Despite the recently concluded political elections, taxpayers continue to have uncertainty regarding potential future tax changes. The impact of these elections, the potential sunset of many individual provisions of the Tax Cuts and Jobs Act of 2017 (TCJA) and a more aggressive tax enforcement environment is causing many taxpayers to be anxious as year-end nears. With this evolving tax landscape, it is important not to lose perspective on current planning goals and focus on both near-term and long-term planning.
As 2024 comes to a close, below is our list of the top seven tax planning areas to discuss with your adviser before the year is out.
Bonus Depreciation & Section 179 Expense
Bonus Depreciation
Bonus depreciation has provided an additional incentive to invest in and expand operations. The tax benefits of accelerated depreciation can reduce the cost of capital. Prior to 2023, most businesses were able to immediately expense capital expenditures through 100% bonus depreciation.
In 2023, the first year of bonus sunsetting brought that 100% of depreciation down to 80%, and 20 percentage points less each year after until its scheduled expiration in 2027. As tax law currently stands, bonus depreciation for 2024 will be limited to 60%.
Section 179 Expenses
Additionally, Section 179 expense is still available if you have significant capital expenditures. While there are additional rules and limitations surrounding Section 179, know that for 2024 it is limited to $1.22 million; for companies with Section 179 additions in excess of $3.05 million, the limit decreases dollar for dollar and is no longer available once qualifying expenditures reach $4.27 million. Any portion of capital expenditures not covered by bonus depreciation or Section 179 can be depreciated over the asset’s normal recovery period.
Accounting Method Changes
Inventory Methods
Inventory represents the biggest cost of many businesses and, therefore, represents the largest potential tax deduction. The choice of inventory methods will directly affect the cost of goods sold calculation, which will impact your business’ taxable income. You can account for inventory using a variety of methods, and in certain situations may value your inventories using the lower-of-cost-or market (LCM) method of accounting. These LCM rules differ from those established for generally accepted accounting (GAAP) principles. You can also potentially write down inventory that is deemed to be wholly worthless or completely obsolete. Evaluating your inventory and considering alternative inventory methods could be beneficial by accelerating the associated cost of goods sold tax deduction.
Prepaid Expenses
Another effective accounting method change that can provide benefit is the deducting of certain prepaid expenses. Prepaid expenses are typically recorded as assets on the balance sheet, and their value is expensed over time as the benefit is received. If certain conditions are met, the tax law allows certain prepaid expenses that span 12 months or less to be deducted when paid, even if your business is otherwise on the accrual basis.
Accounting Method Due Dates
It is also important to consider due dates for accounting methods changes. You can change certain methods using the automatic change procedures, while others must still be filed under the non-automatic change procedures. Automatic method changes typically require you to file Form 3115 with the company’s tax return. However, non-automatic changes require you to file Form 3115 by December 31 for a calendar year taxpayer. Generally, you are required to provide more information for a non-automatic change, meaning if you wish to change methods, you should consider gathering this information as soon as possible.
There are over 250 potential accounting methods changes that can involve either accelerating or deferring income or deductions, so work with your tax adviser to help determine if any are beneficial to your company.
Deduction and Credit Opportunities
Research and Development (R&D)
The R&D tax credit is available to companies developing new or improved business components, including products, processes, computer software, techniques or formulas that result in new or improved functionality, performance, reliability or quality. There are several different methods for calculating this credit, and your facts and circumstances will determine the most appropriate method.
Historically, many taxpayers were able to deduct certain R&D expenditures. However, the TCJA amended the rules for R&D costs incurred for tax years beginning after December 31, 2021. For tax years beginning on or after January 1, 2022, R&D costs must be amortized over five years if you perform the activities in the U.S., or over 15 years if you perform them outside the U.S. There may be opportunities to mitigate the impact of these provisions by examining the related expenditures to ensure they are subject to these provisions.
Qualified Business Income Deduction
The Section 199A qualified business income deduction (QBID) provides for a deduction equal to 20% of your qualified business income, subject to certain limitations. Eligible taxpayers include those operating as sole proprietorships, LLC members and S Corporation shareholders, and trusts and estates. This deduction is subject to a number of adjustments and limitations; as such, maximizing this deduction requires careful planning. In addition, this deduction is currently set to expire for taxable years beginning after December 31, 2025, making it even more important to plan early.
