I love the 4th quarter… it’s filled with my favorite holidays, good shopping, great fall weather, and… opportunities to make the most of last-minute tax deductions. If you haven’t already given this some thought, don’t fret -- there’s still time. 2020 was an unpredictable year, for sure, so if there was ever a time to do some tax planning, it’s now.
Here are seven powerful business tax deduction strategies I often utilize and implement with my clients before the end of the year to maximize their deductions. They are not one-size-fit-all, so before applying any, I strongly suggest a tax-planning strategy session with your tax professional (or ASE Group if you don’t have one) so that your current, future (and even past) taxes can be considered.
1. Prepay Expenses Using the IRS Safe Harbor
This strategy works well if your goal is to lower your taxable income this year, and have funds available to spend. It works even better if you anticipate lower income in the next year, and won’t need as many deductions then. I know this doesn’t happen often, but you might actually want to thank the IRS for its tax-deduction safe harbors. IRS regulations contain a safe-harbor rule that allows cash-basis taxpayers to prepay and deduct qualifying expenses up to 12 months in advance without challenge, adjustment, or change by the IRS.
Under this safe harbor, your 2020 prepayments cannot go into 2022. This makes sense, because you can prepay only 12 months of qualifying expenses under the safe-harbor rule.
For a cash-basis taxpayer, qualifying expenses include lease payments on business vehicles, rent payments on offices and machinery, and business and malpractice insurance premiums.
Example. You pay $3,000 a month in rent and would benefit from a $36,000 deduction this year. So on Thursday, December 31, 2020, you mail a rent check for $36,000 to cover all of your 2021 rent. Your landlord does not receive the payment in the mail until Tuesday, January 5, 2021. Here are the results:
You deduct $36,000 in 2020 (the year you paid the money).
The landlord reports taxable income of $36,000 in 2021 (the year he received the money).
You get what you want—the deduction this year.
The landlord gets what he/she wants—next year’s entire rent in advance, eliminating any collection problems while keeping the rent taxable in the year he/she expected it to be taxable.
Don’t surprise your landlord: if he/she had received the $36,000 of rent paid in advance in 2020, they may have had to pay taxes on the rent money in tax year 2020 if they’re a cash basis taxpayer.
Not sure what it means to be a cash basis taxpayer? Let’s discuss it. Click here to schedule a free consultation call with us.
2. Delay additional income -- Stop Billing Customers, Clients, and Patients
Here is one rock-solid, time-tested, easy strategy if your goal is to reduce your taxable income for this year: stop billing your customers, clients, and patients until after December 31, 2020. (We assume here that you or your business is on a cash basis and operates on the calendar year.)
Customers, clients, patients, and insurance companies generally don’t pay until billed. Not billing customers and patients is a time-tested tax-planning strategy that business owners have used successfully for years.
Example. Min T. Fresh, a dentist, usually bills her patients and the insurance companies at the end of each week; however, in December, she sends no bills. Instead, she gathers up those bills and mails them the first week of January. Presto! She just postponed paying taxes on her December 2020 income by moving that income to 2021.
Similar to strategy #1, this works well if your goal is to lower your taxable income this year, and can afford to delay income. It works even better if you anticipate lower income in the next year, and can stand to push additional income into 2021.
3. Buy Office Equipment
I’m certainly not a fan of buying things just for the deduction, but if you know you need new computers, printers, and office furniture, and you’re searching for extra deductions, go ahead and “Add it to the cart”. With bonus depreciation now at 100% along with increased limits for Section 179 expensing, buy your equipment or machinery and place it in service before December 31st to get a deduction for 100% of the cost in 2020.
Qualifying bonus depreciation and Section 179 purchases include new and used personal property such as machinery, equipment, computers, desks, chairs, and other furniture (and certain qualifying vehicles).
This strategy works best if you would benefit more from the increased deduction in 2020 versus spreading the depreciation expense over the useful life of the equipment. To explore this strategy and determine what would work best for your business, click here to schedule a free consultation call with us.
4. Use Your Credit Cards
I’ll admit -- I’m not the biggest fan of credit cards. But I’m also not a big fan of guacamole, so my opinion clearly doesn’t carry much weight. If you are a single-member LLC or sole proprietor filing a Schedule C to report your business’ profit or loss, the day you charge a purchase to your business or personal credit card is the day the expense is considered to have been incurred (and if it’s before December 31st, as a cash basis taxpayer, it’s a 2020 business expense). Therefore, as a Schedule C filer, you should consider using your credit card for last-minute purchases of office supplies and other business necessities if you do not have the cash available.
If you operate your business as a corporation, and if the corporation has a credit card in the business’ name, the same rule applies: the date of charge is the date of deduction for the corporation.
But if you operate your business as a corporation and you are the personal owner of the credit card, the corporation must reimburse you in order for the corporation to realize the tax deduction, and that happens on the date of reimbursement. Thus, submit your expense report and have your corporation make its reimbursement(s) to you before midnight on December 31.
5. Don’t Assume You Are Taking Too Many Deductions
If your business deductions exceed your business income, you have a tax loss for the year. With a few modifications to the loss, tax law calls this a “net operating loss,” or NOL.
If you are just starting your business, you could very possibly have an NOL. You could have a loss year even with an ongoing, successful business. And if you toss a pandemic on top of it, a loss year is extremely plausible.
You used to be able to carry back your NOL two years and get immediate tax refunds from prior years; however, the Tax Cuts and Jobs Act (TCJA) eliminated this provision. Now, you can only carry your NOL forward, and it can only offset up to 80 percent of your taxable income in any one future year (but there’s more to this story; stay tuned for tip #6).
What does this all mean? You should never stop documenting your deductions, and you should always claim all your rightful deductions. We have spoken with far too many business owners, especially new owners, who don’t claim all their deductions when those deductions would produce a tax loss.
6. BUT WAIT… there’s more! Thank COVID-19 for a 2020 update to the treatment of NOLs
Let’s be real: there’s little to be grateful for with COVID-19, with one of the several exceptions being the potential opportunities to turn NOLs into cash for your business.
Two NOL opportunities come from the Coronavirus Aid, Relief, and Economic Security (CARES) Act:
The CARES Act allows NOLs arising in tax years beginning in 2018, 2019, and 2020 to be carried back five years for refunds against prior taxes.
The CARES Act allows application of 100 percent of the NOL to the carryback years.
Before the CARES Act, you could not carry back your 2018, 2019, or 2020 losses, and your NOL could offset only up to 80 percent of taxable income before your Section 199A deduction (as mentioned in tip #5).
7. Deal with Your Qualified Improvement Property (QIP)
In the CARES Act, Congress finally fixed the qualified improvement property (QIP) error that it made in the TCJA. QIP is any improvement made by the taxpayer to the interior portion of a building that is non-residential real property (think office buildings, retail stores, and shopping centers) if you place the improvement in service after the date you place the building in service.
If you have such property on an already filed 2018 or 2019 return, it’s on that return as 39-year property. You now have to change it to 15-year property, eligible for both bonus depreciation and Section 179 expensing.
Don’t get overwhelmed with all these strategies -- 2020 was overwhelming enough! We’re happy to evaluate your business, its performance over the past 3 years and the tax-saving strategies that would benefit you the most. Let us help you stay sane, and save your cents and sense. Need help with your tax planning and filing?