The Tax Cuts and Jobs Act (TCJA) significantly boosted the potential value of bonus depreciation for taxpayers — but only for a limited duration. The amount of first-year depreciation available as a so-called bonus will begin to drop from 100% after 2022, and businesses should plan accordingly.

Bonus depreciation in a nutshell

Bonus depreciation has been available in varying amounts for some time. Immediately prior to the passage of the TCJA, for example, taxpayers generally could claim a depreciation deduction for 50% of the purchase price of qualified property in the first year — as opposed to deducting smaller amounts over the useful life of the property under the modified accelerated cost recovery system (MACRS).

The TCJA expanded the deduction to 100% in the year qualified property is placed in service through 2022, with the amount dropping each subsequent year by 20%, until bonus depreciation sunsets in 2027, unless Congress acts to extend it. Special rules apply to property with longer recovery periods.

Businesses can take advantage of the deduction by purchasing, among other things, property with a useful life of 20 years or less. That includes computer systems, software, certain vehicles, machinery, equipment and office furniture.

Both new and used property can qualify. Used property generally qualifies if it wasn’t:

• Used by the taxpayer or a predecessor before acquiring it,
• Acquired from a related party, and
• Acquired as part of a tax-free transaction.

Qualified improvement property (generally, interior improvements to nonresidential property, excluding elevators, escalators, interior structural framework and building expansion) also qualify for bonus depreciation. A drafting error in the TCJA indicated otherwise, but the CARES Act, enacted in 2020, retroactively made such property eligible for bonus depreciation. Taxpayers that placed qualified improvement property in service in 2018, 2019 or 2020 may, generally, now claim any related deductions not claimed then — subject to certain restrictions.

Buildings themselves aren’t eligible for bonus depreciation, with their useful life of 27.5 (residential) or 39 (commercial) years — but cost segregation studies can help businesses identify components that might be. These studies identify parts of real property that are actually tangible personal property. Such property has shorter depreciation recovery periods and therefore qualifies for bonus depreciation in the year placed in service.

The placed-in-service requirement is particularly critical for those wishing to claim 100% bonus depreciation before the maximum deduction amount falls to 80% in 2023. With the continuing shipping delays and shortages in labor, materials and supplies, taxpayers should place their orders promptly to increase the odds of being able to deploy qualifying property in their businesses before year-end.

Note, too, that bonus depreciation is automatically applied by the IRS unless a taxpayer opts out. Elections apply to all qualified property in the same class of property that is placed in service in the same tax year (for example, all five-year MACRS property).

Bonus depreciation vs. Section 179 expensing

Taxpayers sometimes confuse bonus depreciation with Sec. 179 expensing. The two tax breaks are similar, but distinct.

Like bonus deprecation, Sec. 179 allows a taxpayer to deduct 100% of the purchase price of new and used eligible assets. Eligible assets include software, computer and office equipment, certain vehicles and machinery, as well as qualified improvement property.

But Sec. 179 is subject to some limits that don’t apply to bonus depreciation. For example, the maximum allowable deduction for 2022 is $1.08 million.

In addition, the deduction is intended to benefit small- and medium-sized businesses so it begins phasing out on a dollar-for-dollar basis when qualifying property purchases exceed $2.7 million. In other words, the deduction isn’t available if the cost of Sec. 179 property placed in service this year is $3.78 million or more.

The Sec. 179 deduction also is limited by the amount of a business’s taxable income; applying the deduction can’t create a loss for the business. Any cost not deductible in the first year can be carried over to the next year for an unlimited number of years. Such carried-over costs must be deducted according to age — for example, costs carried over from 2019 must be deducted before those carried over from 2020.

Alternatively, the business can claim the excess as bonus depreciation in the first year. For example, say you purchase machinery that costs $20,000 but, exclusive of that amount, have only $15,000 in income for the year it’s placed in service. Presuming you’re otherwise eligible, you can deduct $15,000 under Sec. 179 and the remaining $5,000 as bonus depreciation.

Also in contrast to bonus depreciation, the Sec. 179 deduction isn’t automatic. You must claim it on a property-by-property basis.

Some caveats

At first glance, bonus depreciation can seem like a no-brainer. However, it’s not necessarily advisable in every situation.

For example, taxpayers who claim the qualified business income (QBI) deduction for pass-through businesses could find that bonus depreciation backfires. The amount of your QBI deduction is limited by your taxable income, and bonus depreciation will reduce this income. Like bonus depreciation, the QBI deduction is scheduled to expire in 2026, so you might want to maximize it before then.

The QBI deduction isn’t the only tax break that depends on taxable income. Increasing your depreciation deduction also could affect the value of expiring net operating losses and charitable contribution and credit carryforwards.

And deduction acceleration strategies always should take into account tax bracket expectations going forward. The value of any deduction is higher when you’re subject to higher tax rates. Newer businesses that currently have relatively low incomes might prefer to spread out depreciation, for example. With bonus depreciation, though, you’ll also need to account for the coming declines in the maximum deduction amounts.

