Aprio’s End of Year Tax Update
December 8, 2022
Aprio is privileged to offer our year-end tax planning guide for your consideration and use. Year-end tax planning is a consistent theme across the accounting world; many business and investment firms churn out annual tax-planning recaps. Generally, these communications consist largely of a stream of reminders to complete the same tax-planning steps every year: contribute to your IRA, spend your FSA funds, accelerate any major business purchases and remember your estimated tax payments. These are fundamental components of every client’s tax planning – actions you should be taking already. In this guide, we delve into the major tax opportunities – and pain points – for you and your business.
The year 2021 was one of transition for tax legislation, marking the beginning of the end of pandemic-related legislative changes. For example, the popular Employee Retention Credit ended in 2021, though Aprio continues to prepare ERC claims for clients. Individual stimulus payments and expanded child tax credits also ended in 2021. These programs affected taxpayers in ways that may influence 2022 refunds and corresponding tax planning.
However, 2022 brought some significant changes to the tax code. The Inflation Reduction Act contains tax provisions that affect both individuals and businesses. These include new energy credits for personal as well as business expenditures, a return of the corporate minimum tax and a new 1% share buyback excise tax for corporations. Many of these provisions will become effective January 1, 2023.
In addition to the tax legislation passed in the current year, there are a few provisions built into previously passed laws – specifically the Tax Cuts and Jobs Act (TCJA) of 2017 – that will impact many taxpayers more than the 2022 laws did. The TCJA included several sections that will have negative impacts for many taxpayers, affecting both individuals and businesses. During the COVID pandemic, Congress put some taxpayer-unfriendly sections on hold from 2020 through 2022. However, these relief provisions are approaching sunset, resulting in tax increases through phase-outs, or outright elimination of the tax relief as the TCJA provisions kick in during 2022 and 2023.
It is unlikely that we will see any major tax legislation passed in 2023. Democrats have held the Senate, while Republicans are poised to take control of the House of Representatives; in both cases, the parties maintain a very small majority. In this climate of divided government, partisan infighting will preclude major tax policy items, such as cuts or increases; this inaction will bring some stability on the tax front. However, Congress may try to extend several taxpayer-friendly provisions before the end of the current term, specifically rolling back the limitation on business interest expenses and extending the deduction for research and development expenditures.
With few legislative changes expected, we will turn now to concrete items that taxpayers should consider prior to the year-end, as well as recommending steps to prepare for the 2023 tax year. We will begin with items related to individual taxpayers.
Individual Taxpayers may see tax increases due to reduced deductions, while navigating a down year for both the stock market and cryptocurrency markets
A common response to stock market losses is “tax loss harvesting.” Tax loss harvesting is the process of selling stock that has lost value to create losses that can offset current or future gains. The key feature of tax loss harvesting is a rebalancing of the investor’s portfolio, using the proceeds to reinvest in the market, with a view toward creating future gains. However, when considering tax loss harvesting one must consider the wash sale rules. A taxpayer will have their loss disallowed if they sell a security and then repurchase that same security within 30 days of the original sale.
Tax loss harvesting is not the only planning tool in a down year. Retirement plan contributions, and estate planning are also viable planning tools. Investing in one’s retirement account in a down market where share prices are lower can ensure greater future growth in the retirement account as the market recovers. This makes it the ideal time to maximize retirement plan contributions.
Just as the stock market has experienced some volatility and loss, so too has the cryptocurrency market, with digital assets markets experiencing an extreme drawdown in 2022. By early December, Bitcoin was trading at just over $17,000, down 65% for the year and over 75% from its November 2021 peak of just over $69,000. Ethereum also suffered a nearly 65% decrease in trading price for year-to-date 2022. However, the tax treatment of cryptocurrency and digital assets differs from that of stocks and other capital assets. Rather than being taxed as securities, digital assets are treated as property.
This treatment has the advantage of cryptocurrencies not being subject to the wash sale rules, so investors wishing to rebalance their digital asset portfolios will be able to reinvest in the same cryptocurrencies immediately after the sale of their existing holdings. And if a taxpayer is in a gain position in the stock market, losses in cryptocurrency can be used to offset those gains, resulting in a tax-efficient rebalancing. Loss harvesting in digital assets can be done at very low cost and is a prudent strategy to create tax losses, even if those losses must be carried forward to future years.
