In late December of 2020, President Trump signed into law the Consolidated Appropriations Act, 2021 (the Act), which included the long-anticipated pandemic-related Tax Relief Act of 2020. It also included the Taxpayer Certainty and Disaster Relief Act of 2020, which extends or makes permanent numerous tax provisions, including tax breaks for individuals. The following is an overview of these key tax-related provisions for individuals.
Medical Expense Deduction
The Tax Cuts and Jobs Act (TCJA) set the threshold for itemized medical expense deductions at 7.5% of Adjusted Gross Income (AGI), but this threshold was scheduled to return to 10% of AGI as set in the Affordable Care Act. However, the expense deduction had been extended perpetually by Congress, allowing a taxpayer to continue to deduct their total qualified unreimbursed medical expenses that exceed only 7.5% of their AGI. The Taxpayer Certainty and Disaster Relief Act of 2020 made this threshold permanent.
Charitable Contribution Deduction
Generally, charitable donations are tax-deductible only if you itemize your taxes, but the Coronavirus Aid, Relief, and Economic Security (CARES) Act incorporated a provision that authorized individuals who don’t itemize to deduct up to $300 ($600 for married couples filing jointly) in cash donations in 2020. The Taxpayer Certainty and Disaster Relief Act of 2020 extended this provision into 2021 and makes it more valuable for married couples filing jointly.
Taxpayers who do itemize their deductions are typically limited to a 60% cap (i.e., the amount of charitable donations you could deduct generally could not exceed 60% of your AGI). As in 2020, that limit has been suspended in 2021.
Mortgage Insurance Premium Deduction
The Taxpayer Certainty and Disaster Relief Act of 2020 includes a one-year extension of the mortgage insurance premium deduction, so premiums paid or accrued through December 31, 2021 can be deducted on tax returns by those who itemized deductions and otherwise qualify for the mortgage insurance premium deduction.
Exclusion for Canceled Mortgage Debt
Cancelled or forgiven debt by a commercial lender can be counted as income for tax purposes. However, the Mortgage Forgiveness Debt Relief Act of 2007 generally allowed for taxpayers to exclude canceled mortgage debt from their taxable income, but only for a finite number of years. The Taxpayer Certainty and Disaster Relief Act of 2020 extended the Mortgage Forgiveness Debt Relief Act of 2007 through 2025.
Residential Energy-Efficient Property Credit
Individuals who have implemented certain energy-efficient upgrades to their homes (i.e., solar electricity, solar water heaters, geothermal heat pumps, and small wind turbines) are eligible for the residential energy-efficient property credit. The credit had been set to phase out after 2021, but the Taxpayer Certainty and Disaster Relief Act of 2020 extended it as follows:
- Continuing the rate applicable to 2020, eligible property that is put into service in 2022 will qualify for a credit worth up to 26% of the property cost
- Eligible property that is put into service in 2023 will qualify for a credit worth up to 22% of the property cost.
Last year construction contractors saw projects suspended indefinitely (or scrapped altogether) and escalated competition in the bidding process, both of which effectively stifled profit margins. It’s safe to say that the construction industry was not spared the upheaval of 2020. After such a tumultuous year, tax planning for 2021 might seem like a daunting challenge, but it’s a critical step for construction contractors in preparation of the year ahead.
Essential Tax Provisions for 2021 Preparation
With the uncertainty of the Covid-19 pandemic and a transfer of administrations in the White House this year, new legislation affecting tax provisions is a possibility, but there are several provisions under the current tax law, including those put in place under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, that you want to be sure not to pass over.
Are you eligible to use the bonus depreciation this year? Changes have been made to qualifying property under both the Tax Cuts and Jobs Act (TCJA) and the CARES Act as follows:
- TCJA: expanded the bonus depreciation deduction to 100% for specified property obtained and placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
- CARES Act: authorized the qualified improvement property (QIP)—typically interior improvements to nonresidential property—to be depreciable over 15 years and eligible for 100% bonus depreciation.
Tax Credits and Deductions
These tax credits and deductions could aid in reducing tax liability for contractors:
- Research and development credits: contractors who test new techniques or processes on construction jobs could be eligible.
