Despite the passage of the Bipartisan Emergency COVID Relief Act late in 2020, it will likely be a particularly difficult time for many car wash owners as, bad year or not, they prepare their taxes. Although the government has employed a number of programs designed to help struggling businesses cope with the economic fallout from the Coronavirus pandemic, a potentially expensive surprise may be awaiting many of those who reaped and, perhaps, continue to reap the benefits of these programs — an unexpected tax bill.
THE NEW PAYROLL TAX DEFFERAL SCHEME
One such potential problem area involves the President’s August Executive Order allowing employees to skip paying their share of the 6.2% Social Security tax — with only a temporary grace period.
The economic stimulus program passed in March as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act had already authorized a Social Security tax deferral for employers for the balance of 2020. Under the CARES Act, a car wash or other business can pay back 50 percent of the amount of payroll taxes due by the end of 2021 and the remaining 50 percent by the end of 2022.
As mentioned, both of these programs are only “deferrals,” not a complete waiver. Both voluntary plans illustrate the current payback requirement and the unexpected tax bill that awaits.
TRUST FUND PENALTIES
Despite allowing employers to temporarily defer payment of payroll taxes, the employer — or a “responsible party” — is still ultimately responsible for meeting these obligations. If payroll taxes aren’t remitted to the IRS in time, the “responsible party” may be held personally responsible for the full amount of the so-called “trust fund penalty.”
In other words, an owner, manager or the person handling the operation’s finances, could be required to pay the IRS an amount equal to 100 percent of the shortfall out of their own pocket.
END OF INDEPENDENT CONTRACTING?
It may soon be time to say goodbye to workers calling themselves “independent contractors” and the car care services that use them. Those businesses utilizing independent contractors to minimize payroll tax costs and headaches have long battled the IRS and other government agencies over who is and who isn’t an independent contractor. Obviously, being labeled as an employee can have a profound impact on everything from overtime pay to fringe benefits and, of course, taxes.
Intended to force businesses to hire freelance workers as employees with healthcare and other benefits, a California law, Assembly Bill 5 (AB5) imposed some of the most significant restrictions on independent contractors in American history. Restrictions that a number of other states seem to be ready to adopt.
The current economic downturn has resulted in many independent contractors — and the government agencies that regulate them — to re-evaluate the definition of “independent.” Maybe they are not the only ones who should be wary of the independent contractor label.
THE PPP TAX GLITCH
Last fall, the IRS issued guidance that no deduction would be allowed for an expense if the payment of the expense resulted in forgiveness of a PPP loan. That meant that although forgiveness of a PPP loan is tax free, business owners couldn’t claim a tax deduction for those covered expenses.
Just in time for the tax season, the new stimulus bill reverses Treasury Department and IRS rulings that denied the deduction. The new law ensures that PPP recipients can deduct the payroll costs and other expenses covered by forgiven loans, even though the loans themselves are tax-free income.
EIDL LOANS AND GRANTS
A number of car wash operators took out Economic Injury Disaster Loans (EIDLs) from the Small Business Administration (SBA) to help pay expenses during the recent disruptions. A business applying for an EIDL was eligible to receive a grant of up to $10,000 from the SBA after applying for an EIDL loan.
These grants do not need to be repaid under any circumstances — even if the car wash was subsequently denied an EIDL. While grants to small businesses would appear to fit under the general welfare doctrine, the IRS has, in the past, ruled that grants to a business do not qualify.
Congress recently changed the tax laws to make it clear that any contribution by a government entity to a corporation is taxable. Although the rules apply only to corporations, the IRS will, in all likelihood, treat other business entities in a similar fashion.
STATE AND LOCAL GOVERNMENTS
With unemployment levels remaining high and state coffers strained to the maximum, employers are looking down the barrel of a precipitous increase in unemployment insurance taxes. As states attempt to replenish their depleted unemployment trust funds and begin repaying the Treasury loans, some businesses could see tax increases in 2021.
Employers will also see automatic increases in federal unemployment taxes if states haven’t repaid their 2020 Treasury loans by a November 2022 deadline. And, these likely tax increases represent only one of many tax surprises facing their business.
RECAPTURING EXCESS EMPLOYMENT TAX CREDITS
The IRS has issued regulations to reconcile advance payments of refundable employment tax credits and to recapture these credits when necessary. The regulations authorize the assessment of erroneous refunds of the credits paid under both the Families First Coronavirus Response Act and the Coronavirus Aid, Relief and Economic Security (CARES) Act.
Many employers received advance payment of these credits up to the total allowable amounts using IRS Form 7200, Advance Payment of Employer Credits Due to COVID-19. Employers were required to reconcile any advance payments claimed with the total credits claimed and total taxes due on their employment tax returns.
However, any refund of these credits paid to a taxpayer that exceeded the amount the taxpayer should have been allowed is labeled as an “erroneous refund” for which the IRS is required to seek repayment.
Car wash operators and other small business owners recently learned they could borrow $100,000 from their IRA and pay it back three years later with no tax consequences. That’s right, IRA owners who are adversely affected by the Coronavirus pandemic will be eligible to take tax-favored distributions from their IRAs.
In effect, the new policy allows an IRA owner to borrow up to $100,000 from their IRA and recontribute (repay) the amount any time up to three years later with no federal income tax consequences. There are no restrictions on what the withdrawals can be used for during that three-year period. And, best of all, they do not have to pay the 10 percent additional early-distribution tax.
A DIFFERENT TAX TREATMENT
The income and losses of many businesses operating as so-called “pass-through” entities such as S corporations, partnerships, and sole proprietorships, flow through to the owner’s personal income tax return. The losses may or may not be deductible, but the income is reportable.
Fortunately, the owners of pass-through entities can deduct 20 percent of qualified business income when calculating their taxes — but it is not automatic. After all, the law limits the deduction for certain “service” businesses, such as legal, medical, or accounting practices, where taxable income exceeds $321,000 for joint filers ($160,700) for single filers). Owners of service businesses with taxable income in excess of $421,000 for joint filers ($210,700 for single filers) get no deduction.
Although the pass-through deduction and limits are only temporary, consideration might be given to changing the car wash operation’s tax status from a pass-through business to a regular corporation. While pass-through entities may offer advantages, don’t forget the 2017 TCJA reduced income tax rates from 35 percent to a flat 21 percent for all regular corporations.
UTILIZING THOSE INEVITABLE LOSSES
Don’t forget that there is now a five-year carryback for net operating losses (NOLs) arising not only in 2020 but also in 2018 and 2019. While the five-year carryback is providing a welcome injection of liquidity for many car washes suffering the impact of the pandemic, the relief, unfortunately, is only temporary. NOLs arising after 2020 do not have a carryback period and can only be carried forward to offset future taxable income. Of course, an unlimited carryforward period continues to apply to all post-2017 NOLs.
An unfavorable TCJA provision disallowed current deductions for so-called “excess business losses” in tax years between 2018 and 2025. The CARES Act suspended the excess business loss disallowance rule for losses that arise in that period.
Amending a 2018 or 2019 tax return to reflect the disallowance of excess business losses could result in a 2018 or 2019 NOL that could then be carried back to a prior tax year to recover previously paid taxes.
This is just a small taste of the tax complexities and considerations every car wash and auto detailing business could, potentially, face as governments at almost every level continue taking steps to lessen the impact of the Coronavirus pandemic. While tax concerns may not be a priority now, considering the possible tax ramifications of these and other programs can ensure the financial survival of the business later. Of course, qualified professional assistance is always strongly recommended.
Mark E. Battersby is an Ardmore, PA-based freelance writer, specializing in finance and tax issues.