Seven Year-end Tax Planning Strategies
The CARES Act and other COVID-related relief programs offer new tax planning opportunities.
As we approach the end of the year, review these last-minute moves to potentially reduce your tax bill for 2020. While some of these planning strategies may look familiar, the Coronavirus Aid, Relief, and Economic Security (CARES) Act and other COVID-related relief have introduced new techniques you may want to consider. Consider these seven planning ideas in consultation with your tax advisor.
Strategy 1: Accelerate payment of deferred payroll taxes
The CARES Act allows employers to defer payment of their share of the 6.2% Social Security tax on wages paid from March 27, 2020, through Dec. 31, 2020, until 2021 and 2022. Cash method taxpayers must pay the payroll tax before year-end to deduct the payroll taxes in 2020.
Accrual method taxpayers generally must pay the tax within 8.5 months of year-end (i.e., Sept. 15, 2021, for a calendar-year taxpayer) to claim the deduction in the year of accrual, although in some cases they have to pay the payroll tax by year-end to deduct the tax this year. Consider paying deferred payroll taxes before they are due to claim the deduction in 2020.
Example: Sierra Inc. is a calendar-year, accrual-method C corporation. Sierra deferred payment of employer Social Security tax payments associated with payroll paid between March 27, 2020, and Dec. 31, 2020. Half of the deferred tax is due by Dec. 31, 2021, and the balance is due Dec. 31, 2022. If Sierra pays the deferred tax on the due date, Sierra will deduct the tax in the year paid. Any portion of the tax that Sierra pays by Sept. 15, 2021, can generally be deducted on Sierra’s 2020 tax return.
Strategy 2: Identify limitations and plan accordingly
The tax law is full of limitations that can reduce or eliminate tax deductions. As part of year-end planning, work with your CPA to identify limitations that may apply and consider ways to avoid them. Here are two examples.
Example: Losses from an S corporation are deductible only to the extent of a shareholder’s basis in the S corporation stock and loans made directly to the S corporation. Evan is the shareholder in an S corporation, but he doesn’t have any stock or debt basis to use a projected loss. If Evan contributes cash or makes a loan to the S corporation before year-end, Evan can create basis to deduct the loss.
Example: In general, Section 199A allows taxpayers to deduct 20% of qualified business income from a pass-through entity, such as a partnership or S corporation. The deduction for income from a service business is limited if the taxpayer’s income exceeds $163,300 ($326,600 in the case of married taxpayers filing a joint return). Dallin is a self-employed attorney and is single. He expects his taxable income will be $200,000 for 2020, causing the Section 199A deduction for his income from his specified service business to be limited. Dallin may be able to increase his retirement plan contributions or take other proactive measures to reduce his taxable income below $163,300 before year-end to qualify for the deduction.
Strategy 3: Defer gains with opportunity zones
Tax reform added three incentives for reinvesting gains through a qualified opportunity zone fund (QOF) into certain economically distressed areas referred to as opportunity zones:
Deferral of gain invested in the QOF until the earlier of:
- The day the QOF is sold or exchanged, or Dec. 31, 2026;
- Permanent exclusion of up to 10% of the deferred gain if the QOF is held at least five years; and
- Permanent exclusion of post-investment appreciation in the QOF if the investment is held at least 10 years.
Determine whether there is an opportunity for you to defer some of your 2020 gains by investing in a QOF. The incentives are available only when gains are reinvested during a 180-day period. This year, the IRS issued final opportunity zone regulations that allow taxpayers to defer gross Section 1231 gains. This also provides an opportunity to convert a gain that would otherwise offset an ordinary loss to a capital gain.
Example: Mark sold two properties during 2020, generating a $100,000 Section 1231 loss on one property and a $100,000 Section 1231 gain on the other. Mark has no net Section 1231 gain or loss for 2020. Mark can defer the $100,000 gross Section 1231 gain by investing in a QOF within the 180-day period. By doing so, Mark will have a net Section 1231 loss of $100,000, which reduces his ordinary income. When Mark eventually recognizes the deferred gain, the gain may be taxed at preferential capital gain rates if he has not recognized a Section 1231 ordinary loss in the previous five years.
The IRS extended the 180-day investment period — which would have otherwise ended on or after April 1, 2020, and before Dec. 31, 2020, until Dec. 31, 2020. That means there is still time for you to defer certain gain reported on a 2019 return if you make a QOF investment by year-end and file an amended return.
Strategy 4: Accelerate equipment purchases
Following tax reform, you can immediately write off the cost of new and used equipment purchases. If you plan to invest in equipment in 2021 anyway, consider accelerating the purchase so you can deduct the expense on your 2020 tax return.
Strategy 5: Write off old or uncollectible receivables and harvest tax losses
Accrual-method taxpayers may deduct as a tax bad debt or old/uncollectible trade accounts receivable when the possibility of collection becomes remote or uncertain. Before the end of the tax year, carefully analyze your trade receivables and write off any uncollectible accounts. If you have underwater investments, consult with your tax and investment advisors regarding potential strategies to generate a tax loss.
Strategy 6: Increase retirement plan contributions
Consider increasing your retirement plan contributions to reduce your taxable income and set aside money for your future. In some cases, retirement plan contributions must be made by year-end [e.g., elective contributions to a 401(k) plan], and in other cases the contributions can be made after year-end (e.g., IRA contributions).
Strategy 7: Accelerate charitable contributions
The CARES Act increases the maximum deduction available for cash contributions to eligible charities to 100% of adjusted gross income for individuals and 25% of taxable income for C corporations. The increased thresholds present an opportunity for charitably inclined individuals and businesses to benefit from additional contributions, so consider making additional donations this year. A donor-advised fund is not an eligible charity for this purpose.
Before you implement any of these strategies, consider your personal tax situation. Everyone’s situation is different. Tax professionals can answer your questions regarding the tax reform proposal and devise a personalized year-end tax plan to help take advantage of potential opportunities.
Editor’s note: John Werlhof is a principal with CliftonLarsonAllen.
