I know – it’s a stretch – applying a tech term to income taxes, but hear me out. Besides, the term future-proof in the tech world really only gets you through the next six months anyway – I think we can do better in tax.
So here we are, in the middle of a pandemic, and I’m wanting to talk about how we future-proof your income tax situation. Why would I do this you say? Because the pandemic isn’t going to last forever (it’s not, right?) and at some point, all businesses will get back to profitability. Depending on what industry you’re in, you never left profitability. If you’re delivering pretty much anything, or are manufacturing, processing, and distributing food products, you may just be seeing record profits. So let’s see if we can predict and future-proof your income tax situation.
Income Tax Planning Techniques
First off, here’s what we know, income taxes are most likely going up whether there’s a change in Washington or not. Many of the tax incentives included in the Tax Cuts and Jobs Act are set to expire after 2025. This includes the popular 199A deduction applicable to pass through entities, and the reduced individual tax rates. In addition to this, bonus depreciation starts to go away in 2023. Since the chances of any of these provisions being extended past 2025 or made permanent are pretty slim, this is the best case scenario.
There’s also the chance that we could see a big tax increase as early as next year. With GDP dropping and calls for government spending to increase, there’s a good chance that the federal government will have to generate revenue from somewhere (no matter who’s in charge), and absent the biggest bake sale anyone’s ever seen, raising taxes is the easiest answer.
So what do we do? Do we accelerate income? Crazy, I know, but consider the following. For every dollar of taxable income you accelerate into 2020 (by say, electing out of bonus depreciation), you could potentially save 10 percentage points on your federal tax liability. How do we get to 10%? Easy, the top individual income tax rate is currently 37%. If you include the benefit of the 199A deduction, your top individual income tax rate drops to 29.6% (37% x 80%). Compare that to the top individual income tax rate that we’ll revert back to in 2026, and possibly sooner if the TCJA is repealed, of 39.6% – carry the 1 and you get 10 percentage points.
On the flip side, if you defer income and accelerate expenses (the norm in the tax world), you’re missing out on permanent tax deductions that will most likely go away. It’s a roll of the dice for sure, but the appropriate analysis can help you determine whether or not it’s a bet worth making.
Now, this is admittedly way oversimplified. There are hundreds of other things to consider, do you have the cash flow to pay more tax now if it means saving 10 percentage points in a few years? What’s the opportunity cost of not having that cash on hand? If you have the potential for an NOL carryback as enacted by the CARES Act, how does that play into things? What about the decreased deduction for state taxes at the individual level that would presumably also go away in a few years? All of these things must be considered, but you can’t ignore the exercise.
Income taxes aside, another piece to consider is estate planning. The current estate tax exemption is $10,000,000+ adjusted for inflation. This exemption could go away entirely in the next few years. Can you take advantage of this exemption and lock it in forever with the appropriate estate planning? Can you take advantage of the depressed economic climate to get a valuation of a closely held company that makes this a perfect opportunity? There’s a good possibility on both fronts.
Here’s the best news, we’re here to help you sort through this mess. If you have any questions or would like to talk further, please do not hesitate to contact me, Mark Heath, Partner and Director of Tax Services with McKonly & Asbury at firstname.lastname@example.org.