November 21, 2022
Hello and Happy Thanksgiving/Merry Christmas, etc.! We are staying local for Thanksgiving this year as much is going on with the family. We have moved my mom and stepdad into an independent living facility (care can be increased if needed) that is close by and really nice! This place has many fun scheduled activities and excellent meals are included…like a cruise ship but on the ground!!!
We will have Christmas with my side of the family locally and then head to Austin in the RV again for Christmas with Angela’s side of the family…will be a fun Christmas season for sure!
My two favorite smaller motorcycle rallies each held at Luckenbach for over 20 years had their final rallies this year…very sad! The big Lone Star Rally held in Galveston just ended and it is still going strong…best rally ever! The big Republic of Texas rally held in Austin for the last 25 years or so moved in June 2022 to an extremely small location in Bastrop. This rally was so disorganized…no liquor license and no festival permits were obtained by the organizers…can you imagine a motorcycle rally that could not even sell beer? And the generators to supply electricity for the RV’s were not operational for many until the last day of the Rally! No A/C and it was 105 degrees! I decided not to stay it was so bad…so this one is over for me as well! But we just got back from a good time camping at the TX Renaissance Festival…extremely cold but beautiful and no rain!
How about those Astros!!! Angela’s parents got us interested in baseball and specifically the Astros many years ago. We got rid of cable TV and switched to Fubo internet TV just to be able to get all of the Astros games! But not sure what to do now that baseball is over…yikes!
I’m not sure what to say about the election. The Republicans will be in control of the House and the Democrats will keep control of the Senate it appears. And then a week later Trump announced he will run for President in 2024…should be an interesting 2 years!
Please remember to go to my website at www.markhessecpa.com and sign up for my monthly online newsletter...if you have trouble getting to sleep at night, print a copy to keep by your bed!
The Secure Drawer file sharing system has been discontinued as of 08/01/22. I replaced it effective 10/27/21 with a secure file sharing system called Rubex EfileCabinet developed by the same company that created Secure Drawer. So, it will have a similar look as Secure Drawer for those of you that used Secure Drawer in the past. The folder will be called Folder Shared With Mark. Please send me an email if you would like me to have EfileCabinet send you an email to set up this new secure file sharing system. Currently, you cannot set up sub folders with this system. But this is meant to be a bank/military grade secure way to share files with me and me with you…not a permanent storage for files.
Year-End Tax Planning for 2022 (Individuals)
It's that time of year again where we should consider meeting to discuss any year end strategies that might reduce your 2022 taxes. The following are some of the tax breaks from which you may benefit, as well as the strategies we can employ to help minimize your taxable income and resulting federal tax liability for 2022.
Your tax return filing status can impact the amount of taxes you pay. For example, if you qualify for head-of-household (HOH) filing status, you are entitled to a higher standard deduction and more favorable tax rates. To qualify as HOH, you must be unmarried or considered unmarried (i.e., legally separated or living apart from a spouse) and provide a home for certain other persons. If you are in such a situation, we need to review whether you qualify for HOH filing status.
If you are married, you'll either be filing your return using the married filing jointly or married filing separately filing status. Generally, married filing separately is not beneficial for tax purposes, but in some unique cases, such as when one party earns substantially less or when one party may be subject to IRS penalties for issues relating to their tax reporting, it may be advantageous to file as married filing separately (this generally will not work in community property states like Texas). Additionally, if one spouse was not a full-year U.S. resident, an election is available to file a joint tax return where such joint filing status would otherwise not apply and this may help reduce a couple's tax liability.
Income, Deductions, and Credits
Standard Deduction versus Itemized Deductions. The Tax Cuts and Jobs Act of 2017 (TCJA) substantially increased the standard deduction amounts, thus making itemized deductions less attractive for many individuals. For 2022, the standard deduction amounts are: $12,950 (single); $19,400 (head of household); $25,900 (married filing jointly); and $12,950 (married filing separately). If the total of your itemized deductions in 2022 will be close to your standard deduction amount, we should evaluate whether alternating between bunching itemized deductions into 2022 and taking the standard deduction in 2023 (or vice versa) could provide a net-tax benefit over the two-year period. For example, you might consider doubling up this year on your charitable contributions rather than spreading the contributions over a two-year period. If these contributions, along with your mortgage interest, medical expenses (discussed below), and state income and property taxes (subject to the $10,000 deduction limitation on such taxes that applies to both single individuals and married couples filing jointly; and the $5,000 limitation on such expenses for married filing separately returns), exceed your standard deduction, then itemizing such expenses this year and taking the standard deduction next year may be appropriate.
