This year’s planning is more challenging than usual due to recent changes made by the Inflation Reduction Act of 2022 and the potential change in congressional balance of power resulting from the midterm elections.

 Whether or not tax increases become effective next year, the standard year-end approach of deferring income and accelerating deductions to minimize taxes will continue to produce the best results for most small businesses, as will the bunching of deductible expenses into this year or next to maximize their tax value.

 If proposed tax increases do pass, however, the highest income businesses and owners may find that the opposite strategies produce better results: Pulling income into 2022 to be taxed at currently lower rates, and deferring deductible expenses until 2023, when they can be taken to offset what would be higher-taxed income. This will require careful evaluation of all relevant factors.

 We have compiled a list of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all of them will apply to you or your business, but you may benefit from many of them. We can narrow down specific actions when we meet to tailor a particular plan for your business, In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves might be beneficial:

1.      Pass-Through Entity (PTE) Tax Elections: The TCJA introduced the state and local tax (SALT) cap, which restricted the amount of state and local taxes deductible by individuals to $10,000. Many states have begun adopting legislation that allows a PTE (S Corporations and Partnerships) to elect to pay state-level taxes at the company level and claim a federal deduction at the entity level rather than passing the tax liabilities to the pass-through owners. Depending on each state’s legislation, pass-through owners also may claim a credit against their resident state income taxes for their share of PTE tax paid by the business or exclude income that is subject to the PTE tax. Business owners should reach out to us to evaluate if they can benefit from the entity-level state tax elections.

2.      Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income. For 2022, if taxable income exceeds $340,100 for a married couple filing jointly, (about half that for others), 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 business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the business. The limitations are phased in; for example, the phase-in applies to joint filers with taxable income up to $100,000 above the threshold, and to other filers with taxable income up to $50,000 above their threshold.

3.      Taxpayers may be able to salvage some or all of this deduction, by deferring income or accelerating deductions to keep income under the dollar thresholds (or be subject to a smaller deduction phaseout) for 2022. Depending on their business model, taxpayers also may be able increase the deduction by increasing W-2 wages before year-end. The rules are quite complex, so don't make a move in this area without consulting us.

4.      More small businesses are able to use the cash (as opposed to accrual) method of accounting than were allowed to do so in earlier years. To qualify as a small business a taxpayer must, among other things, satisfy a gross receipts test, which is satisfied for 2022 if, during a three-year testing period, average annual gross receipts don't exceed $27 million (next year this dollar amount is estimated to increase to $29 million). Not that many years ago it was $1 million. Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings till next year or by accelerating expenses, for example, paying bills early or by making certain prepayments.

5.      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 interior improvements to a building (but not for its enlargement), elevators or escalators, or the internal structural framework), for roofs, and for HVAC, fire protection, alarm, and security systems.

6.      The generous dollar ceilings mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What's more, the expensing deduction is not prorated for the time that the asset is in service during the year. So expensing eligible items 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.

7.      Through 2022, a 100% bonus first year depreciation deduction is allowed 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. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2022. Starting in 2023 this bonus depreciation decreases to 80%.

8.      Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs aren’t required to be capitalized under the 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, e.g., 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. Where the UNICAP rules aren't an issue, and where potentially increasing tax rates for 2023 aren’t a concern, consider purchasing qualifying items before the end of 2022.

9.      A corporation (other than a large corporation) that anticipates a small net operating loss (NOL) for 2022 (and substantial net income in 2023) may find it worthwhile to accelerate just enough of its 2023 income (or to defer just enough of its 2022 deductions) to create a small amount of net income for 2022. This allows the corporation to base its 2023 estimated tax installments on the relatively small amount of income shown on its 2022 return, rather than having to pay estimated taxes based on 100% of its much larger 2023 taxable income.

10.  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 2½ 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.

11.  Employee retention credit (ERC) –– The ERC encouraged businesses to keep employees on their payroll during the pandemic. Although these credits relate to tax years 2020 and 2021, applying for these credits is still available. The IRS warned employers to be cautious of third parties taking improper positions related to ERC eligibility, as claiming the credit inaccurately can result in severe consequences. We can help you appropriately navigate the ERC.

12.  Losses and shareholder or partnership basis: A shareholder can deduct its pro rata share of S corporation losses only to the extent of the total of its basis in the S corporation stock and debt. This determination is made as of the end of the S corporation tax year in which the loss occurs. Any loss or deduction that can't be used on account of this limitation can be carried forward indefinitely. If a shareholder wants to claim a 2022 S corporation loss on its own 2022 return, but the loss exceeds the basis for its S corporation stock and debt, it can still claim the loss in full by lending the S corporation more money or by making a capital contribution by the end of the S corporation's tax year (in the case of a calendar year corporation, by December 31. Similarly, a partner's share of partnership losses is deductible only to the extent of their partnership basis as of the end of the partnership year in which the loss occurs. Basis can be increased by a capital contribution, or in some cases by the partnership itself borrowing money or by the partner taking on a larger share of the partnership's liabilities before the end of the partnership's tax year.

13.  The impact of the passive activity loss limitation rules must also be considered. Limited partners always have passive activity interests except to the extent IRS regs say otherwise. If an individual who is a limited partner meets the material participation test under the 500-hours-of-participation rule, the five-of-ten-years-of-material-participation rule, or the any-three-prior-year-material-participation rule for a personal service activity, the partner is treated as materially participating in any activity of the limited partnership. This will affect the application of the passive activity rules to their share of any income, gain, loss, deduction, or credit attributable to the limited partnership interest and to any gain or loss from the activity recognized on the sale or exchange of the interest.

These are just some of the year-end steps that can be taken to save taxes. Every business is different, however, and planning more specifically for the year-end is almost always worth the financial cost of doing so. Again, by contacting us, we can tailor a particular plan that will work best for you.