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The economic times were good for so long that it was hard to imagine a downturn. Now that it has arrived faster and deeper than expected, the survivability of some companies depends in part on how they can employ tax strategies to raise, or at least receive, cash.
Ideally, when times were good, companies would have taken a proactive approach, tested their tax position against an imaginary downturn, and taken steps to minimize potential future pain.
But even companies that were less prepared still have plenty of opportunities to quickly reduce their tax burden, especially now that they have better insight into their business operations for 2020.
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For most businesses, the first strategy should be to seek out losses in order to maximize tax refunds and get cash in hand. Their scope for doing this has been expanded by the CARES Act, which enables companies to carry back net operating losses from tax years 2018, 2019 and 2020 to the five previous years. This overrides a provision in the Tax Reform Act of 2017 that ended companies' ability to carry losses back.
This is very good news for businesses during these difficult COVID-19 times. An added bonus is that tax rates were higher in many of those earlier tax years so you can get more cashback.
To decide strategies based on these new regulations, companies must weigh how quickly they will need cash and maximize their overall value.
For businesses that were profitable in 2019 and are now in need of cash quickly, it might make sense to make additional deductions in 2019. However, if you are expecting a loss in 2020, for example, and are in no rush to get cash, these are options to make savings that could be significantly greater.
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Deductions could be postponed until 2020, and that year's losses could be attributed to 2015 or later when the maximum corporate tax rate was 35 percent versus 21 percent now and the maximum individual tax rate was 39.6 percent versus just 29.6 percent now.
The urgency of your cash needs should be an important part of your tax strategy. Below are tax moves businesses should consider in order to maximize their losses and deductions.
1. Harvest losses
Find and reap property, plant and equipment losses. Examples include real estate that has declined in value, obsolete inventory that you have not deducted for tax purposes, or receivables that may be worth less than what you owe. The potential downside to this is that the assets may need to be physically disposed of instead of just ticking another box on your tax form. That could mean tossing them out, selling them, or maybe selling them and leasing them back if the company still needs them. If losses are directly related to the coronavirus pandemic, a choice may be made to deduct those losses in 2019 instead of 2020.
2. Cost Separation Study
This is a way to speed up real estate asset depreciation. Unlike standard 27.5 or 39 year depreciation, a cost segregation study identifies and classifies real estate so you can claim the depreciation over a much shorter period of time. It can also be used to identify assets eligible for bonus amortization, where up to 100% of the cost of an asset can be deducted instantly. This more aggressive strategy ensures that you don't hold onto excessive write-offs in later years when you can't use any more deductions.
3. Real estate improvements
The CARES law gave companies another option for depreciation – qualified property for improvement. Companies can now go back to 2018 and, with a few exceptions, make a 100 percent write-off on all work to improve the interiors of non-residential buildings. According to the tax law of 2017, the depreciation could only be carried out over 39 years.
4. Adjustment of fixed assets
Much like a cost segregation study, it's worth looking through other depreciable assets to make sure you've maximized your depreciation over the years. You may have been eligible for a 100% bonus write-off on an item but only took 50% or did not claim it at all. Perhaps you've written off over a 10 year life when it could have been seven. Some assets may have actually been sold in previous years but never deducted on tax returns. Small changes in these depreciations across a wide range of assets can result in large taxpayers' money.
5. Tax accounting methods
There are many rules about timing assets and liabilities. There are often ways to speed up these deductions. This includes, among other things, the cash method of accounting, prepaid expenses, provisions for compensation, wage taxes, property taxes, medical expenses for employees, prepayments and software development costs. In many cases, deductions may be available even if amounts are shown differently in the books of account. This can be a complicated tax planning area as each item may have different rules. However, this also makes it more likely that there are hidden possibilities as well.
Not all of these strategies are relevant or worthwhile for every business. For companies that are still profitable in this environment, the goal of tax planning may be to build a war chest to take advantage of the opportunities that arise. For those struggling, it will be more about getting cash in hand ASAP.
Regardless of the destination, the existing tax laws, combined with any coronavirus stimulus that may be received, offer many options for alleviating the pain of the economic shutdown.