- Deduction for energy-efficient government buildings: contractors may be eligible for a deduction of up to $1.80 per square foot for building energy-efficient commercial buildings intended for federal, state or local governments.
- Credit for energy-efficient residential properties: Contractors can take advantage of tax credits for certain energy-efficient residential properties.
Note that the deduction and credit for energy-efficient buildings expire at the end of 2021.
Qualified Business Income Deduction
The TCJA replaced the 9% “domestic production activities deduction” under IRC Section 199 with a 20% Qualified Business Income deduction under IRC Section 199A. It also increased eligibility to encompass more businesses. Contractors might want to start the conversation with their tax advisor on how to maximize this deduction as well as receive guidance on how to maneuver through the calculation’s somewhat complicated rules and limits.
Flexibility with Accounting Methods
Smaller construction firms (meaning those with average gross receipts of less than $26 million from the prior three years) generally enjoy more flexibility with tax accounting methods. Such firms could be eligible to use cash, accrual, completed contract or “accrual less retainage” accounting methods, all of which usually aid in managing the timing of revenue recognition. This allows companies to stimulate revenue to counterbalance current losses and recognize revenue now in expectation of higher future tax rates.
Additional Tax Planning Considerations Amid the Pandemic
To help minimize the risks of ongoing economic uncertainty, contractors should consider keeping apprised of tax changes. Given the seemingly ever-changing legislation amid the pandemic, construction firms should keep in regular contact with their tax advisors in order to avoid any tax reform surprises. However, contractors should also aim to operate without presumption of further legislation. While the economic effects of the pandemic are ongoing, don’t assume further stimulus legislation like the Paycheck Protection Program will be passed by Congress.
In light of a turbulent 2020, the construction industry has experienced a return to the business practices that have proven successful in the past: more attention to jobsite monitoring, legal contracts, and insurance costs. Contractors can contact an MKR advisor to incorporate 2021 tax planning into this process.
On Aug. 28, 2020, as part of COVID-19 relief, President Trump issued a presidential memorandum allowing employers to suspend withholding and paying to the IRS eligible employees’ Social Security payroll taxes from September 1, 2020 through December 31, 2020. The IRS then issued guidance on the payroll tax deferral in Notice 2020-65, but some questions still remain, and additional guidance in anticipated. Here’s what we know now.
Notice 2020-65 Provides Basic Guidance
For those implementing the program, the Notice provides barebones components of the payroll tax deferral, which applies to the employee portion of Social Security Tax.
- For employees earning less than $4,000 in a bi-weekly pay period, employers would defer withholding/depositing employee share of social security tax on wages earned for payroll periods on or after September 1, 2020.
- For employees whose wages fluctuate, the deferral is applicable to wages paid in any bi-weekly pay period during the dates specified in which the employee earns less than $4,000, regardless of wages or compensation paid to the employee for any other pay period. Therefore, the employer may defer to collect the tax in a pay period where the employee earns less than $4,000 but be required to collect it for another pay period where the employee earns more than $4,000.
Though Treasury Secretary Mnuchin announced previously that the deferral program would be optional, the Notice does not specifically address whether it is mandatory or optional.
One main reason that employers may not be eager to offer the benefit to employees is due to the absence of guidance regarding the situation of an employee’s termination or otherwise leaving employment ahead of paying the deferred amount. The employer and employee can come up with an arrangement (i.e. deducting the amount owed from the final paycheck), but should an employer fail to collect from the employee, the IRS could go after the employer.
To Defer or Not to Defer?
Given that the motive behind the tax deferral program is to get more money into the pockets of employees now in order to make ends meet due to reduced wages and/or hours, employers may think it worthwhile to extend this option to their employees. An average worker who completely defers Social Security taxes until December 31, 2020 would save just under $800, or about $60 per week. Employees must keep in mind that it is a temporary relief in the form of a deferral, not a tax forgiveness, though the President’s Executive Order does encourage Treasury to look into possible avenues for forgiveness. At best the tax deferral is an opportunity for workers to funnel those funds into an emergency savings account, ensuring that the savings will be on hand should Treasury fail to put forth a path for forgiveness and the taxes are consequently deducted from paychecks next year.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act changed the rules for employers on retirement plans, making it easier for employers to offer 401(k) plans and for employees to take part in them. Here’s how.
