U.S. businesses are facing pressure to drive revenue, manage costs and increase shareholder value, all while surrounded by economic and political uncertainties. Ongoing supply chain disruptions brought about by the pandemic, inflation and rising interest, cooled consumer spending, stock market decline, and the prospect of a recession have all impacted businesses throughout 2022. What’s more, the outcomes of the U.S. congressional elections will contribute to the shape of future tax policies. However, businesses are able to withstand uncertain times by turning toward opportunity, including proactive tax planning. Tax planning is essential for U.S. businesses looking for ways to optimize cash flow while minimizing their total tax liability over the long term.
This article provides a checklist of areas where, with proper planning, businesses may be able to reduce or defer taxes over time. Unless otherwise noted, the information contained in this article is based on enacted tax laws and policies as of the publication date and is subject to change based on future legislative or tax policy changes.
Recent legislative changes – the Inflation Reduction Act and the CHIPS Act
As the U.S. entered 2022, major proposed federal legislation that sought to raise taxes on large profitable corporations and high-income individuals (the Build Back Better Act) had died in the Senate. Although not nearly as broad in terms of tax increases, 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 of certain large corporations (also referred to as the “book minimum tax” or “business minimum tax”), 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.
Generate cash savings through tax accounting method changes and strategic tax elections
Adopting or changing income tax accounting methods can provide taxpayers with valuable opportunities for timing the recognition of items of taxable income and expense, which determines when cash is needed to pay federal tax liabilities.
In general, accounting methods can either result in the acceleration or deferral of an item or items of taxable income or deductible expense, but they do not alter the total amount of income or expense that is recognized during the lifetime of a business. As interest rates continue to rise and debt becomes more expensive, many businesses want to preserve their cash, and one way to do this is to defer their tax liabilities through their choice of accounting methods.
Companies that want to reduce their 2022 tax liability should consider traditional tax accounting method changes, tax elections and other actions for 2022 to defer recognizing income to a later taxable year and accelerate tax deductions to an earlier taxable year.
Write-off Bad Debts and Worthless Stock
While the economy attempts to recover from the challenges brought on by the COVID-19 pandemic, inflation and rising interest rates, businesses should evaluate whether losses may be claimed on their 2022 returns related to worthless assets such as receivables, property, 80% owned subsidiaries or other investments.
Maximize Interest Expense Deductions
The TCJA significantly expanded Section 163(j) to impose a limitation on business interest expense of many taxpayers, with exceptions for small businesses (those with three-year average annual gross receipts not exceeding $27 million for 2022), electing real property trades or businesses, electing farming businesses and certain utilities.
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.
Claim Available Tax Credits
The U.S. offers a variety of tax credits and other incentives to encourage employment and investment, 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. Businesses should make sure they are claiming all available tax credits.
- 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.
- Businesses that incur expenses related to qualified research and development (R&D) activities are eligible for the federal R&D credit.
- 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.
- The New Markets Tax Credit Program provides federally funded tax credits for approved investments in low-income communities that are made through certified “Community Development Entities.”
- 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 federal tax benefits available for investments to promote energy efficiency and sustainability initiatives.
Under the CHIPS Act, taxpayers that invest in semiconductor manufacturing or the manufacture of certain equipment required in the semiconductor manufacturing process may be entitled to a 25% advanced manufacturing investment credit beginning in 2023.
Partnerships and S Corporations
Partnerships, S corporations and their owners may want to consider the following tax planning opportunities:
- Taxpayers with unused passive activity losses attributable to partnership or S corporation interests may want to consider disposing of the interest to utilize the loss in 2022.
- Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income (within certain limitations based on the taxpayer’s taxable income, whether the taxpayer is engaged in a service-type trade or business, the amount of W-2 wages paid by the business and the unadjusted basis of certain property held by the business). Planning opportunities may be available to maximize this deduction.
- Certain tax basis, at-risk and active participation requirements must be met for losses of pass-through entities to be deductible by a partner or S corporation shareholder. In addition, an individual’s excess business losses are subject to overall limitations. There may be steps that pass-through owners can take before the end of 2022 to maximize their loss deductions. The Inflation Reduction Act extends the excess business loss limitation by two years (the limitation was scheduled to expire for taxable years beginning on or after January 1, 2027).
Under current rules, the abandonment or worthlessness of a partnership interest may generate an ordinary deduction (instead of a capital loss) in cases where no partnership liabilities are allocated to the interest. If business conditions are such that the interest does not have value or the partner is considering abandonment, important issues need to be considered.
Considerations for Employers
Employers should consider the following issues as they close out 2022 and enter 2023:
- Employers have until the extended due date of their 2022 federal income tax return to retroactively establish a qualified retirement plan and to fund the new or an existing plan for 2022. However, employers cannot retroactively eliminate existing retirement plans (such as simplified employee pensions (SEPs) or SIMPLE plans) to make room for a retroactively adopted plan (such as an employee stock ownership plan (ESOP) or cash balance plan).
- 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.
- Employers can reimburse employees tax-free for up to $5,250 per year in student loan debt, through Dec. 31, 2025, if the employer sets up a broad-based IRC Section 127 educational assistance plan.
- Employers seeking to attract and retain employees may offer tuition assistance to future employees by providing forgivable loan agreements. When the loans are forgiven (typically after the student has become an employee for a specified period of time), the amount forgiven is taxable wages, subject to income and employment taxes (including the employer share of employment taxes).
- Employers should ensure that common fringe benefits are properly included in employees’ and, if applicable, 2% S corporation shareholders’ taxable wages. Partners and LLC members (including owners of capital interests and profits interests) should not be issued W-2s.
- Generally, for calendar year accrual basis taxpayers, accrued bonuses must be fixed and determinable by year end and paid within 2.5 months of year end (by March 15, 2023) for the bonus to be deductible in 2022. However, the bonus compensation must be paid before the end of 2022 if it is paid by a Personal Service Corporation to an employee-owner, by an S corporation to any employee-shareholder, or by a C corporation to a direct or indirect majority owner.
- Businesses should assess the tax impacts of their mobile workforce. Potential impacts include the establishment of a corporate tax presence in the state or foreign country where the employee works; dual tax residency for the employee; additional taxable compensation for remote workers’ travel to a work location that is determined to be personal commuting expense; and payroll tax, benefits, and transfer pricing issues.
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, identify ways to minimize their state tax liabilities, and eliminate any state tax exposure.
Begin Planning for the Future
Businesses should consider actions that will put them on the best path forward for 2022 and beyond. Business can begin now to:
- Establish or build upon a framework for total tax transparency to bring visibility to the company’s approach to tax and total tax contribution.
- Reevaluate choice of entity decisions while considering alternative legal entity structures to minimize total tax liability and enterprise risk.
- Review available tax credits and incentives for relevancy to leverage within applicable business lines.
- Consider legal entity rationalization, which can reduce administrative costs and provide other benefits and efficiencies.
- Consider the benefits of an ESOP as an exit or liquidity strategy, which can provide tax benefits for both owners and the company.
- Perform a cost segregation study with respect to investments in buildings or renovation of real property to accelerate taxable deductions, claim qualifying bonus depreciation and identify other discretionary incentives to reduce or defer various taxes.
- Evaluate possible co-sourcing or outsourcing arrangements to assist with priority projects as part of an overall tax function transformation.
For more information on these tips and how to plan, reach out to our team.