The end of the year 2022 is fast approaching, but it is not too late for taxpayers to make some decisions prior to year-end to save on taxes in 2022 or plan tax strategies for 2023 and beyond. While 2022 has been relatively slower on tax legislation reforms than prior years, there are certain prior legislations that are worth revisiting now.
Below are some quick pointers for taxpayers as they prepare for year-end tax planning.
1. 100-PERCENT FEDERAL BONUS DEPRECIATION EXPENSE
For the 2022 tax year, the federal bonus depreciation write-off remains at 100 percent on qualifying shorter-life assets. However, beginning in the 2023 tax year, the bonus percentage reduces to 80 percent and will phase down by 20 percent each subsequent year until it reaches 0 percent in 2027, unless Congress enacts legislation to modify or extend the bonus depreciation rules.
GHJ INSIGHTS: For any business that is contemplating making significant large equipment purchases or investing in qualifying leasehold improvements, there is still time to take advantage of the 100-percent bonus depreciation if these purchases and investments are made and placed into service before the end of 2022. This is particularly advantageous if taxpayers were already contemplating spending the capital, as they will receive immediate tax write-offs to reduce their federal taxable income for 2022.
It is a good idea to consider a cost segregation for large real-estate improvements or acquisitions to maximize the amount of bonus depreciation write-off. However, it is important to note that many states, including California, do not conform or only partially conform to the federal bonus depreciation rules, and state tax rules will vary.
2. NET OPERATING LOSS AND EXCESS BUSINESS LOSS
Net operating loss (NOL) rules were enacted in 2017, which limited the NOL utilization to 80 percent of a taxpayer’s taxable income. COVID-19 legislations suspended the 80-percent limitation for tax years 2018, 2019 and 2020, but it became applicable again beginning in 2021. This limitation also applies to NOL that was generated after 2017 and carried forward into 2022. Unused NOLs can be carried forward indefinitely, but they are subject to the 80-percent taxable income limitation each year.
Similar to the NOL limitation, excess business loss (EBL) rules were enacted in 2017, temporarily suspended in 2018, 2019 and 2020 and re-applied in 2021 and later years. EBL rules limit the amount of current-year business losses that a non-corporate taxpayer can use to offset “non-business income” up to an inflation-adjusted index amount. In 2022, the indexed amount is $270,000 for single tax filers and $540,000 for married tax filers.
Consider the following example:
- A single taxpayer has $1,000,000 of overall net trade or business loss and $1,500,000 of non-business income, such as investment capital gains, portfolio income, required minimum distributions, etc.
- The taxpayer can only use $270,000 of the business loss to offset the non-business income, which means they will have taxable income of $1,230,000 in 2022.
- The remaining excess business loss of $730,000 is carried forward to the subsequent tax year as a NOL carryforward. The carryforward will not be subject to the EBL limitation in subsequent tax years, but it is still subject to the 80-percent NOL limitation.
GHJ INSIGHTS: Employee W-2 wages are not considered business income for the purpose of the EBL calculation, so for closely held businesses and their owners, it is worth looking at any year-end bonus compensation vs. shareholder distributions.
Additionally, taxpayers should also be aware that, aside from other tax-reducing strategies and non-business deductions, there still may be a tax liability (1) due on the remaining 20 percent of taxable income after the 80-percent NOL utilization limitation or (2) due to the excess business losses being limited to the indexed amount against the non-corporate taxpayer’s other non-business income.
3. BUSINESS INTEREST EXPENSE LIMITATION
Limitations on the deductibility of business interest expenses were also enacted in 2017. Generally, a taxpayer’s business interest expense deduction is limited to 30 percent of the taxpayer’s adjusted taxable income.
The limitation has become even more restrictive. In 2021 and prior, depreciation and amortization expense were added back to arrive at adjusted taxable income, which provides taxpayers with a higher threshold for the 30-percent limitation calculation. Starting in 2022, the adjusted taxable income no longer includes an addback for depreciation and amortization.
For taxpayers in real estate or fixed-asset-intensive industries, this could severely limit the amount of business interest expense that can be deducted in 2022.
GHJ INSIGHTS: The slight change in the calculation of adjusted taxable income for 2022 is important and should be evaluated. For taxpayers who carry significant debt and pay interest expense but also have significant fixed-asset needs, taking the 100-percent bonus depreciation write-off mentioned above could negatively impact the taxpayer’s ability to deduct the interest expense. This is because the depreciation expense is no longer added back, and this deduction will reduce the taxpayer’s adjusted taxable income. This further adds another layer of complexity, and it should be stressed that any tax strategies being considered should be made with all of these rule interplays in mind and not in a vacuum.
A detailed calculation to take into account these various components is highly recommended. It is also a good opportunity to revisit past decisions and consider if they still make sense. For example, qualifying real estate taxpayers could elect out of the business interest limitation rules, but the downside of such an irrevocable election is the loss of bonus depreciation and slower depreciation methods in current and future tax years. For qualifying real estate taxpayers who have not made an election out in prior years, it could make sense in 2022 to elect out if the economics make sense.
CONSIDER A HOLISTIC VIEW
As both businesses and individual taxpayers seek to possibly increase their deductions and losses, it is important to think about tax situations holistically. While it is generally a prudent tax strategy to accelerate tax deductions and losses, it is important to consider them in combination with other available tax attributes, such as research and development tax credits or energy efficient tax credits.
Please contact GHJ’s Tax Services Team to learn more about these opportunities and how to maximize tax savings.