Technology Companies: Act Fast on 2020 Year-End Tax Planning

Now is the time to be proactive in finalizing year-end tax planning for your technology company. The pandemic has brought changes to business operations and product offerings for many companies, and the Coronavirus Aid, Relief and Economic Security (CARES) Act has changed many tax provisions.

The election could bring more tax changes in 2021, so you may want to plan for different scenarios. Before the year comes to an end, speak with your tax advisor in case there are timely decisions or plans your technology business needs to make to benefit from favorable tax provisions and minimize your 2020 tax liability.

Reevaluate your potential R&D tax credit

The pandemic has led many technology and other businesses to dramatically transform their operating models and change their product offerings. If your company’s activities have involved developing new or improving existing processes, software or products, your company might qualify for the research and development (R&D) tax credit. Even if you expect to report a loss this year, you may still want to get an R&D tax credit study.

For examples of situations triggered by COVID-19 that could lead to research and development expenditures eligible for the R&D tax credit, you need only look to restaurants, retailers and service providers that have rushed to develop or improve their e-commerce platform in hopes of continuing operations without customers in stores. Financial institutions are developing new features to enhance online banking, and medical offices are launching enhanced telemedicine applications for remote consultations. Virtual collaboration also has triggered new software R&D projects.

If your company has worked on these types of projects or others, it’s a good idea to check with your tax advisor to see if your company qualifies for this dollar-for-dollar offset of income tax liability.

Startups with less than $5 million in revenue (and no revenue for the period of five years ending with the credit year) can, in the absence of a tax liability, instead apply the R&D tax credit to offset up to $250,000 in payroll taxes each year for up to five years.
Finally, keep in mind that as of now, the 2021 tax year will be the last year you can expense research and development costs rather than amortize them. After Dec. 31, 2021, taxpayers will be required to capitalize and amortize research or experimental expenditures – which will include all software development costs – over a period of five years. Those costs are currently immediately deductible as expenses. Congress has proposed some increases in the rates of the R&D credit, as well as new benefits, but nobody knows whether this will become law.

If you’re involved in activities or processes that you think might be covered, consult an R&D tax advisor to learn more. A qualified professional with R&D tax experience can help you assess your eligibility, calculate the amount of tax savings you could expect from this credit, as well as advise and assist you with proper documentation for substantiating the credit.

CARES Act has temporarily expanded the ability to take deductions for net operating losses

The CARES Act gives temporary reprieve from Tax Cuts and Jobs Act (TCJA) provisions that stopped the carryback of net operating losses (NOLs) and limited their use to 80% of taxable income. Regarding NOLs, the CARES ACT:

• Grants a five-year carryback period for NOLs arising in tax years beginning January 1, 2018, and ending December 31, 2020.
• Temporarily suspends the 80% of taxable income limitation on the use of NOLs, allowing taxpayers to fully offset taxable income during the allowed tax years, regardless of when the NOL was generated.

Your business may want to take advantage of the carryback by amending or modifying tax returns for tax years dating as far back as 2013.

Consider how Wayfair ruling may affect your sales tax collection and reporting

The Wayfair Supreme Court ruling in June 2018 shifted the tax collection and reporting burden for online purchases from consumers to businesses. In lieu of consumers paying a use tax, retailers now must collect the sales tax on behalf of the consumer.

The court’s decision effectively eliminated the previous requirement for a company to have a physical presence in a particular jurisdiction in order to be subject to that state’s laws and collect sales tax. States have established different sales volume thresholds, which determine a business’ liability. If you are a technology company selling software as a service (SaaS), mobile apps, hardware or other tangible goods, you need to understand how the states where your customers reside are interpreting and following these Wayfair-related laws.

Additionally, state and local governments have seen dramatic decreases in tax and other revenues due to the pandemic, so be prepared for tax rates to rise as governments look to offset these losses. Make sure that your tax professional knows where you are doing business and analyzes the sales tax requirements in each state.

