BMSS’ Year-End Tax Planning Letter
2020 has been a year filled with challenges and adversity like no other and has affected each and every one of us. The coronavirus global pandemic has resulted in economic hardship for many individuals and businesses, and many uncertainties remain for the immediate future.
We are also awaiting final results in a number of November elections that could have a significant impact on federal tax legislation in 2021 and beyond. The presidential election process is ongoing and the January 5th runoffs for the two Georgia Senate spots will have an impact on control of the Senate. Due to these election uncertainties, it will be extremely difficult for taxpayers and professional advisors to anticipate possible tax changes for 2021.
Regardless of uncertainty, year-end tax planning opportunities should still be explored. This letter discusses some options available to help minimize your 2020 tax bill and plan for the years ahead. Additionally, we have included several new opportunities that have arisen from federal legislation passed in 2020.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was officially enacted on January 1, 2020 with the intent to strengthen retirement security across the nation. The Coronavirus Aid, Relief, and Economic Security (CARES) Act was in enacted in March 2020 in response to COVID-19. Included in the CARES Act is the Paycheck Protection Program (PPP), which guaranteed $349 billion in new loans for eligible businesses and nonprofits affected by COVID-19. We will highlight some tax planning opportunities that are available in each piece of new 2020 legislation.
Overview of General Goals and Objectives of Year–end Tax Planning
Most traditional income tax planning strategies focus on several key areas:
- Planning the timing (deferral or acceleration) of particular items of income or deductions, to the extent that they can be shifted from one year to another in order to take advantage of possible differences in the effective tax rate for the current year and succeeding year(s), limitations on deductions, or other factors that may differ from year to year;
- Maximizing, within overall general planning, the character of income (for example, qualified dividends and capital gains) that is subject to preferential, lower tax rates than ordinary income; and
- Taking advantage of special incentive provisions of the Internal Revenue Code when available such as §179 expensing, bonus depreciation, various credits related to different business or personal activities, and Qualified Opportunity Fund investments.
To complicate matters further, these general planning strategies must also consider the impact of taxes other than the regular income tax, such as the alternative minimum tax, the net investment income tax, the Medicare surtax and applicable state and local taxes, to name a few. The limitations applicable to certain itemized deductions must also be considered in planning for the timing of deductions.
As always, tax planning requires a combination of multi-layered strategies, taking into account a variety of possible scenarios and outcomes. There are various income and deduction items to consider and your BMSS trusted advisor will be glad to assist you in order to determine the most beneficial approach to take.
For your reference and background for considering the items discussed in this letter, we have included, immediately following this letter, tax rate schedules and other key tax facts for 2019 and 2020, for comparative purposes.
For additional information on tax provisions enacted as a part of 2020 COVID relief legislation, please see A Proactive Approach to COVID-19 at https://www.bmss.com/coronavirus/.
Capital Gain (Loss) Harvesting
Gain from the sale of capital assets held for longer than one year benefit from the reduced tax rate of no greater than 20 percent. A common strategy regarding investment portfolios as you near the end of the year is to consider selling loss positions to offset incurred or planned capital gains before year end. Keep in mind the “wash sale rules” when reviewing year-end capital gains and dividends. Wash sales are sales of stock or securities in which losses are realized but not recognized for tax purposes because the seller acquires substantially identical stock or securities within 30 days before or after the sale. Non-recognition, however, applies only to losses; gains are recognized in full.
Sale of Principal Residence
If you have or will sell your principal residence in 2020, an exclusion of up to $250,000 ($500,000 for married filing jointly taxpayers) applies to the gains from the sale of a principal residence. To be eligible for the exclusion, the residence must have been owned and occupied as your principal residence for at least two of the five years preceding the sale. If a taxpayer only satisfies a portion of the two-year ownership and use requirement, the exclusion amount is reduced (pro rata basis). If you want to sell your principle residence but decide to wait because of unfavorable market conditions, you can rent the residence for up to three years after the date you move out and still qualify for the exclusion. Any gain attributable to prior year depreciation claimed during the rental period will be taxed at a maximum 25 percent rate.