Buy now, decide later

If you plan on purchasing bonus depreciation qualifying property, it may be wise to do so and place it in service before year end to maximize your options. We can help you chart the most advantageous course of action based on your specific circumstances and the upcoming changes in tax law.

Small businesses may start off using the cash-basis method of accounting. But many eventually convert to accrual-basis reporting to conform with U.S. Generally Accepted Accounting Principles (GAAP). Which method is right for you?

Cash method

Under the cash method, companies recognize revenue as customers pay invoices and expenses when they pay bills. As a result, cash-basis entities may report fluctuations in profits from period to period, especially if they’re engaged in long-term projects. This can make it hard to benchmark a company’s performance from year to year — or against other entities that use the accrual method.

Businesses that are eligible to use the cash method of accounting for tax purposes have the ability to fine-tune annual taxable income. This is accomplished by timing the year in which you recognize taxable income and claim deductions.

Normally, the preferred strategy is to postpone revenue recognition and accelerate expense payments at year end. This strategy can temporarily defer the company’s tax liability. But it makes the company appear less profitable to lenders and investors.

Conversely, if tax rates are expected to increase substantially in the coming year, it may be advantageous to take the opposite approach — accelerate revenue recognition and defer expenses at year end. This strategy maximizes the company’s tax liability in the current year when rates are expected to be lower.

Accrual method

The more complex accrual method conforms to the matching principle under GAAP. That is, companies recognize revenue (and expenses) in the periods that they’re earned (or incurred). This method reduces major fluctuations in profits from one period to the next, facilitating financial benchmarking.

In addition, accrual-basis entities report several asset and liability accounts that are generally absent on a cash-basis balance sheet. Examples include prepaid expenses, accounts receivable, accounts payable, work in progress, accrued expenses and deferred taxes.

Public companies are required to use the accrual method. But small companies have other options, including the cash method.

Tax considerations

Thanks to the Tax Cuts and Jobs Act (TCJA), more companies are eligible to use the cash method for federal tax purposes than under prior law. In turn, this change has caused some small companies to rethink their method of accounting for book purposes.

The TCJA liberalized the small business definition to include those that have no more than $25 million of average annual gross receipts, based on the preceding three tax years. This limit is adjusted annually for inflation. For tax years beginning in 2021, the inflation-adjusted limit is $26 million. For 2022, it’s $27 million. Under prior law, the gross-receipts threshold for the cash method was only $5 million.

In addition, for tax years beginning after 2017, the TCJA modifies Section 451 of the Internal Revenue Code so that a business recognizes revenue for tax purposes no later than when it’s recognized for financial reporting purposes. So, if you use the accrual method for financial reporting purposes, you must also use it for federal income tax purposes.

For more information

There are several viable reasons for a small business to switch to the accrual method of accounting. It can help reduce variability in financial reporting and attract financing from lenders and investors who prefer GAAP financials. But, if you’re eligible for the cash method for tax purposes, you may want to switch to that method for the simplicity and the flexibility in tax planning it provides. Contact us to discuss your options and pick the optimal method for your situation.

What’s considered a casualty for tax purposes? It’s a sudden, unexpected or unusual event, such as a hurricane, tornado, flood, earthquake, fire, act of vandalism or a terrorist attack.

More difficult to qualify

For losses incurred through 2025, the TCJA generally eliminates deductions for personal casualty losses, except for losses due to federally declared disasters. For example, during the summer of 2021, there have been presidential declarations of major disasters in parts of Tennessee, New York state, Florida and California after severe storms, flooding and wildfires. So victims in affected areas would be eligible for casualty loss deductions.

Note: There’s an exception to the general rule of allowing casualty loss deductions only in federally declared disaster areas. If you have personal casualty gains because your insurance proceeds exceed the tax basis of the damaged or destroyed property, you can deduct personal casualty losses that aren’t due to a federally declared disaster up to the amount of your personal casualty gains.

Special election to claim a refund

If your casualty loss is due to a federally declared disaster, a special election allows you to deduct the loss on your tax return for the preceding year and claim a refund. If you’ve already filed your return for the preceding year, you can file an amended return to make the election and claim the deduction in the earlier year. This can potentially help you get extra cash when you need it.

This election must be made by no later than six months after the due date (without considering extensions) for filing your tax return for the year in which the disaster occurs. However, the election itself must be made on an original or amended return for the preceding year.

How to calculate the deduction

You must take the following three steps to calculate the casualty loss deduction for personal-use property in an area declared a federal disaster:

1. Subtract any insurance proceeds.
2. Subtract $100 per casualty event.
3. Combine the results from the first two steps and then subtract 10% of your adjusted gross income (AGI) for the year you claim the loss deduction.

Important: Another factor that now makes it harder to claim a casualty loss than it used to be years ago is that you must itemize deductions to claim one. Through 2025, fewer people will itemize, because the TCJA significantly increased the standard deduction amounts. For 2021, they’re $12,550 for single filers, $18,800 for heads of households, and $25,100 for married joint-filing couples.