163(j) Planning
The current interest rate environment has increased the cost of carrying or acquiring new debt for many businesses. Section 163(j) can further increase the cost of financing by limiting the deduction for net business interest expense in excess of interest income. The limitation is based on 30% of adjusted taxable income (ATI) as computed under Section 163(j).
While this limitation has been in effect since the passing of the TCJA, it is becoming more impactful due to our high-rate environment and the changes to the limitation that began in 2022. Prior to 2022, taxpayers were allowed to add back tax depreciation and amortization, effectively increasing ATI to an amount similar to the financial statement EBITDA measurement. For taxable years beginning after December 31, 2021, the rules for computing ATI changed, and taxpayers can no longer add back depreciation and amortization in computing ATI. This change has made certain planning opportunities that focus on increasing deprecation or other deductions less beneficial.
There are several exemptions to explore, including one for small taxpayers if their average annual gross receipts for the prior three years is not more than $25 million, adjusted for inflation ($30 million in 2024). There is also a real property trade or business exemption available that could benefit certain real estate businesses. This exemption will affect future depreciation but may ultimately reduce the tax burden imposed by the Section 163(j) limitation. Entities that do not meet either of these exemptions still have opportunities to plan around this potential limitation.
International Tax Considerations
IC-DISC
If your business involves the manufacturing or distribution of U.S. goods for export, or foreign architectural, engineering or managerial services, you may be entitled to tax savings by implementing an IC-DISC structure.
A taxpayer who has established an IC-DISC annually calculates, pays and deducts a commission based on qualifying exports and the related net income to the IC-DISC. The receipt of the commission is tax-free due to the IC-DISC being a tax-exempt entity. When the commission amount is distributed to the owners via a dividend payment, it qualifies for the preferential capital gain tax rates.
Foreign-Derived Intangible Income Deduction (FDII)
The foreign-derived intangible income (FDII) deduction provides an incentive to domestic corporations in the form of a lower effective tax rate on income derived from providing tangible and intangible products and services to foreign markets. As a result, a corporation can claim a 37.5% deduction, which results in a 13.125% effective tax rate, for years beginning before January 1, 2026. After that, the deduction is reduced to 21.75%, resulting in an effective tax rate of approximately 16.4%.
State and Local Tax Planning
Pass-Through Entity Tax (PTET)
Another TCJA regulation currently set to sunset after 2025 is the itemized deduction limitation on state and local taxes. From 2018 to 2025, state and local taxes were limited to $10,000 on personal returns. In response, 36 states have enacted pass-through entity tax elections. These elections allow the pass-through entity to pay the PTET and receive a federal deduction, in effect giving the individual receiving the flow-through income a 100% federal deduction of state PTET paid on their behalf. The individuals then receive a state PTET credit for taxes they paid on their personal state returns.
It is important to revisit your state pass-through elections annually, as states continue to modify their legislation around entity and owner eligibility, reductions to the tax credits and election due dates.
If your entity has significant income or is recognizing a large gain on the sale of the business or assets, consider using PTET elections as a tool to reduce your overall tax burden. PTET planning often must occur before year-end, as cash basis taxpayers will need to pay tax by December 31 to receive the federal deduction. As the itemized deduction cap is set to sunset after 2025, many of the state PTET elections may also sunset.
Pass-Through Withholding and Composite Filings
Many states require pass-through entities to remit tax on behalf of their partners or shareholders. States often use either the flow-through withholding or composite filing to make these payments:
- Under flow-through withholding, the entity remits the tax and passes through the payment on a state K-1, with the individual partner potentially still needing to file a state tax return. /li>
- Under a composite filing, the entity remits the tax on behalf of the individual, and the individual often no longer has a state filing requirement.
- Note the federal treatment for both payment types is classified as an owner distribution and not an entity deduction.
Composite tax rates are often at the state’s highest personal marginal tax rate, which tend to be higher than the flow-through withholding rates or individual nonresident rate if filed personally. Be particularly cautious when considering composite filings in states such as California and New York, which have very high composite tax rates.
It may still be beneficial to elect state composite filings, when an entity has numerous qualifying nonresident owners. The higher tax rates may not outweigh the significant compliance fees when you consider that each nonresident owner would be required to file personally in all states the pass-through entity does business if a composite return were not elected.
