Dear Tax Constituent:
The tax landscape for 2022 seems to be somewhat settled after the flurry of COVID-19 response legislation in 2020 and 2021. As of press time, major tax changes from recent years generally remain in place, including lower income tax rates, larger standard deductions, limited itemized deductions, elimination of personal exemptions, a reduced alternative minimum tax (AMT) for individuals, a major corporate tax rate reduction, limits on interest deductions, and generous expensing and depreciation rules for businesses. Non-corporate taxpayers with certain income from pass-through entities may still be entitled to a valuable Qualified Business Income deduction. These rules are scheduled to be in place through 2025 absent earlier changes from Congress.
The composition of the recently elected next Congress, however, may make changes to the tax law politically possible in 2023 and beyond. This could mean potentially higher tax rates to come, and makes tax planning more challenging today.
There was one major tax bill passed late in 2021: the Infrastructure and Investment Jobs Act (IIJA). And there has been one major tax bill passed in 2022: the Inflation Reduction Act of 2022. Key tax provisions of the IIJA include the retroactive termination of the employee retention credit back to October 1, 2021, and information reporting for digital assets like cryptocurrency. The Inflation Reduction Act of 2022 made notable changes to some energy credits that are mostly effective starting in 2023.
Over the summer, President Biden announced a three-part plan to address student loan debt, including forgiveness of up to $20,000 for some borrowers and extended the repayment freeze a final time, until the end of this year. Note that through 2025, the cancellation of student loans is not taxable cancellation of indebtedness income. The constitutionality of Biden’s student loan debt forgiveness is still in question.
Whatever actions Congress takes on tax matters, the time-tested approach of deferring income and accelerating deductions to minimize taxes will still work for most taxpayers, as will the bunching of expenses into this year or next to avoid limitations and maximize deductions. For the highest income taxpayers the opposite strategy may produce the best results: pulling income into 2022 to be taxed at currently lower rates, and deferring deductible expenses until 2023, when they can be taken to offset what could be higher-taxed income. We have divided our commentary between business and individual considerations below:
Business
The Qualified Business Income (QBI) deduction remains in place for 2022. We discussed this deduction earlier at our linked commentary for pass-through businesses and real estate activities. For 2022, the QBI deduction starts to phase out for Specified Service Trade or Businesses (SSTBs), or becomes limited for other pass-through business owners, when taxable income is greater than $340,100 for married taxpayers, and greater than $170,050 for other taxpayers. Taxpayers near these thresholds may benefit from accelerating deductions, deferring discretionary income, or making deductible retirement plan contributions to stay below these thresholds. For non-SSTBs with income exceeding the thresholds, consider increasing W-2 compensation from the business before the end of the year to get the maximum QBI deduction.
The Social Security wage base (the maximum earned income that Social Security tax of a combined 12.4% is assessed upon) will be $160,200 for 2023. The Social Security wage base was $147,000 for 2022.
Businesses can also claim a 100% bonus first year depreciation deduction for machinery and equipment bought used (with some exceptions) or new if purchased and placed in service this year, and for qualified improvement property with a tax life of 20 years or less. The 100% write-off is permitted without any proration for the length of time that an asset is in service during the tax year. As a result, the 100% bonus first-year write-off is available even if qualifying assets are in service for only a few days in 2022. The 100% bonus depreciation stays in effect until January 1, 2023. At that point, the first-year bonus depreciation deduction decreases as follows:
80% for property placed in service during 2023
60% for property placed in service during 2024
40% for property placed in service during 2025
20% for property placed in service during 2026
Even with reduced bonus depreciation, Section 179 could still allow for 100% expensing of qualifying property.
As of June 30, 2022, the California Calsavers program requirements are in full effect. Nonexempt employers with five or more California W-2 employees, at least one of whom is age 18, must register with Calsavers or verify their exemption. As yearend approaches, consider establishing a qualified retirement plan such as a 401(k) to give the business more control over the amount and nature of retirement plan contributions allowed for all employees, including owners.
