Year-end is always an important time for tax planning, that is especially true this year. The COVID-19 pandemic has created historic disruption and challenges for small business owners. While government legislation, such as the Coronavirus Aid, Relief, and Economic Security (CARES) Act, has provided a much-needed financial lifeline for small businesses, many of its tax provisions end or require action by December 31, 2020.
Business owners need to act fast. To help you navigate this complex landscape, here are some key strategies, facts, and often overlooked tax deductions to be aware of as you get into year-end tax planning mode.
1. Revisit your estimated tax payments for a potential shortfall
Many businesses experienced cash flow issues in 2020 and underpaid their estimated taxes. Doing so could result in a penalty from the IRS and your state government. Revisit your estimated tax payments for the year and see if there’s a shortfall based on your anticipated year-end income. Use IRS Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trust to see if you owe a penalty for underpaying your estimated tax. If you do, talk to a tax professional to understand your options and determine if you qualify for an IRS waiver based on your circumstances.
2. Accelerate your AMT credit refund
The CARES Act included a provision that accelerated when and how businesses can claim unused Alternative Minimum Tax (AMT) credits.
The 2017 Tax and Jobs Act eliminated AMT for future tax years but allows businesses to claim any unused AMT credits in tax years 2018, 2019, 2020, and 2021. However, the CARES Act expedited the refund process so you can now claim any remaining credits in the 2020 tax year. This money can then be injected back into your business to aid cash flow or pay operating expenses. To claim a refund for any unused AMT credits (prior to tax year 2018), file IRS Form 1139 or Form 1045 by December 31, 2020.
3. Have a conversation about the COVID-related payroll tax deferment
Another benefit of the CARES Act is that it allows employers to defer payment of their share of 2020 payroll taxes. Deferred amounts must be paid by December 31, 2021, by which time 50% is due with the remaining 50% due by December 31, 2022.
While the deferment was intended to provide much-needed liquidity for the remainder of 2020, it also means that business owners can’t deduct their share of payroll taxes until they are paid. This may not be an issue, but it’s an important conversation to have with a tax advisor who may advise you to pay back your share of the payroll tax early so that you can claim the deduction for 2020.
Read more about Coronavirus Tax Relief for Businesses and how these may impact your 2020 tax year filing preparations.
4. Running your business from home? Take advantage of the home office deduction
If you operate a small business out of your home, you may be overlooking a common tax deduction. According to the U.S. Small Business Administration (SBA), before COVID about 50% of all firms were home-based. Yet, the IRS reports that the deduction is often overlooked by small business owners.
If you are one of the millions of business owners, freelancers, and independent contractors now working from home to stay safe and maintain social distancing, be sure you’re familiar with the nuances of this deduction.
What is the home office deduction? If you rent or own your home and use part of the property for business, you may be able to deduct business expenses associated with your office space such as rent, mortgage interest, property taxes, and utilities.
To encourage business owners to claim the deduction, the IRS offers two methods for calculating the deduction—the simplified option and the regular method. The simplified option lets you deduct $5 per square feet of the home used for business with a maximum deduction of $1,500. The regular method is a little more time consuming and involves determining the expenses of your home office based on the percentage of your home devoted to business.
Now, there are caveats. To claim the deduction, your home must be your principal place of business and you must use a certain area of your home exclusively for business. For example, if you work from a laptop on your kitchen table but also use that space for family mealtimes, you can’t claim the deduction since you aren’t using that space “exclusively” as a home office. However, if you use a separate room or office solely and regularly for business purposes – be sure to claim this important deduction.
Tax season isn’t here yet, but you can prepare now by researching which expenses you can deduct, gather records of your home expenses for the year, and determine which method is best for you (a good conversation to have with your tax advisor). Refer to the IRS guide—Business Use of Your Home – for guidance on how to figure out and claim your deduction.
5. Write off your home office purchases
If you found yourself suddenly operating your small business from home this year, then you probably spent some cash to equip it. Many of these costs can be written off—if they are used exclusively for business purposes. This includes office furniture, computers, printers, office supplies, and even software licenses. Plus, if you drive to the store to make those purchases exclusively, you can deduct the mileage incurred.
If you need any office equipment or furnishings, you might want to purchase those before the end of 2020 as you may be able to use these purchases as a tax deduction this year.
Conduct an audit now of all your purchases in 2020 so that you have the information you need before you complete IRS Form 4562 and attach it to your tax return.
6. If you borrowed funds, deduct the interest
If your business accessed financing during 2020, such as a loan or business line of credit, you may be able to deduct interest payments on the funds you borrowed. For example, if you used a line of credit to purchase equipment or inventory or to fund payroll, the interest would be considered an “ordinary and necessary” business expense by the IRS. Read more about how a business line of credit affects your taxes.
7. Decide whether you should defer income
Looking to reduce your tax liability and preserve cash flow? If you’re a service-based small business and you can defer income until next year by invoicing after December 31. Obviously, you’ll have to pay that tax eventually, but if you need to reduce your estimated tax payments this year, it’s something to consider. Don’t forget, however, that deferring income this year could push you into a higher tax bracket next year. If you’d rather absorb the tax liability now, invoice early and as soon as a project is complete, rather than waiting till the end of the month so that you can declare the income in the 2020 tax year.
8. Max out your retirement plan contributions
If you’re self-employed and have an IRA or simplified employee pension (SEP) you have until Tax Day 2021 to make contributions, but maxing out your contributions before December 31 will lower your taxable income for the year. The maximum contribution for an IRA in 2020 is $6,000 (plus an extra $1,000 if you are aged 50+) and $57,000 for a SEP plan (or 25% of your net earnings from self-employment).
Act now, don’t delay
2020 has been a challenging year, but don’t delay these important year-end tax planning considerations. Not all will apply to your business, but those that do can have an impact on your bottom line and position you to better navigate tax season when it arrives.
Disclaimer: Fundbox and its affiliates do not provide financial, legal or accounting advice. This content has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for financial, legal or accounting advice. You should consult your own financial, legal or accounting advisors before engaging in any transaction.
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