If you own a small or medium-sized business, it may be eligible for some significant tax breaks that aren't available for larger entities. Here are three examples to consider as you file your tax return for 2021 and plan for 2022.
1. QBI Deduction
The qualified business income (QBI) deduction was a centerpiece of the Tax Cuts and Jobs Act (TCJA). For 2018 through 2025, the QBI deduction is available to eligible individuals, trusts and estates. But it's not available to C corporations or their shareholders.
The QBI deduction can be up to 20% of:
- QBI earned from a sole proprietorship or single-member limited liability company (LLC) that's treated as a sole proprietorship for federal income tax purposes, plus
- QBI passed through from a pass-through business entity, meaning a partnership, LLC classified as a partnership for federal income tax purposes or S corporation.
Pass-through business entities report their tax items to their owners who then take them into account on their owner-level returns. When allowed, the QBI deduction is taken at the owner level. The QBI deduction rules are complicated, and the deduction can be phased out at higher income levels. Consult with your tax advisor for details.
2. Eligibility for Cash-Method Accounting
Businesses that are eligible to use the cash method of accounting for tax purposes have the ability to fine-tune annual taxable income. This is accomplished by timing the year in which you recognize taxable income and claim deductions.
Under the cash method, you generally don't have to recognize taxable income until you're paid in cash. And you can generally write off deductible expenditures when you pay them in cash or with a credit card.
Only "small" businesses are potentially eligible for the cash method. For this purpose, the TCJA liberalized the small business definition to include those that have no more than $25 million of average annual gross receipts, based on the preceding three tax years. This limit is adjusted annually for inflation. For tax years beginning in 2021, the inflation-adjusted limit is $26 million. For 2022, it's $27 million.
3. Sec. 179 Depreciation Deduction
If you own a small to medium-sized business, the Section 179 first-year depreciation deduction potentially allows you to write off some (or maybe all) of your qualified asset additions in the first year they're placed in service. This break is available for both new and used property.
For qualified property placed in service in tax years beginning in 2018 and beyond, the Sec. 179 deduction rules are much more favorable than before the TCJA. The enhancements include:
Higher maximum deduction. The TCJA permanently increased the maximum Sec. 179 deduction to $1 million with annual inflation adjustments. For qualified assets placed in service in 2021, the maximum is $1.05 million. For 2022, it's $1.08 million.
Liberalized phase-out rule. The TCJA permanently increased the threshold above which the maximum Sec. 179 deduction begins to be phased out to $2.5 million with annual inflation adjustments. For qualified assets placed in service in 2021, the phase-out threshold begins at $2.62 million. For 2022, it begins at $2.7 million.
The phase-out rule kicks in only if your additions of assets that are eligible for the Sec. 179 deduction for the year exceed the threshold for that year. If they exceed the threshold, your maximum Sec. 179 deduction is reduced dollar-for-dollar by the excess.
More Assets Qualify for Sec. 179 Deductions
The TCJA expanded the definition of assets that qualify for Sec. 179 deductions to include depreciable tangible personal property used predominantly to furnish lodgings. Examples apparently include beds, other furniture, kitchen appliances, and other equipment used in the living quarters of a lodging facility such as a hotel, motel, apartment house, dormitory or other facility where sleeping accommodations are provided and rented out.
As was the case before the TCJA, you can still claim Sec. 179 deductions for qualifying real property expenditures, up to the maximum annual Sec. 179 deduction limit. The TCJA expanded the definition of qualified real property expenditures to include the cost of roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential buildings.
Beware of Sec. 179 Limitations
Sec. 179 deductions are subject to some limitations. First, the Sec. 179 deduction for a tax year can't exceed the taxpayer's aggregate net business taxable income from all sources calculated before any Sec. 179 write-off.
Second, if you're the owner of certain pass-through businesses — including a partner in a partnership, a member of an LLC that's treated as a partnership for tax purposes, or an S corporation shareholder — the annual Sec. 179 deduction limit, the Sec. 179 deduction phase-out rule and the taxable income limitation apply at both the entity level and at your personal level. The interactions can become quite complicated. They can also cause your allowable Sec. 179 deduction to be less than you expected. Ask your tax advisor if this issue applies to you.
