The business and economic climate in which we operate has seen a vast dichotomy of challenges and opportunities over the past year. Rising inflation, accompanied by rising prices to maintain margins; an influx of capital in the private marketplace and consistent M&A activity mark a few of the highs and lows in 2022.
The potential for new legislation and the political environment will also continue to factor into both short-term and long-term planning for taxpayers, as will the many provisions from the Tax Cuts & Jobs Act (TCJA) that had delayed starts and are now coming to fruition. While there is always the possibility of an extender package impacting those provisions, for now we plan with what we know.
And of the few certainties taxpayers can rely on, we know reporting requirements for federal filings will continue to increase, elevating the complexity of tax returns. As a result, strategic year-end tax planning for business owners remains more critical than ever.
Below are eight important tax planning areas to begin discussing with your advisers now.
1. Changes to R&D Expense Deductibility Signal More Planning
The deductibility of U.S. Research & Development expenses for businesses is about to change — from allowing taxpayers prior to 2021 to deduct R&D costs as they were incurred, to capitalizing and amortizing over a period of five years (15 years for any foreign activity) any R&D expenses incurred in tax years beginning after December 31, 2021. It is also important to note this rule change applies even if you are NOT taking the R&D credit.
>> Planning Consideration: If your company conducts a significant amount of R&D, there is a lot of planning around this change. First you will need to ensure all your company’s R&D expenditures are completely accounted for and separately stated in your year-end financials. If you have not been tracking these expenses previously but know your company has R&D activity, consult your tax adviser to discuss how to best capture the expenses. The biggest downside to this provision is that taxable income will increase as the expenses are stretched out over a five-year, or 15-year for foreign activity, period.
However, if you who have not taken advantage of the R&D credit because you felt it was not worth the administrative burden, now may be a good time to explore doing so. The tax benefit of the credit could help offset the downsides.
2. Change in Interest Expense Limitation Calculation Could Mean More Limitations
There are unfavorable changes to the calculation of the interest expense limitation (IRC Section 163j) on the horizon. For tax years beginning before January 1, 2022, depreciation and amortization were added back to taxable income when calculating available Adjusted Tax Income (ATI). These addbacks were favorable to taxpayers, as they increased ATI and allowed a potentially higher interest expense deduction. However, for tax years beginning after December 31, 2021, taxpayers can no longer add back depreciation and amortization when determining their interest expense limitation.
>> Planning Consideration: Highly leveraged businesses and those with significant depreciation/amortization deductions may be subject to more limitations than in the past due to this modification. However, there are some exemptions to explore if you are a small business, having average annual gross receipts of no more than $25 million; or in certain industries, such as real estate or farming.
If you don’t fall into one of these categories and your ATI falls to a point where some of your interest expense is nondeductible in a given year, the expense will carryforward to a year where the taxpayer has “excess” taxable income to free it up. It will be important to consider this as a potential timing difference when looking at tax projections. Looking forward, as this limitation starts to affect more taxpayers, it will be important to factor this into decisions regarding whether to pursue debt or equity financing.
3. The End of Bonus Depreciation as We Know It
Since the passing of the TCJA, taxpayers have been able to fully expense most capital expenditures using 100% bonus depreciation in the year they were placed in service. This provision will begin to phase out starting in 2023, with bonus depreciation set to decrease by 20% each year — meaning your assets will only qualify for 80% depreciation beginning with assets placed in service on January 1, 2023, then 20% less each year thereafter. Pending new legislation, the TCJA eliminates bonus depreciation altogether by 2027.
>> Planning Consideration: If you are purchasing a large asset, such as a piece of new equipment, consider placing it in service before December 31, 2022, so it can qualify for 100% bonus. Also ensure you look at how your bonus deprecation may interact with interest expense limitations. For taxpayers that have yet to file a 2021 return, consider accelerating as much depreciation expense as possible, as it will not impact the interest expense limitation calculation for 2021.
While bonus depreciation has been renewed prior to its sunset date in years past, due to the current political climate we don’t foresee a change to this provision anytime soon. However, all hope is not lost if you hope to accelerate your tax depreciation. Section 179 expense is still available if you have significant capital expenditures. While there are additional rules and limitations surrounding Section 179, know that for 2022 it is limited to $1.08 million, and for companies with additions in excess of $2.7 million, the limit goes down dollar for dollar.
Read more on TCJA changes in “Tax Law Changes Ahead: Are You Ready?”
4. ERC: A Hot Button for the IRS
The Employee Retention Credit (ERC) is still available to qualifying employers for all four quarters of 2020 and the last three quarters of 2021. You can still amend your payroll tax returns to take advantage of this pandemic-related credit. For eligible quarters in 2020, the deadline to amend those payroll filings is March of 2024, while 2021’s deadline would follow in March 2025.
However, the IRS has put out a warning to be wary of third-party firms promoting improper ERC claims. Many firms take hefty fees for their services, whether your company is actually eligible for the credit or not. To date the IRS has had approximately 450,000 claims for the ERC through March and nearly 300,000 more to process as of November. The IRS is keenly aware that many businesses may not legitimately qualify for the credits, so they are on the lookout. If you applied for the ERC and don’t qualify, you will have to pay back the credit with penalties and interest.
