It’s that time of year again! No, we are not referring to the holidays, but time to review your company’s tax situation, identify tax saving opportunities, and implement strategies before year-end to maximize cash flow. Here are our top 5 things small businesses can do to reduce their end of year tax liabilities:
1. Maximize IRC 199A Qualified Business Income Deduction
Also referred to as the 20% pass-through deduction, Internal Revenue Code (IRC) 199A allows some taxpayers (other than corporations) to deduct up to 20% of their qualified business income.
While there are limitations that may preclude some taxpayers from realizing the benefit of IRC 199A (if taxable income exceeds a specified threshold, if the taxpayer is engaged in a service-type trade or business, limitations based on the amount of W-2 wages paid and the unadjusted basis of qualified property held by the trade or business), there are plenty of planning opportunities available to maximize this deduction.
Careful planning should be done to maximize the deduction, which may include deferring income or accelerating deductions (so as not to exceed the dollar thresholds), increase W-2 wages before year-end, increase capital expenditures, and weigh the benefits of not accelerating depreciation (a timing difference) so that IRC 199A deduction (a permanent difference) is maximized.
2. Review Tax Method of Accounting and Related Strategies
Most taxpayers know the benefit of filing tax returns on the cash basis method of accounting, where income may be deferred by delaying invoices to the next taxable year and accelerating expenses (bonuses, commissions, paying invoices early, purchasing and placing in service capital expenditures), but most taxpayers overlook the opportunities available to accrual method taxpayers.
Accrual method taxpayers may still be able to accelerate deductions for compensatory items, like bonuses, as long as they have a documented plan in place that both fixes and determines the liability as of year-end (i.e. the “fixed and determinable” test). Furthermore, accrual basis taxpayers should review their accounts receivable (to determine items that can be written off as uncollectible) and inventory (to determine items that are spoiled/obsolete and can be written off as disposed of). Accrual method taxpayers take caution – there are steps to take before year-end to ensure the items can be adjusted for both financial reporting and tax purposes, so it is best to speak with your tax adviser.
Accrual basis taxpayers who satisfy a gross receipts test ($29 million for 2023, amount is indexed annually for inflation) may be able to file a change in accounting method and file tax returns on the cash method of accounting or change the method they use to account for inventory. While this election is not required to be filed until next year, taxpayers can start the conversion calculation process and year-end planning to reduce taxes.
3. Capital Expenditures Planning
Businesses considering expansion or upgrades should quickly evaluate whether the purchases could be made, and property placed in service by year-end due to generous capital expenditure allowances under the internal revenue code. These are as follows:
- IRC 179 –For tax years beginning in 2023, the expensing limit is $1,160,000, and the investment ceiling limit is $2,890,000. Most depreciable property (other than buildings) and off-the-shelf computer software is eligible for the deduction in addition to most qualified improvement property. Regardless of when the property is purchased/placed into service, the full amount of the property may be eligible for bonus depreciation (and not prorated). Note, states may not conform to this federal provision or may have smaller thresholds.
- Bonus Depreciation– Both used and new property purchased and placed in service is eligible for the write-off of qualifying property. Unlike taking IRC 179 expensing of property which cannot create a net operating loss (“NOL”), bonus depreciation can create a NOL. Starting with tax year 2023, the bonus percentage is 80% of the cost of qualified property. This gradually phases down by 20% each subsequent year until it is 0% for 2027. The election is made by asset class. Analysis should be conducted as to whether it is most appropriate for a taxpayer’s situation to take bonus depreciation, IRC 179 deductions, or standard depreciation over the life of the asset. Note, states may not conform to this federal provision (California does not).
- De Minimis Safe Harbor– Also referred to as the book-tax conformity election, taxpayers can elect to expense the costs of assets, materials, and supplies (that are not required to be capitalized under IRC 263A) if the cost of a unit of property is $5,000 or less if they have applicable financial statements (“AFS”) or $2,500 if they do not have AFS.
4. Net Operating Loss Planning
For tax purposes, having taxable deductions in excess of income may not be a bad thing. In fact, taxpayers with NOLs, or the ability to create NOLs, may realize substantial tax benefits by reducing taxes when cash is needed most. Some considerations for taxpayers to consider:
- In general there is an 80% limitation for NOLs implemented under the Tax Cut and Jobs Act (“TCJA”).
- Before planning for the benefit of any NOL, taxpayers should ensure they do not have any IRC 382 ownership limitations, Alternative Minimum Tax (“AMT”) limitations, and that they can also take the losses for state purposes (California recently suspended the use of NOL deductions for tax years beginning in 2020, 2021, and 2022).
5. Credits and Incentives
Federal, state, and local credits and incentives are often overlooked areas of tax savings for many taxpayers. Before year-end, we recommend taxpayers review some of the more common credits and incentives for tax saving opportunities:
- Research and Development (“R&D”) Credit– federal (and many states, including California) allow an income tax credit (federal has a refundable R&D FICA credit for small businesses) for qualifying research expenditures. See our blog on the recent enhancements to the R&D credit.
- Small Employer Pension Plan Start-up Costs– federal credit for eligible small employers to claim a credit for qualified startup costs incurred in establishing or administering an eligible employer plan.
- California Manufacturing and Research & Development Equipment Exemption –manufacturers and certain research and developers may qualify for a partial exemption of sales and use tax on certain manufacturing and research and development equipment purchases and leases.
- Employee Retention Tax Credit – While this credit does not apply to 2022 or subsequent tax years, taxpayers may still be eligible for credits related to the 2020 and 2021 years. While the IRS has suspended processing of these credits, applications should be submitted now to be top of queue if and when the suspension is lifted.
- Energy Credits – the Inflation Reduction Act of 2022 added many new credit opportunities for energy investment. Two of the most common are:
- A new Qualified Commercial Clean Vehicle Credit is available for qualified vehicles purchased after December 31, 2022, and before 2033 and that are used in a trade or business. The credit is equal to the lesser of: 1) 15% of the vehicle’s basis (30% if the vehicle is not powered by a gasoline or diesel internal combustion engine); or 2) The excess of the vehicle’s purchase price over the cost of a comparable vehicle in terms of size and use, which is powered solely by a gasoline or diesel internal combustion engine.
- The Energy Efficient Commercial Building Deduction allows a taxpayer who owns or leases a commercial building to deduct the cost or a portion of the cost to install energy efficient commercial building property (EECBP). This can apply to one of the following three buildings systems: 1) Interior lighting system, 2) HVAC System, or 3) The building’s envelope.
Aura Advisors, an Accountancy Corporation is a boutique tax consulting, compliance, and representation firm working with start-up/emerging growth companies. Building connections beyond the code.