A number of year-end tax planning strategies are available to business owners that can be used to reduce tax liability. Let’s take a look:
Businesses using the cash method of accounting can defer income into 2021 by delaying end-of-year invoices so that payment is not received until 2021. Businesses using the accrual method can defer income by postponing the delivery of goods or services until January 2021.
Purchase new business equipment
Bonus depreciation. Businesses are allowed to immediately deduct 100% of the cost of eligible property placed in service after Sept. 27, 2017, and before Jan. 1, 2023, after which it will be phased downward over a four-year period: 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.
Section 179 expensing. Businesses should take advantage of Section 179 expensing this year whenever possible. In 2020, businesses can elect to expense (deduct immediately) the entire cost of most new equipment up to a maximum of $1.04 million of the first $2.59 million of property placed in service by Dec. 31, 2020. Keep in mind that the Section 179 deduction cannot exceed net taxable business income. The deduction is phased out dollar for dollar on amounts exceeding the $2.59 million threshold and eliminated above amounts exceeding $3.63 million.
Computer or peripheral equipment placed in service after Dec. 31, 2017, are not included in listed property.
For property placed in service in taxable years beginning after Dec. 31, 2017, taxpayers can elect to include certain improvements made to nonresidential real property after the date when the property was first placed in service.
Qualified improvement property means:
- any improvement to a building’s interior. However, improvements do not qualify if they are attributable to:
- the enlargement of the building
- any elevator or escalator or
- the internal structural framework of the building.
- Roofs, HVAC, fire protection systems, alarm systems and security systems.
Qualified property is defined as property that you placed in service during the tax year and used predominantly (more than 50 percent) in your trade or business. Property that is placed in service and then disposed of in that same tax year does not qualify, nor does property converted to personal use in the same tax year it is acquired.
Real estate qualified improvement property is eligible for immediate expensing, thanks to the CARES Act, which corrected an error in the Tax Cuts and Jobs Act. Taxpayers are also able to amend 2018 tax returns, if necessary.
Timing for purchase of business equipment
You might be able to increase your tax benefit if you buy equipment at the right time. Here’s a simplified explanation:
Conventions. The tax rules for depreciation include “conventions” or rules for figuring out how many months of depreciation you can claim. There are three types of conventions. To select the correct convention, you must know the type of property and when you placed the property in service.
- The half-year convention: This convention applies to all property except residential rental property, nonresidential real property and railroad gradings and tunnel bores (see mid-month convention below) unless the mid-quarter convention applies. All property that you begin using during the year is treated as “placed in service” (or “disposed of”) at the midpoint of the year. This means that no matter when you begin using (or dispose of) the property, you treat it as if you began using it in the middle of the year. You buy a $70,000 piece of machinery on Dec. 15. If the half-year convention applies, you get one-half year of depreciation on that machine.
- The mid-quarter convention: Use the mid-quarter convention if the cost of equipment placed in service during the last three months of the tax year is more than 40 percent of the total cost of all property placed in service for the entire year. If the mid-quarter convention applies, the half-year rule does not apply, and you treat all equipment placed in service during the year as if it were placed in service at the midpoint of the quarter in which you began using it.
- The mid-month convention: This convention applies only to residential rental property, nonresidential real property and railroad gradings and tunnel bores. It treats all property placed in service (or disposed of) during any month as placed in service (or disposed of) on the midpoint of that month.
Other year-end moves to take advantage of qualified business income deductionMany business taxpayers – including owners of businesses operated through sole proprietorships, partnerships and S corporations, as well as trusts and estates – may be eligible for the qualified business income. This deduction is worth up to 20 percent of qualified business income from a qualified trade or business for tax years 2018 through 2025. Your taxable income must be under $163,300 ($326,600 for joint returns) in 2020 to take advantage of the deduction.
This column is for information only and should not be considered advice. Taxes are complicated and mistakes can be costly. Consider consulting a tax professional for assistance.
Editor’s note: The second part of this column will appear in the Nov. 30 edition.
Norm Grill, CPA, (N.Grill@GRILL1.com) is managing partner of Grill & Partners, LLC (www.GRILL1.com), certified public accountants and consultants to closely held companies and high-net-worth individuals, with offices in Fairfield and Darien, 203-254-3880.