2020 YEAR-END TAX PLANNING FOR BUSINESSES
As we are approaching the year-end, implementing strategic tax planning now is key to lowering tax liability that businesses will be soon paying. Here are some key planning opportunities and considerations businesses should consider:
- GILTI & FDII– The 2017 tax reform introduced several international tax rules which may impact the international businesses. GILTI (Global-Intangible Low Tax Income) taxes U.S. shareholders of controlled foreign subsidiaries on income earned by the subsidiaries. FDII (Foreign-Derived Intangible Income) provides a deduction for certain U.S. corporations with certain types of foreign source income. Businesses should consult with their tax advisors to identify ways to minimize the tax impact of GILTI and consider the potential tax benefit of FDII.
Additionally, final relations were published in 2020 allowing a “high-tax exception” which may potentially exclude from GILTI income of a controlled foreign corporation that incurs a foreign tax at a rate greater than 90% of the US corporate rate, currently 18.9%.
- 199A Deduction – The section 199A deduction, otherwise known as Qualifying Business Income Deduction, may reduce business income of individuals, including pass-through income, up to 20%. The rule provides complex qualification criteria and limitations, and documentation requirement in the case of pass-through income. The IRS issued Revenue Procedure 2019-38 that provides a safe harbor allowing certain interests in rental real estate, including interests in mixed-use property, to be treated as a trade or business for purposes of the qualified business income deduction under section 199A. Therefore, we recommend that the individual taxpayers with business and pass-through income should consult with their tax advisor before the year end to do planning in advance.
- Interest Deduction Limitation – Section 163(j) imposes a significant limitation on ability to deduct business interest. In nutshell, the section 163(j) limits interest deduction to 30% of business taxable income before interest deduction, depreciation, amortization and taxes. Highly debt-financed businesses may be subject to substantial limitation if a proper planning is not done in a timely manner.
Please note that the CARES Act increased interest deduction limit of 30% to 50% for 2020.
- Bonus Depreciation- Expanded bonus depreciation rules allow taxpayers full expensing of both new and used qualifying property placed in service before 2023, creating significant incentives for making new investments in depreciable tangible property and computer software. Bonus depreciation allowances increased from 50 to 100 percent for qualified property acquired and placed in service after September 27, 2017, and before 2023 (January 1, 2024, for longer production period property and certain aircraft). Plan purchases of eligible property to assure maximum use of this annual asset expense election and bonus depreciation, as the 100-percent bonus depreciation deduction ends after 2023.
Please note that the CARES Act redefined qualified improvement property (QIP) as improvements placed in service in 2018 and after and is 15-year property, such cost is eligible for 100% bonus depreciation.
- Excess Business Loss Limitation - Non-corporate taxpayers are now subject to a new limitation on the deductibility of business losses from pass-through entities (such as partnership, S-corporation and sole-proprietorship). A taxpayer’s loss from trade or business in total is now limited to $500,000 for joint filers (or $250,000 for single filer) for the tax years 2018 through 2026. Disallowed excess business losses will be treated as net operating loss and carried forward. Year-end tax planning is crucial for individuals with business(es) expect to generate loss for the year.
- R&D Credit - R&D tax credit is not just for large technology, medical device or drug companies. It also applies to manufacturers of all sizes. If a company, in the manufacturing industry, recently introduced new or improved products or manufacturing lines, there may be a good chance that the company would be entitled to the benefit of R&D tax credit. Some of the R&D credit qualifying activities that relate to manufacturers include, but not limited to, designing and developing cost-effective and innovative operational processes; improving product performance and manufacturing processes; evaluating and determining the efficient flow of material; designing and evaluating process alternatives; developing process to meet regulatory requirements or to reduce labor costs; developing and implementing new or improved safety enhancements; increasing operating and economic efficiencies; designing tools, molds, certification testing, environmental testing and automated manufacturing processes and so on.
The benefit of the R&D tax credit could range from 14% to 20% of qualifying expenditures that could be used to offset the company’s tax liabilities. In addition, many states have their own means of incentivizing in-state R&D activities.
- Inventory Revaluation - A taxpayer that has established a book Lower of Cost or Market (LCM) reserve to reduce the cost of inventory to the net realizable value could possibly use the book LCM reserve to write down the cost of subnormal goods or normal goods to the net realizable value for tax purposes if the goods have been offered for sale below cost within the requisite time frame. Accordingly, a taxpayer with a book LCM reserve that is not deducting the LCM reserve for tax purposes might consider changing its tax method of accounting to use the book LCM reserve to write down inventory from cost to net realizable value.
For taxpayers in retail business, generally for tax purposes, a taxpayer that determines actual inventory shrinkage by taking a physical inventory may deduct the shortage. Section 471(b) allows a taxpayer to deduct estimated inventory shrinkage for tax purposes when the taxpayer does not take a physical inventory at year end. For certain retailers, Rev. Proc. 98-29 provides a safe harbor method of estimating inventory shrinkage. Taxpayers may use another method of accounting for estimating inventory shrinkage if it is reasonable and clearly reflects income.
We advise taxpayers to do a comprehensive year-end tax planning, considering all opportunities and updates, to assess their impact and develop tax planning strategies in advance.