2022 Business Planning Guide
With year-end approaching, it is time to consider moves that may help lower your business’s taxes for this year and next. This Guide outlines strategies that may help lower your tax bill. However, careful planning involves more than just focusing on lowering taxes for the current and future years. Each potential tax savings opportunity must be considered in the context of its effect on your entire business. In addition, tax planning for closely-held business entities requires a delicate balance between planning for the business and planning for its owners. WellsColeman is available to answer any questions or help you with your planning needs.
Recent Legislative Changes
The Inflation Reduction Act
The Inflation Reduction Act (IRA) was enacted on August 16, 2022. Tax-related provisions in the IRA include:
- A 15% alternative minimum tax (AMT) on the adjusted financial statement income (also referred to as the “book minimum tax” or “business minimum tax”) of certain large corporations (corporations with at least $1 billion in income), effective for tax years beginning after December 31, 2022.
- A 1% excise tax on corporate stock buybacks, which applies to repurchases made by public companies after December 31, 2022.
- Modification of many of the current energy-related tax credits and the introduction of significant new credits, including new monetization options.
- A two-year extension of the section 461(l) excess business loss limitation rules for noncorporate taxpayers, which are now set to expire for tax years beginning after 2028.
Virginia Creates a New Pass-Through Entity Tax
The Virginia Department of Taxation has released their DRAFT Guidelines for the new Pass-Through Entity Tax (PTET) for tax years 2022 through 2025. The PTET permits a qualifying pass-through entity (“PTE”) to make an annual election to pay an elective income tax at a rate of 5.75% at the entity level. The guidelines also allow a corresponding refundable income tax credit to PTE owners for income tax paid by a PTE if such PTE makes the election and pays the elective income tax imposed at the entity level. In addition, eligible PTEs that make this election will be able to deduct the state tax payment from their federal business tax return in the year a payment is made. To receive the deduction for 2022, an electronic payment using Form 502V must be made by December 31, 2022. Provisions of the bills include:
- Qualifying pass-through entities include:
- General Partnerships
- Limited Partnerships
- Limited Liability Partnerships
- Limited Liability Companies (Single Member Limited Liability Companies do not qualify)
- S Corporations (as long as owned 100% by human beings or other persons eligible to be shareholders in an S-Corporation)
- Certain business trusts
- A qualifying pass-through entity must be owned 100% by human beings. The rules include disregarded entities (single member LLCs) and grantor trusts in the the definition of human beings.
- The election is officially made each year by filling the new PTE form, Virginia Form 502PTET. Once the form is filed (either by the original or extended due date), the election for that tax year is binding. Individual owners will not have an option to opt out of an entity’s election with the Virginia Department of Revenue on the Form 502PTET has been filed.
Consider Tax Accounting Method Changes
More small businesses are eligible to use the cash (as opposed to accrual) method of accounting in earlier years. To qualify as a small business, a taxpayer must, among other things, satisfy a gross receipts test. For 2022, the gross-receipts test is satisfied if, during a three-year testing period, average annual gross receipts do not exceed $27 million. Cash method taxpayers may find it easier to shift income or accelerate expenses.
Qualified Business Income Deduction
Taxpayers other than corporations can deduct up to 20% of their qualified business income. For 2022, if taxable income exceeds $340,100 for a married couple filing jointly or $170,050 for single, married filing separately, and heads of household the deduction may be limited based on:
- Whether the taxpayer is engaged in a service-type trade or business (such as law, accounting, health or consulting);
- The amount of W-2 wages paid by the trade or business; and/or
- The unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business.
The limitations are phased in. For example, the phase-in applies to joint filers with taxable income between $340,100 and $440,100, and to all other filers with taxable income between $170,050 and $220,050.
Business Property Expensing and First Year Bonus Depreciation Deductions
Businesses should consider making expenditures that qualify for the liberalized business property expensing option. For tax years beginning in 2022, the expensing limit is $1,080,000, and the investment ceiling limit is $2,700,000.