>> Planning Consideration: If you believe you may qualify or have already engaged with a third party to apply for the credit, please reach out to a member of your tax engagement team. There are two ways to qualify for the credit — a gross receipts test and the suspension test. Our tax team will be able to discuss the qualifications of both tests as well as the risks involved. Additionally, unlike PPP loan forgiveness, these credits are taxable and likely require amending income tax returns for the years for which you apply for the credit. Thus, it is important your tax advisers are aware of this credit as it relates to your enterprise.
5. More (and More) Informational Reporting
Businesses potentially may have a lot more informational reporting to do for its owners this year in the form of Schedule K-2 and K-3 reporting to shareholders/partners, so individuals can complete their foreign tax credit reporting. Some companies were able to elect out in 2021; for 2022 you may again be able to opt out of this reporting if you meet four requirements:
- You have no or limited foreign activity in the partnership or S Corporation;
- All partners in your partnership are U.S. citizens or resident alien partners;
- You send all partners a notice that you are not providing this reporting unless they tell you they need it (you can provide this notice with copies of the partners'/shareholders’ K-1 copies); and
- You do not have any requests for 2022 Schedule K-2 or K-3 reporting from partners or shareholders by one month before the entity tax return is filed (as late as August 15, 2023).
>> Planning Consideration: IRS guidance on this matter is currently developing, so it is important to discuss with your tax advisers if you believe you will be required to include these schedules with your tax returns. In the meantime, pass-through entities should be prepared to communicate this to partners and shareholders, with which Cohen & Company can assist.
Read “Does Your Partnership or S Corp Need to File a K-2 or K-3 for Its 2021 Taxes?”
6. Going Green Gets Incentivized with the Inflation Reduction Act
The Inflation Reduction Act (IRA) passed in late summer was one most important pieces of energy legislation we’ve seen, providing a runway for the energy industry to develop more clean energy in the U.S. The Act introduces, modifies, extends, and bolsters numerous clean energy tax incentives available to business and nonbusiness taxpayers. Incentives impacted include the nonbusiness energy property credit, residential energy efficient property credit, clean vehicle credit and nonrefundable credit for previously owned clean vehicles. Businesses can take advantage of credits related to advanced manufacturing, clean energy and renewables, renewable fuels, energy efficient building and transportation. It’s important to note that, in many instances, the IRA reduces the baseline tax credit available, but meeting prevailing wage requirements can make your projects eligible for a bonus credit amount or increased deductions.
Read “How to Document Your Eligibility for PTC and ITC Energy Tax Credits”
Key aspects of the IRA beyond clean energy include changes to the corporate alternative minimum tax and excise tax on repurchase of corporate stock, both effective for tax years after December 31, 2022, an increase in the amount of R&D credit that can offset payroll tax for small taxpayers, as well as $80 billion to increase IRS tax enforcement funding, and a two-year extension of the excess business loss rules implemented by TCJA through 2028.
As is the case usually with newer legislation, Treasury is asking taxpayers to be patient until more guidance is available. It’s important to include your tax and legal professionals on any related conversations.
Read more in “5 Areas Taxpayers Should Understand about the Inflation Reduction Act” and “15 Takeaways from the Inflation Reduction Act Clean Energy Tax Incentives”
>> Planning Consideration: The provisions under the IRA are quite specific as to whom they apply, with the construction, real estate and manufacturing industries (specifically those manufacturing wind, solar and battery components) likely benefitting the most from the new energy credit incentives. If you are in one of these industries or are making an investment in energy efficient alternatives for your business, be sure to have the conversation with your tax adviser about what these incentives mean for you.
7. Pass-Through Entity Taxes
Over the past couple of years, 36 states, including Ohio, have enacted the pass-through entity (PTE) tax in various forms. A PTE tax allows a pass-through business to be taxed at the entity level, alleviating some of the federal tax burden of the state and local tax deduction cap at the owner level.
>> Planning Consideration: The PTE tax can be of great benefit to business owners in states that have enacted such a law. However, be aware that no state is the same in their approach to PTE tax, so you must carefully consider each state’s PTE tax and how it may or may not benefit you. Businesses with shareholders or partners residing in more than one state can further complicate the cost-benefit analysis.
Read “How Your Ohio Pass-Through Business Can Be Taxes as an Entity in 2022”
8. Additional Year-End Tips & Considerations
Defer Capital Gains Whenever Possible
Thanks to a very active M&A market, there were a lot of gains realized this year from transactions. Regardless of where your gain originated, there are a host of strategies to consider for deferring them. Consider accelerating deductions or depreciation at the business level; investing in Qualified Opportunity Zone Funds or Businesses; or for taxpayers with charitable endeavors, creating a donor advised fund to accelerate the benefit of future charitable contributions.
Recognize Income to Minimize Losses
If you have a loss from 2022, consider recognizing some of the income from current transactions or deferrals from prior years to minimize the loss. Alternatively, you can defer tax expenses that are typically accelerated, such as bonus depreciation.
Loss Harvesting & ROTH Conversions
Under current market conditions, now may be a great time to harvest losses to offset income. Capital losses in excess of gains can be used to offset up to $3,000 of ordinary income, then carried forward indefinitely, subject to additional limitations depending on your tax situation. Additionally, consider converting a portion of your traditional IRA to a ROTH while market values are low.
Note the Change in Deducting Business Meal Expenses
The ability for businesses to deduct 100% of the cost of food and beverages when provided by a restaurant — originally put in place to help restaurants struggling during the pandemic — will revert to 50% for business meals after 2022.
Contact Kyle Pavilonis at firstname.lastname@example.org or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.