The end of the year provides an opportunity for the owners and financial officers of closely-held businesses to consider upcoming tax preparation, including possible deductions and changes in compliance regulations. Here are some timely topics:
1. Pass-Through Deductions
Owners of pass-through entities, such as S corporations and partnerships, are familiar with the qualified business income (QBI) deduction, also known as the Section 199A deduction. This allows them to deduct up to 20 percent of pass-through business income from their personal returns.
In addition to this high-profile deduction, pass-through owners should make sure they review other possible benefits, such as deductions for self-employed health insurance premiums and retirement plan contributions. If applicable, they should also consider making any state pass-through entity tax (PTET) payments before the year-end to qualify for a 2023 federal tax deduction.
2. Depreciation Strategies
This year, the Tax Cuts and Jobs Act’s 100 percent bonus depreciation begins to phase out. For 2023, businesses can write off only 80 percent of the cost of eligible purchases using bonus depreciation. Next year, bonus depreciation drops to 60 percent, so businesses might consider accelerating upcoming purchases to maximize tax savings.
Section 179 deductions are not reduced for 2024, but they are subject to other limitations. In many cases, businesses can choose either bonus depreciation or Section 179, but deciding which method to use may require complex analysis.
3. Business Interest Expense
For 2023, businesses with average annual gross receipts more than $29 million over the past three years are subject to a business interest expense limitation. Generally, this is an amount equal to 30 percent of the business’s adjusted taxable income.
In addition to recalculating average annual gross receipts to determine if a business is exempt from the limitation, be careful how the deduction is calculated. Since last year, depreciation and amortization are no longer added back in to calculate adjusted taxable income, which could reduce the allowable deduction.
4. Entertainment and Meals Expenses
The temporary 100 percent deduction for business meals expired in 2022, so this year the allowable deduction drops back to 50 percent. There are exceptions, however. Food for employee holiday parties or team-building events are still eligible for 100 percent deduction, so break out meal expenses into appropriate categories. Business-related entertainment expenses remain non-deductible.
5. State and Local Tax Compliance
Watch out for new state income and sales tax filing requirements. Several states made significant changes to both their state income tax and sales tax rules in recent years. These changes could mean that a business is now subject to a new state taxing authority. The scenario is more complicated if the business expanded its operations into a new taxing jurisdiction during the past year. Some states’ income tax codes mirror the federal code, while others differ considerably.
6. Payroll Tax Compliance
The end of the year is a good time to make sure employment records are up to date. Verify the current addresses and other information for Forms 1099 and W-2, including accurate information about any remote work locations. It’s also wise to ask employees if they plan any moves in 2024 in order to anticipate any new state and local tax requirements that might arise. Now is also the time to review independent contractors’ status to be sure they should not be classified as employees.
7. R&D Capitalization
In light of recent changes to tax rules governing research and development costs, companies with even modest R&D budgets should make sure they are accurately tracking such costs, including software development costs, and are categorizing them correctly. In addition to analyzing items to be capitalized under Section 174 of the Internal Revenue Code, a thorough evaluation will also identify costs that are eligible for the R&D tax credit under IRC Section 41.
8. Net Operating Loss Deduction
Since the 2021 tax year, the deduction for businesses that post a net operating loss (NOL) in a prior year has been limited to 80 percent of the business’s current year taxable income. For owners of pass-through entities, the 80 percent NOL limitation applies to the taxable income of the individual partners or S corporation shareholders, so it can be beneficial to manage the timing of personal income to coincide with the timing of business losses. Remember that any unused NOL carried forward to future years will also be limited to 80 percent of the subsequent year’s taxable income.
9. Year-End Analysis
The year’s end is an opportune time to consider any changes in accounting and tax reporting methods, such as a switch from cash to accrual basis (or vice versa) and the deduction of prepaid expenses. It’s also a good time to consider retirement plan options, such as a 401(k) plan, defined benefit pension plan, or a SIMPLE IRA, which can be a good option for businesses with modest income.
10. Tax Preparation Documents
To get a head start on upcoming tax returns, reconcile all accounts on the 2023 financials as soon as possible and have them ready for the company’s tax preparer. End-of-year tax preparation packages should also include copies of any invoices for assets purchased or disposed of during the tax year, along with a list of any questions regarding the 2023 financials.
The tax professionals at Dembo Jones can help you explore these opportunities as well as others that may be relevant to your business. Give us a call to begin the process.