- Expensing is generally available for most depreciable property (other than buildings) and off-the-shelf computer software.
- It is also available for qualified improvement property, such as:
- Any improvement to a building’s interior (but not for enlargement of a building, elevators or escalators, or the internal structural framework);
- Roofs; and
- HVAC, fire protection, alarm, and security systems.
The generous dollar ceilings mean that many small and medium sized businesses that make timely purchases will be able to deduct most, if not all, of their outlays for machinery and equipment. As an additional value consideration, the expensing deduction is not prorated for the time that the asset is in service during the year.
- The expensing deduction may be claimed in full (if you are otherwise eligible to take it) regardless of how long the property is in service during the year and can be a useful tool for year-end tax planning.
- Property acquired and placed in service in the last days of 2022, rather than at the beginning of 2023, can result in a full expensing deduction for 2022.
- Please note that there are some additional limits to expensing vehicles that may prevent a full write-off in the year of purchase.
Businesses can claim a 100% first year bonus depreciation deduction for machinery and equipment bought used (with some exceptions) or new (if purchased and placed in service this year), and for qualified improvement property, described above as related to the expensing deduction.
- The 100% write-off is permitted without any proration based on the length of time that an asset is in service during the tax year.
- The 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2022.
Safe Harbor Election
Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense lower-cost assets and materials and supplies, assuming the costs do not have to be capitalized under the Code Sec. 263A uniform capitalization (UNICAP) rules.
To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS; i.e., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500.
Maximize tax benefits of NOLs
Net operating losses (NOLs) are valuable assets that can reduce taxes owed during profitable years, thus generating a positive cash flow impact for taxpayers. Businesses should make sure they maximize the tax benefits of their NOLs.
- For tax years beginning after 2020, NOL carryovers from tax years beginning after 2017 are limited to 80% of the excess of the corporation’s taxable income over the corporation’s NOL carryovers from tax years beginning before 2018 (which are not subject to this 80% limitation, but may be carried forward only 20 years). If the corporation does not have pre-2018 NOL carryovers, but does have post-2017 NOLs, the corporation’s NOL deduction can only negate up to 80% of the 2022 taxable income with the remaining subject to the 21% federal corporate income tax rate. Corporations should monitor their taxable income and submit appropriate quarterly estimated tax payments to avoid underpayment penalties.
- Losses from pass-through entities must meet certain requirements to be deductible at the partner or S corporation owner level.
Defer tax on capital gains
Tax planning for capital gains should consider not only current and future tax rates, but also the potential deferral period, short and long-term cash needs, possible alternative uses of funds and other factors.
Noncorporate shareholders are eligible for exclusion of gain on dispositions of Qualified Small Business Stock. For other sales, businesses should consider potential long-term deferral strategies, including:
- Reinvesting capital gains in Qualified Opportunity Zones.
- Reinvesting proceeds from sales of real property in other “like-kind” real property.
- Selling shares of a privately held company to an Employee Stock Ownership Plan.
Claim available tax credits
Businesses should make sure they are claiming all available tax credits. The U.S. offers a variety of tax credits and other incentives to encourage employment and investment. These tax credits are often in targeted industries or areas such as innovation and technology, renewable energy and low-income or distressed communities. Many states and localities also offer tax incentives.
- The Employee Retention Credit (ERC) is a refundable payroll tax credit for qualifying employers that were significantly impacted by COVID-19 in 2020 or 2021. For most employers, the compensation eligible for the credit had to be paid prior to October 1, 2021. However, the deadline for claiming the credit does not expire until the statute of limitations closes on Form 941. Therefore, employers generally have three years to claim the ERC for eligible quarters during 2020 and 2021 by filing an amended Form 941-X for the relevant quarter. Employers that received a Paycheck Protection Program (PPP) loan can claim the ERC but the same wages cannot be used for both programs.
- Businesses that incur expenses related to qualified research and development (R&D) activities are eligible for the federal R&D credit.
