2023 Year-End Tax Planning Strategies for Businesses
There are several key tax considerations and tactical approaches for businesses to address while closing out 2023 and moving into 2024. From leveraging tax incentives to optimizing deductions, this guide offers insights into tax planning to help businesses make informed decisions and set a solid foundation for the upcoming year.
Section 174 Research and Experimentation Cost Capitalization
The tax landscape for specified research and experimentation (SRE) activities is evolving with Section 174 changes effective from January 1, 2022. Section 174 mandates the capitalization and amortization of domestic SRE costs over five years and foreign SRE costs over 15 years. SRE expenditures are those incurred in connection with a taxpayer’s trade or business and software development costs. Notice 2023-63, released in September 2023, offers guidance to taxpayers on how the Internal Revenue Service (IRS) intends to apply Section 174 when it issues proposed regulations. The notice is applicable for tax years ending after September 8, 2023. Taxpayers can rely on this notice for tax years starting as early as January 1, 2022, but must consistently apply all the provisions in the notice. Taxpayers can expect some changes to the guidance of Notice 2023-63 as the IRS reviews comments and input from taxpayers and tax practitioners before issuing proposed regulations.
Cost Recovery for Fixed Assets
Bonus depreciation begins to phase down in 2023 and continues with another phase down in 2024:
|Property Placed in Service
With these changes to bonus depreciation, there are several actions a company can take to maximize its deductions for the costs of tangible property:
- Review the company’s de minimis expensing policy/procedure and search out purchases that were capitalized but may be expensed under this policy.
- Review fixed asset schedules to identify assets with incorrect lives or incorrect placed in service dates that may be limiting depreciation deductions.
- Conduct a cost segregation study to identify assets with shorter lives.
- Review capitalized costs to determine if any may be deducted as repair costs, or if a partial disposition deduction is available.
Pass-Through Entity Tax (PTET) Election Planning
State PTET legislation typically offers one of two approaches to how individuals report the impact of state income taxes paid by their pass-through entity:
- Many states allow pass-through entities to distribute an income tax credit to pass-through entity owners from a share of the tax incurred and paid by the pass-through entity.
- Other states allow the pass-through entity owners to reduce their state taxable income by the amount of income previously reported and taxed by the pass-through entity.
To optimize the benefits of this strategy that works around the state and local tax deduction cap, it is advisable to project the PTET liability for 2023 and make state tax payments before year-end. Additionally, it is important to consider the impact of any PTET overpayments or refunds from 2022 and project 2024 PTET estimated tax payments, if any.
There have been changes to state PTET laws and guidance in 2023, and businesses may have seen changes to operations that can expose the company or owners to PTET in new states. Year-end planning can bring attention these changes as well as highlight potential conflicts of interest among pass-through entity owners, consider the need to amend partnership agreements, and monitor S shareholder distributions to stay in compliance with tax law. Careful consideration of PTET election rules and annual compliance rules is essential to a successful PTET strategy.
Inflation Reduction Act of 2022 (IRA) and Clean Energy Tax Credits
The IRA of 2022, unlocks financial incentives in the form of tax credits, tax deductions and grants to reward businesses who make investments around clean energy generation and energy efficiency improvements. A few of these opportunities are highlighted below:
- Section 45W Credit for Qualified Commercial Vehicles encourages the purchase of qualified commercial clean vehicles, offering up to $7,500 for those with a gross vehicle weight (GVW) under 14,000 pounds and up to $30,000 for larger vehicles.
- Section 30C Credit for Alternative Fuel Vehicle Refueling Property supports the installation of alternative fuel vehicle refueling properties with a base credit of 6% of costs – which can be raised to 30% if certain prevailing wage and apprenticeship program requirements are met.
- Investment tax credits are available under several Section 48 Energy Credit designations. Production tax credits are available under several Section 45 designations. These energy tax credits start with a base amount for costs incurred or energy produced but may be boosted five times when certain prevailing wage and apprenticeship program requirements are met.
Many of the IRA energy tax credits and incentives are designed to be transferable to other taxpayers looking to buy federal tax credits or may be refunded in cash to governments or tax-exempt organizations that do not pay income tax.
The IRA incentives can provide financial advantages for businesses investing in clean energy solutions.
