Tax professionals, faced with a massive amount of legislative proposals, shouldn’t lose sight of valuable planning opportunities that already exist.
“They should be looking at opportunities to act in anticipation of potential tax changes,” said Dustin Stamper, managing director at Grant Thornton’s Washington national tax office. “But it’s just as important to seize on the planning opportunities still available under the Tax Cuts and Jobs Act, the CARES Act, and many long-standing tax provisions.”
Mark Luscombe, principal federal tax analyst at Wolters Kluwer Tax & Accounting, agreed. “With the May 17 filing deadline now behind us, there are some new tax issues and proposed tax law changes that should remain in focus, even for those who filed for an extension,” he said. “The American Rescue Plan Act enacted earlier this year included changes that will affect 2021 tax returns and, if enacted, the proposed American Jobs Plan and the American Families Plan could both contain provisions that will impact 2021 tax returns. Additionally, the IRS continues to issue guidance on new tax provisions.”
The Employee Retention Credit, conceived during the heart of the COVID-19 crisis, has been extended and enhanced, Stamper noted. “It still offers a very valuable incentive. Generally, if an employer has more than 500 employees, they can only claim the credit for wages paid to employees when services are not provided, but the IRS has interpreted the rules generously, so that if remote employees are getting their full salaries but are not performing full services, the employer can claim the credit,” he explained. “Employers can use any reasonable method to determine amounts paid to salaried employees for time not worked, although mere reductions in productivity do not qualify.”
Blasts from the past
The deduction for foreign-derived intangible income could well be the Tax Cuts and Jobs Act’s most overlooked tax benefit, according to Stamper. “Most people think that it’s geared toward products sold overseas using U.S. intellectual property,” he said. “In fact, it’s potentially available for any domestic corporation that sells, licenses or leases any products to any foreign entity for use outside the United States. Many businesses left considerable deductions on the table from 2018 to 2020. And it’s one of the benefits that may go away under the Biden administration’s proposals, so it’s important to use now.”
Before the TCJA, U.S.-based multinationals paid the U.S. corporate tax rates on global profits if they repatriated their foreign earnings. Companies that generated income from intangible sources such as drug patents, software and royalties found it increasingly beneficial to shelter their profits in lower-tax jurisdictions overseas. However, the TCJA’s Global Intangible Low Taxed Income, or GILTI, rules attempted to coax businesses back, according to Christine Melilli, tax manager at Smolin Lupin & Co. “The new tax rules featured a 10.5% statutory rate with a 50% earnings deduction, an exclusion of 10% return on foreign tangible assets, and the ability to pool foreign profits, losses and tax credits for a company’s U.S. tax bill,” she said.
“GILTI has a very mechanical calculation that can result in unexpected and unfavorable tax outcomes,” Stamper cautioned.
Careful planning can help manage these issues, particularly with foreign tax credits. “Taxpayers should also assess whether a retroactive election for the high-tax exception in the regulations could result in a prior-year refund. There also may be planning opportunities to benefit from rate arbitrage by adjusting the timing of items before Democrats potentially increase the GILTI rate and adjust the rules.”
It is surprising that the R&D credit is still underused, since it’s one of the longest-
standing tax incentives in the Tax Code, Stamper observed: “Even taxpayers in industries that use the credit heavily, such as manufacturing and technology, suffer from misconceptions. Lots of taxpayers leave money on the table because they don’t understand how broadly the credit can apply.”
Unless it is repealed, the TCJA will end the ability of businesses to deduct research costs in the year they were incurred. Beginning in 2022, these costs will be amortized over a five-year period (for costs incurred inside the U.S.) or 15-year period (for costs outside the U.S.) period, Stamper noted. “Businesses are facing a costly compliance challenge to identify all of the costs covered by this rule, because the tax definition of research expenses is broader than capitalization rules for financial accounting. Taxpayers may need to begin preparing to track these costs now in order to be able to comply for 2022,” he said.
Meals and entertainment deductibility has been made more complex by TCJA and CARES Act changes. The TCJA repealed any deduction for entertainment expenses but left a 50% deduction for meals. The CARES Act raised the deduction to a full 100%.
“The provision is to help restaurants return to normal. It applies to 2021 and 2022,” said Luscombe. “‘Restaurant’ includes takeout and delivery as well as eating inside the facility.”
Businesses may not have the tracking systems in place to identify which meal costs may be eligible for a 50% deduction, a 100% deduction, or no deduction, cautioned Stamper.
Companies caught in the complexities of sales and use tax compliance often don’t realize the significant tax refund opportunities, Stamper indicated. “For example, many states and localities offer sales and use tax exemptions from machinery and equipment or from property purchased for further manufacture or resale,” he said. “Any company that makes frequent or large purchases should consider a comprehensive review of purchase records to identify whether exemptions might apply.”
Act now
As is often the case, some of the new changes that impact 2021 tax returns may require immediate action to take maximum advantage of new tax breaks, Luscombe pointed out: “Even tax breaks that are only proposed and not yet enacted could warrant conversations between tax professionals and their clients to prepare for possible planning opportunities.”
The third round of Economic Impact Payments will impact 2021 returns, Luscombe noted. “If people haven’t received their EIP yet, they should be looking at the reason. It should be based on their 2019 return, but if it was paid based on the 2019 return and the taxpayer gets their 2020 return filed by Aug. 17, 2021, they might get a second check if they were entitled to more based on their 2020 return.”
The American Rescue Plan expanded the Child Tax Credit for 2021, Luscombe noted, with up to $3,600 per child under the age of six, and $3,000 for those ages six to 17. The credit is fully refundable, and will be mailed in monthly installments of up to $300 per child from July 15 through Dec. 15.
“There will be an IRS portal to report a child born in 2021. Unlike the EIP, if a taxpayer receives more than they were entitled to, they have to pay it back,” he noted.
“And the American Rescue Plan expanded the Earned Income Tax Credit for 2021 primarily for childless low-income individuals, so be aware that an individual may be entitled to the EITC for the first time,” said Luscombe. “For example, recent college grads might qualify. Also be aware of the need to document care providers to qualify for the Dependent Care Credit,” he emphasized. “It might take some planning because the taxpayer needs to document how much care was provided and have the ID number of the provider.”
The ARP also expanded the premium credit under the Affordable Care Act, and extended the enrollment period under ACA exchanges, Luscombe noted. “The premium tax credit is more generous than it has been, and observers have suggested that more people are applying to exchanges as a result,” he said.
Trouble ahead — or behind?
The possibility that an increased capital gains rate might be retroactive is a “shot across the bow,” according to Jim Guarino, managing director at Top 100 Firm Baker Newman Noyes. “We’ve all been put on notice. It’s like emergency room triage — I put clients in three categories: those that need critical care immediately, those
that need monitoring, and those that are in a stable condition.”
Guarino recalled a planning session with a client and his investment advisor: “The client had a highly concentrated position with one company’s stock, and desired to diversify. The client earned about $400,000 a year in salary, so they’re close to the capital gain rate flipping for high-income earners from 15% to 20% once the salary exceeds $500,000. Taking the Biden proposal off the table, they would have a $100,000 cushion of capital gains they can recognize this year and maintain the lower rate. I was able to explain to them the different tax thresholds they need to be aware of. They weren’t aware of the Net Investment Income Tax of 3.8% or the thresholds associated with it.”
“This shows the importance of mid-year planning,” he said. “It’s the kind of information that gets buried in a tax return, but it sets the stage for future relationships.”
