The business and economic climate in which we operate has seen a vast dichotomy of challenges and opportunities over the past year. Rising inflation, accompanied by rising prices to maintain margins; an influx of capital in the private marketplace and consistent M&A activity mark a few of the highs and lows in 2022.
The potential for new legislation and the political environment will also continue to factor into both short-term and long-term planning for taxpayers, as will the many provisions from the Tax Cuts & Jobs Act (TCJA) that had delayed starts and are now coming to fruition. While there is always the possibility of an extender package impacting those provisions, for now we plan with what we know.
And of the few certainties taxpayers can rely on, we know reporting requirements for federal filings will continue to increase, elevating the complexity of tax returns. As a result, strategic year-end tax planning for business owners remains more critical than ever.
Below are eight important tax planning areas to begin discussing with your advisers now.
1. Changes to R&D Expense Deductibility Signal More Planning
The deductibility of U.S. Research & Development expenses for businesses is about to change — from allowing taxpayers prior to 2021 to deduct R&D costs as they were incurred, to capitalizing and amortizing over a period of five years (15 years for any foreign activity) any R&D expenses incurred in tax years beginning after December 31, 2021. It is also important to note this rule change applies even if you are NOT taking the R&D credit.
>> Planning Consideration: If your company conducts a significant amount of R&D, there is a lot of planning around this change. First you will need to ensure all your company’s R&D expenditures are completely accounted for and separately stated in your year-end financials. If you have not been tracking these expenses previously but know your company has R&D activity, consult your tax adviser to discuss how to best capture the expenses. The biggest downside to this provision is that taxable income will increase as the expenses are stretched out over a five-year, or 15-year for foreign activity, period.
However, if you who have not taken advantage of the R&D credit because you felt it was not worth the administrative burden, now may be a good time to explore doing so. The tax benefit of the credit could help offset the downsides.
2. Change in Interest Expense Limitation Calculation Could Mean More Limitations
There are unfavorable changes to the calculation of the interest expense limitation (IRC Section 163j) on the horizon. For tax years beginning before January 1, 2022, depreciation and amortization were added back to taxable income when calculating available Adjusted Tax Income (ATI). These addbacks were favorable to taxpayers, as they increased ATI and allowed a potentially higher interest expense deduction. However, for tax years beginning after December 31, 2021, taxpayers can no longer add back depreciation and amortization when determining their interest expense limitation.
>> Planning Consideration: Highly leveraged businesses and those with significant depreciation/amortization deductions may be subject to more limitations than in the past due to this modification. However, there are some exemptions to explore if you are a small business, having average annual gross receipts of no more than $25 million; or in certain industries, such as real estate or farming.
If you don’t fall into one of these categories and your ATI falls to a point where some of your interest expense is nondeductible in a given year, the expense will carryforward to a year where the taxpayer has “excess” taxable income to free it up. It will be important to consider this as a potential timing difference when looking at tax projections. Looking forward, as this limitation starts to affect more taxpayers, it will be important to factor this into decisions regarding whether to pursue debt or equity financing.
