If you’re a small-business owner, don’t overlook tax breaks that could help this year—whether your business is on the ropes or is booming.
Either way, harried owners who have focused mainly on the Paycheck Protection Program and payroll tax deferrals allowed this year may be unaware of other provisions that could aid them. Several were prompted by the pandemic, while others are longstanding but newly relevant.
“Tax strategies aren’t top of mind during a crisis, but they make a difference. Some of them provide cash that many owners need,” says Bill Smith, an attorney who leads CBIZ MHM’s national tax office. One allows owners to sell stock in smaller companies tax-free.
Claim 2020 losses on 2019 tax returns. Section 165(i) of the tax code lets individuals and businesses claim some losses on last year’s tax return if a federal disaster has been declared. The intent is to get cash to victims as soon as possible.
Disaster declarations are usually for events like hurricanes or earthquakes, but this year the pandemic qualifies. For example, a restaurant owner who had a good year in 2019 might be able to deduct 2020 pandemic expenses for food spoilage on the 2019 tax return and reduce taxes owed or get a refund. Alternately, these losses can be claimed on 2020 returns, which are due as late as Oct. 15, 2021.
Not all pandemic costs are deductible, and it’s not clear which ones qualify because the pandemic differs from other disasters. Write-offs may need to be for “casualty” losses as defined by the tax code, which typically requires them to be both sudden and caused by the disaster.
Valrie Chambers, a CPA who studies casualty losses and teaches at Stetson University, thinks that a revenue drop for a restaurant due to capacity limits wouldn’t count. She thinks that added costs for deep-cleaning or a payment to get out of a lease because of the pandemic could count.
The Internal Revenue Service hasn’t issued guidance on pandemic disaster losses, but a spokesman says the agency is aware of the issues.
Next year, carry 2020 losses back up to 5 years. The 2017 tax overhaul ended the ability of many firms to use current operating losses to offset prior-years’ taxes, but this spring’s Cares Act allows a five-year carryback of net losses for 2018, 2019, and 2020. It also removed other restrictions on their use, making this provision highly valuable to some taxpayers.
The expanded carryback benefit can be used both by corporations, including S corporations and by owners of pass-through entities such as partnerships.
Switch to cash accounting to defer taxes. The 2017 overhaul allowed firms averaging less than a certain amount of revenue over three years to use “cash accounting” rather than “accrual accounting.” This means they won’t owe the IRS until customers pay, rather than owing when the customers commit to pay.
Mr. Smith says that this year some smaller firms have seen revenues drop enough to lower their average below the current $26 million thresholds for several years going forward, enabling them to switch to cash accounting.
Get generous treatment for losses from failed businesses. Tax code section 1244 provides a benefit for some failed businesses that are often overlooked, says Dr. Chambers. Certain owners who sell can use up to $50,000 of net losses—$100,000 for a married couple filing jointly—to offset current or future ordinary income such as wages.
Without this provision, the losses would count as capital losses that only offset capital gains, plus $3,000 of ordinary income a year. Such losses could take a long time to use.
The requirements to claim this break apply to many investors in small firms. The business must be organized as a C or S Corporation, not a partnership, and the break often doesn’t apply if more than $1 million in capital was invested at the firm’s outset. It can only be used by original investors, not subsequent ones.
Sell a business, tax-free. Owners who sell at a profit have a terrific opportunity if they can use code section 1202. In that case, some or even all of the gains on the sale may be tax-free.
To be eligible, the business must be a C corporation, and the seller must have held the stock in it for more than five years. The business can’t have had more than $50 million in assets when it was started. If the conditions are met, says Mr. Smith, the owners can often eliminate capital-gains tax on at least $10 million of profits on their sale, and sometimes far more.