Part ONE: The Pandemic (PPP loans), The Election, and Technology
INSIDER’S TIP: Start Tax Planning NOW. Don’t Wait for December.
INTRODUCTION TO THE SERIES
So much has happened this year, and so much has to be done before the year end to help our clients make the correct decisions that will impact their tax liabilities. We are starting our planning now, and we hope you will too.
Most, but not all, of what we are recommending is related to the changes in the laws caused by the pandemic. We know there are lots of questions, but to get the best out of the new tax requirements, there’s no other way to put it: It takes planning.
What to expect in Part One: The Pandemic (PPP loans), The Election, and Technology.
Pandemic Tax Planning (PPP Loans)
As of today, November 4, 2020, the United States Congress wants the PPP loans to be forgiven with no tax consequences. The IRS disagrees. Their stand is that if the PPP loan is forgiven, the expenses that were paid with this loan will not be deductible. In effect, the forgiven loan amount will be treated as taxable income.
Our role, as always, is to keep our clients informed of the changes as they unfold. Then, we will help suggest the best tax planning strategies when a decision has been made.
In the interim, we have a few thoughts on tax planning.
PPP LOANS: “THE UNFORGIVEN” AND “THE GOOD, THE BAD, AND THE UGLY”
If the PPP loan is unforgiven, there are consequences in the sense that you will have to pay back the loan and any accrued interest.
If the loan is forgiven, different consequences ensue, depending on the legal structure of the company, level of income and the timing of forgiveness. For instance, if you are a C corporation, you might manage net income by distributing it out to shareholders through wages. This eliminates taxable income at the C-corporation level and prevents the dreaded double taxation. As the law stands now, if the loan is forgiven, 2020 taxable income will be increased by the loan forgiveness amount. We may want to plan to distribute this extra income to owners before year end if cash is available. This will prevent an unexpected tax for 2020 at the corporate level. In addition, if current tax treatment stands this will result in acceleration of taxable income, which by itself might be a good planning idea – read more about this in the following Election Planning segment. If Congress prevails, the net operating loss that would result on a C corporation level will be available as a carryover in 2021 and will offset 2021 income taxed at a potentially higher rate.
If you are a pass-through entity, like an S corporation or Partnership, you are not subject to double taxation like a C corporation. However, owners need to plan for increased passthrough income resulting from the loan forgiveness. An S corporation owner may want to issue themselves a year-end bonus with sufficient withholdings to cover their potential tax liability. Alternatively, an S corporation owner or Partner in a partnership may want to submit an increased 4th quarter estimated tax payment to cover the potential increased tax liability. Income acceleration is more difficult to achieve in the S corporation setting, but it is not impossible. It will require a more careful planning approach.
Alternative to cash planning for increased taxes, we may want to look at accelerating or delaying deductions to better align them with additional income from the forgiven loan. For example, if the business is considering large purchases of fixed assets, we may want to either accelerate those purchases into 2020 or delay place of service date until 2021 to achieve the desired outcome.
Lastly, delaying the PPP loan forgiveness application process until Congress and the IRS settle on the tax treatment might not be a bad idea especially if there is no change in administration and no threat of tax rate increases. Clarifications on the tax treatment most likely won’t come until after the year end.
Due to all of this confusion and uncertainty with PPP loans, we might be looking at preparing three different tax projections with alternatives for: Income related to loan forgiveness in 2020, Income related to loan forgiveness in 2021, and no income related to loan forgiveness (i.e. assuming Congress gets its act together and passes a law that allows for all PPP Loan related expenses to be deductible and thus no income related to loan forgiveness). We can assess the tax liability using the three different scenarios and will get close to knowing where you stand if each were to occur. Planning helps mitigate surprises, and that’s what we want. No surprises.
In summary, we have “The Good, The Bad, and The Ugly” with PPP Loan Planning:
- The Good – PPP Loans assisted many business owners keep their doors open and paying their employees throughout the ongoing pandemic.
- The Bad – As the law stands now, the IRS clearly intends for any loan forgiveness to be taxable.
- The Ugly – There is no consensus between the Congress and the Treasury on the tax treatment of PPP loans potentially leading to an unexpected tax liability for 2020 or 2021. Proper planning to either mitigate the tax and/or have the necessary cash to pay the tax is essential.
Check with a qualified CPA to see what would be best for your company.
Election Tax Planning
What’s going to happen?
Taxes for High-Net-Worth (HNW) individuals. If we have an administration change, there is an anticipated increase in taxes. As one example, we see that a new administration would most likely increase the tax rates for high-net-worth (HNW) individuals. With taxes higher in 2021, the HNW individuals may want to move income into 2020 and pay income tax at the lower 2020 rate. We can help our clients in this area.
Same applies to capital gains rates. Under the new administration capital gain rates might be increased as well, so cashing in gains on appreciated assets in 2020 might be a good tax planning move too.
Estate planning and gifting. We don’t have a crystal ball, but again, we feel it’s good to be prepared for the potential decrease in estate tax and gift tax exemptions. In this area, we recommend that our clients take advantage of the all-time high lifetime exemption that may be significantly reduced from the current $11.58 million per individual to either $5m or less in the near future.
Our recommendation: Consider gifting heavily this year before the exemption is reduced.
Regardless of how the election turns out, we advise that your tax planning be done by the end of this year. We recommend that our clients talk to their CPA before then. Usually, the objection of our annual year-end tax planning is to accelerate deductions and defer income by pushing income out and bringing deductions in the current year. However, this year, with a potential administration change, we may recommend recognizing more income in 2020 since tax rates may go up in 2021 and beyond. Everyone’s situation is different, and this will take careful analysis before making a decision.
Don’t forget state and local taxes. Everyone has been overburdened by the pandemic, and 2021 will be the beginning of paybacks. Brace yourselves for higher taxes all the way around.
Technology and Tax Planning
“There’s an app for that.” We try to get our clients to track their business mileage and business expenses on a contemporaneous basis. It’s too easy to say, “I’ll catch that when I get back to the office.” And then other, more important things happen and you forget to do that. This is the time of year when it might be too late, but it’s good to plan for the New Year and to research and gather apps that will help for 2021. For 2021 tax returns, we will be asking some of our clients to use our new “app for that”, Tax Caddy from SurePrep®, which is an online portal/mobile app that helps clients to gather, upload and deliver their tax information to us. Waiting until January 2021 to start looking at snazzy accounting technology for capturing tax-related events could be too late. It might be useful to spend some of your holiday free time searching for cool apps.
BOTTOM LINE: The optimal time to be doing year-end planning is NOW. And, please, check back with us often. We will continue to have news-worthy posts to prepare you for year-end tax-planning appointments and to help you shore up your financial health in general.