Multiple Employer Plans
Known as MEPs, multiple employer plans permit businesses to band together to offer employees a defined contribution plan such as a 401(k) or SIMPLE IRA, effectively allowing workers access to the same low-cost plans offered by large employers. While MEPs existed before the SECURE Act, here’s how they are now easier to establish and maintain.
- The “one bad apple rule”, where one employer’s failure to comply jeopardized the entire plan, was done away with.
- The “common nexus” requirement, which restricted the MEP option to small business employers who operated either in the same industry or same geographic location, was eliminated, permitting an “open MEP” that can be administered by a pooled plan provider (typically a financial services firm).
- MEPs with fewer than 1,000 participants (and no more than 100 participants from a single employer) are excluded from a potentially expensive audit requirement.
- Small business employers are also eligible for new tax credits for offering retirement savings options to employees.
Changes to Safe Harbor Plans
A provision of the SECURE Act provides more flexibility for employers who offer safe harbor 401(k) plans, which are 401(k) plans with an employer match that allows for avoidance of most annual compliance tests. If a 401(k) includes a Safe Harbor provision, the employer makes annual contributions on behalf of employees, and those contributions are vested immediately. Flexibility offered by the SECURE Act includes:
- Increasing the automatic enrollment escalation cap under a qualified automatic contribution arrangement (QACA) 401(k) plan from 10 to 15%.
- Removing the notice requirement for nonelective contributions. (The notice requirement is still applicable, however, for plans that implement the safe harbor match.)
- Whereas pre-SECURE Act, switching to a safe harbor plan had to be done before the start of the plan year, employers are now allowed to switch to a safe harbor 401(k) plan with nonelective contributions anytime up to 31 days before the end of the plan year. Amendments after that time are approved if (1) a nonelective contribution of at least 4% of compensation is granted for all eligible employees for that year, and (2) the plan in amended by the close of the following plan year.
Automatic Enrollment Credit
The SECURE Act added an incentive for small businesses to feature automatic enrollment in their plans by allowing businesses with fewer than 100 employees to qualify for a $500 per year tax credit when they create a new plan that includes automatic enrollment. Business can also take advantage of this by converting an existing plan to one with an automatic enrollment. The tax credit is available for three years following the year the plan automatically begins enrolling participants.
Part-Time Employee Participation
Previously, employers could exclude employees who work fewer than 1,000 hours per year from defined contribution plans, including 401(k) plans. Starting in January of 2021, the SECURE Act requires employers to include employees who work at least 500 hours in three consecutive years. This means that in order to qualify under this rule, employees would need to meet the 500-hour requirement for three years starting in 2021 in order to become eligible in 2024.
Choosing the Right Plan for Your Business
- Research 401(k) plan options for your business, keeping in mind that retirement plans can be customized to meet the needs of you and your employees.
- Carefully read through costs and fees of each plan. Recordkeeping fees, transaction fees, and investment fees are some to be mindful of, and these fees might increase if you add more employees and the plan grows (i.e. low-cost plans upfront might not be the best plan for your business in the long term.)
- Look for a 401(k) plan that presents a variety of investment opportunities for employees in terms of stocks, bonds, broad-based international exposure, and emerging markets.
Work with a financial expert who can help you establish and oversee a 401(k) plan. These professionals can include third-party administrators, recordkeepers, and investment advisors and managers.
Entrepreneurs are tasked with not only managing their business finances, but their personal finances as well, and when needs, circumstances, and priorities don’t align with the two, managing it all can feel overwhelming. To keep personal finances from getting pushed to the side, below are some tips to help you handle your own money while overseeing your business’s.
