With interest rates and inflation both on the rise, tax planning is as important as ever for businesses. We’ve compiled some of the key areas that can help business decision makers and entrepreneurs alike manage cash flow for their enterprise, and stay up to date on prominent changes to tax rules and regulations.
Looking ahead, with 2024 being an election year and all the uncertainties that come with it, for now, your tax position is one area in which you can plan with relative certainty.
Capitalization of R&D Expenses – Year 2
At this time last year, any industry with research and development (R&D) activity was planning for the tax impact of recent changes to the deductibility of these costs. As a refresher, in 2022 these expenses were no longer deductible in the year in which they were incurred, but instead added back and amortized over five years (15 years for any foreign expenditure). For some, this meant a large increase in taxable income and new cash flow constraints. For 2023, as legislation currently stands, we will be facing the same negative consequences of this change. It is important to remember this applies even if your business is NOT claiming the R&D credit.
There is a lot of conversation surrounding this topic in Washington, and the new capitalization requirement could be reversed if currently proposed legislation were to pass. With that said, the best we can do right now is plan for worst case scenario and highlight an opportunity. For any business that is R&D intensive, your tax team can provide projections highlighting the effects of this tax addback and the cash flow impact. From an internal standpoint, it is as important as ever that all R&D activity is tracked and separately accounted for; if you’re not sure this is the case, contact your tax adviser to discuss how to best capture the R&D expenditures.
There is a silver lining for some taxpayers that never claimed the R&D credit because they did not think it would be worth the administrative task of tracking. Now that taxpayers are required to track, businesses are trading a temporary addback for a permanent tax benefit. For taxpayers already claiming the credit prior to 2022, we found in many cases that the new legislation provided for a larger credit than they would have claimed under previous legislation.
Interest Expense Limitation — More Prominent Impact
With interest rates quickly approaching a 30-year high, the cost of carrying or acquiring new debt is driving business decisions. From a tax planning perspective, there can be an additional hidden cost of financing through the interest limitation rules, commonly referred to as 163(j). While this limitation has been in effect since the passing of the Tax Cuts and Jobs Act, it is becoming more impactful due to our high-rate environment and the changes to the limitation that began in 2022. Prior to 2022, businesses were able to add back depreciation and amortization before calculating the limitation; however, this addback was removed last year.
The interest limit is calculated using 30% of your ATI. There are complexities to calculating ATI, but here’s a quick example of the potential impact:
For 2023, Company XYZ has an adjusted taxable income of $1 million and $500,000 of interest expense. After applying the 30% limitation, only $300,000 of the interest expense is deductible in the current year, and $200,000 is added back. Assuming a 21% tax rate for corporations and 37% for individuals owning pass-through entities, this would be an additional $42,000 and $74,000 of cash flow required for federal income taxes, respectively.
In the event your industry is slowing down or becoming more leveraged, the likelihood of the limitation coming in to play increases. Any interest expense not deductible in the current year will carryforward indefinitely until there is a year where the taxpayer has excess taxable income to free it up. There are some exemptions to explore, including if you are a small business, having average annual gross receipts of no more than $29 million; or in certain industries, such as real estate, farming or any industry with floor-plan financing.
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, there are some planning ideas you can implement. If your business is affected by this limit, consult your tax adviser to evaluate what other opportunities might be applicable to your situation. It will be important to factor this into cash flow planning and overall decision making regarding whether to pursue debt or equity financing.
Bonus Depreciation Takes a Step Back for 2023
For the last five years, most businesses have been able to immediately realize the tax benefit of capital expenditures through 100% bonus depreciation. In 2023, we will see the first step in this provision sunsetting, going down to 80%, then 20% less each year until it is gone entirely in 2027. Bonus depreciation has provided an additional incentive to invest in and expand operations, while the tax deferral of capital expenditures provides for even more available capital in the short term. As the year comes to close, consider accelerating those large purchases to maximize this benefit while it is still available.
While bonus depreciation has been renewed prior to its sunset date in years past, due to the current political climate a change may be unlikely in the near term. 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 2023 it is limited to $1.16 million, and for companies with additions in excess of $2.89 million, the limit goes down dollar for dollar. Any portion of capital expenditures not covered by bonus depreciation or Section 179 will be depreciated over the asset’s normal recovery period.
Read "Tax Law Changes Ahead: Are You Ready?"
ERC Continues to Face IRS Scrutiny
Employee Retention Credits (ERC) continue to be a hot topic in the business world. You’d be hard pressed to find a business owner who hasn’t already applied, or heard from others in their network receiving the credit. Many of the pop-up firms helping businesses apply are operating on commission, incentivizing them to maximize the number of clients and dollar amounts they pursue. The program’s popularity has unfortunately come with some bad actors and increased scrutiny from the IRS.
Carolyn Schenck, IRS national fraud counsel, said during a webinar earlier this year that the agency is taking erroneous claims “very seriously.” The main fraud the IRS has seen in this area falls into three categories: fictitious businesses making claims, identity theft, and employer intentionally filing false or inflated claims. The government has continued to warn taxpayers to practice extreme caution before applying, as the last category has been driven by scammers. The IRS has even gone as far as announcing a new withdrawal process for businesses to back out of outstanding claims. Additionally, they are expected to announce in the near future a process where taxpayers can voluntarily return received ERC funds.
