Updates

2021 Last-Minute Business Income Tax Deductions

The IRS is not likely to cut you a check for this money, but you’ll realize the cash when you pay less in taxes.

Here are six powerful business tax deduction strategies that you can easily understand and implement before the end of 2021.

1. Prepay Expenses Using the IRS Safe Harbor

You just have to thank the IRS for its tax-deduction safe harbors.

IRS regulations contain a safe-harbor rule that allows cash-basis taxpayers to prepay and deduct qualifying expenses up to 12 months in advance without challenge, adjustment, or change by the IRS.

Under this safe harbor, your 2021 prepayments cannot go into 2023. This makes sense because you can prepay only 12 months of qualifying expenses under the safe-harbor rule.

For a cash-basis taxpayer, qualifying expenses include lease payments on business vehicles, rent payments on offices and machinery, and business and malpractice insurance premiums.

Example. You pay $3,000 a month in rent and would like a $36,000 deduction this year. So on Friday, December 31, 2021, you mail a rent check for $36,000 to cover all of your 2022 rent. Your landlord does not receive the payment in the mail until Tuesday, January 4, 2022. Here are the results:

  • You deduct $36,000 in 2021 (the year you paid the money).
  • The landlord reports taxable income of $36,000 in 2022 (the year he received the money).

You get what you want—the deduction this year.

The landlord gets what he wants—next year’s entire rent in advance, eliminating any collection problems while keeping the rent taxable in the year he expects it to be taxable.

2. Stop Billing Customers, Clients, and Patients

Here is one rock-solid, easy strategy to reduce your taxable income for this year: stop billing your customers, clients, and patients until after December 31, 2021. (We assume here that you or your corporation is on a cash basis and operates on the calendar year.)

Customers, clients, patients, and insurance companies generally don’t pay until billed. Not billing customers and patients is a time-tested tax-planning strategy that business owners have used successfully for years.

Example. Jim, a dentist, usually bills his patients and the insurance companies at the end of each week. This year, however, he sends no bills in December. Instead, he gathers up those bills and mails them the first week of January. Presto! He just postponed paying taxes on his December 2021 income by moving that income to 2022.

3. Buy Office Equipment

With bonus depreciation now at 100 percent along with increased limits for Section 179 expensing, buy your equipment or machinery and place it in service before December 31, and get a deduction for 100 percent of the cost in 2021.

Qualifying bonus depreciation and Section 179 purchases include new and used personal property such as machinery, equipment, computers, desks, chairs, and other furniture (and certain qualifying vehicles).

4. Use Your Credit Cards

If you are a single-member LLC or sole proprietor filing Schedule C for your business, the day you charge a purchase to your business or personal credit card is the day you deduct the expense. Therefore, as a Schedule C taxpayer, you should consider using your credit card for last-minute purchases of office supplies and other business necessities.

If you operate your business as a corporation, and if the corporation has a credit card in the corporate name, the same rule applies: the date of charge is the date of the deduction for the corporation.

But if you operate your business as a corporation and you are the personal owner of the credit card, the corporation must reimburse you if you want the corporation to realize the tax deduction, and that happens on the date of reimbursement. Thus, submit your expense report and have your corporation make its reimbursements to you before midnight on December 31.

5. Don’t Assume You Are Taking Too Many Deductions

If your business deductions exceed your business income, you have a tax loss for the year. With a few modifications to the loss, tax law calls this a “net operating loss,” or NOL.

If you are just starting your business, you could very possibly have an NOL. You could have a loss year even with an ongoing, successful business.

You used to be able to carry back your NOL two years and get immediate tax refunds from prior years, but the Tax Cuts and Jobs Act (TCJA) eliminated this provision. Now, you can only carry your NOL forward, and it can only offset up to 80 percent of your taxable income in any one future year.

What does this all mean? You should never stop documenting your deductions, and you should always claim all your rightful deductions. We have spoken with far too many business owners, especially new owners, who don’t claim all their deductions when those deductions would produce a tax loss.

