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Here's What You Need to Know to Tax Plan in 2020

PostedMonday, December 14,2020 at 11:54 AM

Here's What You Need to  Know to Tax Plan in 2020
Photo by Amol Tyagi on Unsplash

On December 10,2020, Talking Industrial Automation Host Lisa Richter talked with Tim Finerty, a shareholder with Clayton and McKervey to find out what pitfalls and opportunities business owners should know about to ensure maximum cash flow and minimum taxes before the end of the year.

Here is a transcript of the episode. You can listen to the episode here.

Lisa Richter: Welcome to Talking Industrial Automation, a podcast where you get to know the people who make modern industrial automation possible. In today’s episode, we’re doing something a little different by covering a topic that we wouldn’t normally get into --  taxes. I know, I know. It’s not everyone’s cup of tea. But with so much that happened in 2020 that impacted businesses like the CARES Act and Paycheck Protection Program, we felt it was worth spending a little time delving into the implications and obligations as we army crawl over the 2020 finish line.

With me today to help us do that is Tim Finerty, a shareholder with Clayton and McKervey, a tax and advisory firm in Southfield, Michigan, which is focused on growth-oriented, entrepreneurial businesses. Tim heads up the company’s industrial automation sector. Tim, welcome to the podcast.

Tim Finerty: Thanks for having me, Lisa.

Lisa Richter: To get started, help me understand why it is so important for business owners and their financial teams to tax plan in 2020 compared to maybe another year.

Tim Finerty: Lisa, that’s a great question. It’s really important this year because there are so many different things that are out there. We started with a few years ago the Tax Cuts and Jobs Acts of 2017. The CARES Act was put into place this year, which you mentioned a little bit had to do with the Paycheck Protection Program and then there are some different things within that PPP program that relates to the loan forgiveness, taxability, deductibility and maybe how that impacts the R and D credits as well.

Then we have currently a proposed new stimulus bill that could have a few things that we probably need to touch on and then finally we probably want to dive in and understand what might be coming down that pipeline under the Biden tax plan.

Lisa Richter: OK. So, let’s tackle some of that. What do people need to know about the CARES Act?

Tim Finerty: Well, so the CARES Act, a lot of people know that PPP loans were part of that. But there’s a few things that really stick out that people need to better understand what’s in there.

One of the things that they did was they did a 5-year NOL carryback. The NOL is net operating losses. So, if you created some sort of net operating loss in the current year, you could potentially carry it back five years.

They also made a change to allow for a 15-year property that was previously under the Tax Cuts and Jobs Act that you couldn’t take bonus depreciation at.

So now people are doing leasehold improvements or different things like that. They could potentially take 100 percent of that bonus depreciation, which then gets back a little bit to the net operating losses.

Then they got rid of another item that was caused by the Tax Cuts and Jobs Act, which is the business loss limitation. So before, if a business created a loss of a $1 million and, for some reason had – owners took $750,000 in income, they could only offset $500,000 of that loss. So, they would still be paying some tax on their losses. So, there was a limitation that then got rid of.

Lisa Richter: Tell me more about the impact of net operating loss carrybacks.

Tim Finerty: Mentioned just before, right? The five-year carryback. It’s really an interesting opportunity for a lot of businesses. Under the Tax Cuts and Jobs Act of 2017, there’s a few things that happened, which was the 100 percent bonus depreciation.

So, if you’re thinking about buying a piece of new equipment, anything like that that will help you – help the company be more successful in the future, it could be an awesome time to try to get that done before the end of the year where you could take 100 percent bonus appreciation.

So, for example let’s say we wanted to buy a $500,000 piece of equipment. We could take that entire $500,000 as depreciation against our income and then also in that Tax Cuts and Jobs Act for any companies under $25 million in revenue, you can potentially, if you haven’t already done it, change from an accrual basis taxpayer to a cash basis taxpayer.

With that, you could potentially create additional deductions that are out there to create an NOL. So, for example if I had a $1 million of book income to start with, I bought this piece of equipment. I could depreciate it $500,000. So, I would be at $500,000 of income. But if I did that accrual to cash adjustment, let’s just say I had a $1.5 million accrual to cash adjustment, meaning that I had a ton of receivables compared to where my payables were and offset that, therefore I creates a $1 million tax loss in this scenario that I just gave.

I could take that $1 million, take it back 5 years to a year. Maybe I was profitable and paid at the highest tax level and asked for that money back.

So really creates a huge opportunity if we’re doing some tax planning to understand why we would want to do that.