Alternative Minimum Tax – Individuals
The possibility of being subject to alternative minimum tax (AMT) should not be ignored as doing so may negate certain year-end tax strategies. While certain provisions of the TCJA (e.g., cap on state and local tax deductions and elimination of miscellaneous itemized deductions) mean fewer individuals will be subject to AMT, the tax does still exist. An AMT exemption is allowed; however, the exemption is phased out as taxpayers reach high levels of alternative minimum taxable income (AMTI). See the accompanying key tax facts following this letter for exemption amounts.
Net Investment Income Tax (NIIT) – Individuals
The NIIT is a 3.8 percent Medicare surtax imposed on the lesser of an individual’s (a) net investment income (NII), or (b) the amount of modified adjusted gross income (AGI with foreign income added back) that exceeds the thresholds below:
- $250,000 for MFJ (married filing jointly) or SS (surviving spouse)
- $125,000 for MFS (married filing separately)
- $200,000 for single taxpayers and HOH (head of household)
The NIIT generally applies to passive income and is not imposed on income derived from a trade or business or from the sale of property used in a trade or business. NII includes the following:
- Gross income from interest, dividends, annuities, royalties, and rents, provided this income is not derived in the ordinary course of an active trade or business;
- Gross income from a trade or business that is a passive activity for the taxpayer;
- Gross income from a trade or business of trading in financial instruments or commodities; and
- Gain from the disposition of property not held in an active trade or business.
NII can be reduced by certain investment-related expenses, such as investment interest expense, investment brokerage fees, royalty-related expenses, and state and local taxes allocable to items included in net investment income.
Keeping income below the thresholds, spreading income out over a number of years or offsetting the income with both above-the-line and itemized deductions are possible approaches to avoid the NIIT. Of course, every taxpayer’s situation is different and planning for the NIIT requires a very personalized strategy.
Additional Medicare Tax – Individuals
An additional 0.9 percent high income Medicare tax is imposed on wages and self-employment income that exceeds the same thresholds as the NIIT thresholds listed above. Although the thresholds are the same, this additional tax should not be confused with the 3.8 percent Medicare surtax on NII.
If federal income tax withholdings and estimated tax payments have not been made under a “safe harbor,” you can request that your employer withhold additional federal income taxes from your wages before year end to avoid an underpayment penalty related to this tax or the NIIT.
Converting a Traditional IRA to a Roth IRA
Considering whether to convert your traditional IRA to a Roth IRA is a tax planning strategy that can allow future distributions from the Roth IRA to be tax free. The taxpayer will have to pay tax on the converted funds, but once the money is in the Roth, all future earnings are tax free. Present and future tax rates, as well as remaining number of years before planned distributions, are key in your decision on whether a Roth conversion makes sense. If you expect the tax rate you will pay in retirement to remain the same or increase, then switching to a Roth IRA may pay off in regard to taxes. If your tax rate in retirement will be lower, the tax-free Roth distributions during retirement may not be advantageous. Also, you do not need to convert the entire amount to a Roth at one time. The money can be moved in increments over time, spacing out the tax hit. BMSS can assist with analyses of alternatives in this area.
Traditional IRA Contributions
The SECURE Act, enacted on January 1, 2020, has removed the age restriction for traditional IRA contributions. Individuals over the age of 70½ who are still working in 2020 can contribute to a traditional IRA. If you are over age 70½ and plan to make a Qualified Charitable Distribution (QCD) from your IRA, making a deductible IRA contribution could affect your ability to exclude future QCD’s from your income.