6. Deal with Your Qualified Improvement Property (QIP)

In the CARES Act, Congress finally fixed the qualified improvement property (QIP) error that it made when enacting the TCJA.

QIP is any improvement made by you to the interior portion of a building you own that is non-residential real property (think office buildings, retail stores, and shopping centers) if you place the improvement in service after the date you place the building in service.

The big deal with QIP is that it’s not considered real property that you depreciate over 39 years. QIP is 15-year property, eligible for immediate deduction using either 100 percent bonus depreciation or Section 179 expensing. To get the QIP deduction in 2021, you need to place the QIP in service on or before December 31, 2021.

Planning note. If you have QIP property on an already filed 2018 or 2019 return, it’s on that return as 39-year property. You need to fix that—and likely add some cash to your bank account because of the fix.

How Are Roth IRA Withdrawals Taxed?

Some withdrawals are taxable.

Even worse, some can be socked with a 10 percent early withdrawal penalty tax, and this can happen even when there’s no income tax hit.

Any withdrawals from any of your Roth accounts are federal-income-tax-free qualified withdrawals if you, as a Roth IRA owner,

  • are age 59 1/2 or older, and
  • have had at least one Roth IRA open for over five years.

Such withdrawals are usually state-income-tax-free too. Good!

You must pass both the age and the five-year tests to have a qualified withdrawal.

The five-year period for determining whether your withdrawals are qualified starts on January 1 of the first tax year for which you make a Roth contribution. It can be a regular annual contribution or a conversion contribution.

A non-qualified withdrawal is potentially subject to both federal income tax and the 10 percent early withdrawal penalty tax. The only exceptions are

  • when the special first-time home purchase provision applies, or
  • when the account owner (that would be you) is disabled or dead.

Be Sure to Know the Tax-Home Rule

When you travel out of town overnight, you need to know the tax-home rule. The IRS defines your tax home, and it’s not necessarily in the same town where you have your personal residence.

If you have more than one business location, one of the locations will be your tax home. It’s generally your main place of business.

In determining your main place of business, the IRS takes into account three factors:

  1. the length of time you spend at each location for business purposes;
  2. the degree of business activity in each area; and
  3. the relative financial return from each area.

Here’s a recent court case that illustrates this rule.

Akeem Soboyede, an immigration attorney, was licensed to practice law in both Minnesota and Washington, D.C., and he maintained solo law practices in both Minneapolis and Washington, D.C. 

Although Mr. Soboyede’s primary personal residence was in Minneapolis, he divided his time between his office in Minneapolis and his office in Washington, D.C.

Get ready for a chuckle: in court, Mr. Soboyede admitted in his testimony that he did not keep the necessary documentation because he “did not know . . . [he] was going to get audited.”

Due to the lack of records, the IRS disallowed most of the deductions. The remaining issue for the court was the travel expenses for lodging for which Mr. Soboyede had the records.

The court noted that Mr. Soboyede’s lodging expenses were only deductible if he was “away from home” as required by Section 162(a)(2).

In deciding whether Mr. Soboyede’s tax home was in Minneapolis or Washington, D.C., the court used the following two factors:

  • Where did he spend more of his time?
  • Where did he derive a greater proportion of his income?

Answer: Washington, D.C. Think about this: He had his home in Minneapolis, but the court ruled that his “tax home” was in Washington, D.C. As a result, he lost his travel deductions.

Ready, Set, Depreciate

Are you thinking about buying personal property (such as a car, a computer, or other equipment) or real property (such as a building)?

If you use the property for personal purposes, it’s not deductible.

But if you use it in a business, you can deduct the full cost using regular depreciation, bonus depreciation, or IRC Section 179 expensing.

Regular depreciation takes three to 39 years depending on the property involved, while bonus deprecation allows you to deduct 100 percent of the cost of personal property in one year through 2022. Up to $1,050,000 of personal property may also be deducted in one year under IRC Section 179.

