COVID-19 Tax Considerations for Business Owners
COVID-19 continues to have a wide-ranging impact on business, our economy, and our everyday lives. But what about your taxes? Temporary changes under the CARES and SECURE Acts, regulatory changes by the Fed, and deadline extensions have thrown a wrench in what we have come to expect from a tax-planning perspective. But, 2020 has been full of enough surprises, so we want to arm our business owners with the information they need to put together an effective 2020 tax filing strategy.
Here’s what you need to know about the most common COVID-19 tax concerns:
1. Penalty Free 401 (K) Withdrawal Tax Schedule:
Under section 2202 of the CARES Act, individuals are eligible to withdraw up to $100,000 of coronavirus-related distributions from eligible retirement plans (certain employer retirement plans, such as section 401(k) and 403(b) plans, and IRAs) without incurring the 10% early withdrawal fee that typically applies until December 30, 2020. This section also temporarily increases the limit on the amount a qualified individual may borrow from an eligible retirement plan (not including an IRA).
So when will you owe taxes on these funds? If you take a coronavirus-related distribution from an eligible retirement plan between January 1, 2020, and December 30, 2020, up to an aggregate limit of $100,000 from all plans and IRAs, you will have three years to pay taxes on these funds starting with the year which you receive your distribution.
For example, if you withdraw $12,000 in 2020, you will report $4,000 in income on your federal income tax return for each of 2020, 2021, and 2022. However, you have the option of including the entire distribution in your income for the year of the distribution. Consult with your financial advisor and tax professional to choose the most tax-efficient split.
2. Eligible Tax Deductions on PPP Relief Funds:
The intention of the CARES Act was to allow small businesses receiving PPP loans to receive the benefit of their deductions for ordinary business expenses. However, there has been quite a bit of confusion around whether the funds qualify as tax-free grants (if/when the loans are forgiven) or as tax-free income.
Here’s why it matters. The tax code normally disallows deductions associated with tax-free income. So, if the loan has yet to be forgiven, can expenses paid with the funds be deducted? As of November 18th, the federal government said “no,” ruling that expenses such as payroll and rent paid for with PPP funds cannot be deducted a business expenses.
This is frustrating for business owners who saw these funds as a government grant and used PPP money to replace lost revenue and payroll expenses that they normally would have been able to deduct from their taxable income. The result is a greater tax exposure than many businesses weren’t expecting.
For now, the treatment of PPP funds is still up in the air and depends largely on whether or not Trump will overturn or sustain the ruling before he leaves office.
3. CARES Act Tax Benefit for Charitable Contributions:
With the 2020 holiday season in full swing, you may have ramped up your giving efforts. While donating to charities is likely a foundation of your core values, it can also be an important, strategic way to lower your tax obligation.
This year, thanks to the CARES Act, filers are eligible to take a $300 above-the-line charitable giving deduction, but only for those taking the standard deduction. If you itemize, you are not eligible to claim this offer.
Why is this significant? Because historically, anyone taking a standard deduction has not been able to reduce their adjusted gross income (AGI) with charitable contributions. Keep in mind, the funds must be donated to qualified organizations as outlined in the IRS tax code.
This change gives you an opportunity to lower your AGI without needing to itemize deductions. It also incentivizes Americans to give charitably this season, which is especially important at a time when so many people and organizations are in need.
4. State Tax Implications of Remote Workers:
As the pandemic swept our nation, many employees were quickly forced to begin working from home. For many (especially those in smaller states who may have crossed state lines along their commute), the work from home model resulted in the individual working from a state other than the one where their office was geographically located.
Under normal circumstances, businesses with largely mobile workforces would have to carefully track reporting and payment obligations to remain tax compliant with government and state laws. However, urgency and a longer-than-expected quarantine period resulted in very lackadaisical enforcement of such legislation. Some states announced relief from certain obligations, but it has been on a state-by-state basis and no one knows how long this relief will last.
At this juncture, businesses should pay close attention to their states’ published guidance on how to handle the compliance landscape going forward.
Adjusting Your Strategy
If your income or circumstances have changed as a result of the COVID-19 pandemic, you may be due for a strategy session with your financial and tax professionals to address your tax plan for the future. The best way to save money on your taxes is to look ahead, be smart, and be prepared.
If you are a business owner wondering how your taxes could be affected by legislation passed, we urge you to reach out to us. We have been working alongside business owners like yourself, navigating the many twists and turns of 2020 each step of the way. We can help you, too. Schedule a Call with one of our RiversEdge advisors today to learn how.