Several significant tax law changes took effect in 2021 that may affect your business’s federal tax filings. As the year draws to a close, we should review these changes, as well as your business’s projected taxable income or loss to see what actions might be appropriate before year end to reduce taxes. It’s also important to ascertain whether enough estimated taxes have been paid to avoid any underpayment of estimated tax penalties.
As COVID-19 has continued to impact businesses, Congress passed the Consolidated Appropriations Act, 2021 (CAA 2021) at the end of last December and the American Rescue Plan (ARP) Act in March. A major highlight in CAA 2021 is a provision allowing businesses to fully deduct expenses paid with the proceeds of a forgiven Paycheck Protection Program loan, effectively overriding earlier guidance. The ARP followed up by extending and modifying certain refundable payroll tax credits for both businesses and self-employed individuals, which are discussed in depth below. As a result of this latter change, the IRS has revised Form 941‐X to allow businesses to correct COVID‐19 related employment tax credits reported on Form 941 earlier in the year. Reviewing your payroll tax returns to ensure that your business took full advantage of these credits, and filing any amended returns that may be necessary, should be one of our top year-end tax planning priorities.
Section 179 Expensing and Depreciation Deductions
Depending on what the income of your business looks like for 2021, there are two “go-to” deductions that generally take priority when trying to reduce income for tax purposes: the Section 179 deduction, where your business can elect to deduct the entire cost of certain property acquired and placed in service during the year, and the bonus depreciation deduction, where 100 percent of the cost of business property may be expensed. Under the Section 179 expensing option, your business can immediately expense the cost of up to $1,050,000 of “Section 179” property placed in service in 2021. This amount is reduced dollar for dollar (but not below zero) by the amount by which the cost of the Section 179 property placed in service during the year exceeds $2,620,000.
The bonus depreciation rules apply unless the business specifically elects out of those rules. An election out might be preferable where a business expects a tax loss for the year and the bonus depreciation would just increase that loss or where it might be advantageous to push depreciation deductions into future years. For example, where the owner of a pass-thru entity to whom these deductions would flow expects to be in a higher tax bracket in future years, such deductions might be of more use in those future years. If applying both the Section 179 deduction and the bonus depreciation deduction to an asset, the Section 179 deduction applies first.
If you are in the market for a vehicle, the purchase of a sport utility vehicle weighing more than 6,000 pounds, can trigger a bigger deduction than if a smaller vehicle is purchased. This is because vehicles that weigh 6,000 pounds or less are considered listed property and the related first-year deduction is limited to $18,200 for cars, trucks and vans acquired and placed in service in 2021. For vehicles weighing more than 6,000 pounds, however, up to $26,200 of the cost of the vehicle can be immediately expensed.
Payroll Tax Credits Available
Paid sick or family leave. Refundable payroll tax credits are available for businesses with under 500 employers that offered paid sick or family leave through September 30, 2021 (i.e., qualified leave wages), to employees who took leave due to COVID-19. In addition, an employee retention credit is available for all four quarters of 2021 for businesses that were impacted by COVID-19 but kept employees on the payroll.
Generally, employers claim these payroll tax credits on either Form 941, Employer’s Quarterly Federal Tax Return, or Form 7200, Advance Payment of Employer Credits Due to COVID-19. Because of the numerous changes to the dates these credits apply, the IRS recently made significant revisions to Form 941‐X to allow for correcting COVID‐19 related employment tax credits reported on Form 941. Thus, we need to review the Forms 941 or any Forms 7200, Advance Payment of Employer Credits Due to COVID-19, filed for your business to ensure that all payroll tax credits for which your business is eligible have been claimed.
For the first three quarters of 2021, employers are eligible for tax credits for wages paid for up to 80 hours of paid sick leave in an amount equal to either: (1) the employee’s regular wage, capped at $511/day, up to a total of $5,110 if the employee was sick or quarantining, awaiting the results of a COVID test, obtaining or recovering from a vaccine; or (2) two-thirds of the employee’s regular wage, capped at $200/day, up to a total of $2,000, if the employee was taking time to care for someone quarantining or to provide care due to COVID-19 school or child care provider closures. In addition, employers may receive tax credits for up to 12 weeks of paid family leave provided to employees who are unable to work for any of the reasons listed above. These credits are equal to two-thirds of an employee’s regular wages, capped at $200/day up to a total of $12,000. Additionally, the payroll tax credits are also available to self-employed individuals, who will recoup these credits by filing Form 1040 or Form 7202, Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals.