2022 and 2023 anticipated conditions create unique opportunities for estate planning and wealth transfer tools
In 2017, the TCJA temporarily increased the lifetime estate and gift tax exempt amounts (also known as the unified credit), boosting the value of assets that high-net worth individuals could transfer by either gift or estate from $5.5 million for an unmarried individual to $11 million, with increases indexed for inflation (annual amounts are doubled for married couples). The IRS recently announced that the unified credit amounts for 2023 will be $12.92 million.
The TCJA contained a sunset provision; after December 31, 2025, unless Congress acts to preserve some or all the increased exclusion amount, the unified credit will revert to around $6.8 million. For a married couple, the exemption in 2025 will be more than $26 million, but will drop in 2026 by more than $12 million, to around $14 million. At a 40% tax rate, that is about a $5,000,000 increase in estate taxes for those worth more than $26 million.
The potentially fleeting increased exclusion amount, coupled with a down market, provides an opportunity for certain taxpayers to make lifetime gifts of assets subject to appreciation. Those transfers would remove from the value of the giver’s gross estate not only the fair market value of the asset transferred, but also any future appreciation of the asset’s value. Aprio’s National Estate and Trust Planning Partner, Larry Leaf, would be glad to speak with you about how to best navigate this upcoming change.
2022 saw the extension of some taxpayer-unfriendly provisions, as well as the expiration of some taxpayer-friendly ones
The Inflation Reduction Act extended the business loss limitation rule for individuals. Introduced by the TCJA, Section 461(l) limits an individual taxpayer’s deduction of business losses generated in a tax year. The excess business loss limitation delays a deduction for losses that exceed business income plus certain threshold amounts: $540,000 for married filing jointly filers and $270,00 for all other filers in 2022. The excess loss limited in the current year is carried forward to following tax years, in accordance with the rules for deducting net operating losses. Because this provision was delayed at the onset of the COVID pandemic, the loss limitation, originally scheduled to sunset on December 31, 2026, is extended for two additional years, to the end of 2028.
In 2022, we saw the expiration of several tax provisions benefiting individual taxpayers, many of which were included in either the TCJA or were enacted as part of COVID relief programs. Among the phased-out tax benefits are:
- Expanded child tax credit
- Expanded child and dependent care credit
- Increased exclusion for employer-provided dependent care assistance
- Special earned income tax credit rules for individuals without qualifying children
- Treatment of mortgage insurance premiums as deductible mortgage interest
- A $300 charitable contribution deduction for non-itemizers
- Increased percentage limits for charitable contributions
2022 also brought some new tax incentives for both individual taxpayers
The Inflation Reduction Act provided several new benefits for taxpayers, reflecting the Biden Administration’s priorities in incentivizing clean energy technologies. The Act either extended, expanded, or created tax credits designed to encourage individuals to make clean energy or energy-efficient investments. 2022 saw the extension and expansion of tax credits for making energy-efficient home improvements. This includes an extension of the nonbusiness energy property credit, which is applicable for the installation of heat pumps, solar rooftops, electric HVAC systems and energy-efficient water heaters. The modification of this credit also removes the lifetime limitation on the credit amount in favor of a $1,200 annual limitation.
Additionally, the act includes a new tax credit of up to $4,000 for used electric vehicles and an expanded $7,500 credit for the purchase of new electric vehicles. These credits may be transferred to the dealer selling the car in exchange for payment, effectively making them immediately refundable.
New zero-emissions sedans will qualify for the credit if they have an MSRP of up to $55,000 while zero-emissions trucks, vans and SUVs will qualify if their MSRP is up to $80,000. The credits are available to taxpayers with an adjusted gross income (AGI) lower than $150,000 ($300,000 MFJ). The bill has certain limitations and phase-ins related to requirements that the vehicles must be assembled in the US and sets requirements on the sources of critical minerals and battery components in the vehicle, which will exclude many vehicles that would have qualified under earlier tax credit programs. The credit will expire at the end of 2032.
In 2022 law enacted Code Section 25E, which introduces a new nonrefundable personal tax credit for the purchase of a qualifying previously owned vehicle. The credit can be transferred to a registered dealer in exchange for payment. This credit applies to vehicles acquired after 2022. The transfer of credit provision will apply to vehicles acquired after 2023.
In 2022 we also saw the extension of Section 25C through the end of 2032. This credit provides an annual credit of up to $1,200 for both qualified energy efficiency improvements (e.g., new windows) and residential energy property expenditures (e.g., geothermal heat pump). The IRA also modified the standards for determining energy efficiency for this credit. This replaces the former credit which had a lifetime limit of only $500.
