Carry back provisions that allow deductions for losses all the way back to 2013 provides new tax relief
ENTREPRENEUR LEADERSHIP NETWORK WRITER
Partner at Plante Moran
Ideally, companies would have taken a pro-active approach during good times, testing their tax situation against an imaginary downturn and taking steps to minimize any potential future pain.
But even businesses that had prepared less well still have a lot of options to reduce their tax burden quickly, especially now that they have greater visibility into their operations for 2020.
Related: The 5 Best Tax and Financial Franchises You Can Open This Year
For most businesses, the first strategy should be to sniff out any losses in order to maximize tax refunds and get cash in hand. Their scope for doing so has been boosted by the CARES Act, which allows businesses to carry back net operating losses from 2018, 2019, and 2020 tax years to the 5 previous years. This reverses a provision in the 2017 tax reform bill that had ended companies’ ability to carry back losses.
This is very good news for businesses during these tough COVID-19 times. An added bonus is that tax rates were higher in many of those earlier tax years, so you can get more cashback.
To decide on strategies based on these new provisions, businesses will need to weigh how quickly they need cash versus maximizing their overall benefit.
For companies that were profitable in 2019 and now need cash fast, it may have made sense to take extra deductions in 2019. But if, for example, you expect a loss in 2020 and are not in as much of a hurry for cash, there are options to achieve savings that could be substantially larger.
Related: Tax Lawyers Answer Your Questions About How to Access Your Retirement Account Funds Now
The deductions could be pushed into 2020 and that year’s losses can be carried back to 2015 or later years when the maximum corporate tax rate was 35 percent compared to 21 percent now and the maximum individual tax rate was 39.6 percent compared to as low as 29.6 percent now.
The urgency of your cash needs should be an important part of the tax strategy. Following are tax steps that business should consider to maximize their losses and deductions.
1. Harvesting losses
Find and harvest losses on property or equipment. Examples might include real estate whose value has declined, obsolete inventory that you haven’t deducted for tax purposes, or receivables that may be worth less than what you’re owed. The potential drawback here is this may require physically disposing of the assets rather than just checking a different box on your tax form. That could mean throwing them out, selling them, or perhaps selling them and leasing them back if they’re still required by the business. If losses are directly related to the coronavirus pandemic, an election may be available to deduct these losses in 2019 instead of 2020.
2. Cost segregation study
This is a way of accelerating depreciation on real estate assets. In contrast to the standard depreciation over 27.5 or 39 years, a cost segregation study identifies and reclassifies property so you can claim depreciation over a much shorter period. It can also be used to identify assets eligible for bonus depreciation under which up to 100% of an asset’s cost can be deducted immediately. This more aggressive strategy helps ensure you aren’t stuck with excess depreciation in later years when you can’t utilize any more deductions.
3. Real property improvements
The CARES Act opened up another depreciation opportunity for companies – qualified improvement property. Businesses can now go back to 2018 and take a 100 percent depreciation on any work done to improve interior spaces of non-residential buildings, with a few exceptions. Under the 2017 tax law, the depreciation could only be taken over 39 years.
4. Fixed asset scrubbing
Similar to a cost segregation study, it’s worth sifting through other depreciable assets to make sure that you’ve maximized your depreciation over the years. Maybe you were eligible for 100% bonus depreciation on an item but only took 50% or didn’t claim it at all. Maybe you were depreciating over a 10-year life when it could have been seven. Maybe some assets were actually disposed of in prior years but never got deducted on the tax return. Small changes in depreciation like this across a broad range of assets can add up to big tax dollars.
5. Tax accounting methods
There are a lot of rules surrounding the proper timing of assets and liabilities. Opportunities often exist to accelerate these deductions. This includes the cash method of accounting, prepaid expenses, compensation accruals, payroll taxes, property taxes, employee medical expenses, advance payments, and software development costs, among others. In many cases, deductions may be available even if amounts are accounted for differently on the business’s books. This can be a complicated area for tax planning because each item may have a different set of rules that applies to it. However, that also makes it more likely for there to be hidden opportunities as well.
Not all of these strategies will be relevant or worthwhile for every business. For businesses still profitable in this environment, the aim of tax planning may be to build up a war-chest to take advantage of opportunities that emerge. For those that are struggling, it will be more about getting cash in hand as quickly as possible.
Whatever the goal, existing tax laws combined with any coronavirus stimulus you might have received provide a lot of options to ease the pain from the economic shutdown.
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