The purpose of this article is to get the IRS to owe you money.
Of course, the IRS is not likely to cut you a check for this money (although in the right circumstances, that will happen), but you’ll realize the cash when you pay less in taxes.
This article gives you seven powerful business tax deduction strategies that you can easily understand and implement before the end of 2020.
Prepay Expenses Using the IRS Safe Harbor
You just have to thank the IRS for its tax-deduction safe harbors.
IRS regulations contain a safe-harbor rule that allows cash-basis taxpayers to prepay and deduct qualifying expenses up to 12 months in advance without challenge, adjustment, or change by the IRS.
Under this safe harbor, your 2020 prepayments cannot go into 2022. This makes sense because you can prepay only 12 months of qualifying expenses under the safe-harbor rule.
For a cash-basis taxpayer, qualifying expenses include, among others, lease payments on business vehicles, rent payments on offices and machinery, and business and malpractice insurance premiums.
You pay $3,000 a month in rent and would like a $36,000 deduction this year. So on Thursday, December 31, 2020, you mail a rent check for $36,000 to cover all of your 2021 rent. Your landlord does not receive the payment in the mail until Monday, January 4, 2021. Here are the results:
- You deduct $36,000 in 2020 (the year you paid the money).
- The landlord reports $36,000 as rental income in 2021 (the year he received the money).
You get what you want—the deduction this year.
The landlord gets what he wants—next year’s entire rent in advance, eliminating any collection problems while keeping the rent taxable in the year he expects it to be taxable.
Don’t surprise your landlord: if he had received the $36,000 of rent paid in advance in 2020, he would have had to pay taxes on the rent money in 2020.
Before sending a big rent check to your landlord, make sure the landlord understands the strategy. Otherwise, he might not deposit the rent check (thinking your payment was a mistake) and instead might return the check to you. This could put a crimp in the strategy because you operate on a cash basis.
Also, think proof. Remember, the burden of proof is on you. How do you prove that you mailed the check by December 31? (Think like an IRS auditor or, better yet, a prosecuting attorney.)
Answer: Send the check using one of the postal service’s tracking delivery methods, such as priority mail with tracking and possibly signature required, or one of the old standards, such as certified or registered mail.
With these types of mailings, you have proof of the date that you mailed the rent check. You also have proof of the day the landlord received the check.
If you are using USPS online tracking, make sure to print the delivery and receipt tracking results for your tax records, because that tracking information disappears from the postal service records long before you would need it for the IRS.
Stop Billing Customers, Clients, and Patients
Here is one rock-solid, time-tested, easy strategy to reduce your taxable income for this year: stop billing your customers, clients, and patients until after December 31, 2020. (We assume here that you or your corporation is on a cash basis and operates on the calendar year.)
Customers, clients, patients, and insurance companies generally don’t pay until billed. Not billing customers and patients is a time-tested tax-planning strategy that business owners have used successfully for years.
Jim Schafback, a dentist, usually bills his patients and the insurance companies at the end of each week; however, in December, he sends no bills. Instead, he gathers up those bills and mails them the first week of January. Presto! He just postponed paying taxes on his December 2020 income by moving that income to 2021.
Buy Office Equipment
With bonus depreciation now at 100 percent along with increased limits for Section 179 expensing, buy your equipment or machinery and place it in service before December 31 and get a deduction for 100 percent of the cost in 2020.
Qualifying bonus depreciation and Section 179 purchases include, among others, new and used personal property such as machinery, equipment, computers, desks, furniture, and chairs (and certain qualifying vehicles).
Planning note. If you qualify for the Section 199A deduction, the increased expenses will reduce your Section 199A deduction as explained in 2020 Last-Minute Section 199A Tax Reduction Strategies.
Use Your Credit Cards Correctly
If you are a single-member LLC or sole proprietor filing Schedule C for your business, the day you charge a purchase to your business or personal credit card is the day you deduct the expense. Therefore, as a Schedule C taxpayer, you should consider using your credit cards for last-minute purchases of office supplies and other business necessities.
If you operate your business as a corporation, and if the corporation has a credit card in the corporate name, the same rule applies: the date of charge is the date of the deduction for the corporation.
But if you operate your business as a corporation and you are the personal owner of the credit card, the corporation must reimburse you if you want the corporation to realize the tax deduction, and that happens on the date of reimbursement. Thus, submit your expense report and have your corporation make its reimbursements to you before midnight on December 31.
