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Small Business Tax Briefs: March 2020
Work Opportunity Tax Credit extended through 2020
If you’re a business owner, be aware that a recent tax law extended a credit for hiring individuals from one or more targeted groups. Employers can qualify for a valuable tax credit known as the Work Opportunity Tax Credit (WOTC).
The WOTC was set to expire on December 31, 2019. But a new law passed late last year extends it through December 31, 2020.
Generally, an employer is eligible for the credit for qualified wages paid to qualified members of these targeted groups: 1) members of families receiving assistance under the Temporary Assistance for Needy Families program, 2) veterans, 3) ex-felons, 4) designated community residents, 5) vocational rehabilitation referrals, 6) summer youth employees, 7) members of families in the Supplemental Nutritional Assistance Program, 8) qualified Supplemental Security Income recipients, 9) long-term family assistance recipients and 10) long-term unemployed individuals.
For each employee, there’s a minimum requirement that the employee has completed at least 120 hours of service for the employer. The credit isn’t available for certain employees who are related to the employer or work more than 50% of the time outside of a trade or business of the employer (for example, a maid working in the employer’s home). Additionally, the credit generally isn’t available for employees who’ve previously worked for the employer.
There are different rules and credit amounts for certain employees. The maximum credit available for the first-year wages is $2,400 for each employee, $4,000 for long-term family assistance recipients, and $4,800, $5,600 or $9,600 for certain veterans. Additionally, for long-term family assistance recipients, there’s a 50% credit for up to $10,000 of second-year wages, resulting in a total maximum credit, over two years, of $9,000.
For summer youth employees, the wages must be paid for services performed during any 90-day period between May 1 and September 15. The maximum WOTC credit available for summer youth employees is $1,200 per employee.
Here are a few other rules:
- No deduction is allowed for the portion of wages equal to the amount of the WOTC determined for the tax year;
- Other employment-related credits are generally reduced with respect to an employee for whom a WOTC is allowed; and
- The credit is subject to the overall limits on the amount of business credits that can be taken in any tax year, but a 1-year carryback and 20-year carryforward of unused business credits is allowed.
Make sure you qualify
Because of these rules, there may be circumstances when the employer might elect not to have the WOTC apply. There are some additional rules that, in limited circumstances, prohibit the credit or require an allocation of it. Contact us with questions or for more information about your situation.
Determine a reasonable salary for a corporate business owner
If you’re the owner of an incorporated business, you probably know that there’s a tax advantage to taking money out of a C corporation as compensation rather than as dividends. The reason is simple. A corporation can deduct the salaries and bonuses that it pays executives, but not its dividend payments. Therefore, if funds are withdrawn as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is taxed only once, to the employee who receives it.
However, there’s a limit on how much money you can take out of the corporation this way. Under tax law, compensation can be deducted only to the extent that it’s reasonable. Any unreasonable portion isn’t deductible and, if paid to a shareholder, may be taxed as if it were a dividend. The IRS is generally more interested in unreasonable compensation payments made to someone “related” to a corporation, such as a shareholder or a member of a shareholder’s family.
How much compensation is reasonable?
There’s no simple formula. The IRS tries to determine the amount that similar companies would pay for comparable services under similar circumstances. Factors that are taken into account include:
- The duties of the employee and the amount of time it takes to perform those duties;
- The employee’s skills and achievements;
- The complexities of the business;
- The gross and net income of the business;
- The employee’s compensation history; and
- The corporation’s salary policy for all its employees.
There are some concrete steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation. For example, you can:
- Use the minutes of the corporation’s board of directors to contemporaneously document the reasons for compensation paid. For example, if compensation is being increased in the current year to make up for earlier years in which it was low, be sure that the minutes reflect this. (Ideally, the minutes for the earlier years should reflect that the compensation paid then was at a reduced rate.)
- Avoid paying compensation in direct proportion to the stock owned by the corporation’s shareholders. This looks too much like a disguised dividend and will probably be treated as such by IRS.
- Keep compensation in line with what similar businesses are paying their executives (and keep whatever evidence you can get of what others are paying to support what you pay).
- If the business is profitable, be sure to pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.
Planning ahead can help avoid problems. Contact us if you’d like to discuss this further.