So even if you qualify for a casualty deduction, you might not get any tax benefit, because you don’t have enough itemized deductions.

Contact us

These are the rules for personal property. Keep in mind that the rules for business or income-producing property are different. (It’s easier to get a deduction for business property casualty losses.) If you are a victim of a disaster, we can help you understand the complex rules.

Liberalized rules for NOL carryforwards

The CARES Act includes favorable changes to the rules for deducting net operating losses (NOLs). First, it eases the taxable income limitation on deducting NOLs.

Under an unfavorable provision included in the 2017 Tax Cuts and Jobs Act (TCJA), an NOL arising in a tax year beginning in 2018 or beyond and carried forward to a later tax year couldn’t offset more than 80% of the taxable income for the carryforward year (the later tax year), calculated before the NOL deduction.

For tax years beginning before 2021, the CARES Act removes the TCJA taxable income limitation on deductions for prior-year NOLs carried forward into those years. So NOL carryforwards to tax years beginning before 2021 can be used to fully offset taxable income for those years.

For tax years beginning after 2020, the CARES Act allows NOL deductions equal to the sum of:

• 100% of NOL carryforwards from pre-2018 tax years, plus
• The lesser of 1) 100% of NOL carryforwards from post-2017 tax years, or 2) 80% of remaining taxable income (if any) after deducting NOL carryforwards from pre-2018 tax years.

As you can see, this is a complicated rule. But it’s more taxpayer-friendly than what the TCJA allowed. This favorable change is permanent.

Carrybacks allowed for certain NOLs

Under another unfavorable TCJA provision, NOLs arising in tax years ending after 2017 generally couldn’t be carried back to earlier tax years and used to offset taxable income in those earlier years. Instead, NOLs arising in tax years ending after 2017 could only be carried forward to later years. But they could be carried forward for an unlimited number of years.

Under the CARES Act, NOLs that arise in tax years beginning in 2018 through 2020 can be carried back for five years. For example, a taxpayer could carry back an NOL arising in 2020 to 2015 and recover federal income tax paid for that year. That could be very beneficial, because the federal income tax rates for both individuals and corporations were higher before the TCJA rate cuts took effect in 2018.

When advantageous, taxpayers can elect to waive the carryback privilege for an NOL and, instead, carry the NOL forward to future tax years. In addition, barring a further tax-law change, the no-carryback rule will come back into play for NOLs that arise in tax years beginning after 2020.

Excess business loss rules postponed

Another unfavorable TCJA provision disallowed current deductions for so-called “excess business losses” incurred by individuals and other noncorporate taxpayers in tax years beginning in 2018 through 2025.

An excess business loss is one that exceeds $250,000 ($500,000 for a married joint-filing couple). These limits are adjusted annually for inflation.

The CARES Act removes the excess business loss disallowance rule for losses arising in tax years beginning in 2018 through 2020.

Barring a further tax-law change, the excess business loss disallowance rule will come back into play for losses that arise in tax years beginning in 2021 through 2025. Any disallowed excess business loss for one of those years will be carried forward to the following year and can be deducted under the rules for NOL carryforwards.

Amended return opportunities

These taxpayer-friendly CARES Act changes can affect prior tax years for which you’ve already filed returns. Amended returns may be needed to benefit from the changes. Contact your tax professional for more information.

Note: This post comes directly from Edelstein’s 2020-2021 Tax Guide, which can be found here.

To provide tax relief to businesses suffering during the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily relaxes the limitation on deductions for business interest expense. Here’s the story.

TCJA created new limitation

Before the Tax Cuts and Jobs Act (TCJA), some corporations were subject to the so-called “earnings stripping” rules. Those rules attempted to limit deductions by U.S. corporations for interest paid to related foreign entities that weren’t subject to U.S. income tax. Other taxpayers could generally fully deduct business interest expense (subject to other tax-law restrictions, such as the passive loss rules and the at-risk rules).

The TCJA shifted the business interest deduction playing field. For tax years beginning in 2018 and beyond, it limited a taxpayer’s deduction for business interest expense for the year to the sum of:

• Business interest income,
• 30% of adjusted taxable income (ATI), and
• Floor plan financing interest expense paid by certain vehicle dealers.

Business interest expense is defined as interest on debt that’s properly allocable to a trade or business. However, the term trade or business doesn’t include the following excepted activities:

• Performing services as an employee,
• Electing real property businesses,
• Electing farming businesses, and
• Selling electrical energy, water, sewage disposal services, gas or steam through a local distribution system, or transportation of gas or steam by pipeline, if the rates are established by a specified governing body.

Interest expense that’s disallowed under the limitation rules is carried forward to future tax years indefinitely and treated as business interest expense incurred in the carry-forward year.

