Although 2020 is history (thankfully), business taxpayers can still take actions that will lower last year’s federal income tax liability and/or federal income tax liabilities for future years. This column supplies some ideas. Here goes.
Decide to claim 100% first-year bonus depreciation or not
For qualifying assets placed in service in 2020, business taxpayers can deduct 100% of the cost in Year 1. The 100% instant write-off is allowed for both new and used qualifying assets, which include most categories of tangible depreciable assets. While claiming 100% first-year bonus depreciation whenever it is allowed is usually considered a tax-smart move, think twice about claiming it for 2020 additions if you anticipate higher tax rates in future years. In that case, consider foregoing bonus depreciation on last year’s return and instead depreciate the assets in question over a number of years. That way, the depreciation write-offs will offset future income that you suspect might be taxed at higher rates (maybe much higher rates). The choice to claim 100% first-year bonus depreciation for 2020 asset additions, or not, is made on last year’s return.
The NOL factor
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) allows a five-year carryback privilege for a business net operating loss (NOL) that arises in a tax year beginning in 2020. Claiming 100% first-year bonus depreciation can potentially create or increase an NOL for the year. If so, the NOL can be carried back, and you can recover some or all of the federal income tax paid for the carryback year. So, this factor argues in favor of claiming 100% first-year bonus depreciation on last year’s return. Talk to your tax pro about what makes the most sense for your specific situation.
Take advantage of COVID-19 tax relief
The CARES Act included several valuable federal tax relief provisions for business taxpayers. These provisions can impact last year’s business return. For instance:
- The CARES Act liberalized the business net operating loss (NOL) deduction rules for NOLs that arose in tax years beginning in 2020. Those NOLs can carried back up to five tax years. So, an NOL that is reported on last year’s return can be carried back to an earlier year and allow you to recover some or all of the federal income tax paid in the carry-back year. Because federal income tax rates were generally higher in years before the Tax Cuts and Jobs Act (TCJA) took effect, NOLs carried back to those years can be especially beneficial.
- The CARES Act allows much faster depreciation for real estate Qualified Improvement Property (QIP). QIP is generally defined as an improvement to an interior portion of a nonresidential building that is placed in service after the date the building was first placed in service. The CARES Act provision allows 100% first-year bonus depreciation for the cost of QIP that was placed in service in 2020. Alternatively, you can depreciate QIP placed in service in 2020 over 15 years using the straight-line method.
- An unfavorable TCJA provision disallowed current deductions for so-called excess business losses incurred by individuals in tax years beginning in 2018-2025. An excess business loss is one that exceeds $250,000 or $500,000 for a married joint-filing couple. The CARES Act suspended the excess business loss disallowance rule for losses that arose in tax years beginning in 2020.
- Talk to your tax pro about other federal tax relief provisions that may be available for your business’s 2020 tax year.
Decide to extend your business return or not
Because 2020 was such a strange year, business taxpayers have lots of additional things to consider for last year’s federal income tax returns. You have the aforementioned COVID-19 tax relief provisions to evaluate. You have the impact of the election on taxes for 2021 and beyond to think about. Because what you choose to do on last year’s return can affect your tax bills for later years, extending last year’s return might be a wise move. That would give you more time to evaluate all the relevant factors in your specific situation.
- The filing deadline for the 2020 Form 1040 of an individual who operates a business as a sole proprietorship or as a single-member LLC that is treated as a sole proprietorship for tax purposes is 4/15/21, but you can extend the deadline to 10/15/21 by filing IRS Form 4868.
- The filing deadline for the calendar-year 2020 return of a partnership, LLC treated as a partnership for tax purposes, or S corporation is 3/15/21, but you can extend it to 9/15/21 by filing IRS Form 7004.
- The filing deadline for the calendar-year 2020 return of a C corporation is 4/15/21, but you can extend it to 10/15/21 by filing IRS Form 7004.
Claim Qualified Business Income (QBI) deduction on your personal return
For 2020, you can potentially claim a personal federal income tax deduction for up to 20% of qualified business income (QBI) from a sole proprietorship, an LLC treated as a sole proprietorship, an LLC treated as a partnership for tax purposes, a partnership, or an S corporation. However, the deduction is subject to restrictions that can apply at higher personal income levels. If you qualify, the deduction is claimed on your 2020 Form 1040 which is due on April 15 or October 15 if you extend your return. You may want professional help to interpret the complicated QBI deduction rules and calculate your maximum allowable write-off.