It’s the time of year when we’re immersing ourselves in fall sports, thinking about the holiday season, preparing budgets for next year, and of course, planning year-end tax strategies.
Year-end tax planning for businesses will come with more certainty than in recent years. The passage of the Inflation Reduction Act provided closure for many tax hikes aimed at businesses and individuals that were proposed by lawmakers over the past couple of years, which means that businesses will be able to develop a clear plan moving into 2023, and with the right strategies, even small adjustments can yield greater gains for the financial health and growth of your business.
Below are the key tax updates and strategies to consider before yearend.
Inflation Reduction Act Tax Implications
Most businesses averted major tax legislation proposed in the beginning of the year that sought to sharply raise corporate and capital gains taxes. Instead, a more toned-down version of the bill was passed in August. Effective for tax years after Dec. 31, 2022, the Inflation Reduction Act unveiled four major tax changes for businesses, including:
- 15% alternative minimum tax (AMT) on corporations with over $1 billion in revenue
- 1% excise tax on corporate share buybacks
- Two-year extension of limitation on excess business losses
- Research and development credit increase
Large Corporations subject to the new AMT in 2023 will need to calculate their adjusted financial statement income for tax years 2020, 2021, and 2022.
It’s also worth noting that the scope of the excise tax may apply to more situations beyond public company share buyback programs, such as preferred stock redemptions, split-off transactions, leveraged buyouts, tax-free reorganizations with boot, or special purpose acquisition company redemptions. Consider these potential tax implications in your year-end planning strategy.
Post-Election Tax Extenders
While the Inflation Reduction Act finally made its way into law this year, there are many changes that could still resurface and some extenders that taxpayers are hoping for. Here are a couple of notable items with bipartisan support or high priority items for one political party or the other that could be on the table after the election in Mid-November through Mid-December.
- Section 174 research and development immediate expensing. See below for further explanation.
- Retirement legislation aimed at growing Americans’ retirement savings. The House passed a bill back in March with significant bipartisan support, and there are two Senate Committees with bills, all three having many overlapping provisions.
- LIFO (“Last-In, First-Out”) inventory accounting method for Auto Dealers has huge co-sponsorship in Congress.
- Restoring the business interest expense deduction limit back to higher 2020 limits.
Massachusetts’s Pass-Through Credit
The Inflation Reduction Act also passed with no repeal or changes to the state and local tax (SALT) deduction limitation. Luckily, many states have enacted workarounds to the $10,000 cap. Specifically, Massachusetts introduced a workaround for taxpayers in September 2021 that eliminates some of the rules and limitations surrounding the elective pass-through entity tax.
Beginning on or after January 1, 2021, this elective tax allows S corporations, partnerships, and certain trusts to elect to pay a 5% pass-through entity tax on taxable income at the entity level to reduce the amount of federal taxable income passed through the each of the owners. Since the business entity is not subject to the SALT cap, it can deduct a much higher amount than the individuals can on a personal return, thus circumventing the cap. Qualifying taxpayers are eligible for a credit equal to 90% of their distributive share of the elective tax paid.
Be sure to discuss eligibility, timing of election and payments, and other considerations with your advisor to determine if this strategy makes sense for you and your business.
Sunsetting Bonus Depreciation
One of the most significant provisions amplified and extended by the Tax Cuts and Jobs Act of 2017 is the 100% bonus depreciation on qualifying property. The full deduction amount is phasing out after 2022, which means taxpayers only have a few weeks left to take advantage of this big benefit.
Businesses have an opportunity to deduct the full amount of qualifying assets with a recovery period of 20 years or less placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
Qualifying new and used property may include:
- Machinery and equipment
- New and used vehicles
- Computers and software
- Furniture and appliances
- Film, television, and live theatrical production
After 2022, bonus depreciation is set to be reduced by 20% in subsequent years, eventually phasing out completely in 2027.
Businesses can also pair Section 179 deductions—currently capped at $1.08 million—with bonus depreciation on most qualifying new and used property. Section 179 deductions are gradually phased out when expenditures exceed $2.7 million.
As a year-end planning strategy, businesses should consider a cost segregation study to increase the value of bonus depreciation (especially while deductions are high) and Section 179 expensing. Performed by a team of engineers, accountants, and construction professionals, a cost segregation study would be able to accurately identify, classify, and calculate all building assets that would be eligible for accelerated depreciation, therefore increasing cash flow and saving you money.
Section 174 R&E Expenditures
There are substantial efforts from the American Institute of CPAs (AICPA) and others in the industry as well as in Congress to delay or repeal this change; however, unless changes are enacted by Congress, taxpayers can no longer immediately expense research and experimental (R&E) expenditures. Starting in 2022, R&E expenses must be capitalized and amortized over a 5-year period, or 15 years for foreign expenditures. As a result of this new tax-accounting treatment, this change may prompt some businesses to file for a change in accounting method; although, as of the date of this article, the IRS has not issued any formal guidance.
While there’s bipartisan support to postpone or eliminate this change, we encourage businesses to put a plan in place to accurately capture R&E costs and distinguish them from other business expenditures. It’s also important to consider how the increase in taxable income may change quarterly estimated income tax payments.
Additional Considerations
In addition to the above-mentioned tax changes and strategies, businesses should also consider:
- Maximizing net operating loss (NOL) tax deductions – 80% carry forward in 2022
- Maximizing Section 163(j) interest expense deductions
- Deferring tax on capital gains
- Leveraging 100% business-related meal deduction set to revert to 50% deduction in 2023
Defer or Accelerate Income?
Depending on your current situation and goals for the future, deferring or accelerating income and deductions is a traditional year-end planning strategy used to reduce tax liability.
Traditionally, deferring income by delaying billing for goods and services into next year is one way to defer the tax on that income if your business uses the cash method of accounting. Conversely, if your business uses the accrual method, then delaying the shipping of goods or delivery of services can be used to defer taxable income.
Next Steps
Contact me at stu@eaglerockfinancial.net to schedule a year-end business planning meeting to discuss strategies for your business.