Retirement Plan Distributions
2020 presents a unique opportunity for taxpayers to take distributions from 401k plans and IRAs due to COVID-19. If the taxpayer meets certain requirements, the distributions, up to a combined limit of $100,000 from all retirement plans, are not subject to the 10 percent additional tax on early distributions and may be included in taxpayer’s taxable income over a three-year period, one third each year, beginning the year the distribution is received. Taxpayers may recontribute the withdrawn amounts to a tax-qualified plan or IRA at any time within three years after the distribution. These repayments will be treated as a tax-free rollover and are not subject to that year’s cap on contributions.
Under the SECURE Act, the age for Required Minimum Distributions (RMD) was increased to 72. The new age limit does not apply to individuals who turned 70½ prior to the end of 2019.
One major change to retirement plan distributions under the SECURE Act is the 10-year distribution rule. This new rule requires most non-spousal beneficiaries of retirement plans, after January 1, 2020, to distribute the entire inherited account within 10 years of the account owner’s passing. This 10-year rule applies both to traditional IRAs and to Roth IRAs. Beneficiaries are no longer allowed to take minimum distributions over their own life expectancy due to this new rule. Exceptions to the 10-year distribution rule are:
- Surviving spouse,
- A minor child (10-year rule applies once the minor reaches the age of majority),
- A disabled individual,
- A chronically ill individual, or
- An individual who is not more than 10 years younger than the deceased participant or IRA owner.
Contributing to your 401(k)
For 2020, the contribution limit is $19,500 ($26,000 for individuals age 50 or older). Amounts you defer and pay into your 401(k) plan are generally pretax, meaning they are not subject to federal income tax or payroll taxes. The exception to the pre-tax treatment is contributions to a Roth 401(k) plan if available from your employer.
Simplified Employee Pension Plans
A Simplified Employee Pension (SEP) plan allows employers to contribute to traditional IRA’s set up for employees. Employers can contribute up to 25 percent of the employee’s annual salary (up to an annual maximum set by the IRS each year.) The maximum SEP contribution for 2020 is $57,000 and the contribution must be made by the extended due date of the employer’s return.
A self-employed individual can also contribute to an SEP plan. Net earnings from self-employment must be reduced by one-half of self-employment tax and the SEP contribution when computing the maximum deduction for the SEP contribution. The contribution must be made by the extended due date of the individual’s return.
Child and Education Related Tax Benefits – Individuals
Adoption Credit and Adoption Assistance Programs
Most taxpayers can claim a credit for qualified expenses incurred in connection with the adoption of an eligible child. The credit for each adoption finalized in 2020 is limited to a maximum amount of $14,300 (nonrefundable) per child. Additionally, $14,300 received under an adoption assistance program may be excluded from gross income. Both the credit and gross income exclusion are phased out for higher income taxpayers. Examples of eligible adoption expenses include adoption fees, legal fees, court costs, and travel expenses. The adoption credit is available for eligible expenses that are paid out of pocket, less any reimbursed amounts.
Different rules apply to adoptions regarding domestic children, foreign children, and children with special needs. For example, taxpayers who adopt a special needs child can claim the full amount of the adoption credit, even if the actual expenses were less than the maximum adoption credit of $14,300.
Child and Dependent Care (CDC) Credit
Taxpayers who incur expenses to care for children under age 13 (or for an incapacitated dependent or spouse) in order to work or look for work can claim a credit for those expenses. The credit is calculated as a percentage of the expenses incurred, up to a maximum of $3,000 for taxpayers with one qualifying child or dependent and $6,000 for taxpayers with two or more qualifying children or dependents. A qualifying individual for the child and dependent care credit includes the following:
- Your dependent qualifying child is under age 13 when care is provided, or
- Your spouse, who is physically or mentally incapable of self-care, lived with you for more than half of the year.
Child Tax Credit (CTC)
Taxpayers are allowed an income tax credit of $2,000 for each qualifying child under the age of 17 at the end of the calendar year. The child tax credit is refundable, up to $1,400, for some taxpayers, but begins to phaseout for higher-income taxpayers at the thresholds below:
- $400,000 for MFJ (complete phaseout at $440,000)
- $200,000 for single taxpayers, HOH and MFS (complete phaseout at $240,000)
Taxpayers are also allowed to take a $500 nonrefundable credit for qualifying dependents other than children.