But depreciation won’t begin if you purchase property with the intent of beginning a new business. You must actually be in business to claim depreciation. This doesn’t require that you make sales or earn profits—only that your business is a going concern.

Also, depreciation doesn’t begin the moment you purchase property for your business. It begins only when you place the property in service in your business. You don’t have to use the property to place it in service, but the property must be available for use in your active business. This could occur after you purchase the property.

Finally, if you use regular depreciation, you must apply rules called conventions to determine the month in which your depreciation deduction begins. The earlier in the year, the larger your deduction for the first year.

The default rule is that regular depreciation for the personal property begins July 1 the first year (mid-year convention). But if you purchase 40 percent or more of your total personal property for the year during the fourth quarter, your depreciation begins at the midpoint of the quarter in which it is placed in service (mid-quarter convention).

First-year depreciation for the real property begins at the middle of the month during which the property is placed in service (mid-month convention).

What is a 401(k) Plan?

401(k) plans let you and your employees defer current income into the plan. You can match
your employees’ deferrals make discretionary profit-sharing contributions or both.

These may be your best choice if you want to let your employees fund the bulk of their own accounts:

Some highlights:

1. You can defer up to 100% of your “covered compensation” or $19,500, whichever is less. (Covered comp is wages, salary, and bonus up to $290,000.)

2. You can let employees age 50 or older make extra “catch-up” contributions of up to $6,500 not limited by antidiscrimination rules.

3. You can match part or all of employee deferrals and make profit-sharing contributions. These are nontaxable until participants start withdrawing funds from their accounts. The employer’s contributions are tax deductible.

4. Total “annual additions” from employee deferrals (but not catchups), employer matches, and employer profit-sharing contributions are limited to 100% of covered compensation, but not more than $58,000.

5. You can let employees take tax-free loans from their accounts. Most loan provisions allow loans up to $50,000 or 50% of the vested account balance, whichever is less, and repay it in substantially level installments, at least quarterly, over five years. If employees leave their job and take their accounts with outstanding loans, the unpaid balance is taxable unless they repay it from another source.

6. You can let employees take “hardship withdrawals” of their own deferrals (but not employer contributions or earnings) for “immediate and heavy” financial needs: medical bills, a down payment on a house, college costs, or amounts needed to prevent eviction or foreclosure on their primary residence. If the plan allows loans and hardship withdrawals, employees have to take the maximum loan before taking a hardship withdrawal. Employees who take hardship withdrawals can’t make new deferrals for 12 months.

7. Plan withdrawals are taxed as ordinary income. There’s a 10% penalty for withdrawals before age 59½ except for specified exceptions: death, permanent and total disability, health insurance while unemployed, amounts deductible as medical or dental expenses, college costs, early retirement at age 55 or older, or qualified domestic relations orders.

8. Rollovers to another qualified plan or IRA are nontaxable.

What is a SIMPLE IRA?

SIMPLE IRA is an employer sponsored retirement account that allows employees to save up to $13,500 (an additional $3,000 if you are 50 or older)

It allows employees to save beyond their own IRA contribution of $6,000 per year (or $7,000 if you are 50 or older)

You as the employer can choose one of two options:

1. Contribute up to 2% of employee’s earnings (W-2), whether they participate or not.

2. Match 100% of their contribution up to 3% of their earnings. (Employer can reduce it as low as 1% for two out of every five years.

You must include any employees earning at least $5,000 in any two preceding years and reasonably expected to earn $5,000 this year.

Big Mistake: Filing Your Tax Return Late

Three bad things happen when you file your tax return late.

What’s Late?

You can extend your tax return and file during the period of extension; that’s not a late-filed return.

The late-filed return is filed after the last extension expired. That’s what causes the three bad things to happen.

Bad Thing 1

The IRS notices that you filed late or not at all.