Medical Expenses, Health Savings Accounts, and Flexible Savings Accounts. For 2022, your medical expenses are deductible as an itemized deduction to the extent they exceed 7.5 percent of your adjusted gross income. To be deductible, medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. They don't include expenses that are merely beneficial to general health, such as vitamins or a vacation. Deductible expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract. Depending on what your taxable income is expected to be in 2022 and 2023, and whether itemizing deductions would be advantageous for you in either year, you may want to accelerate any optional medical expenses into 2022 or defer them until 2023. The right approach depends on your income for each year, expected medical expenses, as well as your other itemized deductions.
You may also want to consider health saving accounts (HSAs) if you don't already have one. These are tax-advantaged accounts which help individuals who have high-deductible health plans (HDHPs). If you are eligible to set up such an account, you can deduct the amount you contribute to the account in computing adjusted gross income. These contributions are deductible whether you itemize deductions or not. Distributions from an HSA are tax free to the extent they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2022, the annual contribution limits are $3,650 for an individual with self-only coverage and $7,300 for an individual with family coverage.
In addition, if you are not already doing so and your employer offers a Flexible Spending Account (FSA), consider setting aside some of your earnings tax free in such an account so you can pay medical and dental bills with pre-tax money. Since you don't pay taxes on this money, you'll save an amount equal to the taxes you would have paid on the money you set aside. FSA funds can be used to pay deductibles and copayments, but not for insurance premiums. You can also spend FSA funds on prescription medications, as well as over-the-counter medicines, generally with a doctor's prescription. Reimbursements for insulin are allowed without a prescription. And finally, FSAs may also be used to cover costs of medical equipment like crutches, supplies like bandages, and diagnostic devices like blood sugar test kits.
Charitable Contributions. The tax benefits of making charitable contributions and taking an itemized deduction for such contributions were tamped down as a result of the increase in the standard deduction in the TCJA. More people are forgoing itemized deductions as their standard deduction is more favorable.
If you are itemizing deductions, you can maximize the tax benefit of making a charitable contribution by donating appreciated assets, such as stock, instead of cash. Doing so generally allows you to deduct the fair market value of the asset while also avoiding the capital gains tax that would otherwise be due if you sold the asset. For example, if you own stock with a fair market value of $1,000 that was purchased for $250 and your capital gains tax rate is 15 percent, the capital gains tax you would owe is $113 ($750 gain x 15%). If you donate that stock instead of selling it, and are in the 24 percent tax bracket, your ordinary income deduction is worth $240 ($1,000 FMV x 24% tax rate). You also save the $113 in capital gains tax that you would otherwise pay if you sold the stock; that amount goes to the charity. Thus, the after-tax cost of the gift of appreciated stock is $647 ($1,000 - $240 - $113) compared to the after tax cost of a donation of $1,000 cash which would be $760 ($1,000 - $240). However, it's important to also keep in mind that tax deductions for contributions of appreciated long-term capital gain property may be limited to a certain percentage of your adjusted gross income depending on the amount of the deduction.
In addition, if you have an individual retirement account and are 70 1/2 years old and older, you are eligible to make a charitable contribution directly from your IRA. This is more advantageous than taking a distribution and making a donation to the charity that may or may not be deductible as an itemized deduction. If your itemized deductions, including the contribution, are less than your standard deduction, then you receive no tax benefit from making the donation in this manner. By making the donation directly from your IRA to a charity, you eliminate having the IRA distribution included in your income. This in turn reduces your adjusted gross income (AGI). And because various tax-related items, such as the medical expense deduction or the taxability of social security income or the 3.8 percent net investment income tax, are calculated based on your AGI, a reduced AGI can potentially increase your medical expense deduction, reduce the tax on social security income, and reduce any net investment income tax.
Expenses Incurred While Working from Home. Although more people are working from home these days, related expenses are not deductible if you are an employee. TCJA eliminated the deductibility of such expenses when it suspended the deduction for miscellaneous itemized expenses that was available before 2018. However, if you are self-employed and worked from home during the year, tax deductions are still available. Thus, if you have been working from home as an independent contractor, we should discuss what expenses you have incurred that might reduce your taxable income.