American Opportunity Tax Credit (AOTC)
The maximum credit that can be taken is $2,500 per eligible student for the first four years of higher education and up to $1,000 of that amount is refundable. The AOTC is phased out for single taxpayers with incomes ranging from $80,000 to $90,000, and for joint taxpayers with incomes ranging from $160,000 to $180,000.
Lifetime Learning Tax Credit
The lifetime learning credit is a nonrefundable credit for qualified students and is available for all years of post-secondary education. The maximum credit is $2,000 and is phased out for single taxpayers with incomes ranging from $59,000 to $68,000 and joint taxpayers with incomes ranging from $118,000 to $136,000. The lifetime learning credit and American Opportunity credit cannot be taken in the same tax year. The Lifetime Learning Tax Credit is not available in the following circumstances:
- The taxpayer claimed the AOTC during the same tax year;
- The taxpayer pays for college expenses for someone who is not a dependent;
- The taxpayer files federal income tax returns as married filing separately; or
- The taxpayer or spouse is a nonresident alien who is not treated as a resident alien for tax purposes.
Coverdell Education Savings Accounts (ESAs)
ESAs are trust or custodial accounts created exclusively to pay the qualified elementary, secondary and higher education expenses of a single named beneficiary. Annual contributions are limited to $2,000 per beneficiary, but this limit is phased out for higher-income contributors. Contributions may be made to an ESA up to the original due date of the return. The contributions are not tax deductible, but the designated beneficiary can receive tax-free distributions to pay qualified education expenses.
Qualified Tuition Programs (QTP)
A Qualified Tuition Program is an education savings plan designed to help families set aside funds for future college costs. Contributions to a QTP are not deductible, however, the earnings in the plan grow tax free, provided they are used for qualified expenses (e.g. tuition, fees, room and board, books, supplies, computers and software) while enrolled at an eligible educational institution.
Educational Assistance Programs
Employees are allowed to exclude up to $5,250 from gross income and wages for annual educational assistance provided under an employer’s nondiscriminatory “educational assistance plan.” For employer programs to qualify, the program should not allow employees to choose to receive cash or other benefits that must be included in gross income instead of educational assistance. Also, employer-provided educational benefits may be excluded as a fringe benefit.
The CARES Act amends the rules of IRC Section 127 to allow employers to pay eligible employees’ student loans as educational assistance. Payments must be made by the employer on or after the date the CARES Act was enacted (March 27, 2020) and before January 1, 2021. If this provision of the CARES Act expires as scheduled, then employer payments on or after January 1, 2021 would be taxable compensation once again (as prior to March 27, 2020).
Any amount received as a qualified scholarship and used for qualified tuition and related expenses can be excluded from income. The exclusion does not apply to any portion of the amount received which represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship (with limited exceptions). Also, amounts used for incidental expenses, such as room and board, travel, and optional equipment, must be included in gross income.
Student Loan Interest Deduction
Taxpayers may deduct from gross income, subject to certain conditions, interest payments made on qualified education loans. The deduction is an above-the-line adjustment to income that can be claimed by all individuals, not just those who itemize. The maximum deduction of $2,500 is reduced when modified AGI exceeds $80,000 ($165,000 married filing jointly) and is completely eliminated when modified AGI reaches $95,000 ($195,000 married filing jointly). Please be sure to keep any 1098-E forms you receive relating to this deduction.
Educators can claim a deduction for up to $250 of classroom expenses (such as books, supplies, and computer equipment), and should maximize those expenses by year end. If you are married filing jointly and both of you are eligible educators, the limit is $500 ($250 each). This deduction is an above-the-line deduction, meaning it directly lowers your AGI.