- Small business start-ups are permitted to use up to $250,000 of their qualified R&D credits to offset the 6.2% employer portion of social security payroll tax. The IRA doubles this payroll tax offset limit to $500,000, providing an additional $250,000 that can be used to offset the 1.45% employer portion of Medicare payroll tax.
- Taxpayers that reinvest capital gains in Qualified Opportunity Zones may be able to temporarily defer the federal tax due on the capital gains. The investment must be made within a certain period after the disposition giving rise to the gain. Post-reinvestment appreciation is exempt from tax if the investment is held for at least 10 years but sold by December 31, 2047.
- Other incentives for employers include the Work Opportunity Tax Credit, the Federal Empowerment Zone Credit, the Indian Employment Credit and credits for paid family and medical leave (FMLA).
- There are several tax benefits available for investments to promote energy efficiency and sustainability initiatives. The IRA extends and enhances certain green energy credits as well as introduces a variety of new incentives. Projects that have historically been eligible for tax credits and that have been placed in service in 2022 may be eligible for credits at higher amounts.
Considerations for employers
Employers should consider the following issues as they close out 2022 and enter 2023:
- Now is a good time to review your company’s retirement plan to make sure you are taking advantage of tax deductions as well as providing opportunities for employees and owners to save for retirement.
- Contributions made to a qualified retirement plan by the extended due date of the 2022 federal income tax return may be deductible for 2022; contributions made after this date are deductible for 2023.
- Small businesses can contribute the lesser of (i) 25% of employees’ salaries or (ii) an annual maximum set by the IRS each year to a Simplified Employee Pension (SEP) plan by the extended due date of the employer’s federal income tax return for the year that the contribution is made. The maximum SEP contribution for 2022 is $61,000. The maximum SEP contribution for 2023 is $66,000. The calculation of the 25% limit for self-employed individuals is based on net self-employment income, which is calculated after the reduction in income from the SEP contribution (as well as for other things, such as self-employment taxes).
- Year-end bonuses can be timed for maximum tax effect by both cash- and accrual-basis employers. Cash basis employers deduct bonuses in the year paid, so they can time the payment for maximum tax effect. Accrual-basis employers deduct bonuses in the accrual year, when all events related to them are established with reasonable certainty. However, the bonus must be paid within two months after the end of the employer’s tax year for the deduction to be allowed in the earlier accrual year. Accrual employers looking to defer deductions to a higher-taxed future year should consider changing their bonus plans before year-end to set the payment date later than the 2.5-month window or change the bonus plan’s terms to make the bonus amount not determinable at year-end.
State and local taxes
Businesses should monitor the tax laws and policies in the states in which they do business to understand their tax obligations, to identify ways to minimize their state tax liabilities, and to eliminate any state tax exposure. The following are some of the state-specific areas taxpayers should consider when planning for their tax liabilities in 2022 and 2023:
- Has the business reviewed the nexus rules in every state in which it has property, employees or sales to determine whether it has a tax obligation? State nexus rules are complex and vary by state. Even minimal or temporary physical presence within a state can create nexus (i.e., temporary visits by employees for business purposes; presence of independent contractors making sales or performing services, especially warranty repair services; presence of mobile or moveable property; or presence of inventory at a third-party warehouse). In addition, many states have adopted a bright-line factor-presence nexus threshold for income tax purposes (i.e., $500,000 in sales). Also keep in mind that foreign entities that claim federal treaty protection are likely not protected from state income taxes, and those foreign entities that have nexus with a state may still be liable for state taxes.
- Has the business considered the state income tax nexus consequences of its mobile or remote workforce, including the impacts on payroll factor and sales factor sourcing? Most states that provided temporary nexus and/or withholding relief relating to teleworking employees lifted those orders during 2021.
These are just some of the year-end tax planning strategies that could potentially benefit you and your business. Please contact us if you have questions, want more information, or would like us to assist with year-end planning.
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