Mortgage Interest Deduction. If you sold your principal residence during the year and acquired a new principal residence, the deduction for any interest on your acquisition indebtedness (i.e., your mortgage) could be limited. The mortgage interest deduction on mortgages of more than $750,000 obtained after December 14, 2017, is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). If you have a mortgage on a principle residence acquired before December 15, 2017, the limitation applies to mortgages of $1,000,000 ($500,000 in the case of married taxpayers filing separately) or less. However, if you operate a business from your home, an allocable portion of your mortgage interest is not subject to these limitations.
Interest on Home Equity Indebtedness. You can potentially deduct interest paid on home equity indebtedness, but only if you used the debt to buy, build, or substantially improve your home. Thus, for example, interest on a home equity loan used to build an addition to your existing home is typically deductible, while interest on the same loan used to pay personal expenses, such as credit card debt, is not.
Sale of a Home. If you sold your home this year, up to $250,000 ($500,000 for married filing jointly) of the gain on the sale is excludible from income. However, this amount is reduced if part of your home was rented out or used for business purposes. Generally, a loss on the sale of a home is not deductible. But again, if you rented part of your home or otherwise used it for business, the loss attributable to that portion of the home is deductible.
Discharge of Qualified Principal Residence Indebtedness: If you had any qualified principal residence indebtedness which was discharged in 2022, it is not includible in gross income.
Deductions for Mortgage Insurance Premiums: You may be entitled to treat amounts paid during the year for any qualified mortgage insurance as deductible qualified residence interest if the insurance was obtained in connection with acquisition debt for a qualified residence.
Deductions for Excess Business Losses. Taxpayers other than corporations can deduct excess farm losses; however, such taxpayers cannot deduct excess business losses. An excess business loss for the tax year is the excess of aggregate deductions attributable to your trades or businesses over the sum of your aggregate gross income or gain plus a threshold amount. The threshold amount for 2022 is $270,000 or $540,000 for joint returns.
Qualified Business Income Passthrough Tax Break. Under the qualified business income tax break, a 20 percent deduction is allowed for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. If you qualify for the deduction, which is available to both itemizers and nonitemizers, it is taken on your individual tax return as a reduction to taxable income. This tax break is subject to some complicated restrictions and limitations, but the rules that apply to individuals with taxable income at or below a certain threshold ($340,100 for joint filers; $170,050 for other taxpayers) are simpler and more permissive than the rules that apply to individuals with income above those thresholds.
Child Tax Credit. The enhanced child tax credit (CTC) that was available last year was not renewed. Thus, for 2022, for each child under age 17, a CTC of up to $2,000 credit is available, depending on your modified adjusted income. In addition, a $500 nonrefundable credit is available for qualifying dependents other than qualifying children. Where the credit exceeds the maximum amount of tax due, it may be refundable. The maximum amount refundable for 2022 is $1,500 per qualifying child. The $500 credit applies to two categories of dependents: (1) qualifying children for whom a child tax credit is not allowed, and (2) qualifying relatives. The amount of the credit is reduced for taxpayers with modified adjusted gross income over $200,000 ($400,000 for married filing jointly) and eliminated in full for taxpayers with modified adjusted gross income over $240,000 ($440,000 for married filing jointly).
Earned Income Credit. The earned income tax credit (EITC) is determined by multiplying your earned income for the year (but only up to a maximum amount of earned income) by a credit percentage that varies depending on whether you have any qualifying children and, if so, the number of qualifying children. The EITC is also subject to a limitation based on your adjusted gross income. For 2022, the maximum amount of the EITC is (1) $560 for a taxpayer with no qualifying children, (2) $3,733 for a taxpayer with one qualifying child, (3) $6,164 for a taxpayer with two qualifying children, and (4) $6,935 for a taxpayer with three or more qualifying children. In addition, the EITC cannot be claimed if your investment income (including interest, dividends, capital gain net income, and net rental income) exceeds $10,300 for 2022.
Dependent Care Credit: If you incurred expenses to care for a child or another dependent so that you can work, you may be eligible for the child and dependent care credit. This credit is available to individuals who, in order to work or to look for work, have to pay for childcare services for dependents under age 13. The credit is also available for amounts paid for the care of a spouse or a dependent of any age who is physically or mentally incapable of self-care. The credit is not available for amounts paid to a dependent or a taxpayer under age 19. The amount of the credit is a specified percentage of your total employment-related expenses - generally, 35 percent reduced (but not below 20 percent) by one percentage point for each $2,000 by which your adjusted gross income for the tax year exceeds $15,000. Employment-related expenses incurred during any tax year which may be taken into account cannot exceed $3,000 for one qualifying individual or $6,000 for two or more qualifying individuals.