Above the Line Charitable Deduction
Under the CARES Act, taxpayers are now able to take a $300 charitable deduction ($600 married filing jointly) without having to itemize your deductions on your 2020 tax return. A qualifying deduction will be a cash contribution made to a qualifying organization made during the 2020 calendar year.
Qualified Business Income Deduction
For tax years beginning after 2017, taxpayers, other than corporations, may be entitled to a deduction of up to 20 percent of their qualified business income. For an individual taxpayer entitled to the full 20 percent deduction, the highest marginal rate on the qualified business income can be reduced from the regular tax highest marginal rate of 37 percent to 29.6 percent. For 2020, if taxable income exceeds $326,600 for married filing jointly, or $163,300 for all other taxpayers, the deduction may be subject to certain limitations. The deduction may be limited based on whether the taxpayer is engaged in a service type trade or business (such as law, accounting, health, or consulting), by the amount of W-2 wages paid by the trade or business, and/or by the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business. The limitations are phased in for joint filers between $326,600 and $426,600 and, for all other taxpayers with taxable income, between $163,300 and $213,300.
Standard and Itemized Deductions – Individuals
Standard Deduction – Click here for key tax information supplement.
- State and local taxes (including personal property and real estate) are limited to $10,000 ($5,000 if married filing separately).
- The floor for medical expenses in 2020 is 7.5 percent of AGI.
- Section 2205 of the CARES Act has increased the limit for cash charitable contributions from 60 percent to 100 percent of AGI. Any cash gifts in excess of the limit can be carried forward for five years. Contributions to non-operating private foundations or donor-advised funds are not eligible for the 100 percent AGI limitation.
- For mortgages taken out after December 14, 2017, only interest on the first $750,000 of mortgage debt is deductible. For mortgages before December 14, 2017, the mortgage interest deduction lets you deduct mortgage interest paid on the first $1,000,000 of mortgage debt for a primary or secondary home.
- Interest on home equity loans is no longer deductible if it is not connected to home improvement expenses. Interest on home equity loans is subject to the $750,000 mortgage limit (MFJ), or $375,000 for a married taxpayer filing a separate return.
- Personal casualty and theft losses are deductible only if they are attributable to a federally declared disaster and only to the extent the $100 per casualty and 10 percent of AGI limits are met.
Estate, Trust and Gift Taxes
The 2020 estate and gift tax exemption is $11,580,000 per person ($23,160,000 for a married couple). These figures are scheduled to go back to $5 million and $10 million, respectively, after 2025; however, these limits can be reduced by legislation. Preliminary consideration to more robust gifting strategies for 2020 may be appropriate. IRS regulations issued in 2018 indicate that gifts under the gift tax exemption amount at the date of the gift(s) will not be “clawed back” upon a taxpayer’s death even if the taxpayer made gifts in excess of the estate tax exemption ultimately in effect at the taxpayer’s death. The maximum federal unified estate and gift tax rate is 40 percent. The annual gift tax exclusion allows taxpayers to give up to $15,000 during 2020 to any individual ($30,000 for married couples who split the gifts), gift-tax free and without counting the amount of the gift toward the lifetime exclusion. The annual exclusion for gifts made to noncitizen spouses in 2020 is $157,000.
Exclusion for Educational and Medical Expenses
In addition to the $15,000 annual exclusion amount, nontaxable gifts or transfers may be made for certain educational and medical expenses. Any amount paid on behalf of an individual as tuition directly to certain educational organizations for the education or training of such individual is not treated as a transfer by gift for purposes of the gift tax. For medical expenses, the exclusion applies for certain medical expenses paid on behalf of an individual not reimbursed to the individual by insurance. The exclusion for educational and medical expenses is unlimited in amount and can be made on behalf of anyone you choose, as long as the payments are made directly to the educational institution or health care provider. If this exclusion applies to you, be sure to pay the educational institution directly, rather than paying the money to an individual.
