Tax regulations are created and modified by legislation passed by Congress. As we discuss the various tax regulations and opportunities, several recent bills will be referenced as these significantly impacted the tax opportunities available to individuals and business owners.
To help guide you through the acronyms, here is a quick list of recent legislation:
The Tax Cuts and Jobs Act changed deductions, depreciation, expensing, tax credits, and other tax items that affect businesses.
The Consolidated Appropriations Act added new phases, allocations, and guidance from the CARES Act.
The Family First Coronavirus Response Act addressed the COVID-19 pandemic by increasing funding for American workers affected by the pandemic.
The American Rescue Plan Act provided economic and other relief from COVID-19 and extended critical provisions in the CARES Act and the Consolidated Appropriations Act.
The Coronavirus Aid, Relief, and Economic Security Act provided relief to individuals and businesses to help them weather the pandemic.
The Infrastructure Investment and Jobs Act created a modest number of tax changes and focused on spending for roads, highways, bridges, public transit, and utilities.
The Inflation Reduction Act included significant provisions related to climate change, health care, and taxes.
As a business leader, you should surround yourself with trusted advisors who have specific expertise to help you make effective business decisions. Your tax advisor is an integral part of your team.
An Enrolled Agent (EA) is a tax specialist, and a Certified Public Accountant (CPA) specializes in tax preparation and planning, as well as other advisory services. Having licensed advisors is an important differentiator.
Tax planning is a year-round process and your advisors should meet with you regularly, not just at year-end tax-filing time.
Your advisor should take the time to understand you, your family, and your financial and business goals. A strategic advisor should also help you with budgeting, projections, growth, and succession planning.
We all know taxes are inevitable. But rather than dreading working through tax issues, bring in an expert advisor who gives you the confidence that you are minimizing your tax burdens as much as possible.
As you embark on the upcoming year, create a list of what has gone well in the past and what improvements you would like with your new tax advisor.
A tax credit is considered more favorable than a tax deduction because it reduces the tax due, not just the amount of taxable income.
A tax deduction reduces your taxable income and the tax rate used to calculate your taxes. The result can be a larger refund of your tax withholding.
A tax credit reduces your taxes which gives you a larger refund of your withholding. Plus certain tax credits can give you a refund even if you have no withholding.
Here is an Example of the Impact of a $10,000 Tax Deduction vs. a $10,000 Tax Credit:
|Adjusted Gross Income||$90,000||$90,000|
|Less Tax Deduction||($10,000)|
|Tax Rate Example||25%||25%|
|Less Tax Credit||($10,000)|
|Your Tax Bill||$20,000||$12,500|
Projecting your business’s income for this year and next can allow you to time income and deductions to your advantage. It’s generally — but not always — better to defer tax.
If your business uses the cash method of accounting, you can defer billing for products or services at year-end. If you use the accrual method, you can delay shipping products or delivering services.
If you’re a cash-basis taxpayer, you may pay business expenses by December 31st so you can deduct them this year rather than next. Both cash and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid.
If your business is a flow-through entity and you’ll likely be in a higher tax bracket next year, accelerating income and deferring deductible expenses may save you more tax over the two-year period.
An organization that is formed for one or more people to conduct business activities is known as a business entity.
The choice of business entity structure is crucial as it determines how the entity is taxed and who will be liable for paying the obligations and debts.
Income taxation and owner liability are the main factors that differentiate one business entity structure from another.
Many businesses choose entities that combine pass-through taxation with limited liability, namely limited liability companies (LLCs) and S corporations. But recent changes warrant revisiting the tax consequences of business entity structures.
The now flat corporate tax rate (21%) is significantly lower than the top individual rate (37%), providing significant tax benefits to C corporations and helping to mitigate the impact of double taxation for owners.
In addition, the corporate alternative minimum tax (AMT) has been repealed, while the individual AMT remains (though it will affect far fewer taxpayers). But the TCJA also introduced a powerful deduction for owners of pass-through entities.
For tax or other reasons, a structure change may be beneficial in certain situations. But there also may be unwelcome tax consequences that effectively prevent such a change.
