With 2023 coming to a close, now is an ideal time for individuals and businesses to explore tax-planning strategies that may help reduce their overall tax bill. It is of significant consideration for taxpayers to be aware of are the several tax changes introduced in the Tax Cuts and Jobs Act (TCJA). Several TCJA-related tax rules are scheduled to expire or fully sunset in 2025, making the next 18 months crucial for tax planning, unless new legislation is passed.
Below is an overview of some key tax considerations to be aware of as you approach year end:
1. Qualified Business Income (QBI) Deduction
Pass-through entities, including partnerships, limited liability companies, S corporations and sole proprietors, can deduct up to 20% of its QBI. This is subject to certain limitations based on W-2 wages paid, the unadjusted basis of qualified property and taxable income. This deduction is set to expire in 2025, so qualifying entities should take advantage of this tax-savings opportunity while they still can.
2. Bonus Depreciation
Although the bonus depreciation deduction was decreased to 80% for 2023, it is still a worthy tax benefit for businesses that own machinery, computer systems, software, certain vehicles, equipment or office furniture, to name a few. Under the current phase-out schedule, this deduction will decrease by 20% each subsequent year through 2027, so we encourage you to maximize the current deduction amount for optimal savings. Also of note, the Inflation Reduction Act of 2022 included a tax credit allowing companies that look to install solar panels or purchase electric vehicles to reap the benefits of both bonus depreciation and energy tax credits.
3. Estate Tax and Gift Tax Exemptions
The annual exclusion and tax exemptions increased in 2023, with the gift tax annual exclusion increasing to $17,000, and the estate and gift tax exemption to $12.92 million (both adjusted for inflation). The gift tax exclusion is the amount you may give each year without depleting any of your gift and estate tax exemption. The gift and estate tax exemption is the amount you can transfer without being subject to a 40% tax. The gift and estate tax exemptions are both expected to return to $5 million in 2026, so it’s critical for taxpayers to not delay their estate and gift tax planning.
4. State and Local Tax (SALT) Limitation
The TCJA put a $10,000 cap on the SALT deduction for taxpayers who itemize their returns through 2025. Previously, there was no limit on this deduction, which allows taxpayers to deduct property, income and sales tax. With the limitation in mind, it’s important to evaluate whether to deduct sales tax versus income tax when itemizing deductions, depending on where you reside or if you’ve purchased any major items this year. There has been proposed legislation to repeal the $10,000 limitation, so be on the lookout for this as we approach the year end.
5. Section 163(j) Business Interest Expense Deduction
This deduction reverted to its TCJA rules this year, which imposes a limitation on the deduction and removes the addback of depreciation, amortization and depletion in the adjusted taxable income (ATI) calculation. Under Section 163(j), the amount of deductible business interest expense in a taxable year cannot exceed the sum of the taxpayer’s business interest income, 30% of the taxpayer’s adjusted taxable income (ATI) and the taxpayer’s floor plan financing interest. Taxpayers with average annual gross receipts of $25 million or less ($29 million for 2023) for the three previous tax years are generally exempt from the limitation.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily increased the interest expense deduction limit to 50% of ATI for the 2019 and 2020 tax years, so be sure to work with your tax advisor to ensure you’re making the proper tax elections related to your business activity moving forward.
6. Section 174
This tax code was amended under the TCJA and removed the option to expense research and experimental (R&E) expenditures in the year paid or incurred. Instead, taxpayers are required to capitalize and amortize domestic research expenditures over a five-year period (15 years for foreign expenditures), for amounts paid in tax years starting after Dec. 31, 2021. The amended code also specifies that amortization will begin with the midpoint of the taxable year in which expenses are paid or incurred, creating a significant impact on taxpayers.
Another major change in the rule is classifying software development costs as R&E expenditures under Section 174, subjecting them to the same mandatory amortization periods. With these capitalization requirements in mind, it’s important to properly identify R&E expenditures incurred within your business. The IRS recently issued Notice 2023-63, which offers some much-needed guidance on how to navigate the treatment of R&E expenditures under Section 174 for taxable years ending after Sept. 8, 2023, which is the effective date of the notice.
7. Net Operating Loss (NOL) Limitation
The TCJA significantly changed the NOL rules, limiting NOL incurred after Dec. 31, 2017, to 80% of taxable income (previously 100%) and disallowing NOL carrybacks. However, the TCJA allows NOL to be carried forward indefinitely. An NOL carryforward allows taxpayers to move a tax loss to future years to offset a profit, which can be beneficial from a tax planning perspective. The NOL would be even more valuable if the tax rates go up as outlined in the 2024 Revenue Proposals of Biden Administration.
Unsure on which of these tax incentives or deductions apply to you? We encourage you to conduct year-end tax planning to evaluate your current tax position and identify ways to optimize it, plus help minimize your overall liability.
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