Don’t Assume You Are Taking Too Many Deductions
You should never stop documenting your deductions, and you should always claim all your rightful deductions. We have spoken with far too many business owners, especially new owners, who don’t claim all their deductions when those deductions would produce a tax loss.
But this won’t happen to you. Why? Because, as a subscriber (member), you know all deductions are valuable. And you know even those deductions not used this year can create tax benefits for you in the future.
If your business deductions exceed your business income, you have a tax loss for the year. With a few modifications to the loss, tax law calls this a “net operating loss,” or NOL.
If you are just starting your business, or with all that’s happened this year, you could very possibly have an NOL. And the good news is that NOLs can turn into cash infusions for your business, as explained directly below.
Let’s be real: there’s little to be grateful for with COVID-19, with one of the exceptions being the potential opportunities to turn NOLs into cash for your business.
Two NOL exceptions come from the Coronavirus Aid, Relief, and Economic Security (CARES) Act:
1. The CARES Act allows NOLs arising in tax years beginning in 2018, 2019, and 2020 to be carried back five years for refunds against prior taxes.
2. The CARES Act allows the application of 100 percent of the NOL to the carryback years.
Before the CARES Act, you could not carry back your 2018, 2019, or 2020 losses, and your NOL could offset only up to 80 percent of taxable income before your Section 199A deduction.
If you have an NOL, consider doing the following:
- For a 2018 NOL, file amended returns.
- For a 2019 NOL, for a quick refund, file a tentative refund claim before December 31, 2020, or file an amended return later.
- For a 2020 NOL, get your tax info together quickly so you can file early next year—you have to file your tax return before you can claim an NOL carryback.
Deal with Your Qualified Improvement Property (QIP)
In the CARES Act, Congress finally fixed the qualified improvement property (QIP) error that is made in the Tax Cuts and Jobs Act (TCJA).
QIP is any improvement made by the taxpayer to the interior portion of a building that is nonresidential real property (think office buildings, retail stores, and shopping centers) if you place the improvement in service after the date you place the building in service.
If you have such property on an already filed 2018 or 2019 return, it’s on that return as 39-year property. You now have to change it to 15-year property, eligible for both bonus depreciation and Section 179 expensing.
For what’s needed, see CARES Act Fixes TCJA Glitch on QIP, Requires Action.
When it comes to your taxes, business deductions are king. The more business deductions you can claim, the better. The more business deductions you claim, the less you pay in regular taxes.
Yes, paying less in taxes is good.
Here are the seven last-minute tax deduction strategies we covered in this article:
1. Prepaying your 2020 expenses right now reduces your taxes this year, without question. While it’s true you kicked the can down the road some, perhaps you have an offset with a big deduction planned for next year. And even if you don’t have such a plan at the moment, you have plenty of time to create one or to put additional big deductions in place for 2021.
2. The easiest year-end strategy of all is simply to stop billing your customers, clients, and patients. Once again, this kicks the can down the road some and makes your 2021 tax planning more important.
3. With 100 percent bonus depreciation and increased Section 179 expensing in 2020, you can make significant purchases of equipment, machinery, and furniture and write off 100 percent of the value. Make sure you place the assets in service on or before December 31, 2020, to get the deduction this year.
4. Charges to your credit cards can create deductions on the day of the charge. This is true if you are a sole proprietor or if you operate as a corporation and the credit card is in the name of the corporation. But if you operate as a corporation and the credit card is in your name, your corporation needs to reimburse you before December 31 to create the 2020 deduction at the corporate level.
5. Make sure to claim all your legitimate deductions. Don’t think you have too many, and don’t try to avoid deductions that you think could be a red flag. First, it’s unlikely you could have enough deductions to create a red flag. Second, no one knows what those red flags are. Third, if the deduction is legitimate, it doesn’t matter if the IRS audits it—you’ll win.
6. If your deductions exceed your income, you will have a loss for the year and that loss can create an NOL. The good news here is that the NOL can give your business a cash infusion from the taxes you paid five years ago.
7. If you placed QIP in service in 2018 or 2019, you have some work to do because that QIP is no longer 39-year property; it is the 15-year property and requires a 100 percent bonus depreciation deduction if you don’t elect out of bonus depreciation.