Personal Liability of Owners
|C Corporation||Unlimited number of shareholders allowed; no limit on stock classes||Generally no personal liability of the shareholders for the obligations of the corporation||Corporation taxed on its earnings at the corporate level and the shareholders have a further tax on any dividends distributed (double taxation)|
|S Corporation||Up to 75 shareholders allowed; only one basic class of stock allowed||Generally no personal liability of the shareholders for the obligations of the corporation||Entity generally not taxed as the profits and losses are passed through to the shareholders (pass-through taxation)|
|Sole Proprietorship||One owner||Unlimited personal liability for the obligations of the business||Entity not taxed as the profits and losses are passed through to the sole proprietor|
|General Partnership||Unlimited number of general partners allowed||Unlimited personal liability of the general partners for the obligations of the business||Entity not taxed as the profits and losses are passed through to the general partners|
|Limited Partnership (LP)||Unlimited number of general and limited partners allowed||Unlimited personal liability of the general partners for the obligations of the business; limited partners generally have no personal
|Entity not taxed as the profits and losses are passed through to the general and limited partners|
|Limited Liability Company (LLC)||Unlimited number of members allowed||Generally no personal liability of the members for the obligations of the business||Entity not taxed (unless chosen to be taxed) as the profits and losses are passed through to the members|
Through 2025, the TCJA provides the Section 199A deduction for sole proprietorships and owners of pass-through business entities such as partnerships, S corporations, and LLCs that are treated as sole proprietorships, partnerships, or S corporations for tax purposes.
Qualified Business Income (QBI) is the net amount of qualified items of income, gain, deduction, and loss from any qualified trade or business which includes income from partnerships, S corporations, sole proprietorships, and certain trusts.
The deduction generally equals 20% of QBI, subject to limitations that can begin to apply if taxable income exceeds the applicable threshold. In 2022, those limits are:
If you’re over that limit, a special formula is used to calculate the deduction.
Bonus depreciation has been available in varying amounts for some time.
Immediately before the passage of the TCJA, for example, taxpayers generally could claim a depreciation deduction of 50% of the purchase price of qualified property in the first year — as opposed to deducting smaller amounts over the useful life of the property under the modified accelerated cost recovery system (MACRS).
Businesses can take advantage of the deduction by purchasing, among other things, property with a useful life of 20 years or less. This includes computer systems, software, certain vehicles, machinery, equipment, and office furniture.
Both new and used property can qualify. Used property generally qualifies if it wasn’t:
Qualified improvement property (generally, interior improvements to nonresidential property excluding elevators, escalators, interior structural framework, and building expansion) also qualifies for bonus depreciation.
A drafting error in the TCJA indicated otherwise, but the CARES Act, enacted in 2020, retroactively made such property eligible for bonus depreciation.
Taxpayers who placed qualified improvement property in service in 2018, 2019, or 2020 may, generally, now claim any related deductions not claimed then — subject to certain restrictions.
Buildings themselves aren’t eligible for bonus depreciation, with their useful life of 27.5 (residential) or 39 (commercial) years, but cost segregation studies can help businesses identify components that might be.
These studies identify parts of real property that are tangible personal property. Such property has shorter depreciation recovery periods and therefore qualifies for bonus depreciation in the year placed in service.
The placed-in-service requirement is particularly critical for those wishing to claim 100% bonus depreciation before the maximum deduction amount falls to 80% in 2023.
With the continuing shipping delays and shortages in labor, materials, and supplies, taxpayers should place their orders promptly to increase the odds of being able to deploy qualifying property in their businesses before year-end.
Take note that the IRS automatically applies bonus depreciation unless a taxpayer opts out. Elections apply to all qualified property in the same class of property placed in service in the same tax year (for example, all five-year MACRS property).
At first glance, bonus depreciation can seem like a no-brainer. However, it’s not necessarily advisable in every situation.
The TCJA expanded the bonus depreciation deduction to 100% in the year qualified property is placed in service through 2022, with the amount dropping each subsequent year by 20% until bonus depreciation sunsets in 2027. Special rules apply to properties with more extended recovery periods.
|Year||Bonus Depreciation Limit|
Taxpayers sometimes confuse bonus depreciation with Section 179 expensing. The two tax breaks are similar but distinct.
Eligible assets include software, computer and office equipment, certain vehicles and machinery, and qualified improvement property. However, Section 179 is subject to some limits that don’t apply to bonus depreciation. For example, the maximum allowable deduction for 2022 is $1.08 million.
It begins phasing out on a dollar-for-dollar basis when qualifying property purchases exceed $2.7 million. In other words, the deduction isn’t available if the cost of Section 179 property placed in service this year is $3.78 million or more.