Recent IRS changes have made it easier for taxpayers to protect the privacy of their tax information
The IRS announced it will re-open its Identity Protection Personal Identification Number (IP PIN) program as a continuation of its efforts to help taxpayers protect the privacy of the information they provide to the IRS from malicious third-party actors. Beginning on January 9, 2023, individual taxpayers can apply for the IP PIN by using the Get an IP PIN tool. The IP PIN is designed to help the IRS verify a taxpayer’s identity and more securely accept the taxpayer’s federal income tax returns, whether those returns are filed electronically or by paper. It is available to any individual who has a valid Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN) and can verify their identity. This tool provides an extra layer of security to protect taxpayer information in the tax filing process.
Business taxpayers face a challenging tax landscape at the end of 2022 and moving into 2023
For many business taxpayers, whether partnerships or corporations, 2022 will mark the beginning of effective tax increases due to the loss of deductions arising from the expiration of several business-favorable tax provisions, unless Congress acts to extend those benefits. Many of the tax increases set to begin in 2022 arise from sunset periods included in the 2017 TCJA, or from the end of COVID-relief tax programs. We discuss the impact of the ending of these tax benefits below.
One of the most dramatic changes occurring in the 2022 tax year is the elimination of the ability for businesses to deduct research and experimentation (R&E/R&D) expenses in the year incurred. Before 2022, a taxpayer had the option to expense immediately R&D costs.
Unless Congress acts to postpone or repeal the new rules, beginning January 1, 2022, R&D expenses may no longer be expensed immediately. Instead, they must be amortized over five years (15 years for foreign expenditures). Amortization must continue even if the underlying property is disposed, retired, or abandoned during the amortization period. This includes software development costs.
Many venture-backed companies which historically have tax losses could now have taxable income and may have limited ability to utilize their net operating losses. Your company may have delayed performing a NOL (net operating losses) Study under IRS Code Section 382, but you may need to now accelerate this analysis to determine the extent to which NOLs carried over from previous years may be used in 2022. Cardell McKinstry who leads Aprio’s M&A Tax Practice, handles these studies, which are complex but may yield significant tax savings.
Business interest limit under section 163(j)
Another change in tax law that some taxpayers may have forgotten involves the calculation of the business interest deduction limit under section 163(j). The deduction is limited to 30% of the taxpayer’s adjusted taxable income (ATI) for the tax year. The limit was temporarily increased to 50% for 2019 and 2020 for all taxpayers but partnerships, and 50% for partnerships for 2020 only.
Interest expense prior to 2022 was limited to a percentage of EBITA and in 2022, the limitation is based on EBIT. This could cause many companies to not be able to deduct some or all their actual interest expense in the current year, with excess interest expense carried forward to future years. For those with floating interest rate debt, interest expense increased in 2022; the combination of higher interest cost and a limitation on tax deductibility of that interest cost creates an unenviable situation for businesses that rely on longer-term financing to run their operations.
Phase out of 100% percent bonus depreciation
One of the most valuable tax benefits available to businesses is a bonus depreciation deduction which has been available for some time with various percentage rates. The TJCA expanded the deduction to allow a 100% bonus depreciation deduction for qualified property placed in service through 2022. However, the bonus rate is scheduled to phase out 20% a year beginning in 2023. Thus, the bonus rate for qualifying property (other than long production property and certain noncommercial aircraft) is:
- 100 percent for property placed in service after September 27, 2017, through 2022,
- 80 percent for property place in service in 2023,
- 60 percent for property place in service in 2024,
- 40 percent for property place in service in 2025 and
- 20 percent for property place in service in 2026.
Without a legislative change, a taxpayer planning on purchasing property that would qualify for bonus depreciation might want to purchase and place into service property before December 31, 2022. This may be especially difficult with continuing delays in shipping goods and labor shortages that have occurred during the past few years.
Small Business Stock
If your company is taxed as a Partnership or S Corporation and you previously considered converting to a regular corporation to receive future benefits under IRC Section 1202, this may be a good time to have that conversation. While your company may have been worth more than, say, $50 million in 2021, with the reduction of company valuations, your company might be worth less than $50 million today, thus affording the opportunity to convert now.
You can couple the 1202 opportunity with estate and gift planning. Aprio is here to help you explore these opportunities for you.
Conversely, if you were considering converting a regular Corporation to an S Corporation, with reduced valuations, your built-in-gain exposure for future tax could be lower today because of the lower valuations.
