Small Business Taxes & Management

Special Report


Year-End Tax Planning--Part I

 

Small Business Taxes & ManagementTM--Copyright 2020, A/N Group, Inc.

 

 

General Comments

This is going to be one of the most difficult years for many individuals, business owners and tax professionals. There have been some changes in the tax law, but the real issue is your income. As an individual you may have been laid off, as a business your revenue could have plummeted--or, for some businesses, could have gone up. Expenses may be down because you laid off workers, etc. The numbers could be all over, and maybe even out of, the ball park. If your income is way down you might want to generate "artificial" income by selling assets. If you are in the red already, you want to explore possibilities with net operating losses.

For many taxpayers his is not the year to ignore or take year-end planning lightly. You could be throwing away big dollars. And, while taxes may not go up next year, the new administration will be unlikely to decrease them.

Before doing any serious planning you should review your income and expenses for the year. If you have a business operating as an S corporation, partnership, LLC, or sole proprietorship, the income and losses will be passed through to you. So you've got to have a good idea of how the business is doing. Much the same applies if you have a rental property (or properties) and can deduct the losses or if the property throws off income. In the past we've said that rental properties tend to be more stable than an operating business. Even that's not true this year. You may have tenants who are behind in the rent--or moved out.

The theory behind business tax planning is similar to planning for your personal return. You want to defer the income to a low tax rate year. If you do business as a sole proprietorship (i.e., file a Schedule C), S corporation, partnership, or LLC (limited liability company), income and losses of the business are passed through and reported on your personal tax return. Thus, your approach to year-end planning is similar to that for individual planning. (There are some factors that can complicate the issue; they're discussed below.) And, yes, while it's true you can save taxes by making equipment and other purchases, you're out-of-pocket cost is still more than 50%. For example, you purchase a $1,000 laptop. If you're in the 37% bracket for federal purposes and 10% for state, you're effective tax rate is probably about 45% (you get a deduction for your state taxes on your federal return). That means the government is picking up $450 of the cost; you're paying for the other $550. If you're self-employed or doing business as a partnership or LLC, your rate will be slightly higher when you add in the self-employment tax. Best suggestion? As always, economic considerations come first. Don't buy what you don't need; don't buy more than you need.

For a list of tax rates, facts on alternative minimum tax, standard deduction, credits, etc. go to our Tax Tables page for the details.

Projecting Your Income--Business

Before going any further you've got to have a good handle on the income from your business. Your accounting records are a good starting point, but more than likely you'll have to adjust them to conform to the tax accounting rules. Here are some possible adjustments:

CAUTION--If you got a PPP loan and the loan was, or you expect it to be, forgiven, it's not income to the business. On the other hand, at this time, the law states that you can't deduct expenses you paid with the loan proceeds. For example, you got a $200,000 loan and $180,000 was forgiven. You claimed you paid $140,000 in salary and $40,000 in rent from the loan proceeds. Your salary deduction for 2020 must be reduced by $140,000 and your rent deduction by $40,000. There is a small chance the rules could be changed, but for planning purposes, you should go with the current law.

Check with your accountant on these issues. Hopefully, the differences will be slight, and, if so, can be ignored.

In the past we've suggested annualize your income (e.g., take the first 10 (or 11 if you have them) months, divide the income by 10 (or 11) and multiply by 12) to figure your full-year profit or loss and then account for any variations during the year. Far fewer businesses are likely to be able to do that this year. You might try and forecast revenue and expenses through the end of the year. Alternatively, use the latest couple of months, say August, September, and October, divide by three and multiply by two to estimate November and December. Whatever you do, don't just wing it. Use a rational approach. You might even use more than one scenario. Again, this will be an important year for tax planning.

Businesses that operate as a sole proprietorship, LLC, partnership, S corporation, etc. have their income (or losses) passed through to the owners and reported on the owners' individual tax returns. That means you'll have to project both the businesses income and your personal income to evaluate your tax bracket. See below.

 

Projecting Your Income-Personal

If you do business as an S corporation, sole proprietorship, etc. your share of profits or losses are passed through and taxed on your personal return. (If you, or you and your spouse are the only shareholders in an S corporation, taking a smaller or larger salary won't change the outcome materially. A larger salary will just mean the pass-through income from the S corporation will be reduced and vice versa. But the total income will be virtually unchanged. That means you'll have to do a projection of your personal as well as business income before you can do any serious business planning. Fortunately, projecting your personal income is likely to be easier. Assemble your records for the first 10 months of the year. If you record income and expenses on a regular basis, this should be a snap. The purpose of this article is to determine if it makes sense to make any last minute busness capital expenditures to take advantage of bonus depreciation, etc. While we've included a list of items to take into account at the personal level, you can cheat and estimate some of them. For example, your charitable contributions usually run $500 to $1,000. For now your best guess is good enough. Concentrate on the bigger numbers.

Caution!--If you turned 70-1/2 this year you'd normally have to start taking distributions (required minimum distributions or RMD) from your IRA and certain other plans if you're a business owner or retired. Everyone is entitled to defer required distributions from IRAs and defined contribution plans this year. You won't have to double-up next year. If you already started taking distributions you can also defer distributions with no penalty.

Finding your tax bracket. If you've got a good handle on your income and expenses you can net the two to arrive at your taxable income.

If you're pretty confident of your computations, you can find your tax bracket by using the Tax Tables in our Reference File. Keep in mind that long-term capital gains and qualifying dividends are taxed at a lower rate. Go to our Tax Tables for the details. However, we strongly suggest you use tax software to do the calculations. Many 2019 versions have a 2020 planning module. Alternatively, you can use the 2019 version. For planning purposes you won't be far off.

Caution. Your chance of getting hit with the alternative minimum tax (AMT) is substantially less than before the 2017 tax law change. But it's still possible. If you were subject to it in 2019 there's a chance you may face it again.

We'll discuss specifics of tax planning for businesses in the next article and planning for individuals in the final article.

 


Copyright 2020 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536


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--Last Update 11/10/20