Of course, the “I didn’t file at all” people receive the IRS’s “come on down and bring your tax records” letter. In general, the meeting with the IRS about non-filed tax returns does not go well.

For the late filers, the big problem is exposure to an IRS audit. Say you’re in the group that the IRS audits about 3 percent of the time, but you file your tax return late. Your chances of an IRS audit increase significantly, perhaps to 50 percent or higher.

Simply stated, bad thing 1 is this: file late and increase your odds of saying: “Hello, IRS examiner.”

Bad Thing 2

When you file late, you trigger the big 5 percent a month, not to exceed 25 percent of the tax-due penalty.

Here, the bad news is 5 percent a month. The good news (if you want to call it that) is this penalty maxes out at 25 percent.

Bad Thing 3

Of course, if you owe the “failure to file” penalty, you likely also owe the penalty for “failure to pay.” The failure-to-pay penalty equals 0.5 percent a month, not to exceed 25 percent of the tax due.

The penalty for failure to pay offsets the penalty for failure to file such that the 5 percent is the maximum penalty during the first five months when both penalties apply.

But once those five months are over, the penalty for failure to pay continues to apply. Thus, you can owe 47.5 percent of the tax due by not filing and not paying (25 percent plus 0.5 percent for the additional 45 months it takes to get to the maximum failure-to-pay penalty of 25 percent).

Don’t let the three bad things happen to you.

Harvest Tax Losses on Bitcoin and other Cryptocurrency

Here’s something to know about cryptocurrencies.

Because cryptocurrencies are classified as “property” rather than as securities, the wash-sale rule does not apply if you sell a cryptocurrency holding for a loss and acquire the same cryptocurrency before or after the loss sale.

You just have a garden-variety short-term or long-term capital loss depending on your holding period. No wash-sale rule worries.

This favorable federal income tax treatment is consistent with the long-standing treatment of foreign currency losses.

That’s a good thing because folks who actively trade cryptocurrencies know that prices are volatile. And this volatility gives you two opportunities:

  1. profits on the upswings
  2. loss harvesting on the downswings

Let’s take a look at the harvesting of losses:

  • On day 1, Lucky pays $50,000 for a cryptocurrency.
  • On day 50, Lucky sells the cryptocurrency for $35,000. He captures and deducts the $15,000 loss ($50,000 – $35,000) on his tax return.
  • On day 52, Lucky buys the same cryptocurrency for $35,000. His tax basis is $35,000.
  • On day 100, Lucky sells the cryptocurrency for $15,000. He captures and deducts the $20,000 loss ($35,000 – $15,000) on his tax return.
  • On day 103, Lucky buys the same cryptocurrency for $15,000.
  • On day 365, the cryptocurrency is trading at $55,000. Lucky is happy.

Observations:

  • Assuming Lucky had $35,000 in capital gains, Lucky deducted his $35,000 in cryptocurrency capital losses. If he had no capital gains, he had a $3,000 deductible loss and carried the other $32,000 forward to next year.
  • On day 365, Lucky has his cryptocurrency, which was his plan on day 1. He thought it would go up in value. It did, from its original $50,000 to $55,000.
  • Lucky’s tax basis in the cryptocurrency on day 365 is $15,000.

Here’s what Lucky did:

  1. He kept his cryptocurrency.
  2. He banked $35,000 in losses.

Be alert. Losses from crypto-related securities, such as Coinbase, can fall under the wash-sale rule because the rule applies to losses from assets classified as securities for federal income tax purposes. For now, cryptocurrencies themselves are not classified as securities.

Planning point. If you want to harvest losses, make sure you hold a cryptocurrency and not a security.

Two Ways to Fix Tax Return Mistakes Before the IRS discovers Them

If you made an error on your tax return, don’t worry—there are two easy ways to fix it:

  1. A superseding return
  2. A qualified amended return

A superseding return is an amended or corrected return filed on or before the original or extended due date. The IRS considers the changes on a superseding return to be part of your original return.

