On the tax front, 2023 (as of now) has not seen any major legislation. This means fewer tax changes in 2023 than in years past. As always, there is a potential for that to change before the end of the year.
As another year ends with interest rates and markets in flux, one thing remains certain: Reducing your company’s tax bill can improve your cash flow and your bottom line. Below are strategies that you can execute before the turn of the new year to minimize your company’s tax liability.
Take action on asset purchases
Timing your asset purchases so you can place the items “in service” before year-end has long been a viable method of reducing your taxes. However, now there’s a ticking clock to consider. That’s because the TCJA reduces 100% first-year bonus depreciation by 20% each tax year, until it vanishes in 2027 (absent congressional action). The deduction has already dropped to 80% for 2023.
First-year bonus depreciation is available for computer systems, software, vehicles, machinery, equipment, office furniture and qualified improvement property (generally, certain improvements to nonresidential property, including roofs, HVAC, fire protection and alarm systems, and security systems).
Usually, though, it’s advisable to first apply the IRC Section 179 expensing election to asset purchases. Sec. 179 allows you to deduct 100% of the purchase price of new and used eligible assets. Eligible assets include machinery, office and computer equipment, software, certain business vehicles, and qualified improvement property.
The maximum Sec. 179 “deduction” for 2023 is $1.16 million. It begins phasing out on a dollar-for-dollar basis when a business’s qualifying property purchases exceed $2.89 million. The maximum deduction is limited to the amount of your income from business activity, but you can carry forward unused amounts indefinitely or claim the excess amounts as bonus depreciation, which is subject to no limits or phaseouts. (Note: If financing asset purchases, consider the impact of high interest rates in addition to the potential tax savings.)
Maximize the qualified business income (QBI) deduction
One caveat regarding depreciation deductions is that they can reduce the QBI deduction for pass-through entity (PTE) owners. (Note that the QBI deduction is scheduled to expire after 2025 absent congressional action.) If the QBI deduction is allowed to expire, PTE income could be subject to rates as high as 39.6% if current rates also expire.
For now, though, PTE owners can deduct up to 20% of their QBI, subject to certain limitations based on W-2 wages paid, the unadjusted basis of qualified property and taxable income. Accelerated depreciation reduces your QBI (in addition to certain other tax breaks that depend on taxable income) and thus your deduction.
On the other hand, you can increase the deduction by increasing W-2 wages or purchasing qualified property. In addition, you can bypass income limits on the QBI deduction by timing your income and deductions (see below).
Time income and expenses
With the election looming next November, it’s unlikely that 2024 will see significant changes to the tax laws. As a result, the perennial tactic of timing income and expenses is worth pursuing if you use cash-basis accounting.
For example, if you don’t expect to land in a higher tax bracket next year, you can push income into 2024 and accelerate expenses into 2023. As discussed above, though, you could end up with a smaller QBI deduction.
Use cash vs accrual
More small businesses are able to use the cash (as opposed to accrual) method of accounting than were allowed to do so in earlier years. To qualify as a small business a taxpayer must, among other things, satisfy a gross receipts test, which is satisfied for 2023 if, during a three-year testing period, average annual gross receipts don’t exceed $29 million. Cash method taxpayers may find it a lot easier to shift income, for example by holding off billings till next year or by accelerating expenses, for example, paying bills early or by making certain prepayments. For 2024, the amount rises to $30 million.
Take advantage of the de minimis safe harbor election
Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book tax conformity election) to expense the costs of lower-cost assets and materials and supplies, assuming the costs aren’t required to be capitalized under the UNICAP rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS, e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $2,500. Where the UNICAP rules aren’t an issue, consider purchasing qualifying items before the end of the year.
Time year-end bonuses
Year-end bonuses can be timed for maximum tax effect by both cash- and accrual-basis employers. Cash basis employers deduct bonuses in the year paid, so they can time the payment for maximum tax effect. Accrual-basis employers deduct bonuses in the accrual year, when all events related to them are established with reasonable certainty. However, the bonus must be paid within two-and-a-half months after the end of the employer’s tax year for the deduction to be allowed in the earlier accrual year. Accrual employers looking to defer deductions to a higher-taxed future year should consider changing their bonus plans before year end to set the payment date later than the 2.5-month window or change the bonus plan terms to make the bonus amount not determinable at year end.
Purchase clean commercial vehicles
Beginning January 1, 2023, taxpayers may qualify for a credit if they buy a new, qualified plug-in electric vehicle or fuel cell electric vehicle. Businesses and tax-exempt organizations that buy a qualified commercial clean vehicle may qualify for a clean vehicle tax credit of up to $40,000. The credit equals the lesser of:
- 15% of the vehicle purchase price for plug-in hybrid electric vehicles
- 30% of the vehicle purchase price for EVs and FCEVs
- The incremental cost of the vehicle compared to an equivalent internal combustion engine vehicle
Maximum tax credits may not exceed $7,500 for vehicles under 14,000 lbs. and $40,000 for vehicles above 14,000 lbs.
Consider disposing of a passive activity
Sometimes the disposition of a passive activity can be timed to make best use of its freed-up suspended losses. Where reduction of current-year income is desired, consider disposing of a passive activity before year-end to take the suspended losses against current income.
A tangled web
Beyond the strategies noted above the usual year-end planning strategies also still apply, such as managing gains and losses from taxable investments. There is no one size fits all for tax planning and any strategy may have unintended consequences if not evaluated holistically considering the changing landscape. Seemingly small tax decisions may have costly unintended consequences under different tax provisions. Contact your DunlapSLK team member for assistance. We can help your business make the right year-end tax planning moves and tailor a plan that will work best for you.