Filing a 2021 income tax return for a business: What you need to know

• The Build Back Better infrastructure bill, which includes proposals to increase capital gains tax and limit business deductions, did not pass, meaning small business owners are spared from potentially significant new taxes.
• Some tax credits and relief measures related to Covid have expired, but the Employee Retention Credit remains a key provision that can still be claimed by some business owners.
• Tax season is likely to be unresponsive due to the IRS's record backlog of tax returns, experts predict.

Significant changes have occurred in the rules surrounding small business taxes over the past two years. This year marks the end of many pandemic-era deductions and deferrals.

Although the benefits are ending, the impact on small business owners' overall tax rate won't be significant. Accountants and tax planners say that the bigger impact would have come from the Build Back Better infrastructure bill, which includes proposals to increase capital gains tax, limit the 20% deduction for qualified business income under section 199A, and other factors that would increase taxes. However, these proposals have not yet been implemented.

According to Dean Zerbe, national managing director at Alliantgroup, a tax consultancy, the tax bill has been mostly positive due to the absence of capital gains and state tax changes.

Small business owners should be aware of the significant alterations to tax season due to the pandemic, as they can still apply retroactively for certain benefits.

It’s not too late to claim Employee Retention Credit

The Employee Retention Credit, which was established in 2020 under President Donald Trump as part of the CARES Act, ended three months earlier than anticipated in September. This fully refundable payroll tax credit for employers can provide up to $70,000 per quarter to incentivize businesses to retain their employees.

In the past two years, the program experienced significant modifications, resulting in many business owners being unaware of or not utilizing it.

The program was initially exclusive to those who did not receive a PPP loan. However, this changed with the second iteration, and the rules were relaxed to allow businesses to receive more funding based on the impact of the pandemic.

Filing retroactively for the program is still possible for small businesses that missed the deadline, according to Kevin Kuhlman, vice president of federal government relations at the National Federation of Independent Business. Despite some business owners being unfamiliar with the program, they can still apply. It is predicted that retroactive filings will make up a significant portion of this year's taxes.

Business owners have expressed frustration about the changes to the program, particularly the shortening of it, which made them feel like they were not fully taken care of, especially if they relied on the tax credit, according to Kuhlman.

Tax treatment of operating losses is less generous

The rules for carrying back or carrying forward net operating losses (NOLs) have undergone significant changes in recent years. Prior to these changes, NOLs could be carried back two years and carried forward 20 years. However, with the implementation of the Tax Cuts and Jobs Act in 2017, NOL deductions are now limited to 80% of taxable income, and carrybacks are no longer allowed.

The CARES Act waived TCJA rules and enabled business owners to carry back net operating losses generated between December 31, 2017, and January 1, 2021, for up to five years. Additionally, the cap for business interest expenses was increased to 50% of business income, up from 30%. Net operating losses were significant in 2020 taxes, and business owners also amended their previous tax returns to include net operating losses that they carried back.

The rules for using business interest expenses and net operating losses have been reverted to their pre-pandemic state. This means that limits on net operating losses could result in additional income tax payments. For example, if a business owner had a net operating loss in 2018 and taxable income in 2019, they could use the net operating loss to decrease their 2019 taxable income. Under the CARES Act, this could also be carried backwards if they had taxable income in 2017. However, this is now coming to an end.

Tax credit for paid Covid-19 leave has expired

Due to Covid-19, many individuals have had to take time off from work to care for quarantined family members or children who require constant supervision because schools are closed. The Families First Coronavirus Response Act, enacted in March 2020, mandated that certain employers provide paid sick leave or medical leave for pandemic-related reasons. Although this provision expired at the end of 2020, employers who continued to offer such benefits could use payroll tax credits to cover the cost of benefits. However, the tax credit for Covid-19 related paid leave expired in September, making it challenging for smaller employers to provide additional paid leave.

Deferred Social Security payments are due

The CARES Act allowed employers to defer payments of the employer portion of Social Security. However, these payments are now due, with half being paid by the end of 2021 and the other half by the end of this year. The IRS has warned that taxpayers who miss the Dec. 31 deadline will face penalties.

According to tax planners, the change is less likely to cause business owners pain since only a few took advantage of it. Edward Renn, a partner in the private client and tax team at Withers, stated that he's not seeing many problems as many clients prudently put the money aside in a bank account, ready for when needed.

Due to the numerous changes in tax rules over the past two years, small business owners may require the assistance of an accountant or tax planner more than ever. Additionally, the stress of tax filings is compounded by the IRS's lack of responsiveness, as they are currently dealing with a record backlog of tax returns.

Meredith Tucker, principal at Kaufman Rossin, stated that it feels like the tax season has gone off track. With 6 million pieces of returns still to be filed and only one out of every 10 phone calls being answered, the situation is concerning. Taxpayers who have an overpayment may want to apply that overpayment to the next period, but the earlier tax filings have not yet been processed.