Premium Tax Credit. A health insurance subsidy is available in the form of a premium assistance tax credit for eligible individuals and families who purchase health insurance through the Health Insurance Marketplace, also known as the "Exchange." The provision is the result of the Patient Protection and Affordable Care Act (PPACA). This credit is refundable and payable in advance directly to the insurer on the Exchange. In the past, individuals with incomes exceeding 400 percent of the poverty level were not eligible for these subsidies. However, as a result of the American Rescue Plan (ARP) Act, the cap was eliminated for tax years beginning in 2021 or 2022 and therefore, anyone can qualify for the subsidy. In addition, the percentage of your income paid for a health insurance under a PPACA plan is limited to 8.5 percent of income. Thus, if you buy your own health insurance directly through an Exchange, you can receive increased tax credits to reduce your premiums.
Education-Related Deductions and Credits. Certain education-related tax deductions, credits, and exclusions from income may be available for 2022. For example, tax-free distributions from a qualified tuition program, also referred to as a Section 529 plan of up to $10,000 are allowed for qualified higher education expenses. Qualified higher education expenses for this purpose include tuition expenses in connection with a designated beneficiary's enrollment or attendance at an elementary or secondary public, private, or religious school, i.e., kindergarten through grade 12. It also includes expenses for fees, books, supplies, and equipment required for the participation in certain apprenticeship programs and qualified education loan repayments in limited amounts. A special rule allows tax-free distributions to a sibling of a designated beneficiary (i.e., a brother, sister, stepbrother, or stepsister). As a result, a 529 account holder can make a student loan distribution to a sibling of the designated beneficiary without changing the designated beneficiary of the account.
Depending on your modified adjusted gross income for the year, you may also qualify for: (1) an American Opportunity Tax Credit of up to $2,500 per year for each eligible student; (2) a Lifetime Learning credit up to $2,000 for tuition and fees paid for the enrollment or attendance of yourself, your spouse, or your dependents for courses of instruction at an eligible educational institution; (3) an exclusion from income for education savings bond interest received; and (4) a deduction for student loan interest.
If you qualified for student loan forgiveness under the plan announced by the Biden administration earlier this year, the forgiven amount will generally be excludible from your income for federal tax purposes. However, you may be liable for state or local income taxes as a result of the discharge.
Clean Energy Credits. For 2022, the clean energy tax credits available include (1) residential energy property credits (the nonbusiness energy property credit and the residential clean energy property credit) and (2) vehicle-related credits (the qualified plug-in electric drive motor vehicle credit and the alternative fuel refueling property credit). These credits were significantly expanded by the Inflation Reduction Act, generally beginning after December 31, 2022. However, as described in more detail below, a change to the credit for purchasing an electric vehicle, requiring the final assembly of the vehicle in the United States, takes effect on August 17, 2022.
For years before 2023, the nonbusiness energy property credit (renamed the energy efficient home improvement credit by the Inflation Reduction Act) is a credit for: (1) 10 percent of the cost of qualified energy efficiency improvements installed during the year; and (2) the amount of the residential energy property expenditures paid or incurred during the year. Qualified energy efficiency improvements include the following qualifying products: (1) energy-efficient exterior windows, doors and skylights; (2) roofs (metal and asphalt) and roof products; and (3) insulation. Residential energy property expenditures generally include: (1) energy-efficient heating and air conditioning systems, and (2) water heaters (natural gas, propane, or oil). There is a lifetime limit of $500 on the total amount of nonbusiness energy property credits that may be claimed. In addition, the amount of the credit taken with respect to windows is limited to $200. The following additional limitations also apply to the nonbusiness energy property credit: (1) $300 for any item of energy-efficient building property; (2) $150 for any furnace or hot water boiler; and (3) $50 for any advanced main air circulating fan.
Beginning in 2023, this credit is increased to 30 percent of the costs of all qualified energy efficiency improvements and residential energy property expenditures made during the year. In addition, the lifetime credit limitation is replaced with an annual limit of $1,200. The annual limits for specific types of qualifying improvements are (1) $250 for any exterior door ($500 total for all exterior doors), (2) $600 for exterior windows and skylights, (3) $600 for other qualified energy property (including central air conditioners; electric panels and certain related equipment; natural gas, propane, or oil water heaters; oil furnaces; water boilers), and (4) a higher $2,000 annual limit for heat pumps and heat pump water heaters, biomass stoves, and boilers. The Inflation Reduction Act also added a credit of up to $150 per year for home energy audits. Roofs no longer qualify for the credit beginning in 2023.