Applying the deduction can’t create a loss for the company. Any cost not deductible in the first year can be carried over to the next year for an unlimited number of years. Such carried-over costs must be deducted according to age — for example, costs carried over from 2019 must be deducted before those carried over from 2020.
For example, if you purchase machinery that costs $20,000 but, exclusive of that amount, has only $15,000 in income for the year it’s placed in service. Presuming you’re otherwise eligible, you can deduct $15,000 under Section 179 and the remaining $5,000 as bonus depreciation.
You must claim it on a property-by-property basis.
The Work Opportunity Tax Credit (WOTC) is a federal tax credit available to employers who hire individuals from certain targeted groups.
An employer is eligible for the tax credit for qualified wages paid to qualified members of these targeted groups:
The size of the tax credit depends on the hired person’s target group, the wages paid to that person, and the number of hours that person worked during the first year of employment.
The maximum tax credit that can be earned for each target group member is generally $2,400 per adult employee. The CAA extends this credit through December 31, 2025.
The credit can be higher for members of specific target groups, up to as much as $9,600 for certain veterans. Employers aren’t subject to a limit on the number of eligible individuals they can hire. If ten individuals qualify, the credit can be ten times the listed amount.
It’s probably no surprise that businesses in many industries across the U.S. undertake innovative work every day.
From designing new products and processes to testing prototypes, improving current products and processes, engaging in testing and certifying and more, innovation drives growth — and growth plays a vital role in today’s competitive business landscape.
What may surprise you is that those businesses, including potentially yours, have an opportunity to receive substantial money for their innovative work. Thanks to federal and state research and development (R&D) tax credits, this opportunity exists.
Today, R&D tax credits are one of the most significant tax tools under current law for maximizing a business’s cash flow.
Yet year after year, companies in multiple industries miss out on tens, even hundreds, of thousands of dollars in money-saving opportunities.
In fact, according to industry experts, less than 33% of companies that qualify for R&D credits apply for them. Consequently, millions of dollars undoubtedly go unclaimed each year. Why is that?
The chief reason lies with a long-held misconception, still prevalent today, that R&D tax credits are reserved for companies with established R&D departments staffed by “white lab coat” types (e.g., scientists, medical researchers, technicians, and testing personnel). The misconception was further entrenched by the temporary nature of the tax credit program over many years (specifically, it was hastily extended more than a dozen times since its passage in 1981).
Thankfully, federal R&D tax credits have now been made permanent, so there is no better time to reinvest in your business by getting credit for your qualified R&D activities.
While lots of businesses in many industries potentially qualify for R&D tax credits, “typical” R&D businesses (e.g., professional, scientific, and technical services) comprise only 10% of all credits claimed, according to the IRS.
On top of that, only one out of every 20 eligible businesses takes advantage of the R&D credit. Why?
Because many companies don’t realize that their industry is ripe with eligible activities. So, which of your business’s activities could potentially qualify? An R&D tax credit survey can help you make that determination.
In general, if your company has invested money, time, and resources in activities that help improve a process, product, technique, or formula, or contribute to the invention of a new process or product, you stand a good chance of qualifying.
Additionally, certain expenses qualify for R&D tax credits. These include supplies directly linked to qualified research activities, wages related to performing a qualified service, and payments to third-party contractors that meet the same qualification requirements for wages.
Now that you have a better sense of the R&D tax credit, what kinds of activities potentially qualify, and in what industries such activities typically occur, how do you know if your activities are eligible for R&D tax credits?
The R&D tax credit incentivizes certain research activities by reducing a company’s liabilities for spending money on that research. The credit is equal to a certain percentage of a business’s qualified research expense (QRE) over a base amount.
Expenses that qualify are more comprehensive than you may think — QREs can include the salaries of employees and supervisors conducting research, supplies, and even some of the research contracted out.
Regardless of your business’s size, revenue, or industry, the IRS’s Four-Part Test can help you determine whether your work meets the R&D tax credit eligibility.
Even though the R&D tax credit is a lucrative incentive by most standards, it has proven to be an elusive target for many businesses. That’s largely because confusion over qualification and documentation has prompted far too many companies to turn away from the credits, leaving them primarily within the sphere of large companies and the high-tech industry.
For this reason, we recommend that business owners partner with an outside expert to manage the nuts and bolts of an R&D tax credit survey for their company.
An R&D tax credit survey from a professional R&D tax expert will help you determine which of your business activities qualify and they will guide you through the documentation needed for eligibility.
