COMMENTARY

10 Last-Minute Tax Moves to Reduce Your Financial Hit on April 15

Syed Nishat, BFA

Disclosures

February 18, 2021

Since last summer, my pediatrician client from Nevada had an income drop of more than 50% because parents frightened by the pandemic were too cautious to bring their children in for regular checkups.

I found many government programs available to her — US Small Business Administration loans, the Paycheck Protection Program, and programs through the US Department of Health and Human Services (HHS) — to help her keep her business afloat. And of course, many physicians have made use of similar programs.

Now, almost a year later, and with a combination of small business loans and grants along with the slowly normalizing volume of patients, my client's pediatric office managed to survive. Yet her business is still down about 30% compared with prepandemic levels. My client, as a physician and first responder, has received both doses of the vaccine, and she's not the exception. With time and an expanded rate of vaccination, our country can develop the safety net of herd immunity and businesses may, albeit slowly, come back to full swing.

However, there is a new challenge. Most of my client's HHS grants were received as income, meaning there is a tax bill coming due. Obviously, these grants were very useful at the time to keep her business viable, but the money has been spent and overall revenue is still down. This is not an uncommon side effect; nearly all of my physician clients who received HHS grants are currently facing down the taxes associated with those grants while their income is still not at a prepandemic amount.

Although this sounds grim, there have been some favorable tax changes for small businesses due to the Tax Cuts and Jobs Act of 2017 and the more recently passed Coronavirus Aid, Relief, and Economic Security (CARES) Act in 2020.

Here are some important tax planning tips for small business owners to take advantage of before the 2020 tax filing deadline, with an eye to lessening the taxes incurred during the pandemic.

1. Establish a cash balance plan and 401(k) profit-sharing plan for 2020: The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law in December 2019 and became effective on January 1, 2020. The law extended the deadline for a business to adopt a 401(k) profit-sharing plan or cash balance plan for small business owners. Previously, plans had to have been adopted by December 31 of that year to be eligible for employer contributions. Now it is extended to before the corporate tax filing deadline. For most S corporations, that is March 15, 2021, for the year 2020.

Due to uncertainty about year-end finances as well as the hassle of setting something up so late in the year, many small businesses were hesitant to adopt pension plans. This extension helps small businesses adopt a plan before the tax-filing deadline by allowing them the time to budget accordingly.

As for how a self-employed individual can benefit, a 60 year old who is self-employed can contribute almost $260,000 into a cash balance plan alone or $57,000 into a 401(k) profit-sharing plan; either of these contributions is completely tax-deductible. So, for example, if you are in a 35% tax bracket, you can save almost $91,000 in taxes by contributing to a cash balance plan.

Please note that if you have employees, there may be a contribution requirement for them in both 401(k) profit-sharing and cash balance plans to pass the nondiscrimination testing. Also, unlike a 401(k) plan, a cash balance plan is a defined benefit plan and the contribution amount is not discretionary; it is based on age, employment history, salary history, and legislative interest rate. However, the cash balance plan can be amended to reflect the desired contribution year once you set up the plan.

The ideal candidate for a cash balance plan is small practice with fewer than 30 employees and physicians' practices that have consistent cash flow. To make it cost effective, a cash balance plan is usually combined with a 401(k) profit-sharing plan. You work with a financial advisor and an actuary who design the client's overall plan to lower employee cost and certify the calculations, and complete the Form 5500–filing requirement. 

2. Take a qualified business income deduction: Small businesses can write off 20% of qualified income as a tax deduction, known as the qualified business income (QBI) deduction. This graded deduction starts to lessen when income is more than $315,000; it is unavailable above $415,000. As an example, a business with an income of $100,000 can claim a deduction of $20,000. If a business owner is in the 30% tax bracket, they will save $6000 in taxes.

However, a business with an income of $500,000 will not be allowed a QBI deduction because it is too high to qualify. Also, any small business owners, including hotel owners or physicians, own the property in which they work and pay themselves rent or have a real estate investment. For actively managed rental property, the owner can deduct up to 20% of the rental income as QBI deduction on their taxes. There are rules about qualification for properties as a trade or business that include separately maintained books for each property and a minimum number of hours worked in real estate.

3. Open a simplified employee pension plan individual retirement account (SEP-IRA) and/or IRA: For a straightforward contribution method, individuals can contribute to a traditional IRA before April 15, 2021, as a 2020 contribution. The maximum amount is $6500 ($7000 if the individual is older than 50). Self-employed individuals can contribute to a SEP-IRA before the tax-filing deadline as well. The contribution amount is 25% of the Form W-2 salary/compensation amount or $57,000, whichever is the lesser amount.

Also, in a SEP-IRA, if you have employees who had worked for three of the last 5 years, you have to contribute the same percentage amount as you are contributing for yourself. A 401(k) profit-sharing or cash balance plan may be better alternative if you have a lot of eligible employees in a SEP-IRA.