The residential energy efficient property credit (renamed the residential clean energy credit by the Inflation Reduction Act) equals 30 percent of the cost of certain qualified property installed on or used in connection with your home. For 2022, qualifying properties are: (1) solar electric property, (2) solar water heaters, (3) fuel cell property, (4) small wind turbines, (5) geothermal heat pumps, and (6) biomass fuel property. Biomass fuel property expenditures no longer qualify after December 31, 2022. However, battery storage technology expenditures qualify beginning in 2023.
The qualified plug-in electric drive motor vehicle credit may be available if you acquired a qualified electric vehicle and placed it in service this year. For 2022, the amount of the credit is $2,500, plus an amount based on the battery capacity of the vehicle if the vehicle draws propulsion energy from a battery with at least 5 kilowatt hours of capacity. The credit begins to phase out for a manufacturer's vehicles when at least 200,000 qualifying vehicles have been sold for use in the United States. For instance, Tesla and GM vehicles purchased in 2022 are not eligible for tax credits since those manufacturers have exceeded the 200,000 vehicle threshold.
The Inflation Reduction Act significantly modified the electric vehicle credit. After August 16, 2022, the credit is generally available only for qualifying electric vehicles for which final assembly occurred in North America. However, under a transition rule, if you entered a written binding contract to purchase an electric vehicle on or before August 16, 2022, but took possession of the vehicle after that date, you would not be subject to the final assembly requirement. The Inflation Reduction Act also increased the amount of this credit, effective after December 31, 2022. Beginning in 2023, the total credit amount is $7,500, consisting of $3,750 for vehicles meeting a critical minerals requirement and $3,750 for vehicles a battery component requirement. In addition, price limits apply depending on the vehicle type ($80,000 for vans, SUVs, and pickup trucks; $55,000 for other vehicles). The credit is also not available to taxpayers with adjusted gross income over $300,000 (married filing jointly), $225,000 (head of household), and $150,000 (single). Other requirements apply beginning after 2023.
The alternative fuel vehicle refueling property credit is a credit for 30 percent of the cost of purchasing qualified alternative fuel vehicle refueling property. This credit initially expired at the end of 2021 but was extended through 2032 by the Inflation Reduction Act. The amount of the credit is limited to a certain dollar amount, which depends on whether the property is used for business or personal purposes. The amount of the credit for business-use property (i.e., depreciable property) is limited to $30,000. The amount of the credit for personal-use property (i.e., non-depreciable property) is limited to $1,000.
Beginning next year, the credit allowed with respect to any single item of qualified alternative fuel vehicle refueling property placed in service during the tax year cannot exceed (1) $100,000 in the case of depreciable property, and (2) $1,000 in any other case. In addition, the definition of qualifying property is expanded to include bidirectional charging equipment and the credit can also be claimed for electric charging stations for two- and three-wheeled vehicles that are intended for use on public roads.
If you can afford to do so, investing the maximum amount allowable in a qualified retirement plan will yield a large tax benefit. If your employer has a 401(k) plan and you are under age 50, you can defer up to $20,500 of income into that plan for 2022. Catch-up contributions of $6,500 are allowed if you are 50 or over. If you have a SIMPLE 401(k), the maximum pre-tax contribution for 2022 is $14,000. That amount increases to $17,000 if you are 50 or older. The maximum IRA deductible contribution for 2022 is $6,000 and that amount increases to $7,000 if you are 50 or over.
Life events can have a significant impact on your tax liability. For example, if you are eligible to use head of household or surviving spouse filing status for 2022 but will change to a filing tax status of single for 2023, your tax rate will go up. If you married or divorced during the year and changed your name, you need to notify the Social Security Administration (SSA). Similarly, the SSA should be notified if you have a dependent whose name has been changed. A mismatch between the name shown on the tax return and the SSA records can cause problems in the processing of tax returns and may even delay tax refunds. Let me know if you have been impacted by a life event, such as a birth or death in your family, the loss of a job or a change in jobs, or a retirement during the year. All of these can affect you tax situation.
Impact of Future Legislation
There have been ongoing discussions between Republicans and Democrats about a potential last minute end-of-year tax deal regarding a reinstatement of the research and development credit, which expired at the end of 2021 and which businesses are anxious to see reinstated, in exchange for an enhanced child tax credit that is similar to the 2021 enhanced child tax credit enacted as part of the American Rescue Plan Act of 2021. Because it is unclear what, if any, tax legislation may be passed before the end of the year, we'll need to base our year-end planning on existing law.
