Year-End Tax Planning
Topics in this Update
Status of New Rules for Deduction of Research & Development Expenses
Charitable Contribution Strategies
Roth IRA Conversion
Federal Tax Deduction for State Taxes paid by Pass-Through Entities
Qualified Opportunity Funds
Other Year-End Tax Planning
Status of New Rules for Deduction of Research & Development Expenses:
With the lame-duck session of Congress closing fast and the need to fund the government, Congress is unlikely to make significant tax legislation a top priority before year-end.
The most likely change could be a delay in new rules for research and development expenses. These new rules, effective for 2022, require that R&D expenses be written off over five years instead of deducted immediately. However, many business leaders and legislators are pushing to delay or eliminate this new provision. The delay in the new R&D rule being promoted by Republicans would be in exchange for higher child tax credits pushed by Democrats.
Businesses with significant R&D expenses will need to keep an eye on the legislative status of the R&D provisions and prepare for potentially having to identify R&D expenses that would be required to be capitalized and amortized over five years, resulting in higher taxes.
Charitable Contribution Strategies:
Charitable contribution strategies to reduce taxes include:
Donating appreciated assets that have been held for more than one year such as stock, land, or art allows you to deduct the value of the property, up to 30% of your adjusted gross income (AGI), without paying tax on the appreciation. Check with us about appraisal requirements for contributions of appreciated property other than publicly traded securities.
Donations can be “bunched” to increase your deductions. If your itemized deductions (Form 1040 Schedule A) are less than your standard deduction, you may be able to itemize every other year by doubling up on (bunching) tax deductible donations every other year. In the year you do not bunch donations you can claim the standard deduction. The standard deduction for 2022 is $12,950 for single filers ($14,700 if over age 65) and $25,900 for married filing jointly filers (plus $1,400 for each spouse over age 65).
Donations made by credit card before year-end result in a deduction this year even though the credit card bill may not be paid until next year.
Qualified Charitable Distributions (QCD) of up to $100,000 a year can be made from a Traditional IRA if you are over age 70½. A QCD can be used to satisfy all or part of your required minimum distribution requirement and will allow for a charitable contribution deduction even if you do not itemize. A QCD reduces adjusted gross income (AGI) which may result in larger tax deductions (e.g. medical costs), lower other taxes (e.g. net investment income tax), and reduce Medicare premiums.
Donor Advised Funds (DAF) allow you to prepay multiple years of donations for those charitable organizations that rely on your yearly donations. If you are unfamiliar with DAFs, then you may want to look at the North Carolina Community Foundation. See https://www.nccommunityfoundation.org for more details.
NOTE: Be sure to obtain and retain proper tax receipts for your charitable contributions. Donations of $250 or more are not deductible without a proper tax receipt.
Roth IRA Conversions:
Roth IRA Conversions from Traditional IRAs continue to be popular due to the current decline in the stock market, anticipated substantial increase in government spending, and potential for higher tax rates in the future. The conversion of Traditional IRA funds to a Roth IRA is a taxable event.
Current tax rates, combined with the qualified business income tax deduction, are possibly the lowest we will see for some time. The primary consideration in deciding whether to convert funds from a Traditional IRA to a Roth IRA is whether you anticipate your current income tax rate to be lower than your future income tax rate. It is difficult to estimate your future tax rate with certainty due to ever-changing tax laws and unforeseeable changes in your own personal tax situation. So, it may not be advisable to go "all in", but instead convert a portion of Traditional IRA funds to a Roth IRA.
Lastly, a great time to consider a conversion to a Roth IRA is if you retire before starting required minimum distributions and as a result your taxable income is lower.
NOTE: In either case above it may not be worthwhile to convert Traditional IRA funds to a Roth IRA if you do not have funds outside of the IRA to pay taxes on the conversion.
Federal Tax Deduction for State Taxes paid by Pass-Through Entities:
S Corporations, qualified partnerships, and qualified LLCs should consider paying state pass-through entity (PTE) taxes in December to every participating state in which there are business operations or rented property. The North Carolina PTE tax is 4.99% of NC taxable income (excluding Section 179 and charitable contribution deductions) and is paid using form NC-429 PTE.