Pass-Through Entity (PTE) Loss Limitations
Individuals who are PTE owners face four hurdles to deducting flow-through business losses on their Form 1040 tax return:
- Stock and debt basis limitation
- At-risk limitation
- Passive activity loss limitation
- Excess business loss limitations
To overcome these challenges, PTE owners should consider their position relative to each of these limitations and design a strategy for them. For example, PTE owners may make loans or capital contributions before year-end to enhance their basis or monitor their active participation in the PTE’s business to avoid passive activity designation. Additionally, strategic financial planning within the PTE, such as deferring deductions or accelerating income, may help PTE owners mange the impact of the loss limitations hurdles.
Compensation and Benefit Plan Strategies
Employers seeking to recruit and retain employees can leverage nontaxable compensation strategies for the benefit of their employees.
One benefit option is to install a plan to reimburse employees that make payments on qualified student loan debt during the year. The amount that may be paid to an employee under such a plan is capped at $5,250 annually. There must be a written plan that does not discriminate in favor of highly compensated employees and does not involve salary reduction from the employee. This benefit is similar to and tied with a tuition reimbursement plan.
Another benefit employers may want to offer employees is the tax-free reimbursement of qualified dependent care expenses. Employers may reimburse up to $5,000 annually to an employee. This benefit can be offered on a salary reduction basis. A plan like this must be in writing and not discriminate in favor or highly compensated employees.
Employers who have not yet implemented a qualified retirement savings plan for employees have new incentives. SECURE 2.0 increased the tax credits available to small employers who are setting up, administering and contributing to qualified retirement plans for employees. Employers with new plans may qualify for up to $5,000 in tax credits to offset 100% of costs for plan set up and administration and receive up to $1,000 per employee to offset 100% of employer contributions to the retirement savings plan. A qualified retirement savings plan can be established and funded after the tax year ends.
Employers can further optimize their tax-saving strategies by combining different plans, such as a 401(k), profit-sharing, and defined benefit plans, for larger deductions and enhanced financial benefits.
Buy/Sell Transactions in 2023
Companies that engaged in an acquisition or disposition transaction in 2023 should promptly assess the tax implications to avoid potential tax surprises. Preliminary tax reporting and issue identification can be initiated before the financial statement audit is completed. A head start in addressing any tax-related concerns arising from the transaction can highlight options for tax planning actions the company may take before year end and ensure a smoother process for tax provision and tax return preparation for 2023.
International Affiliates and Transfer Pricing
Companies with international operations seeking to optimize their operating structure to efficiently manage U.S. and foreign taxes should review their strategies annually. This involves updating the entity organization chart and transfer pricing documents to ensure compliance with the current strategy and indicate where changes may be needed.
Companies can use year-end planning to confirm the proper implementation of transfer pricing within company operations and records. This can save time and effort over waiting until sometime after year end to record transfer pricing activity. Finally, once a year the company should review and verify the filing of foreign reporting forms (such as 5471, 5472, FinCEN 114, etc.) for the current year and all prior years. These measures collectively contribute to maintaining a streamlined and compliant international business structure.
Search the Balance Sheet for Deductions
Companies can review their bad debt reserves, inventory reserves, and identify subnormal goods, then take actions to generate current year deductions for these bad debts or inventory goods that are unsaleable. Other reserves or accruals on the balance sheet may require an actual payment to generate a tax deduction. The company can consider accelerating these payments into 2023 to accelerate a tax deduction.
It is important to consider any accruals or transactions with related parties to avoid loss disallowances for deductions. Consider if there are investments or assets that should be sold, disposed or abandoned before year end to claim a tax deduction in 2023. These strategic approaches to reviewing assets and liabilities on the balance sheet can optimize tax deductions for the company.
Traditional Tax Planning and Looking Forward
As the year concludes, businesses should assess whether they anticipate higher profits and taxes in 2024 compared to 2023. The company should confirm the amount of estimated taxes already paid in 2023 and plan cashflow needs for fourth quarter 2023 estimates, extension payments and first quarter 2024 estimates. This is an optimal time a great time to review the 2022 tax preparation process and schedule the timing and people needed for efficient preparation and filing of the company’s 2023 tax returns.
Looking forward, companies should begin to plan for the sunset of many tax provisions in the Tax Cuts and Jobs Act (TCJA). After 2025, individual owners of PTEs may see marginal tax rates increase, the Section 199A 20% deduction expire, and a significant reduction of the lifetime estate tax exemption. It is not too early to begin planning to pivot when the tax law changes.
Your Guide Forward
Your Cherry Bekaert tax advisor is here for your questions about year-end planning and preparing for 2024. We look forward to the opportunity to work with you and your company.