Author: Leon Clinton

The purpose of this letter 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.

Here are six powerful business tax deduction strategies that you can easily understand and implement before the end of 2021. 

1. 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 2021 prepayments cannot go into 2023. 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 lease payments on business vehicles, rent payments on offices and machinery, and business and malpractice insurance premiums.

Example. You pay $3,000 a month in rent and would like a $36,000 deduction this year. So on Friday, December 31, 2021, you mail a rent check for $36,000 to cover all of your 2022 rent. Your landlord does not receive the payment in the mail until Tuesday, January 4, 2022. Here are the results:

• You deduct $36,000 in 2021 (the year you paid the money).
• The landlord reports taxable income of $36,000 in 2022 (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. 

2. Stop Billing Customers, Clients, and Patients

Here is one rock-solid, easy strategy to reduce your taxable income for this year: stop billing your customers, clients, and patients until after December 31, 2021. (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.

Example. Jim, a dentist, usually bills his patients and the insurance companies at the end of each week. This year, however, he sends no bills in December. Instead, he gathers up those bills and mails them the first week of January. Presto! He just postponed paying taxes on his December 2021 income by moving that income to 2022.

3. 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 2021.

Qualifying bonus depreciation and Section 179 purchases include new and used personal property such as machinery, equipment, computers, desks, chairs, and other furniture (and certain qualifying vehicles).

4. Use Your Credit Cards

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 card 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 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.

5. Don’t Assume You Are Taking Too Many Deductions

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, you could very possibly have an NOL. You could have a loss year even with an ongoing, successful business.

You used to be able to carry back your NOL two years and get immediate tax refunds from prior years, but the Tax Cuts and Jobs Act (TCJA) eliminated this provision. Now, you can only carry your NOL forward, and it can only offset up to 80 percent of your taxable income in any one future year.

What does this all mean? 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.

6. Deal with Your Qualified Improvement Property (QIP)

In the CARES Act, Congress finally fixed the qualified improvement property (QIP) error that it made when enacting the TCJA.

QIP is any improvement made by you to the interior portion of a building you own that is non-residential 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.

The big deal with QIP is that it’s not considered real property that you depreciate over 39 years. QIP is 15-year property, eligible for immediate deduction using either 100 percent bonus depreciation or Section 179 expensing. To get the QIP deduction in 2021, you need to place the QIP in service on or before December 31, 2021.

Planning note. If you have QIP property on an already filed 2018 or 2019 return, it’s on that return as 39-year property. You need to fix that—and likely add some cash to your bank account because of the fix.

I trust that you found the six ideas above worthwhile. If you would like to discuss any of them, please call me on my direct line (408-778-9651).

• By Leon Clinton
• November 22, 2021

Remember to consider your Section 199A deduction in your year-end tax planning. If you don’t, you could end up with an undesirable $0 for your deduction amount.

Here are three possible year-end moves that could, in the right circumstances, (a) reduce your income taxes and (b) boost your Section 199A deduction at the same time.

First Things First

If your taxable income is above $164,900 (or $329,800 on a joint return), then your type of business, wages paid, and property can reduce and/or eliminate your Section 199A tax deduction.

If your deduction amount is less than 20 percent of your qualified business income (QBI), then consider using one or more of the strategies described below to increase your Section 199A deduction.

Strategy 1: Harvest Capital Losses

Capital gains add to your taxable income, which is the income that 

• determines your eligibility for the Section 199A tax deduction,
• sets the upper limit (ceiling) on the amount of your Section 199A tax deduction, and
• establishes when you need wages and/or property to obtain your maximum deductions.

If the capital gains are hurting your Section 199A deduction, you have time before the end of the year to harvest capital losses to offset those harmful gains.

Strategy 2: Make Charitable Contributions

Since the Section 199A deduction uses your Form 1040 taxable income for its thresholds, you can use itemized deductions to reduce and/or eliminate threshold problems and increase your Section 199A deduction.

Charitable contribution deductions are the easiest way to increase your itemized deductions before the end of the year (assuming you already itemize).

Strategy 3: Buy Business Assets

Thanks to 100 percent bonus depreciation and Section 179 expensing, you can write off the entire cost of most assets you buy and place in service before December 31, 2021.

This can help your Section 199A deduction in two ways:

1. The big asset purchase and write-off can reduce your taxable income and increase your Section 199A deduction when it gets your taxable income under the threshold.
2. The big asset purchase and write-off can contribute to an increased Section 199A deduction if your Section 199A deduction currently uses the calculation that includes the 2.5 percent of unadjusted basis in your business’s qualified property. In this scenario, your asset purchases increase your qualified property, which in turn increases your Section 199A deduction.

This can get confusing. If you would like my help, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 18, 2021

The big advantage of 529 plans is that qualified withdrawals are always federal-income-tax-free—and usually state-income-tax-free too. 

What you may not know is that not all 529 withdrawals are tax-free qualified withdrawals, even in years when you have heavy college costs.

Here are six important points to know about 529 withdrawals. 

Point No. 1: You Usually Have Several Payment Options

Say you are the 529 account owner or plan participant. Plans commonly use both terms to describe the person who established and controls the account. This letter will use account owner. 

As the account owner, you can generally have a withdrawal check cut in your own name or have an electronic deposit made into your own account. 