Corporate Alternative Minimum Tax (AMT)
The TCJA eliminated the corporate alternative minimum tax; however, less than five years later, the Inflation Reduction Act reinstated a minimum tax based on a corporation’s financial statement income (book AMT). The new book AMT is effective for tax years beginning on or after January 1, 2023. It applies to domestic C-corporation taxpayers with a three-year average annual financial statement income of more than $1 billion. For certain US companies owned by foreign corporations, book AMT applies if the three-year average receipts exceed $100 million. This new minimum tax imposes a 15% tax rate on “adjusted financial statement income” less the AMT foreign tax credit. Book AMT is then compared with the corporation’s regular tax (including any Base Erosion and Anti-Abuse Tax), and the corporation pays the higher of the two amounts.
There are adjustments, exceptions and limitations that will complicate the application of book AMT. An important first step is to determine if a corporation, or group of corporations, may be subject to this new tax.
One Percent (1%) Excise Tax on Corporate Stock Buybacks
The Inflation Reduction Act adds a new tax provision to assess a 1% excise tax on a company that is repurchasing its own stock from shareholders. This tax provision was included in earlier drafts of the Build Back Better Act of 2021. The excise tax applies to stock repurchases by publicly traded companies beginning in 2023. The excise tax is 1% of the fair market value of any stock repurchased during a taxable year. The tax is not deductible. A domestic corporation with its stock trading on an established securities market may be subject to this tax. This new tax will not apply to:
- Buybacks of less than $1 million
- Repurchases connected to contributions to retirement savings plans, including employee stock ownership plans
- Transactions by regulated investment companies and real estate investment trusts
- Repurchases that are taxed as dividends
- Transactions that are part of a nontaxable corporate reorganization transaction
2022 Tax Law Changes provided new or enhanced tax benefits for clean energy expenditures
While 2022 and 2023 will result in many businesses paying higher taxes due to the loss of deductions, legislation passed in 2022 also offers new tax benefits for businesses as well as individuals, again providing incentives for clean energy investment. The Inflation Reduction Act provided several new benefits for taxpayers, while extending and/or expanding some existing tax incentives. Additionally, Congress created tax benefits designed to provide incentives for domestic semiconductor manufacturing.
The Inflation Reduction Act extended the beginning-of-construction deadlines for both renewable electricity production tax credits under Internal Revenue Code Section 45, and energy investment tax credits under Section 48 to the end of 2024. Also, the Section 48 credit is expanded to include solar and wind facilities located in a low-income community or housing project, tribal land or connected with another other low-income economic benefit project.
Several energy-efficient or clean energy credit provisions were expanded through 2032, including the energy efficient home credit, available to contractors and manufacturers constructing energy efficient homes. Also, the Section 45Q carbon oxide sequestration credit beginning-of-construction date is extended to the end of 2032, as is the Section 30C credit for alternative fuel vehicle refueling property. The alternative fuel vehicle refueling property credit was also modified to increase the credit limit to $100,000 per item of qualifying property but reduce the credit rate from 30% to 6% for depreciable property.
Internal Revenue Code (IRC) §179D is modified to include a new formula for calculating the energy-efficient commercial buildings deduction and provides an alternative deduction for energy-efficient building retrofit property placed in service after 2022.
2022 introduced several new tax credits for businesses
The IRA introduces several new tax credits to support businesses investing in clean energy technologies and operations, including:
- Credits for production of clean hydrogen (IRC 45V) and for sales of sustainable aviation fuel (IRC §40B)
- Up to $7,500 credit for each qualified commercial-clean vehicle with a gross vehicle weight under 14,000 pounds and for clean vehicles exceeding that weight limit, up to $40,000 credit (IRC §45W)
- Advanced manufacturing production credit for components and critical minerals sold after 2022 for production of solar energy components, wind energy components, inverters and battery components (IRC §45X)
- Clean electricity production credit (IRC §45Y) and clean fuel production credit (IRC §45Z)
- Investment credit for property investments in energy storage technology (IRC §45E)
Boosting the New Tax Credits
The Inflation Reduction Act incorporates additional incentives for taxpayers by identifying actions taxpayers can take to boost a credit up to five times (5x) its base amount. Most of these steps center around paying wages at prevailing rates and providing apprenticeship programs. Other credits can be increased if the activity occurs in certain low-income communities or former energy communities, such as those near coal mining or oil refining. Certain credits, such as the clean vehicle tax credit, include domestic materials content and assembly requirements.