4. Look into the research and development tax credit: Due to the pandemic, many practices are investing funds into improving technology to streamline their processes or researching new products to introduce to their business model in order to improve overall service and deal with new challenges.

Small practices should speak to their certified personal accountant (CPA) to see if any of their research and development expenses qualify for the research and development tax credit. This doesn't mean a business needs to make a major research breakthrough. The experimentation doesn't even need to succeed to qualify for the credit. What qualifies is systematic evaluation of some aspect of the business and making an attempt to improve reliability and performance within the structure of the business.

5. Consider accelerated bonus depreciation and cost segregation for real estate: For small business owners like physicians and restaurant owners, a cost segregation analysis can be an important tool in a tax-saving strategy. Depreciation reduces tax liability on real estate income.

A cost segregation study can be used to accelerate deprecation from 39 years to as little as 5 or 7 years by separating the aspects of the real estate into pieces, generating significant tax savings in both active and passive income. The Tax Cuts and Job Act of 2017 allows up to a 100% bonus percentage through the tax year 2022. Particularly when income is lower during this time, the tax savings can be invested immediately back into a business.

6. Claim a net operating loss: A net operating loss (NOL) occurs when business activity for a particular year results in an overall net loss, meaning that the business' tax deductions exceed the business' taxable revenue over a given tax period. The recently enacted CARES Act included changes for the 2020 tax period that look at the NOL of a business for a broader range. This change allows for a 5-year carryback period for the time after December 31, 2017, and before January 1, 2021, for a business' NOL.

For example, let's say a physician owns a building for their practice and seeing patients, and there was a NOL of $200,000 in 2020. However, over the past 4 years, there was a taxable income of $50,000 annually from rent. The 2020 NOL of $200,000 can be broken up and applied against the previous years to balance out the income of those past 4 years and reduce the tax liability to break even through amended tax returns.

7. Consider a backdoor Roth IRA: For 2020, an investor can still contribute post-tax money to a traditional IRA account and then immediately convert the account to a Roth IRA by April 15 for year 2020 contribution. For an investor who has hit their maximum contribution into a pension plan, this can be a good strategy for growing money in a tax-free environment.

Although the taxes on the actual contribution have already been paid, once the money is in the Roth IRA, the growth is tax free, as are any withdrawals in the future. One thing to keep in mind, if there is an existing, funded IRA account, the aggregate amount of all pre-tax IRA account balances must be taken into consideration when the post-tax money is converted to a Roth IRA later.

8. Open an IRA account for your child: Do you think your child is too young for a retirement account? There is actually no age restriction for opening a minor's IRA account. A parent can open a custodian IRA account for a child before they're 19 years old to get retirement savings started early.

Keep in mind, the child does need to have some earned income in order to qualify for opening the account. There's no minimum requirement on the income, however; whether a child worked a summer job or is a child celebrity, a parent can open an IRA or Roth IRA account in the child's name by April 15 for year 2020. The maximum contribution for 2020 is $6500 per child, and that's a great way to get started in both financial literacy and saving for retirement.

9. File itemized deductions: Although it may be simpler to take the standard deduction when filing taxes, which is $24,800, a self-employed physician can save a significant amount by itemizing deductions if qualified expenses add up to more than the standard deduction for 2020. Deductions may include a portion of medical expenses, license renewal fees, charitable donations, and mortgage interest, so it can be worth taking the time to do the research into what qualifies throughout the year.

10. Take a home office deduction: For individuals working from home in a space exclusively used for business, amendments to the IRS rules allow self-employed filers to claim this deduction even if they haven't qualified in the past. If an individual qualifies, they can write off any expenses related to the space used, including rent, utilities, and supplies. Although the individual does have to pay taxes on any profit resulting from depreciation claimed for the home office, the portion of the home used as an office is still considered tax free in the profit of the home sale, unlike the way it was treated under previous IRS rules.

Please note that the home office deductions are only for self-employed physicians and not for regular hospital physicians filing a Form W-2 who are working from home. There are also certain criteria that need to be met such as the house as a principal place for business used exclusively to deal with patients or used for inventory for trade goods like medicines.

Some self-employed physicians have changed their business structure to best cope with the pandemic. It's best to speak with your CPA to make sure you can qualify for home office deductions.

This lengthy pandemic has put an incredible strain on many small businesses, although we're finally seeing signs of recovery. It's not unreal to hope that with time, businesses will come back just as strong as they were before. In the meantime, tax planning, as always, is a complex issue, and it can be an additional headache to business owners already struggling with the current conditions. Most importantly, you don't have to do it alone. Speak with a fiduciary financial advisor who can coordinate with CPAs and tax planning attorneys to give you the advice tailored to your unique needs in 2020 and in your future as you aim for success.

Syed Nishat, BFA, is a partner and financial advisor at Wall Street Alliance Group based in New York City.

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