The coronavirus pandemic and presidential election may have most of your attention as a small business owner this year, but it's not too late to consider tax planning moves to understand what you'll owe the government in 2020 and to improve your position for 2021.
“By mid-November, you need to have a team meeting with your tax attorney, accountant and banker about how to accomplish this," said Paul E. DeLauro, City National Bank wealth planning manager.
Here's how to get started.
Start by assessing your current situation to see if you're making the right choices for saving and keeping more of your hard-earned dollars.
Before year end, for example, consider analyzing your qualified retirement plan — whether it's a 401(k), Simplified Employee Pension, profit-sharing or another employer-sponsored program — to make sure you're maximizing your tax-deferred contributions and using the best option for your business.
"Business owners should make sure they're contributing enough," DeLauro said, "and that the plan their company uses allows them to contribute as much as possible. A lot of small business owners have the wrong kind of plan for their unique situation."
Along the same lines, you might benefit from exploring whether you're using the optimal business structure for your company.
If your closely held business operates as a C corporation, DeLauro suggested considering whether you really need to use that structure rather than an S corporation.
As a C corporation, your company pays its own income tax while you separately pay personal income tax based on your compensation.
But S corporations don't pay corporate income tax, instead passing on business revenue as personal income to the company's owner or owners.
A C corporation with $1 million in EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) would pay 21 percent, the current corporate income tax rate, before distributing dividends, salaries or bonuses, while an S corporation wouldn't incur that cost, DeLauro noted. Owners might have chosen a C corp structure to protect their personal assets when they incorporated, but they can achieve the same protection using an S corp, he explained.
A C corp allows different stock classes, which enables the business to raise capital, "but many companies don't need to raise capital," he noted.
Sometime in 2021, depending on which party wins control of the U.S. Senate, corporate income taxes could increase to 28 percent, which could make the S corp structure even a bigger savings for business owners.
"Maybe it's time to contact your CPA or your tax attorney and ask, 'Do I have the right business structure to maximize my after-tax income?'" DeLauro said.
It's getting late to implement such a change in time to benefit for the 2020 tax year, but it's still possible to do, he said.
If you need to purchase equipment or make another significant investment in your business, you may be able to trim your 2020 tax bill by accelerating the process and taking this step by year end, noted Gaye L. Chun, City National Bank senior wealth planner.
"Some people may consider taking the tax deduction now," she said.
Taking a deduction for an asset purchase now could prove even more advantageous if policymakers eliminate the ability to take upfront deductions on certain asset acquisitions, DeLauro said.
Consider accelerating capital gains in 2020 as well, Chun and DeLauro said.
Democratic Party tax proposals could result in long-term capital gains being treated as ordinary income and taxed at 39.6 percent on income higher than $1 million, Chun noted.
Under those potential changes, a high earner selling a property for $1 million could incur a 39.6 percent tax on the sale proceeds rather than the current 20 percent capital gains tax, Chun explained.
One of Chun's clients who receives installment payments on a sale is thinking of accepting full payment now in return for a small price discount so he can log the full capital gain in 2020 and avoid the possibility of seeing future payments taxed as ordinary income.
Because of potential changes in estate tax policies, Chun and DeLauro also suggested that business owners with substantial personal assets also consider strategies available to accelerate gifts to children and grandchildren this year.
Accelerating giving may make good financial sense as well.
A taxpayer might own highly appreciated land, rental property, or other assets. The owners may want to diversify out of those assets, but if they do a direct sale they'll immediately incur big capital gains taxes, DeLauro explained.
The owner, however, could use an irrevocable charitable remainder unitrust, or CRUT, to sell the property, invest the proceeds, receive a percentage back annually over time, defer capital gains taxes by paying them pro rata and eventually leave a generous donation to charity.
A CRUT can be a good idea for philanthropically inclined business owners and taxpayers looking to sell a high-value asset that has appreciated in value considerably over time, DeLauro said.
While it's not a step to be taken lightly, DeLauro and Chun noted that some high-net-worth individuals are leaving high-tax states for lower-tax jurisdictions — or are considering whether to do so.
City National advisors have talked to clients about various strategies, including setting up trusts and shifting assets to adult children in states with lower taxes, said Chun. A business owner could gift significant stakes in the company to each child, spreading the income over family members and taking advantage of lower tax brackets.
Whatever tax-savings strategies may benefit you and your business when it comes to paying your 2020 returns, it's best not to delay.
“Sit down now and talk to your accountant," advised Chun.
City National Bank encourages you to consult with your banker, financial advisor and tax professional before making major changes to your financial situation. Need to discuss your wealth plan with an advisor and wish to find one? Get in touch with a City National advisor today.
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This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.
City National, its managed affiliates and subsidiaries, as a matter of policy, do not give tax, accounting, regulatory or legal advice. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. You should consult with your other advisors on the tax, accounting and legal implications of actions you may take based on any strategies presented, taking into account your own particular circumstances.