Direct Pay and Transferability
The Act permits eligible organizations, such as tax-exempt entities, government units, tribal governments and similar non-taxpaying organizations, to elect to treat certain credits as a refundable payment of tax – even if the organizations are not subject to federal income tax or have no federal income tax liability. This tax provision applies to many of the new credits added by the IRA and will allow non-taxpaying entities to participate in clean energy initiatives and benefit from cash flow from the related credits.
Similarly, the IRA permits these same non-taxpaying entities to elect to transfer some of these tax credits to an individual or business. Transferability may allow, say, a rural electric cooperative to benefit from the sale of credits generated from §45Y clean electricity production to a for-profit taxpayer looking for a way to reduce its tax costs.
The IRA made an important change to the election to apply research and development (R&D) tax credits against an employer’s payroll tax liability rather than against income tax. The IRA doubled the eligible amount from $250,000 to $500,000. This is a beneficial election available to early-stage businesses with a limited history of generating revenue. It enables these companies to monetize their R&D tax credits long before they realize an income tax liability.
The CHIPS Act provides tax and other incentives for US domestic semiconductor production
Congress enacted a bill that would provide roughly $55 billion in grants, loan guarantees and other support to increase US semiconductor production. The legislation creates a new temporary 25% “advanced manufacturing investment credit” for investments in semiconductor manufacturing property, estimated to cost $24 billion. The legislation also authorizes (but does not appropriate) more than $200 billion in future federal spending to promote US research programs.
The CHIPS (Creating Helpful Incentives to Produce Semiconductors) Act provides $52.7 billion in emergency supplemental appropriations over five years to implement a Commerce Department semiconductor initiative to develop domestic manufacturing capability and support research and development (R&D) and workforce development programs that were authorized by the Fiscal Year (FY) 2021 National Defense Authorization Act (NDAA). Of this amount, $39 billion is appropriated over five years to provide financial assistance to build, expand, or modernize domestic manufacturing capabilities, with up to $6 billion of these funds to be used for the cost of direct loans and loan guarantees. An appropriation of $11 billion over five years is provided to support R&D and workforce development programs.
The legislation includes $2 billion for the Microelectronics Commons, a national network for onshore, university-based prototyping, lab-to-fab transition of semiconductor technologies and semiconductor workforce training. An additional $500 million is appropriated over five years for the purpose of coordinating with foreign government partners to support international information and communications technology security and semiconductor supply chain activities, and $200 million is provided over five years for the National Science Foundation to promote growth of the semiconductor workforce.
New advanced manufacturing investment tax credit
The CHIPS Act would create a new temporary 25% advanced manufacturing investment credit for investments in semiconductor manufacturing property. The credit would include incentives for the manufacturing of semiconductors and specialized tooling equipment required in the semiconductor manufacturing process. Eligible taxpayers could elect to treat the credit as a payment against tax (direct pay), and the credit provision includes various special rules. The credit would apply for property placed in service after December 31, 2022, for which construction begins before January 1, 2027.
Increased research funding authorized
The CHIPS Act would authorize around $200 billion in new funding to promote US research programs and R&D, and workforce development. This authorized new funding would require future action by Congress as part of annual appropriations bills. The House and Senate are currently considering appropriations measures for the federal government’s 2023 fiscal year, which begins on October 1, 2022.
Whether through new legislation or the built-in expiration of tax benefits passed in the TCJA, both individuals and businesses potentially face higher tax bills through the loss of previously available deductions. However, the new tax landscape also contains benefits for certain taxpayers engaged in specified activities tied to clean energy technologies, semiconductor manufacturing, or other tax-favored activities.
About the Author
Cardell is a partner in the Transaction Advisory Services group at Aprio. Cardell has over 15 years of tax consulting experience serving clients across a wide range of industries, including construction, distribution, financial services, manufacturing and telecommunications. Cardell focuses on advising financial and strategic clients on the tax aspects and structuring of taxable and tax-free transactions. These include mergers and acquisitions, dispositions, restructurings, leveraged buy-outs and recapitalizations.
As Aprio’s National Estate and Trust Leader, Lawrence helps clients build and protect legacy. His specialties include estate and trust planning and administration; family office services, including private foundation support; and complex income tax planning. As a trustee for numerous trusts and private foundations, he coordinates front- and back-office services and the activities of investment advisors and legal counsel. He leverages 20+ years of experience to create large trust, estate and foundation solutions that make it easier for clients to realize family, philanthropic and financial goals.