Small business exception

Many businesses are exempt from the interest expense limitation rules under what we’ll call the small business exception. Under this exception, a taxpayer (other than a tax shelter) is exempt from the limitation if the taxpayer’s average annual gross receipts are $25 million or less for the three-tax-year period ending with the preceding tax year. Businesses that have fluctuating annual gross receipts may qualify for the small business exception for some years but not for others — depending on the average annual receipts amount for the preceding three-tax-year period.

For example, if your business has three good years, it may be subject to the interest expense limitation rules for the following year. But if your business has a bad year, it may qualify for the small business exception for the following year. If average annual receipts are typically over the $25 million threshold, but not by much, judicious planning may allow you to qualify for the small business exception for at least some years.

Special rules for partnerships and S corporations

The interest expense deduction limitation rules get more complicated for businesses operating as partnerships, limited liability companies (LLCs) treated as partnerships for tax purposes and S corporations.

Basically, the limitation is calculated at both the entity level and at the owner level. Special rules prevent double counting of income when calculating an owner’s ATI for purposes of applying the limitation rules at the owner level.

IRS proposed regs set forth the special rules for applying the business interest expense limitation to partnerships and S corporations and their owners. The rules are complex and present significant compliance challenges.

Favorable CARES Act changes

The CARES Act generally allows businesses, unless they elect otherwise, to increase the interest expense deduction limitation to 50% of ATI for tax years beginning in 2019 or 2020. Businesses can also elect to use 2019 ATI to calculate the 2020 ATI limitation, which can allow for a larger deduction if 2020 ATI is less, which may be the case for many businesses.

For partnerships (including LLCs treated as partnerships for tax purposes), the 30% of ATI limitation remains in place for tax years beginning in 2019 but is 50% for 2020. Disallowed partnership business interest expense from a partnership’s 2019 tax year is allocated to partners and carried over to their 2020 tax years.

Unless a partner elects otherwise, 50% of carried-over partnership business interest expense from 2019 is deductible in the partner’s 2020 tax year without regard to the business interest expense limitation rules. The remaining 50% is subject to the normal limitation rules, calculated at the partner level, for carried-over partnership business interest expense. Like other businesses, partnerships can elect to use 2019 ATI to calculate the 2020 ATI limitation.

Help is available

As you can see, the business interest expense limitation rules are complicated. The temporarily relaxed limitations can allow affected businesses to reduce their federal tax liabilities for 2019 and 2020. However, for partnerships and partners, limitation rules are relaxed only for 2020. Your tax advisor can help your business take advantage of the relaxed rules for business interest expense deductions and benefit from other tax relief measures made available by the CARES Act.

Note: This post comes directly from Edelstein’s 2020-2021 Tax Guide, which can be found here.

Also, keep in mind that, under the Tax Cuts and Jobs Act (TCJA), annual inflation adjustments are calculated using the chained consumer price index (also known as C-CPI-U). This increases tax bracket thresholds, the standard deduction, certain exemptions and other figures at a slower rate than was the case with the consumer price index previously used, potentially pushing taxpayers into higher tax brackets and making various breaks worth less over time. The TCJA adopted the C-CPI-U on a permanent basis.

Individual income taxes

Tax-bracket thresholds increase for each filing status but, because they’re based on percentages, they increase more significantly for the higher brackets. For example, the top of the 10% bracket increases by $75 to $150, depending on filing status, but the top of the 35% bracket increases by $3,125 to $6,250, again depending on filing status.
2021 ordinary-income tax brackets.

The TCJA suspended personal exemptions through 2025. However, it nearly doubled the standard deduction, indexed annually for inflation through 2025. For 2021, the standard deduction is $25,100 (married couples filing jointly), $18,800 (heads of households), and $12,550 (singles and married couples filing separately). After 2025, standard deduction amounts are scheduled to drop back to the amounts under pre-TCJA law.

Changes to the standard deduction could help some taxpayers make up for the loss of personal exemptions. But it might not help taxpayers who typically itemize deductions.

AMT

The alternative minimum tax (AMT) is a separate tax system that limits some deductions, doesn’t permit others and treats certain income items differently. If your AMT liability is greater than your regular tax liability, you must pay the AMT.

Like the regular tax brackets, the AMT brackets are annually indexed for inflation. For 2021, the threshold for the 28% bracket increased by $2,000 for all filing statuses except married filing separately, which increased by half that amount.

Education and child-related breaks. The AMT exemptions and exemption phaseouts are also indexed. The exemption amounts for 2021 are $73,600 for singles and heads of households and $114,600 for joint filers, increasing by $700 and $1,200, respectively, over 2020 amounts. The inflation-adjusted phaseout ranges for 2021 are $523,600–$818,000 (singles and heads of households) and $1,047,200–$1,505,600 (joint filers). Amounts for separate filers are half of those for joint filers.

The maximum benefits of various education and child-related breaks generally remain the same for 2021. But most of these breaks are limited based on a taxpayer’s modified adjusted gross income (MAGI). Taxpayers whose MAGIs are within an applicable phaseout range are eligible for a partial break — and breaks are eliminated for those whose MAGIs exceed the top of the range.

