In the ever-changing world of taxation, the last few years have been a rollercoaster ride resulting in numerous changes in the tax law that affect business tax planning. COVID-19 relief bills enacted in December 2020 and March of 2021 and pending legislation are at the root of the changes which will affect 2021 tax filings.
This article will outline business planning items which are in effect for 2021 for pass through entities with no speculation on the recent proposed tax legislations under the Build Back Better Plan.
QUALIFIED BUSINESS INCOME DEDUCTION:
Businesses operating as sole proprietorships, partnerships, S corporations, and some trusts and estates may be entitled to a deduction of up to 20% of their qualified business income (QBI). If a qualifying taxpayer’s income exceeds a certain threshold amount, then the deduction may be limited based on, whether the taxpayer is engaged in a service-type trade or business (SSTB), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property held by the trade or business.
EMPLOYEE RETENTION TAX CREDIT:
Employers who experienced a 20% or greater reduction in gross receipts in any calendar quarter in 2021 compared to the same calendar quarter in 2019, or who were subject to certain government orders due to COVID-19 may be eligible to claim a credit up to $7,000 per employee per quarter in the first three quarters of 2021.
Taxpayers should consider making expenditures that qualify for IRC Section 179 and/or 100% Bonus Depreciation.
Section 179 Deduction
- For 2021, the expensing limit is $1,050,000 and the phase out starts at $2,620,000.
- Expensing is generally available for most depreciable property (other than buildings), off the shelf computer software and business use vehicles (though restrictions apply)
- Expensing is also available for “qualified improvement property” (any interior improvement to a building’s interior but not the enlargement of the building, elevators or escalators, or the internal structural framework) as well as roofs, HVAC, fire protection, alarm, and security systems.
- There is a taxable income limitation in taking the deduction. The depreciation cannot produce a loss.
- Note – States may not follow Section 179
- If a trust is an owner in the entity, Section 179 is not allowed as a deduction at the trust level.
100% BONUS DEPRECIATION
- Businesses are permitted a 100% deduction for qualified new or used property with a recovery period of 20 years or less with the following disqualifiers:
- building and its structural framework (39 year property),
- elevators/escalators are considered “structural”,
- new expansions to an existing building,
- residential property (27.5 years) and
- deposit or receipt of property which has not been placed in service by the end of the year.
- 100% write off is allowed without any proration based on the length of time that the asset is place in service this year.
- No taxable income limitation in taking the deduction, however taxpayer must be aware of their basis in the entity for deducting any losses.
- Note – States may not follow bonus depreciation
DE MINIMIS SAFE HARBOR ELECTION
- This election is an administrative convenience that allows businesses to deduct small dollar expenditures for the acquisition or production of property that otherwise would have to be capitalized, other than amounts paid for inventory or land.
- $2,500 per item or invoice for a company without applicable financial statements, $5,000 per item or invoice for company with applicable financial statements.
DEPRECIATION LIMITATIONS ON LUXURY, PASSENGER AUTOMOBILES, AND HEAVY VEHICLES:
Tax reform changed depreciation limits for luxury passenger vehicle placed in service after December 31, 2017.
- If the taxpayer does not claim bonus depreciation, the maximum allowable depreciation deductions for 2021 is $10,200 for the first year.
- Passenger autos eligible for the added bonus first-year depreciation, the maximum first-year depreciation allowance remains at $8,000. It applies to new and used vehicles acquired and placed in service after September 27, 2017 and remains in effect for tax years through December 31, 2022.
- Heavy vehicles, including pickup trucks, vans, and SUVs whose gross vehicle weight rating is more than 6,000 pounds, are treated as transportation equipment instead of passenger vehicles.
- Heavy vehicles (new or used) placed in service after September 27, 2017, and before January 1, 2023, qualify for a 100 percent first-year bonus depreciation deduction.
COST SEGREGATION STUDIES:
Taxpayers who are placing in service new structures or major improvements to a building’s envelope, should consider taking advantage of a cost segregation study to accelerate depreciation deductions. By segregating the costs between the building and tangible personal property, the costs allocable to the tangible personal property can be written off sooner than the costs allocated to the building.
Doing a Cost Segregation Study will require an outside consultant to do a study of the costs and to provide a report to determine how much of the cost is allocable to the tangible personal property verses the building structure.
LIMITATIONS ON DEDUCTION OF BUSINESS INTEREST:
For tax year 2021, every business, regardless of its form, is generally subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income (ATI). The net interest expense disallowance is determined at the tax filer level; however, a special rule applies to pass-though entities, which requires the determination to be made at the entity level. For 2021, ATI generally is computed without regard to deductions allowable for depreciation, amortization, or depletion. For tax years after January 1, 2022, depreciation, amortization, and depletion cannot be added back to income to calculate ATI.
- Exemptions from limits on business interest are:
- An election to be excepted from these rules applies for taxpayers with average annual gross receipts for the three-year tax period ending with the prior tax year that do not exceed $26 million.
- Real property trades or businesses can elect out of the provision, but must use ADS depreciation methods instead of bonus depreciation
- Floor plan financing
Small Businesses Exception
With the expansion of small businesses exception, more entities can take advantage of the cash basis method of accounting (as opposed to accrual) for tax purposes.
Qualification as a small business, a taxpayer must, among other things, satisfy a gross receipts test.(– during a three-year testing period, average annual gross receipts cannot exceed $26 million for 2021).
Using the cash basis, taxpayers can shift income, e.g., by deferring billings until next year or by paying bills in 2021 to accelerate deductions.
If the taxpayer can meet the small business gross receipt test, there may be certain benefits in using the following methods of accounting:
- UNICAP – not required to capitalize additional costs to inventory
- Allow inventory to be treated as non-incidental materials and supplies, or any method that represents financial accounting treatment of inventory
- Percentage-of-Completion not required for long term construction contracts
MEALS & ENTERTAINMENT:
The Consolidated Appropriations Act of 2021, to stimulate the food and beverage industry, changed the meals and entertainment deduction allowances.
- Entertainment – NOT Deductible
- Meals – 50% deductible unless meets exceptions
- Meals at entertainment events are 50% deductible
- Free coffee, soda, bottled water, chips, donuts and other snacks in a break room available to all employees are 50% deductible
- Meals for the convenience of the employer 50%
- Team building outing, including purchase of tickets for your staff is allowed and 100% deductible
- Food and beverages are 100% deductible if purchase from a restaurant in 2021 and 2022
QUALIFIED RETIREMENT PLANS:
Retirement plans, depending on they type of plan that fits the organization, should be set up before the end of the year
SALT DEDUCTION LIMITATION WORKAROUND:
Many states have recently passed legislation to circumvent the $10,000 SALT deduction limitation by allowing the passthrough entity to pay the state taxes at entity level and get a deduction for federal tax purposes. Currently, 19 states in total including NJ and NY have these provisions.
IRS Notice 2020-75 confirmed that the Pass-Through Entity Tax (PTET) elections would allow businesses to fully deduct state and local taxes from the entity’s taxable income.
Paying state taxes at entity level may require elections to be made and in order to take the benefit in 2021, cash basis entities should consider making the appropriate elections and making the payments in 2021.