Year-End Trust Distribution Planning
For certain trusts that are not required to make distributions, distribution planning is important in order to minimize the overall tax due on the trust’s income. In general, a trust not otherwise required to make distributions is liable for the tax on all of its income if no distributions are made to beneficiaries. If distributions are made, the beneficiary is taxed on the portion of the income distributed, not the trust. Trusts hit the top income tax rate of 37 percent for ordinary income in excess of $12,950 in 2020. For individuals, this amount is $518,401 for single filers, and $622,051 for joint filers. Due to the compressed tax bracket for trusts, distributions to beneficiaries often result in a lower overall tax burden. Of course, all factors should be considered as to whether a distribution is appropriate, not just for income tax planning. If a trustee determines that distributions are appropriate, trusts have until 65 days after year end (March 5, 2021) to make a distribution and treat it as a distribution for the 2020 tax year.
Reviewing Retirement Plan Beneficiaries
For future planning purposes, avoid unintended consequences by updating beneficiary designations of your 401(k) or 403(b) plans, annuities, pensions, and IRAs to account for life changes such as marriage, divorce, or the death of a spouse or other beneficiary listed. Also, be sure to review the beneficiaries listed in your will and taxable accounts. If you do not have a will, consider drafting one sooner rather than later.
C corporations continue to face double taxation, with taxes paid once at the entity level and again when dividends are paid to shareholders. With the TCJA, the C corporation tax rate was reduced to 21 percent. Corporate Alternative Minimum Tax and the Domestic Production Activities Deduction were both repealed under the new laws. Many businesses, however, are not taxed at the entity level as corporations; instead taxable profits and losses are passed through to their owners. With the highest individual tax rate at 37 percent and additional surtaxes on passive income by way of the 3.8 percent Net Investment Income Tax, minimizing tax remains a challenge in 2020.
Deductions and Credits – Business
100 percent first-year bonus depreciation is available for qualifying property placed in service in the 2020 tax year. In order to be eligible for bonus depreciation, qualifying property can be new (first-time use) or used tangible property. Any qualifying property acquired and placed in service after September 27, 2017 and before January 1, 2023 is eligible for bonus depreciation. In addition, buyers of heavy SUVs used solely for business can write off the full cost, thanks to bonus depreciation. SUVs must have a gross weight rating over 6,000 pounds. Further, the bonus depreciation deduction will decrease in future years as follows:
- 80 percent for property placed in service after December 31, 2022 and before January 1, 2024
- 60 percent for property placed in service after December 31, 2023 and before January 1, 2025
- 40 percent for property placed in service after December 31, 2024 and before January 1, 2026
- 20 percent for property placed in service after December 31, 2025 and before January 1, 2027
Code Section 179 Expensing
Code Section 179 property includes new or used tangible personal property that is purchased to use in an active trade or business. Under the enhanced expensing, for 2020, businesses can expense up to $1,040,000 in qualifying expenditures, with no reduction unless expenditures exceed $2,590,000. Note that the amount expensed cannot exceed the business’s taxable income. Bonus depreciation does not have this rule.
Qualified Improvement Property
Due to an error in the Tax Cuts and Jobs Act (TCJA), qualified improvements to property were not eligible to be immediately written off with accelerated depreciation. The CARES Act has corrected this error and is allowing taxpayers to amend 2018 and 2019 tax returns to claim this write off, generating potential refunds.
Net Operating Losses
When your business experienced a net operating loss, you were only allowed to carry the loss forward to future years to offset 80 percent of the current year taxable income.
The CARES Act changed the treatment of NOLs generated in 2018, 2019, and 2020. Taxpayers are now allowed to carry these losses back five years and they are not subject to a taxable income limit. This change also provides taxpayers the opportunity to amend prior year returns to claim the loss and receive a refund.
Limitation on the Deduction of Business Interest
The CARES Act made a temporary change in the limitation on the taxpayer’s deduction for business interest expense. In general, the deduction is limited to the sum of:
- The taxpayer’s business interest income for the tax year for which the taxpayer is claiming the deduction (not including investment income);
- 50 percent of the taxpayer’s adjusted taxable income (up from 30 percent in 2019); and
- The taxpayer’s floor plan financing interest.
