Small Business Taxes & Management

Special Report


Year-End Tax Planning--Part I

 

Small Business Taxes & ManagementTM--Copyright 2021, A/N Group, Inc.

 

 

General Comments

While this year-end planning session may not be as difficult as last year, it still presents challenges. There are two bills that could affect your tax planning, but many of those proposed changes have been dropped. You should also be aware that some beneficial provisions for 2021 are expiring at the end of this year. In addition, some of the tax breaks of 2020 such as partial exemption for unemployment benefits are gone. The major scares in earlier versions of the bills have disappeared. (Look to the end of this article for a list of changes for 2021 and potential changes for 2022.) But you could be in a different financial situation than usual, whether you're simply an employee, an independent contractor, or own a regular business. Many taxpayers are still in a recovery mode so next year may be better than this. For a more limited number the reverse could be true. Also keep in mind that full 100 percent bonus depreciation will be available in 2022, it drops to 80 percent in 2023 and to 60 percent in 2024. Capital spending plans can be long term for many businesses.

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 again this year. Depending on the market, you may have tenants who are behind in the rent, moved out, or had new tenants moving in--some at a higher rent, some lower.

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 may 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:

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. Consider how business has gone for the year. 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 business 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 72 this year you'll have to start taking distributions (required minimum distributions or RMD). There's no option to defer this year. And the IRS is checking to make sure the distribution is made. Failure to do so can result in a substantial penalty. There's no exception for IRAs, but an RMD may not be required from a pension plan if you're still working. Check with your accountant.

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 2020 versions have a 2021 planning module. Alternatively, you can use the 2020 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 2020 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.

 

Tax Law Changes

This is not a complete list of changes. We've omitted minor changes, some changes that won't affect tax planning and ones that are unlikely to apply to most taxpayers such as those involving foreign business transactions.

Potential Changes in Pending Legislation. As mentioned earlier potential changes have been significantly scaled back. But there are some changes that could prove costly.

Income tax surcharge of 5 percent on individual income of more than $10 million. Depending on the wording in the final bill that could affect taxpayers selling a business, a tract of land, etc. Of more interest, the tax applies to trusts and estates with income of more than $200,000. That would apply to income after 2021.

The 3.8 percent net investment income tax (NIIT) would apply to S corporation, partnership, LLC, income on an individual's tax return. Currently such income is exempt. The change would apply to joint filers with income over $500,000 ($400,000 for head of households and single filers). Applicable to income after 2021.

The bill would enhance the child tax credit in several ways including increasing the age limit, increasing the amount of the credit, and changing the phaseout.

The bill would increase the number and amount of energy credits. The credit for nonbusiness energy property would be extended to 2031. The credit covers items such as energy efficient windows and doors and the limit on the credit would change from a lifetime to an annual credit and increase to $1,200. The credit for electric cars would increase and would be extended to used vehicles.

The bill would bring back the alternative minimum tax for C corporations at a 15 percent rate, with a number of modifications and exemptions for small entities.

Changes for in 2021 From Existing Laws. Again, we're only discussing important changes that could affect year-end planning for most individuals and small businesses.

For 2021 only, meal expenses are 100 percent deductible.

Last year you could have deferred your required minimum distributions from IRAs and pension plans. Not so for 2021. Make sure you do so by the end of the year and either have taxes withheld or make estimated payments.

Most of the special payroll tax credits for paid sick and family leave, employee retention, etc. expired at the end of this year.

 


Copyright 2021 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 11/3/21