Employee Retention Tax Credit. I emailed you previously about potential payroll tax credits, but it is worth mentioning again. Your business may be eligible for an employee retention tax credit (ERTC) if your business either (1) had their operations fully or partially suspended under government orders in 2021, or (2) experienced a decline in gross receipts for a quarter in 2021 of 20 percent or more compared to the same quarter in 2019 (i.e., a “significant decline in gross receipts). However, if the business did not exist as of the beginning of the same calendar quarter in calendar year 2019, then the same calendar quarter in 2020 is used. The ERTC generally equals 70 percent of the first $10,000 in wages, including certain health plan expenses, per employee in each quarter of 2021. For the third and fourth quarters of 2021, the credit amount is increased to $50,000 per quarter if the business is a “recovery startup business.” A recovery startup business is any business which (1) began carrying on any trade or business after February 15, 2020, (2) for which the average annual gross receipts for the three-tax year period ending with the tax year which precedes such quarter does not exceed $1,000,000, and (3) with respect to such quarter, the operation of the trade or business is not subject to a government-ordered suspension or a significant decline in gross receipts. Its worth noting that the infrastructure bill passed by the Senate would terminate the ERTC as of September 30, 2021. That provision does not affect a recovery start-up business and its unknown whether this provision will survive in a final bill.
The IRS has issued guidance which says that, because of the interaction of certain Internal Revenue Code provisions, wages paid to majority owners, their spouses, and children generally are not qualified wages for purposes of the ERTC. This interpretation appeared to run contrary to the intent of Congress when it enacted the ERTC legislation. If your business is in this situation, we should discuss the potential avenues available for claiming, or postponing the claiming of, this credit.
If you have taken or plan to take the Employee Retention Tax Credit, please contact us immediately. This will affect your 2020 and 2021 tax returns.
Expenses Paid with Paycheck Protection Program Loan Funds
If your businesses received a loan through the Paycheck Protection Program (PPP), which ended on June 30, 2021, and has not yet received forgiveness of that loan, a simplified loan forgiveness application has been issued for PPP loans of $150,000 or less. A forgiven PPP loan is not includible in income, and no deduction will be denied, no tax attribute will be reduced, and no basis increase will be denied by reason of the exclusion from gross income of a forgiven PPP loan. If you have not applied for forgiveness please do so prior to the end of the year.
Importance of Employee Benefits
As you probably well know, the employment landscape has changed significantly since the beginning of the COVID pandemic. Many businesses are facing worker shortages and are reevaluating what it will take to get employees in the door. If your business is not already doing so, it may reap substantial tax benefits, as well as non-tax benefits, by offering a retirement plan and/or other fringe benefits to employees. Businesses that offer such benefits have a better chance of attracting and retaining talented workers which, in turn, reduces the costs of searching for and training new employees. Contributions made to retirement plans on behalf of employees are deductible and your business may be eligible for a tax credit for setting up a qualified plan.
In addition, as a business owner you, and your spouse, can take advantage of a retirement plan yourselves. By adding your spouse as an employee and paying a salary up to the maximum amount that can be deferred into a retirement plan you could realize significant tax savings. For example, if your spouse is 50 or older, a salary of $26,000 could all go into a 401(k), leaving him or her with a retirement account but no current year taxable income.
Meal and Entertainment Expenses
Generally, the business deduction allowable for food or beverage expenses is limited to 50 percent of the amount spent. However, CAA 2021 enacted a more lenient rule for expenses relating to food and beverages purchased from restaurants in 2021 and 2022. Under that rule, a 100 percent deduction is allowed, providing the expense is properly documented. As part of that documentation, the business purpose of the meal must be provided. The term “restaurant” in this case means a business that prepares and sells food or beverages to retail customers for immediate consumption, regardless of whether the food or beverages are consumed on the business’s premises. It does not include a business that primarily sells pre-packaged food or beverages not for immediate consumption, such as a grocery store; specialty food store; beer, wine, or liquor store; drug store; convenience store; newsstand; or a vending machine or kiosk.
Increasing Basis in Pass-thru Entities
If you are a partner in a partnership or a shareholder in an S corporation, and you expect the entity to pass through a loss for the year, it’s important to determine if you have enough basis to absorb the loss. If not, then we should review actions that can be taken before the end of the entity’s tax year to increase your basis. Generally, increasing basis in an entity is done by contributing or loaning money to the entity.
S Corporation Shareholder Salaries
If you are doing work for an S corporation, it’s important to ensure that you are being paid an amount that is commensurate with your workload. The IRS scrutinizes S corporations which distribute profits instead of paying compensation subject to employment taxes. Failing to pay arm’s length salaries can lead not only to the assessment of tax deficiencies, but also penalties and interest on those deficiencies as well. The key to establishing reasonable compensation is being able to show that the compensation paid for the type of you did during the year is similar to what other corporations would pay for similar work. In such cases, we need to document the factors that support the amount paid.
If you have questions regarding these topics or issues, please contact our office today to setup a tax planning meeting.