The MAGI phaseout ranges generally remain the same or increase modestly for 2021, depending on the break. For example:

The American Opportunity credit. The phaseout ranges for this education credit (maximum $2,500 per eligible student) remain the same for 2021: $160,000–$180,000 for joint filers and $80,000–$90,000 for other filers.

The Lifetime Learning credit. The phaseout ranges for this education credit (maximum $2,000 per tax return) increase for 2021. They’re $119,000–$139,000 for joint filers and $59,000–$69,000 for other filers — up $1,000 for joint filers but the same as 2020 for others.

The adoption credit. The phaseout ranges for eligible taxpayers adopting a child will also increase for 2021 — by $2,140 to $216,660–$256,660 for joint, head-of-household and single filers. The maximum credit increases by $140, to $14,440 for 2021.

(Note: Married couples filing separately generally aren’t eligible for these credits.)

These are only some of the education and child-related breaks that may benefit you. Keep in mind that, if your MAGI is too high for you to qualify for a break for your child’s education, your child might be eligible to claim one on his or her tax return.

Gift and estate taxes

The unified gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption are both adjusted annually for inflation. For 2021, the amount is $11.7 million (up from $11.58 million for 2020).

The annual gift tax exclusion remains at $15,000 for 2021. It’s adjusted only in $1,000 increments, so it typically increases only every few years. (It increased to $15,000 in 2018.)

Retirement plans

Not all of the retirement-plan-related limits increase for 2021. Thus, you may have limited opportunities to increase your retirement savings if you’ve already been contributing the maximum amount allowed:

Traditional IRAs. MAGI phaseout ranges apply to the deductibility of contributions if a taxpayer (or his or her spouse) participates in an employer-sponsored retirement plan:Your MAGI may reduce or even eliminate your ability to take advantage of IRAs. Fortunately, IRA-related MAGI phaseout range limits all will increase for 2021:

• For married taxpayers filing jointly, the phaseout range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan:
  • For a spouse who participates, the 2021 phaseout range limits increase by $1,000, to $105,000–$125,000.
  • For a spouse who doesn’t participate, the 2021 phaseout range limits increase by $2,000, to $198,000–$208,000.
  • For single and head-of-household taxpayers participating in an employer-sponsored plan, the 2021 phaseout range limits increase by $1,000, to $66,000–$76,000.

Taxpayers with MAGIs in the applicable range can deduct a partial contribution; those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.

But a taxpayer whose deduction is reduced or eliminated can make nondeductible traditional IRA contributions. The $6,000 contribution limit (plus $1,000 catch-up if applicable and reduced by any Roth IRA contributions) still applies. Nondeductible traditional IRA contributions may be beneficial if your MAGI is also too high for you to contribute (or fully contribute) to a Roth IRA.

Roth IRAs. Whether you participate in an employer-sponsored plan doesn’t affect your ability to contribute to a Roth IRA, but MAGI limits may reduce or eliminate your ability to contribute:

• For married taxpayers filing jointly, the 2021 phaseout range limits increase by $2,000, to $198,000–$208,000.
• For single and head-of-household taxpayers, the 2021 phaseout range limits increase by $1,000, to $125,000–$140,000.

You can make a partial contribution if your MAGI falls within the applicable range, but no contribution if it exceeds the top of the range.

(Note: Married taxpayers filing separately are subject to much lower phaseout ranges for both traditional and Roth IRAs.)

Crunching the numbers

With the 2021 cost-of-living adjustment amounts inching slightly higher than 2020 amounts, it’s important to understand how they might affect your tax and financial situation. We’d be happy to help crunch the numbers and explain the best tax-saving strategies to implement based on the 2021 numbers.

Quick refunds

Businesses facing cash flow crunches can take advantage of a provision in the CARES Act that accelerates the timeline for recovering unused alternative minimum tax (AMT) credits. The Tax Cuts and Jobs Act (TCJA) eliminated the corporate AMT but allowed businesses with unused credits to claim them incrementally in taxable years beginning in 2018 and through 2020.

Under the TCJA, for tax years beginning in 2018, 2019 and 2020, if AMT credit carryovers exceed regular tax liability, 50% of the excess is refundable, with any remaining credits fully refundable in 2021. But the CARES Act lets businesses claim all remaining credits in 2018 or 2019, opening the door to immediate 100% refunds for excess credits. Instead of amending a 2018 tax return to claim the credits, a business owner can file Form 1139, “Corporate Application for Tentative Refund,” by December 31, 2020.

The CARES Act also temporarily loosened the rules for net operating losses (NOLs). The TCJA limits the NOL deduction to 80% of taxable income and NOLs can’t be carried back. Now, NOLs arising in 2018, 2019 or 2020 can be carried back five years to claim refunds in previous tax years. No taxable income limitation applies for years beginning before 2021, meaning NOLs can completely offset income in those years.