A qualified amended return is an amended return that you file after the due date of the return (including extensions) and before the earliest of several events, but most likely when the IRS contacts you with respect to an examination of the return. If you file a qualified amended return, you avoid the 20 percent accuracy-related penalty on that mistake.

When it comes to the IRS, an ounce of prevention is worth a pound of cure. If you made a mistake, fix it as soon as you know about it, which will save you penalties, increased interest accruals, and the headache of an IRS review of your return.

How to Deal with the New $142,800 Base for Self-Employment Taxes

What happens when lawmakers enact a new tax?

It starts small.

It looks easy.

In 1935, the self-employment tax topped out at $60. Those 1935 lawmakers must be twirling in their graves with the new rules for 2021, which levy the following taxes:

  • A self-employment tax of up to $21,848, which comes from the 15.3 percent rate that applies to self-employment income of up to $142,800.
  • A 2.9 percent tax that applies to all self-employment income in excess of the base amount.

Beware

You know the expression “Don’t let the camel’s nose get under the tent”? It applies here.

Look at what has happened to self-employment taxes since they first came into being in 1935, assuming you earn at the base amount:

  • $60 in 1935
  • $60 in 1949
  • $3,175 in 1980
  • $7,849 in 1990
  • $14,413 in 2006
  • $21,848 in 2021

To put the rates in perspective, say you are single and earn $150,000. On the last dollar you earned—dollar number $150,000—how much federal tax did you pay? The answer in round numbers—39 cents (14 cents in self-employment and 24 cents in federal income taxes).

Wow! That’s a lot. Then, if you live in a state with an income tax, add the state income tax on top of that.

Tax Planning

Two things to know about tax planning:

  1. Your new deductions give you benefits starting at your highest tax rates.
  2. In most cases, the return on your planning is not a one-time event. Once your plan is in place, you reap the benefits year after year. Thus, good tax planning is like an annuity.

Checklist

Here is a short checklist of some tax-planning ideas. Review these ideas so you can identify new business deductions for your tax return. You want business deductions because business deductions reduce both your income and your self-employment taxes.

  • Eliminate the word “friend” from your vocabulary. From now on, these people are sources of business, so start talking business and asking for referrals over meals and beverages.
  • Hire your children. This creates tax deductions for you, and it creates non-taxable or very low taxed income for the children. Also, wages paid by parents to children are exempt from payroll taxes.
  • Learn how to combine business and personal trips so that the personal side of your trip becomes part of your business deduction under the travel rules (for example, traveling by cruise ship to a convention on St. Thomas).
  • Properly classify business expansion expenses as immediate tax deductions rather than depreciable, amortizable, or (ouch!) non-deductible capital costs.
  • Properly identify deductible start-up expenses ($5,000 up-front and the balance amortized) rather than letting them fall by the wayside (a common oversight).
  • Correctly classify business meals that qualify for the 100 percent deduction rather than the 50 percent deduction.
  • Know the entertainment facility rules so your vacation home can become a tax deduction.
  • Identify the vehicle deduction method that gives you the best deductions (choosing between the IRS mileage method and the actual expense method).
  • Correctly identify your maximum business miles, so you deduct the largest possible percentage of your vehicles.
  • Use a 1031 exchange to defer taxes (perhaps until death, when the tax code marks up your assets to fair market value and the income taxes disappear).
  • Qualify your office in your home as an administrative office.
  • Use allocation methods that make your home-office deductions larger.
  • If you are married with no employees, hire your spouse and install a Section 105 medical plan (Health Reimbursement Arrangements) to move your medical deductions to Schedule C for maximum benefits.
  • Operate as a one-person S corporation to save self-employment taxes.
  • If you are single with no employees, operate as a C corporation and install a Section 105 medical plan so you can deduct all your medical expenses.

If you would like my help implementing any of the ideas above, please don’t hesitate to contact us.