Lisa Richter: If a company creates net operating losses for 2020, why should they care about R and D credit?

Tim Finerty: A couple of things there. So, for example on the last example I gave, if I was able to carry back that loss, that means in the current year, I wasn’t going to be – I didn’t have a loss or I didn’t have any income. So, I wouldn’t be able to use my R and D credits.

However, the R and D credits are automatically carried back one year. So, if 2019 was a good year, I could carry back those credits and use them to offset taxes that I already paid.

So now I’m kind of double dipping, which is an awesome cash flow idea, and when you file your 2020 return and you do this automatic carryback, the cash coming back gets back to you much quicker. Then the other thing is, so this NOL that we talked about briefly before doesn’t always impact – some of these things some of these things don’t always impact the states.

So, you might have some state taxes. But about 35 of the states have research and development tax credits and some of those states also have refundable credits.

You really need to look at it and figure out what makes the most sense.

Lisa Richter: So, you mentioned that some states have R and D credits that are refundable. Can you tell me a little bit more about that?

Tim Finerty: So different states really look at what you’re doing from a research and development credit. I will take an example that we recently did is Arizona. So, Arizona has got a nice refundable credit. Basically, if you calculate your federal credit and say it was $200,000, you’re going to effectively get about a $200,000 Arizona tax credit.

Well, the state income tax isn’t as high as the federal income tax. So, you may not use all of it and you would have a lot carried over. Well, in that situation, there are opportunities to say, OK, let’s manage one year that we want a refundable. Next year we want to use it against our tax and then carry it forward for future because what you want to do long term too is really plan out how you’re going to use some of these credits and these credits can also be used on sale.

So, when you sell the company or have a big thing, you can use any unused credits against your federal tax liabilities and your state tax liabilities during those years.

Lisa Richter: Knowing my audience, which is a bunch of engineers, they like to really DIY stuff, right? They like to get on YouTube or figure out how to do stuff themselves. Is this tax planning something they should try and do on their own or do you feel like it’s a topic that’s just too complicated or there are too many nuances to really be able to recommend that?

Tim Finerty: I can’t even do it on my own! I have a team of 70 people in our office, and I must go to certain ones for certain things because I can’t be an expert in everything. So yes, it is very important I think to make sure that you’re looking at these opportunities because every opportunity right now is a cash savings opportunity to put more money in your pocket.

I think a lot of business owners have found out that with this pandemic, you just never know what happens in a year, and cash is king. So, if you’re doing some of these things that you can set out now to really be better in the future or to keep more cash in the business to reinvest and do other things, it really makes it a huge opportunity to plan. I mean there’s a lot of different ways to do it and so yes, I would say that you want to talk to your current tax provider to go through some of these things.

But in certain issues like when you’re talking about R and D tax credits, it’s hard to – if you’re using a tax firm or some other things, really it’s both parties have to get together to understand how it’s going to impact and I think that’s where – you know, one of the benefits that we’ve tried to do and one of the reasons we put in a focus on the R and D credits is to truly understand and see the impact of what it is to the system integrators, right?

Trying to have them be able to go to a one-stop shop of just being able to say OK, if I call Tim, he’s going to help me with these different things. One of the big items right now that we just kind of were talking about is the Paycheck Protection Program. The loan forgiveness right now is the expenses against that loan forgiveness. If you feel like you’re going to get the loan forgiveness under the current way that the code is written are not deductible.

So, you’re going to pick up additional income for that. A lot of the things too that could cause some problems there is if you’re using – if you’ve been taking an R and D credit and most of your wages are engineering wages and you’re using this paycheck protection; those wages potentially won’t qualify.

But under the new scenario where you got the option to take 8 weeks or 24 weeks, you may be able to look at how we’re applying wages. So, you could use wages that are not for certain people that are doing research credits. So, you don’t reduce your research credit in that situation.

Lisa Richter: What are some other key year-end planning matters people should think about?

Tim Finerty: We’ve just talked about the PPP loan, which is a huge loan. I think that the other big thing is, you know, for some of my smaller clients depending on what’s happening with total wages that they have and income, you want to look at how do I maximize by QBI, which is my qualified business income because what that does is if I give myself – if I’m a flow-through entity and I give myself a $1 million salary let’s just say, I’m going to pay at 37 percent on that salary.

Well, if I was able to – really my salary should be about $250,000 and the rest of the income flowing through is just income from the activity, that $750,000 can be applied against QBI if it hits the qualifications and reduces your tax rate from like 37 percent down to 30 percent. So, you really want to look at how to maximize your QBI. So that’s one thing.