This new PTE tax can be deducted on an eligible company’s federal income tax return, resulting in federal income tax savings for the owners. For example, if a company makes a taxable profit of $1 million and pays $50,000 to NCDOR by December 31, the federal tax savings to the owners could be as much as $20,000. If the owners of the company personally pay the NC income tax, there will likely be no federal tax benefit because the owners will either (1) claim the standard deduction instead of itemized deductions or (2) are subject to the $10,000 cap on itemized deductions for state and local taxes.
Qualified Opportunity Funds:
An Investment in a Qualified Opportunity Fund (QOF) can defer and permanently reduce taxes on a gain from the sale of investments, real estate, and certain business assets. An amount equal to the taxable gain must be invested in a QOF within a certain period after the gain is realized. The taxable gain can then be deferred until 2026, at which point the gain will be taxed.
NOTE: Deferring the taxable gain through a QOF may not be a good strategy if the overall capital gains tax rates increase.
Other Year-End Tax Planning:
Other year-end planning strategies include:
Review your realized capital gains and losses to consider whether to sell additional securities by year-end to minimize your taxable gains, by maximizing the tax benefit of losses (tax loss harvesting).
NOTE: Be careful not to buy the same or a very similar security within 30 days before or after the sale of a security at a loss, as “wash sales” losses cannot be deducted.
Cash method businesses should consider paying their bills by year-end and prepaying certain expenses for up to one year in advance to capture deductions this year, so long as you do not anticipate your tax rate to increase in 2023.
Businesses that can place equipment purchases in service by year-end are able to take maximum advantage of 100 percent bonus depreciation (bonus depreciation drops to 80% of cost in 2023) plus Section 179 depreciation of up to $1,080,000 for equipment and certain real property.
NOTE: The Section 179 depreciation deduction begins to phase out if purchases of eligible property are over $2,700,000.
Verify your tax basis and hours of participation if you own an interest in a pass-through entity such as an S corporation, LLC, or partnership that may report a loss this year. Be sure you have sufficient tax basis to allow for a deduction of the loss and review your participation in the activity to document that you satisfy the passive activity rules. Also, if you expect "qualified business income" from a pass-through entity, confirm if it is subject to limitations based on W-2 wages or taxable income, and plan accordingly.
Maximize pre-tax retirement plan contributions for 401(k), SIMPLE, SEP or Traditional IRA. Contributions by employers can be made after year-end but generally must be paid by April 15, 2023. Employee 401(k) and SIMPLE deferrals must be made by year-end to reduce this year’s taxes.
Accrual basis, calendar year employers should declare any bonuses by December 31st and should pay the bonuses by March 15th next year to deduct the bonuses on their 2022 tax return.
Employers can reimburse employees tax-free for business expenses that employees paid personally.
Take your required minimum distribution (RMD) from your retirement plan(s) if you will be over 72 years of age by year end. NOTE RMDs do not apply to Roth IRAs. You can elect to have taxes withheld from your RMD in lieu of making quarterly estimated tax payments.
Avoid underpayment penalties by reviewing estimated taxes paid-to-date and year-to-date tax withholdings on your W-2 wages or retirement plan distributions, and adjust if necessary to avoid or reduce penalties for underpayment of taxes.
Make gifts to children and grandchildren of up to $16,000 each ($32,000 for married couples who elect to “split gifts”) if you think your assets could be subject to the estate tax, or if you want to shift income to your children. Direct payments of tuition and medical expenses to qualified institutions on behalf of donees are not counted against the annual $16,000 gift tax exclusion limit.
Lastly, if you have children, keep in mind that the child tax credit is $2,000 per eligible child this year and the dependent care credit reverts to pre-2021 amounts.
As always, please contact us with any questions or to schedule a meeting to discuss your taxes.
This update represents a general checklist and should not be relied upon without consulting your tax advisor. Any tax information contained in this update is not intended to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or state tax law provisions.