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Taking steps to defer your federal income bill is almost always good idea if you expect to be in the same or lower tax bracket in future years. In that situation, making moves that lower this year’s taxable income at the cost of increasing taxable income in future years will at least put off the tax day of reckoning until the bill comes due. If tax rates turn out to be lower in future years, your overall tax bill will be lower. Great. The same principle applies to businesses run by individuals as sole proprietorships and to businesses operated as partnerships, LLCs, and corporations.
But what if the opposite happens, and tax rates go up? Then you might be sorry for making moves that decreased 2019 taxable income while increasing taxable income for later years. What to do? Please keep reading.
The elephant in the room
The Tax Cuts and Jobs Act (TCJA) lowered individual federal income tax rates through 2025 and permanently lowered the corporate federal income tax rate to a flat 21%. However, tax changes are always subject to “political risk” and this is an election year. 2021 and beyond could be a whole new ballgame. If we have a complete political turnover, there’s even a risk that a new president and Congress could impose retroactive tax rate increases that take effect this year. Yikes. That’s rather unlikely, but you never know.
The extended return advantage
This future-tax-rate uncertainty scenario is concerning. The good news: you can extend your 2019 personal return to October 15. You can extend a calendar-year 2019 return for a partnership, LLC treated as a partnership for tax purposes, or S corporation until September 15. You can extend a calendar-year 2019 return for a regular C corporation until October 15.
By extending your return to the applicable date, you can delay making (or not making) choices that will lower taxable income for 2019 at the cost of increasing taxable income for 2020 and beyond. And by the applicable date in the Fall, we may know which way the political wind is blowing for the Nov. 3 general election. Maybe. If you don’t extend, you’re casting your tax fate to the wind. So extend my friends, extend!
How to extend
To extend a calendar-year 2019 personal return (Form 1040), file IRS Form 4868 by no later than 4/15/20.
To extend a calendar-year 2019 return for a partnership or an LLC treated as a partnership for tax purposes (Form 1065), file IRS Form 7004 by 3/15/20.
To extend a calendar-year 2019 return for an S corporation (Form 1120-S), file Form 7004 by 3/15/20.
To extend a calendar-year 2019 return for a C corporation (Form 1120), file Form 7004 by 4/15/20.
You can download Form 4868 and Form 7004 and the instructions to these forms from the IRS website at www.irs.gov.
Tax deferral choices that small business owners can put off by extending returns
Several choices that result in tax deferral (or not) can be put off until tax return time. If you extend your return, you can put off those choices until the extended due date. By then, we hope, you’ll have a much better feel for how the November 3 election is likely to turn out.
Electing to claim first-year bonus depreciation (or not)
With your extended 2019 return, you can choose to reduce 2019 taxable income by claiming 100% first-year bonus depreciation for qualifying assets that were placed in service last year. Or you can choose Plan B and not claim 100% first-year bonus depreciation and instead reduce taxable income for 2020 and beyond by depreciating those assets over the applicable period (3, 5, or 7 years for most assets). If tax rates go up in future years, you might be glad you choose Plan B.
Election to claim first-year Section 179 depreciation (or not)
With your extended 2019 return, you can choose to reduce 2019 taxable income by claiming first-year Section 179 depreciation deductions for qualifying assets that were placed in service last year. Or you can choose Plan B and not claim Section 179 deductions and instead reduce taxable income for 2020 and beyond years by depreciating those assets over the applicable period. If tax rates go up in future years, you might be glad you choose Plan B.
Using installment sale reporting for gains from property sales (or not)
Say you or your business entity sold some business-related real property last year and provided seller financing. You will receive the sales proceeds over several years. You can generally use the installment method to spread the taxable gain from the sale over the years you receive the sales proceeds. Fair enough. But if tax rates go up in the future, you could wind up paying a higher rate on the gains recognized in future years. And the total tax bill could be higher than if you elect out of the installment method and simply report the entire gain on your 2019 return. You can elect out of the installment method for one or more eligible property sales with your extended 2019 return.
Make maximum deductible retirement plan contributions (or not)
With your extended 2019 return, you can claim deductions for contributions to a small business retirement plan — such as a SEP plan, a SIMPLE-IRA plan, a self-employed Keogh plan, a solo 401(k) plan, or a defined benefit pension plan. As a general rule, you can make contributions for the 2019 tax year as late as the extended due date for that year’s return.
If you make a deductible contribution for the 2019 tax year, you receive a tax-saving benefit at today’s rates. When you take retirement plan distributions in future years, those distributions will be taxed at the rates if effect for those years. Those rates could be higher.
So, if there was ever a time to defy convention wisdom and not contribute as much as possible to your tax-deferred retirement plan, this might be the time. Your 2019 tax bill will be that much bigger, but you will not be deferring more income into future years when tax rates might be higher.
Consider negative impact of tax deferral moves on your 2019 QBI deduction
Say you run your business as a sole proprietorship, a one-owner LLC that’s treated as a sole proprietorship for tax purposes, a partnership, an LLC that’s treated as a partnership for tax purposes, or an S corporation. You may be eligible to deduct up 20% of your qualified business income (QBI) from the operation. Great!
However, your QBI is reduced by 100% first-year bonus depreciation deductions, first-year Section 179 depreciation deductions, and deductible retirement plan contributions.
In addition, the QBI deduction cannot exceed 20% of your taxable income calculated before the QBI deduction and before any net capital gain (net long-term capital gains in excess of net short-term capital losses plus dividends). Your taxable income for the QBI deduction calculation is reduced by the aforementioned write-offs.
So, claiming them on your 2019 return can potentially have the adverse side effect of reducing your allowable 2019 QBI deduction. That’s not good because the QBI deduction creates permanent tax savings, and it’s a use-it-or-lose-it proposition that’s scheduled to expire at the end of 2025. Unless our beloved DC politicians take it away sooner.
The bottom line
Huddle with your tax adviser to figure out how you feel about this admittedly confusing business tax deferral issue. I’m not advocating a rejection of tax deferral opportunities. I’m just suggesting that you think about them before reflexively choosing to make the usual time-honored tax deferral moves on your 2019 return — because they may not be such a great idea this time around. Meanwhile, please take my advice and extend your 2019 return if any of these tax deferral issues are meaningful in your specific situation. See which way the political wind is blowing in September or October and file your return then.