Individually, there are a few things that I think are important that people need to look at. Some of these owners or different things. Maybe there’s a reason that – to take out some money up to $100,000 in your retirement fund. There’s no – under the CARES Act basically, they eliminated the early distribution penalties on that, and you have up to three years to pay the tax on it. But you potentially could put the money back [0:14:27] [Indiscernible]. So, then you wouldn’t have any tax.

So that’s a nice little potential. If you put away some good money but you want to have access to it without having to pay that 10 percent penalty, there’s an opportunity for owners to look at something like that.

Charitable contributions, you know, sometimes it was limited to the 60 percent of your total income. If for some reason you had an event and you really want to put a lot more away or something like that, you could start a donor-advised fund that money would go in there and then you could put it out to certain charities in the future. But it could really save some taxes right now if you had the cash and wanted to give to charity at this time. I have a couple of clients that had some transactions that they’re taking advantage of. You know, now got rid of not having to look at where your adjusted gross income is that it limits it on that.

So that’s one thing. Another interesting one that’s out there that really hasn’t had a whole lot to talk about is this employer education payment. If I was going to give bonuses to some of my employees but a lot of them had student loans or different things like that, I could give a non-taxable bonus for these employee education payments for $5250 per employee.

So, if I got a $10,000 bonus, I could take $5000 of it and just use it, give it to an employee that they could pay down student loan debt without having to pay tax on it.

So, it’s a nice little benefit that create and get rid of some of the student loans on there. So those are kind of the big things, other additional planning things that we would suggest looking at.

Lisa Richter: You talked about the R and D credit a lot. But why should a company file timely every year?

Tim Finerty: Yes. So, there’s a couple of reasons why. So, there’s – under the R and D credit scenario when you look at it, there are two different methods that are out there. There’s the regular credit method and there’s the alternative simplified credit method.

If you do it timely each year, you can take advantage of either one of them. What I mean by that is as you’re going through it and you do the calculation, it could change year to year based off of what qualifies and what doesn’t qualify, of which method is better to use.

For example, we had a client this past year that we had taken the regular credit in a previous year and then we kind of passed on doing the credits for three years. We made the election to do it.

But under that scenario, we weren’t able – one of the years, we would have created more credit under the alternative simplified method. In this case, it didn’t cost that much. But it could be significant when you’re looking at it.

So, you want to do that. Plus, the nice thing about doing credits each year is that you’re not doing amended returns, which sometimes then open up more opportunities. But a lot of times too is the state credits. A lot of people forget about the state credits. Sometimes you don’t pay as much in federal. You’re portioning out different things to the state.

So, you want to keep those state credits out there and I just think it’s a much easier plan to get it done on an annual basis.

Lisa Richter: Finally, let’s talk about President-Elect Biden’s tax plan. What could we expect?

Tim Finerty: He has put out kind of some different things that have I think made some of our entrepreneurs a little nervous of what could happen in the future. So, I will briefly go through that and then maybe give my opinion on where I think certain things might be.

You know, he wants to take the corporate tax rate, which is at 21 percent right now to 28 percent and, I believe the way that it’s worded is it imposed a minimum tax of 15 percent on any corporations with more than $100 million in book profits.

Now not many of the CSIA clients are going to be at that amount. But I think that eliminates, meaning that if you were able to take your federal tax down below that 15 percent for – you know, because you had R and D credits or different things, potentially you would still have to pay at that 15 percent level.

But one of the big things that he’s doing and exactly what – how it’s going to be calculated, if it’s on W-2 or if it’s on flow-through income. We’re not exactly sure. But he’s planning on imposing a 12.4 percent Social Security payroll tax on income earned over $400,000.

So right now, you basically cap out of your Social Security at like $135,000. So, what he’s proposing is if you got income over $400,000, you’re going to now have to pay again at that 12.4 percent. Basically, pay that 12.4 percent up to $135,000 and then you just pay the Medicare, which is another 2.9 percent and really this is both the employer portion and the employee portion.

Employers, if they had people that made over $400,000, are then going to be required I believe potentially to pay a little bit more on their side as well.

So that’s one thing that we have to look at and then also he’s planning on repealing that 20 percent QBI, like qualified business income deduction for owners on the pass-through entities.

He’s planning on increasing the top individual tax rates from 37 percent back up to 39.6. Now a few of the things that we think he might be doing is for some of the larger states like New York or California, they put limitations on your state income tax and property tax limitation at $10,000 that – well, for everybody. But they were impacted more.