Alternatively, you can have a withdrawal issued in the name of the account beneficiary (the college student for whom you set up the 529 account, usually a child or grandchild) or issued directly to the educational institution for the benefit of the account beneficiary. 

You choose your payment option by submitting a withdrawal request to the 529 plan. 

Point No. 2: Watch Out for Withdrawals from 529 Accounts Funded with Custodial Account Money

Say you funded the 529 account with money that came from a custodial account that was set up for the account beneficiary—your child or grandchild—under your state’s Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA). 

In this situation, you must use any money taken from the custodial account for the benefit of the child or grandchild. 

You can’t take a 529 account withdrawal for yourself if the 529 account was funded with money from a child’s or grandchild’s custodial account. Because the money in the 529 account came from the custodial account, the 529 account money legally belongs to your child or grandchild, not you. 

On the other hand, if you funded the 529 account with your own money, the money in the account is fair game. You can take withdrawals and do whatever you want with them—subject to the potential federal income tax implications explained later.

Point No. 3: The IRS Knows about Withdrawals

For any year that a 529 withdrawal is taken, the plan must issue a Form 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530), by February 1 of the following year. If the withdrawal goes to the 529 account beneficiary (your child or grandchild), the 1099-Q goes to him or her. If the withdrawal goes to you as the account owner, the 1099-Q goes to you. Either way, the IRS gets a copy, so the IRS knows what happened. 

Point No. 4: Withdrawals May Be Taxable Even in Years When Substantial College Costs Are Incurred 

When the Form 1099-Q shows withdrawn earnings, the IRS becomes interested in the 1099-Q recipient’s Form 1040 because some or all of the earnings might be taxable. Here’s the deal on that. 

Withdrawn earnings are always federal-income-tax-free and penalty-free when total withdrawals for the year do not exceed what the IRS calls the account beneficiary’s adjusted qualified education expenses, or AQEE, for the year.

AQEE equals the sum of the 529 account beneficiary’s 

• college tuition and related fees; 
• room and board (but only if the beneficiary carries at least half of a full-time course load); 
• required books, supplies, and equipment; 
• computer hardware and peripherals, software, and internet access costs; and
• expenses for special needs services.

Next, you must subtract any federal-income-tax-free educational assistance to calculate the account beneficiary’s AQEE. 

According to the IRS, tax-free educational assistance includes costs covered by

• tax-free Pell grants; 
• tax-free scholarships, fellowships, and tuition discounts;
• tax-free veterans’ educational assistance; 
• an employer’s tax-free educational assistance program under Internal Revenue Code Section 127; and 
• any other tax-free educational assistance (other than assistance received in the form of a gift or an inheritance). 

In addition, tax-free educational assistance includes any costs used to claim the American Opportunity tax credit or the Lifetime Learning tax credit.

Key point. You can also include in AQEE

• up to $10,000 annually for the account beneficiary’s K-12 tuition costs;
• the account beneficiary’s fees, books, supplies, and equipment required to participate in a registered apprenticeship program; and
• interest and principal payments on qualified student loan debt owed by the account beneficiary or a sibling of the account beneficiary—subject to a $10,000 lifetime limit.

Bottom line. When withdrawals during the year exceed AQEE for the year, all or part of the withdrawn earnings will be taxable. When withdrawals don’t exceed AQEE, all the withdrawn earnings are federal-income-tax-free.

Point No. 5: When You Keep a Withdrawal, There Are Tax Consequences 

Assuming the 529 account was funded with your own money (as opposed to money from a custodial account), you are free to change the 529 account beneficiary to yourself and then take federal-income-tax-free withdrawals to cover your own AQEE if you decide to go back to school. 

But if you take a withdrawal that you use for purposes other than education, report the taxable portion of any related account earnings as miscellaneous income on your Form 1040. Taxable amounts may also get hit with a 10 percent penalty tax to boot (see below). 

Finally, if you liquidate a loser 529 account (worth less than the total amount of contributions), there are no federal income tax consequences. (The government stopped participating in your losses for tax years 2018-2025.)

Point No. 6: Withdrawals Not Used for Education Can Also Be Hit with a 10 Percent Penalty Tax 

As explained earlier, some or all of the earnings included in a 529 withdrawal taken during the year must be included in gross income when the withdrawals exceed the account beneficiary’s AQEE for the year. But there’s more. 

According to the general rule, the taxable amount of earnings is also hit with a 10 percent penalty tax. 

But the 10 percent penalty tax doesn’t apply to earnings that are taxable only because the account beneficiary’s AQEE was reduced by

• tax-free Pell grants; 
• tax-free scholarships, fellowships, and tuition discounts;
• tax-free veterans’ educational assistance; 
• tax-free employer-provided educational assistance;
• any other tax-free educational assistance; or 
• costs used to claim the American Opportunity or Lifetime Learning tax credit. 

In addition, the 10 percent penalty tax doesn’t apply to earnings withdrawn when the account beneficiary attends one of the U.S. military academies (such as West Point, Annapolis, or the Air Force Academy). 

Finally, the 10 percent penalty tax doesn’t apply to earnings withdrawn after the account beneficiary dies or becomes disabled.

If you have questions about the 529 plan, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 10, 2021