3 Pending Changes that Could Impact Year-End Small Business Tax Planning

Congress has been debating a number of big bills that contain tax changes. Some of the proposed changes are favorable; many are not. All of them may affect your bottom line. Final tax changes may not be known for weeks, and many won’t take effect until 2022. Nonetheless, pay attention now…year-end tax planning may be completely different this year than in prior years.

Whether your business is a C corporation or a pass-through entity (S corporation, partnership, LLC, or sole proprietorship), tax rates likely are going to change starting in 2022. A proposal would increase the corporate tax rate from the current 21% to 26.5%. The top tax rate on individuals would rise from 37% to 39.6%. But the tax hike on owners of pass-throughs could be even greater due to:

• Changes in the qualified business income deduction. The current 20% personal deduction based on business income could be limited for higher income taxpayers or killed entirely.
• The net investment income (NII) tax of 3.8% currently only applies to owners who do not materially participate in their businesses (i.e., silent partners). A proposal would impose the tax on all pass-through income for an owner otherwise subject to the NII tax, regardless of his or her level of participation in business activities.
• State and local income taxes could also change as many are tied to the federal tax rules. Yes, there’s a federal tax deduction for state and local income taxes, but there’s a cap (“SALT cap”) of $10,000 and this is only for individuals who itemize personal deductions instead of claiming the standard deduction (nearly 90% of individuals use the standard deduction). The SALT cap may be raised or eliminated entirely, but may not necessarily be of benefit to all small businesses owners.

A number of new rules—some good and some bad—have been debated but have not yet enacted. These include increasing over time the age for commencing required minimum distributions to 75. It would also mandate automatic enrollment plans (e.g., 401(k)s that enroll eligible employees, giving them a choice to opt out or change their salary reduction contribution amounts from a default amount), while increasing the tax credit for small employers to start retirement plans with automatic enrollment.

What to do: Monitor the “Secure Act 2.0” as it has come to be known. It may become part of a larger tax package, with provisions hidden among numerous other changes. Review your business’s current retirement plan if you have one, or consider whether to adopt one now…or wait for a larger tax credit to do so after legislation is enacted.

There are a number of tax rules set to expire at the end of 2021. These include the tax credit for builders of energy-efficient homes, a credit for two-wheel plug-in electric drive vehicles, and various other energy-related tax credits. Will they be extended? Who knows?

What to do: If any of the expiring provisions would benefit you, take advantage of the opportunity now.

If Congress delays action on pending changes until late in the year, it leaves little time for year-end tax planning. Businesses should be reviewing their books year-to-date and working with their tax advisers to devise tax strategies in light of possible law changes.