Read "IRS Announces ERC Claim Withdrawal Process"
We are also advising clients to exercise caution in approaching the topic. However, for businesses that are truly eligible, the credit can be a very positive influx of cash. While the IRS has temporarily stopped processing new applications to get through their backlog, the ERC is still available to qualifying employers for the periods covering March 16, 2020, through September 30, 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 April of 2024, while 2021’s deadline would follow in April 2025.
If you have outstanding ERC applications you’re concerned about, or still think you are eligible, reach out to your tax adviser to discuss your next steps.
Corporate Transparency Act – What It Means for Business Owners
Effective January 1, 2024, all entities not otherwise excluded from doing so will be required to file a report with FinCEN, providing general personal and contact information on their owners. This initiative, also known as Beneficial Ownership Information Reporting (BOI), goes into effect next year, with initial filings due by January 1, 2025. There are currently 23 exemptions to filing this report; however, the fines for not filing can add up quickly. While not a tax-specific issue, this is a far-reaching business issue to consult on with your advisory teams as to how BOI reporting will or will not affect you.
Read "7 Q&As to Guide You Through Beneficial Ownership Information Reporting Under the Corporate Transparency Act"
Additional Year-End Considerations
Ongoing Information Reporting for Partnerships
On Partner K-1s for 2023, there are a few changes to reporting requirements. Previously, line J regarding ownership changes indicated if a decrease in percentage was due to a sale or exchange of partnership interest. There was one checkbox that combined both of these options. In 2023, however, there are separate checkboxes for sale versus exchange.
The second change to note is in reporting a partner’s share of partnership liabilities. New for the current year, there is a checkbox indicating if a partner is subject to guarantees or other payment obligations related to any of the liabilities reported on the K-1.
These changes, while not major, continue the IRS trend in recent years of gathering more and more information related to partnerships and their owners.
Section 1202 Offers Opportunity for Significant Tax Savings
More and more taxpayers are taking advantage of a tax provision that excludes gains from the sale of stock from a taxpayer’s taxable income. Qualified investments are referred to as Section 1202 stock, and, in short, are shares of stock in small start-up businesses organized as C corporations. Whether you’re eligible or not depends on if you satisfy certain shareholder and corporate level requirements.
If you have recently sold, are looking to sell or even considering an investment in C corporation stock in a small business, you may want to consider your eligibility for the benefits under Section 1202.
Read "New Insights on Excluding Gain on the Sale of Small Business Stock Under Section 1202"
Pass-Through Entity Tax Offers Opportunity for Owners
In 2022, pass-through entity tax (PTET) elections allowed pass-through businesses 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. These elections have proven to be even more valuable in a year where you may have a sale or other unique transaction subject to state tax.
Read "2023 Private Company Conference Brings Awareness on Key Topics"
Positive Changes to Ohio CAT
Many taxpayers may no longer need to file and pay Ohio’s Commercial Activity Tax (CAT) starting in 2024. This gross receipts based tax will only be applicable to companies with $3 million or more gross receipts in Ohio (previously $150,000), as the exclusion to file increases as of January 1, 2024. If you anticipate being below this threshold to file going forward, you can cancel your CAT account with the state, effective December 31, 2023. However, be sure to file any outstanding quarterly or annual filings still applicable for 2023.
Read "Ohio Commercial Activity Tax (CAT) Update — Filing Reductions Ahead"
Accounting Method Changes
While not a new planning tool or tax law change, accounting method changes may be more prominent for business owners to consider. With rising costs of materials and extra inventory on the shelves, implementing LIFO or other inventory method changes may help manage taxable income and ease cash flow. Another example for eligible small taxpayers would be to consider switching to cash basis for tax purposes. With the phase-out of bonus depreciation kicking in this year, it would be a good time to review treatment of fixed assets and capitalization policies as well. All of this to say, there are tools available to business owners to help manage and defer taxable income. There are over 200 accounting method changes taxpayers can implement. Your tax adviser will be able to help navigate which may be the most applicable and beneficial for your situation.
For the last two years as part of other stimulus plans and incentives, businesses have been able to deduct 100% of expenses for meals purchased from a restaurant for their employees, customers, clients, etc. For 2023 and beyond, these expenses are back to 50% deductibility. It is important that these expenses are tracked and accounted for separately in detail to the benefit of the business. For instance, some meals are still fully deductible, including holiday parties or picnics, drinks or snacks for customers, food and beverage supporting a charitable cause, and in-office dinner expenses for employees working late.
Similar to market conditions at the end of 2022, now is a good time to consider ways in which to manage the tax on your investment accounts and plans for retirement. With many investments trading lower or becoming stagnant, loss harvesting and ROTH conversions are both planning tools to consider. Alternatively, if you have recognized losses, you can explore recognizing capital gains to use those losses now as opposed to carrying them forward.
Make good use of the remaining days of the year to sit down with your tax advisers and map out a plan to find tax efficiencies and opportunities for your business. Also, don’t miss “2023 Year-End Tax Planning for High-Net-Worth Individuals” for additional planning tips and strategies.
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.