Consider tax impact of employees working remotely in another state

In addition to sales taxes owed on goods sold in other states, as well as other typical conditions that create nexus for state and local taxes, COVID-19 may have left you with employees who worked from home in other states for part of this year. This may create nexus or change the way your tax liability is apportioned in states outside of your headquarters. Because of this, you may have new states in which to file taxes, and you may not have paid required estimated state taxes in some states.

Maximize your deduction for qualified business income (QBI)

As in the 2019 tax year, owners of certain pass-through entities may be able to receive a 20% deduction on qualified business income, which may reduce their maximum effective tax rate for 2020. Pass-through entities include subchapter S corporations, partnerships and some limited liability companies.

There’s another plus for pass-throughs: they keep the deduction on entity-level state and local taxes. The deduction may be limited to 50% of the W-2 wages paid, or the sum of 25% of the wages plus 2.5% of certain depreciable basis. Research whether you have paid enough wages to use this deduction – if you’re close, now may be the time to pay bonus wages to employees. Smaller, more closely held businesses, where the owner is also the most highly compensated employee, should particularly pay attention to this.

The QBI deduction limitations and restrictions are set at the owner level. Planning for year-end 2020 should include discussion of salaries, timing and distribution of income. Also, be aware that filers who claim the QBI deduction must now show how they calculated QBI, by using Form 8995. Each business must stand separately and will require its own Form 8995.

If you aren’t sure whether your business qualifies for the QBI deduction, now is the time to discuss it with your tax advisor. It’s important that he or she have a deep understanding of your business in order to make a recommendation. This is also a good time of year to consider if you want to make any change to your business entity type, or carve out a segment into a separate entity, which might help you to qualify for the QBI deduction. Consult with your tax advisor and attorney before making any major changes.

Decide whether to acquire and place in service depreciable assets prior to year-end or defer to Q1 2021

The TCJA increased bonus depreciation, allowing businesses to fully depreciate property placed in service on their federal tax return. This aims to incentivize companies, especially in the technology, manufacturing, and construction sectors, to invest in their business and purchase new assets. It is important to note that some states have decoupled and disallowed this bonus depreciation, so you will need to consider whether your state is following federal or state tax laws as it relates to bonus depreciation when filing your 2020 tax return.

Speak with your tax advisor about the potential tax implications of any asset acquisitions you are contemplating, and whether it is better to acquire them at the end of this year or to wait until early 2021. For example, if you think the rates are rising, you may not want to accelerate your deductions now.

Startup employees may want to delay tax on qualified equity grants

The TCJA gave startup employees the opportunity to delay paying income taxes on restricted stock for up to five years. Note that startup employees taking this approach would be relying on the startup’s financial success, and the impact of this new provision might be limited by its real-world application and reliance on guidance from the IRS.

Some of your investors may be eligible for tax breaks

If your company has assets of $50 million or less and is a C corporation, individuals who buy stock directly from the company and hold it for more than five years can exclude all their gain when they sell. This gain is also exempt from the Alternative Minimum Tax.

This exclusion applies to any purchases after September 27, 2010. It is capped at the greater of $10 million or 10 times share basis, and only applies to certain industries – of which technology is one. Speak with your tax advisor to learn more.

Self-created IP sale can no longer benefit from capital gains rate

Inventors with self-made intellectual property such as inventions, patents and designs may have seen their tax rates increase because of the TCJA’s classification of self-made property as ordinary income when sold (as opposed to capital assets). You may want to consider how you sell patented assets and what impact that would have on your business’ deals across the technology industry.
These are just a few of the topics a technology companies should keep in mind for year-end tax planning. For more on the tax changes in the CARES Act, payroll tax credits and deferrals you may eligible for, and other year-end tax planning ideas for businesses, read our blog post “2020 Tax Planning More Complex than Usual for Businesses.”

Contact a Kaufman Rossin tax advisor to learn more about how these and other tax provisions may affect your technology company’s 2020 tax bill and how you can get ahead now with tax planning.