Eligibility requirements are clearly defined by the IRS and governments in states that offer R&D tax credits. Any company considering the R&D tax credit path should be prepared to identify, document, and support its qualifying activities.
In this regard, it is critical to establish appropriate tracking mechanisms and documentation strategies for all R&D activities.
The Inflation Reduction Act (IRA) includes new, extended, and increased tax credits intended to incentivize businesses and individuals to boost their use of renewable energy.
For example, it provides tax credits to private companies and public utilities to produce renewable energy or manufacture parts used in renewable projects such as wind turbines and solar panels. Clean energy producers that pay a prevailing wage also may qualify for tax credits.
The IRA includes a wide range of tax incentives aimed at combating the dire effects of climate change. One of the provisions receiving considerable attention from consumers is the expansion of the Qualified Plug-in Electric Drive Motor Vehicle Credit (IRC Section 30D), now known as the Clean Vehicle Credit.
While the expanded credit seems promising, questions have arisen about just how immediate its impact will be.
Here’s what you need to know about the credit if you’re thinking about purchasing an electric vehicle (EV):
It’s NOT available to:
The credit is also limited by the price of the vehicle. Vans, pickup trucks, and SUVs with a manufacturer’s suggested retail price (MSRP) of more than $80,000 don’t qualify. Other cars must have MSRPs no higher than $55,000.
One critical change that took effect immediately after President Biden signed the bill into law is the so-called “final assembly” requirement.
It limits the credit to vehicles for which final assembly occurred in North America. Final assembly generally refers to the production of an EV at the location from which it’s delivered to a seller with all the necessary component parts included. The requirement is designed to encourage domestic production.
The IRS has established a two-step process to check whether a specific vehicle satisfies the final assembly requirement.
First, check the U.S. Department of Energy’s Alternative Fuels Data Center’s list of 2022 and 2023 EVs that likely meet the requirement (https://bit.ly/3An4yYz). Be aware that because some models are assembled in multiple locations, some of the listed vehicles might not meet the requirement.
Second, to confirm that a specific vehicle’s final assembly occurred in North America, enter its Vehicle Identification Number (VIN) into the National Highway Traffic Safety Administration’s VIN decoder tool (https://bit.ly/3dOLUkF).
By scrolling to the bottom of the results page, you’ll see the vehicle’s “Plant Information,” which includes the country where the plant is located.
For now, taxpayers who purchase qualifying EVs will continue to claim a credit on their annual tax returns. The IRA, however, provides an alternative — and much more taxpayer-friendly — option beginning in 2024.
At that point, EV purchasers can transfer their credit to dealers at the point of sale, rather than waiting to claim it on their annual tax returns. The credit will directly and immediately reduce the purchase price.
The IRA imposes “applicable percentage” requirements for critical minerals and battery components.
The initial percentages will take effect after the IRS issues proposed guidance, which the IRA mandates to occur before December 31, 2022.
The percentages then ramp up over time, peaking at 80% of critical minerals after 2026 and 100% of battery components after 2028.
The critical mineral exclusion takes effect for vehicles placed in service after 2024. The battery component exclusion is effective for vehicles placed in service after 2023.
The credit is not available for vehicles with critical minerals or battery components from a “foreign entity of concern,” including China and Russia.
These rules have raised concerns among the automotive industry, particularly as a substantial amount of the supply chain for minerals and battery components is located in China.
What if you signed a contract on an EV before August 16, 2022, when the IRA was enacted, but haven’t yet received the vehicle?
The IRS has stated that the changes in the law won’t affect your tax credit. You can claim it under the rules in effect when you signed the purchase contract.
Unfortunately, that means the manufacturer cap will still apply. If you purchase a vehicle from a manufacturer that hit the 200,000 vehicle threshold more than a year prior, you don’t qualify for the EV credit. On the other hand, the final assembly requirement won’t apply.
If you purchase and take possession of a qualifying EV after the law was signed (on August 16, 2022) but before January 1, 2023, the only difference to the prior rules is the applicability of the final assembly requirement.
That means the manufacturer cap also would apply to your purchase. So, if you’re interested in a model that’s disqualified under the cap, it might pay to wait until 2023 if the vehicle meets the requirements then.
The IRA also creates tax credits for used EVs (Section 25E) and commercial EVs (Section 45W), both starting in 2023. The IRS has indicated it will release more information on these credits in the coming months.
According to the IRA, the Section 25E credit is worth the lesser of $4,000 or 30% of a qualified vehicle’s sales price. The sales price can’t exceed $25,000. The credit is available only for EVs with model years at least two years earlier than the year of purchase.
