As another year ends, we still have uncertainty whether a tax package will be included in legislation to extend expiring tax credits, delay or remove the change to the treatment of research and development expenses or if the child credit will be enhanced again. We have been watching the actions of Congress and following the elections. Since we now know that we have a split Congress we are not expecting any major tax packages to be passed while they are focusing on the December 16th deadline for government funding.
Year-end tax planning is always important, even when we do not have all the legislative answers and certainty. This advisor includes items that you should consider as it relates to your taxes and year-end planning.
Each year has its own opportunities and challenges, the end of 2022 is no different. The best way to start is by identifying any changes in your personal situation that would affect your taxes this year and that you expect to occur in the future.
Postponing income is typically desirable for those taxpayers who anticipate being in a lower tax bracket next year due to a change in their financial circumstances. In the past, postponing income went together with accelerating deductions, but this may not be the best plan for you as you may see in our bunching deductions section below. If you think you will be in a higher tax bracket in 2022 due to increased income or a different tax situation, then postponing income to 2022 may not be advisable.
Capital Gains and Losses
If you currently have large, realized capital gains, consider harvesting capital losses. You can realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, the original holding can be sold, then buy back the same securities at least 31 days later. Minimizing the net capital gains will also help lower the 3.8% surtax on net investment income and the QBI deduction described below. If you are in a lower tax bracket, your long-term capital gains tax rate may be 0% so make sure to analyze your situation before you sell stocks at a loss. If you are on the opposite side of this position and have already realized capital losses, you may want to consider harvesting your capital gains. You could sell stocks that you are holding at a gain, recognize it and then repurchase the same stock if you still want to hold it.
Another way to lower your 2022 income is through retirement plans. Employees wishing to defer income to future years should take advantage of maximizing the amount contributed into their employer sponsored retirement plan. For 401(k) plans:
- For 2022, the maximum deferral is $20,500 with an additional catch-up contribution of $6,500 for those over 50 years old as of December 31, 2022.
- For 2023, the maximum deferral is increased to $22,500 and the additional catch-up contribution increases to $7,500.
For a list of other cost of living adjustments
, we’ve compiled a three-year side-by-side comparison of the dollar limitations for benefits and contributions.
Roth IRA Conversions
Depending on your retirement accounts, your personal tax situation, and the current decline in the markets it may be beneficial for you to convert your traditional IRA to a Roth IRA. The amount converted would be taxable in the current year, but the earnings will grow tax free and not be taxable when distributed. There are many items to consider with a Roth IRA conversion so you should talk to your advisor before initiating a conversion.
Qualified Business Income (QBI) Deduction
The rules for this deduction are very complex. Adding to the complexity are taxable income limitations, wage limitations and/or asset limitations. If you are in a specified trade or business (most service businesses), the taxable income limitations are critical and will likely make the difference of getting the QBI deduction or not. For these business owners, lowering your taxable income may help you take full advantage of this deduction. Lowering your taxable income can be done in various ways, including:
- postponing income into 2023;
- increasing itemized deductions, such as charitable contributions; or
- increasing retirement plan contributions.
For divorces finalized on or after January 1, 2019, alimony is no longer deductible for the payer, or taxable to the payee. For divorces finalized on or before December 31, 2018, the old rules still apply.
Required Minimum Distribution (RMD)
The SECURE Act
increase the age for taking RMDs from 70 ½ to 72 for individuals who did not reach age 70 ½ before January 1, 2020. If you are in this age group and have not yet received your RMD for 2022 or discussed it with your financial advisor, you should contact them to discuss the distribution.
Consider funding a 529 Plan for educational purposes. There is currently no federal deduction for 529 plan contributions but in Ohio but there is a state tax deduction of up to $4,000 per beneficiary. In addition, 529 plan distributions
can now be used for grades K-12 tuition (up to $10,000 per year) making them even more advantageous. If you have kids in college, you may be eligible for some tuition tax credits, even if they are working on their master’s degree.