Small business owners still have time to set up a SEP plan for last year
Do you own a business but haven’t gotten around to setting up a tax-advantaged retirement plan? Fortunately, it’s not too late to establish one and reduce your 2019 tax bill. A Simplified Employee Pension (SEP) can still be set up for 2019, and you can make contributions to it that you can deduct on your 2019 income tax return. Even better, SEPs keep administrative costs low.
Deadlines for contributions
A SEP can be set up as late as the due date (including extensions) of your income tax return for the tax year for which the SEP first applies. That means you can establish a SEP for 2019 in 2020 as long as you do it before your 2019 return filing deadline. You have until the same deadline to make 2019 contributions and still claim a potentially substantial deduction on your 2019 return.
Generally, most other types of retirement plans would have to have been established by December 31, 2019, in order for 2019 contributions to be made (though many of these plans do allow 2019 contributions to be made in 2020).
Contributions are optional
With a SEP, you can decide how much to contribute each year. You aren’t required to make any certain minimum contributions annually.
However, if your business has employees other than you:
- Contributions must be made for all eligible employees using the same percentage of compensation as for yourself, and
- Employee accounts must be immediately 100% vested.
The contributions go into SEP-IRAs established for each eligible employee. As the employer, you’ll get a current income tax deduction for contributions you make on behalf of your employees. Your employees won’t be taxed when the contributions are made, but at a later date when distributions are made — usually in retirement.
For 2019, the maximum contribution that can be made to a SEP-IRA is 25% of compensation (or 20% of self-employed income net of the self-employment tax deduction), subject to a contribution cap of $56,000. (The 2020 cap is $57,000.)
How to proceed
To set up a SEP, you complete and sign the simple Form 5305-SEP (“Simplified Employee Pension — Individual Retirement Accounts Contribution Agreement”). You don’t need to file Form 5305-SEP with the IRS, but you should keep it as part of your permanent tax records. A copy of Form 5305-SEP must be given to each employee covered by the SEP, along with a disclosure statement.
Although there are rules and limits that apply to SEPs beyond what we’ve discussed here, SEPs generally are much simpler to administer than other retirement plans. Contact us with any questions you have about SEPs and to discuss whether it makes sense for you to set one up for 2019 (or 2020).
Coronavirus (COVID-19): Tax relief for small businesses
Businesses across the country are being affected by the coronavirus (COVID-19). Fortunately, Congress recently passed a law that provides at least some relief. In a separate development, the IRS has issued guidance allowing taxpayers to defer any amount of federal income tax payments due on April 15, 2020, until July 15, 2020, without penalties or interest.
On March 18, the Senate passed the House's coronavirus bill, the Families First Coronavirus Response Act. President Trump signed the bill that day. It includes:
- Paid leave benefits to employees,
- Tax credits for employers and self-employed taxpayers, and
- FICA tax relief for employers.
Tax filing and payment extension
In Notice 2020-18, the IRS provides relief for taxpayers with a federal income tax payment due April 15, 2020. The due date for making federal income tax payments usually due April 15, 2020 is postponed to July 15, 2020.
Important: The IRS announced that the 2019 income tax filing deadline will be moved to July 15, 2020 from April 15, 2020, because of COVID-19.
Treasury Department Secretary Steven Mnuchin announced on Twitter, “we are moving Tax Day from April 15 to July 15. All taxpayers and businesses will have this additional time to file and make payments without interest or penalties.”
Previously, the U.S. Treasury Department and the IRS had announced that taxpayers could defer making income tax payments for 2019 and estimated income tax payments for 2020 due April 15 (up to certain amounts) until July 15, 2020. Later, the federal government stated that you also don’t have to file a return by April 15.
Of course, if you’re due a tax refund, you probably want to file as soon as possible so you can receive the refund money. And you can still get an automatic filing extension, to October 15, by filing IRS Form 4868. Contact us with any questions you have about filing your return.
Any amount can be deferred
In Notice 2020-18, the IRS stated: “There is no limitation on the amount of the payment that may be postponed.” (Previously, the IRS had announced dollar limits on the tax deferrals but then made a new announcement on March 21 that taxpayers can postpone payments “regardless of the amount owed.”)
