accounting: By adopting the cash method of accounting instead of the accrual method, you can generally put yourself in a better position for accelerating deductions and deferring income. There is still time to implement this planning idea, because an automatic change to the cash method can be made by the due date of the return including extensions. The following three types of businesses can make an automatic change to the cash method: (1) small businesses with average annual gross receipts of $1 million or less (even those with inventories that are a material income producing factor); (2) certain C corporations with average annual gross receipts of $5 million or less in which inventories are not a material income producing factor; and (3) certain taxpayers with average annual gross receipts of $10 million or less. Provided inventories are not a material income producing factor, sole proprietors, limited liability companies (LLCs), partnerships, and S corporations can change to the cash method of accounting without regard to their average annual gross receipts. Installment Sales: Generally, a sale occurs when you transfer property. If a gain will be realized on the sale, income recognition will normally be deferred under the installment method until the payments are received. So if you sell property prior to the end of 2021 and will receive payments in future years, you should, consider reporting the gain on the property using the installment method to defer payments (and tax) until next year or later.
The TCJA allows small business taxpayers with average annual gross receipts of $25 million or less in the prior three-year period to use the cash method of accounting. The law expands the number of small business taxpayers eligible to use the cash method of accounting and exempts these small businesses from certain accounting rules for inventories, cost capitalization and long-term contracts. As a result, more small business taxpayers can change to cash method accounting starting after Dec. 31, 2017.
Installment Sales: Generally, a sale occurs when you transfer property. If a gain will be realized on the sale, income recognition will normally be deferred under the installment method until the payments are received. So if you sell property prior to the end of 2021 and will receive payments in future years, you should, consider reporting the gain on the property using the installment method to defer payments (and tax) until next year or later.
Delay Billing: : If you are on the cash method, delay year-end billing to clients so that payments are not received until 2022.
Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year.
Accelerating Income into 2021
You may benefit from accelerating income into 2021. For example, you may anticipate being in a higher tax bracket in 2022, or perhaps you need additional income in 2021 to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note, however, that accelerating income into 2021 will be disadvantageous if you expect to be in the same or lower tax bracket for 2022.
If you report your business income and expenses on a cash basis, issue bills and pursue collection before the end of 2021. Also, see if some of your clients or customers are willing to pay for January 2022 goods or services in advance. Any income received using these steps will shift income from 2022 to 2021.
Qualifying Dividends: Qualified dividends are subject to rates similar to the capital gains rates. Qualified dividend income is subject to a 15% rate for taxpayers below the 39.6% tax bracket. For taxpayers in the 39.6% bracket, the rate is 20%. Note that qualified dividends may be subject to an additional 3.8% net investment income tax. Qualified dividends are typically dividends from domestic and certain foreign corporations. The corporate board may consider the tax impact of declaring a dividend on its shareholders. If you are not in the highest bracket for 2021, but you expect to be in 2022, consideration should be made as to authorizing any dividend payment prior to the end of 2021 to utilize the 15% favorable tax rate vs. the 20% rate at higher income levels.
Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses, and their dependents as an above-the-line deduction. If you itemize your deductions and do not claim 100% of your self-employed health insurance costs on your Form 1040, you may include the rest with all other medical expenses on Schedule A, subject to the 7.5% of Adjusted Gross Income limit (for 2017 through 2019 under the Tax Cuts and Jobs Act). The limit is scheduled to go back up to 10% of AGI in 2021. Self Employed Health Insurance includes eligible long term health care premiums.
Equipment Purchases: If you purchase equipment, you may make a "Section 179 election," which allows you to expense (i.e., currently deduct) otherwise depreciable business property. Section 179 does come with limits – there are caps to the total amount written off ($1,040,000 for 2020), and limits to the total amount of the equipment purchased ($2,590,000 in 2020). The deduction begins to phase out on a dollar-for-dollar basis after $2,590,000 is spent by a given business (thus, the entire deduction goes away once $3,500,000 in purchases is reached), so this makes it a true small and medium-sized business deduction.
All businesses that purchase, finance, and/or lease new or used business equipment during tax year 2021 should qualify for the Section 179 Deduction (assuming they spend less than $3,500,000). Most tangible goods used by American businesses, including “off-the-shelf” software and business-use vehicles (restrictions apply) qualify for the Section 179 Deduction. For basic guidelines on what property is covered under the Section 179 tax code, please refer to the list of qualifying equipment. Also, to qualify for the Section 179 Deduction, the equipment and/or software purchased or financed must be placed into service between January 1, 2021 and December 31, 2021.
Vehicles Weighing Over 6,000 Pounds: A popular strategy in recent years is to purchase a vehicle for business purposes that exceeds the depreciation limits set by statute (i.e., a vehicle rated over 6,000 pounds). Doing so would not subject the purchase to the statutory dollar amount, $3,160 for 2021; $3,460 in the case of vans and trucks. Therefore, the vehicle can qualify for the full equipment expensing dollar amount. However, for SUV’s (rated between 6,000 and 14,000 pounds gross vehicle weight) the expensing amount is limited to $25,000.
Capitalization of Tangible Property: Recent rules clarify whether certain items you purchase for use in your business (i.e. copiers, computers) can be expensed in the year purchased, or must be capitalized and deducted over several years. The rules include certain elections that may simplify your recordkeeping and/or increase your current deductions. We should discuss these rules when we meet.
Home Office Deduction: Expenses attributable to using the home office as a business office are deductible under §280A if the home office is used regularly and exclusively: (1) as a taxpayer's principal place of business for any trade or business; (2) as a place where patients, clients, or customers regularly meet or deal with the taxpayer in the normal course of business; or (3) in the case of a separate structure not attached to the residence, in connection with a trade or business. If you have been using part of your home as a business office, we should talk about the amount of any deduction you would like to take because an IRS safe harbor could be used to minimize audit risk.