Verify Your Withholding
allows tax to be paid via several methods: payroll withholding, retirement withholding and quarterly estimates. The IRS has two safe harbors to avoid underpayment penalties. The first is by paying 100% of your prior year tax amount (110% if your prior year adjusted gross income was over $150,000), and the second is paying 90% of your current year tax amount. It is important to verify that you will meet one of these safe harbors to avoid penalties.
Maximize Above-the-Line Deductions
- Health Savings Accounts (HSA). If you become eligible on or before December 2022 to make HSA contributions, you can make a full year’s worth of deductible HSA contributions for 2022.
- Simplified Employee Pension (SEP) Contribution. If you have self-employed income, consider putting money into a SEP. This option is available to you even if you have already deferred the maximum amount into your employer-sponsored 401(k) plan. By contributing money to a SEP, you can typically avoid both current year federal and state taxes on the amount contributed. The maximum SEP contribution for 2022 is $61,000 and it can be funded as late as the due date of your federal tax return, including extensions.
- Student Loan Interest. You may be eligible to take an above-the-line deduction for student loan interest paid up to a maximum of $2,500.
- Self-Employed Health Insurance. Partners and S-Corp shareholders owning more than 2% of the entity stock and self-employed individuals are permitted a deduction for their health insurance for themselves and their dependents. This is different than the itemized deduction since it is above-the-line and not subject to the 10% Adjusted Gross Income limitation.
Bunching Itemized Deductions
With the Tax Cuts & Jobs Act (“TCJA”), many itemized deductions were either eliminated or severely limited. Bunching deductions may be a way to preserve deductions that would otherwise be wasted or lost due to the higher standard deduction. The deduction for state and local taxes and real estate taxes is limited to $10,000. If your mortgage is paid off and you don’t have any high medical expenses, your only other itemized deduction would be charitable contributions. It may be worth your while to fund several years’ worth of charitable contributions in one year to accelerate the deduction into that year, and then use the standard deduction in the subsequent years. One good way to do this is through a Donor-Advised Fund. This vehicle allows you to donate the money one year and get a tax deduction while keeping the money in the fund until you distribute it to the various charities in subsequent years.
- Medical Expense Deduction. For 2022, medical expenses are only deductible to the extent that they exceed 10% of your adjusted gross income. Medical expenses include health insurance premiums, Medicare premiums, amounts paid to doctors for medical care, prescriptions, etc. Unless you have a high amount of medical expenses, you most likely will not qualify for this deduction.
- State and Local Tax Deduction. You can deduct up to $10,000 of state and local income taxes and real estate. If you can itemize your deductions and have not reached the $10K limit, you may want to consider paying your real estate taxes in December 2022 as opposed to January 2022. If you have already met the limit, then there is no benefit to pre-paying these taxes.
- Mortgage Interest Deduction. Interest you pay on your home is typically deductible to the extent that the average mortgage balance does not exceed $750,000. For mortgages placed in service prior to December 15, 2017, the limit is $1,000,000. Home equity loan interest is only deductible if the loan was used to buy, build or improve the home. The old rule allowing a deduction for the first $100,000 of home equity interest was eliminated. Also, don’t overlook mortgage points paid upon purchase or refinancing as these may be deductible as well.
- Charitable Contribution Deduction. Consider making charitable contributions before year-end either in cash or non-cash such as highly appreciated stocks. If you donate highly appreciated stock, you can get a donation deduction for the fair market value of the stock and avoid capital gains tax. You can also make contributions at year-end using your credit card, even if the credit card is not paid until 2023. You can write a check to charity and mail it on December 31, 2022 and take a 2022 tax deduction even if the check doesn’t clear your bank until January. Non-cash donations valued over $5,000 (except publicly traded stock) require a written appraisal and a letter from the charity acknowledging the donation to be deductible.
- If you are over age 70 ½, you can make a charitable contribution up to $100,000 directly from your IRA to satisfy the required minimum distribution requirement.
- Beginning in 2022, Ohio offers tax credits to individuals supporting scholarship-granting organizations (SGOs), nonprofit organizations that provide private school scholarships to students in need. This tax-credit scholarship program allows taxpayers to receive a dollar-for-dollar tax credit up to $750 ($1,500 for married filers) for their donations to SGOs. Please reach out to your trusted tax advisor for more information on this new Ohio tuition tax credit.