In Notice 2020-18, the due date is postponed only for federal income tax payments for 2019 normally due on April 15, 2020 and federal estimated income tax payments (including estimated payments on self-employment income) due on April 15, 2020 for the 2020 tax year.
As of this writing, the IRS hasn’t provided a payment extension for the payment or deposit of other types of federal tax (including payroll taxes and excise taxes).
This only outlines the basics of the federal tax relief available at the time this was written. New details are coming out daily. Be aware that many states have also announced tax relief related to COVID-19. And Congress is working on more legislation that will provide additional relief, including sending checks to people under a certain income threshold and providing relief to various industries and small businesses.
We’ll keep you updated. In the meantime, contact us with any questions you have about your situation.
The new COVID-19 law provides businesses with more relief
On March 27, President Trump signed into law another coronavirus (COVID-19) law, which provides extensive relief for businesses and employers. Here are some of the tax-related provisions in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
Employee retention credit
The new law provides a refundable payroll tax credit for 50% of wages paid by eligible employers to certain employees during the COVID-19 crisis.
Employer eligibility. The credit is available to employers with operations that have been fully or partially suspended as a result of a government order limiting commerce, travel or group meetings. The credit is also provided to employers that have experienced a greater than 50% reduction in quarterly receipts, measured on a year-over-year basis.
The credit isn’t available to employers receiving Small Business Interruption Loans under the new law.
Wage eligibility. For employers with an average of 100 or fewer full-time employees in 2019, all employee wages are eligible, regardless of whether an employee is furloughed. For employers with more than 100 full-time employees last year, only the wages of furloughed employees or those with reduced hours as a result of closure or reduced gross receipts are eligible for the credit.
No credit is available with respect to an employee for whom the employer claims a Work Opportunity Tax Credit.
The term “wages” includes health benefits and is capped at the first $10,000 paid by an employer to an eligible employee. The credit applies to wages paid after March 12, 2020 and before January 1, 2021.
The IRS has authority to advance payments to eligible employers and to waive penalties for employers who don’t deposit applicable payroll taxes in anticipation of receiving the credit.
Payroll and self-employment tax payment delay
Employers must withhold Social Security taxes from wages paid to employees. Self-employed individuals are subject to self-employment tax.
The CARES Act allows eligible taxpayers to defer paying the employer portion of Social Security taxes through December 31, 2020. Instead, employers can pay 50% of the amounts by December 31, 2021 and the remaining 50% by December 31, 2022.
Self-employed people receive similar relief under the law.
Temporary repeal of taxable income limit for NOLs
Currently, the net operating loss (NOL) deduction is equal to the lesser of 1) the aggregate of the NOL carryovers and NOL carrybacks, or 2) 80% of taxable income computed without regard to the deduction allowed. In other words, NOLs are generally subject to a taxable-income limit and can’t fully offset income.
The CARES Act temporarily removes the taxable income limit to allow an NOL to fully offset income. The new law also modifies the rules related to NOL carrybacks.
Interest expense deduction temporarily increased
The Tax Cuts and Jobs Act (TCJA) generally limited the amount of business interest allowed as a deduction to 30% of adjusted taxable income.
The CARES Act temporarily and retroactively increases the limit on the deductibility of interest expense from 30% to 50% for tax years beginning in 2019 and 2020. There are special rules for partnerships.
Bonus depreciation for qualified improvement property
The TCJA amended the tax code to allow 100% additional first-year bonus depreciation deductions for certain qualified property. The TCJA eliminated definitions for 1) qualified leasehold improvement property, 2) qualified restaurant property, and 3) qualified retail improvement property. It replaced them with one category called qualified improvement property (QIP). A general 15-year recovery period was intended to have been provided for QIP. However, that period failed to be reflected in the language of the TCJA. Therefore, under the TCJA, QIP falls into the 39-year recovery period for nonresidential rental property, making it ineligible for 100% bonus depreciation.
The CARES Act provides a technical correction to the TCJA, and specifically designates QIP as 15-year property for depreciation purposes. This makes QIP eligible for 100% bonus depreciation. The provision is effective for property placed in service after December 31, 2017.
Careful planning required
This article only explains some of the relief available to businesses. Additional relief is provided to individuals. Be aware that other rules and limits may apply to the tax breaks described here. Contact us if you have questions about your situation.