No credit is available if the lesser of the taxpayer’s MAGI for the year of purchase or the preceding year exceeds:
The credit for commercial EVs is the lesser of 15% of the vehicle’s basis (30% for vehicles not powered by a gas or diesel engine) or the incremental cost of the vehicle over the cost of a comparable gas- or diesel-powered vehicle.
The maximum credit per commercial vehicle is $7,500 for vehicles with a gross vehicle weight under 14,000 pounds and $40,000 for heavier vehicles.
The federal residential solar energy credit is a tax credit that can be claimed on federal income taxes for a percentage of the cost of a solar photovoltaic (PV) system.
The credit is available for residential, commercial, and utility investors in solar energy properties. The tax credit is equal to a percentage of the cost basis of installing eligible solar energy property.
In December 2020, Congress approved an economic stimulus package designed in part to provide COVID-19 relief. That package included a two-year extension of the Federal Solar Investment Tax Credit (ITC). The ITC for solar customers was initially scheduled to drop from 26% in 2020 to 22% in 2021 and then be phased out all together in 2022.
The recent IRA legislation increased and extended the credit to 30% from 2022 through 2032. In 2033, it will reduce to 26%, and in 2034 to 22%.
Operating in another state means possibly being subject to taxation in that state. The resulting liability can, in some cases, inhibit profitability. But sometimes, it can produce tax savings. Nexus means a business presence in a given state that’s substantial enough to trigger that state’s tax rules and obligations. Precisely what activates nexus in a given state depends on that state’s chosen criteria.
A minimal amount of business activity in a given state probably won’t create tax liability there. For example, an HVAC company that makes a few service calls a year across state lines probably wouldn’t be taxed in that state.
Or if a salesperson travels to another state to establish relationships or gauge interest. As long as they don’t close any sales and you have no other activity in the state, you likely won’t have nexus.
If your company already operates in another state and you’re unsure of your tax liabilities there — or if you’re considering starting up operations in another state — consider conducting a nexus study. This is a systematic approach to identifying the out-of-state taxes your business activities may expose you to.
Keep in mind that the results of a nexus study may not be negative. You might find that your company’s overall tax liability is lower in a neighboring state. In such cases, it may be advantageous to create nexus in that state (if you don’t already have it) by setting up a small office there. If all goes well, you may be able to allocate some income to that state and lower your tax bill.
Did you know you can defer capital gains on investment properties with a 1031 like-kind exchange? As an investor in real estate, you may be able to take advantage of IRS Section 1031.
A 1031 exchange is also referred to as a like-kind exchange because it is a swap of one investment property for another for tax purposes.
You can change your investment to another property without cashing out the fund or recognizing the income as capital gains. This allows for tax-deferred growth of your initial investment.
There is no limit to how often you use the Section 1031 option. You can roll over your initial investment as many times as you like. You will only need to pay capital gains on the investment when you cash out.
Like-kind is a general term that allows you to exchange many investment properties – they do not need to be the same type of investment. For example, you can exchange an apartment building for raw land or a strip mall for a different kind of business.
One rule you need to be wary of is the Depreciable Property rule. If you swap improved land with a building for unimproved land without a building, the depreciation you previously claimed on the building will be recaptured as ordinary income.
There is a 45-day rule that states you must designate the replacement property for the property you sold. And a 180-day law states you must close on the new property within 180 days of the sale of the old property.
This sounds simple, but some exceptions and clarifications may come into play with your individual scenario.
Eventually, the tax deferral will end and there could be a big tax hit when that happens. Estate planning can help as tax liabilities end with death. Your heirs can inherit the property at the stepped-up market rate value, and they won’t be required to pay the taxes you postponed paying with the Section 1031 scenarios.
You are required to submit Form 8824 when you file your tax return for the year in which the exchange occurred. The form requires that you provide details of the properties including each property’s value.
Your primary and secondary residences do not qualify for Section 1031 unless you rent it out for a reasonable period and do not live there during that time. At that point, the property becomes an investment property and may qualify.
Tax planning is an essential part of your business strategy. Each business has its own unique circumstances and using an experienced tax advisor who will delve into your specific situation is imperative.
This eGuide provides highlights of each tax credit and deduction currently available. But rules shift and change and understanding how to use each option together will net the best results. Tax planning is a year-round discussion. Don’t wait until year-end.