Estate Tax Planning
Take advantage of the annual gift tax exclusion. Make gifts sheltered before the end of the year to save gift and/or estate taxes. The exclusion applies to gifts of up to $16,000 made in 2022 to each of an unlimited number of individuals and increases to $17,000 in 2023. You are unable to carry over unused exclusions from one year to the next. The transfers might also save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
Lifetime Exemption Planning
Although the estate tax exemption is now $12,060,000 and is indexed for inflation, there is a sunset clause after December 31, 2025. After this date, the estate tax exemption will decrease to $6,800,000, and your estate threshold will be the greater of the estate tax threshold or the total taxable gifts you have already made during your lifetime. It is important to consider whether additional wealth transfer strategies should be implemented before any change in lifetime exemption amounts takes effect.
Although the business tax rates and the rules are mostly the same as prior years, it is still a good practice to consider your entities structure and verify that you are operating in the best business form. Under the TCJA, corporate tax rates were reduced to 21% and the addition of the Qualified Business Income (QBI) deduction (20% business income deduction) for other taxpayers reduces the tax rate on business income at the individual level, but this deduction is set to sunset after 2025 with other expiring individual provisions.
The TCJA also expanded the small business gross receipts threshold to $27 million for 2022, which allows businesses to elect or remain eligible for various accounting methods, such as utilizing the cash method of accounting and treating inventory as non-incidental materials and supplies or to avoid the uniform capitalization rules for resellers and manufacturers. Your business’ taxable income could be much lower under the cash method of accounting or through various other method changes allowed for small businesses.
Generally, the essence of good tax planning is to defer income and accelerate deductions. But this may not be the case for everyone depending on their tax situations if they have net operating losses to utilize or are expecting to have lower income in the future. Tax planning should be evaluated on a business-by-business basis.
Net Operating Losses (NOLs)
Net operating losses are able to be carried forward indefinitely but are limited to 80% of taxable income in the year that they will be utilized.
Take advantage of generous depreciation rules for assets such as computers, software, equipment, furniture, or certain property improvements purchased in 2022.
- Section 179. Allows you to expense otherwise depreciable property if placed in service in 2022. You may elect to expense up to $1,080,000 of fixed asset costs (with a dollar-for-dollar phase-out for purchases greater than $2,700,000). Additionally, the deduction is limited to business income. Certain real estate improvements can be “Qualified Improvement property” (QIP) and still be eligible for the Sec. 179 deduction.
- Bonus Depreciation. In addition to the Sec. 179 deduction, your business can also deduct first-year bonus depreciation equal to 100% of the cost of most fixed assets with a tax life of 20 years or less. The 100% first-year bonus depreciation will begin to phase out by 20% a year in 2023 through 2026. The CARES act has clarified that QIP is a 15-year property and is eligible for 100% bonus depreciation. QIP includes most non-residential improvements to the interior of a building.
De Minimis Safe Harbor Election
The “de minimis safe harbor election” (also known as the book-tax conformity election) allows businesses to expense lower-cost assets, materials and supplies. To qualify for the election, the unit of property cost cannot exceed $5,000 if the taxpayer has an applicable financial statement (e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no applicable financial statement, the cost of a unit of property can’t exceed $2,500.
There are numerous tax credits which can help lessen the tax burden for a business and its owner.
- R&D Credit. Businesses that incur certain research and development (R&D) costs, such as wages, supplies and contract research, are eligible for this general business R&D tax credit.
- Work Opportunity Tax Credit. Businesses that hire individuals from targeted groups (i.e. qualified veterans, long-term unemployment recipients, ex-felons) are eligible for a tax credit equal generally to 40% of up to $6,000 of the individual’s first-year wages paid (per employee).
- Employee Retention Credit. A credit of up to 70% of wages paid by employers forced to close or partially close by government order or experiencing a 20% or greater quarterly reduction in sales. This credit was for the 2020 and 2021 tax year, but qualifying businesses are still able to take advantage of the credit by amending their payroll tax returns.