Year-End Tax Planning for 2022 (Business)
As the year draws to a close, it's important that we meet to discuss any year-end strategies that might help lower your business's taxable income for 2022.
The most significant tax law changes during the year took place in August when the 2022 Inflation Reduction Act (2022 IRA) was signed into law. While the new law did not change tax rates for most businesses, it does extend some expiring business tax credits while also introducing some new tax credits that may benefit your business. It also provided a hefty increase in IRS funding to bolster taxpayer services and enforcement of the tax code.
The following are some strategies we should consider for reducing your business's taxes for 2022.
Section 179 Expensing and Depreciation Deductions
The two business tax deductions that present the best opportunities for reducing your business's taxable income are the Section 179 deduction, where your business can elect to deduct the entire cost of certain property acquired and placed in service during the year, and the bonus depreciation deduction, where 100 percent of the cost of business property may be expensed. Under the Section 179 expensing option, your business can immediately expense the cost of up to $1,080,000 of "Section 179" property placed in service in 2022. This amount is reduced dollar for dollar (but not below zero) by the amount by which the cost of the Section 179 property placed in service during 2022 exceeds $2,700,000.
The bonus depreciation rules apply to all businesses unless the business specifically elects out of these rules. An election out might be preferable where a business expects a tax loss for the year and the bonus depreciation would just increase that loss or where it might be advantageous to push depreciation deductions into future years. For example, if the owner of a pass-thru entity to whom these deductions would flow expects to be in a higher tax bracket in future years, such deductions might be of more use in those future years. When applying both the Section 179 deduction and the bonus depreciation deduction to an asset, the Section 179 deduction applies first.
If you need a vehicle for your business, purchasing a sport utility vehicle weighing more than 6,000 pounds, can trigger a bigger deduction than if a smaller vehicle is purchased. This is because vehicles that weigh 6,000 pounds or less are considered listed property and the related first-year deduction is limited to $19,200 for cars, trucks and vans acquired and placed in service in 2022. For vehicles weighing more than 6,000 pounds, however, up to $27,000 of the cost of the vehicle can be immediately expensed.
It's worth noting that if you leased a passenger automobile in 2022 with a value of more than $56,000, the deduction available for that lease expense is reduced. In such cases, you must include in gross income an amount determined by a formula the IRS issues each year.
Qualified Business Income Deduction
If you are conducting your business as a sole proprietorship, a partner in a partnership, a member in an LLC taxed as a partnership, or as a shareholder in an S corporation, the qualified business income (QBI) deduction can significantly help reduce taxable income. The QBI deduction allows eligible taxpayers to deduct up to 20 percent of their QBI, plus 20 percent of qualified real estate investment trust dividends and qualified publicly traded partnership income. A W-2 wage limitation amount may apply to limit the amount of the deduction. The W-2 wage limitation amount must be calculated for taxpayers with a taxable income that exceeds a statutorily defined amount (i.e., the threshold amount). For any tax year beginning in 2022, the threshold amount is $340,100 for married filing joint returns and $170,050 for all other returns.
Since the QBI deduction reduces taxable income, and is not used in computing adjusted gross income, it does not affect limitations based on adjusted gross income such as the medical expense deduction or the calculation of social security income that is includible in income. However, the QBI deduction does not apply to a "specified service trade or business," which is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.
Rental Real Estate
If you have any rental real estate activities, it's important to determine if the activity will be considered a passive activity by the IRS. Generally, losses from passive activities are only deductible against passive activity income. However, a deduction of up to $25,000 ($12,500 if married filing separately) may be allowed against nonpassive income to the extent you actively participate in the rental real estate activities. This deduction is subject to a phaseout for individuals with modified adjusted gross income above $100,000 (or $50,000 if married filing separately). Additionally, you may be eligible for a qualified business income deduction if certain criteria are met, such as the rental activity qualifying as a Section 162 trade or business.
Substantiation of Vehicle-Related Deductions
In audits, the IRS tends to focus on deductions taken for vehicle expenses. If not properly substantiated, such deductions are disallowed. Thus, if vehicles are used in any part of your business or business-related activities, your tax records with respect to each vehicle should include the following:
(1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance, etc.);
(2) the amount of mileage for each business or investment use and the total miles for the tax period;
(3) the date of the expenditure; and
(4) the business purpose for the expenditure.