Businesses can obtain even larger refunds by accelerating deductions into years when higher pre-TCJA tax rates were in effect (for example, a 35% corporate tax rate vs. 21% under the TCJA). Bear in mind, though, that carrying back NOLs can trigger a recalculation of other tax attributes and deductions, such as AMT credits and the research credit, often referred to as the “research and development,” “R&D,” or “research and experimentation” credit.

Capital assets purchases

Capital investments have long been a useful way to reduce income taxes, and the TCJA further juiced this technique by expanding bonus depreciation. And the CARES Act finally remedies a drafting error in the TCJA that left qualified improvement property (QIP), generally interior improvements to nonresidential real property, ineligible for bonus deprecation.

For qualified property purchased after September 27, 2017, and before January 1, 2023, businesses can deduct 100% of the cost of new and used (subject to certain conditions) qualified property in the first year the property is placed into service. Special rules apply to property with a longer production period.

Qualified property includes computer systems, purchased software, vehicles, machinery, equipment and office furniture. Beginning in 2023, the amount of the bonus depreciation deduction will fall 20% each year. Absent congressional action, the deduction will be eliminated in 2027.

Congress clearly intended for QIP that was placed in service after 2017 to qualify for 100% first-year bonus depreciation, but a drafting error prevented that favorable treatment. The CARES Act includes a technical correction to fix the problem. As a result, businesses that made qualified improvements in 2018 or 2019 can claim an immediate tax refund for the missed bonus depreciation.

Under the TCJA, Sec. 179 expensing (that is, deducting the entire cost) is available for several improvements to nonresidential real property, including roofs, HVAC, fire protection systems, alarm systems and security systems. The law also increases the maximum deduction for qualifying property. The 2020 limit is $1.04 million (the maximum deduction is limited to the amount of income from business activity). The expensing deduction begins phasing out on a dollar-for-dollar basis when qualifying property placed in service this year exceeds $2.59 million.

Business interest management

The TCJA generally has limited the deduction for business interest expense to 30% of adjusted taxable income (ATI). The CARES Act allows C- and S-corporations to deduct up to 50% of their ATI for the 2019 and 2020 tax years (special partnership rules apply for 2019).

It also permits businesses to elect to use their 2019 ATI, rather than 2020 ATI, for the calculation, which should increase the amount of the deduction for many businesses. Businesses should consider using accounting method changes to shift their business interest deductions from 2019 to 2020 to boost their 2019 ATI.

Income and expense timing

Businesses that haven’t expected to be in a higher tax bracket the following tax year have long deferred income and accelerated expenses to minimize taxable income. If the Democrats win the White House and the Senate, and retain the House of Representatives, tax rates could increase as soon as 2021. In that case, it could be advantageous to accelerate income into 2020, when it would be taxed at the lower current rates.

Even if tax rates don’t climb next year, companies of all kinds have seen downturns in business this year due to the far-reaching effects of the COVID-19 pandemic. Those that expect to be more profitable in 2021 may want to push their expense deductions past year-end to help offset profits.

Payroll tax deductions

A similar analysis applies to payroll tax deductions. The CARES Act allows businesses and self-employed individuals to delay their payments of the employer share (6.2% of wages) of the Social Security payroll tax. Such taxpayers can pay the tax over the next two years, with the first half due by December 31, 2021, and the second half due by December 31, 2022.

Sticking with those dates, however, will affect 2020 taxes. Businesses generally can’t deduct their share of payroll taxes until they actually make the payments. Certain businesses might find it more worthwhile to pay those taxes in 2020. This could, for example, increase the amount of NOLs they can carry back to higher tax-rate years.

Avoid missteps

Many of these taxing planning opportunities come with filing requirements, whether for amended tax returns, applications for changes in accounting method (IRS Form 3115) or applications for tentative refunds. In addition, some of these strategies could have a negative impact on taxpayers who claim the qualified business income deduction. Contact us and we can help determine your best course forward and ensure you don’t miss any critical deadlines.

TCJA rule changes

Prior to the Tax Cuts and Jobs Act (TCJA), Section 274 of the Internal Revenue Code generally prohibited deductions for expenses related to entertainment, amusement or recreation (commonly referred to as “entertainment” expenses). The tax code granted exceptions, however, for entertainment expenses “directly related to” or “associated with” actively conducting business. Businesses generally could deduct 50% of such expenses.

The tax code also limited deductions for food and beverage expenses that satisfied one of the exceptions. A deduction was permitted only if 1) the expense wasn’t lavish or extravagant under the circumstances, and 2) the taxpayer (or an employee of the taxpayer) was present when the food or beverages were furnished. The amount of the deduction was limited to 50% of such expenses.

The TCJA amended Sec. 274 to generally prohibit deductions for any expenses related to entertainment, regardless of whether they’re directly related to or associated with conducting business. Some taxpayers wondered if the amendment also banned deductions for business meal expenses.