He may be getting rid of that. It may be somewhat of a wash at that level. But again, that QBI is that key thing that’s getting eliminated. Then another big item is he’s talking about eliminating the capital gain tax at the 20 percent rate up to – to go back to 39.6 rate, the highest tax individual rate on any capital gains over a $1 million.

You know, what then happens there is for some of the companies that are looking at a potential sale down the road, if that sale is going to be over a $1 million, you may be paying at normal ordinary income rates. So, you’re paying at 40 percent on the $1 million that you had. So, you’re taking home half of – you’re paying 100 percent more tax than what you did previously on some of that. So, a few of my clients were looking at, “Oh, should I try to sell my company this year if we’re getting close? How do I do that? Should I get out of some of my long-term portfolio, take capital gains there?”

You know, some of that stuff is – the question is when this is going to get impacted by Biden and we’re not completely sure. I think if we hope that Georgia retains at least one seat in the Senate as Republican, he’s going to have a tough time passing a tax plan at least for 2 years. So that’s a good thing.

The other big item that a lot of people don’t think about because it only happens upon an individual’s death is, he’s looking at eliminating the step-up in basis on inherited property.

So, for example, if your company that you have is valued at – the basis in it is let’s just say $100,000. If upon your death, you die, you get a valuation and the company’s basis now is $5 million, you don’t – you get a step-up in basis and wouldn’t have to pay tax on that difference. You would sell it; you would have to pay tax. So that inherited step-up in basis is a huge item for gifting and estate planning.

So, it’s something that if he eliminates it, it really is – a lot of people are going to have bigger tax bills upon death. Then he’s also thinking about reducing the current estate tax gifting which is really over $11 million per individual or about $23 million with inflation for spouses and with – including your spouse.

So, he’s thinking about taking it down to about $7 million. So, it totally changed who’s impacted by it and then more estate planning. I think one of the biggest things I continue to hear on the news and different things like that is like estate planning attorneys have been like busier than ever getting things drafted up just in case he’s going to have the ability to do it.

You know, right now he still can’t because of the Republican Senate. They’re not going to push it. But if something changed in Georgia come January 5, you could see a lot of activity that potentially is going to happen with that.

I think he has got – in my opinion, he has got a lot of other things on his mind. You know, I mean we’re still in COVID. There are still some different things there. So, I think that’s more pressing than some other stuff.

Lisa Richter: Anything to share with business owners before 2020 wraps up?

Tim Finerty: Yeah. I think there’s a couple of things I forgot to hit on and I think a couple of final points as well. You know, right now there is a proposed new stimulus bill that’s in – that hopefully will get passed before the end of the year. In that we believe – we still haven’t seen all the details. But in that is allowing a deductibility of those expenses against the PPP loan.

So, it wouldn’t be picked up in the income. They would be deductible. So, you wouldn’t be picking – so saying you had a $1 million of a PPP loan. That $1 million wouldn’t get picked up in the income. It would basically be flat.

So again, it makes it very difficult for tax planning because if I don’t have that $1 million and I don’t have any issues with how it’s handled, the R and D or different things like that, I may be able to yeah, create some losses that we talked about earlier by switching from accrual base to cash base, buying some equipment or different things like that, to take the depreciation, and then be able to carry back and give more cash.

So that I think over like the last 3 or 4 years, it has been very difficult to truly tax plan because we’re getting all this legislation toward the end of the year. So, it really is still very important to have those conversations, to at least be equipped and say, OK, maybe let’s make this decision, let’s make that decision. We don’t want to make any decisions that are going to impact owners the wrong way. But if we lay different things out, you have more scenarios to try to figure out what makes the most sense to be able to best consult with your clients.

So, I guess the last thing I would say is, as you mentioned, it’s December 10 today. You really have most likely until the end of the year, right? Because there’s not a whole lot you can do after the end of the year. But take some – take a few moments to at least think about what maybe you could do and really if you need to, reach out to your current tax advisers. We would be happy to have discussions with you as well, pointing you in the right direction.

But there are huge opportunities to really help try to generate additional cash in your business so that you can reinvest that and continue to grow and hopefully get past this pandemic that we’re in and have a successful 2021.

Lisa Richter: Well, that’s it for today’s episode of Talking Industrial Automation. If you’re interested in learning more about Tim Finerty or Clayton and McKervey, you can find them on the Industrial Automation Exchange at www.csiaexchange.com. Thanks for listening and thank you Tim for joining me today.

Tim Finerty: Thanks for having me.