Small to medium-sized businesses can recognize tax benefits or minimize tax risks using the following tips.
Our tax expert, Steven Rosenthal, has created this list of tax tips that are of particular interest to SMBs.
1. Proceeds from PPP Loans are deductible - The IRS has ruled that business expenses paid with Paycheck Protection Program (PPP) loans will be tax-deductible under the Consolidated Appropriations Act, signed into law on December 27, 2020. This supersedes IRS guidance that such expenses could not be deducted, bringing the policy in line with what hundreds of business associations have argued was Congress’s intention when it created the PPP as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
Q) Should my business deduct expenses that were paid with the proceeds of my PPP loan?
A) Yes, although other expense deduction limitations may apply. Please consult your CPA to determine the applicability of the deduction to your circumstances.
2. Net Operating Losses may be carried back in 2020 - Under the CARES Act, a special elective 5-year net operating loss (NOL) carryback deduction has been made available for NOLs incurred from 2018 through 2020. Starting in 2021, NOLs may only be carried forward and are limited to offsetting 80% of taxable income.
Q) Should my business elect to carry back net operating losses from 2020 to prior years?
A) If your business has paid substantial taxes in the prior five years and has a present need for cash, the deduction of the carryback NOL would make sense vs. only applying the NOL on a carryforward basis. Electing to use the carryback will reduce your 2020 taxes now.
3. Failure to deduct depreciation may increase taxes on the sale of a business asset - Businesses that fail to deduct depreciation during the useful life of a business asset may be taxed twice if they try to use a "catch-up" depreciation deduction in the year the assets are sold under rules regarding "depreciation recapture." Depreciation expense from using capital assets (which lowers your taxes) must be taken every year during the useful life of the assets. If the depreciation is not expensed, the IRS may not allow you to get tax benefits from that depreciation when the asset is sold. To prevent the risk of double taxation when you sell business properties, make sure to take depreciation deductions at the right time.
Q) My business failed to depreciate an asset on prior-year tax returns. How should the business re-claim this deduction?
A) Businesses may amend their tax returns for prior years and claim the depreciation or file for a change of accounting method with the IRS using Form 3115.
4. Passive Activity Losses are deductible on the sale of an asset but must be tracked properly - Real estate rental businesses (or other passive businesses as defined by the Internal Revenue Code) must keep track of their passive activity loss carryovers. They must deduct those losses from gains generated when the assets are sold or deduct those losses to offset other passive income. Properly tracking passive activity loss carryovers will reduce your taxes when business assets are sold.
Q) I just sold rental real estate at a substantial gain. How do ensure that the passive losses are deducted?
A) Your CPA should track these losses for you, but if you have rented real estate for a long time or switched CPAs during your ownership of the property, confirm that your passive loss carryovers have been properly tracked throughout.
5. Qualified Business Income Deduction (QBI) rules are complicated and must be reviewed carefully - Most small businesses are eligible to get a deduction of up to 20% against their qualified net business income (QBI). Businesses should be diligent to ensure that they are taking advantage of the deduction and are properly carrying over any QBI business losses to the next year. The QBI deduction was created to provide a tax reduction for small businesses that would be comparable to the lowered corporate tax rates that are generally available to large corporations under the Tax Cuts and Jobs Act (effective 2018). There are special rules that apply to real estate businesses. Ensure that your business qualifies for an up to 20% QBI deduction to increase tax savings for current and future years.
Q) How will I know if my real estate business is eligible to use 20% of the QBI deduction?
A) There are several tests for determining eligibility for the QBI deduction. The IRS has published safe harbor rules that apply to real estate businesses in Notice 2019-07. Please consult your CPA for a more complete determination.
6. Washington real estate businesses may be subject to multiple B&O tax rates – In 2020, Washington State law changed the Business and Occupations (B&O) tax rates and classifications for several types of service businesses, including real estate. Businesses will save taxes if they classify their multiple lines of business to take advantage of the lowest possible B&O rates.
Q) What are the recent changes to the Washington B&O tax that affect real estate businesses?
A) Real estate businesses with sales of over $1 million might be facing multiple tax rates, such as the 1.5% rate for commissioned sales vs. a 1.75% rate for property management fees.
7. Remote states may impose sales tax collection responsibilities – 43 states have imposed sales tax collection and remission responsibilities on out-of-state businesses that are selling goods and services to in-state customers. Remote sales tax is imposed by Washington on out-of-state retailers selling goods and services to Washington residents. Conversely, other states also impose sales taxes on businesses located in Washington that sell to non-Washington residents. These laws were enacted in response to the U.S. Supreme Court decision in South Dakota v. Wayfair in 2018. If you own a Washington business selling taxable items to customers in other states, you must comply with the remote sales tax collection laws to prevent future tax liability imposed by the remote states.
Q) Will a Washington business be required to collect sales taxes for goods sold in another state, even without a presence in that state?
A) Yes. Previously, retailers needed to have a physical presence in a remote state to be required to collect and remit sales taxes. The Wayfair case eliminated the physical presence requirement when other factors indicate a retailer has an economic presence.
8. Washington businesses may owe income taxes to other states based on apportionment and nexus rules - Businesses that operate on a multi-state basis and meet the nexus requirements in another U.S. state need to properly apportion their income to that state-based upon sales, property, and/or payroll factors. Apportionment factors are designed to allow states to tax a fair share of income earned in their states, but the rules have been changing in the era of e-commerce. Washington businesses can minimize tax exposure to other states by limiting their contact with those states. This income tax exposure is separate and distinct from the duty to collect sales taxes on sales in other states.
Q) Will a Washington company that offers cloud-based services be required to file an income tax return in another state based on sales to remote customers in the state?
A) This depends on the state. Many states have apportionment formulas and nexus rules that, taken together, will enable income taxes to be imposed on the sale of online services into their state, such as in the State of New Jersey.
Steven Rosenthal, JD, CPA, MBA, LLM, CFP®, has 30 years of experience providing tax research, planning, and audit defense for publicly traded companies such as AT&T, eBay, PayPal, Ericsson, and Expedia. Today, Steve serves as Senior Tax Expert at Fulcrum Wealth Advisors where he specializes in business valuation and tax strategies for small and mid-size businesses seeking to maximize their “after-tax” returns.
Fulcrum Wealth Advisors provides financial guidance and plans for business owners seeking a strong foundation for both family and business finances that ultimately achieves life and legacy goals. Rise above the complexity and create a path for what’s next with our experienced advisor team. Learn more about our business financial planning services.
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