The limitation applies to all taxpayers except a small business with average annual gross receipts for the three prior tax years of $26 million for 2020. The small business exception does not apply to tax shelters, including syndicates, which remain subject to the limitation. The limitation also does not apply to certain excepted businesses including an electing real property business, an electing farming business, and certain regulated utility businesses. Like the qualified business income deduction, the Treasury has issued lengthy, complex regulations for IRC section 163(j). BMSS is equipped to assist you in determining the application of the limitation to your business.
Taxpayers can defer the gain (or portion of that gain) on the exchange of like-kind property. Both the relinquished property and the acquired property must be held for business or investment purposes. After TCJA, like-kind exchanges are limited to exchanges of real property that are held for use in a trade or business or for investment. Real property includes land and generally anything built on or attached to it. Further, exchanges of personal property no longer qualify for deferral.
Tangible Personal Property Regulations
The IRS issued final regulations in 2014 that refine and simplify the rules for expensing tangible personal property, including the de minimis safe harbor. For 2020, the safe harbor enables taxpayers to routinely deduct items whose cost is below $5,000 for taxpayers with an applicable financial statement (AFS) and $2,500 for taxpayers without an AFS.
The research credit provides a credit for 20 percent of qualified research expenses over a base amount. The research credit applies to any amounts paid or incurred for qualified research and experimentation. BMSS has a Research and Development team ready to meet with you to discuss your company’s R&D potential.
Standard Mileage Rate – See key tax information supplement following this letter.
Payroll Protection Program
One of the major components of the CARES Act was the Paycheck Protection Program (PPP). The PPP allowed small business to take loans up to $10 million which they could use to cover the costs of keeping employees, adding employees, and paying certain other expenses. A main concern for every business that received a PPP loan is the forgiveness of the loan. Borrowers have ten months from the completion of the covered period to submit their forgiveness application. BMSS has assembled a team that will be handling PPP loan forgiveness calculations and would welcome the opportunity to assist you with this matter.
The CARES Act states that the forgiven PPP loans are not to be included in federal taxable income. The IRS has said in guidance that businesses are not permitted tax deductions for expenses, such as rent or wages, that are paid by forgiven loans. Some lawmakers have pushed back against that interpretation, although they have not yet addressed it by passing legislation.
The question becomes even more complicated when a loan is forgiven in a different tax year than when the deduction would normally occur. The IRS or Treasury may give additional guidance on this situation, but it is uncertain if that will happen before year end. If guidance is not forthcoming, for expenditures made during 2020 funded by a PPP loan forgiven in 2021, the conservative approach would be to not deduct the expenses in 2020. BMSS is here to assist you in understanding the different scenarios and the potential risks if IRS guidance is not available.
IRS Notice 2020-75
This recent notice announces that Treasury will issue regulations to provide that partnerships or S corporations may deduct specified income tax payments against non-separately stated taxable income or loss for the taxable year of the payment. Specified income tax payments include amounts paid by the partnership or S corporation pursuant to a direct imposition of income tax on the partnership or S corporation, rather than the owners. Several states, including New Jersey and Connecticut, have created these entity level taxes on pass-through businesses to find a path around the cap on state income tax deductions by individuals. Some of these new entity level taxes, for example New Jersey, are based on an election by the entity, and these elections should be considered. Alabama has yet to pass any legislation creating an entity level tax.
We’re Here to Help You
BMSS understands that the complexity of the tax law can make year-end tax planning overwhelming, but it is a necessity. This letter covered several of the high points, but there are many more strategies that can help reduce your tax liability over a period of time.
Please contact BMSS at (833) CPA-BMSS if you have any questions regarding the opportunities presented in this letter or to schedule an appointment to develop a year-end tax plan for your unique circumstances. BMSS strives to provide each client with peace of mind and we look forward to helping you plan for the upcoming tax season.