Interplay with Bonus Depreciation
While Sec. 179 deductions may be limited, those limitations don't apply to first-year bonus depreciation deductions. For qualified assets placed in service in 2022, 100% first-year bonus depreciation is available. After this year, the first-year bonus depreciation percentages are scheduled to start going down as follows:
- 80% for qualified assets placed in service in 2023,
- 60% for qualified assets placed in service in 2024,
- 40% for qualified assets placed in service in 2025,
- 20% for qualified assets placed in service in 2027, and
- 0% for 2028 and beyond.
After this year, the Sec. 179 deduction privilege can be more valuable than first-year bonus depreciation. That's because you can potentially write off 100% of the cost of qualified assets in the first year they're placed in service with the Sec. 179 deduction while the ability to do that with first-year bonus depreciation is going away. Unfortunately, large businesses may be ineligible for Sec. 179 deductions due to the phase-out rule.
Tax-Saving Combo for Small Business Owners
Some tax-savvy small business owners are able to double their tax savings by combining the purchase of a heavy SUV, pickup or van with the home office deduction. Here's how this strategy works.
1. Buy a Suitably Heavy Machine
Qualifying vehicles that are acquired and placed in service between September 28, 2017, and December 31, 2022, may be eligible for a 100% first-year bonus depreciation. This break is only available for a new or pre-owned SUV, pickup or van with a manufacturer's gross (loaded) vehicle weight rating (GVWR) above 6,000 pounds that's purchased (not leased). First-year depreciation deductions for lighter vehicles are subject to a much lower limit (maximum of $18,200 for 2022).
You can usually find the GVWR on a label on the inside edge of the driver's side door. Many attractive vehicles have GVWRs above the 6,000-pound threshold. Examples include the Chevy Tahoe, Dodge Grand Caravan, Ford Explorer, Jeep Grand Cherokee, Porsche Cayenne, Toyota 4Runner and many full-size pickups.
The 100% first-year bonus depreciation deal is only allowed if you use your heavy SUV, pickup or van over 50% for business. Calculate your business-use percentage for the year by dividing business mileage by total mileage. If business usage is between 51% and 99%, you can deduct that percentage of the cost. The write-off will reduce your federal income tax bill and self-employment tax bill, if applicable. You might get a state tax income deduction, too.
2. Play the Home Office Card
The over-50%-business-use test is sometimes difficult to pass for small business owners. That's where a home office might come into play. You're more likely to pass if you have an office in your home that qualifies as a principal place of business. Then your business mileage includes commuting mileage from your home office to 1) temporary work locations (such as client sites) and 2) other regular places of business (such as a second office located downtown). Plus, you can treat all mileage between any other regular place of business (such as a downtown office) and temporary work locations as business mileage.
More business mileage means a bigger first-year depreciation deduction for your heavy vehicle. For example, if you buy a $60,000 heavy SUV in 2022 and use it 80% for business, that translates into a first-year bonus depreciation deduction of $48,000 (80% × $60,000). If your business usage is 60%, your first-year deduction drops to $36,000 (60% × $60,000).
Additionally, allowable home office expenses count as business deductions that will reduce your federal income tax bill and your self-employment and state income tax bills, if applicable.
How to Make Your Home Office a Principal Place of Business
Self-employed people — including sole proprietors, partners, and LLC members — have two ways to qualify a home office as a principal place of business. First, they can conduct most of their income-earning activities in the home office.
Alternatively, they can conduct administrative and management tasks in the home office. However, to take advantage of this qualification rule, you can't make substantial use of any other fixed location (such as a second office downtown) for administrative and management chores.
Either way, you must use the home office space regularly and exclusively for business purposes during the whole year. Exclusively means no personal use at any time during the year.
Important: If you're an employee of your own corporation, you can't write off home office expenses under the current rules
For More Information
Small and mid-sized businesses may be eligible for some special tax breaks that aren't offered to their larger counterparts. Contact your HK tax professional to determine whether you're taking advantage of all available tax breaks, including those that are available to small and large businesses alike.