Although it has been a relatively quiet year in the tax world, there are still opportunities to take advantage of, as well as planning opportunities for tax changes that are scheduled to be implemented in the years ahead.
State Pass-Through Entity Tax Elections
2023 saw several additions to the list of states enabling pass-through entity tax elections (PTET), as well as clarifications to already existing programs. In short, the PTET election allows an entity to pay state tax on income that would have previously been passed through and paid at the individual shareholder/partner level. This tax paid at the entity level is then considered an expense of the entity for tax purposes, reducing Federal income that is passed on to the member. The tax payment generally retains characterization as a distribution for book purposes, similar to any composite payment made.
Each state’s program functions slightly differently, and the complex set of rules around which states require addbacks or allow credits create additional compliance, but ultimately can provide a large Federal benefit for owners. Ahead of any fourth-quarter payments, it is key to consider whether inclusion in a PTET filing makes sense at the entity level.
Accelerated Depreciation Methods
From 2018 through 2022, the bonus depreciation rate has been consistent at 100%, allowing taxpayers to fully “expense” the cost of eligible fixed assets within the first year via this advantageous special depreciation method. As of January 2023, the bonus depreciation phase out began so taxpayers are only eligible for an 80% first year depreciation deduction, with the remaining 20% depreciated over the course of the remaining useful life. It may make sense for some taxpayers to hasten already planned acquisitions in order to place in service prior to year-end, though that should be evaluated in the context of overall book and taxable income, as well as business needs.
The full bonus depreciation phase-out schedule is as follows:
- 2024: 60%
- 2025: 40%
- 2026: 20%
- 2027: 0%
It’s key to note there is always potential for revision to the currently anticipated phase out, but there is also potential to utilize other programs like Section 179 or cost segregation studies in order to see maximum tax benefits.
Interest Expense Limitations
Originally imposed through the Tax Cuts and Jobs Act of 2017, code section 163(j) imposed an interest expense limitation for many businesses. Currently, interest expense for a business could be limited if the interest expense exceeded 30% of tax-based EBIT. In a rising interest rate environment and change of the limitation formula from tax-based EBITDA, many more companies are subject to the interest expense limits. Proper year-end planning will be key to plan for and potentially avoid any limitations.
Employment Credits
The Work Opportunity Tax Credit (“WOTC”) and Empowerment Zone Credits (“EZ”) are wage based credits for employees which meet certain criteria (i.e. residence, food stamp recipients, veteran, and ex-felons to name a few). The amount is driven on the amount of wages paid to eligible employees and is set to expire on December 31, 2025. You must have a process in place to screen eligible employees before claiming the credit. If you are not claiming the credits, consider evaluating the credit as it can yield significant credit amounts in high-turnover businesses such as restaurants.
Tax Incentives Relating To Energy Efficient Improvements
Energy Efficient Home Credits — The Inflation Reduction Act (IRA) updated IRC Section 45L, which now allows eligible contractors a potential credit for qualifying homes meeting applicable ENERGY STAR or DOE Zero Energy Ready Home requirements. The program has tiered benefits available once very specific qualifications are met, so it’s important to discuss potential programs and credits with a tax advisor prior to beginning any work.
Energy Efficient Commercial Building Deductions — The IRC §179D Energy Efficient Commercial Building Deduction is a federal tax incentive to encourage taxpayers to build energy efficient building and make energy efficient improvements to existing structures. Through the IRA, the maximum benefit has been increased to $5.00 per square foot of a building which has an energy efficient component. Contractors who perform public projects can obtain a significant permanent tax savings from this deduction. The reduction in federal bonus depreciation can also provide increasing benefits to contractors who perform non-public projects.
Section 174 Treatment
Thus far, the requirement to capitalize certain research and development expenses under IRC Section 174 has not been corrected in any year-to-date regulatory changes. As a result, planning for 2023 should include consideration of any addback, as well as calculation of the associated amortization expense. If you have not already been claiming the R&D credit but find yourself falling subject to the addback of expenditures, it may be worthwhile to discuss the potential of an R&D tax credit study. The rules regarding what expenditures qualify are complex, and analysis of the total capitalization cost can be quite involved, so it’s important to allow the appropriate time for such analysis to occur.
Meals & Entertainment
Rules relating to the deductibility of entertainment expenses have not changed – they are still fully non-deductible. For meals, the 2021 and 2022 tax years saw 100% deductibility of certain qualified meal expenditures, mostly in an effort to encourage restaurant patronage during a period heavily impacted by COVID. For the 2023 tax year this benefit has ended, and meals have largely returned to 50% deductible.
Start Planning for Known Law Changes
Many favorable tax provisions such as the Qualified Business Income (“QBI”) deduction and decreased individual income tax rates are scheduled to expire on December 31, 2025. Although this is two years away, owners should begin considering these law changes when evaluating capital expenditures, exit transactions, or any other tax strategy which has an opportunity to defer the recognition of expense or accelerate the recognition of income. Being proactive in managing known changes in tax law can manage significant benefits in the long term.
Connecting with your tax advisor now is the best way to ensure potential tax benefits aren’t missed, and upcoming tax liabilities are estimated and managed effectively. Contact your GBQ team member to learn more about these opportunities.
View year-end tax planning strategies for individuals by clicking here.