- Small employer Health Insurance. Up to 50% of employer contributions for employee health insurance may be available for two consecutive years.
Review your methods of accounting for tax purposes to determine if you are using the optimal methodologies to maximize tax deductions. Deducting certain prepaid items, accruing for company payroll or bonuses (must be paid within 2.5 months of year-end) and reviewing all depreciation methods are common areas to analyze. Considering your overall accounting method of accrual or cash method of accounting may also create an opportunity for your business. Starting in 2022, research expenses based in the US should be capitalized and amortized over 60 months. This is a change from deducting as incurred in 2021 and prior.
Many businesses, especially service-based businesses, utilize the cash method of accounting. These businesses can accelerate deductions into the current year by bunching expenses to the extent possible. Under TCJA even more businesses are eligible if they are considered ‘small’ (<$27M in gross receipts).
LIFO (Last-in-First-Out) Inventory
While not new, this method allows in periods of rising inflation for deductions for cost of goods sold to be maximized, substantially reducing taxable income.
State and Local Taxes
We are seeing an increase in changes to state tax laws and regulations, as well as their approach to tax audits. Most states are becoming increasingly aggressive in trying to capture tax revenue from out-of-state businesses
. The Wayfair decision will require increased sales tax filings for most out-of-state sellers of goods. Make sure your business is not caught off guard. Specific state and local tax areas to be mindful of include income tax, sales and use tax, payroll and property tax. Additionally, pass through entities may want to revisit how they choose to file at the state level. Some states allow an entity level assessment of the income tax which bypasses the $10,000 itemized deduction limitation at the individual level. The taxes are deducted from the businesses income and don’t get deducted on the individual return as an itemized deduction, but as a reduction of taxable income. Ohio has created a new Pass-Through Entity Tax
that may be beneficial for your entity to consider for 2022.
If you own an interest in a partnership or S corporation where losses may be limited due to basis limitations, consider whether you need to increase your basis in the entity to deduct a loss from it for this year.
The Cares Act had a special provision to allow a business meal from a restaurant to be 100% deductible for 2021 and 2022 to help stimulate the restaurant industry after the impact of COVID-19. After 2022, these meals will return to 50% deductible with the other types of business meals. Entertainment is still non-deductible, so business activities that include a meal and an entertainment component should be broken out and tracked as separate line items.
If your business is not ‘small’ (<$27M in gross receipts), your deductions for interest may be suspended. The rules in this area are complex and wide ranging but proper planning can ensure that deductions are not missed unexpectedly. In general, the interest expense is limited to 30% of adjusted taxable income. Last year, an adjustment for amortization and depreciation was allowed, which is no longer an available adjustment in 2022. This could substantially reduce the amount of deductible interest compared to 2021. Interest rates are increasing with inflation, so taxpayers should plan for this change as early as possible.
To reduce 2022 taxable income, consider disposing of a passive activity in 2022 if it will allow you to deduct suspended passive activity losses.
If your business has foreign sales, consider utilizing an IC-DISC. A business that has export sales and utilizes an IC-DISC can create a tax benefit in which a portion of its income is taxed at the long-term capital gains rate.
The foreign reporting requirements
are comprehensive and complex for businesses with activities outside of the United States. Business owners and employees who have any financial interest in or signature authority over a foreign financial account exceeding $10,000 at any time in a calendar year must file a Report of Foreign Bank and Financial Accounts
(FBAR). The Foreign Account Tax Compliance Act
(FATCA) requires businesses to report and possibly withhold payments made to foreign entities. Investments, assets and legal entities outside the U.S. may subject the business to various reporting requirements.
These are some of the year-end steps that can be taken to minimize your tax burden. We can help tailor a customized plan that will work best for your tax planning goals. Additional ideas and information may be found in our 2022 Year-End Tax Planning Guide.
Please contact your BMF Advisor if you would like to review any of the items mentioned, schedule a tax planning strategy session or discuss potential implications of the various tax law changes.