For California Pass-through Entity owners, the Pass-through Entity Elective Tax (PEET) credit offers a way to get a tax benefit for paying related individual state income tax through the pass-through entity. To get a 2022 deduction, it is generally considered necessary to make a payment before December 31, 2022. See our earlier linked discussion for additional limitations and considerations.
Individual
Specifically for 2022, given the general decline of the stock market, it may make sense to harvest capital losses if other 2022 income would be higher than usual. Alternatively, if 2022 looks to be a lower than usual income year, then a Roth conversion of regular taxable retirement assets may make sense. A Roth conversion is most beneficial when stock values have significantly declined, and when the current tax rate is expected to be lower than the tax rate that would apply when future regular taxable retirement plan distributions are taken.
If Required Minimum Distributions (RMDs) are not needed to meet current financial obligations, and you are charitably minded, consider paying some of the RMD (up to $100,000) directly to charity. This generally produces the best tax benefit by not increasing your Adjusted Gross Income (AGI) by the RMD, and avoiding the threshold for itemizing deductions. A charitable contribution of appreciated property held longer than one year is generally better than a cash donation as well. A taxpayer can get a deduction for the higher fair value of the appreciated property while avoiding the recognition of capital gain from selling the property.
If you are facing a penalty for underpayment of estimated tax and increasing your wage withholding won't sufficiently address the problem, consider taking an eligible rollover distribution from a qualified retirement plan before the end of 2022. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2022. You can then timely roll over the gross amount of the distribution (i.e., the net amount you received plus the amount of withheld tax) to a traditional IRA. No part of the distribution will be includible in income for 2022, but the withheld tax will be applied pro rata over the full 2022 tax year to reduce previous underpayments of estimated tax. Be careful of the strict timing limits on this strategy.
If you become eligible in December of 2022 to make Health Savings Account (HSA) contributions, you can make a full year's worth of deductible HSA contributions for 2022 before April 15, 2023.
What is new for individuals for 2022:
Expanded health insurance subsidies are extended through 2025.
Both the child tax credit and the child and dependent care credit revert to pre-pandemic levels.
The CTC reverts to $2,000 and the old phase-out applies.
The age of a qualifying child decreases to under age 17
The child and dependent care credit reverts to its lower pre-pandemic amount.
The exclusion from income for employer-provided dependent care assistance also decreases to pre-pandemic levels.
The temporary charitable deduction for nonitemizers expired on December 31, 2021.
Possible changes for individuals in 2023:
The SECURE Act 2.0 (if passed by Congress) could require automatic enrollment in or expanded access to certain retirement plans; a potential increase to 75 for the age at which required minimum distributions must start; enhancements to the age 50+ catch-up contribution provisions; modified rules to allow SIMPLE IRAs to accept Roth contributions; and creating an online “lost and found” for retirement accounts.
Provisions affecting individuals that are scheduled to expire at the end of 2022 include the temporary allowance of a 100% deduction for business meals, the mortgage insurance premium deduction, and COVID-19 credits for sick and family leave for the self-employed.
Proposed legislation could change the transfer by gift or bequest of appreciated assets with unrealized gains to a “realization event” for tax purposes, and tax the transfer as if the underlying property was sold. In addition, such property transferred by gift or held at death would be subject to a $5 million lifetime exclusion for a single filer. Unrealized capital gains in appreciated assets would also be taxed if they were transferred into or distributed in kind from an irrevocable trust, partnership or other noncorporate entity if the transfer was effectively a gift to the recipient.
There are also proposed changes to the rules for donor advised funds (DAFs), grantor retained annuity trusts (GRATS), the way promissory notes are valued when selling appreciated property to a grantor trust and limits to the generation-skipping transfer (GST) exemption that would limit the GST exemption to direct skips no more than two generations from the grantor.
If you would like our assistance with your specific yearend tax planning, or more information on these or other tax topics of interest to you, please contact our office.
—McAvoy + Co, CPA