The IRS responded to this question in the fall of 2018 with Notice 2018-76. The notice listed several circumstances under which businesses could continue to treat business meal expenses, including meals consumed by employees on work travel, as 50% deductible expenses until the IRS published its proposed regulations explaining when business meal expenses are nondeductible entertainment expenses.

Applicability of the proposed regulations

The proposed regulations provide that the deduction limitation rules generally apply to all food and beverages, whether characterized as meals, snacks or other types of food or beverage items. The deduction limitations apply even to food and beverages treated as de minimis fringe benefits.

The proposed regulations define food or beverage expenses as the cost of food or beverages, including any delivery fees, tips and sales tax. But the deductible expenses for employer-provided meals at an eating facility don’t include operating expenses for the facility (for example, the salaries of employees preparing and serving meals and other overhead costs).

Food and beverages at entertainment activities

Food or beverages provided during or at an entertainment activity aren’t considered nondeductible entertainment expenses under the proposed regulations as long as they’re purchased separately from the entertainment, or their cost is stated separately from the entertainment cost on a bill, invoice or receipt. For example, let’s say you take a client to a football game. You buy some food at the game and pay for it separately from the game tickets. The amount may qualify for a deduction, if you meet certain other requirements.

The 2018 notice provided that taxpayers couldn’t circumvent this entertainment disallowance rule by inflating the amount charged for food and beverages. The proposed regulations tackle this issue by requiring that the amount charged for food or beverages reflect 1) the venue’s usual selling cost for those items if purchased separately from the entertainment, or 2) the reasonable value of the items.

Business meal expenses

The proposed regulations generally follow the lead of the 2018 guidance on the deductibility of business meal expenses, but also incorporate other statutory requirements taxpayers must meet to deduct 50% of the expense. Thus, businesses may deduct 50% of business meal expenses if:

• The expense isn’t lavish or extravagant under the circumstances,
• The taxpayer (or an employee of the taxpayer) is present at the furnishing of the food or beverages, and
• The food and beverages are provided to a business associate.

The proposed regulations also clarify the requirement in Notice 2018-76 that the food and beverages be provided to a “business contact.” The notice described such an individual as a current or potential business customer, client, consultant, or similar business contact.

The proposed regulations use the term “business associate,” defined as a person the taxpayer could reasonably expect to engage with in business, including a current or prospective customer, client, supplier, employee, agent, partner, or professional advisor. The inclusion of employees makes the standard applicable to employer-provided meals and situations where a business provides meals to both employees and nonemployee business associates at the same event.

Travel meal expenses

Although the TCJA didn’t explicitly change the rules for travel expenses, the proposed regulations are intended to provide comprehensive rules for food and beverage expenses. As a result, they apply the general rules for meal expenses to travel meals.

The proposed regulations also incorporate statutory substantiation requirements for travel meal expenses — evidence of the amount, time and place, and business purpose of the meal. In addition, meal expenses for spouses, dependents or other individuals accompanying the taxpayer (or an employee of the taxpayer) on business travel generally aren’t deductible unless the individual is an employee of the taxpayer and traveling for a bona fide business purpose.

Other food and beverage expenses

In addition, the proposed regulations provide that business meal expenses and 50% deduction limits don’t apply to expenses that fall within one of the following exceptions:

• Expenses treated as compensation,
• Reimbursed food and beverage expenses,
• Expenses related to recreational, social or similar activities for employees, such as holiday parties, annual picnics and summer outings that don’t favor highly compensated employees (but not free food and beverages in break rooms or provided for the convenience of the employer, such as that provided for employees who must stay on call for emergencies),
• Items available to the public (as long as more than 50% of the actual or reasonably estimated consumption is by the general public, including customers, clients and visitors), and
• Goods and services sold to customers (for example, food or beverage items that are purchased as part of preparing and providing meals to a restaurant’s paying customers, which are also consumed at the worksite by employees).

These expenses all are fully deductible.

Final regulations are on the way

Comments on the proposed regulations must be submitted by April 13, 2020, and a public hearing may be held. In the meantime, you can rely on the proposed regulations as well as the guidance in Notice 2018-76 until the IRS issues final regulations. If you have questions on business-related meal and beverage expenses, please don’t hesitate to contact us.

The IRS has issued new guidance updating the rules for using optional standard mileage rates when calculating “above-the-line” deductions for the costs of operating an automobile for certain purposes. IRS Revenue Procedure 2019-46 also lays out rules for establishing the amount of an employee’s transportation expenses that are reimbursed using the optional standard mileage rates.

Understanding the allowable deductions

The Tax Cuts and Jobs Act (TCJA) temporarily suspends all miscellaneous itemized deductions that are subject to the 2% floor, until 2026. The suspension applies to most employees’ miscellaneous itemized deductions for unreimbursed business expenses — including the costs of operating an automobile for business and unreimbursed travel costs.

But self-employed individuals and qualified employees (including Armed Forces reservists, qualifying state or local government officials, educators, and performing artists) are still allowed to deduct unreimbursed expenses during the suspension. The suspension doesn’t preempt the deductions because these taxpayers can claim the expenses “above the line,” or when computing their adjusted gross income (AGI), rather than as itemized, below-the-line deductions. The guidance provides rules for how to do so.