NOL Carryback Period: NOL Carryback Period: NOL carryback is eliminated. The Tax Cuts and Jobs Act (TCJA), section 13302, eliminated the option for most taxpayers to carry back a net operating loss (NOL). Most taxpayers can only carry NOLs arising from tax years ending after 2017 to a later year. An exception applies to certain farming losses. See section 172(b) or Pub. 225, Farmer’s Tax Guide, for more information..
Bad Debts: If you use the accrual method, you can accelerate deductions to 2020 by analyzing your business accounts receivable and writing off those receivables that are totally or partially worthless. By identifying specific bad debts, you should be entitled to a deduction. You may be able to complete this process after year-end if the write-off is reflected in the 2022 year-end financial statements. For non-business bad debts (such as uncollectible loans), the debts must be wholly worthless to be deductible, and will be probably only be deductible as a capital loss. If you have any worthless debts, we should discuss them when we meet.
Small Employer Pension Plan Startup Cost Credit: Certain small business employers that did not have a pension plan for the preceding three years may claim a nonrefundable income tax credit for expenses of establishing and administering a new retirement plan for employees. The credit applies to 50% of qualified administrative and retirement-education expenses for each of the first three plan years. However, the maximum credit is $500 per year.
Credit for Employee Health Insurance Expenses of Small Employers: Eligible small employers are allowed a credit for certain expenditures to provide health insurance coverage for their employees. Generally, employers with 10 or fewer full-time equivalent employees (FTEs) and an average annual per-employee wage of $25,000 or less are eligible for the full credit. In 2016, the credit amount begins to phase out for employers with either 11 FTEs or an average annual per-employee wage of more than $25,000. The credit is phased out completely in 2016 for employers with 25 or more FTEs or an average annual per-employee wage of $50,000 or more. The inflation-adjusted amount is $52,000. For 2016, the credit is available on a sliding scale for up to 50% of the employer’s contribution toward employee health insurance premiums, is only allowable if the health insurance is purchased through a Small Business Health Options (SHOP) Exchange, and is only available for two consecutive taxable years.
Employer-Provided Child Care Credit: For 2021, the federal tax credit is equal to 25 percent of the child care expenditures made by the employer. Employers may claim a credit of up to $150,000 for supporting employee child care or child care resource and referral services. The credit is allowed for a percentage of “qualified child care expenditures,” including for property to be used as part of a qualified child care facility, for operating costs of a qualified child care facility, and for resource and referral expenditures.
Subnormal Goods: You should check for subnormal goods in our inventory. Subnormal goods are goods that are unsalable at normal prices or unusable in the normal way due to damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes, including second-hand goods taken in exchange. If your business has subnormal inventory as of the end of 2021, you can take a deduction for any write-downs associated with that inventory provided you offer it for sale within 30 days of your inventory date. The inventory does not have to be sold within the 30-day timeframe.
Health Care Planning
SHOP Exchanges: In 2021, the Small Business Health Options Program is available for employers with 100 or fewer full-time equivalent employees. Coverage must be offered to all full-time employees working 30 or more hours per week. Each exchange will offer its own SHOP marketplace. Self-employed persons with no employees cannot use the SHOP Exchange.
Premium Health Care Credits: Small businesses with less than 25 employees may qualify for health care tax credits using the health insurance marketplace. These premium tax credits can cover up to 50% of the cost of employee health insurance. The uncovered amount can be deducted from your taxes as usual. The tax credits are available through plans offered on the SHOP marketplace exclusively.
The TCJA added a new tax credit for employers that offer paid family and medical leave to their employees.
The credit applies to wages paid in taxable years beginning after December 31, 2017, and before January 1, 2020.
The credit is a percentage of wages (as determined for Federal Unemployment Tax Act (FUTA) purposes and without regard to the $7,000 FUTA wage limitation) paid to a qualifying employee while on family and medical leave for up to 12 weeks per taxable year. The percentage can range from 12.5% to 25%, depending on the percentage of wages paid during the leave.
Pay to Play Excise Tax: For the 2021 plan year, if you have 50 or more employees, you could be subject to an excise tax, which could be as much as $2,000 per employee, for failure to provide an adequate health care plan to your employees. The first 30 workers are excluded from the penalty excise tax. Larger employers, you should be considering their health care plan needs in light of this potential excise tax liability.
QSEHRA: A new and increasingly popular option, the qualified small employer health reimbursement arrangement (QSEHRA) is a new HRA created by Congress in December 2016. With a QSEHRA, businesses offer employees a monthly allowance of tax-free money. Employees then choose and pay for health care, potentially including insurance policies, and the business reimburses them up to their allowance amount. All reimbursements are free of payroll tax for the business and its employees can be free of income tax if the employee has MEC. The QSEHRA is often the best choice for small businesses: It allows businesses to set their own budgets while employees can purchase health care that’s tailored to fit their exact needs.
Health Care Reporting: 2021 Forms 1095-C, 1095-B, 1094-C and 1094-B are due in early 2021. Paper filings are due February 29, 2022, or March 31, 2022, if filing electronically. Employee statements are due February 1, 2022.
Temporary allowance of full deduction for business meals: The Act temporarily allows a 100% business expense deduction for meals (rather than the current 50%) if the expense is for food or beverages provided by a restaurant. This provision is effective for expenses incurred after Dec 31, 2020 and expires at the end of 2022.
Certain charitable contributions deductible by nonitemizers: The Act extends and modifies the $300 charitable deduction for nonitemizers for 2021 and increases the maximum amount that may be deducted to $600 for married couples filing jointly. The Sec. 6662 penalty is increased from 20% to 50% of the underpayment for taxpayers who overstate this deduction.