The IRS will consider the following as adequate substantiation for such expenses: (1) records such as a notebook, diary, log, statement of expense, or trip sheets; and (2) documentary evidence such as receipts, canceled checks, bills, or similar evidence.
It’s important to note that records are considered adequate to substantiate the element of a vehicle expense only if they are prepared or maintained in such a manner that each recording of an element of the expense is made at or near the time the expense is incurred.
One area I would like to discuss with you are the tax and other advantages your business could reap by offering a retirement plan and/or other fringe benefits to employees. By offering such benefits, your business has a better chance of attracting and retaining talented workers which, in turn, reduces the costs of searching for and training new employees. Contributions made to retirement plans on behalf of employees are deductible and your business may be eligible for a tax credit for setting up a qualified plan if you don't already have one.
If you haven't already done so, you might consider the establishment of a flexible spending arrangement (FSA). An FSA allows employees to be reimbursed for medical expenses and is usually funded through voluntary salary reduction agreements with the employer. The employer has the option of making or not making contributions to the FSA. Some of the benefits of providing an FSA for employees include contributions made by the business being excluded from the employee's gross income, reimbursements to the employee are tax free if used for qualified medical expenses, the FSA can be used to pay qualified medical expenses even if the employer or employee haven't yet placed the funds in the account, and up to $570 of funds in the FSA can be carried over to subsequent years indefinitely.
Another popular employee benefit your business might consider is a high deductible health plan paired with a health savings account (HSA). The benefits to your business include savings on health insurance premiums that would otherwise be paid to traditional health insurance companies and having employee wage contributions to the plan not being counted as wages and thus neither the employer nor the employee is subject to FICA taxes on the payroll contributions. As for employees, they can reap a tax deduction for funds contributed to the HSA, and there is no use-it-or-lose-it limit like there is for most flexible spending arrangements (FSAs). Thus, the funds can grow tax free and be used in retirement.
Pass-Thru Entity Considerations
If you are operating a business through a pass-thru entity such as a partnership or S corporation, your basis in the entity must be high enough to allow for any loss deduction, if you have one for the year. In such a situation, we should consider the options available for increasing your basis in such entity.
If you are an S corporation shareholder it's important to ensure that you and other shareholders involved in running the business are paid an amount that is commensurate with the work being done. The IRS scrutinizes S corporations which distribute profits instead of paying compensation subject to employment taxes. Failing to pay arm's length salaries can lead to tax deficiencies, interest, and penalties. The key to establishing reasonable compensation is showing that the compensation paid for the type of work an owner-employee does for the S corporation is similar to what other entities would pay for similar work. An S corporation needs to adequately document the factors that support the salary an S corporation owner is being paid.
Also, because there are stringent requirements for who may be an S corporation shareholder, if the number of shareholders have changed or increased during the year, we should review the residency or citizenship status of the S corporation's shareholders and S corporation stock beneficiaries (including contingent and residuary beneficiaries).
Energy Efficient Commercial Building Deduction
If your business owns a commercial building, a deduction is available for an amount equal to the cost of energy efficient commercial building property placed in service during the tax year. The maximum deduction with respect to any building for any tax year is the excess (if any) of (1) the product of $1.88, and the square footage of the building, over (2) the aggregate amount of the deductions for all prior tax years.
New and Modified Tax Credits
The 2022 IRA modified tax credits for electric vehicles (EVs) and fuel cell vehicles. The law also enacted new tax credits for used and commercial clean vehicles. Multiple factors determine whether an EV purchased in 2022 qualifies for federal tax credits. Many EVs purchased before August 16, 2022, qualify for a tax credit of up to $7,500 (with smaller amounts available for certain makes and models). Vehicles manufactured by Tesla or General Motors purchased in 2022 are not eligible for tax credits, as Tesla and GM have exceeded the 200,000 vehicle threshold that limits the number of tax credits that can be claimed for vehicles made by a manufacturer.
For vehicles purchased after August 16, 2022, only vehicles for which final assembly occurred in North America qualify. The U.S. Department of Energy has released a list of model year 2022 and 2023 vehicles with final assembly in North America.
EV purchasers who ordered a vehicle before August 16, 2022 and take delivery of their vehicle at a later date may be able to claim tax credits for vehicles not assembled in North America if they had a written binding contract to purchase the vehicle. Most of the changes to the clean vehicle tax credit are effective starting in 2023, with the exception of the final assembly in North America requirement, mentioned above. Beginning in 2023, EVs qualify only if the vehicle's battery meets certain conditions. The maximum potential credit is the sum of two amounts: the critical mineral amount and the battery component amount.
