Tax Planning in Another Year of Uncertainty
2021 is not the first year that taxpayers, both individuals and businesses, face uncertainty as they plan for year end. In 2020 it was the outcome of the election that posed uncertainties, and in 2017 it was passage of the Tax Cuts and Jobs Act.
Tax Planning Considerations
With Congress still debating terms of the President’s proposed “Build Back Better” plan, it is important to not lose sight of the tax changes that are already in place for 2021 or begin in 2022. Following are a few of these items for business owners and management to consider for year-end planning.
Section 163(j) Interest Expense Limitation
For 2021, the limit for deducting business interest expense is 30% of adjusted taxable income (ATI). ATI is roughly defined as taxable income plus addbacks for depreciation and amortization expense. Beginning in 2022 however, ATI will no longer include the addback of depreciation and amortization expense. Thus, for the same taxable income, a business will have a lower interest expense deduction next year. Taxpayers should consider the impact of the limit on interest expense deductions and what changes can be made to transform debt financing to equity financing.
Employee Retention Credit (ERC)
Currently, the ERC will expire at the end of 2021. This credit against employer payroll taxes continues to provide strong financial support to businesses. Employers claiming the ERC must also reduce their compensation deductions for tax purposes by the amount of the credit. Similarly, the American Rescue Plan Act offered COBRA premium reimbursements to employers via a reduction in employer payroll tax. Companies should adjust their expense accounts accordingly.
Transfer Pricing, GILTI and FDII, New Tax Forms
Supply chain disruptions, expansions and contractions of businesses, and other effects of the worldwide pandemic may have had significant impacts to businesses with offshore operations. This is an opportune time to revisit a company’s activities outside the U.S. and update required tax reporting records. In addition, the IRS has introduced two new sets of forms to disclose foreign activities of partnerships and S corporations. These new Forms K-2 and K-3 are designed to standardize information flowing to owners of pass-through entities. Finally, congressional proposals and the Treasury’s Green Book indicate that offshore income is a source for raising tax revenue. Stay tuned for more to come in this area of the tax law.
Innovation In The Midst Of COVID
Business leaders and owners have been creative and resourceful during the pandemic. Companies have invented, transformed, and accelerated adoption of products and processes. The reward for these efforts may be a research and development tax credit. Companies can use time now to collect the documentation of problem solving and scientific methods to support the R&D credit.
Nexus, Telecommuting Workers, And Pass-Through Entity Tax
Year-end planning for state and local taxes will be important in 2021 as companies address the evolving state laws regarding nexus and consider if employees working away from their usual locations create new reporting and payment requirements for both income and employment taxes. Approximately 20 states have enacted legislation to allow pass- through entities (PTEs) to pay state income tax on company income rather than the PTE owners paying the tax. The goal of the PTE taxation option is to work around the $10,000 limit on state and local income taxes for individual taxpayers. All PTEs should consider the opportunity that PTE taxation may offer.
Claiming Pass-Through Losses
Individual owners of pass-through entities face four hurdles before a business loss can be deducted on their returns: 1) stock and debt basis limitations; 2) at risk limitations; 3) passive activity loss limitations; and 4) excess business loss limitation. Owners should consider each of these limits and take action before year end to maximize their deductions from an anticipated PTE loss.
Net Operating Loss Carryforward
Beginning in 2021 and for all subsequent tax years, federal net operating losses (NOLs) generated can only be carried forward. In addition, NOLs generated in tax years 2018 and after may only offset 80% of current year taxable income. However, NOLs generated in years before 2018 may offset up to 100% of current year taxable income.
Retirement Savings Plans
At the end of 2021 and even into 2022 employers can consider establishing and funding qualified retirement savings plans for their employees as a way to lower 2021 taxable income. Many businesses are also experiencing a competitive market for employees. Reward programs such as nonqualified deferred compensation, pay down of student loans, and donations of unused vacation time for disaster relief might distinguish one employer over another.
Conclusion
Congress and the President may deliver a new tax law before year’s end, leaving little time for planning into its provisions. However, companies have the opportunity now to assess their current results; consider current tax law, and consider projections for company results in the next tax year. Your Cherry Bekaert tax advisor will be reaching out to discuss year end planning. We look forward to the opportunity to work with you to identify the best tax positions and opportunities for the company.