Work with your tax adviser to evaluate whether PTET, nonresident withholding or composite filing will be the most cost-effective pass-through filing.
Business Risk Considerations
Doing business throughout the U.S. has become increasingly more complex. With businesses expanding their service offerings and digital footprint, as well as shifting to more remote work, businesses must annually reevaluate their multistate tax responsibilities.
The Wayfair decision, intended to apply to sales tax, has led to states more aggressively pursuing taxpayers for all tax types and passing legislation to further expand their list of nexus creating activities. Further, many businesses are unprepared for the added tax and administrative responsibilities of expanding through remote employees. Adding employees in states a company has not historically done business not only leads to payroll tax considerations, but also to income, sales and property tax as well as legal considerations.
State tax nexus studies have become an increasingly important tool in tax planning and risk mitigation. Nexus studies can help you understand your filing requirements and assist with identifying and mitigating tax exposure in prior periods. Specifically, sales tax has become the leading area of concern for buyers in a transaction. Even if you believe your purchases or customers are exempt users, buyers want to see those exemption certificates and understand the efforts you’ve made to become compliant.
Revisit your sales, use, property and payroll tax, and/or your unclaimed property procedures and reporting responsibilities before a state tax auditor inquires or a potential buyer is at the door.
Overall, when it comes to year-end tax planning, don’t overlook the impact of state tax ramifications as an integral piece of your federal planning; these two can sometimes work in tandem to increase your overall opportunities.
Other Considerations
Corporate AMT
The Inflation Reduction Act of 2022 created the corporate alternative minimum tax (CAMT), which imposes a 15% minimum tax on the adjusted financial statement income (AFSI) of large corporations for taxable years beginning after Dec. 31, 2022. CAMT generally applies to large corporations with average annual financial statement income exceeding $1 billion.
While the CAMT applies to only certain taxpayers, as the AFSI threshold is quite high, there are potential reporting requirements for partnerships with corporate partners. Those partnerships must furnish information needed for corporate partners to calculate their CAMT, if requested. Proposed regulations issued in September 2024 provide additional guidance and provisions to be aware of.
Basis Shifting Transactions
The IRS has recently provided guidance regarding basis shifting transactions involving partnerships and related parties that intend to take advantage of certain partnership provisions applying to distributions of partnership property and transfers of partnership interests. Through the new tax Form 7217, the IRS is requiring additional information regarding these transactions.
Basis-shifting transactions generally fall into several categories, including:
- High-basis property distributed to a low-basis partner,
- Transfers of partnership interests, and
- Low-basis property distributed in liquidation to a high-basis partner.
Recent guidance has been issued in this area. The IRS has published Notice 2024-54 to announce upcoming regulations to address these types of transactions. In addition, Rev. Rul. 2924-14 clarifies when the economic substance doctrine may apply to disallow tax benefits associated with certain basis shifting transactions. This guidance, along with the Form 7217 reporting requirements, makes it clear the IRS intends to closely scrutinize these transactions. The new guidance and reporting requirements may create a significant administrative burden for taxpayers, including those who are not engaging in them for tax avoidance purposes.
Corporate Transparency Act
Effective January 1, 2024, many companies in the U.S. will be required to report information about their beneficial owners — the individuals who ultimately own or control the company. This initiative, known as Beneficial Ownership Information Reporting (BOI), requires all entities not otherwise excluded from doing so to file a report with FinCEN. If your company was created or registered prior to January 1, 2024, you will have until January 1, 2025, to file your BOI report. If your company is created or registered on or after January 1, 2024, you must report BOI withing 90 days of notice of creation or registration. For companies created or registered on or after January 1, 2025, the BOI report must be filed within 30 days of notice of creation or registration.
There are a number of exemptions to filing this report; however, the penalties for not filing can add up quickly. While not a tax-specific issue, this is a far-reaching business issue to consult on with your advisory teams as to how BOI reporting will affect you.
While we all navigate uncertain times and likely many twists and turns ahead, addressing these seven broad areas with your tax advisers — as soon as possible, but definitely before year-end — is a great place to start the conversation.
Contact Jeff McMichael, Ashley Altizer or a member of your service team to discuss this topic further.
