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Income Tax Planning When Tax Provisions Keep Changing

The Tax Cuts and Jobs Act of 2017 (TCJA) brought in the most sweeping changes in federal tax law in recent history. It was followed by the CARES Act, which reversed some TCJA provisions and added new tax planning opportunities.

At the end of 2021, some of these provisions are set to expire. It is still unclear if tax legislation in future spending bills will reinstate or alter these expiring provisions. What we do know is that income tax planning will be very important going forward. Do not assume that the tax opportunities of last year are still available. Do not rule out new opportunities to explore.

Pending their future reinstatement or revision, here are the tax provisions set to expire on December 31, 2021. This means that they will not be available for the 2021 tax year:

  • Net Operating Loss Carrybacks (NOLs) – The CARES Act reinstated this provision for the 2020 tax year, but it is not available for losses arising in the 2021 tax year.
  • Excess Business Loss Limitation – This provision is capped for 2021 at $250,000 if filing single and up to $500,000 for joint filers, adjusted for inflation. The CARES Act only provided a one-year lifting of the cap.
  • Section 471 Exemption – The TCJA allowed small businesses (less than $25M in annual revenue) to be exempt from Sec. 471 which requires businesses to capitalize inventory. This allowed small business taxpayers to deduct inventory as incidental materials and supplies when purchased as opposed to when it was used/sold. In 2021, the Treasury department issued some final regulations (T.D. 9942) that removed this exemption, and small business taxpayers who elected to deduct their inventory for tax purposes now need to change their accounting methods to bring inventory back onto their tax basis balance sheet. This will likely result in an increase in taxable income.

Tax Provisions Still in Play for Now

Income tax planning opportunities for 2021 through the 2025 tax year (when more TCJA tax provisions expire) include the following:

  • State and Local Tax Deduction (SALT) – It is not clear if new legislation will raise the federal cap of $10,000 even though the House has proposed a spending bill to raise the cap to $80,000 and support businesses in highly taxed states. For now, business owners may take a pass-through deduction at the state level in many states.

Check your state’s laws before planning on this opportunity. For example, Colorado has the SALT Parity Act, which allows pass-through entities (PTEs) such as partnerships and S corporations to elect to pay Colorado income taxes on behalf of the owners at the entity level. To achieve this, the PTE must make an annual election, which is available for tax years beginning in 2022 and until the federal cap is no longer in place. This election may impact the Sec. 199A Qualified Business Income deduction, so it may not be for everyone.

  • Standard deduction and personal exemption – The repeal of the personal exemption and the expanded standard deduction put in place by the TCJA will sunset at the end of 2025. For the majority of taxpayers, this law change has eliminated the need to itemize deductions, however, taxpayers should still maintain receipts and plan for the expiration of this tax provision.

Other Tax Planning Considerations

Legislation is in play that will give the IRS an expanded budget to focus on enforcement. Although it can be difficult to communicate with the IRS for resolution of tax issues in favor of the taxpayer, you can expect that any taxes owed to the federal government will be prioritized and pursued by the agency.

There are at least three special enforcement areas that taxpayers should be aware of in their planning and tax preparation:

  • Filing of 1099s – the IRS favors W2 employees and will place more attention on proper classification and tax reporting for contractors.
  • Reporting basis and ownership on tax returns – Partnerships and LLCs do this and the IRS is pushing for this reporting for S Corps.
  • Nexus and apportionment – States are lowering the thresholds of what constitutes doing business in their state to collect a greater share of business taxes.

With more changes ahead on the tax horizon, work with your CPA to identify new tax opportunities while phasing out the expiring provisions from your strategy. Talk to us at WhippleWood with your questions.

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