Many family businesses have been adversely affected by the novel coronavirus (COVID-19) pandemic. But there's a silver lining: Proactive tax planning can help your family business take advantage of potential opportunities in the COVID-19 era. Here are some tax-smart ideas to consider.
Hire Your Kids
This tax-saving strategy is most beneficial when your family business operates as:
- A sole proprietorship,
- A single-member limited liability company (LLC) that's treated as a sole proprietorship for tax purposes,
- A partnership that's owned by a married couple, or
- An LLC that's treated as a married couple's partnership for tax purposes.
Owners of these types of noncorporate family businesses can hire their under-age-18 children — as legitimate employees — and the children's wages will be exempt from Social Security, Medicare and FUTA taxes. In fact, the FUTA tax exemption lasts until your employee-child reaches age 21.
Hiring your kid — instead of an unrelated person — also keeps more money in the family. Right now, that's a big advantage. It could be part of an overall life-saving strategy for your business.
You can hire your child part-time or full-time. Currently, your under-age-18 child may not be attending school — either due to the pandemic or summer break. And the 2020-2021 school year could be delayed or conducted remotely. So, in the COVID-19 era, your child's availability to work in the family business may be greater than during normal conditions.
Thanks to the Tax Cuts and Jobs Act (TCJA), your employee-child can use his or her standard deduction to shelter up to $12,400 of 2020 wages paid by your business from federal income tax. Back in 2017, prior to the TCJA, the standard deduction was only $6,350. The TCJA nearly doubled it for 2018 through 2025. So, under current law, your child can shelter almost twice as much wage income with the today's much bigger standard deduction.
This means that your under-age-18 child will owe no federal income tax on the first $12,400 of wages for 2020 unless he or she has income from other sources. Your child can use his or her wages to help keep the family afloat financially — or to fund a college savings account or contribute to a Roth IRA.
Rules for Older Kids
If you hire a son or daughter who's 18 or older, his or her wages are subject to Social Security and Medicare taxes, like for any other employee. However, the wages won't be subject to the FUTA tax if the child is under age 21. And, under the TCJA, an unmarried child can use the standard deduction to shelter up to $12,400 of 2020 wages received from the family business from federal income tax, or up to $24,800 if your child is married and files a joint tax return with his or her spouse.
Rules for Incorporated Businesses
If you operate your business as an S or C corporation, your child's wages will be subject to Social Security, Medicare and FUTA taxes, like for any other employee, regardless of the child's age. However, you can deduct the wages and the employer's share of the related payroll taxes as a business expense.
Rules for Other Family Members
Wages paid to other relatives — such as grandchildren, uncles or nieces — will be subject to Social Security, Medicare and FUTA taxes, like for any other employee. The family member can use his or her standard deduction to shelter up to $12,400 of 2020 wages received from the family business from federal income tax, or up to $24,800 if the family member is married and files a joint return with his or her spouse.
Income Tax Advantages
When you hire a child or other family member, you get a business tax deduction for employee wage expense, plus:
- For so-called “pass-through” entities, including the noncorporate entities listed above and S corporations, the wage expense deduction reduces your individual federal taxable income, your individual net self-employment income (if applicable) and probably your individual state taxable income (if applicable).
- If you operate your business as a C corporation, the deduction reduces your corporation's federal taxable income and probably your corporation's state taxable income (if applicable).
If your business will be unprofitable this year due to the COVID-19 crisis, the deductions might create or increase a net operating loss (NOL) for 2020. If so, that NOL can be carried back as many as five tax years — potentially all the way back to 2015. The NOL carryback privilege can trigger a refund of income taxes paid for earlier years.
Consider Taking Bonus Depreciation for Qualified Expenditures
To survive and possibly even thrive during the novel coronavirus (COVID-19) crisis, your family business might need to spend some money to reconfigure its operations. The good news is that many business assets, which are placed in service in 2020 through 2022, will qualify for 100% first-year bonus depreciation for federal income tax purposes.
That means you can immediately write off the entire cost on the applicable federal income tax return. It doesn't matter if your business is unincorporated or operates as an S or C corporation.
Under current tax law, the following new and used assets can qualify for bonus depreciation:
- Most business equipment (including computers, peripherals and related software),
- Fixtures, and
- Heavy vehicles with a gross vehicle weight rating above 6,000 pounds, including SUVs, long-bed pickups and vans, that are used over 50% for business.
In addition, under a technical correction included in the Coronavirus Aid, Relief and Economic Security (CARES) Act, real estate qualified improvement property expenditures are now eligible for 100% first-year bonus depreciation. If you're considering real estate expenditures to reconfigure or re-purpose space used in the family business, ask your tax advisor if what you have in mind will qualify for 100% first-year bonus depreciation.
If your business will be unprofitable this year due to the COVID-19 crisis, deductions for 100% first-year bonus depreciation can create or increase a net operating loss (NOL) for 2020. If so, that NOL can be carried back as many as five tax years and trigger refunds of income taxes paid for those years.
The PPP Loan Factor
If you took out a Small Business Administration (SBA) loan under the federal Paycheck Protection Program (PPP) for your family business, for the loan to be forgiven, you must spend the loan proceeds on payroll and other eligible expenses. These expenses include:
- Certain employee healthcare benefits
- Mortgage interest
- Interest on other existing debt obligations
If you spend PPP proceeds for other business purposes, like acquiring assets that qualify for 100% first-year bonus depreciation, the loan won't be forgiven. And PPP loans that aren't forgiven must be repaid within 24 months. That's OK if the money is better spent for those other business purposes. Plus, the annual interest rate on PPP loans is only 1%.
Members of Congress have been discussing possible legislation that would liberalize the rules regarding PPP loan forgiveness. Contact your tax advisor for the latest developments.
This article only covers a few strategies that can help family businesses save taxes in the era of COVID-19. For more information or ideas, contact your tax advisor.