Definitive Guide to Tax Credits and Deductions

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:

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.

Here are Three Things to Look for in a Tax Advisor:

• 1. What certifications do your experts have?

  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.

• 2. Are they available ALL year?

  Tax planning is a year-round process and your advisors should meet with you regularly, not just at year-end tax-filing time.

• 3. What is their consultative approach?

  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.

Ask Yourself These Questions to Determine if Your Tax Advisor is the Right Fit:

• Does your tax advisor provide continuous information to help your business all year long?
• As your business has grown, have you now outgrown your tax advisor’s expertise?
• Does your tax advisor discuss growth planning, budgeting, and profitability goals?
• Has your tax advisor discussed succession planning and the importance of starting early?
• How much help did your tax advisor provide during COVID-19 with PPP loans, Employee Retention Credits, and other stimulus legislation opportunities?

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.

Here is an Example of the Impact of a $10,000 Tax Deduction vs. a $10,000 Tax Credit:

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.

Here are Three Things to Consider:

• Defer income to next year

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.

• Accelerate deductible expenses into the current year

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.

• Take the opposite approach

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.

 

What is a Business Entity?

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.

 

Comparing the Entity Type Options

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.

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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.

What is Qualified Business Income?

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.

• QBI doesn’t include certain investment items, reasonable compensation paid to an owner for services rendered to the business, or any guaranteed payments to a partner or LLC member treated as a partner for services rendered to the partnership or LLC.
• The 199A deduction isn’t allowed in calculating the owner’s adjusted gross income, but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction (though you don’t have to itemize to claim it).
• When the income-based limit applies to owners of pass-through entities, the 199A deduction generally can’t exceed the greater of the owner’s share of:
• 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year
• The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property

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).

Bonus Depreciation Overview

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:

• Used by the taxpayer or a predecessor before acquiring it
• Acquired from a related party
• Acquired as part of a tax-free transaction

Qualified Improvement Property

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).

Some Caveats to Understand About Bonus Depreciation

At first glance, bonus depreciation can seem like a no-brainer. However, it’s not necessarily advisable in every situation.

• For example, taxpayers who claim the QBI deduction for pass-through businesses could find that bonus depreciation backfires. The amount of your QBI deduction is limited by your taxable income, and bonus depreciation will reduce this income. Like bonus depreciation, the QBI deduction is scheduled to expire in 2026, so you might want to maximize it before then.
• The QBI deduction isn’t the only tax break that depends on taxable income. Increasing your depreciation deduction could also affect the value of expiring net operating losses, charitable contributions, and credit carryforwards.
• The value of any deduction is higher when you’re subject to higher tax rates. And deduction acceleration strategies always should take into account tax bracket expectations in the future. Newer businesses that currently have relatively low income might prefer to spread out depreciation, for example. With bonus depreciation, you’ll also need to account for future declines in the maximum deduction amounts.

Five Things to Know About Bonus Depreciation and Section 179

1. Like bonus depreciation, Section 179 allows a taxpayer to deduct 100% of the purchase price of new and used eligible assets.

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.

2. The deduction is intended to benefit small- and medium-sized businesses.

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.

3. The Section 179 deduction also is limited by the amount of a business’s taxable income.

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.

4. The business can claim the excess as bonus depreciation in the first year.

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.

5. In contrast to bonus depreciation, the Section 179 deduction isn’t automatic.

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.

Examples of Qualifying Individuals

An employer is eligible for the tax credit for qualified wages paid to qualified members of these targeted groups:

WOTC Deadlines and Dollar Values

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.

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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.

A Primer on Qualifying Activities and Industries

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.

A General List of Qualifying Activities and Industries

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.

Here are Some Common Qualifying R&D Activities:

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.

Knowing How to Qualify: Understanding the Four-Part Test

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.

The Answer Lies in the IRS's Four-Part Test

1. Develop a New or Improved Business Component (Product or Process)

• You must create a new product, process technique, formula, invention, patent, or software, or improve an existing one.
• You must improve performance, functionality, quality, reliability, or cost.

2. Technological in Nature (The Discovering Technological Information Test)

• The process of experimentation must rely on the hard sciences such as engineering, physics, chemistry, biology, or computer science.

3. Elimination of Uncertainty

• You must demonstrate that you’ve attempted to eliminate uncertainty about developing or improving a product or process.

4. Process of Experimentation

• You must demonstrate (through modeling, simulation, systematic trial and error, or other methods) that you’ve evaluated alternatives for achieving the desired result.

(Download Video Transcript)

Tips on Working with an R&D Tax Credit Expert

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.

Understanding the Details of the Clean Vehicle Credit

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.

The Credit in a Nutshell

Here’s what you need to know about the credit if you’re thinking about purchasing an electric vehicle (EV):

• The Qualified Plug-in Electric Drive Motor Vehicle Credit has been around since 2008. For passenger vehicles and light trucks acquired after December 31, 2009, the credit starts at $2,500. Vehicles with battery capacities rated at five kilowatt hours qualify for an additional $417, plus an additional $417 for each kilowatt hour of capacity exceeding five kilowatt hours. The credit’s maximum amount is $7,500.
• The credit amount begins to phase out for a manufacturer’s vehicle when at least 200,000 qualifying vehicles have been sold for use in the United States (for sales after December 31, 2009). As a result of this limitation, certain vehicles (including those manufactured by Tesla and General Motors) no longer qualify for the credit.
• The IRA extends the newly named Clean Vehicle Credit through December 31, 2032. It also makes several significant changes to the credit, most of which will phase in over time. For example, the credit now applies to any “clean” vehicle, so a hydrogen fuel cell car or a plug-in hybrid could qualify. It also eliminates the manufacturer production cap after 2022.
• The IRA leaves intact the $7,500 maximum credit amount but bifurcates it. You can earn a $3,750 credit if the qualifying vehicle meets a critical minerals requirement and another $3,750 credit if the vehicle meets a new battery component requirement (see “Potential Hurdles” below).

The Credit Now Includes Income Limitations, Too

It’s NOT available to:

• Single filers with modified adjusted gross income (MAGI) over $150,000
• Married couples filing jointly with MAGI over $300,000
• Heads of household with MAGI over $225,000

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.

Understanding the Two-Step Process

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.

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What are the Potential Hurdles?

The IRA imposes “applicable percentage” requirements for critical minerals and battery components.

• At least 40% of critical minerals must be processed or extracted from the United States (or a country with which the United States has a free trade agreement) or recycled in North America.
• At least 50% of battery components must be manufactured or assembled in North America.

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.

Details of the Transitional Relief for Purchasers

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.

There are New Credits for Used and Commercial Vehicles

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:

• $75,000 for single filers
• $150,000 for married couples filing jointly
• $112,500 for heads of household

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.

(Download Video Transcript)

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.

What are the Eligible Expenses?

Other Considerations for Businesses Regarding the Federal Solar Tax Credit

Triggers Can Vary, But Common Criteria Include:

• Employing workers in the state
• Owning (or, in some cases, even leasing) property there
• Marketing your products or services in the state
• Maintaining a substantial amount of inventory there

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.

Nexus Study

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.

Here are the Top 5 Things You Should Know About Section 1031

What are the Downsides?

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.

What Reporting is Necessary?

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.

Can Residential Properties Be Included?

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.

(Download Video Transcript)

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.

SVA's 2024 - 2025 Tax Planning Guide