The 2022 IRA also introduced a new credit for qualified commercial electric vehicles placed into service by the taxpayer after 2022. The amount of credit is 30 percent of the cost of the vehicle, up to $7,500 in the case of a vehicle that weighs less than 14,000 pounds, and up to $40,000 for all other vehicles.
The energy investment tax credit (ITC) was also extended by the 2022 IRA and could reduce your business's federal tax liability by a percentage of the cost of a solar system installed during the tax year. Solar systems placed in service in 2022 or later, and that began construction before 2033, are eligible for a 30 percent ITC or a production tax credit based on a kilowatt-hour formula if they meet certain labor requirements or are under 1 megawatt in size.
Research and Development Deductions and Credits
Finally, the provision allowing a deduction for research and development (R&D) expenses expired at the end of 2021. Such expenditures must now be amortized over five years. However, under the 2022 IRA, businesses that engage in certain types of research may qualify for an income tax credit based on its qualified research expenses. The credit is calculated as the amount of qualified research expenditures above a base amount that is meant to represent the amount of research expenditures in the absence of the credit. Because some small businesses may not have a large enough income tax liability to take advantage of their research credit, the law allows that small business (i.e., a business with less than $5 million in gross receipts and that is under five years old) to apply up to $250,000 of the research credit toward its social security payroll tax liability. The 2022 IRA expanded the amount available for the credit from $250,000 to $500,000 for tax years beginning after 2022.
It's worth noting that there is a slim chance that the R&D expensing provision that terminated at the end of 2021 may be restored. There have been ongoing discussions between Republicans and Democrats about a potential last minute end-of-year tax deal regarding a reinstatement of the R&D credit, which expired at the end of 2021 and which businesses are anxious to see reinstated, in exchange for an enhanced child tax credit that is similar to the 2021 enhanced child tax credit enacted as part of the American Rescue Plan Act of 2021. Because it is unclear what, if any, tax legislation may be passed before the end of the year, our year-end planning will have to be based on existing law.
As you can see, there is much to consider before we prepare your 2022 business tax return and calculate any estimated tax payments that might be due in 2023.
Please call me if you would like to set up a phone or Zoom conference ($176/hour, 15 minutes minimum) to estimate your tax liability for the year and discuss whether any of the options above may be beneficial to you.
I’ve enclosed your 2022 tax return organizer, which includes amounts from your 2021 return (if I prepared your 2021 return) to help you summarize your 2022 tax information. If you are not sure where specific tax information belongs, just include the related documentation. Please bring this organizer to our meeting whether you have completed it or not. If you mail or drop by your data, please try to fill out the organizer as much as possible. (This will save us time and you money!)
In order for me to prepare your return by April 17, 2023, I must have your completed organizer in my office no later than Friday, March 10, 2023 (PLEASE NOTE: this is an estimated cut-off date...it could be sooner). Please call/e-mail to schedule an office appointment or Zoom conference as soon as possible or just drop your data/organizer by my office. Generally, my fee will be significantly more if we meet in an office conference vs. dropping off your data with a phone or Zoom conference.
My appointments will be scheduled Tuesday through Thursday at 8:30AM, 10:00AM, 11:30AM, 2:30PM & 4:30PM only (I’ll be working out of my home office evenings, Mondays, Fridays and weekends). Please select one of these conference times (note that the morning appointments are 1.5 hours & the afternoon appointments are 2.0 hours...my minimum in-office conference is one hour @ $240/hour) and leave your desired time/date on my voice mail or by e-mail. I will then confirm your appointment by e-mail or phone.
Immediately following this letter is an engagement letter, which is designed to help you understand the nature of the services I am providing. Please read, sign and date this letter and bring it with you to our meeting (or e-mail/fax it to me if we do not meet). I must have this signed letter before I can complete your return.
Please feel free to call me if you need any help completing your organizer or if I can provide other tax services. My #1 goal is to make sure you pay the least legal tax. Thanks for your business and Merry Christmas/Happy Hanukkah/etc.! Have a fun and safe New Year in 2023 and remember, I’ll do the tax...You relax!
Mark E. Hesse, CPA
P.S. If you would prefer an electronic organizer, just e-mail your request with your preferred e-mail address and I’ll send you a link to your electronic organizer securely encrypted and password protected. When you’ve completed the organizer, simply e-mail it back to me.