Using the business standard rate

For owned or leased automobiles used for business, taxpayers generally can deduct an amount equal to either:

• The business standard mileage rate (for 2019, 58 cents) multiplied by the number of business miles traveled, or
• The actual fixed and variable costs paid that are attributable to traveling those business miles.

The new guidance provides that eligible taxpayers generally can use the business standard mileage rate instead of actual fixed and variable costs when computing AGI, subject to certain limitations. (For example, you can’t use the business rate for fleet operations of five or more autos.)

If you opt to use the business rate, though, you generally can’t also deduct your costs for items such as depreciation or lease payments, maintenance and repairs, tires, gasoline (including all taxes), oil, insurance, and license and registration fees.

You can, however, deduct parking fees and tolls attributable to business use above the line. Under certain circumstances, you also can deduct interest on the purchase of the automobile and related state and local property taxes. (If the auto isn’t used solely for business purposes, these expenses must be allocated accordingly.)

As for depreciation, taxpayers are required to reduce the basis of an automobile used in business by the greater of the amount of depreciation claimed or allowable. Under the guidance, in any year during which you use the business standard mileage rate, a specified per-mile amount (published annually by the IRS) is treated as both the depreciation claimed and the depreciation allowable.

The guidance also provides that taxpayers with deductible unreimbursed travel expenses can use the business standard mileage rate when calculating their AGI.

Documenting transportation expenses

The new guidance includes rules for documenting — or “substantiating” — the amount of an employee’s ordinary and necessary transportation expenses that an employer, its agent or a third party reimburses using a mileage allowance.

According to the guidance, an employee will be deemed to satisfy the substantiation requirements if he or she actually substantiates to the reimbursing party the time, place (or use) and business purpose of the expense. The amount is considered substantiated simply because the reimbursing party pays a mileage allowance instead of reimbursing the actual transportation expenses the employee incurs or may incur (subject to certain limitations).

Under the revenue procedure, self-employed individuals and qualified employees aren’t required to include in gross income the portion of a mileage allowance received from an employer, its agent or a third party that is less than or equal to the amount deemed substantiated. Assuming other requirements for accountable plans — plans that comply with IRS requirements for reimbursing workers for business expenses in which reimbursement isn’t counted as income — are met, that portion of the allowance isn’t reported as wages or other compensation and is exempt from withholding and payment of employment taxes.

The portion of an allowance that exceeds the substantiated amount, however, must be included in gross income and is treated as paid under a nonaccountable plan. As a result, such amounts are reported as wages or other compensation and subject to employment tax withholding and payment.

Be aware that taxpayers aren’t required to use the method described in the guidance to establish their reimbursed transportation expenses. If you maintain adequate records or other sufficient evidence, you can instead choose to substantiate your actual expense amounts.

The guidance provides additional rules for satisfying the requirements that employees return allowance payments that exceed substantiated amounts. If an employer provides an advance mileage allowance that anticipates more business miles than the employee substantiates, the employee must return a certain portion of the excess, depending on the type of allowance.

FAVR allowances

The revenue procedure also includes guidance on computing fixed and variable rate (FAVR) allowances to establish an employee’s automobile expenses. A FAVR is a mileage allowance that uses a flat rate or stated schedule that combines periodic fixed payments (for items such as depreciation or lease payments, insurance, registration and license fees, and personal property taxes) and variable rate payments (for items such as gasoline and all related taxes, oil, tires, and routine maintenance and repairs).

Employers must base the amount of a FAVR allowance on data that’s derived from the relevant geographic area and reflects retail prices. The data must be reasonable and statistically defensible in approximating the actual expenses an employee would incur as owner of the “standard automobile” (the automobile the payer selects to use as the basis for a specific FAVR allowance).

The guidance provides that the standard automobile cost for a calendar year can’t exceed 95% of the sum of the retail dealer invoice cost for the standard auto in the area and the state and local sales or use taxes on the purchase of the auto. (The IRS publishes the maximum standard auto cost annually.) Its guidance addresses the determination of business use percentage, allowance limitations and the payer’s recordkeeping and reporting obligations.

Effective now

The new IRS guidance is effective for deductible transportation expenses paid or incurred, and mileage allowances or reimbursements paid, on or after November 14, 2019. In addition to business driving expenses, it also addresses the deductible costs of operating a vehicle for charitable, medical or moving purposes. We’d be pleased to answer your questions regarding mileage-rated deductions.

Additional Resources for year-end tax planning:

• Factor 2020 cost-of-living adjustments into your year-end tax planning
• Business year-end tax planning in a TCJA world
• It’s not too late to trim your 2019 tax bill
• Selling securities by year end? Avoid the wash sale rule
• If you are a calendar-year C Corporation, the fourth installment of 2019 estimated income taxes payment must be made by December 16.