Plan for Rainy Days
Building an emergency fund for rainy days is not novel advice, but business owners might want to stash away even more than the recommended three to six months’ worth of living expenses. Are you prepared for circumstances like irregular fluctuations in cash flow, loss of a major client, or a national pandemic? Keep in mind that the purpose of an emergency fund is not to earn a big yield on this money but to be sure it’s there and accessible, so keep it in an FDIC-insured cash bank account.
Separate Business and Personal Finances
When you first start a business, open a business bank account and apply for a business credit card for business expenses. In addition to helping you build business credit, this will streamline your tax prep during tax season, lend more credibility to your business as an actual business, remove personal liability in case of adversity, and eliminate the burden of your business’s financials from your personal accounts.
Automate Bill Payment Schedules
A common personal financial tip is to automate your bill payment schedule, so consider carrying this practice over to your business finances as well. This will hep to prevent you from getting overwhelmed with both personal and business bills, thereby avoiding late payment fees and knocks to your credit score.
Manage Your Personal Credit
You know how crucial good credit is for your business, so it makes sense to keep your personal credit in check as well. Be sure to pay bills on time even if there are months when you can only make the minimum payment. Also be aware of your credit utilization (the percentage of credit that you’re actually using versus your total available credit limit). Keeping your credit utilization below 30% will keep your credit in good standing for loan approval.
Save for Retirement
Although it’s typical for business owners to invest profits back into their business, you still need to prepare for retirement, and investing and diversifying your savings may help you save more money for retirement than you could as an employee. SEP IRAs, SIMPLE IRAs, Solo 401(k)s, and SIMPLE 401(k)s are all retirement plan options available to small businesses. Research each one to determine which would be the best fit for you and your business. As for diversifying investments, look into options like stocks, bonds, ETFs, and money market mutual funds. Allocating your assets into different funnels will give you some breathing room should your business experience a struggle period.
Look to Tax Professionals
It’s no secret that U.S. tax laws are complex, and different business entities have different taxation rules. An accountant or tax professional can help you determine what your obligations are. To streamline the process, be sure to keep clear and organized records all year long.
With the learning curve of the first tax filing season in the TCJA era behind us, year-end tax planning is a perfect time to incorporate those lessons learned. Here is a general overview of some steps business owners can take in their year-end tax planning.
If your business has acquired a fixed asset or property (one that you don’t intend to sell for at least one year and will be used to earn long-term income), and it’s placed in service before the end of the year, you can typically write off the cost in 2019. Thanks to changes made by the TCJA, this now applies to both new and used assets. The TCJA boosted the deduction limit to $1.02 million with a phase-out threshold of $2.55 million for 2019. It also increased bonus depreciation to 100% for property placed in service after September 27, 2017 and before January 1, 2023.
The IRS recently clarified that food and beverage costs are deductible by 50% in certain circumstances and when those costs are stated separately from entertainment on invoices or receipts.
One of the most significant changes made by the TCJA affects owners of pass-through entities (partnerships, S corporations, and LLCs) as it authorized a deduction of up to 20% of the owner’s qualified business income (QBI) for the tax years 2018 through 2025. The QBI deduction is reduced for some taxpayers based on the amount of their income, so some individuals may need to consider reducing their taxable income so it falls under the $157,500 threshold ($315,000 for married filing jointly), whether by making contributions to retirement plans or health savings accounts, or even through charitable contributions. Something to keep in mind is that specified service business owners, which includes most personal-service providers, are not eligible for the deduction if their taxable income is above a certain threshold.
It isn’t a bad idea to complete minor repairs by the end of the year because the deductions can offset taxable business income. However, costs of improvements to business property must be written off over time. If you’re unsure whether a specific renovation or upgrade falls under a repair or an improvement, the IRS recently issued regulations that clarify the distinctions.
Estimated Tax Payments
If your corporation is anticipating a small net operating loss for 2019 but a substantial net income in 2020, you might think about accelerating just enough of the corporation’s 2020 income to create a small amount of net income for 2019. You could also choose to defer some 2019 deductions. This way, rather than having to pay estimated taxes based on 100% of your 2020 taxable income, you will be able to base your estimated tax installments on the comparatively small amount of income shown on your 2019 return.